Financial Analysis, Planning and Control

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Financial Analysis, Planning and Control

• Presented by
• Mr. Moses Bazibu
• Lecturer - Faculty of Commerce
• Makerere University Business School
• Kampala - Uganda

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INTRODUCTION

• It is all very well getting up-to-date financial
  statements, but they don't always tell you how
  particular aspects of your business are doing.
• This needs a greater depth of analysis and
  interpretation. Over the years, many useful
  analysis techniques have been developed.

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Introduction

• Financial statements enable decision making.
• Financial statements are like colours of the sky,
  they do not tell us much.
• They need to be interpreted/ analyzed to get
  their meaning.
• The purpose of financial analysis is to identify
  areas that need attention, or those areas where
  performance is exceptionally good.

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Questions to address in Financial Analysis

• Is there undue short-term risk that the company
  cannot meet its working capital requirements thus
  jeopardising its image?
• Is there undue long-term risk that the company is
  too reliant on borrowed funds?
• Does the company generate adequate profits in
  relation to the assets, investments, sales, etc?
• Is management using assets at its disposal
  efficiently?

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Financial analysis Techniques

• Ratio Analysis
• Common size Analysis
• Break even Analysis

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1.0 Ratio - Analysis

• Ratio analysis was developed to determine the
  stability of various financial aspects of a
  business.
• It shows the relationship between two figures, or
  two aspects of your business. It helps you work
  out your business' financial weaknesses and
  strengths, so that you can take appropriate
  action.

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Introduction contd

• Ratio analysis also offers a view of your
  business' competitive performance in relation to
  similar businesses in your industry. We will only
  discuss a few ratios here, as some can become
  very complicated.

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MAJOR RATIOS

• Essentially, we will group the ratios we discuss
  into the following types
• Measures of liquidity
• Profitability ratios
• Efficiency ratios.

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1.1 Measures of liquidity

• These ratios analyze the available liquid assets
  your business has at any given time to meet
  current liabilities.
• In other words, it tells you how much
  cash-on-hand you have, as well as assets that can
  readily be turned into cash. This lets you know
  how much money is accessible if needed to pay
  your liabilities or debts.

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Liquidity contd

• A good rule of thumb is the greater your
  liquidity, the better.
• However, bear in mind, the higher the liquidity
  ratio, the greater the proportion of resources
  tied up in relatively non-productive assets.
• This may have an adverse effect on earnings. It
  is necessary, to aim to achieve a balance between
  earnings and liquidity.

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Current ratios

• This is the difference between current assets and
  current liabilities. The current ratio (CR) is
  calculated by dividing current assets (CA) by the
  current liabilities (CL) listed on your balance
  sheet
• Acid Test Ratio (CA Inventory) CL
• Current Ratio Current Assets Current
  Liabilities
• E.g. if current ratio 1.9 1
• This means for every dollar you owe you have
  1.90 available in current assets. A current
  ratio of assets to liabilities of 21 is usually
  considered to be acceptable (ie., your assets are
  twice your liabilities).

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Fixed assets ratio

• Fixed and current assets "compete", if you like,
  for the limited funds available to your business.
  Therefore, you need to reach a balance.
• The best depends on your type of business. You
  may, for instance, have most of your capital tied
  up in fixed assets, like equipment, with minimal
  investment in current assets such as stock.

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Calculation of fixed assets ratio

• The fixed asset ratio is calculated by comparing
  the proportion of a business' total fixed assets
  against total assets, as follows
• Fixed Asset Ratio (Fixed Assets Total Assets)
  x 100

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1.3 Profitability measures

• These relate your profit level to your sales and
  fees and show to what extent each dollar of
  sales/fees generates profit for your business.
• Moreover, they relate profit to your assets and
  show how productive your assets are in generating
  profit. These ratios include the gross profit
  margin and the net profit margin.

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Profit contd

• Using your profit margins
• The gross profit margin (GPM) calculates the
  average profit per dollar of sales/fees before
  operating expenses. The ratio is defined as
• Gross Profit Margin Gross Profit Sales

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1.3 Efficiency ratios

• If your assets are being used to their best, you
  would expect that the return on your assets
  should also be at a maximum.
• One way of assessing this is to measure their
  frequency of turnover, such as asset turnover.
  You can measure this with efficiency ratios (like
  asset turnover, average collection period) and
  use them to track improvements.

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Asset turnover

• This ratio can be calculated as follows
• Asset Turnover Sales Total Assets
• For example, if sales/fees were 120,000 Total
  assets 50,000120,000 50,000 2.4 times
• Therefore your asset turnover is 2.4. Obviously,
  the higher the turnover, the better use of your
  assets.

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Average collection period

• This ratio calculates how long it takes for you
  to collect your money from your debtors. This is
  useful for businesses whose customers may be on
  14 or 30 day credit terms.
• The average collection period is used to compare
  the average age of debtors (ie. how long have
  they been outstanding) from one point in time to
  another and shows how good your clients are at
  paying their bills.

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Average collection period contd

• Average Collection Period (Debtors Total
  Credit Sales) x 365 days
• If debtors are 6,640 and Total credit sales/fees
  are 34,460 then
• (6,640 34,460) x 365 70 days
• Therefore your average collection period is 70
  days. Generally it is preferable to keep this to
  below 60 days.

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Things to note on using ratio analysis

• Don't make the assumption that ratio analysis
  will tell you everything you need to know about
  your business' financial performance however.
  Ratios provide a great deal of information, but
  they do have limitations.
• Remember that ratios only indicate the
  relationship between two sets of figures. What is
  more, one ratio should not be taken to represent
  the whole of your business. Try to get an overall
  picture.

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Notes contd

• Ratio analysis allows you to compare current and
  past performances of the company but doesn't
  offer any indication of future performance.
• Additionally, if you make comparisons with other
  businesses in your industry, keep in mind not all
  businesses are the same. Ratios are usually
  comparisons with industry averages, however your
  business will not, and should not be, exactly the
  same as others in your industry.

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Notes contd

• It should also be noted that financial statements
  are often prepared by different methods,
  resulting in financial ratios that may not
  present an accurate account of the average
  business in your industry.
• Ratios are developed for specific periods.
  Consequently, if you operate a seasonal business,
  ratios may not provide an accurate measure of
  financial performance.

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2.0 Common Size Analysis

• Common size analysis uses a scaling factor to
  enable comparability.
• It develops insights into the economic
  characteristics of different firms and different
  industries.
• Financial data is re-stated on a common size
  basis.

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Types of Common size analysis

• Inter-industry common size analysis
• Analysis is made by comparing with other firms in
  the industry.
• Inter- firms analysis enables comparison with
  other firms in the same industry.
• Intra- Company analysis
• Analysis is made by extracting a trend over time.
• Comparing performance over time is useful in
  forecasting.

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Procedure

• Determine a scaling factor for the balance sheet
  and income statement.
• The key financial information parameter may serve
  as the scaling factor.
• Income statement - Sales
• Balance sheet - Total assets
• Express each item in the financial statement as a
  percentage of the scaling factor.

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Example 1Trend analysis Using PL
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Solution 1
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Example 2Inter firm analysis of Balance Sheet
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Solution 2
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3.0 Break-even analysis

• Break-even analysis is particularly important in
  the planning stages of your business. It shows
  what sales and fees you need to make on a daily,
  weekly or monthly basis, in order to pay all your
  expenses.
• To put together a break-even analysis, you must
  first separate variable costs from fixed costs.
  Fixed costs are predictable on a monthly basis,
  and occur whether or not you are open for
  business, while variable costs change according
  to your business operations, such as the cost of
  your supplies, material or labour.

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• THANK YOU FOR YOUR ATTENTION

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• Question time
• Comments/Remarks
• Experiences