Financial Analysis & Management

Student:

Sanjar Tursunov

ID number: B0391KGKG0812 Submitted to: Palan Ambikai

2
Table of Contents
Question 1 ............................................................................................................................................... 3 Question 2 ............................................................................................................................................... 6 Question 3 ............................................................................................................................................... 8 References: ............................................................................................................................................. 9

3
Question 1
Money is important for every single staring business, in other words money can be considered as the language of a business which allows business to purchase machinery, tools, property or any other assets. Obviously, the purpose of each business is to gain profit. There might be a question comes up such as, why do businesses need to make profit? There are quiet few reasons behind it; some of them are shown below: Retained profit; Survival of a business; Making an investment into faulty projects; Investing into the same project more, where required.

An organization needs to make a decision before making an investment into presented project at a given time which is most of the time is long term decision. Investment appraisal can be considered as a financial decisions evidence especially; when businesses take a decision on making an investment into projects that will have a huge affect on the businesses future wealth, health and success. Additionally, it identifies that presented project is worth investing or not. Else, there can be value added to the investment appraisal as the undertake of certain project would cause increase in present value as well as the future fortune. There are quite a few ways of decision making that companies use for investment. Examples are listed below: Investment appraisal Accounting Rate of Return (ARR); Payback Period (Payback, PBP); Net Present Value (NPV); Internal Rate of Return (IRR)
John R. Dyson, (2010)

Discounted cash flow allows comparing the existing cost of a project with the future flow of discounted cash that is possibly will be produced. It gives a chance to illustrate companys profitability within the project. It is done by discounting the future cash flow, moreover, putting their sums in comparison. Using discounted cash flow method of an investment appraisal is being able to choose a project that which has more real return from other projects, therefore, the real return term means affect of net cash flow by the money value change during the particular period of time. In other words, because of inflation, there is always a negative affect expected in the future towards change in money value. The longer it takes to the investment to produce cash inflow; the lower will be the value of the inflow cash. At 5% inflation rate, a 100 that is been made through few years time period would be worth roughly 95 in real terms. This means that the value of the money has been decreased by inflation, in other words, the reduction of the money power. Furthermore, year by year, there will be more of inflation going on, and certainly it will be affecting the money power.

4
There are 2 main Discounted Cash Flow methods, which are: the NPV (Net Present Value) and the IRR (Internal Rate of Return) methods, they both consider the time value money, and there are same methods applied in computerized interest income deposits. In method of Net Present Value, the expected future returns (cash inflows) and a discount rate are multiplied together in order to gain their Present Value. The existing investment cost and other costs (outflow-cash) are taken away from the Present Value to get the net Present Value of an investment. If the Net present value is positive then the investment can be made into given project. The method of internal rate of return is literally calculates the percentage of return that the chosen project produces during its life time with discounted cash flow. The advantage of using the internal rate of return is that it does not consider at time - value money, furthermore, it is supposed to be more accurate in details than method of accounting rate of return. The IRR is calculated via methods of trial and error which uses a mathematical diagram or a formula.
Ken Little. (2011).

Examples of NPV Assume that company A wants to buy company B and company A carefully takes a look at company Bs future plans for 10 years and it puts all those projected plans inflows into discount to gain the WACC (Weighted average cost of capital) and takes off the Company Bs purchasing cost from that. Purchase cost of company B today: 1,000,000 Company Bs present value cash flow:
Year 1: 210,000 Year 2: 140,000 Year 3: 110,000 Year 4: 85,000 Year 5: 60,000 Year 6: 65,000 Year 7: 40,000 Year 8: 55,000 Year 9: 40,000 Year 10: 10,000 Total: 815,000 Hence, we do know the total cash flow for 10 years, and now the formula can be used to get the NPV Net Present Value (NPV) = 815,000- 1,000,000 = -185,000

5
Example of IRR

Suppose that Company A needs to take a decision over buying an equipment for a factory for the price of 200,000. The use of equipment is 3 years; however, it is assumed that it can add up 150,000 to annual profit. Also it is considered by the company to sell it for 40,000 afterwards. By using the IRR method, company A is able to decide whether the purchase of the equipment is more appropriate for its cash than the other available options, which eventually should have return of 10% Formula for calculating IRR is: 0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . +Pn/(1+IRR)n and there solution is shown below according to the formula: 0 = -200,000 + (180,000)/(1+.2431) + (180,000)/(1+.2431)2 + (180,000)/(1+.2431)3 + 40,000/(1+.2431)4 the IRR of the investment is 25.35% which makes the present values investment cash flow equal to 0. According to the result, technically, company A can buy the equipment as there will be return of 25.35% to the company. Additionally is it quite higher that 10%
Glen Arnold (2005)

6
Question 2
Profitability It can be define as the last measure of the success of an organization/business in terms of its investment made. Such success is defined as significance of the accounting net profit. Profitability is the main target of all business fields. The businesses would not last long without having profitability. Comparing and analysing current and previous profitability and aiming the future profitability is quiet important. Profitability can be measured with some expenses and income. Definition of income is the money produced by the tasks of the business. For instance, if carrots and cattle is produced and sold, income is made. But when the money coming from the procedures, such as, called borrowing is not considered as an income. It is just another form of cash transaction between the business and another organization/individual in order to run the business. Moreover, expenses can be seen as the resource costs or expenditures that are done by the procedures of the business. For instance, carrot is an expense for a farm related business as it is necessary to be used within the production part of the business. The procedure of profitability usually done by as shown below: (Return on Assets = Net Income / Total Assets) and (Return on Equity = Net Income / Equity)
Smith Dale. (2010).

