FINANCIAL MANAGEMENT
PREPARED BY:SYAZLIANA HJ. KASIM
FACULTY OF ACCOUNTANCYUITM SHAH ALAM
FINANCIAL PERFORMANCE EVALUATION
Financial analysis is the assessment of a firm’s past, present and anticipated future financial performance.
It involves looking at the historical performance to estimate future performance.
It allows comparison of the company’s performance over time as well as its performance relative to its competitors in the industry.
Financial analysis helps an individual to check whether a business is doing better this year than it was last year, or whether it is doing better or worse than other companies in the same industry.
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OBJECTIVES OF FINANCIAL ANALYSIS
To identify the firm’s strengths and weaknesses. It is important to identify the strengths so that
the company can take advantage of those strengths to compete with the rest of the competitors.
The identification of own weaknesses is to enable the planning of corrective actions to be taken to improve the weaknesses and if possible to turn them into strengths. This would allow the company to stay competitive and relevant within the industry.
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FINANCIAL RATIOS
The principle tool of financial analysis is financial ratios which are designed to evaluate and compare financial performance.
Financial ratios look at the relationship between individual values and relate them to how a company has performed in the past, and might perform in the future.
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OBJECTIVES OF RATIO ANALYSIS
To standardize financial information for comparison purposes.
To evaluate current operations of the company.
To compare present performance with past performance.
To compare the performance of the company with other firms or industry standards.
To assess the efficiency of operations. To assess the risk of operations.
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LIQUIDITY RATIOS
Liquidity ratios are intended to show the firm’s ability to meet their short-term financial obligations, that is, whether the company has the resources to pay its creditors when they are due.
These ratios compare the firm’s total current assets with total current liabilities.
Higher ratios indicate increased liquidity. The higher the liquidity, the easier it is for the
company to pay its creditors on time, and vice-versa.
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LIQUIDITY RATIOS
=Current Asset
Current Liabilities
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=Current Asset – Inventories -
PrepaymentsCurrent Liabilities
CURRENT RATIO
ACID-TEST RATIO
EFFICIENCY RATIOS
Efficiency ratios are also known as asset management ratios and used to measure the effectiveness of the firm in managing its assets in generating sales.
These ratios will indicate whether the assets are too high, too low or reasonable for the firm’s current and projected operating levels.
They show the amount of sales generated for every dollar of asset investment.
Efficiency ratios also show us the firm’s efficiency in collecting debts as well as turning its stocks into sales.
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EFFICIENCY RATIOS
=Cost of goods sold
Average inventory @ Closing inventory
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=Trade receivables
X 365 daysAnnual credit sales
INVENTORY TURNOVER
AVERAGE COLLECTION PERIOD
EFFICIENCY RATIOS
=Sales revenue
Net fixed assets
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=Sales revenue
Total assets
TOTAL ASSETS TURNOVER
FIXED ASSETS TURNOVER
LEVERAGE RATIOS
Leverage ratios measure the level of debt or borrowings in a firm.
They tell us whether the company uses more debt financing to finance its assets and operations as compared to equity financing.
In addition, they highlight the ability of the firm to honour its medium and long-term debt commitments in terms of repayment of the principal as well as the interest charges.
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LEVERAGE RATIOS
=Total debt
Total assets
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=Profit Before Interest and Tax
Interest Expense
DEBT RATIO
TIMES INTEREST EARNED
PROFITABILITY RATIOS
Profitability ratios measure how effectively the firm uses its assets to make profits.
They show the profits earned for every dollar of sales made or the profits earned per dollar of investment in assets.
These ratios also indicate the firm’s efficiency in controlling costs and its pricing policy.
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PROFITABILITY RATIOS
=Gross Profit
X 100 %Sales Revenue
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=Profit before interest and
tax X 100 %Sales Revenue
=Net income available to common shareholders X 100 %
Sales Revenue
NET PROFIT MARGIN
OPERATING PROFIT MARGIN
GROSS PROFIT MARGIN
PROFITABILITY RATIOS
=Net income available to common shareholders X 100 %
Total assets
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=Net income available to common shareholders X 100 %
Shareholders’ Fund
RETURN ON EQUITY
RETURN ON ASSETS
MARKET RATIOS
These ratios are also called as the investors ratios. They relate a firm’s stock price to its earnings and
book value per share. They give the management an indication of what
investors think of the company’s past performance and future prospects.
