Easy understanding of Finance for non-finance Managers

1. Prof. Parag Tikekar
Whatsapp/ Cell: +97150- 5785927
E-mail: ParagTikekar@yahoo.com
Finance for Strategic Managers
(Part 3 of 4)

2. About Parag Tikekar
 BE Electronics & Communication from DIT, India.
 MBA Finance & Marketing from IIM, India.
 Keynote Speaker on Segmentation at SMI Branch Banking
Conferences at London – June ‘07, ‘08, ‘09; Uniglobal
Conference Barcelona – Oct ‘08; EFMA Conference Paris –
June ‘09; Coreventus Conference KL – Sep ‘10.
 Sharia’ah Certified; Project Management; Credit Policy; Cash
Management; Omega Credit Skills Program & Trade Finance;
Quality Team Building; Customer Care – In-house courses.
 CRM Conferences at USA – NW University, Chicago – Oct ’99;
Florida – Jan ‘01 & Dallas – June ‘02.
 Gulf Marketing Review Conference on Increasing Marketing
Effectiveness at Bahrain – Oct ‘01.

3. Agenda- Day 2
 Tools of Financial Analysis
 Introduction
 Risk Management
 Trend Analysis
 Users of Financial Information
 Balance-Sheet
 P&L
 Cash Flow
 Assets
 Liabilities
 Activities

4. Tools of Financial Analysis

5. Introduction
 Measuring the financial performance of a business is
an essential task for those either directly involved in
its operations or those, such as investors, who have a
specific interest in the business.
 By doing so, it is possible to monitor the progress of
the business over a period of time & identify how
successfully the business is performing.
 It provides a method to determine how well things are
going, as well as keeping a close eye on areas which
may be cause for potential concern.
 However, such analysis can also be used to monitor
specific areas of operation & find out where funds are
being leaked away & thus steps can be taken to
reduce costs.

6. Risk Management
 Essence of managing risk is making effective
decisions.
 To facilitate this, accurate information must be
available & proper analysis needs to be carried
out.
 By carrying out regular checkups on financial
condition & performance, companies are more
likely to treat causes rather than address only
symptoms of problems.
 Furthermore, financial statements provide
information that can help to identify emerging
problems so that appropriate & timely action can
be taken to prevent further problems arising.

7. Trend Analysis
 Comparing financial statements from past years
proves helpful as this usually reveals any trends
or patterns.
 Comparing current statements to those of past
periods will indicate what has been happening to
the financial health of the business:
 The balance sheet shows changes in the owners’
equity &, thus, exposure to risk (whether there has
been an increase, a decrease or it remains the
same).
 The P&L account indicates any trends related to
profit.
 The cash flow account can help establish an

8. Users of Financial Information
Internal users
 The main users of financial information within a company will be
managers.
 Accurate & current financial information will support the decision
making that is necessary to keep the business in operation.
 It can also be used for activities such as recording the purchase
of assets and the handling of liabilities, analysis & evaluation of
business trends, & financial control.
 The employees may also wish to have a sound knowledge of
the success, or otherwise, of the company. This may prove
particularly useful during wage bargaining processes where
information about profitability, liquidity & future financial
prospects could provide valuable points for discussion.
 The owners of the company will need this information for the
preparation of business plans involving any necessary bank
loans, for example.

9. Users of Financial Information
(continued…)
External users
 A variety of external users will seek to gain
financial information about a business.
 The legal requirement to make accounts available
to the public means that free access is possible.
This will be essential to:
 Tax authorities
 Auditors
 Registrar of Companies

10. Users of Financial Information
(continued…)
Other External users
 Banks
 Suppliers
 Competitors
 Local community
 The media
 Investors & financial analysts
 Government agencies

11. Balance Sheet

12. Balance Sheet
 Summarises the values of the assets & liabilities of a
business.
 The difference between the assets & liabilities is the
owners’ equity, or net worth of the business.
 However, assets that are leased are not included in the
balance sheet as they are not owned by the business,
even though it can be argued that they make significant
contributions to its productive capacity.
 The key issue to be determined when a balance sheet is
prepared concerns which values should be used. There
are 4 main types of values:
1. Historical value – what the asset cost when it was
acquired
2. Market value – the likely revenue if the asset was sold
now
3. Replacement value – the cost of replacing the asset

13. Balance Sheet (continued…)
 The method selected will depend to some extent on the nature of the
industry in which the company operates.
 In some cases, there is a preference for the use of market value, whilst
accountants tend to choose the book value for assets.
 Indeed, some companies have adopted a practice of including a table
showing 2 sets of values – 1 for book value, & another for current
market value.
 In the case of certain businesses where there is some overlap between
the business & personal interests of the owners, such as farms, there
are occasions where there is some justification for producing 2 distinct
balance sheets: 1 for the business & a separate one for the owner’s
personal situation.
 This provides a clear differentiation between assets owned by the
business and those that are personal.
 Where the business structure is more complex, there may be a need for
more balance sheets, each 1 reflecting the portion of the business
owned by or attributed to each joint partner or owner.

