2 EXECUTIVE SUMMARY We commissioned this report to inspect the importance of cases in finance A company that would be mainly focused on is ratios Issues, such as the reason it is significant for manag[.]
EXECUTIVE SUMMARY We commissioned this report to inspect the importance of cases in finance A company that would be mainly focused on is ratios Issues, such as the reason it is significant for managers to recognize the sustainability and the impact of sustainability, would be discussed The research brings attention to the fact that sustainability, which comprises economic, environmental and social aspect, has become more challenging for organizations today compared to the past Balancing the three aspects is crucial for organizations that want to be profitable, able to protect the environment and sorting out problems which are socially related simultaneously The manager plays the role of decision-makers, thus contributes to the organizations The transition towards a sustainable path TABLE OF CONTENTS Sr.No Topic Pages Introduction Part A Part B 15 References 22 INTRODUCTION The significant financial statements of a company are the balance sheet, income statement and cash flow statement (statement of sources and applications of funds) These statements present an overview of the financial position of a firm to both the stakeholders and the management we analyze the information provided by these statements We cannot understand the right financial situation of the firm The analysis of financial statements plays an essential role in determining the financial strengths and weaknesses of a company relative to that of other companies in the same industry The analysis also reveals whether the company's financial position has been improving or deteriorating FINANCIAL RATIO ANALYSIS Financial ratio analysis involves the calculation and comparison of ratios which are derived from the information given in the company's financial statements The historical trends of these ratios can make inferences about a company's financial condition, its operations and its investment attractiveness Financial ratio analysis groups the ratios into categories that tell us about the different facets of a company's financial state of affairs They describe some types of rates below: • Liquidity Ratios give a picture of a company's short term financial situation or solvency • Operational/Turnover Ratios show how efficient a company's operations and how well it is using its assets • Leverage/Capital Structure Ratios show the quantum of debt in a company's capital structure • Profitability Ratios use margin analysis and show the return on sales and capital used • Valuation Ratios show the performance of a company in the capital market Part A Q1) Explain various problems associated with financial statement analysis While financial statement analysis is an excellent tool, there are several issues to be aware of that can interfere with the interpretation of the analysis results These issues are: • Comparability between periods The company preparing the financial statements may have changed the accounts in which it stores financial information, so that results may differ from period to period For example, an expense may appear in the cost of goods sold in one period, and in administrative costs in another period • Comparability between companies An analyst frequently compares the financial ratios of different companies to see how they match up against each other However, each compa ny may aggregate financial information differently, so that the results of their ratios are not comparable Can lead an analyst to draw incorrect conclusions about the effects of a company in comparison to its competitors • Operational information The financial analysis only reviews a company's financial information, not its operational data, so you cannot see a variety of key indicators of future performance, such as the size of the order backlog, or changes in warranty claims Thus, the financial analysis only presents part of the total picture Q2) Discuss various types of capital budgeting techniques Also, identify the most appropriate technique and justify with logical reasoning • Capital budgeting is used by companies to evaluate significant projects and investments, such as new plants or equipment • The process involves analyzing a project's cash inflows and outflows to determine whether the expected return meets a set benchmark • The significant methods of capital budgeting include throughput, discounted cash flow, and payback analyses • Types of Capital Budgeting ▪ Throughput Analysis Throughput analysis is the most complicated form of capital budgeting analysis but also the most accurate in helping managers decide which projects to pursue Under this method, the entire company is considered as a single profit-generating system Throughput is measured as an amount of material passing through that system The analysis assumes that nearly all costs are operating expenses, that a company needs to maximize the throughput of the entire system to pay for expenses, and that the way to maximize profits is to maximize the performance passing through a bottleneck operation A bottleneck is a resource in the system that requires the longest time in activities This means that managers should always place a higher priority on capital budgeting projects that will increase throughput passing through the bottleneck ▪ DCF Analysis Discounted cash flow (DCF) analysis looks at the initial cash outflow needed to fund a project, the mix of cash inflows in the form of revenue, and other future flows in the way of maintenance and additional costs These costs, except for the initial outflow, are discounted back to the present date The resulting number from the DCF analysis is the