Professional Documents
Culture Documents
net/publication/350833314
CITATIONS READS
0 159
1 author:
Sivanathan Sivaruban
International Training Institute Port Moresby Papua New Guinea
10 PUBLICATIONS 4 CITATIONS
SEE PROFILE
Some of the authors of this publication are also working on these related projects:
All content following this page was uploaded by Sivanathan Sivaruban on 13 April 2021.
Sivanathan Sivaruban MBA (Aus), FCMA, B.Com (Spl), CPA PNG, HNDA, MAAT
Senior Lecturer/ Executive Manager –International Training Institute,
Port Moresby, Papua New Guinea
Email:ssivaruban% iti.ac.pg Phone : +675 7 67 89 749
Abstract
The study examined on how financial analysis tools can be used on the financial institution in the global
pandemic crisis event. The Financial analysis of a financial institution is based on the financial tools such as the
results of financial statements analysis, the Company valuation methods, Due Diligence, Qualitative factors, and
Options –based valuation. The financial tools can be used to make a decision on the acquisitions of the Financial
Institution. Forecasting Financial Statement under COVID-19, the global pandemic is very complex and cannot
be predicted accurately. The Financial statements prediction is impacted heavily by the global pandemic,
COVID-19 resulting in negative economic growth in the world. The primary data collection for this study were
collected from a quoted public list financial company’s financial statement. The Investment decision will be
based on the future earnings of the Company, at the same, the past financial years’ performance and financial
position which can help to make a viable decision. The final come of this study concluded that financial analysis
cannot done in the logical manner and analysist should be a more resilient. The future study on the financial
statement analysis tools need be develop a suitable model under any crisis event.
Keyword: Financial Analysis, liquidity, profitability, solvency, due diligence, cash flow, option-based valuation
and Accounting ratios.
1. Introduction
This research paper has prepared a detailed analysis on the profitability, liquidity and solvency, cash flow
statement analysis and valuation of the Company. The researcher has selected one Financial Institution based on
the steady industrial financial growth in the financial market.
The Company had a strong profitability ratio in the last five years. The predictable figures on the same ratios
will decline due to the impact of COVID 19, resulting in the deterioration of quality assets and an increase in
the operational costs and taxes.
The Liquidity ratio is paramount for the financial institution to maintain its minimum liquidity reserve with the
Central Bank. The Solvency ratio is to measure the long-term going concern of the Company without any
interruption from the debt capital and equity capital. The calculated accounting ratios on the solvency are
acceptable ratios within the range of the Licensed Finance Company and the specialized lease Company sectors.
The situation of the Shareholder ratios is a more favorable for the present Financial Institution investors. The
analysis of the Cash flow statement has indicated that the Company has generated sufficient cash and cash
equivalent to meet business operations. However, the net cash flow from operating activities and the free cash
flow negative figures for the years 2016 to 2019.
The different valuation methods can provide different answers so that only options are available to arrive at the
final average price where the author of this article proposes to bid –offer U$ 80.00 per share.
Based on the traditional financial results, the Company equity valuation creates a more favorable situation for
the acquisition decision. The author of this article is making an assumption that the acquirer/interested Company
has an exclusive right on the acquisition project. Therefore, the author of this article is highly recommending for
the delay of the investment decision - based on option–based valuation method by considering the COVID - 19
negative impacts.
The first part of the article outlines the concept of financial statements analysis such as horizontal, vertical
analysis, two years of predictions based on the trend analysis and accounting ratios analysis. The two years
1|P a g e
The second part of the article outlines the different valuation methods in valuating of Finance Institute. The
Board of Directors of the acquirer can perform the acquisition decision with due diligence test and also
considering the qualitative factors of the Finance Institute. The article has enclosed appendixes on Income
statement, accounting ratios, company valuations and forecasted financial statement.
The final recommendation in the last of part of the analysis is on the financial statement, and Company valuation
including options based - valuation from second part of the article. The final conclusion can be made by
considering the quantitative factors and qualitative factors including the due diligence test on the acquisitions.
2. Literature Review
The Concept of Financial Statement Analysis refers to interpreting the business entity’s financial performances
and the financial position in a meaningful manner. The Financial Statements are in numbers and are meaningless
in the presentation but by using the accounting ratio analysis, trend analysis and other mathematics techniques,
they can be useful tools to make the financial statement meaningful. The investor of the company is mostly
concerned with the business growth, risk and return of their investment such as market price increase, dividend
and level of equity to debt. Financial statement analysis is an essential tool for making an informed decision
(Afagh, Mohammadi, & Nassivi, 2012).
