Strategic Finance

By:
Dr Imamuddin Khoso
(PhD, Japan), (Post Doctorate, Canada)
Director IBA, University of Sindh Jamshoro

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Outlines

 Financial Statements
 A Possible Framework for Analytical
Perspective
 Financial Ratios

 Trend Analytical Perspective

Common-Size and Index Analytical
Perspective
 Finance defined

 The body of facts, principles, and theories relating to the

raising and using of money by individuals, businesses,
and governments.
 It is the art of creating and managing money.
 Strategic finance  refers to study of finance with a long
term view considering the strategic goals of the enterprise.
Financial management is nowadays increasingly referred
to as Strategic Financial Management so as to give it an
increased frame of reference.

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 Nobel laureates in Finance

 Harry Markowitz is the father of modern portfolio

theory, the scientific study of how to trade of risk and
reward and choosing among risky investments.
 William Sharpe showed that a very specific
structure must exist on risky assets through (Capital
Asset Pricing Model).
 Modigliani-Miller (M&M) showed that how
financing policies (capital structure) affect the total
value of a firm.
 Robert C. Merton discovered a mathematical
formula for the pricing of options and derivative
securities.
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 Major Decisions of Finance

 Investment Decision
 Financing Decision
 Asset Management Decision

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Work of Management

Planning
Planning
Directing
Directing and
and
Motivating
Motivating

Controlling
Controlling
 Challenges to Financial Manager

 Heightened corporate competition, globalization,

technological change, volatility in interest rates and
inflation, fluctuating exchange rates, tax law changes,
and ethical concerns over certain financial dealings must
be dealt with almost daily.
 Agency problem
 If you become a Financial Manager, your ability to adapt
to change, raise funds, invest in assets, and mange
wisely will affect the success of your firm and, ultimately,
the overall economy as well.
 It is indeed a time of both challenge and opportunity.

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 Business Ethics and Corporate
Social Responsibility (CSR)
 Wealth maximization does not preclude the firm from being
socially responsible.
 Assume we view the firm as producing both private and
social goods.
 CSR such as protecting the consumer, paying fair wages to
employees, maintaining fair hiring practices, safe working
conditions, supporting education, and becoming involved in
such environmental issues as clean air and water.
 Sustainability: Meeting the needs of the present without
compromising the ability of future generations to meet their
needs.
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 Examples
Examples of
of External
External Uses
Uses of
of
Statement
Statement Analysis
Analysis

 Trade Creditors -- Focus on the liquidity of the

firm.
 Bondholders -- Focus on the long-term cash
flow of the firm.
 Shareholders -- Focus on the profitability and
long-term health of the firm.
 Examples
Examples of
of Internal
Internal Uses
Uses of
of
Statement
Statement Analysis
Analysis

 Plan -- Focus on assessing the current

financial position and evaluating potential
firm opportunities.
 Control -- Focus on return on investment for
various assets and asset efficiency.
 Understand -- Focus on understanding how
suppliers of funds analyze the firm.
 Star Corporation Balance Sheet
(thousands) Dec. 31, 2013
Cash and C.E. $ 90 Notes Payable $ 290
Acc. Rec. 394 Acc. Payable 94
Inventories 696 Accrued Taxes 16
Prepaid Exp 5 Other Accrued Liab. 100
Accum Tax Prepay 10 Current Liab. $ 500
Long-Term Debt 530
Current Assets $1,195 Shareholders’ Equity
Fixed Assets (@Cost) 1030 Com. Stock ($1 par) 200
Less: Acc. Depr. (329) Add Pd in Capital 729
Net Fix. Assets $ 701 Retained Earnings 210
Investment, LT 50 Total Equity $1,139
Other Assets, LT 223 Total Liab/Equity $2,169
Total Assets $2,169
Star Corporation Income Statement (in
thousands) for Year Ending December 31, 2013

Net Sales $ 2,211

Cost of Goods Sold 1,599
Gross Profit $ 612
Oper.Expenses 402
EBIT $
210 Interest Expense
59 EBT $
151 Income Taxes 60
EAT $ 91
Cash Dividends 38
Increase in RE $ 53
 Framework
Framework for
for Financial
Financial Analysis
Analysis