net current value (NPV) Projects with the highest NPV should rank over others unless one or more are mutually exclusive ▪ Payback Analysis Payback analysis is the purest form of capital budgeting analysis, but it's also the least accurate It's still widely used because it's quick and can give managers a "back of the envelope" understanding of the real value of a proposed project This analysis calculates how long it will take to recoup the costs of an investment The payback period is identified by dividing the initial investment in the project by the average yearly cash inflow that the project will generate Q3) List and describe the three general areas of responsibility for a financial manager Forecasting and Planning: The financial manager must interact with other executives as they look ahead and lay the plans which will shape the firm's future Significant Investment and Financing Decisions: A successful firm usually has rapid growth in sales, which requires investments in plant, equipment and inventory It is the task of the financial manager to help determine the optimal sales growth rate, and he (she) must help decide what specific assets to acquire and the best way to finance those assets For example, should the firm finance with debt, Equity, or some combination of the two, and if the debt is used, how much should be long term and how much should be short term? Coordination and Control: The financial manager must interact with other executives to ensure that the firm is operated as efficiently as possible All business decisions have financial implications, and all managers financial and otherwise need to take this into account Dealing with Financial Markets: The financial manager must deal with the money and capital markets Each firm affects and is affected by the general financial markets where funds are raised, where the firm's shares and debentures are traded, and where its investors either make or lose money Risk Management: All business face risks, including natural disasters such as fires and floods, uncertainties in commodity and share prices, changing interest rates and fluctuating foreign exchange rates However, many of these risks can be reduced by purchasing insurance or by hedging Q4) The managers of a firm wish to expand the firm's operations and are trying to determine the amount of debt financing the firm should obtain versus the amount of equity financing that should be raised The managers have asked you to explain the effects that both of these forms of investment would have on the cash flows of the firm Write a short response to this request Debt Financing When a firm raises money for capital by selling debt instruments to investors, it is known as debt financing In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid on a regular schedule Equity Financing Equity financing is the process of raising capital through the sale of shares in a company With equity financing comes an ownership interest for shareholders Equity financing may range from a few thousand dollars raised by an entrepreneur from a private investor to an initial public offering (IPO) on a stock exchange running into the billions Q5) Assume you are a credit manager in charge of approving commercial loans to business firms Identify three aspects of a firm's cash flows you would review and explain the type of information you hope to gain from studying each of those five aspects Types of cash flow include: Cash from Operating Activities – Cash that is generated by a company's core business activities – does not include CF from investing This is found on the company's Statement of Cash Flows (the first section) Free Cash Flow to Equity (FCFE) – FCFE represents the cash that's available after reinvestment back into the business (capital expenditures) Read more about FCFE Free Cash Flow to the Firm (FCFF) – This is a measure that assumes a company has no leverage (debt) It is used in financial modelling and valuation Read more about FCFF Net Change in Cash – The change in the amount of cash flow from one accounting period to the next This is found at the bottom of the Cash Flow Statement Q6) Give some examples of ways in which a manager's goals can differ from those of shareholders Value Profitability is the bottom line in the business world and both the manager and shareholders are typically in agreement on this point, in principle However, the way that a manager tries to achieve profitability won't always be in line with the shareholders' ideas For example, shareholders may be focused on cost-cutting while the manager seeks additional resources to improve productivity Managers may find their hands tied from time to time regarding what they can to increase productivity Time Performance levels measured by both managers and shareholders in various increments of time Long-term profitability and sustainability are generally more important than the short-term bottom line but not to investors who buy and sell frequently, trying to time the rise and fall of the market Managers must also be focused on short-term and intermediate goals because these results affect their employment in the present while remaining mindful of the company's longterm prospects Employees Although profitability is the bottom line and affects everyone within a company, managers who get the most out of their employees generally have some type of ongoing relationship with those employees In some cases, it may be merely an artificial working relationship, but in other cases, managers get deeply involved in the lives of their workers Shareholders not necessarily align their goals with this type of relationship in mind The shareholder does not have to be involved in the lives of employees and may make decisions about his holdings within the company