THE ROLE OF FINANCIAL

MANAGEMENT
PROF DR DAW TIN HLA
YOU SHOULD BE ABLE TO:
WHY DO WE CARE ABOUT FINANCIAL
MANAGEMENT?
- NEIL ARMSTRONG
- NEIL ARMSTRONG
- NEIL ARMSTRONG
- NEIL ARMSTRONG
- NEIL ARMSTRONG
- NEIL ARMSTRONG
THANK YOU
MBA

Financial Management
Financial Ratio Analysis
LEARNING OUTCOME

Be able to interpret financial statements for planning and

decision making
ASSESSMENT CRITERIA
• analyze financial statements to assess the financial viability of
an organization
• apply financial ratios to improve the quality of financial
information in an organization’s financial statements
• make recommendations on the strategic portfolio of an
organization based on its financial information
RATIO ANALYSIS
Ratio
Analysis

Gearing
Profitability Liquidity Efficiency Investment
Ratios focus
Ratios focus Ratios Ratios focus Ratios focus
on
on focus on on on
capital
firm working operational shareholder
structure
performances capital efficiency s’ returns
and
financial
risk
RATIO ANALYSIS

• Purpose:

- To identify aspects of a business’s performance to

aid decision making

- Quantitative process – may need to be supplemented

by qualitative factors to get a complete picture
RATIO ANALYSIS

1. Liquidity – the ability of the firm to pay its way

2. Investment/shareholders – information to enable decisions to be made on the extent
of the risk and the earning potential of a business investment
3. Gearing – information on the relationship between the exposure of the business to
loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits given sales and or its capital
assets
5. Financial – the rate at which the company sells its stock and the efficiency with which it
uses its assets
LIQUIDITY
ACID TEST (OR) QUICK RATIO

• Also referred to as the ‘Quick ratio’

• (Current assets – stock) : liabilities
• 1:1 seen as ideal
• The omission of stock gives an indication of the cash the firm has in relation
to its liabilities (what it owes)
• A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as
it owes – very healthy!
• A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has
cash to pay for those liabilities. This might put the firm under pressure but is
CURRENT RATIO
• Looks at the ratio between Current Assets and Current Liabilities
• Current Ratio = Current Assets : Current Liabilities
• Ideal level? – 1.5 : 1
• A ratio of 5 : 1 would imply the firm has £5 of assets to cover every £1 in
liabilities
• A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to
cover every £1 it owes
• Too high – Might suggest that too much of its assets are tied up in
unproductive activities – too much stock, for example?
• Too low - risk of not being able to pay your way
INVESTMENT/SHAREHOLDERS RATIOS
INVESTMENT/SHAREHOLDERS RATIOS

• Earnings per share – profit after tax / number of shares

• Price earnings ratio – market price / earnings per share

- The higher the better generally.
- Comparison with other firms helps to identify value placed on the
market of the business.

• Dividend yield – ordinary share dividend / market price x 100

- Higher the better.
- Relates the return on the investment to the share price.
GEARING
GEARING

• Gearing Ratio = Long term loans / Capital employed x 100

- The higher the ratio the more the business is exposed to

interest rate fluctuations and to having to pay back interest and loans
before being able to re-invest earnings
Debt/Equity ratio describes financial structure in terms of the proportion
of debt to equity
Gearing Ratio= Long term loans /Equity = 750/42172= 1.78%
Interpretation, long term debt is less than 2% of equity.
In general, the higher the gearing ratio, the higher the risk that when the
company’s profits are low, it will be unable to cover the interest and
repayment of debt when it falls due.
PROFITABILITY
PROFITABILITY
• Profitability measures look at how much profit the firm
generates from sales or from its capital assets

• Different measures of profit – gross and net

• Gross profit – effectively total revenue (turnover) – variable

costs (cost of sales)
• Net Profit – effectively total revenue (turnover) – variable
costs and fixed costs (overheads)
PROFITABILITY

• Gross profit looks at how much of the sales revenue is

converted into profit

Gross Profit Margin = Gross profit / turnover x 100

- The higher the better
- Allows the firm to assess the impact of its sales and how much it
cost to generate (produce) those sales
- A gross profit margin of 35% means that for every £1 of sales,
the firm makes 35p in gross profit
PROFITABILITY

• Net profit looks at how much of the sales revenue is left as net
profit
Net Profit Margin = (Net Profit / Turnover) x 100
- Includes overheads / fixed costs
- Net profit is more important than gross profit for a business as all
costs are included
- A business would like to see that this ratio has improved over time
PROFITABILITY
• Another profitability ratio – looks at operating profit and
capital employed by the business

