Introduction to Financial Management

Understanding of Accounting and Financial Management and the key elements and structure of
financial statements

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Table of Contents
Introduction............................................................................................................................................1
What is Accounting and Financial Management?..............................................................................1
Key Elements of the Financial Statements..........................................................................................1
Profitability Ratio, Earnings Capacity Ratio, and Assets efficiency Ratio:.................................2
Liquidity ratios:.................................................................................................................................3
Gearing ratios:...................................................................................................................................4
The Limitations of Ration Analysis......................................................................................................4
Conclusion..............................................................................................................................................4
References...............................................................................................................................................5

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Introduction
A sustainable business needs excellent planning and financial management. Ratio analysis is
a powerful management technique that may help a business better comprehend financial
outcomes and patterns over time as well as give crucial indications of organizational
effectiveness (Berk et al., 2013). Managers use ratio analysis to identify strengths and
weaknesses in order to develop plans and strategies (Besley and Brigham, 2014). Investors
may use ratio analysis to compare company’s performance to those of other firms or to make
judgements about management effectiveness and mission impact. Ratios must be calculated
using dependable, accurate financial data in order to be relevant and meaningful. Compare
internal benchmarks and goals to those of other businesses in the industry. Carefully
evaluated in the appropriate context, given the numerous other relevant aspects and
indications involved in evaluating success. This report will describe about the accounting and
financial management, key elements of the financial management, ratio analysis and the
limitation of the ratio analysis.

What is Accounting and Financial Management?

Accounting is an information system in which a firm recognizes its transactions, records and
organizes them, analyse them, and makes them available to the company's intended users
(Gitman et al., 2015). Companies use accounting to make short- and long-term financial
decisions. Accounting assists managers in making strategic decisions by increasing
operational efficiency and long-term investment plans (Jensen et al., 2015). Managerial
accounting monitors, forecasts, and tracks a company’s performance. It guarantees that actual
outcomes are within the budgets and expectations laid forth at the start.
Financial management is a fundamental function in every business. It is the planning,
arranging, managing, and monitoring of financial resources to meet organizational objectives
(Libby et al., 2014). It is a great method for regulating an organization's financial operations
such as fund procurement, fund use, accounting, payments, risk assessment, and anything
else linked to money (Moeti et al., 2017). Financial management enables managers to
employ management techniques similar to those used in company management to assure total
control over money and greater corporate performance. The financial management system's
data transparency enables business owners to make informed budgeting and investment
decisions.

Key Elements of the Financial Statements

Financial statement components are basic groups of line items provided within the statements
(Parrino et al., 2011). These divisions will differ based on the business's structure. As a result,
the features of a for-profit company's financial statements differ from those of a non-profit
company's financial statements (which have no equity accounts). The key elements of the
financial statements are assets, liabilities, revenues, expenses, and shareholder’s equity.
Assets: An asset is a piece of property or equipment bought solely or mostly for company
usage (Ross et al., 2018). They can also be intangible assets, such as intellectual property.
The balance sheet itemizes and values business assets. They are presented in order of
liquidity and at historical cost.
Liabilities: A liability is a debt that a person or corporation owes to another party, generally
in the form of money (Scott and O'Brien, 2013). Liabilities are paid over time by the
transmission of economic advantages such as money, products, or services. Liabilities are

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loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accumulated
costs, which are all recorded on the right side of the balance sheet.
Equity: Shareholders' equity (or owners' equity for privately held companies), represents the
amount of money that would be returned to a company's shareholders if all of the assets were
liquidated and all of the company's debt was paid off in the case of liquidation (Warren et al.,
2020). In the case of acquisition, it is the value of company sales minus any liabilities owed
by the company not transferred with the sale. Equity in a balance sheet represents the
shareholders' ownership of the company.
Revenue: The sales of services or goods to clients result in a gain in assets or a drop in
liabilities (Weygandt et al., 2019). It is a measurement of the gross activity created by a
company. Product and service sales are two examples. Revenues are reported on the income
statement.
Expenses: The depreciation of an asset as it is utilized to produce revenue (Wild et al., 2017).
Interest expenditure, compensation expense, and utility expense are a few examples. The
income statement includes expenses.
Profitability Ratio, Earnings Capacity Ratio, and Assets efficiency Ratio:
Profitability ratio is used to learn about of the capability of making profit of a company (Berk
et al., 2013). That is how the stakeholders of the company learn that if the company is
actually making profit of not. Gross profit ratio, profit margin ratio, net profit ratio and return
of investment (roi) are the most known profitability ratios (Besley and Brigham, 2014).
Earnings capacity ratio is used to learn about the capacity of earning power of a company.
Return of equity is one of the most known earnings capacity ratios. Assets efficiency ratio
shows how well a company use their assets internally (Gitman et al., 2015). One of the most
known assets efficiency ratios is asset-turnover ratio.
Earningsbefore Interest∧Tax (EBIT )
Return on Investment (ROI) = x 100
Total Assets
£ 12,000,000
= x 100
£ 400,000,000
= 3%
The return on investment (roi) of Star Ltd is 3% which is less than the average roi in the
industry (5%).
Gross Profit
Gross Profit Ratio = x 100
Net Revenues
£ 20,000,000
= x 100
£ 100,000,000
= 20%
The gross profit ratio of Star Ltd is 20% which is more than the average gross profit ratio in
the industry (15%).
Earningsbefore Interest∧Tax (EBIT )
Profit Margin Ratio = x 100
Net Revenues

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 £ 12,000,000
= x 100
£ 100,000,000
= 12%
The profit margin ratio of Star Ltd is 12%.