The concept of financial statement analysis can be divided into two methods.
The Financial performance is more importantly focused on external factors such as market risk, competition and
market power and also concertation (S G Sisira Dharmasri Jayasekara, Perera, & Ajward, 2018). The different
stakeholders of the company can use the Financial Statement analysis for their decision making. The objectives
of financial statement analysis among stakeholders can be a conflicting objective among them. The investment
decision is made based on the predicted financial outcomes of the business entity. Therefore, the concept of
financial statement analysis can be an aid to make viable decision in the corporate world.
The concept of financial statement analysis can be assessed on the following important elements;
Profitability: The profitability of the business means the business entity has the ability to generate earning
from its resource (assets) over periods of time and the profitability can be assessed on the statement of the
financial performance of the business entity. The profitability indicates the company position in the competitive
environment and evaluation of smart management team of the business entity.
Solvency: The Solvency of the business entity is an obligation to meet the long-term liabilities of the business.
The assessment of solvency is done on the financial position of the Company. The finance company has been
regulated by the Central Bank on Capital adequacy requirements to fulfill solvency testing.
Liquidity: The liquidity of the business defined that the business entity has the ability to pay short term debt
obligation within a given period of time and also able to pay unexpected contingency that arise in the future.
The financial company has to maintain the liquidity ratio @12% based on the Central Bank requirement. If any
2|P a g e
Efficiency: Efficiency means; how the company uses resources or assets to create earning and its efficiency in
the management of the business operation. The efficiency ratio can be measured based on the usage of working
capital and other assets. The efficiency ratio can help to assess the liquidity of the entity since the activity ratio
has impacts on the liquidity ratio.
The Concept of Financial Statement Analysis can be divided into three methods such as horizontal vertical
analysis methods and trend analysis.
Horizontal financial statement analysis involves comparing the same Company financial information between
two or more connective years to assess the growth and risk of the business. In other words, the Horizontal
financial statement analysis can show the structural changes in the financial statement of the business entity. The
horizontal analysis can be of absolute amount or percentage in comparison with trend analysis.
The final result of the horizontal financial statement analysis can be benchmarked with the same industry for
self-assessment of the company in a particular industry context. The horizontal financial statement indicates
any usual changes in the financial statement so that analysis can out identify the clause of usual changes in the
Company’s financial statement. The main objective of the horizontal financial statement analysis to compare
fluctuation within the year and between years (C. Mashkoor 2020).
Net Fee and Commission Income 19% 73% 31% 45% -3% -15% -4%
Operating Expenses and Provision 108% 72% 65% 66% 24% -10% -5%
Provision for Taxation 46% 36% 41% 19% -2% -10% -2%
Profit for the Year 38% 42% 40% 11% 11% -9% 2%
The Gross Income has been increased at a steady level from year 2015/2016 to 2018/2019 and declined in the
year 2019/2020 due to the Easter Sunday bomb blast in Sri Lanka in the month of April 2019 at the beginning
3|P a g e
The Projected figure on the statement of profit and loss is based on the current economic activities in Sri Lanka
and the global pandemic circumstances. Therefore, the author of this article cannot be able to describe in detail
due to uncertainty and unpredictable economic trends in Sri Lanka and in the global context.
The Company has been maintaining a strong assets base from 2015/2016 to 2018/2019 but it has declined heavily
in the year 2019/2020 due to the deduction in the finance lease net portfolio (Annual Article 2019/2020 p 69).
Total equity has increased in the year 2018/2019 due to right issues of shares to the existing shareholders. The
4|P a g e
Table 4 show a total, steady, healthy asset-building over a period of time. The Company has recorded total assets
amounting to $ 51.42 Bn during the financial year 2019/2020. The Total Assets curve is rising up in a positive
way without a decline.
Vertical Financial statement analysis is conducted in a single period of time and with comparison to the base
items with a relative proportion of the different elements of the financial statement. The Vertical Financial
Statement analysis can be commonly used for comparing with the previous year’s financial performance,
comparing current performance with similar entities and benchmark with the industry average. Normally
Vertical analysis on Income statement can be expressed as percentage to the sale while the financial position is
stated to in the total assets.