Trend / Seasonal Component

How much funding will be
1. Analysis of the funds
needs of the firm.
required in the future?
Is there a seasonal component?
 Framework
Framework for
for Financial
Financial Analysis
Analysis

1. Analysis of the funds
needs of the firm.
2. Analysis of the financial
condition and profitability
of the firm.
Health of a Firm
Financial Ratios
1. Individually
2. Over time
3. In comparison
 Framework
Framework for
for Financial
Financial Analysis
Analysis

Business risk relates to

the risk inherent in the
1. Analysis of the funds
needs of the firm.
operations of the firm.
2. Analysis of the financial Examples:
condition and profitability
of the firm. Volatility in sales
3. Analysis of the business Volatility in costs
risk of the firm.
Proximity to break-even
point
 Framework
Framework for
for Financial
Financial Analysis
Analysis

A Financial
Manager
1. Analysis of the funds must
needs of the firm. Determining
the consider all
2. Analysis of the financial Financing capacity/ three jointly
condition and profitability needs of
of the firm. the firm.
when
3. Analysis of the business determining
risk of the firm. the financing
capacity/
needs of the
firm.
 Financial
Financial Ratios
Ratios

A Financial Ratio is an Types of

index that relates two Comparisons
accounting numbers
and is obtained by Internal
dividing one number Comparisons
by the other. External
Comparisons
 Liquidity
Liquidity Ratios
Ratios

Balance Sheet Ratios Current

Current Assets
Liquidity Ratios Current Liabilities

Shows a firm’s ability For Star Corporation

to cover its current December 31, 2013
liabilities with its $1,195 = 2.39
current assets. $500
 Liquidity
Liquidity Ratio
Ratio Comparisons
Comparisons

Current Ratio
Year SC Industry
2013 2.39 2.15
2012 2.26 2.09
2011 1.91 2.01

Ratio is stronger than the industry average.

 Liquidity
Liquidity Ratios
Ratios

Balance Sheet Ratios Acid-Test (Quick)

Current Assets - Inv

Liquidity Ratios Current Liabilities

Shows a firm’s ability For Star Corporation

to meet current December 31, 2013
liabilities with its most
$1,195 - $696 = 1.00
liquid assets. $500
Liquidity
Liquidity Ratio
Ratio Comparisons
Comparisons

Acid-Test Ratio
Year SC Industry
2013 1.00 1.25
2012 1.04 1.23
2011 1.11 1.25

Ratio is weaker than the industry average.

Current
Current Ratio
Ratio --
-- Trend
Trend Analysis
Analysis
Comparison
Comparison
Trend Analysis of Current Ratio

2.5
2.3
Ratio Value

2.1
SC
1.9 Industry
1.7
1.5
2011 2012 2013
Analysis Year
Acid-Test
Acid-Test Ratio
Ratio --
-- Trend
Trend Analysis
Analysis
Comparison
Comparison

Trend Analysis of Acid-Test Ratio

1.5

1.3
Ratio Value

1.0 SC
Industry
0.8

0.5
2011 2012 2013
Analysis Year
Financial
Financial Leverage
Leverage Ratios
Ratios

Balance Sheet Ratios Debt-to-Equity

Total Debt
Financial Leverage Shareholders’ Equity
Ratios
For Star Corporation
December 31, 2013
Shows the extent to
which the firm is $1,030 = .90
financed by debt. $1,139
Financial
Financial Leverage
Leverage Ratio
Ratio Comparisons
Comparisons

Debt-to-Equity Ratio
Year SC Industry
2013 .90 .90
2012 .88 .90
2011 .81 .89
SC has average debt utilization
relative to the industry average.
 Financial
Financial Leverage
Leverage Ratios
Ratios

Balance Sheet Ratios Debt-to-Total-Assets

Total Debt
Financial Leverage Total Assets
Ratios
For Star Corporation
Shows the percentage of December 31, 2013
the firm’s assets that are
supported by debt $1,030 = .47
financing. $2,169
Financial
Financial Leverage;
Leverage; Ratio
Ratio Comparisons
Comparisons

Debt-to-Total-Asset Ratio
Year SC Industry
2013 .47 .47
2012 .47 .47
2011 .45 .47
SC has average debt utilization
relative to the industry average.
 Coverage
Coverage Ratios
Ratios

