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2 EXECUTIVE SUMMARY We commissioned this report to inspect the importance of cases in finance A company that would be mainly focused on is ratios Issues, such as the reason it is significant for manag[.]

EXECUTIVE SUMMARY

We commissioned this report to inspect the importance of cases in finance A company that would be mainly focused on is ratios Issues, such as the reason it is significant for managers to recognize the sustainability and the impact of sustainability, would be discussed The research brings attention to the fact that sustainability, which comprises economic, environmental and social aspect, has become more challenging for organizations today compared to the past Balancing the three aspects is crucial for organizations that want to be profitable, able to protect the environment and sorting out problems which are socially related simultaneously The manager plays the role of decision-makers, thus contributes to the organizations The transition towards a sustainable path

improving or deteriorating

FINANCIAL RATIO ANALYSIS

Financial ratio analysis involves the calculation and comparison of ratios which are derived from the information given in the company's financial statements The historical trends of these ratios can make inferences about a company's financial condition, its operations and its investment attractiveness

Financial ratio analysis groups the ratios into categories that tell us about the different facets of

a company's financial state of affairs They describe some types of rates below:

• Liquidity Ratios give a picture of a company's short term financial situation or solvency

• Operational/Turnover Ratios show how efficient a company's operations and how well

it is using its assets

• Leverage/Capital Structure Ratios show the quantum of debt in a company's capital

structure

• Profitability Ratios use margin analysis and show the return on sales and capital used

• Valuation Ratios show the performance of a company in the capital market

Part A

Q1) Explain various problems associated with financial statement analysis

While financial statement analysis is an excellent tool, there are several issues to be aware

of that can interfere with the interpretation of the analysis results These issues are:

• Comparability between periods The company preparing the financial statements may have

changed the accounts in which it stores financial information, so that results may differ from period to period For example, an expense may appear in the cost of goods sold in one period, and in administrative costs in another period

• Comparability between companies An analyst frequently compares the financial ratios of

different companies to see how they match up against each other However, each compa ny may aggregate financial information differently, so that the results of their ratios are not comparable Can lead an analyst to draw incorrect conclusions about the effects of a company in comparison to its competitors

• Operational information The financial analysis only reviews a company's financial

information, not its operational data, so you cannot see a variety of key indicators of future performance, such as the size of the order backlog, or changes in warranty claims Thus, the financial analysis only presents part of the total picture

Q2) Discuss various types of capital budgeting techniques Also, identify the most appropriate technique and justify with logical reasoning

• Capital budgeting is used by companies to evaluate significant projects and investments, such as new plants or equipment

• The process involves analyzing a project's cash inflows and outflows to determine whether the expected return meets a set benchmark

• The significant methods of capital budgeting include throughput, discounted cash flow, and payback analyses

• Types of Capital Budgeting

▪ Throughput Analysis

Throughput analysis is the most complicated form of capital budgeting analysis but also the most accurate in helping managers decide which projects to pursue Under this method, the entire company is considered as a single profit-generating system Throughput is measured as an amount of material passing through that system

The analysis assumes that nearly all costs are operating expenses, that a company needs to maximize the throughput of the entire system to pay for expenses, and that the way to maximize profits is to maximize the performance passing through a bottleneck operation A bottleneck is

a resource in the system that requires the longest time in activities

This means that managers should always place a higher priority on capital budgeting projects that will increase throughput passing through the bottleneck

▪ DCF Analysis

Discounted cash flow (DCF) analysis looks at the initial cash outflow needed to fund a project, the mix of cash inflows in the form of revenue, and other future flows in the way of maintenance and additional costs

These costs, except for the initial outflow, are discounted back to the present date The resulting number from the DCF analysis is the net current value (NPV) Projects with the highest NPV should rank over others unless one or more are mutually exclusive

▪ Payback Analysis

Payback analysis is the purest form of capital budgeting analysis, but it's also the least accurate It's still widely used because it's quick and can give managers a "back of the envelope" understanding of the real value of a proposed project

This analysis calculates how long it will take to recoup the costs of an investment The payback period is identified by dividing the initial investment in the project by the average yearly cash inflow that the project will generate

Q3) List and describe the three general areas of responsibility for a financial manager

1 Forecasting and Planning:

The financial manager must interact with other executives as they look ahead and lay the plans which will shape the firm's future

2 Significant Investment and Financing Decisions:

A successful firm usually has rapid growth in sales, which requires investments in plant, equipment and inventory It is the task of the financial manager to help determine the optimal sales growth rate, and he (she) must help decide what specific assets to acquire and the best way

to finance those assets For example, should the firm finance with debt, Equity, or some combination of the two, and if the debt is used, how much should be long term and how much should be short term?