Net Interest Income 49% 39% 40% 39% 42% 42% 43%
Total Operating Income 55% 49% 49% 48% 50% 49% 49%
5|P a g e
Profit for the Year 15% 14% 15% 13% 13% 14% 14%
Financial performance on the pie a graph shows the sustaining progress of firm (Table 6). The Interest Income
contributes more or equals 90% to the Gross Income from the core business operation of lending money and
finance lease. The vertical analysis shows prudent finance management resource approaches on the business
operation across the board in order to achieve the strategic financial objectives of the Company. The relative
proportions of each financial elements changed slightly in a single period. Table 6: shows a vertical statement
analysis on the financial statement for the year 2019/2020 with 92% contributions from Interest Income to the
Gross Income for the Finance Company.
The Total equity has increased in the year 2019 /2020 with a slight reduction in the total liabilities. The right
issues on the share capital and the increase in the retained earnings are leading to capital structure in the financial
position of the business entity. The Company has changed the strategy to reduce borrowing from other financial
6|P a g e
60%
40%
20% 13%
Table 8 describes how total assets were financed by total liabilities and total equity.
The forecasting of financial statements is a challenging task to the analyst due to fluctuation from the previous
years. Financial PLC has a steady and sustainable business growth over the periods from the year 2016 to the
year 2020. Several statistical tools are used to forecast on the future growth of the business. The predications
of the financial statement cannot be the correct or the wrong answer as long as a reasonable forecast is accepted.
The forecasting of Financial Statement under COVID 19 Global pandemic is very complex and cannot be
predicted accurately. According to the two years, the financial statements prediction was impacted heavily by
the COVID 19 Global pandemic resulting in the recession of the economic growth in the world. The author of
this article has computed and forecasted in the negative growth for the current year 2020/2021 due to the
reduction in the economic activities, increased in non- performing loan ratio, current political instability and
other various external environmental factors in Sri Lanka.
The predicated statement of profit and loss figures are based on the average growth for the last five years with
the adjustment of impact on COVID 19 to the Sri Lanka’s economic and global context.
The exceptional economic growth for Sri Lanka is 2.20% for 2020 and will recover moderately to 3.50 in 2021
(Asian Development Bank, 2020). The predicting figure might downgrade further due to a continuous increase
in COVID 19 cases. The Company is also facing a big economic and financial burden due to the relief package
to the business entities. Therefore, the forecasted figures on the financial statement are accurately reasonable
due to the existing economic activity in Sri Lanka and in the global context.
Table 9: Statements of Financial Performances for the years 2020/2021 and 2021/2022
7|P a g e
Table 10: Forecast on Statements of Financial Performances for the years 2020/2021 and 2021/2022
Table 10 describes the forecast income statements in comparison between the two years during the COVID 19
situation and also indicating there were no big changes in the two years due to the delays on the recovery stage
of COVID19.
8|P a g e
The Analysis of Profitability is the company’s existence and it’s a critical evaluation of the business entity.
Smooth growth ensures higher future returns to shareholders and there lies the profitability which means not
only current profits but future returns as well (Adam, 2014).
Net Profit Margin 15% 14% 15% 13% 13% 14% 14%
Return on Assets 6% 5% 6% 6% 6% 5% 5%
**ROCE 3% 4% 4% 4% 4% 4% 4%
Assets Turn Over 15% 17% 18% 18% 19% 18% 18%
Earnings per Share 12.35 17.48 23.59 20.37 21.29 19.48 19.95
The above profitability ratios are showing that the profitability of the Financial Institution during the last five
financial years were high. This is due to an increase in the interest income and the improvement on the operations
efficiency. This has resulted in cost savings management and the deduction on the cost of funding cost (Central
Bank Annual Report 2019/2020 on Financial Institution page 68). The Company has an extraordinary financial
result in the financial year 2017/2018 and recorded the highest in its’ 10th years of business operations in Sri
Lanka. The Company had strong profitability in the first three years of this analysis but declined dramatically in
the financial years 2018/2019 and 2019 /2020 respectively. The Finance Company is continuously maintaining
the return on assets of 6% which is the above average of 3 % in the licensed Finance & specialized lease company
sector of the industry. The return of equity is also well above the industry average (Central Bank Annual Article
2019). Financial performance is assessed using accounting ratios such as return on assets and return of equity (S
G Sisira Dharmasri Jayasekara, Perera, & Ajward, 2018). Therefore, the company is at a steady level of
profitability based on past records.