Return on Capital Employed (ROCE) = (PBIT / capital

employed) x 100

- Typically should be 20-30%

- Need to compare to previous years and competitors to get a clear picture
- Can improve this by increasing profits without increasing fixed assets /
capital
PROFITABILITY
• The higher the better

• Shows how effective the firm is in using its capital to generate profit

• A ROCE of 25% means that it uses every £1 of capital to generate

25p in profit

• Partly a measure of efficiency in organisation and use of capital

EFFICIENCY
ASSET TURNOVER RATIO
• Looks at a businesses sales compared to the assets used to generate the
sales
Asset turnover = sales or turnover / net assets
• Net assets = Total assets – current liabilities
• The value will vary with the type of business:

• Businesses with a high value of assets who have few sales will have a low
asset turnover ratio
• If a business has a high sales and a low value of assets it will have a high
asset turnover ratio
• Businesses can improve this by either increasing sales performance or
getting rid of any additional assets
STOCK TURNOVER RATIO
• Another efficiency ratio
• Looks at how efficiently a company converts stock to sales

Stock turnover ratio = cost of sales / stock

- High stock turnover means increased efficiency

- However it depends on the type of business
- Low stock turnover could mean poor customer satisfaction as people
might not be buying the stock
Stock turnover ratio Cont’
Depend on the type of business

– Supermarkets might have high stock turnover ratios whereas a shop

selling high value musical instruments might have low stock turnover
ratio
- Low stock turnover could mean poor customer satisfaction if people
are not buying the goods (Marks and Spencer?)
DEBTORS COLLECTION PERIOD
• This is another efficiency ratio
• This looks at how long it takes for the business to get back money
it is owed
Debtors collection ratio = debtors x 365 / turnover
- The lower the figure the better as get cash more quickly
- However sometimes need to offer credit terms to customers so
this may increase it
- Need to ensure keep track of any changes in credit terms as
these should impact this ratio
26
DETERMINANTS OF GROWTH
• Profit margin – operating efficiency
• Total asset turnover – asset use efficiency
• Financial leverage – choice of optimal debt ratio
• Dividend policy – choice of how much to pay to shareholders versus
reinvesting in the firm
LIMITATIONS WITH RATIO ANALYSIS

• To be most beneficial the results need to be compared with other

data including:

• The results for the same business over previous years

• The results of ratio analysis for their competitors
• The results of ratio analysis for other firms in other industries
OTHER FACTORS NEED TO CONSIDER

• The market the business is trading in

• The position of the firm in the market
• The quality of the workforce and management
• The economic environment
THANK YOU
FINANCIAL
STATEMENT
ANALYSIS
METODS
Four Types of
Financial Analysis for
a company
Financial Analysis

Financial and
1. Horizontal
Managerial Analysis
Analysis
1. Actual and Budget
2. Vertical Analysis
3. Ratio Analysis
Horizontal
Analysis
Actual and Budget variance
Presentation of financial results

Net Profits for each business segment

6

5
5
4,4 4,5
4,3
4
3,5
3
3 2,8
2,4 2,5
2 2
2 1,8

0
Category 1 Category 2 Category 3 Category 4
Series 1 Series 2 Series 3
Vertical Analysis
Ratio Analysis
Reading Financial Reports
Thank You

[email protected]
https://scholar.google.com/citations?hl=en&user=QKljV3
MAAAAJ
FINANCIAL
STATEMENT
ANALYSIS
METODS
Four Types of
Financial Analysis for
a company
Financial Analysis

Financial and
1. Horizontal
Managerial Analysis
Analysis
1. Actual and Budget
2. Vertical Analysis
3. Ratio Analysis
Horizontal
Analysis
Actual and Budget variance
Presentation of financial results

Net Profits for each business segment

6

5
5
4,4 4,5
4,3
4
3,5
3
3 2,8
2,4 2,5
2 2
2 1,8

0
Category 1 Category 2 Category 3 Category 4
Series 1 Series 2 Series 3
Vertical Analysis
Ratio Analysis
Reading Financial Reports
Thank You

[email protected]
https://scholar.google.com/citations?hl=en&user=QKljV3
MAAAAJ
MBA