based on numbers alone Risk A manager's goals based on calculated risks that the manager is willing to take This is true of shareholders as well, but agency theory suggests that managers will sometimes set personal goals and make decisions based on what they believe they can to meet the goals of shareholders The manager sometimes finds that she cannot realistically achieve the shareholders' goals and, therefore, acts in her self-interest based on the calculated risk that she can meet the needs of shareholders by doing things her way, rather than theirs While shareholders may set goals that require a considerable amount of risk, the manager may decide to scale back and avoid some of that risk for the good of herself, her workers and the company as a whole Q7) Describe the major differences between individual and institutional investors Access to resources 10 Institutional investors are substantial companies and can take advantage of numerous resources such as financial professionals to oversee their portfolio daily, allowing them to enter and exit the market at the right time Individual investors need to the same on their own through research and available data Decision-making With institutional investors, the investments are usually overseen by different individuals in the organization For example, the board of directors makes the decision-making process more challenging as people are likely to propose different ideas on what trades to make As an individual investor, you are your boss and the sole decision-maker when it comes to buying and selling shares Identifying investment opportunities Since institutional investors can access a large number of resources and capital, they are privy to investment structures and products available before anyone else By the time investment opportunities reach from the hedge fund or private equity funds to the individual investor level, the rest can use second-hand investment strategies that have already been implemented by the large institutions Q8) What issues are involved in ratio analysis? Explain the impact of those issues on financial planning One of the most critical limitations of ratio analysis include: Historical Information: Information used in the report is based on real past results that are released by the company Therefore, ratio analysis metrics not necessarily represent future company performance Inflationary effects: Financial statements are released periodically and, therefore, there are time differences between each release If inflation has occurred in between periods, then real prices 11 are not reflected in the financial statements Thus, the numbers across different periods are not comparable until they are adjusted for inflation Changes in accounting policies: If the company has changed its accounting policies and procedures, this may significantly affect financial reporting In this case, the critical business metrics utilized in ratio analysis are altered, and the financial results recorded after the change are not comparable to the findings recorded before the turn It is up to the analyst to be up to date with changes to accounting policies Changes made are generally found in the notes to the financial statements section Operational changes: A company may significantly change its functional structure, anything from their supply chain strategy to the product that they are selling When significant operational changes occur, the comparison of financial metrics before and after the functional change may lead to misleading conclusions about the company's performance and prospects Seasonal effects: An analyst should be aware of seasonal factors that could potentially result in limitations of ratio analysis The inability to adjust the ratio analysis to the seasonality effects may lead to false interpretations of the results from the study Manipulation of financial statements: Ratio analysis is based on information that is reported by the company in its financial statements This information may be manipulated by the company's management to report a better result than its actual performance Hence, ratio analysis may not accurately reflect the true nature of the business, as the misrepresentation of information is not detected by simple analysis It is essential that an analyst is aware of these possible manipulations and always complete extensive due diligence before reaching any conclusions Q9) Compare and contrast various methods of capital budgeting Capital budgeting is a set of techniques used to decide which investments to make in projects There are many capital budgeting techniques available, which include the following: 12 Discounted cash flows Estimate the amount of all cash inflows and outflows associated with a project through its estimated useful life, and then apply a discount rate to thes e cash flows to determine their present value If the current value is positive, accept the funding proposal Internal rate of return Determine the discount rate at which the cash flows from a projected net to zero The project with the highest internal rate of return is selected Constraint analysis Examine the impact of a proposed project on the bottleneck operation of the business If the proposal either increases the capacity of the bottleneck or routes works around the bottleneck, thereby increasing throughput, then accept the funding proposal Breakeven analysis Determine the required sales level at which a proposal will result in positive cash flow If the sales level is low enough to be reasonably attainable, then accept the funding proposal Discounted payback Determine the amount of time it will take for the discounted cash flows from a proposal to earn back the initial investment If the period is sufficiently short, then accept the project