Gross Profit has a steady growth percentage during the last five years of Financial PLC. The Company is
continuously increasing its earnings per share from the year 2015/2016 to 2019 /2020 and the highest recorded
earnings per share was $ 23.59 in the year 2017/2018(Table 12 on Earnings per Share). The return of equity has
recorded the highest for the first three years but it has declined in these years 2018 /2019 and 2019 /2020
respectively due to right issues of shares capital and changes in the reserves of the Finance PLC. Financial
Institutions maintaining the return of equity above the expected market return rate in Sri Lanka. However, the
projected financial statements are continuously declining on profitability due to reduced economic activity. High
credit risk and higher loan concentration have a negative effect on profitability to firms ( Ivan D, Nazaria, Ying,
& Saad, 2018).The Sri Lanka Economic growth reduces to 2.2% as forecasted by the Asian Development Bank
under COVID 19 global pandemic (Asian Development Bank, 2020).Therefore, the above- forecasted figures
9|P a g e
20.00
15.00
10.00
5.00
-
2015/2016 2016/2017 2017/2018 2018/2019 2019/2020
Liquidity is the life and blood of a financial institution. There should be adequacy of liquidity sources comparing
to present and future needs, the availability of assets readily convertible to cash without an undue loss (Ally,
2013 ). The main objective of financial institutions is to maintain liquidity and profitability. The financial
institution does not maintain current liabilities and current assets due to non –classify of customers deposits
because customers will demand any time to cash from their deposit. Hence, the classification of assets and
liabilities in current and non - current is impractical and also the company has sufficient liquidity assets to meet
the business operations.
Liquidity Ratio to
deposits 19% 21% 19% 15% 19% 17% 18%
Liquidity assets have been increased by 1.60 Bn compared to the previous year 2019/2020. The Financial
Institution has been maintaining the liquidity ratio to deposits above industry requirements. The Company has
built strong and healthy liquidity by practicing business ethics and standard guidelines for the last 13 years.
The Current global COVID 19 has had an impact on the liquidity position of the company. A large number of
this ratio implies sufficient liquidity to meet unexpected customer’s need in cash (Guisse, 2012). Financial sector
liquidity will be impacted by the debt moratoriums issued by the Monetary Board of Central Bank of Sri Lanka,
although there is offset to some extent by a reduction in the liquidity requirements for the financial institutions
(PwC, 2020). Therefore, the Company has sustainable growth in liquidity position over a period of time and
maintaining the current ratio within the industry standard
10 | P a g e
Debt to Equity ratio 10.80 11.00 10.63 7.71 6.94 4.73 4.37
The Company has been maintaining the acceptable ratio level for times interest earned ratio from years 2016 to
2020 and it’s within the limit so that the times’ interest earned ratio is showing financial sustainability without
much fluctuating ratio. Nevertheless, the Company is maintaining a remarkable ratio on the number of times
interest earned from 1.58 to 1.50 during the last five years of business operations.
The debt ratio means the company has the ability to pay long term debts and its relatively lower ratio is indicating
financial sustainability and a more favorable situation for the business entity. The Financial institution has had
a lower –risk in debts in all the five years. Based-on the debt ratio it describes how the total assets is financed
by the debts and the Finance Company which has been continuously decreasing the level of dependence on debt
finance over a period of time. Hence, the company has been built on a strong equity capital over time by reducing
dependent on debt to run a business operation.
Market-based ratio analysis is mainly for the present and potential investor to critically analyze business entity
on the return of the investment such as capital gain and dividend. The investor is concern on the changes of share
prices, dividend and the risk in their investment. The Financial Institution has paid dividends to shareholders for
the last five years except for the year 2018/2019.
Price Earning per Share 4.35 3.35 2.84 3.23 2.52 2.48 2.51
Net Assets per Share 46.42 61.55 79.45 92.94 110.05 137.22 153.14
11 | P a g e
60 61.55
46.42
40
20
0
2015/2016 2016/2017 2017/2018 2018/2019 2019/2020
The Cash Flow statement prepared is based on comparing the balance sheet within each two-year period
including the following three elements;
Net Cash generated from Operating -392% -13258% -330% -512% 188%
Net Cash generated from Investing -11% -764% -882% -23% -13%
Net Cash generated from Financing 303% 14121% 1112% 635% -75%
Net Increase in Cash and Cash equivalents -100% 100% -100% 100% 100%
The vertical analysis on the cash flow statement on table 15 indicates relative proportions from operating,
investing and financing activities to the net cash generated during the last five years. The company has relatively
generated a small amount of cash and cash equivalents in the year 2016 /2017. The Company has reassessed
and adjusted the cash flow statement to reflect the COVID 19 impact on the loan for expected credit loss (
Finance, 2015 -2020).
