financial analysis and decision making powerpoint

8/13/2019 Financial Analysis and Decision Making powerpoint

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Financial Analysis and

Decision Making

Introduction to Ratio Analysis


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Steps in Financial Analysis

1. Determine what it is you are trying to

measure.

2. Select appropriate figures

3. Consider and appropriate benchmark


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Financial

Statements

Investors

Lenders

Suppliers

CustomersCompetitors

Employees

Government

EXTERNAL USERS OF

FINANCIAL INFORMATION


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NEEDS OF USERS

If you were a shareholder, what are the keythings you would look for in the financialstatements? Profitwhich profit?

Dividends

Returnwhat is meant by this?

If you were a holder of debentures, what

would you look for?Ability to pay interestAbility to repay debentures

Liquidity

Security


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What is the objective of golf ?
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I play golf , how can I judge my

performance?

Can only judge performance if wecompare score with something

Compare my score with

Previous rounds COMPARISON OVER TIME (T)

My playing partner COMPARISON WITH

COMPETITORS/INDUSTRY(I)

Par score for course COMPARISON WITH EXPECTATION(E)

Can only judge performance if wecompare results with a BENCHMARK.


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Benchmarks

Time

To establish trends

Industry Averages To compare performance against competitors

Expectations

To see if targets have been met


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Which student will obtain higher

marks in their coursework ?


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INTERPRETATION OF ACCOUNTS

Interpretation of accounts is a detailed

explanation of the f inanc ial perform ance

of any entity incorporating the information

contained within a set of financialaccounts (Dyson, 2004)


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BASIC PROCEDURES

Data collection

Historical data of 35 year period

Economic, financial, political and social national and

international environment Data analysis

Horizontal analysis

Trend analysis

Vertical analysis

Ratio analysis


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COMPARISON TO PREVIOUS

YEARS

All published accounts show

comparatives

Putting current year in context(trend analysis)

Where are the major increases and

decreases from previous years to thecurrent year?

What areas should you be

investigating further?


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COMPARISON TO PREVIOUS

YEARS

How do you compare figures to previous years

in a useful way?

Example (figures in m)

Yr 2 Yr 1

Profit 250 235

Profit increased by 15m Yr 1 to Yr 2useful?

Much more meaning fu l to g ive % increase

Profit increased by 6%


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HORIZONTAL ANALYSIS

A line-by-line comparison of the company

accounts for each accounting period

chosen for investigation

For example:

2010 2009 2008

Revenue 133M 114M 95M+16.7% +20.0%


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TREND ANALYSIS

Similar to horizontal analysis

The first set of accounts in the series (i.e. theearliest period) is given a base of 100,

subsequent accounts are then related to thatbase

For example:

2007 2006 2005

Revenue 133M 114M 95MTrend analysis 140 120 100


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VERTICAL ANALYSIS All the P&L items and B/S items are to be expressed

as a percentage of their respective totals

For example:

2007 2006

Inventory 112k (32%) 60k (30%)Trade receivables 168k (48%) 88k (44%)

Other receivables 35k (10%) 26k (13%)

Prepayments 14k (4%) 16k (8%)

Cash at Bank 21k (6%) 10k (5%)Current assets 350k (100%) 200k (100%)


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RATIO ANALYSIS

Profitability ratios Evaluate the profitability of the company

Efficiency ratios Examine the ways in which various resources of the

company are utilised and managed Solvency and liquidity ratios

Indicate whether the company is able to meet its financialobligations and raise enough cash when needed

Investment ratios Help investors to assess the returns on their investment


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PROFITABILITY

Most users interested in profitability

Ability of a business to provide returns

to investors and lenders dependant onprofits

Ability of a business to generate cash

ultimately dependant on profits

Ability of a business to generate profits

depends also on the management of

resources


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RATIO ANALYSIS

Profitability ratios

Return on capital employed (ROCE)

Gross profit margin

Net profit margin

Asset Turnover Rate


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Return on Capital Employed

(ROCE)ON CAPITAL EMPLOYED

ROCE = Profit before interest and tax (PBIT) x 100

Capital employed

ROCE is a fundamental measure of business

performance

It compares the profit before interest and tax (PBIT)

with the overall capital used to generate that profitThere are many other ways of calculating ROCE


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RETURN ON CAPITAL EMPLOYED

What is PBIT?

Gross profit?

Operating profit/ Profit before interest and tax ?

Profit before taxation?

Profit for the year?


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ROCE = Operating profit x 100

Capital employed


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What is capital employed?

Equity shareholders funds?

Equity shareholders funds + non-current

liabilities?


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ROCE

= Operating profit x 100

Equity shareholders funds + Non-current liabilities(interest-bearing borrowings)


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Net profit margin= Operating profit x 100

Revenue

Net profit margin shows the proportion of sales that

resulted in a profit after all overheads (other than

interest) have been deducted

Net profit can be improved by reducing overheads

but a balance has to be achieved between costreduction and business efficiency

NET PROFIT MARGIN


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ASSET TURNOVER

Asset turnover examines how effectively the assets

of the company are being used to generate salesIn general, a higher ratio is preferred to a lower one

However, a very high ratio may suggest that the

company is overtrading on its assets

Asset turnover= Revenue

Total assets less current liabilities

= RevenueCapital Employed


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ROCE = Profit from operations

Capital employed

Asset turnover

= SalesNet assets

Net profit margin

= Profit from operationsSales

X

RELATIONSHIP OF

PROFITABILITY RATIOS


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Gross profit margin = Gross profit x 100Revenue

Gross Profit Margin

ROSS PROFITGross profit margin shows the proportion of

revenue that resulted in a gross profit to thecompany

It is affected by various factors:

Changing price levels

Sales mix

Marketing strategy

Stock valuation


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Gross profit

Sales

Expenses

Sales

GP%

ROCE = Profit from operations

Capital employed

Asset turnover

= SalesNet assets

Net profit margin

= Profit from operationsSales

RELATIONSHIP OF

PROFITABILITY RATIOS

X

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