Accounting rate of return This is the ratio of an investment's average annual profits to the amount invested in it If the outcome exceeds a threshold value, then financing is approved Real options Focus on the range of profits and losses that may be encountered throughout the investment period The analysis begins with a review of the risks to which a project will be subjected, and then models for each of these risks or combinations of risks The result may be more exceptional care in placing large bets on a single likelihood of probability 13 When analyzing a possible investment, it is useful also to analyze the system into which the investment will be inserted If the order is unusually complex, it is likely to take longer for the new Asset to function as expected within the system The reason for the delay is that there may be unintended consequences that ripple through the system, requiring adjustments in multiple areas that must be addressed before any gains from the initial investment can be achieved Lincoln Industries' current ratio is 0.5 Considered alone, which of the following actions would increase the company's current ratio? Explain your choice a Use cash to reduce long-term bonds outstanding b Borrow using short-term notes payable and use the cash to increase inventories c Use cash to reduce accruals d Use cash to reduce accounts payable e Use cash to reduce short-term notes payable Current Ratio = 0.5 Given that the CR is less than 1, then an increase in the current assets and current liabilities would result in an increase in the CR Original CR= ½= 0.5 Increase in CA and CR= 1+1/2+1= 2/3= 0.67 Hence borrowing on short termbasis to increaseinventories is advisable Hence Option B 11 Brodax has $20 million in current assets and $10 million in current liabilities, while Smaland's current assets are $10 million versus $20 million of current liabilities Both firms would like to "window dress" their end-of-year financial statements, and to so each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts Which of the statements below best describes the results of these transactions? Justify your choice with logical arguments a The transaction would improve both firms' financial strength as measured by their current ratios b The transactions would raise Broadax's financial strength as measured by its current ratio but lower Smaland's current ratio c The transactions would lower Brodax 's financial strength as measured by its current ratio but raise Smaland's current ratio d The transaction would have no effect on the firm' financial strength as measured by their current ratios 14 e The transaction would lower both firm' financial strength as measured by their current ratios Brodax = 20/10= Smaland = 10/20 = 0.5 Borrowing $10 million will lead to CR being : Broadax = 20+10/10+10= 30/20 = 1.5 Smaland = 10+10/20+10= 20/30 = 0.67 Option C is the right one 15 Part B Exercise A firm generated net income of $862 The depreciation expense was $47 and dividends were paid in the amount of $25 Accounts payables decreased by $13, accounts receivables increased by $28, inventory decreased by $14, and net fixed assets decreased by $8 There was no interest expense What is the net cash flow from operating activity? Explain the usefulness of the net cash flow from operating activities in decision making Net Income = $862 Depreciation Expense = $47 Dividends = $ 25 Accounts Payable-= $13 Accounts receivable = $28 Inventory = $14 Net Fixed assets = $8 Int Exp = Net cash flow from operating activities = 862+47-13-28+14= $882 Exercise Hutchinson Corporation has zero debt-it is financed only with common Equity Its total assets are $410,000 The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book value How much must the firm borrow to achieve the target debt ratio? Show all calculations Total Assets = 410,000 Debt / Assets Ratio = 40% Debt = ? 40% = Debt/ 410,000 = 410,000 X 40% 16 = 164,000 Exercise Following information is extracted from the books of Brox Ltd: a Current Accounts ▪ 2017: CA = 18,900; CL = 11,300 ▪ 2016: CA = 14,700; CL = 11,600 b Fixed Assets and Depreciation ▪ 2017: NFA = 88,100; 2016: NFA = 85,700 ▪ Depreciation Expense = 1500 c Long-term Debt and Equity (R.E not given) ▪ 2017: LTD = 17,000; Common stock & APIC = 1,400 ▪ 2016: LTD = 15,650; Common stock & APIC = 1,400 d Income Statement ▪ EBIT = 16,000; Taxes = 1400 ▪ Interest Expense = 1,240; Dividends = 1,700 Required: i Compute the cash flow from Asset for Brox Ltd Cash Flow From Assets (CFFA) = Operating Cash flow (OCF) - Net Capital Spending (NCS) - Change in Net Working Capital (NWC) OCF = EBIT + Depreciation - Tax = 16,000 + 1,500 - 1,400 = 16,100 NCS= Ending NFA - Beginning NFA + depreciation = NCS= 88,100 - 85,700 + 1,500 = 3,900 Change in NWC= Ending WC - Beginning WC = Ending(CA - CL) - Beginning(CA CL) ii NWC= (18,900 - 11,300) - (14,700 - 11,600) = 4,500 CFFA = 16,100 - 3,900 - 4,500 = 7,700 Comment on usefulness of cash flow from Asset in financial decision making - Figuring out any shortage in cash early, that will help us to take the right decision for future financing 17 - While preparing business plan, or project strategy to solid the credit request - If the balance is positive in any period, we can use some of this cash and invest in the capital to make new source of income Exercise Following financial information is related to Glow Corporation and Blue Corporation: Glow Corporation Blue Corporation 2001 2000 2001 2000 Current ratios 1.16 95 2.25 2.17 Working capital $11 ($2) $30 $28 A/R turnover 31.7 times 45 times 30 times 30 times Inventory Turnover 16.6 times 22.5 times 15 times 15 times Asset turnover 2.4 times 3.2 times 3.6 times 3.8 times Total debt to total assets 86.9% 81.7% 14.2% 15.4% Sh Equity to total assets 13.1% 