MBA CASE STUDY LECTURE: FINANCIAL ASPECTS IN CASE STUDY
•INTRODUCTION •OVERVIEW ANALYSIS •FINANCIAL ANALYSIS: RATIOS •RATIO ANALYSIS •USES OF FINANCIAL RATIOS •FIVE GROUPS OF RATIOS
INTRODUCTION
• The assessment of financial position of a firm constitutes an important aspect of the internal analysis and is very important to analyses to determine the strengths and weaknesses. • The overall performance of the firm will ultimately be measured in financial terms. • A financial analysis will also reveal some of the constraints in terms of formulating particular strategic objectives and plans. • It is usual for a case study in strategic management to provide financial information relating to the firm under consideration and which students are expected to analyse.
OVERVIEW ANALYSIS
To place a detailed financial analysis it is necessary to consider: • Trends in key figures over a number of years. Most important and interesting trends are: Sales, profit, Net assets and dividends. • Overall trend should be noted and the percentage annual increase or decrease in each should be calculated. • When interpreting trends overtime when inflation has occurred, care should be taken. In order to assess the true underlying performance of a company the reported figure should be converted to real figures to eliminate the effect of inflation. One way of adjusting for inflation is to deflate the reported figure by an inflation index which reflects changes in the prices of goods for the industry to which the firm belongs.
FINANCIAL ANALYSIS: RATIOS
• Most of the information on which the financial analysis is based is provided in the organisation's profit & loss accounts and balance sheet. These statements give absolute financial values, which will answer the following questions: – Has a profit or loss been made? – Has it geared cash? To understand more about the company from these statement we need to answer the following questions: – Is the company being run efficiently in comparison with other firms in the same industry or previous year? – Is the company able to continue trading and is it paying creditors? – Would you recommend investing money in the business?
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RATIO ANALYSIS
Ratio analysis is an extensively used method of assessing the financial position of a firm. Techniques can be used in two ways:
1. TIME SERIES ANALYSIS: To analyse trends over a number of years and to examine the way in which performance may have changed over time. CROSS-SECTIONAL ANALYSIS: For comparison with the industry average or with competitors at a single point in time. This comparison allow a judgement to be made about the firm's position within the industry.
2.
USES OF FINANCIAL RATIOS
• • • • • • • EXISTING SHAREHOLDERS MEMBERS OF SOCIETY MANAGERS OF A COMPANY EMPLOYEES POTENTIAL SHAREHOLDERS LENDERS/INVESTORS GOVERNMENT AGENCIES
FIVE GROUPS OF RATIOS
1. 2. 3. 4. 5. LIQUIDITY RATIOS GEARING RATIOS ACTIVITY RAIOS PROFITABILITY RATIOS STOCK MARKET RATIOS
LIQUIDITY RATIOS
The balance sheet will show the immediate liabilities are at a certain point in time. The test here is to see if the value of the current assets of the business will cover the current liabilities. Liquidity ratio is a determination of the firm's ability to pay off short term obligations as they come due. Main ratios are:
1. The Current ratio = current assets/current liabilities Current ratio indicates the extent to which a firm can meet its short term liabilities firm its current assets without having to raise finance by borrowing, issuing more shares or selling fixed assets. 2. The Acid Test ratio: Current assets-Stocks/C Liabilities Measures the firms ability to meet its short term liabilities from its current assets without having to rely on the sale of its stock.
GEARING RATIOS
Gearing Ratio measures the financial contribution of the owners of the business through shareholders funds compared to he financing provided from outside the firm borrowed funds. Main ratios are: 1. Debt Ratio: Total borrowings/capital employed*100% - measures the proportion of capital employed which is financed by borrowed funds. 2. Debt to equity ratio: Total borrowings/Shareholders fund*100% measures the amount of borrowing as a percentage of shareholders fund. 3. Interest cover: profit before interest and tax/Interest payable – measures how many times interest payments are covered by operating profits.
ACTIVITY RATIO
AR indicates how efficiently management is using the resources of the firm. Main ratios are: 1. Net Asset Turnover: sales/Net Asset – Measures how efficiently the net assets are used to generate sales. 2. Fixed Asset Turnover: Sales/F.Assets 3. Stock Turnover: Sales/Stocks- measures the number of times that stocks of finished goods were sold during the year.
PROFITABILITY RATIOS
PR measures how efficiently the total firm is being managed. Main ratios are: 1. ROCE = Operating profit/capital employed*100% measures the performance of the firm regardless of the method of financing. 2. Return on equity= profit after tax/Shareholders fund*100% -measures the profitability of the shareholder's investment in the firm. 3. Operating profit margin = Operating profit/Sales*100% -Shows how much £1 of sales earn as operating profit.
STOCK MARKET RATIOS
1. EPS =Profit after Tax/Number of ordinary shares in
issues –measures the earning generated for each ordinary share.
2. Net Dividend Yield = Dividend per share/Market
price per share*100% -indicates the net dividends rate of return to ordinary shareholders.