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Financial Management Strategies
Financial analysis is an important aspect of MBA Coursework . Industry analysts make frequent use of financial ratios as a tool for
analysis and planning regarding the performance of companies in both the
private and public sectors. Foremost among these groups are accountants and
auditors who utilize such tools as part of their records and reporting
responsibilities. Many accounting boards and committees have initiated courses
in fraud examination as well because of the aftermath of corporate scandals in
the United States. This discussion examines the
use of financial analysis not to verify accounting regulation compliance but in
order to ascertain company performance and strategic management. The question
is to determine if financial analysis in the form of financial ratios is
adequate to determine companies’ performance levels in their industries and respective
markets.
However, in terms of financial analysis and its utility for performance
identification, a variety of researchers have utilized financial analysis for
just such a purpose. For example, market analysts recognize that ratio analysis
is adept in detecting red flags for a fraud examination among other accounting
related uses but identifies cash flow as being most useful for performance
reasons. Most financial ratios that
are used in this manner usually focus only on balance sheets and income
statements as well as the cash flow statement. This type of information is
useful and especially so since financial analysis using ratios offer useful
insights regarding performance and management. Balance sheet ratios generally
provide a specific time perspective, whereas the financial analysis on cash
flow statements usually represents activity for a continuous period of time or,
in other words, a moving picture of performance. Income statements allow
management to identify and track the results of operations for a given period
of time, but do not reveal other important changes in resources that result
from activities related to financing and investing initiative. Financial
analysis utilizing ratios from cash flow statements supports analysis using
balance sheets and income statements by providing additional information
related to an organization’s ability to operate efficiently, to finance expansion
and to service its debt obligations.
Importance of Financial Metrics
Financial analysis utilizing financial ratios is one of the most
important financial statements for a project or business to consider. The financial
analysis discussed in the following sections can be as simple as a one page
analysis or may involve several schedules that feed information into a larger,
more involved financial statement. Financial analysis is a listing of the performance
of a firm’s cash flows into and out of a given business or project as well as
those related to ongoing operations. Financial analysis is not only concerned
with the amount of the cash flows within a given company or firm but also the
timing of the flows into and out of a firm.
A variety of ratios are constructed with multiple time periods in
relation to a company’s financial performance. For example, financial analysis
may be based on a firm’s monthly cash inflows and outflows over a year’s time
or some other time frame but typically these are either quarterly or annually.
A company’s working capital is also an important part of the typical financial
analysis utilizing financial ratios. Working capital is commonly defined as the
amount of money needed to facilitate business operations and transactions, and
is calculated as current assets, which is cash or near cash assets less current
liabilities, which are liabilities due during the upcoming accounting period,
whatever that may be. Computing the amount of working
capital gives an analyst or corporate executive a quick analysis of the
liquidity of the targeted business over the future accounting period.
This discussion is confined to corporate
and industry analysis as it relates to financial reporting ratios and
specifically to those related to the three common financial statements which
are the cash flow statement, income statement and the balance sheet. Some of
the main focal points of this research regard the applications of financial
analysis and the use of financial analysis relative to ascertaining company
performance. The performance factor is important because both executives and
outside analysts have long been
aware of the importance of such things as cash flows and in particular
operating cash flows, to corporate financial health and performance. Indeed, at
the centre of financial analysis is an assessment of a company's ability to
generate cash sufficient to meet its ongoing debt and operating obligations.
Debt Management Ratios
Return on Investment
The ratio of a company’s return on
investment or ROI is utilized to determine the overall effectiveness of the
company’s capital investments. The ROI ratio is calculated by taking revenues
and dividing them by expenses which results in a multiple that reveals how the
company has managed to benefit from its investments. The ROI determines the effectiveness of leadership’s core strategies.
Return on Assets
The return on assets or ROA of a given firm
is a broad indication of how well the company makes use of its resources. The
ROA is calculated by dividing the net income by the firm’s total assets. The ROA reveals how well a firm and its management are
producing revenues from all of the company’s assets which include both physical
facilities and financial instruments.
Return on Equity
Companies need to constantly asses how
profitable they are in terms of outputs as a measure of the overall value of
the firm. In order to identify this metric a firm must undertake an ROE or a
return on equity analysis which is nothing more than dividing net incomes by
total equity of a given firm. The ROE is an
important performance metric and is used to indicate how profitable the firm is
relative to the value of the company’s outstanding shares.
Current Ratio
A current ratio is a financial metric that
analyses how strong a company is financially. The current ratio is found by
dividing all of a firm’s assets by its total current liabilities which then
leaves a multiple and ideally assets should be larger than liabilities. However, the most ideal ratio is completely dependent upon the industry
in which a company is competing as with almost all financial metrics. Companies
in the industrial sector can generally be regarded as strong if their multiple
is around 1.5 to 2.0 and above.
Quick Ratio
A quick ratio is used to determine how
liquid a company is which indicates how fast it could control its liabilities.
The quick ratio is also known as an acid-test or a liquid ratio and is found by
dividing current assets by current liabilities. The purpose
that managers and investors rely on the quick ratio for is to determine how
well the company could maintain its operations with existing cash reserves
during periods when other sources of revenue may be absent.
Inventory Turnover
The inventory turnover ratio reveals how
strong a company is in its market. It is found by dividing the cost of goods
sold or cogs by the current period’s total inventory value. A low
turnover ratio is generally not a good sign because a low turnover generally
indicates low sales and greater risk for product damage or decay of some type.
Days Sales Outstanding
The day’s sales outstanding is a financial
metric that informs management how long it takes the company to collect on its
sales. The days sales outstanding is found by dividing the accounts receivable
of the firm by the total credit outstanding and this figure is then multiplied
by the number of days on average it takes to receive payment. A
lower multiple informs management that the company will have greater access to
cash flows. A larger multiple may reveal that the firm is attempting to hide
weak sales or under-performing markets.
Fixed Asset Ratios
There a couple of ratios within this
category of financial ratios. The first is the fixed assets to net worth ratio
that is found by dividing fixed assets by liabilities and then adding equity
where a ratio of .75 us typically not good because it reveals over-investment. The other fixed asset ratio is the fixed asset to total
asset ratio. This ratio is found by dividing fixed assets by total assets where
a multiple of .5 or more reveals poor use of working capital in a firm and
means that the company cannot carry accounts receivable for very long. Fixed asset ratios generally inform management and leadership
about how flexible and adaptive the company can be in its market and industry. |