18.3% 85.8% 84.6% Gross margin ratio 30% 33% 25% 25% Return on sales 10% 11.9% 10% 10% Return on assets 24.5% 38.5% 35.5% 38.5% Return on equity 186.3% 210.5% 41.4$ 45.5% Required: Conduct financial analyses of the two companies based on the above data and deduct, which is performing better, and why? Current ratio: the higher ratio, the better results, We can see here that the ration of Glow Corporation is (1,160.95 both years) times, while the current quota of Blue Corporation is (2,25-2,17 both years) times, so the short term liquidity of blue corporation is much better than Glow corporation Working Capital: the number of current assets in excess to current liabilities of the company In the above giving figures, we notice that Glow Corporation has working capital of (11$-2$ both years) while Blue Corporation has (30$-28$ both years) as working capital Higher working capital of Blue Corporation would enable the company to address the short term financial needs effectively A/R Turnover: effectiveness of providing credit to the end-user and collecting cash As per the above details, the Glow Corporation has an A/R turnover of (31.7-45 both years) times, against (30-30 both years) times A/R turnover for the Blue Corporation, that's mean, the Glow Corporation in a better position to give their end-user longer period of credit and cash collection 18 Inventory Turnover: the ability to convert the company's inventory into cash The Glow Corporation has an inventory turnover of (16.6-22.5 both years) times, against (15 -15 both years)times inventory turnover for Blue Corporation That's mean, the Blue Corporation has less inventory turnover, and can help to turn these inventory faster into cash, and has a better short term liquidity position Asset Turnover: the assets used by the company to generate its revenue The Glow Corporation has an asset turnover of (2.4-3.2 both years) times, and Blue Corporation has (3.6-3.8 both years), and that's higher utilization on the Asset to generate revenue Total debt to total assets: to pay off the liability of the company in the event of bankruptcy, higher ratio means higher risk The Glow Corporation has a total debt of (86.9%-81.7% both years), and Blue Corporation has (14.2%-15.4% both years) it's clear that Glow Corporation has higher ratio and means higher risk to the amount of debt Sh.Equity to Total Assets Ratio: the number of assets funded through the Equity, the higher the best Glow Corporation shows (13.1%-18.3% both years) and Blue Corporation shows (85.8%-84.6% both years) and the Blue Corporation has a lower risk in terms of the amount of Equity as against the value of its assets Gross margin ratio: the profitability of the business at the operating level Glow Corporation has a gross ratio of (30%-33% both years) while Blue Corporation has (25% both years) and that's mean the Glow Corporation has better gross profit in the asset operations Return on Sales: is the ratio of operating income to net sales, the higher the best The Glow Corporation making (10%-11.9% both years) and Blue Corporation making (10% both years), we can see that both companies doing almost the same, while Glow Corporation made a bit better on the year of 2000 Return on Asset: the percentage of how profitable the company's assets are in generating revenue Glow Corporation shows (24.5%-38.5% both years) and Blue Corporations (35.5%-38.5% both years) in comparison, we see that Blue Corporation has a higher ratio and the assets making higher revenue Return on Equity: is a measure of the profitability of business concerning the Equity Glow Corporation was doing (186.3%-210.5% both years) and Blue Corporation doing (41.4%45.5% both year) it is clear that Glow Corporation was having a much higher return on Equity Exercise Using the following information, answer the questions listed below: 19 Dana Dairy Products Key Ratios Income Statement Dana Dairy Products For the Year Ended December 31, 2013 Balance Sheet Dana Dairy Products December 31, 2013 Required: 20 i Calculate the following ratios for 2013: a Current ratio Current Ratio Quick ratio = current asset / current liabilities = 14,750 / 15,675 = 0.94 = (Current asset – inventory) /current liabilities = (14,250 – 4,350) / 15,675 = 0.63 b Net working capital NWC = Current Asset – Current liabilities = 14,250 – 15,675 = - (1,425) c Inventory turnover Inventory Turnover = Cost of goods sold / inventory = 87,000 / 4,350 = 20 d Average collection period Avg collection period = (Account receivable / Sales )*365 = (8,900 / 100,000) * 365 = 32.48 days e Gross profit margin Gross profit margin f Net profit margin Net profit margin g Return on assets Return on assets = (Gross profit / Net Sales)*100 = (13,000 / 100,000)*100 = 13% = NPBT / Sales = (1,500 / 100,000) *100 = 1.5% = (Net income / total asset)*100 = (900 / 36,000)*100 = 2.5% h Return on Equity Return on equity = (Net income / shareholder equity)*100 = 900 / 16,200 = 5.5% ii Based on the calculations in part (i) above, comment on the performance of the company as compared to its industry and its own last year results In general we can notice that the company has increased the profits and efficiency such as net profit increased to 1.5% and return on asset to 2.5% and return on Equity to 5.5% that's mean the company has improved in the current year compering with the previous one 21 REFERENCES Bragg, S and Bragg, S., 2020 Financial Statement Analysis — Accountingtools [online] AccountingTools.Available at: [Accessed April 2020] Your Article Library 2020 Top Responsibilities Of A Financial Manager | Financial Management [online] Available at: [Accessed April 2020] Investopedia 2020 Debt Financing Vs Equity Financing: What's The Difference? 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