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Notes of Financial Management Part 2

Notes of Financial Management Part 2

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Published by Nauroz Khan
2nd copy of FM notes, which we studied in last class...
2nd copy of FM notes, which we studied in last class...

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Published by: Nauroz Khan on Feb 22, 2010
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11/30/2012

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Notes:FinancialManagementPrepared By:Nauroz KhanUniversity:Abasyn UniversityPeshawarDate:22/02/2009Part:(2-2)
 
Inventory turnover Ratio:
A ratio showing how many times a company's inventory is sold and replaced over a period.Although the first calculation is more frequently used, COGS (cost of goods sold) may besubstituted because sales are recorded at market value, while inventories are usuallyrecorded at cost. Also, average inventory may be used instead of the ending inventorylevel to minimize seasonal factors.
Inventory for whole year:
= Inventory x 360 days-----------------------------------(COGS)
Operating Cycle VS Cash Cycle:
Operating cycle and cash cycle
are two important components of working capitalmanagement. Together they determine the efficiency of a firm regarding working capitalmanagement.Operating cycle refers to the delay between the buying of raw materials and the receipt of cash from sales proceeds. In other words, operating cycle refers to the number of daystaken for the conversion of cash to inventory through the conversion of accountsreceivable to cash. It indicates towards the time period for which cash is engaged ininventory and accounts receivable. If an operating cycle is long, then there is lower accessibility to cash for satisfying liabilities for the short term.Operating cycle takes into consideration the following elements: accounts payable, cash,accounts receivable, and inventory replacement.The following formula is used for calculating operating cycle:
Operating cycle = age of inventory + collection periodCash cycle
is also termed as net operating cycle, asset conversion cycle, working capitalcycle or cash conversion cycle. Cash cycle is implemented in the financial assessment of a commercial enterprise. The more the figure is increased, the higher is the period for which the cash of a commercial entity is engaged in commercial activities and isinaccessible for other functions, for instance investments. The cash cycle is interpreted asthe number of days between the payment for inputs and getting cash by sales of commodities manufactured from that input.
 
The fundamental formula that is applied for the calculation of cash conversion cycle is asfollows:
Cash cycle = (Average Stockholding Period) + (Average Receivables ProcessingPeriod)- (Average Payables Processing Period)
HereAverage Receivables Processing Period (in days) = Accounts Receivable/Average DailyCredit Sales Average Stockholding Period (in days) = Closing Stock/Average DailyPurchases Average Payable Processing Period (in days) = Accounts Payable/AverageDaily Credit Purchases.A short cash cycle reflects sound management of working capital. On the other hand, along cash cycle denotes that capital is occupied when the commercial entity is expectingits clients to make payments.
Profitability Ratio:
Profitability ratios are used to assess a business' ability to generate earnings as comparedto expenses over a specified time period.
Gross Profit Ratio:
= Gross Profit---------------------------- x 100Total Sale
Net Profit Ratio:
= Net Profit------------------------------- x 100Sale
Investment Ratio:
Formula = Net Profit------------------ x 100Total Asset
Return on Equity:
The amount of net income returned as a percentage of shareholders equity. Return onequity measures a corporation's profitability by revealing how much profit a companygenerates with the money shareholders have invested.ROE is expressed as a percentage and calculated as:
Return on Equity = Net Income/Shareholder's Equity
 Net income is for the full fiscal year (before dividends paid to common stock holders butafter dividends to preferred stock.) Shareholder's equity does not include preferred shares.

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