14. Balance Sheet (continued…)
 The Balance Sheet is a statement showing the
assets owned by, & the claims on, the
organisation at a certain date.
 The Balance Sheet provides a snapshot of the
business, & because of this it is headed, ‘Balance
sheet as at ...’.
 Compare this with the P&L Account which is
headed ‘P&L Account for the year ending’.

15. Balance Sheet (continued…)
 The claims on an organisation are made up of:
1. Liabilities – money owing on loans & to creditors,
including accruals (the sums to be paid for items
such as rent & electricity)
2. Equity capital – what shareholders have invested in
the organisation, & the profits that are retained or
reserved to be ploughed back in
 On the balance sheet, the total assets are shown on
the LHS; the total sources of all the money used are
shown on the RHS.
 The 2 sides must always balance.

16. Activity

17. Activity

18. Activity
 A manager identifies 2 errors that have been
made:
1. A delivery of raw materials has been omitted:
The value of it is £1,000 & as yet the company
has not yet paid for it.
2. The company has also purchased a car for
£10,000. This has been paid for by increasing
the bank loan
What difference will it make to the B/S when
these items are included?

19. Activity / Feedback

20. Profit & Loss (P&L)

21. P&L
 Reports the level of profit generated by the business, usually on
an annual basis.
 Shows the level of income & expenditure, but it is important to
consider any changes in inventory, rather than just cash
transaction, when measuring the overall performance &
profitability of the business.
 Shows the operating activities of an organisation, its turnover, its
gross profit after the cost of making its sales, & the net profit after
the deduction of its business expenses over a specified period.
 Note those 2 words ‘gross’ & ‘net’; you will find that finance
people use them a lot. If a business buys goods worth £10,000 &
sells them for £15,000, it makes a:
 Gross profit = Income – Cost = £15,000 - £10,000 = £5,000
 However, that figure ignores all the business expenses: wages,
rent, heating, lighting, advertising... If these business expenses
total £4,000 then the:
 Net profit = Gross profit – Expenses = £5,000 - £4,000 = £1,000

22. Depreciation
 The P&L account contains figures for
depreciation of fixed assets.
 For example, if the company bought a car in
2012 for £20,000, by 2015 it will need to replace
it, perhaps selling it for £5,000.
 We can say that the car depreciates by £15,000
over the 3 years, in other words we need to
include a figure of £5,000 for car depreciation in
every year’s accounts.

23. Activity

24. Activity
 Study the following P&L statement
for year-ended 31st December 2015.
 a) How was the cost of inventory
sold (£160,000) calculated?
 b) What does the figure of £120,000
in the RH column represent and
how was it calculated?
 c) How are the gross profit & net
profit calculated?

25. Activity / Feedback
 a) Cost of inventory sold = Opening inventory +
Inventory purchased - Closing inventory
 b) The £120,000 is the total of all the expenses
(£60,000 + £20,000 + £15,000 + ...)
 c) Gross profit = Sales – Cost of Inventory Sold
Net Profit = Gross Profit - Expenses

26. Cash Flow
 One particularly important question for owners &
managers of all businesses is, “Will we have
enough cash to pay the bills?”
 The cash flow forecast does exactly what it says:
it forecasts how much cash the organisation will
have each month.
 However, that represents only part of the story of
financial recording.

27. Cash Flow
a) The owner put in
£4,000 from savings, &
sales of £10,000 were
predicted.
b) Total payments of
£9,850 were predicted.
c) There was no cash at
the start of the month but
by the end there was
£4,000 cash in the bank.
That £4,000 is carried
forward to become the
Balance brought forward
in May.

28. Cash Flow (continued…)
 Looking at the later months, it’s quite easy to see how
the Total Receipts & the Total Payments are
calculated.
 To work out the figures in the bottom 3 rows, for May:
Receipts – Payments = £12,600 - £10,000 = £2,600
Balance brought forward = Balance Carried forward
from April
Balance carried forward from May = £4,000 - £2,600 =
£1,400

29. Activity

30. Activity
 a) Overall, how much cash does the business make in
the 6 month period?
 b) What problem/s can you see for the business in
that period?

31. Activity / Feedback
 At the start of April, no cash is brought forward from
the previous month, but the owner puts in £4,000. At
the end, the balance carried forward to October will
be £9,000. In other words, the business has £5,000
more cash than it had at the start.
 b) The only problem shown by this forecast occurs in
June. There is a -ve balance of -£200 at the end of
the month. In other words, the business will need to
pay out £200 that it has not got. It may be that the
owner will have to put in another £200 & then take it
out again in July when sales are predicted to be
higher.

