ICMA Pakistan ----- Strategic Level 2

Strategic Financial Management [S5]

Session 2

Institute of Cost and Management Accountants of Pakistan 1

 Our focus for the next few sessions

Part A – Formulation of Financial Strategy W - 10%

1) Objectives of organizations
a) Objectives of Companies
 2) Constraints on Financial Strategy
a) Constraint Factors

b) Stakeholders and Objectives b) Economic Constraints
c) Objectives of public owned c) International Constraints
d) Objectives of non‐commercial bodies d) Regulatory bodies

3) Forecasting and Analysis 4) Financial Strategies

a) Performance Analysis a) Working Capital Management
b) Cash Forecasts b) Dividend Policy
c) Financial Statements Forecast
d) Sensitivity Analysis and Changes
in Variables

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 Reference to Study Material

Resource Chapter Comments

1) Van Horne Chapter 12

2) Khan & Jain Chapter 6

3) E.F. Brigham Chapter 3

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 Let’s start …..

Part A – Formulation of Financial Strategy

3) Forecasting and Analysis

a) Performance Analysis
b) Cash Forecasts
c) Financial Statements Forecast
d) Sensitivity Analysis and Changes in Variables

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 Financial Ratio Analysis
 Performance Appraisal
• Comparing performance against:
• Planned objectives (or Standards of performance)
• Industry Averages or Competitors’ performance
• Past period performances

 Planning and Forecasting

• As part of (Financial) Objectives
• Projected Balance Sheet, Income Statement and Cash Flow Statement

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 Financial Ratios
1. Profitability Ratios

2. Liquidity Ratios

3. Activity (or Fund Management) Ratios

4. Financial Gearing (or Capital Structure) Ratios

5. Investors (or Stock Market) Ratios

1. Profitability ratios
Financial Management and Policy 2. Liquidity ratios
James C. Van Horne’s book 3. Debt ratios
4. Coverage ratios
5. Market-value ratios

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 Profitability Ratios

 Gross Profit Ratio

 Operating Profit Ratio

 Net Profit Ratio

 Return on Capital Employed (ROCE)

 Return on Assets (ROA)

 Return on Equity (ROE)

 Assets Turnover

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 Liquidity Ratios

 Gross Working Capital

 Net Working Capital

(or Working Capital or Net Current Assets)

 Current ratio (or Working Capital ratio)

 Quick ratio (or Acid‐test ratio)

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Activity (Fund Management) Ratios

 Inventory Turnover

 Receivable Turnover

 Payable Turnover

 Length of Operating Cycle

 Length of Cash Cycle

 Assets Turnover
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Financial Gearing (Capital Structure) Ratios

 Equity Gearing

 Capital Gearing

 Interest (or Finance Charge) Cover

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Investors (Capital Market) Ratios

 Earning per share (EPS)

 Earning yield

 Price – Earning (P/E) ratio

 Dividend per share (DPS)

 Dividend Cover

 Dividend yield

 Dividend Payout ratio

 Earnings Retention ratio

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 Financial Ratio Analysis
 Common Size Statements [Vertical Analysis]
Common size, or vertical analysis, is a method of evaluating financial
information by expressing each item in a financial statement as a
percentage of a base amount for the same time period.

If the income statement is used, the base amount will be net sales.
Accordingly, all expenses and profits are expressed as a percentage of net
sales.

If the balance sheet is used, the base amount will be total assets.
Resultantly, all individual assets and liabilities are expressed as a
percentage of total assets.

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 Financial Ratio Analysis
 Trend Analysis [Horizontal Analysis]

The horizontal analysis focuses on trends and changes in financial statement

items over time. Along with the dollar amounts presented in the financial
statements, horizontal analysis can help a financial statement user to see
relative changes over time and identify positive or perhaps troubling trends.

Usually, a base year is selected, and the dollar amount of each financial
statement item in subsequent years is converted to a percentage of the base
year dollar amount. Alternatively, instead of a fixed‐base‐year, the change can
be measured using the chain‐based method. In the chain‐based method, the
immediately preceding year figure is taken as the base year to measure the
change in the item over a one year.

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 Financial Ratio Analysis
 Limitations

• Financial Statements data that are used for ratio analysis

may themselves be manipulated.

• Ratios in isolation (without referring to underlying numbers)

may provide misleading conclusions.

• There are multiple definitions (or formulas) for computing

the same ratio ‐ this may intentionally be used to mislead
the end users.

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That’s the end of Session 2.

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