Topic 2

FINANCIAL STATEMENT

EVALUATION

O U TLIN E
1. The fin.& nonfinancial objectives for
org.
2. 3 key financial management
3. Benefits of matching characteristics
of investment and financing in the
longer term
4. Dividend decisions.
5. External and internal constraint
2

A .Form ulation of F.
Strategy
2. Evaluate the financial strategies and

objectives of an organisation and the extent

of their attainment
(a) identify an organisations objectives in financial terms
(b) evaluate the attainment of an organisations financial

objectives
(c) evaluate current and forecast performance taking account
of potential variations in economic and business factors
(d) evaluate alternative financial strategies for an organisation
taking account of external assessment of the organisation by
financiers and other stakeholders, including likely changes to
such assessment in the light of developments in reporting.

Sum m ary for Form ulation ofFS

PART 2
1. Economic forces in FS formulation-int, taxes, exc
rates.
2. Assessing attainment-using ratios etc.
3. External assessment-credit worthiness &
compliance with agreement etc.
4. Modeling & forecasting cash flow/ f. statements
given set of scenarios.
5. Sensitivity to changes.
6. Implications to other objectives eg. Dividends
7. Current or emerging issues eg. Environmental
reporting etc.
4

Evaluating fi
nancialstrategies

Attainment
Current

ratios
Forecasts
statements:
Alternatives

using financial
forecast financial
P&L, F. Position & CF
variation & fin

factors
5

Perform ance appraisal

Ratios

Examples

Profitability

Profit margin, ROE, ROCE, Assets turnover

Liquidity

Current, Quick, Inventory turnover, Receivables

turnover,

Gearing

Capital gearing/debt ratio, interest cover

Stock market

Market price, EPS, P/E ratio, earnings yield,

dividend yield

Ratio
Liquidity

Profitability

Gearing

MKT

Indication

CR, Acid Test

CA/CL, C+MS+Rec/ CL

ST debt paying
ability

Rec TO, Rec

collection
Inv TO, Inv
selling period

Net c.sales/A.A/R,
365/Rec TO
COGS/ A.INV, 365/Inv
TO

Liquidity of
assets

GPMargin

Gprofit/Rev * 100

High PM is good

ROCE

O.profit/Cap employed
*100

Mgt efficiency in

ROE

Net profit/Equity *100

generating profit

Assets TO

Rev/ Cap E or Rev/

NCAssets

How much rev

generated with

Cap.gearing

Debt/E *100 or
Debt/Debt+E*100

Measure of risks

Interest cover

PBIT/Int payable

Debt ratio

LTDebt/TA

P/E ratio

Current price/EPS

Investor
confidence

Earnings yield

EPS/SP

Future earnings
power

Creditor
protection
..

W orking capital
m anagem ent
Working capital
capital available to conduct day to day
operations of an entity.
Working capital management
Managing of working capital is the
administration of current assets and current
liabilities.
Effective management of working capital
ensures that the organisation is running
efficiently and therefore saving on costs.
8

Liquidity vs profi
tability in W C
m anagem ent
ASSETS/
LIABILITY

Benefits of

Benefits of

CASH

High cash level

Available cash for sudden
surge
Easy to pay debts

Low cash level

More cash can be
invested
High profitability

RECEIVABLE
S

Longer credit term

Customer would like, increase
potential sales & profitability

shorter credit term

High turnover,
increase liquidity

INVENTORY

High inventory level:

Few stock outs
Good for sales, profitability

Low inventory level:

Less cash tied up in
inventory costs, high
cash liquidity

PAYABLES

Taking extended credit

Preserves own cash & cheap
financing, high liquidity
Lenders may be unhappy

Adhere to term
Lenders are contentgood relationship &
few disruption
9

Policies for W C m anagem ent

3 types of policies exist:
1. Conservative policy
Funding: All permanent current assets & fluctuation
in current assets are financed by long-term funding.
-have large inventory.
2. Aggressive policy
Funding: short term fund for all fluctuation &
permanent part of current assets.
-Hold minimal inventory
3. Moderate policy- In between
10

Com parison betw een W CM

appr
Benefitsoaches
: Aggressive
Conservative approach
approach
1. Lower level CA->lower fin
costs.

1. Lower liquidity risk.

2. Lower fin const-> better

profitability.

2. Greater ability to meet

sudden surge in sales demand

3. Quicker cash t/over -> allow

more reinvestment.

3. More relaxed credit policy

may improve sales.

4. More reinvestment ->expand

quickly.

***The more conservative the approach, the

lower the risk, but higher the cost in terms of
money tied up in working capital.
11

M easuring W C cycle
Length of cycle
Time between paying out cash for

purchases to receiving cash in sales,

calculated as:
Av. Inv

+ Av. Receivables - Av.

Payables
holding
collection
***The longer the operating cycle, the more
payment
financial
resources the entity needs.
period
period

12

D ecision on W CM
Decision on WCM depends
1. Industry & firms customer
expectation.
2. Type of product sold- perishable vs
durable
3.Manufactured or. ready made
manufacturing firm have higher
level of inv.
4. Level of sales
***Balancing
between
profitability & liquidity:
5.
Inventory
management
Shortening o.cycle may improve liquidity but can
reduce profitability
13

W ays to shortened o.cycle

1. Reduce raw material stocking.
2. Obtain more financing from suppliers by
delaying
payments.
3. Reduce WIP
4. Reduce FG Inventory
5.Reduce credit given to customers

14

O vertrading (O T)
Condition when entity enters into

commitment in excess of its

available short term resources. This
can arise even an entity is trading
profitably & is typically caused by
financing constrains imposed by a
lengthy operating cycle or production
cycle.
Undercapitalised new entities are
prone to suffer from OT.
15

Sym ptom s ofO T

1. Fall in liquidity ratios
2. Rapid increase in revenue
3. Sharp increase in Sales/non- current assets
ratio.
4. Increase in inventory in relation to revenue
5.Increase in A.rec
6. Increase in acct. payable period
7. Increase in s/term borrowing and a decline in
cash balances
8. Increases in gearing
9. Decrease in profit margin.
16

Potentialrem edies for O T

1. Introduce new
capital
2. Reduce
distribution
3.Cut cost

4.Factoring/
discounting Acct.
Receivables
Lease or hire
purchase assets

Ex. Overdraft, negotiable

but can be risky, issue new
shares or Long term loan
Not welcome by
shareholders,
Less salary/bonus
Ex. Reduce expenses
Delaying capital
expenditures
Quick cash but lesser
amount.
Alternatively can have a
sales and leaseback

17

M ultinationalW CM
Objectives:
1. Ensure fast collection of cash
2. Take longer to pay out cash
3.Optimise cash flow within the entity
4. Generate best return on cash
surpluses.
Other risks involved:
Default, interest, exchange, political
18

Financing options
Long term
financing
1. Equity
2. Preference
shares
3. Loans/bonds/
sukuk

Short term financing

1. Bank overdraft
2. Term loan
3. Money market
borrowings
4. Revolving credit
facilities
5. Supplier credits,
supply chain financing

19