B415 Finance Lecture 3
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Transcript of B415 Finance Lecture 3
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Principles of Business Introduction to Finance –lecture 3
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Overview
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• Developing financial fluency• Interpreting financial statements
- Profitabilty- Liquidity- Gearing- Investors
• Budgeting
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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
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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?
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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?
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Key ratios
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1. Profitability ratios
Gross ProfitGROSS PROFITSALES REVENUE
Net ProfitNET PROFITSALES REVENUE
Sales Revenue per EmployeeSALES REVENUENUMBER OF EMPLOYEES
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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)
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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
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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
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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
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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
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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
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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!