Financial Management
Financial Ratio Analysis
LEARNING OUTCOME

Be able to interpret financial statements for planning and

decision making
ASSESSMENT CRITERIA
• analyze financial statements to assess the financial viability of
an organization
• apply financial ratios to improve the quality of financial
information in an organization’s financial statements
• make recommendations on the strategic portfolio of an
organization based on its financial information
RATIO ANALYSIS
Ratio
Analysis

Gearing
Profitability Liquidity Efficiency Investment
Ratios focus
Ratios focus Ratios Ratios focus Ratios focus
on
on focus on on on
capital
firm working operational shareholder
structure
performances capital efficiency s’ returns
and
financial
risk
RATIO ANALYSIS

• Purpose:

- To identify aspects of a business’s performance to

aid decision making

- Quantitative process – may need to be supplemented

by qualitative factors to get a complete picture
RATIO ANALYSIS

1. Liquidity – the ability of the firm to pay its way

2. Investment/shareholders – information to enable decisions to be made on the extent
of the risk and the earning potential of a business investment
3. Gearing – information on the relationship between the exposure of the business to
loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits given sales and or its capital
assets
5. Financial – the rate at which the company sells its stock and the efficiency with which it
uses its assets
LIQUIDITY
ACID TEST (OR) QUICK RATIO

• Also referred to as the ‘Quick ratio’

• (Current assets – stock) : liabilities
• 1:1 seen as ideal
• The omission of stock gives an indication of the cash the firm has in relation
to its liabilities (what it owes)
• A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as
it owes – very healthy!
• A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has
cash to pay for those liabilities. This might put the firm under pressure but is
CURRENT RATIO
• Looks at the ratio between Current Assets and Current Liabilities
• Current Ratio = Current Assets : Current Liabilities
• Ideal level? – 1.5 : 1
• A ratio of 5 : 1 would imply the firm has £5 of assets to cover every £1 in
liabilities
• A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to
cover every £1 it owes
• Too high – Might suggest that too much of its assets are tied up in
unproductive activities – too much stock, for example?
• Too low - risk of not being able to pay your way
INVESTMENT/SHAREHOLDERS RATIOS
INVESTMENT/SHAREHOLDERS RATIOS

• Earnings per share – profit after tax / number of shares

• Price earnings ratio – market price / earnings per share

- The higher the better generally.
- Comparison with other firms helps to identify value placed on the
market of the business.

• Dividend yield – ordinary share dividend / market price x 100

- Higher the better.
- Relates the return on the investment to the share price.
GEARING
GEARING

• Gearing Ratio = Long term loans / Capital employed x 100

- The higher the ratio the more the business is exposed to

interest rate fluctuations and to having to pay back interest and loans
before being able to re-invest earnings
Debt/Equity ratio describes financial structure in terms of the proportion
of debt to equity
Gearing Ratio= Long term loans /Equity = 750/42172= 1.78%
Interpretation, long term debt is less than 2% of equity.
In general, the higher the gearing ratio, the higher the risk that when the
company’s profits are low, it will be unable to cover the interest and
repayment of debt when it falls due.
PROFITABILITY
PROFITABILITY
• Profitability measures look at how much profit the firm
generates from sales or from its capital assets

• Different measures of profit – gross and net

• Gross profit – effectively total revenue (turnover) – variable

costs (cost of sales)
• Net Profit – effectively total revenue (turnover) – variable
costs and fixed costs (overheads)
PROFITABILITY

• Gross profit looks at how much of the sales revenue is

converted into profit

Gross Profit Margin = Gross profit / turnover x 100

- The higher the better
- Allows the firm to assess the impact of its sales and how much it
cost to generate (produce) those sales
- A gross profit margin of 35% means that for every £1 of sales,
the firm makes 35p in gross profit
PROFITABILITY

• Net profit looks at how much of the sales revenue is left as net
profit
Net Profit Margin = (Net Profit / Turnover) x 100
- Includes overheads / fixed costs
- Net profit is more important than gross profit for a business as all
costs are included
- A business would like to see that this ratio has improved over time
PROFITABILITY
• Another profitability ratio – looks at operating profit and
capital employed by the business

Return on Capital Employed (ROCE) = (PBIT / capital

employed) x 100

- Typically should be 20-30%

- Need to compare to previous years and competitors to get a clear picture
- Can improve this by increasing profits without increasing fixed assets /
capital
PROFITABILITY
• The higher the better

• Shows how effective the firm is in using its capital to generate profit

• A ROCE of 25% means that it uses every £1 of capital to generate

25p in profit

• Partly a measure of efficiency in organisation and use of capital

EFFICIENCY
ASSET TURNOVER RATIO
• Looks at a businesses sales compared to the assets used to generate the
sales
Asset turnover = sales or turnover / net assets
• Net assets = Total assets – current liabilities
• The value will vary with the type of business:

