FINANCIAL ANALYSIS, PLANNING & CONTROL

Dr. H. ROMLI M. KURDI, SE, MSi

What is Financial Analysis ??

Financial Analysis is the process of determining the significant operating and financial characteristics of a firm from accounting and financial statements The goal of such analysis is to determine the efficiency and performance of the firm, as reflected in the financial records and reports External analysis is performed by outsider Internal analysis is performed by corporate finance and accounting department, and is more detailed than external analysis. Analyst must be careful to distinguish between the cause of problems, and a symptom of problem

FINANCIAL STATEMENTS ANALYSIS

FINANCIAL RATIOS
Financial ratios are used to locate symptom of problems. Once the symptom have been located, financial analyst must determine the cause of any problem, then he/she must find a solution for it A ratio may be defined as a fixed relationship in degree or number between two numbers (variables). To compare different companies in the same industry To compare different industries To compare performance in different time periods

BASIC TYPES OF FINANCIAL RATIOS

1. Liquidity ratios, which measure the firms ability to meet its maturing short-term obligations 2. Leverage ratios, which measure the extent to which the firm has been financed by debt 3. Activity ratios, which measure how effectively the firm is using its resources 4. Profitability ratios, which measure managements overall effectiveness as shown by the return generated on sales and investment Growth ratios, measure the position of growth Valuation ratios, complete measure of performance : risk ratios (1&2), return ratios (3,4,5)

Liquidity Ratios :
CURRENT RATIO
Dividing current assets by current liabilities

QUICK RATIO
Calculated by deducting inventories from current assets and dividing the remainder by current liabilities

Leverage Ratios :
Which measure the funds supplied by creditors as compared with the financing provided by the firms owners, is called Debt to Equity Ratio Total Debt to Total Assets, generally called Debt Ratio, measure the percentage of total funds provided by creditors. Debt include current liabilities. Time interest Earned, is determined by dividing EBIT by interest charges Fixed charge coverage, are defined as interest plus annual long term lease obligation (profit before taxes + interest charges + lease obligation) : ( interest charges + lease obligation) Cash flow coverage = cash inflows : (fixed charges + preferred stock/(1 - T) + debt repayment/ (1 - T).

Activity Ratio
Measure how effectively the firm employs the resources at its command. Ratios all involve comparison between level of sales and the investment in various asset accounts (acc. receivables, inventories, fixed assets and others. Inventory turnover, defined as sales divided by average-inventory Receivable turnover, defined as credit sales divided by average receivable. Average collection period :
Sales per day = Sales/360 = $ . Average Collection Period = Receivables/Sales per day = .. Days.

Fixed Assets Turnover, the ratio of sales to fixed assets = Sales/Net fixed assets Total Assets Turnover = Sales/Total Assets

Profitability Ratio
Profitability is the net result of a large number of policies and decisions It answer about how effectively the firm is being manage Profit Margin on Sales = Net Income/Sales Operating Profit Margin = Operating profit/Sales Gross Profit Margin = Gross profit/Sales Return on Total Assets = Net income/Total Assets, measure the return on total investment (ROI)
Return on Net Worth = Net income/Net worth ROE

Growth Ratio & Valuation Ratios

Growth ratio measure how well the firm is maintaining its economic position in the general economy (ie : sales, net income, EPS, DPS) = (ending value : beginning value) = CVIF r, N Valuation Ratios, measure the performance of the firm, as they reflect the combined influence of risk ratio and return ratio
Price to Earnings Ratio = Price/Earnings Market to Book Ratio = Market Value/Book Value Du Pont System of Financial Analysis It brings together the activity ratio and profit margin on sales, and show these ratios interact to determine the profitability of assets ROI = (profit/sales) X (sales/investment) Extending Du Pont System to include leverage : ROE = ROI : % of assets financed by net worth

FUNDS FLOW ANALYSIS SOURCES AND USES OF FUNDS ANALYSIS

The determination of the sources of cash flowing into the firm and the uses of that cash by the firm provides a comprehensive views of a firms receipts and outlay useful for monitoring how well a firm realize its established plans for obtaining funds (from its sales, as well as its lender and investors) and for using those funds.
1. Balancing Sources and Uses. This format has two categories : sources and uses. The source must equal the uses. The rule are : a. Sources are : a decrease in assets, an increase in liabilities, an increase in stockholders equity b. Uses are : an increase in assets, a decrease in liabilities, a decrease In stockholders equity 2. Measuring Changes in Cash This format has 3 categories : source, uses, and changes is the cash balance This format consider current accounts as part of the sources and uses profile, but cash is excluded. 3. Measuring Changes in Net Working Capital This format has 3 categories : sources, uses, and changes in net working capital Let exercise .