They measure the investors’ perceptions and judgements towards the firm’s growth potential. These are the result of the company’s overall performance.
They take into account the firm’s liquidity, asset management, debt management and profitability ratios.
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MARKET RATIOS
=Net income available to common
shareholders
Number of ordinary shares issued
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=Ordinary shares dividends
Number of ordinary shares issued
EARNINGS PER SHARE
DIVIDEND PER SHARE
MARKET RATIOS
=Dividend per share
Earnings per share
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=Market price per share
Earnings per share
DIVIDEND PAYOUT RATIO
PRICE/EARNINGS RATIO
=Latest annual dividends
Current market share price
DIVIDEND YIELD
LIMITATIONS OF FINANCIAL RATIOS
Comparison with industry averages is difficult for conglomerates.
Average performance as shown in the industry average may not be desirable.
Seasonal factors can also distort ratios. Inflation distorts the firm’s financial statements. Different operating and accounting practices
make comparison difficult. Sometimes, it is difficult to decide whether a
ratio is good or bad. Difficult to conclude whether a firm’s overall
performance is good or bad.SYAZLIANA HJ. KASIM FACULTY OF ACCOUNTANCY UiTM
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CAPITAL BUDGETING
Capital budgeting techniques are used to evaluate any long term investments.
Examples of long term investments are the acquisitions of property, plant and equipments.
It is important that companies make the right decisions because these investments require a huge amount of cash outflow.
A right decision will increase the firm’s value as well as the shareholders’ wealth.
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CAPITAL BUDGETING PROCESS
Generating long-term investment proposals, which are consistent with a firm’s long-term objectives.
Estimating the relevant after-tax incremental cash flows for these project proposals.
Evaluating these cash flows. Selecting the project that will maximize
shareholder’s wealth. Re-evaluating these projects from time to
time for control purposes and carrying out post-audits for completed projects.
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TYPES OF PROJECTS INDEPENDENT PROJECTS
These are the projects with cash flows which are independent or unrelated to one another.
Hence, a decision to accept one project will not affect the decision to accept another.
MUTUALLY EXCLUSIVE PROJECTSThese are projects where a decision is made
to choose ONLY ONE project from the many projects being considered.
Therefore, a decision to accept one will automatically reject the other alternatives.
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TYPES OF CAPITAL BUDGETING DECISIONS
Capital budgeting projects are considered for either the following purposes:- For expansion
For example, a company wants to open up a new branch, introduce new product or venture into new market.
For replacement of existing assets For example, a company is considering of
purchasing a new machine to replace an old machine.
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GUIDELINES FOR CAPITAL BUDGETING
Use cash flows and not accounting profit. Focus on incremental cash flows. Consider the synergistic effect. Consider the loss of revenue from existing
product. Ignore sunk costs. Include opportunity costs. Incorporate working capital requirements. Do not include interest payments.
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CAPITAL BUDGETING TECHNIQUES
Capital budgeting techniques can be divided into two types: Non-discounted cash flow method Discounted cash flow method
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NON-DISCOUNTED CASH FLOW METHODS
Under these methods, the timing of the cash flows is insignificant for evaluation purposes.
Most popular methods under this category are: Payback period
Payback is the amount of time it is expected to take for the cash inflows from a capital investment project to equal the cash outflows.
Accounting rate of return ARR aims to compare the average after-tax profits
generated by the capital project with the average dollar size of investment required.
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DISCOUNTED CASH FLOW METHODS
Under this category, cash flows from potential investment projects will be discounted using appropriate discount factor in parallel with the time value of money concept.
The methods under this category include:Net present valueInternal Rate of ReturnModified Internal Rate of ReturnDiscounted Payback PeriodProfitability Index
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DISCOUNTED CASH FLOW METHODS
Net Present Value Method (NPV) The NPV is the sum of the present value (PV)
of all the cash inflows from a project minus the PV of all of the cash outflows.
Internal Rate of Return Method (IRR) This method involves calculating the exact
DCF rate of return that the project is expected to achieve.
This is the discount rate at which the NPV is zero.
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DISCOUNTED CASH FLOW METHODS
Modified Internal Rate of Return Method (MIRR) This is an improved technique to provide the
decision makers with a better percentage evaluation technique and an improved reinvestment rate assumption.
Discounted Payback Period This method is similar with the Payback
Period but it applies the time value of money concept.
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