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Financial Analysis and Decision Making powerpoint
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Transcript of 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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RETURN ON CAPITAL EMPLOYED
ROCE = Operating profit x 100
Capital employed
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RETURN ON CAPITAL EMPLOYED
What is capital employed?
Equity shareholders funds?
Equity shareholders funds + non-current
liabilities?
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RETURN ON CAPITAL EMPLOYED
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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