Module 2 - Financial Management

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.

SYAZLIANA HJ. KASIM FACULTY OF ACCOUNTANCY UiTM SHAH ALAM 2

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.

SYAZLIANA HJ. KASIM FACULTY OF ACCOUNTANCY UiTM SHAH ALAM 3

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.

SYAZLIANA HJ. KASIM FACULTY OF ACCOUNTANCY UiTM

SHAH ALAM4

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.


SHAH ALAM5

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.


SHAH ALAM6

LIQUIDITY RATIOS

=Current Asset

Current Liabilities


SHAH ALAM7

=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.


SHAH ALAM8

EFFICIENCY RATIOS

=Cost of goods sold

Average inventory @ Closing inventory


SHAH ALAM9

=Trade receivables

X 365 daysAnnual credit sales

INVENTORY TURNOVER

AVERAGE COLLECTION PERIOD

EFFICIENCY RATIOS

=Sales revenue

Net fixed assets


SHAH ALAM10

=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.


SHAH ALAM11

LEVERAGE RATIOS

=Total debt

Total assets


SHAH ALAM12

=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.


SHAH ALAM13


=Gross Profit

X 100 %Sales Revenue


SHAH ALAM14

=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



Total assets


SHAH ALAM15


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.


SHAH ALAM16

MARKET RATIOS

=Net income available to common

shareholders

Number of ordinary shares issued


SHAH ALAM17

=Ordinary shares dividends

Number of ordinary shares issued

EARNINGS PER SHARE

DIVIDEND PER SHARE

MARKET RATIOS

=Dividend per share

Earnings per share


SHAH ALAM18

=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

SHAH ALAM19

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.


SHAH ALAM20

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.


SHAH ALAM21

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.


SHAH ALAM22

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.


SHAH ALAM23

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.


SHAH ALAM24

CAPITAL BUDGETING TECHNIQUES

Capital budgeting techniques can be divided into two types: Non-discounted cash flow method Discounted cash flow method


SHAH ALAM25

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.


SHAH ALAM26

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


SHAH ALAM27


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.


SHAH ALAM28


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.


SHAH ALAM29


SHAH ALAM30

THANK YOU

Documents

Module 2 - Financial Management