• Businesses with a high value of assets who have few sales will have a low
asset turnover ratio
• If a business has a high sales and a low value of assets it will have a high
asset turnover ratio
• Businesses can improve this by either increasing sales performance or
getting rid of any additional assets
STOCK TURNOVER RATIO
• Another efficiency ratio
• Looks at how efficiently a company converts stock to sales

Stock turnover ratio = cost of sales / stock

- High stock turnover means increased efficiency

- However it depends on the type of business
- Low stock turnover could mean poor customer satisfaction as people
might not be buying the stock
Stock turnover ratio Cont’
Depend on the type of business

– Supermarkets might have high stock turnover ratios whereas a shop

selling high value musical instruments might have low stock turnover
ratio
- Low stock turnover could mean poor customer satisfaction if people
are not buying the goods (Marks and Spencer?)
DEBTORS COLLECTION PERIOD
• This is another efficiency ratio
• This looks at how long it takes for the business to get back money
it is owed
Debtors collection ratio = debtors x 365 / turnover
- The lower the figure the better as get cash more quickly
- However sometimes need to offer credit terms to customers so
this may increase it
- Need to ensure keep track of any changes in credit terms as
these should impact this ratio
26
DETERMINANTS OF GROWTH
• Profit margin – operating efficiency
• Total asset turnover – asset use efficiency
• Financial leverage – choice of optimal debt ratio
• Dividend policy – choice of how much to pay to shareholders versus
reinvesting in the firm
LIMITATIONS WITH RATIO ANALYSIS

• To be most beneficial the results need to be compared with other

data including:

• The results for the same business over previous years

• The results of ratio analysis for their competitors
• The results of ratio analysis for other firms in other industries
OTHER FACTORS NEED TO CONSIDER

• The market the business is trading in

• The position of the firm in the market
• The quality of the workforce and management
• The economic environment
THANK YOU
Direct costs and indirect costs

Indirect costs are

overhead costs (period costs, indirect costs)

Direct costs (Direct materials, direct labour, and other direct costs)

Indirect costs or overhead costs (Indirect materials, indirect labour and other period costs)

Different types of Overhead costs

1. Manufacturing or production overhead costs

2. Administrative overhead costs
3. Selling and distribution overhead costs

Selling price = Total cost + Profit margin

Total cost = Direct costs + Indirect costs

Total costs = Variable costs + Fixed costs

Batch costing or job costing

Activity based costing (ABC Costing)

Process costing

Standard costing

Full costs

Marginal costs
7 TYPES OF BUDGETS: DETAIL EXPLANATION
Budgeting
Businesses prepare budgets for financial forecasts and performance evaluations.
The Budget serves many purposes to any business including; Planning, Control,
Performance measurement, motivation, and communication. Depending on the
purpose and nature of the budget, it can be classified into different categories.

Fixed budgets and Flexible budgets. By budgeting approach, a budget can be

categorized into four broad categories:

1. Incremental budgets
2. Zero-based budgets
3. Activity-based budgets
4. rolling budgets

Some of the budgeting methods for business are

 Incremental budgeting: This method uses the previous year's budget as
a base and adjusts it for inflation, growth, and other factors.
 Activity-based budgeting: This method identifies, analyzes, records
and forecasts the costs of different business activities.
 Value proposition budgeting: This method aligns the budget with the
value proposition of the business, i.e. the benefits it offers to its
customers.
 Zero-based budgeting: This method starts the budget from scratch each
year and requires justification for every expense.
 Envelope budgeting: This method allocates a fixed amount of money
for each category of spending and limits the spending to that amount.
1) FIXED Or STATIC BUDGETS:

In the traditional approach of budgeting, each activity of the business is

supposed to remain static. Fixed budgets are allocated for each activity of
business separately. As the name suggests fixed budgets are:

“Budgets that are supposed to remain the same regardless of the actual level of
change in the activity”

This approach uses historic data and adjusts for expected inflation or deflation
in the estimates. Once budgets are allocated, the management then makes sure
to achieve the forecasted results. These types of budgets are most difficult to
achieve as variances are bound to happen.

2) Flexible Or Variable Budgets:

Flexible budgets are assigned to the activities by dividing them into fixed and
variable costs. With this approach each activity can change the level of actual
results; hence the budgeting can also be changed and adjusted.