Income Statement Interest Coverage

Ratios
EBIT
Interest Charges
Coverage Ratios
For Star Corporation
Indicates a firm’s December 31, 2013
ability to cover interest
charges. $210 = 3.56
$59
 Coverage
Coverage
Ratio
Ratio Comparisons
Comparisons
Interest Coverage Ratio
Year SC Industry
2013 3.56 5.19
2012 4.35 5.02
2011 10.30 4.66
SC has below average interest coverage
relative to the industry average.
Coverage
Coverage Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
Comparison
Trend Analysis of Interest Coverage Ratio
11.0

9.0
Ratio Value

7.0 SC
Industry
5.0

3.0
2011 2012 2013
Analysis Year
 Activity
Activity Ratios
Ratios

Income Statement / Receivable Turnover

(Assume all sales are credit sales.)
Balance Sheet
Ratios Annual Net Credit Sales
Receivables
Activity Ratios
For Star Corporation
Indicates quality of December 31, 2013
receivables and how
successful the firm is in its $2,211 = 5.61
collections. $394
 Activity
Activity Ratios
Ratios

Income Statement / RT in days

Balance Sheet
Days in the Year
Ratios
Receivable Turnover

Activity Ratios For Star Corporation

December 31, 2013
Average number of days
that receivables are
outstanding. 365 = 65 days
(or RT in days) 5.61
 Activity
Activity
Ratio
Ratio Comparisons
Comparisons

Average Collection Period

Year SC Industry
2013 65.0 65.7
2012 71.1 66.3
2011 83.6 69.2
SC has improved the average collection
period to that of the industry average.
 Activity
Activity Ratios
Ratios

Income Statement / Payable Turnover (PT)

(Assume annual credit
Balance Sheet purchases = $1,551.)
Ratios
Annual Credit Purchases
Accounts Payable
Activity Ratios

Indicates the promptness of

For Star Corporation
payment to suppliers by the December 31, 2013
firm. $1551
= 16.5
$94
 Activity
Activity Ratios
Ratios

Income Statement / PT in Days

Balance Sheet
Ratios Days in the Year
Payable Turnover
Activity Ratios
For Star Corporation
December 31, 2013
Average number of days
that payables are 365
outstanding. = 22.1 days
16.5
Activity
Activity
Ratio
Ratio Comparisons
Comparisons
Payable Turnover in Days
Year SC Industry
2013 22.1 46.7
2012 25.4 51.1
2011 43.5 48.5
SC has improved the PT in Days.
Is this good?
 Activity
Activity Ratios
Ratios

Income Statement / Inventory Turnover

Balance Sheet
Ratios Cost of Goods Sold
Inventory
Activity Ratios
For Star Corporation
Indicates the effectiveness December 31, 2013
of the inventory
management practices of $1,599 = 2.30
the firm. $696
 Activity
Activity
Ratio
Ratio Comparisons
Comparisons

Inventory Turnover Ratio

Year SC Industry
2013 2.30 3.45
2012 2.44 3.76
2011 2.64 3.69
SC has a very poor inventory turnover ratio.
Inventory
Inventory Turnover
Turnover Ratio
Ratio
--Trend
--Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Inventory Turnover Ratio
4.0

3.5
Ratio Value

3.0 SC
Industry
2.5

2.0
2011 2012 2013
Analysis Year
Activity
Activity Ratios
Ratios

Income Statement / Total Asset Turnover

Balance Sheet
Ratios Net Sales
Total Assets
Activity Ratios
For Star Corporation
Indicates the overall December 31, 2013
effectiveness of the firm in
utilizing its assets to $2,211 = 1.02
generate sales. $2,169
Activity
Activity
Ratio
Ratio Comparisons
Comparisons

Total Asset Turnover Ratio

Year SC Industry
2013 1.02 1.17
2012 1.03 1.14
2011 1.01 1.13
SC has a weak total asset turnover ratio.
 Profitability
Profitability Ratios
Ratios

Income Gross Profit Margin

Statement /
Balance Sheet Gross Profit
Ratios Net Sales
Profitability
For Star Corporation
Ratios
December 31, 2013
Indicates the efficiency
of operations and firm $612 = .277
pricing policies. $2,211
Profitability
Profitability
Ratio
Ratio Comparisons
Comparisons
Gross Profit Margin
Year SC Industry
2013 27.7% 31.1%
2012 28.7 30.8
2011 31.3 27.6

SC has a weak Gross Profit Margin.