32. Cash Flow (continued…)
 The cash flow statement presents details of the sources
& uses of cash resources.
 It shows not only the change in the cash resources of the
business but also where the cash was spent during the
accounting period.
 In order for a business to run smoothly, it is necessary for
the timing of cash receipts and expenditures to be carefully
planned so that cash flow problems do not arise.
 However, cash flow is only concerned with short-term
transactions.
 It is, therefore, necessary to consider longer-term
sustainability when looking at the purchase of larger
equipment & plant.
 Issues of depreciation must be considered to ensure that
there is adequate cash available for effective day-to-day
operation.
 An organisation may be making a profit, but if it doesn’t
have the cash available to pay for its expenses, it can’t

33. Liquidity
 Exists when the organisation has a good cash
flow or has enough cash to meet short-term
requirements & commitments.
 Thus, refers to the amount of cash available in
relation to the size of debts which are payable in
the near future.

34. Assets
 An organisation will typically also own things like
a building, equipment & materials: everything it
owns (including cash) is known as its assets.
 There are different types of assets.
 Fixed assets are the long-term assets that aren’t
used up in the organisation’s operations, in other
words things like buildings, land & equipment
 Current assets are cash, stocks of materials that
the organisation uses to generate products, & any
other assets that can be converted into cash.
Examples include debts owed to the
organisation, stock & temporary investments

35. Liabilities
 The organisation will also know that it has some
longer term payments to make; for example, the
regular repayments on a bank loan, or the
amounts to be paid to electricity and phone
companies.
 All of the amounts that it owes are known as its
liabilities.
 The organisation’s overall wealth at any one
time can be calculated as:
Wealth = Assets - Liabilities

36. Activity

37. Activity
 A company owns building & equipment worth
£100,000.
 At the start of the year it also has £3,000 in cash, &
stocks of materials worth £10,000.
 It knows that this month it will need to pay equipment
hire charges of £2,000 & other regular payments of
£5,000.
 The expected income from sales this month is £6,000.

38. Activity / Feedback
The monthly income (the receipts) amounts to £6,000 & the monthly
payments (the liabilities) are £7,000.
In other words, the organisation is losing £1,000 every month!!

39. Scenario Analysis
What-if’ Calculations
 When cash flow statements are presented in the form of a spreadsheet,
they provide a very useful opportunity to see what happens under a
range of changing conditions.
 It is possible to alter any particular figure(s) that has been predicted &
then see the consequences of this change.
 If for example the number of units sold in the coming month is
predicted to be 6,500 instead of 9,200, we might see that the costs of
production are not covered & the business registers a loss as a result.
 In this way, it is possible to determine the effective break-even sales
figure which must be reached in order for the business to be in a
profitable position.
 A further example might be that you want to calculate figures for the 6
month period if the business chose to perhaps increase advertising
spending to £800.
 You could do it by simply replacing each of the advertising amounts to
£800 & manually adjusting the rest of the figures.
 Therefore, the use of spreadsheets can allow you to quickly calculate
answers to ‘What-if’ scenarios.
 This is a commonly used tool in all financial decision making.

40. Interpretation & limitations of
financial statements
 The financial statements of any organisation are
interpreted by interested parties for decision-
making & control purposes.
 Interpretation of accounts involves 5 key steps:
1. Reading the accounts in order to understand
the business
2. Calculating the main ratios, %’ages &
performance indicators
3. Identifying the main strengths & weaknesses of
the business
4. Drawing appropriate conclusions as to how the
business has performed historically

41. Information from financial
statements
 Comparing current performance to historical &
projected/budgeted performance so that it is possible
to establish how actual outcome varies from what was
expected.
 Comparing the performance of the business with that
of similar businesses. This will make it possible to
determine the relative status & position of a business
in a specific market. If performance is below the
market average, this may suggest that additional
profits are possible & that there is potential for greater
productivity if appropriate management action is
taken.
 Comparing the performance of a business & another
similar-sized & structured business operating in a
different market.
 This may enable the identification of any opportunities
that are being missed as a result of over-

42. Limitations of financial
statements
 Financial statements can only report past
performance.
 Financial statements are purely factual &
objective - they do not consider the qualitative
aspects of the management of a business.
 Financial statements are unable to identify
changes in the structure of a business – it is
essential to understand how the structure of a
business is evolving if forecasts of future success
are to be made.
The use of additional Directors’ Reports &
Notes to the Accounts becomes particularly
important here.

43. Any questions?

44. Thank you!