12 | P a g e
Cash flow from operating activities describes the cash generated from the core operation of the business entity.
The Financial Institution has generated negative net cash flow from its operation for the last four years however,
last year the company generated positive cash flow. The negative cash flow from operating activities is often
indication of a Financial Institutions poor performance. The Company has been maintaining a strong
profitability level but the cash flow from operating activities is negative except for last year 2019/2020 it the
positive.
18%
-19%
-32% -27%
-4%
Table; 16 is showing net cash generated from operating activities from the last five years. The main clause for
the negative cash flow from operation is due to the high amount of amortization on finance assets including
advanced loan and hire purchases.
Operating Cash flow/ Interest Income -68% -63% -6% -45% 22%
Free Cash Flow *** (24.19 Bn) (34.12Bn) (16.52 Bn) (40.88 Bn) 19.97 Bn
*** Free Cash Flow = Cash flow from operating activities minus capital expenditure.
The free cash flow to the organization was negative for the first four years of operation but in the year 2019/2020
free cash flow changes into a positive figure amounting to $ 19.97 Bn. The net increase in cash and cash
equivalents had been fluctuating with a negative and positive figure. Financial Institution had positive figures in
2016/2017, 2018/2019 and 2019/2020 whereas other years are in a negative figure. Therefore, the Cash flow
from operating activities has deteriorated at the beginning but it had improved down lines.
13 | P a g e
The Cash flow from investing activities is surplus which cash invested into investment portfolios has generated
extra income to the business entity. The Company has generated negative cash flow from investing activities for
the last five years where the Company has invested significant amounts of cash for long-term health investment.
The negative cash flow from investing activities is not a bad sign to the investor. The Company has invested
amounting to $ 12.03 Billion in the year 2017/2018 and it’s the biggest negative cash generated from the
investing activities for the last five years due to building 16 –story new headquarters building at prime business
location Colombo 03. Therefore, the Cash for investing activities exposures a healthy position of Finance PLC.
Cash flow from financing activities describes cash movement between shareholders, lenders and business
entities. The Company has been maintaining positive cash flow from financing activities for the last four years
which means there are increases in the company assets for the same periods. However, the year 2019/2020,
Financial Institution generated negative cash from the financing activities due to dividend payments to the
shareholders and servicing debts. Therefore, a potential investor will have a strong believe in the Company
capital structure in reduction on the debt capital and an increase in the equity for capital holders.
Table: 18 indicates cash flow from operating activities contributing to a positive figure of 68% to the net cash
generated for the year while net cash-generating from financing and investing activities resulted in a negative
figure. However, The Company has ended up with positive cash flow generated during the year 2019/2020 due
to exceptional performances on the operating activities.
14 | P a g e
Company Valuation is the valuation of equity capital than debt capital and equity holder who is the owner of the
business entity. The objectives of valuation in Companies are taking place for different purposes. The valuation
result are company indicators than directions. The author of this article has performed the valuation of Financial
Institution for potential acquisition decisions. The following are traditional methods (Static view method) of
equity valuation of the Company.
The above valuation methods are based on certain assumptions and these valuation methods will be selected
depending on the availability of information. Hence, the different valuations will arise with different prices until
it finally arrives at an average price that is compromised between the different valuations. The valuation of
Company equity is called art and not science since we cannot compute the answer accurately at 100 % for the
valuation. Company Valuation is not a precise science and is affected by bargaining skills, psychological factors
and financial pressures (ACCA, 2019).
Book valuation is based on the historical valuation method without incorporating the current market value of the
assets. Book Valuation starts with net assets of the business, in other words total assets excluding intangible
assets minus current liabilities is equal to the net assets of the business entity. Assets valuation, to be realistic
and valuation of individual assets is based on going concern or break up basis.
Example; The summary statement of the financial position of XYZ Ltd is as follows.
Goodwill 20,000
Current Assets
Inventory 80,000
Receivables 60,000
Current Liabilities
15 | P a g e
Taxation 20,000
340,000
Non-Current Liabilities
340,000
Required: The Value of an ordinary share using the net assets basis of valuation.
Bonds 60,000
16 | P a g e
The dividend valuation models involve the present valuation of the future dividends. This valuation is generally
more relevant to the small equity holders than the entire equity valuation to the business entity (CA, 2015). The
Dividend valuation method is based on an equilibrium price for a share in the stock market and future expected
income stream, discounted at an expected market rate of return. The assumption of this model that the expected
dividend will have constant growth throughout the period of time.
Po = do (1+g)
(ke –g)
Example: May Bank Ltd paid a dividend of $ 3.24 per share. The bank has an expected dividend growth rate of
8%. The appropriate cost of capital rate is 15%.
The constant dividend growth model is having a certain drawback as it’s difficult to estimate the future dividend
growth and the unrealized assumption that the growth will be constant.
The highest business valuation is usually calculated by valuing the earnings. The price - earnings ratio (P/E ratio)
which shows the share market’s view of the growth prospects of a company (CA, 2015). Price /Earnings ratio is
more suitable for the public quoted Company and it’s very difficult for unquoted Company valuation. The P/E
ratio consists of expected required rates of return, expected dividend growth and this ratio can be exclusively
used for the investor.
17 | P a g e
The problems with using the P/E ratio such as a similar range of activities and the diversification of quoted
Company cannot be realized as a benchmark for unquoted company. Therefore, the P/E ratio indicates the growth
and the potential of a Company.
Example: SPA Ltd has earned profit after tax $ 5.60 Mn and P/E ratio 16. If SR Ltd P/E is currently 21.20
and it anticipates in turning SPA Ltd around so that it shares SR Ltd growth prospects, Calculate the value of
SPA Ltd in $ Mn.
SR Ltd.’s P/E ratio is higher, indicating higher growth prospects. If SPA Ltd can be turned around and will
share these growth prospects, then its earnings of $ 5.60m will have a total value of $ 118.7 M (5.60 X 21.20).
Free cash flow means the cash available for payment to investors including equity and debt holders (ACCA,
2019) and the free cash flow to equity is cash available for payment to shareholders. Free cash flow models can
be used under circumstances where dividend payments or less dividend payments are made to the shareholders.
The FCFF valuation approach estimates the value of the firm as the present value for future FCFF (Free Cash
Flow Firm) discounted at the weighted average cost of capital (WACC) (Kuhlemever, 2009). The free cash flow
will be increased due to the acquisition of the new company due to the synergies effect. Therefore, free cash
flow can be considered for the shareholders’ valuation.
OR
Free Cash Flow = Net Income –Capital Expenditure - Increase in Working Capital + Non –Cash expenses.
Example: XYZ Ltd had a net income $ 2,000, Capital expenses $ 600, non-cash expenses $ 300 and increase
in working capital $ 250.
Description $
18 | P a g e
The balance sheet or Net Assets valuation of Finance PLS has calculated based on the assumptions that assets
are historical values and intangible assets are not included in the net asset’s valuation.
Description Valuation
Market Valuation
No of Shares 58,863,350
100
80
60
40
20
0
2015/2016 2016/2017 2017/2018 2018/2019 2019/2020
The above graph is showing a continued increase in book value per share while market price is fluctuating
between years. The Company is having a strong base for the book value for the shares.
19 | P a g e
The Valuation of Financial Institution on the constant dividend growth model-based assumes that the Company
has constant growth over a period of time. The expected rate of return has adjusted with extra risk premium due
to Finance Company is a highly risky business.
Description Valuation
g 16%
The Price based on constant dividend growth is more than the market price and we will assume that current
market price arises based on the current valuation on the dividend growth model.
P/E ratio is the earnings–based valuation method and more suitable for quoted public company.
Description Valuation
Free cash flow can be calculated in a different way by using the cash flow from operating activities, minus
capital expenditure.
Description Valuation
20 | P a g e
The different valuation methods can provide a different answer so that the only options are available to arrive at
the average price. The above four valuations can be applied under different circumstances and also the potential
investor has to consider the quality factors and other risk factors before arriving at the final decision on
acquisition.
Description Valuation
The Author of this article has based on the above calculations to arrive at the final average valuation
amounting to $ 80.00/- on the negotiable table between two parties.
100
80
60
40
20
0
Book Value per Dividend P/E Valuation Free Cash Flow Average Final
Share Growth Model per share Value per Share Valuation per
per share Share
The above graph indicates the relationships between different valuation of shares and the average final
valuation per share.
21 | P a g e
Acquisition can be a risky decision made at the corporate world so any acquisition decision, needs to be evaluated
with due diligence so it can protect the buyer from risky business deals (Downs, 2020). Due diligence will take
place at the final stage before the formal announcement for acquisition. Due diligence is an audit or investigation
of a potential investment to confirm facts that may have a direct impact on the buyer’s decision to acquisition
(Downs, 2020). The due diligence procedures can be helpful to the buyers to adjust expectations of the buying
company, information and documents gathered during the due diligence procedures that can be used during
negotiations between the two parties. Corporate organizations owe a duty to fully disclose matters concerning
their operations so as to aid investors in marking investment decisions ( Blessing & l E. Onoja, 2015). Therefore,
the Company may fail to disclose the material fact which can affect the buyers’ decision in an adverse manner
so that due diligence must be performed during the acquisition. Financial Institution has a comprehensives
corporate governance in places including various committees and ethics standards for the Board of Directors and
senior management.
Qualitative factors for valuation are equally important for decision marking and they are more complex to be
evaluated. So that not – so –tangible factors that also impact the valuation of the business (qualitative factors
in valuation, 2020). The ABC Board of Directors can be considering the following ten qualitative factors for the
acquisition of Finance PLC.
Company Core Business The Company has been in existence for the last 13 years
and the main revenue generated is from interest income.
The Company has been maintaining a constant profit
margin over a period of time.
Customers and Geographic exposure Lending customer base 62,345 and deposit customer 8,425
and 40 Network Branches except for North and Eastern
Province ( Finance, 2015 -2020) p 33
Competitive Advantage Most innovative Finance product for the year 2020 and
brand image for the innovative financial product ( Finance,
2015 -2020)
Industry growth trends Increase in the lending portfolio and customer deposit and
now assets base 50 Billion.
Competitive analysis The license finance and specialized lease Companies sector
comprised of 42 and 4 respectively with 1,432 branches
and 599 services centers (Lanka, 2019).
Market share More innovative finance product and in the top ten finance
Company.
22 | P a g e
The above qualitative factors are disclosed in the annual article of Financial Institution for the year 2019/202 so
that the Company is having the sustainable competitive advantage based on the above qualitative factors.
The traditional valuation methods are a static approach to the business environment so decisions cannot be made
in a dynamic business environment. The traditional valuations are not dynamic and also without practical
context. Therefore, options-based valuation has incorporated limitation in the traditional valuation methods.
Optional –based valuation is an attempt to incorporate real-life uncertainty and flexibility into the capital
investment decision (CA, 2015). Black –Scholes has developed a valuation model on options –based valuation.
Real Options
Option to delay
Option to expand
Could mean that valuable
If successful, other new business information
projects will follow is available.
due to brand name or
technology Option to redeploy Option to
withdraw
Assets can be switched from
one project to another Easy to sell assets
if the project fails
The above table diagram describes the real options available for the investor under the Black –Scholes option
valuation model. The result of the Black –Scholes Option (BSOP) valuation can be incorporated into the
23 | P a g e
The author of this article is highly recommending to delay the investment decision based on options–based
valuation model and the current economic situation in Sri Lanka and also in the global context. The author of
this article has made the assumption that the ABC Company has an exclusive right on the acquisition project to
execute the option to delay based on the real options theory. In this context, smarter decision markers always
think in a totally different corner before making the final decision.
8. Conclusion
24 | P a g e
The Liquidity ratio is paramount for the financial institution and in maintaining the minimum liquidity reserve
with the Central Bank of Sri Lanka. The Solvency ratio is to measure the long-term going concern of the
Company without any interruption from the debt capital and equity capital. The calculated accounting ratios on
the solvency are acceptable ratios within the Licensed Finance Company & Specialized lease Company sectors.
The Shareholder ratios are a more favorable situation for the present investor and also the analysis of the Cash
flow statement indicated that the Company has generated sufficient cash and cash equivalent to meet business
operations. However, net cash flow from operating activities and free cash flow in the negative figures for the
years 2016 to 2019.
The present traditional financial calculation results are more favorable for the investment but the author of this
article is highly recommending to delay the investment decision - based on the current economic situation in Sri
Lanka and global context. The author of this article is making an assumption that the acquirer Company has an
exclusive right on the acquisition project. In this context, smarter decision markers always think in a totally
different corner before making the final decision. The author of this article outlines the following reasons to
delay the investment decision; The Gross Income will be reduced in the future due to the Debt Moratoriums
issued by the Monetary Board, Central Bank (Annual report p 253). Sri Lanka economic growth is slowly
declining to 2.20%. The Company expansions plan, increase risk factors on non –performing loan ratio, increase
in costs of operations, and the reduction on the growth of deposit and lending portfolios (credit issues) will
impact the profitability of the Company.