Gross
Gross Profit
Profit Margin
Margin --
--
Trend
Trend Analysis
Analysis Comparison
Comparison

Trend Analysis of Gross Profit Margin

35.0
Ratio Value (%)

32.5

30.0 SC
Industry
27.5

25.0
2011 2012 2013
Analysis Year
Profitability
Profitability Ratios
Ratios

Income Statement / Net Profit Margin

Balance Sheet
Ratios Net Profit after Taxes
Net Sales
Profitability Ratios
For Star Corporation
Indicates the firm’s December 31, 2013
profitability after taking $91 = .041
account of all expenses $2,211
and income taxes.
Profitability
Profitability Ratio
Ratio Comparisons
Comparisons

Net Profit Margin

Year SC Industry
2013 4.1% 8.2%
2012 4.9 8.1
2011 9.0 7.6

SC has a poor Net Profit Margin.

Net
Net Profit
Profit Margin
Margin --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Net Profit Margin
10
9
Ratio Value (%)

8
7 SC
6 Industry

5
4
2011 2012 2013
Analysis Year
 Profitability
Profitability Ratios
Ratios

Income Statement / Return on Investment

Balance Sheet
Ratios Net Profit after Taxes
Total Assets
Profitability Ratios
For Star Corporation
Indicates the profitability December 31, 2013
on the assets of the firm
(after all expenses and $91 = .042
taxes). $2,160
Profitability
Profitability Ratio
Ratio Comparisons
Comparisons

Return on Investment
Year SC Industry
2013 4.2% 9.8%
2012 5.0 9.1
2011 9.1 10.8

SC has a poor Return on Investment.

Return
Return on
on Investment
Investment ––
Trend
Trend Analysis
Analysis Comparison
Comparison

Trend Analysis of Return on Investment

12
Ratio Value (%)

10

8 SC
Industry
6

4
2011 2012 2013
Analysis Year
 Profitability
Profitability Ratios
Ratios

Income Statement / Return on Equity

Balance Sheet
Ratios
Profitability Ratios
Indicates the profitability to
the shareholders of the firm
(after all expenses and
taxes).
Net Profit after Taxes
Shareholders’ Equity
For Star Corporation
December 31, 2013
$91 = .08
$1,139
Profitability
Profitability Ratio
Ratio Comparisons
Comparisons

Return on Equity
Year SC Industry
2013 8.0% 17.9%
2012 9.4 17.2
2011 16.6 20.4

SC has a poor Return on Equity.

Return
Return on
on Equity
Equity --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Return on Equity
21.0
Ratio Value (%)

17.5

14.0 SC
Industry
10.5

7.0
2011 2012 2013
Analysis Year
 Summary
Summary of
of the
the Profitability
Profitability Trend
Trend
Analyses
Analyses

 The profitability ratios for Star Corporation have

ALL been falling since 2011. Each has been
below the industry averages for the past three
years.
 This indicates that COGS and administrative
costs may both be too high and a potential
problem for SC.
SC
 Note, this result is consistent with the low interest
coverage ratio.
Summary
Summary of
of Ratio
Ratio Analyses
Analyses
 Inventories are too high.
 May be paying off creditors
(accounts payable) too soon.
 COGS may be too high.
 Selling, general, and administrative
costs may be too high.
 Common-size
Common-size Analysis
Analysis