Liquidity Liquidity is a company/organizations ability of meeting short term responsibilities. In other words, a companys ability of turning its assets into cash. When it is said short term, generally it refers to responsibilities that within one accounting year. It also has an effect on cycle of operation, such as, purchasing, selling, and producing. An organization which is not able to pay creditors at agreed time and keeps on not to respect and follow the responsibilities towards credit suppliers, goods and services, possibly can be announced as bankrupt or a sick company. There might be serious affect on companys operations if the short term liabilities are not met on time and therefore, it can reflect to the business reputation badly. Not having enough cash or too many assets on hand might cause the company to miss out the motivation shown by the credit suppliers, goods and service suppliers. As a result, the cost of good will be higher which leads to have negative effect on profitability of the business. It is important to keep particular level of liquidity within the company to maintain the healthy business. However, unfortunately, there is no liquidity standard framework. All is up to the behaviour of the business, operation scales, location and variety types of other factors. Each stakeholder is interested in a companys liquidity position. Any goods supplier checks the organization/companys liquidity level before having any business with them. In addition, even employees are curious about companys liquidity as if the company can cover employee related responsibilities, such as, pension, salary etc. Also, shareholders have interest in understanding the liquidity as it has a massive affect on profitability of the business. They might not like liquidity on high level as profitability. But the shareholders are

7
aware of that if the company has non liquidity then it will lead to missing the incentives from all suppliers including bankers and creditors. John Coombe (1999). Working capital management It involves relation between organizations assets and liabilities, both are in short- term. The main target of working capital management is that the organization has ability of to keep its business running and has adequate ability of impressing debts in short term and forthcoming expenses. The working capital management includes managing cash, payable and receivable accounts and inventories. When a firm/organization has a large amount of working capital, then it has a meaning of that the firm/organization has a well balanced liquidity. The organizations balance sheet financial information can be considered as a key to calculate the working capital. It can be done by taking away current liabilities from current assets; therefore the answer is equal to working capital.
economywatch (2009).

8
Question 3
Investment rules have their own history in economics, as a contrast accounting has different origin. Whilst publishers are investors in book titles, courts use the documents that are in accounting format to check if the company is able to pay its debts. Banks learn the balance sheet of the company while taking decision on lending a load to the company. Organizations looking for a loans or investment from external sources have to make business plan which should include forecast in a format of accounting. Speaking of companies, published accounts are considered as quite important source of information for government, suppliers, employees, consumers for future planning points. In some cases there are no accounts published, such accounts offer internal vital information, effectiveness and solvency of the directors board. John Coombe (1999) Within young, growing economies, published accounts refer to generating the taxation level that needs to be paid to the government. In advanced economies they are used as a measuring tool, (in order to attract employees, suppliers, investors and banks) research of market data, requirement of stock market list. In developed countries like the US and the UK, shareholders are targeted by published accounts. To attract overseas investment and gain more confidence, majority of the young economies adopt global accounting methods. Unfortunately, there is not any format used but the fundamental rules are slightly similar. Different sort of standards are being adopted by different countries. Income Statement
Whilst putting in comparison the two figures of profit, it is important to keep in mind that public listed organizations/companies must satisfy their public shareholders; meanwhile, there might be involvement of private shareholders to running the company, moreover, banks must be satisfied for lending money purposes, consumers, employees and suppliers too. With the advice and suggestion of the auditors, private companies will look for the legal ways of minimizing the taxes on profit.

The Balance Sheet In majority of countries, assets are shown on the side on the balance sheet, and the liabilities are on the other side. Each side must be equal. Its layout may be perfect for an accountant who is more comfortable with the double entry but it is the other way around for the publishers, banks and entrepreneurs unless they were trained how to use it. Global trend is to have the balance sheet more concentrated at business owners and the shareholders. For private owner smaller firms/organizations, balance sheet is made on entity basis.

9
References:
Glen Arnold (2005). Corporate Finance. Great Britain: Prentice Hall. p99-68. Graham Mott, (2005). Accounting for non accounting students. 6th ed. London, England: Pan Books. John Coombe (1999). Statement of Principles for financial report. UK: accounting standards board. 47-79. John R. Dyson, (2010). Accounting for non accounting students. 8th ed. Harlow, England: Pearson

economywatch (2009). Source of finance. [ONLINE] Available at: http://www.economywatch.com/finance/. [Last Accessed 15 April 13]. Ken Little. (2011). Use Cash Flow to Evaluate Stocks. Available: http://stocks.about.com/od/a/Cashflw092005.htm. Last accessed 14th Apr 2013. Smith Dale. (2010). Understanding Profitability. Available: https://www.extension.iastate.edu/wholefarm/html/c3-24.html. Last accessed 16th Apr 2013.