The external environment pressures are the foreign exchange rate, interest rate fluctuations, rising inflation rate.
Investor and business confidence decline on current political instability and global COVID 19 impacts on the
finance sector.
Based on the above operating environment, the company will have a rippling negative effect on their income
due to Sri Lanka and global economic growth will slow down. Therefore, The Company will have a negative
impact due to cascading effects and also negative signs in the industry.
The investor can delay investment decision on the Financial Institution due to the negative effects from the
operating environment and unpredictable economic activities in Sri Lanka and global context.
9. References
25 | P a g e
Adam, M. H. (2014). Evaluating the Financial Performance of Banks Using Financial Ratios- A Case Study of
Erbil Bank for Investment and Finance. European Journal of Accounting Auditing and Finance Research ,
162-177.
Afagh, M., Mohammadi, M., & Nassivi, F. (2012). Comparison of Malaysia Manufacturing Companies by
Financial Statement Analysis tools. Academica Science Journal, 89-94.
Asian Development Bank, A. D. (2020, April 3). COVID-19 Clouds Sri Lanka's Growth Prospects — ADB.
Asian Development Bank. Colombo, Western, Sri Lanka: Asian Development Bank.
Bezawada , M., & Sudhir, B. (2020, July 14). An empirical study on Financial performance of "the tirupati
Cooperative Bank Limited . Retrieved from ssrn: https://ssrn.com/abstract=2345890
Blessing , A., & l E. Onoja, E. (2015). THE ROLE OF FINANCIAL STATEMENTS ON INVESTMENT
DECISION MAKING: A CASE OF UNITED BANK FOR AFRICA PLC (2004-2013). European Journal of
Business, Economics and Accountancy, 12-37.
CA, S. (2015). KC 2 Corporate Finance and Risk Management . London: BPP Learning Media Ltd .
Downs, B. (2020, July 25). Due Diligence in Mergers and Aquisitions. Retrieved from Business Benefits
Group : www. bbgbroker.com/due diligence in Mergers and Acquisitions
Finance, A. (2015 -2020). Annual Articles 2015 to 2020 Finance PLC. Colombo: Finance PLC.
Giddy, I. (2000). Option-Based Corporate Valuation. Option-Based Corporate Valuation. New York, United
States of America : NYU Stern School of Business New York University.
Giddy, P. I. (2000). Option -Based Corporate Valuation . Option -Based Corporate Valuation . New York ,
NYU, USA : New York University .
Guisse, M. L. (2012, June). Financial Performance of the Malaysian Banking Industry: Domestic vs Foreign
Banks. Gazimağusa, North Cyprus, Cyprus: Eastern Mediterranean University.
Ivan D, T., Nazaria, M. A., Ying, Y., & Saad, K. Y. (2018, March 30). Determinants of Commercial Banks’
Profitability in Malaysia. Retrieved from Munich Personal RePEc Archive: https://mpra.ub.uni-
muenchen.de/85598/
Jayasekara, S., & K. L. (Journal of Research in Emerging Markets). Empirical studies on the performance of
banks: A systematic literature review for future research. Journal of Research in Emerging Markets, 1-20.
Nouman, M., Kamran, K. M., & Muhammad, I. (2017, September 30). Determinants of financial performance
of financial sectors (An assessment through economic Value added). Retrieved from Munich Personal RePEc
Archive: https://mpra.ub.uni-muenchen.de/81659/
PwC. (2020). COVID-19 Outbreak Impact on Sri Lanka and Recommendations. Colombo :
PricewaterhouseCoopers (Private) Limited.
26 | P a g e
S G Sisira Dharmasri Jayasekara, Perera, K. L., & Ajward, A. (2018). Fair Value Accounting Practices and
Financial Performance of Commercial Banking Industry. World Journal of Social Sciences, 106 -121.
van Greuning, J., Henry, E., & R. Robinson, T. (2011). Financial Analysis Techniques. In Financial Analysis
Techniques (pp. 272-342). USA : CFA Institute .
Workbook, A. (2020). Advanced Financial Management . London : BPP Learning Media Ltd .
27 | P a g e