An analysis of percentage financial statements

where all balance sheet items are divided by
total assets and all income statement items
are divided by net sales or revenues.
Star
Star Corporation’
Corporation Common
Corporation
Corporation’ Common Size
Size
Balance
Balance Sheets
Sheets
Regular (thousands of $) Common-Size (%)
Assets 2011 2012 2013 2011 2012 2013
Cash 148 100 90 12.10 4.89 4.15
AR 283 410 394 23.14 20.06 18.17
Inv 322 616 696 26.33 30.14 32.09
Other CA 10 14 15 0.82 0.68 0.69
Tot CA 763 1,140 1,195 62.39 55.77 55.09
Net FA 349 631 701 28.54 30.87 32.32
LT Inv 0 50 50 0.00 2.45 2.31
Other LT 111 223 223 9.08 10.91 10.28
Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0
 Star
Star Corporation’
Corporation Common
Corporation
Corporation’ Common Size
Size
Balance
Balance Sheets
Sheets
Regular (thousands of $) Common-Size (%)
Liab+Equity 2011 2012 2013 2011 2012 2013
Note Pay 290 295 290 23.71 14.43 13.37
Acct Pay 81 94 94 6.62 4.60 4.33
Accr Tax 13 16 16 1.06 0.78 0.74
Other Accr 15 100 100 1.23 4.89 4.61
Tot CL 399 505 500 32.62 24.71 23.05
LT Debt 150 453 530 12.26 22.16 24.44
Equity 674 1,086 1,139 55.11 53.13 52.51
Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0
Star
Star Corporation’
Corporation Common
Corporation
Corporation’ Common Size
Size
Income
Income Statements
Statements
Regular (thousands of $) Common-Size (%)
2011 2012 2013 2011 2012 2013
Net Sales 1,235 2,106 2,211 100.0 100.0 100.0
COGS 849 1,501 1,599 68.7 71.3 72.3
Gross Profit 386 605 612 31.3 28.7 27.7
Adm. 180 383 402 14.6 18.2 18.2
EBIT 206 222 210 16.7 10.5 9.5
Int Exp 20 51 59 1.6 2.4 2.7
EBT 186 171 151 15.1 8.1 6.8
EAT 112 103 91 9.1 4.9 4.1
Cash Div 50 50 50 4.0 2.4 2.3
 Index
Index Analyses
Analyses

An analysis of percentage financial statements

where all balance sheet or income statement
figures for a base year equal 100.0 (percent) and
subsequent financial statement items are
expressed as percentages of their values in the
base year.
 Star
Star Corporation’
Corporation
Corporation’
Corporation
Indexed
Indexed Balance
Balance Sheets
Sheets

Regular (thousands of $) Indexed (%)

Assets 2011 2012 2013 2011 2012 2013
Cash 148 100 90 100.0 67.6 60.8
AR 283 410 394 100.0 144.9 139.2
Inv 322 616 696 100.0 191.3 216.1
Other CA 10 14 15 100.0 140.0 150.0
Tot CA 763 1,140 1,195 100.0 149.4 156.6
Net FA 349 631 701 100.0 180.8 200.9
LT Inv 0 50 50 100.0 inf. inf.
Other LT 111 223 223 100.0 200.9 200.9
Tot Assets 1,223 2,044 2,169 100.0 167.1 177.4
Star
Star Corporation’
Corporation
Corporation’
Corporation
Indexed
Indexed Balance
Balance Sheets
Sheets

Regular (thousands of $) Indexed (%)

Liab+Equity 2011 2012 2013 2011 2012 2013
Note Pay 290 295 290 100.0 101.7 100.0
Acct Pay 81 94 94 100.0 116.0 116.0
Accr Tax 13 16 16 100.0 123.1 123.1
Other Accr 15 100 100 100.0 666.7 666.7
Tot CL 399 505 500 100.0 126.6 125.3
LT Debt 150 453 530 100.0 302.0 353.3
Equity 674 1,086 1,139 100.0 161.1 169.0
Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4
Star
Star Corporation’
Corporation Indexed
Corporation
Corporation’ Indexed Income
Income
Statements
Statements

Regular (thousands of $) Indexed (%)

2011 2012 2013 2011 2012 2013
Net Sales 1,235 2,106 2,211 100.0 170.5 179.0
COGS 849 1,501 1,599 100.0 176.8 188.3
Gross Profit 386 605 612 100.0 156.7 158.5
Adm. 180 383 402 100.0 212.8 223.3
EBIT 206 222 210 100.0 107.8 101.9
Int Exp 20 51 59 100.0 255.0 295.0
EBT 186 171 151 100.0 91.9 81.2
EAT 112 103 91 100.0 92.0 81.3
Cash Div 50 50 50 100.0 100.0 100.0
 Thank You

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