Net Profit
Net Profit Ratio = x 100
Net Revenues
£ 9,000,000
= x 100
£ 100,000,000
= 9%
The net profit ratio of Star Ltd is 9% which is more than the average net profit ratio in the
industry (8%)
Net Profit
Return on Equity (ROE) = ' x 100
Owner s Equity
£ 9,000,000
= x 100
£ 100,000,000
= 9%
The return on equity (roe) of Star Ltd is 9% which is less than the roe in the industry (12%).
Net Revenues
Assets Turnover Ratio =
Total Assets
£ 100,000,000
=
£ 400,000,000
= 0.25
The assets turnover ratio of Star Ltd is 0.25 which is less than the assets turnover ratio
in the industry (1.6)
Liquidity ratios:
Liquidity ratio helps to understand the amount of current assets and current liabilities, ability
to pay the short-term debt off, and the amount of working capital of a company (Jensen et al.,
2015). Current ratio and acid test ratio are most known liquidity ratios. The average current
ratio is 1.5 and average acid test ratio is 1.1 in the UK’s ai market. The current ratio and acid
test ratio of Star Ltd is calculated below;
Current Assets
Current Ratio =
Current Liabilities
£ 200,000,000
=
£ 180,000,000
= 1.11
The current ratio of Star Ltd is 1.11 which is less than the average current ratio in the
industry.

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 Quick Assets
Acid-Test Ratio =
Current liabilities
Current Assets−Inventories
=
Current liabilities
£ 200,000,000−£ 60,000,000
=
£ 180,000,000
= 0.78
The acid-test ratio of Star Ltd is 0.78 which is less than the average acid test ratio in
the industry.
Gearing ratios:
Gearing ratios compare the total amount of debt with the total amount of Equity (Libby et al.,
2014). To calculate gearing ratio, total amount of debt is needed to divide by the total amount
of equity. The average gearing ratio in UK ai industry is 2:1. The gearing ratio of Star Ltd is
calculated below:
Total Debts
Gearing Ratio =
Total Equities
£ 300,000,000
=
£ 100,000,000
= 3:1
The gearing ratio of Star Ltd is 3:1 which is more than the average gearing ratio in the
industry.

The Limitations of Ration Analysis

There are some limitations in ratio analysis.
1. The data utilized in the research is based on actual previous results published by the
company. As a result, ratio analysis indicators may not always accurately predict
future firm success.
2. Companies publish financial analyses on a regular basis. If there has been inflation
between periods, actual prices are not represented in the financial accounts. As a
result, figures from various periods are incomparable unless they are corrected for
inflation.
3. The operational structure of a firm can change substantially, from its supply chain
strategy to the product it offers. When a company undergoes significant operational
changes, comparing financial measurements before and after the change may result in
incorrect assumptions about the company's success and prospects.
4. An analyst should be aware of seasonal effects that may restrict ratio analysis. Unable
to account for seasonality effects in the ratio analysis may lead to an inaccurate
interpretation of the study results.
5. Ratio analysis is based on the information disclosed by the firm in its financial
statements. Management may modify this data to reflect a better outcome than its true
performance. As a result, ratio analysis may not properly reflect the true character of
the firm, because the basic analysis does not discover manipulated information
(Warren et al., 2020). It is critical for an analyst to be aware of these potential
manipulations and to do sufficient due diligence before making any conclusions.

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Conclusion
In conclusion, ratio analysis demonstrates the financial condition of a company. If a company
makes enough profit, if it has enough working capital to execute its short-term transaction
like short-term debt paying off, if the company uses its assets effectively and efficiently
internally can be known from the ratio analysis. Investors, management, and creditors can
make critical financial decisions very easily by studying the ratio analysis. In this report, the
ratio analysis of Star Ltd, a UK based ai producing company, is studied. Here, this company
is well profitable company. But the company does not have sufficient amount of liquid assets
to execute the short-term transaction like short-term loans paying off. The return on both the
investment and equity is lower than the average ratio in the industry. So, the company should
be careful about this short-comings and take necessary steps to resolve the problems and raise
their ratio than the average rate in the market.

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References

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of corporate finance. Pearson Higher Education AU.
Besley, S. and Brigham, E.F., 2014. Principles of finance. Cengage Learning.
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
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Jensen, T., Popowich, W., Hurley, S., Koumarelas, R.S. and Meacher, R., 2015. Fundamental
accounting principles. W. Ross MacDonald School Resource Services Library.
Libby, R., Libby, P.A., Short, D.G., Kanaan, G. and Gowing, M., 2014. Financial accounting
(p. 140). McGraw-Hill/Irwin.
Moeti, K., Khalo, T. and Mafunisa, J. eds., 2017. Public finance fundamentals. Juta and
Company Ltd.
Parrino, R., Kidwell, D.S. and Bates, T., 2011. Fundamentals of corporate finance. John
Wiley & Sons.
Ross, S.A., Westerfield, R. and Jordan, B.D., 2018. Fundamentals of corporate finance. Tata
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Scott, W.R. and O'Brien, P.C., 2013. Financial accounting theory (Vol. 3, pp. 141-143).
Toronto: prentice hall.
Warren, C.S., Jonick, C. and Schneider, J., 2020. Financial accounting. Cengage Learning.
Weygandt, J.J., Kieso, D.E., Kimmel, P.D., Trenholm, B., Warren, V. and Novak, L., 2019.
Accounting Principles, Volume 2. John Wiley & Sons.
Wild, J.J., Shaw, K.W., Chiappetta, B., Dahawy, K. and Samaha, K., 2017. Fundamental
accounting principles (p. 1216). McGraw-Hill.

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