3 Coordination and Control:

The financial manager must interact with other executives to ensure that the firm is operated as efficiently as possible All business decisions have financial implications, and all managers financial and otherwise need to take this into account

4 Dealing with Financial Markets:

The financial manager must deal with the money and capital markets Each firm affects and is affected by the general financial markets where funds are raised, where the firm's shares and debentures are traded, and where its investors either make or lose money

5 Risk Management:

All business face risks, including natural disasters such as fires and floods, uncertainties in commodity and share prices, changing interest rates and fluctuating foreign exchange rates However, many of these risks can be reduced by purchasing insurance or by hedging

Q4) The managers of a firm wish to expand the firm's operations and are trying to determine the amount of debt financing the firm should obtain versus the amount of equity financing that should be raised The managers have asked you to explain the effects that both of these forms of investment would have on the cash flows of the firm Write a short response to this request

Debt Financing

When a firm raises money for capital by selling debt instruments to investors, it is known as debt financing In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid on a regular schedule

Q5) Assume you are a credit manager in charge of approving commercial loans to business firms Identify three aspects of a firm's cash flows you would review and explain the type

of information you hope to gain from studying each of those five aspects

Types of cash flow include:

Cash from Operating Activities – Cash that is generated by a company's core business activities – does not include CF from investing This is found on the company's Statement of Cash Flows (the first section)

Free Cash Flow to Equity (FCFE) – FCFE represents the cash that's available after reinvestment back into the business (capital expenditures) Read more about FCFE

Free Cash Flow to the Firm (FCFF) – This is a measure that assumes a company has no leverage (debt) It is used in financial modelling and valuation Read more about FCFF

Net Change in Cash – The change in the amount of cash flow from one accounting period to the next This is found at the bottom of the Cash Flow Statement

Q6) Give some examples of ways in which a manager's goals can differ from those of shareholders

Value

Profitability is the bottom line in the business world and both the manager and shareholders are typically in agreement on this point, in principle However, the way that a manager tries to achieve profitability won't always be in line with the shareholders' ideas For example, shareholders may be focused on cost-cutting while the manager seeks additional resources to improve productivity Managers may find their hands tied from time to time regarding what they can do to increase productivity

Time

Performance levels measured by both managers and shareholders in various increments of time Long-term profitability and sustainability are generally more important than the short-term bottom line but not to investors who buy and sell frequently, trying to time the rise and fall of the market Managers must also be focused on short-term and intermediate goals because these results affect their employment in the present while remaining mindful of the company's long-term prospects

Employees

Although profitability is the bottom line and affects everyone within a company, managers who get the most out of their employees generally have some type of ongoing relationship with those employees In some cases, it may be merely an artificial working relationship, but in other cases, managers do get deeply involved in the lives of their workers Shareholders do not necessarily align their goals with this type of relationship in mind The shareholder does not have to be involved in the lives of employees and may make decisions about his holdings within the company based on numbers alone

Risk

A manager's goals based on calculated risks that the manager is willing to take This is true of shareholders as well, but agency theory suggests that managers will sometimes set personal goals and make decisions based on what they believe they can do to meet the goals of shareholders The manager sometimes finds that she cannot realistically achieve the shareholders' goals and, therefore, acts in her self-interest based on the calculated risk that she can meet the needs of shareholders by doing things her way, rather than theirs While shareholders may set goals that require a considerable amount of risk, the manager may decide to scale back and avoid some of that risk for the good of herself, her workers and the company as a whole

Q7) Describe the major differences between individual and institutional investors

1 Access to resources

Institutional investors are substantial companies and can take advantage of numerous resources such as financial professionals to oversee their portfolio daily, allowing them to enter and exit the market at the right time Individual investors need to do the same on their own through research and available data

2 Decision-making

With institutional investors, the investments are usually overseen by different individuals in the organization For example, the board of directors makes the decision-making process more challenging as people are likely to propose different ideas on what trades to make As an individual investor, you are your boss and the sole decision-maker when it comes to buying and selling shares

3 Identifying investment opportunities

Since institutional investors can access a large number of resources and capital, they are privy to investment structures and products available before anyone else By the time investment opportunities reach from the hedge fund or private equity funds to the individual investor level, the rest can use second-hand investment strategies that have already been implemented by the large institutions

Q8) What issues are involved in ratio analysis? Explain the impact of those issues on financial planning

One of the most critical limitations of ratio analysis include:

Historical Information: Information used in the report is based on real past results that are released by the company Therefore, ratio analysis metrics do not necessarily represent future company performance

Inflationary effects: Financial statements are released periodically and, therefore, there are time differences between each release If inflation has occurred in between periods, then real prices

are not reflected in the financial statements Thus, the numbers across different periods are not comparable until they are adjusted for inflation

Changes in accounting policies: If the company has changed its accounting policies and procedures, this may significantly affect financial reporting In this case, the critical business metrics utilized in ratio analysis are altered, and the financial results recorded after the change are not comparable to the findings recorded before the turn It is up to the analyst to be up to date with changes to accounting policies Changes made are generally found in the notes to the financial statements section

Operational changes: A company may significantly change its functional structure, anything from their supply chain strategy to the product that they are selling When significant operational changes occur, the comparison of financial metrics before and after the functional change may lead to misleading conclusions about the company's performance and prospects

Seasonal effects: An analyst should be aware of seasonal factors that could potentially result in limitations of ratio analysis The inability to adjust the ratio analysis to the seasonality effects may lead to false interpretations of the results from the study

Manipulation of financial statements: Ratio analysis is based on information that is reported by the company in its financial statements This information may be manipulated by the company's management to report a better result than its actual performance Hence, ratio analysis may not accurately reflect the true nature of the business, as the misrepresentation of information is not detected by simple analysis It is essential that an analyst is aware of these possible manipulations and always complete extensive due diligence before reaching any conclusions

Q9) Compare and contrast various methods of capital budgeting

Capital budgeting is a set of techniques used to decide which investments to make in projects There are many capital budgeting techniques available, which include the following: