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Managing Finance and Budgets

Managing Finance and Budgets. Seminar 4. Seminar Four - Activities. Preparation: read Chapter 7 (M & A 2 nd Edition) Or Chapter 6 (M & A 1 st Edition) Describe key concepts: Analysing accounts Ratios Exercises:

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Managing Finance and Budgets

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  1. Managing Finance and Budgets Seminar 4

  2. Seminar Four - Activities • Preparation: read Chapter 7 (M & A 2nd Edition) Or Chapter 6 (M & A 1st Edition) • Describe key concepts: Analysing accounts Ratios Exercises: • M & A (2nd Ed.) Exercise 7.3 (pages 239-240) and Exercise 7.5 (pages 241-242) • Or M & A (1st Ed.) Exercise 6.3 (pages 215-216) and Exercise 6.5 (pages 217-218)

  3. Starting Points • Describe what is meant by Financial Ratio Analysis, and outline the key steps in performing such an analysis. • State some of the things we need to consider when we are examining accounts, and some of the factors which might affect such our analysis.

  4. Identify users and their information needs Interpret and evaluate the results Select and calculate appropriate ratios The key steps of financial ratio analysis

  5. Key Ratios • State the different categories of financial ratio that can be used in analysing accounts, and describe the purpose of each one. • State some of the measures within each category.

  6. Categories Profitability Efficiency Liquidity Gearing Investment Financial ratio classification

  7. Return on ordinary shareholders’ funds Formula Net profit after taxation and preference dividend (if any) x 100Ordinary share capital + Reserves Return on capital employed Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans Net profit margin Net profit before interest and taxation x 100 Sales Gross profit margin Gross profit x 100 Sales Sales Profitability

  8. Formula Average stock turnover period Average stock held x 365Cost of sales Average settlement period for debtors Trade debtors x 365Credit sales Average settlement period for creditors Trade creditors x 365Credit purchases Sales to capital employed _______ Sales__________ Long-term capital employed _______Sales_______ Number of employees Sales per employee Efficiency

  9. Net profit before interest and taxation sales multiplied by Sales______ Long-term capital employed equals Return on capital employed The main elements comprising the ROCE ratio

  10. Formula Current assets_______________Current liabilities (creditors due within one year) Current ratio Current assets (excluding stock) Current liabilities Acid test ratio Operating cash flows to maturing obligations Operating cash flows Current liabilities Liquidity

  11. Formula Long-term liabilities _______ Share capital + Reserves + Long-term liabilities Gearing ratio Interest cover ratio Profit before interest and taxation_ Interest payable Gearing

  12. The effect of financial gearing

  13. Formula Dividends announced during the period Number of shares in issue Dividend per share Dividend payout ratio Dividends announced for the year x 100Earnings for the year available for dividends Dividend per share/(1-t) x 100Market value per share Dividend yield ratio Earnings available to ordinary shareholders Number of ordinary shares in issue Earnings per share Operating cash flow per share Operating cash flows – preference dividends Number of ordinary shares in issue Price/earnings ratio (P/E) Market value per share Earnings per share Investment ratios

  14. Calculating and Using the Ratios (1) • What are the criteria that an investor should look for when selecting a company in which to invest? • McLaney & Atrill Exercise 7.3 (6.3 1st ed)

  15. Dividend yield ratiosSource: Financial Times 31 May 1997 6 5 4 3 2 Water Electricity Food retailers Retail banks Media Oil exploration and production 1 Pharmaceuticals Building and construction Chemicals Engineering Tobacco Distribution 0

  16. 40 35 30 25 20 15 10 Water Electricity Food retailers Retail banks Media Oil exploration and production Pharmaceuticals 5 Building and construction Chemicals Engineering Tobacco Distribution 0 Average P/E ratiosSource: Financial Times 31 May 1997

  17. Calculating and Using the Ratios (2) • What criteria should a supplier look for when deciding whether to supply a business customer? • McLaney & Atrill Exercise 7.5 (6.5 1st ed)

  18. Current ratio 1.6 Acid test ratio 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Consumergoods Utilities Mineralextraction Generalindustries Services Average current ratio and average acid test ratio for 1996 for UK listed companies in various industrial sectors

  19. Current ratio XYZ Ltd Industry average 19X2 19X3 19X1 19X4 19X5 Time Graph plotting current ratio against time

  20. Calculating and Using the Ratios (3) • What early-warning signs can be detected that a company may be heading towards insolvency and failure?

  21. Failed firms Non-failed firms Cash flow Total debt Net income Total assets Total debt Total assets 0.79 +0.1 +0.45 0.78 +0.35 0.0 0.65 +0.25 0.58 +0.15 0.51 -0.1 +0.05 0.44 -0.05 0.37 -0.2 -0.15 3 3 4 4 5 5 2 2 1 3 4 5 1 1 2 Mean ratios of failed and non-failed businesses

  22. Failed firms Non-failed firms Working capital Total assets Current ratio No credit interval +0.15 3.5 0.42 0.36 3.0 +0.05 0.30 0.24 -0.05 2.5 0.18 0.12 -0.15 2.0 0.06 3 3 4 4 5 5 2 2 1 3 4 5 1 1 2 Mean ratios of failed and non-failed businesses

  23. Failed businesses Non-failed businesses Current ratio ROCE ratio Scatter diagram showing the distribution of failed and non-failed businesses

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