Three format of Statement :

FUNDS FROM OPERATION THE FUNDS COME FROM THE EVERYDAY BUSINESS OF THE FIRM

Sales minus cash expenses Cash Basis Sales xxxx Less cash expenses xxxx Less non cash exp (dep) EBIT Cash remaining xxxx Less interest payment xxxx Less taxes xxxx Net Income Cash remaining xxxx Add back non cash expenses + Funds from operation xxxx
Other Sources : - sale of stock - Long term borrowing -Sale of fixed assets

Net Income plus noncash expenses Accounting Basis xxxx xxxx xxxx xxxx .. Xxxx xxxx xxxx xxxx + xxxx
Other Uses : - Purchase of fixed assets - Pay off liabilities - Pay cash dividend - Make up losses

ANTICIPATING THE FUTURE >>> FORECASTING

Forecasting is the prerequisite to planning in any organization (company) Forecasting offers information about the future to be used in decision making Approaches : 1. Expert opinion 2. Trends : trend line, moving average, exponential smoothing 3. Causal Model - Regression Y = a + bx
n xy - (x )( y ) ---------------------------------n x x - ( x ) ( x ) av Y b av X 1/n = (Ending Value/Beginning Value) 1

b =

a =

4. Growth Model

PERCENT OF SALES METHOD

The most important variable that influence a firm financing requirements is its projected Rp ($) volume of sales A good sales forecast is an essential foundation for forecasting financial requirement, assets utilization or needed. Step : 1. Isolate those balance sheet items that can be expected to vary directly with sales 2. The items are tabulated as percentage of sales 3. Put in equation form :
= = A/TR (TR) - B/TR (TR) A/TR (TR) - B/TR (TR) - b.m. (TR2)

Total Funds needed External Funds Needed A/TR B/TR TR m b TR2 = = = = = =

assets as percent of sales current liabilities as percent of sales change in total revenue or sales net profit margin (NIAT per sales) earnings retention ratio total sales (revenues) projected for the year

Let exercise ...

WHAT IS FINANCIAL PLANNING ??

Financial Planning is a process of : Analyzing the interactions of the financing and investment choices open to the firm. Projecting the future consequences of present decision, in order to avoid surprises and understand the links between present and future decisions Deciding which alternatives to undertake (these decisions are embodied in the final financial plan) Measuring subsequent performance against the goal set in the financial plan Different kind of planning : Short-term financial planing (horizon not longer than 12 months) Long-term financial planning (horizon is 5 years), focus on aggregate investment by division or line of business, look at total capital investment outlay Alternatives : 1. An aggressive growth plan, calling for heavy capital investment and new product, increase existing market, entry new market 2. A normal growth, which the division growth with its market 3. A retrenchment, designed to minimize required capital outlays, gradual liquidation of divisions 4. Divestiture, sale or liquidation of the division

BASIC ELEMENTS OF PLAN & REQUIREMENT

Elements : 1. Pro Forma Statements. The plan will present pro forma (forecasted) : balance sheet, income statements, statements describing sources & uses of funds. 2. Capital Expenditure and Business Strategy. Planned capital expenditure are broken down by category : investment for replacement, for expansion, for new products, for mandated expenditures. Strategy by division or line of business 3. Planned Financing. This plan include of a discussion dividend policy, because the more the firm pays dividend, the more capital it will have to find from sources other than retained earnings.
Requirements : 1. Forecasting 2. Finding the Optimal Financial Plan Approach :
FINANCIAL PLANNING MODEL

FINANCIAL MODEL EQUATIONS

INCOME STATEMENT EQUATION : 1. REV = Forecast by model user 2. CGS = a.1. REV DEP = a.1. FA VC = a.1. REV FC = specified by model user ADM = a.1. REV 3. INT = a.2. D 4. TAX = a.3. (REV- CGS - DEP - ADM - INT) a.3. (REV - VC - FC - DEP - INT) 5. NET = REV - CGS - DEP - ADM - INT - TAX = REV - VC - FC - DEP - INT - TAX

REV = Sales

(a.1. = percent) (a.2. = interest rate) (a.3. = taxes rate)

Sources and Uses Funds Statement Equations :

6. OCF = NET + DEP 7. D = NWC + INV + DIV - OCF - SI = D - D ( -1) 8. SI = specified by model user = NWC + INV + DIV - OCF - D 9. NWC = OCF + D + SI - INV - DIV = NWC - NWC ( -1) 10. INV = specified by model user = OCF + D + SI - NWC - DIV = DEP + FA - FA ( -1) 11. DIV = a.4. NET = OCF + D + SI - NWC - INV (accounting identity) (accounting identity) (accounting identity) (accounting identity) (accounting identity) (accounting identity) (accounting identity) (a.4. = dividend pay out ratio)

BALANCE SHEET EQUATIONS

12. NWC = = = 13. FA = = = 14. D = = = 15. E = a.1. REV NWC ( -1) + NWC (accounting identity) a.1. FA a.1. REV FA ( -1) + FA >> FA = INV - DEP FA ( -1) + INV - DEP (accounting identity) D + D ( -1) (accounting identity) a.1. REV a.1. TA E ( -1) + NET - DIV (accounting identity) NET - DIV = E

Note

: ( -1) = previous year

Let Exercise !!!