Transcript
Principles of Business Introduction to Finance –lecture 3
Overview
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• Developing financial fluency• Interpreting financial statements
- Profitabilty- Liquidity- Gearing- Investors
• Budgeting
Learning outcomes
By the end of this session you should be able to:
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• Analyse a company using financial statements• Apply key ratios• Understand the role and purpose of budgets• Prepare a cash budget
Recap from finance week 1
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The key financial statements:
Income statementBalance Sheet /
Statement of Financial Position
Statement of Cashflows
Financial Performance Financial Position Cash inflows and outflows
Revenue – costs = Profit Assets – Liabilities = Equity Inflow – outflow = net
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Financial fluency• Making the numbers talk…• What is the story of the company that the financial statements are
telling us? • Do the financial statements show that the company has been
successful? How? • What do your calculations mean?• What potential issues can we identify from the financial statements?
Developing financial fluency
How to analyse financial statements:
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Step 1: Scan through each financial statement, and identify:- Large numbers- Significant variances from prior year- Inconsistencies (e.g. between revenue growth and movements in
costs of sales).
Step 2: Identify areas of the financial statements to focus on (eg. risky areas, profitability, liquidity)
Step 3: Calculate appropriate ratios
Step 4: What do those ratios tell you?
- How do they compare to prior year or other organisations?- How do they relate to qualitative information that you have?- What are the implications for the company?
Key ratios
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1. Profitability ratios
Gross ProfitGROSS PROFITSALES REVENUE
Net ProfitNET PROFITSALES REVENUE
Sales Revenue per EmployeeSALES REVENUENUMBER OF EMPLOYEES
Key ratios
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Profitability ratios
Return on Capital EmployedOPERATING PROFITTOTAL CAPITAL EMPLOYED (long term debt plus equity)
Asset Turnover(Asset Utilisation)
SALESTOTAL CAPITAL EMPLOYED
Return on Shareholder’s fundsOPERATING PROFITSHAREHOLDER’S FUNDS (EQUITY)
Key ratios
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2. Liquidity ratios
Current Ratio
= Current Assets : Current Liabilities
Liquidity/Quick/Acid Test Ratio
= Liquid Current Assets (ie. Exclude inventory) : Current Liabilities
Ability to pay debts as they fall due:
= Cash Generated from Operations/Current Liabilities
Key ratios
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3. Gearing: debt/equity ratio
Total Capital Employed
Equity
for Ordinary
Shareholders
External Debt
including any
redeemable
preference
shares
Key ratios
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4. Investor ratios
Dividend yield:
Dividend per Share net of base income tax rateMarket Value per Share
Earnings Per Share
Ordinary Shareholder’s EarningsNumber of Shares in Issue
PE Ratio
Market Price Per ShareEarnings Per Share
Budgeting
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A Budget is a short-term business plan, designed to link planning and decision making to strategic objectives
NB. It is not a Forecast, which is an estimate of future financial outcomes
Budgeting
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Perform review and
control
Select strategic options
and formulate plans
Identify and assess the
strategic options
Undertake a position
analysis
Establish mission and
objectives
Evaluate options and make a selection
Respond to variances
Revise plans (and budgets) if necessary
Consider options
Identify business objectives
Prepare long-term (strategic) plan
Prepare budgets
Measure actual performance
Budgeting
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Budgeting approaches
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Top down budgeting: Top management impose the budget
that the organisation must work to.
Bottom up budgeting: Developed by lower-level managers
who submit to top management.
Incremental budgeting: Modification of current year actual
results.
Zero-based budgeting: budget prepared from scratch each
period.
Rolling budget: continuous budgeting
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Pre-seminar work
• Read Chapters 7 and 12 of core textbook and attempt the questions at the back of the chapter.
• You will need access to a FTSE 100 company’s financial statements for the seminar!
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