Flexible budgets also offer top management an overview of operating and

planning variances, by comparing the revised budgets with the original and then
with the actual results.

See also When Should A Company's Budget be Revised?

When a company has cash flows problem

A budget is a tool used to plan or forecast a future period of a business.

Businesses make or revise their budgets after a specified period, which is
usually every year.

While budgets are set annually for most businesses, it may be necessary to
revise them before the usual annual revisions.

Therefore, businesses must know when they should revise their budgets. A few
reasons for businesses to revise their budgets are as below.
When There Are Cash Flow Problems

If a business starts having cash flow problems after preparing a budget, then it
means the budget needs revision.

A business manages its cash flows according to the budgets made at the start of
the period.

If the business cannot regulate its performance according to the budgeted

expectations and starts having cash flow problems, then it means that the budget
is unrealistic.Therefore, in these conditions, the budget must be revised to
reflect more realistic expectations and to stop the cash flow problem from
spreading to other parts of the business.

When There Are Changes In Environmental Factors

Depending on the management style and hierarchy the budget types can be
categorized as budgeting approaches.

3) Incremental Budgets:

In this approach, management starts with the previous year’s data, adds
“increments” to previous budgets, and prepares the new budgets.
suitable
In
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for
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ADVANTAGES DISADVANTAGES

Does not challenge operational

A traditional and easy method of
managers to achieve results beyond
budgeting doesn’t require complex skill
targets

Suitable for stable and uniform production

Does not eliminate waste and idle
facilities with a less changing
activities
environment

Less useful for dynamic and rapidly

changing business natures
4) Zero-Based Budgeting:
This budgeting approach does not account for the previous activity level but
rather takes each activity as the new one. In other words, it calls for the
justification of each cost driver, and the level of activity is considered from
zero. Zero-based budgeting takes form in stages from planning to allocation:

 Each activity is defined individually at the management level

 Each activity is then assigned costs and revenue attached to it
 Activities are then evaluated and ranked for budget allocation priority
 Based on the priority each activity is assigned budgets

ADVANTAGES DISADVANTAGES

Each activity cost needs to be

Assigning cost drivers to each activity
justified, eliminating waste
requires special skills and time
and reducing costs

Challenges staff to achieve

operational efficiencies and Operational managers may not agree to
achieve higher performance the final performance appraisals
targets

More responsive to external

In stresses on short-term operational
business environment than
efficiencies
incremental budgets

Resource allocations are more

efficient
5) Activity-Based Budgets:

Closely adapted from the activity-based costing method, which takes into
account the variable overhead costs. It can be defined as “a budgeting method
based on activity level and using cost drivers to identify variances”.

See also Zero Based Vs. Incremental Budgeting: 7 Main Differences That
Should Know

Overhead costs form a large portion of the total unit cost of the product, cost
drivers are the activities associated with these overhead costs.
insights
Budgeting
and
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ADVANTAGES DISADVANTAGES
Consistent with the activity-based
costing method, emphasis on Often considered a time-consuming practice
overhead costs

Stresses on cost “driver” rather Difficult to identify each activity cost driver, as
than the activity itself often cost drivers overlap

Offers better control of costs, Long-term or fixed overheads do not change

hence improving favorable budget frequently, hence do not account for any
variances variances in the ABB method
6) Rolling Budgets:

Traditionally, budgets are prepared for one year or longer terms. A Fast-
changing business environment demands quick responses to market changes.
Often a seasonal demand or a new competitor’s entrant compels management to
change the production levels.

A Rolling budget is kept continuously updated with each budgeting period

ADVANTAGES DISADVANTAGES

Offers continuous upgrades

to the budgets hence It is often time-consuming and requires special
keeping performance in skills to update budgets so frequently
check

Provides more accurate and

Operational managers may not agree to the notion
updated operational
of an “on-demand” budgeting approach
efficiency insights

Resources are allocated on-

demand with varying needs
that eliminate the
uncertainty among lower
management
expiring. This can often be “rolled” or updated as monthly or quarterly.

7) Beyond Budgeting Approach:

The modern approach to budgeting is to continuously change and adapt to the

changes in the business environment with both internal and external factors.
This approach calls for more flexibility, responsiveness, and a collective
approach features often lacking in traditional budgeting.
This approach continuously updates budgets on a monthly or quarterly basis as
in the rolling budget approach.

Key performance indicators and critical success factors eventually are

monitored regularly, which provides robust performance and control measures
to the management.