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Finance is rightly been termed as master key providing access to all sources required for running business activities. Finance is the management of monetary affairs of a company.
DEFINITION OF FINANCE
Ray G.Jones and Dean Dudly observes that the word finance comes from a Latin word Finis. In simple words Finance is Economics and Accounting, economics is proper utilization of scarce resources and accounting is keeping a record of things. Keenth Midgely and Ronold Burns define finance is the process of organizing the flow of funds so that a business can carry its objectives in the most efficient manner and meet its obligations as they fall due.
SCOPE OF FINANCE
The scope of finance function is as wide as the periphery of finance. It concentrates primarily on money management and different auxiliaries, which are incidental to it. For effective money management, the different resources of business enterprises must be mobilized. The finance penetrates all the activities irrespective of whether they relate to product, pricing, expansion, acquisition, re-organization and in fact anything, which needs finance.
FUNCTIONS OF FINANCE
Finance function is the task of providing funds required by an enterprise on the terms most favorable to it in the light of objectives of business. There are three finance functions: Investment decision takes to selection of both long term and short term asset in which funds will be invested by a firm. Financing decision is concerned with financing mix or capital structure.
The mix of debt- equity and debt is the main issue in financing to share holders and also financial risk. Dividend decision has a strong influence on the marked price of the share therefore; the dividend policy is to be determined in terms of its impact on shareholders value.
FINANCIAL MANAGEMENT
Finance is the life blood of a business. Financial Management refers to the process of procuring and judicious use of financial resources with a view to maximizing the value of the firm thereby the value of the owners i.e., equity share holders in a company. Financial management provides the best guide for the future resource allocation by firm and provides relatively uniform yardstick for judging most of the operations and projects. The importance of financial management has arisen because of the fact that present day business activities are predominantly carried on through company or corporate form of organization. The advent of corporate enterprises has resulted into: The increase in size and influence of the business enterprises Wide distribution of corporate ownership and Separation of ownership and management
The above three factors have further increased the importance of financial management. Financial management helps the firm in optimizing the output from The given input of funds. It helps in monitoring the effective employment of funds in both Fixed and current assets. It helps in profit planning, capital budgeting etc., It is necessary for non-profit organizations to control cost and to use funds at their disposal in the most useful manner.
Profit Maximization Profit helps in measuring the economic performances of firms. It makes allocation of resource to profitable and desirable areas. On these profits maximization serves as criteria for financial decisions. Wealth Maximization Wealth maximization is an important objective of an enterprise. Financial theory asserts that wealth maximization is the single substitute for stock holders utility. When the firm maximizes the stock holders wealth, the individual stockholder can use this wealth to maximize his individual utility.
Financial statement provides a summarized view of operations of a firm. The significance of financial statement analysis is as follows: It helps as a screening tool in the selection of investment. It can be used as forecasting tool for future profitability and financial soundness of the business. It helps the management in identifying the factors responsible for creating managerial, operating and other problems. It is an important tool for evaluation of the performance of both the management and organization. USES OF FINANCIAL STATEMENT ANALYSIS The uses financial statement analyses are as follows:Insiders consist of management personals, owners, employers and stockholders who are basically interested in the overall performance of the firm to know the returns on their investments, their performance, to evaluate themselves etc. Outsiders includes persons like creditors, debenture holders, shareholders, investors and government. Steps involved in financial statement analysis:There are three steps involved in the analysis of financial statements. These are:I. II. III. Selection Classification and Interpretation
The first step involves selection of information (data) relevant to the purpose of analysis of financial statements. The second step involved is the methodical classification of the data and the third step includes drawing of interference and conclusions.
The following procedure is adopted for the analysis and interpretation of Financial Statements:1) The analyst should acquaint himself with the principles and postulate of accounting. He should know the plans and policies of the management so that he may be able to find out whether these plans are properly executed or not. 2) The extent of analysis should be determined so that the splurge of work may be divided. If the aim is to find out the earning capacity of the enterprise then analysis of income statement will be undertaken. On the other hand, if financial position is to be studied then balance sheet analysis will be necessary. 3) The financial data given in the statements should be re-organized and re-arranged. It will involve the grouping of similar data under same heads, breaking down of individual components of statements according to nature. 4) A relationship is established among financial statements with the help of tools and techniques of analysis such as ratios, trends, common size, funds flow etc. 5) The information is interpreted in a simple and understandable way. The significance and utility of financial data is explained for helping decision-taking. 6) The conclusions drawn from interpretation are presented to the management in the form of reports.
The analysis conducted by persons who have access to the internal accounting records of a business firm is known as internal analysis. Such an analysis can, therefore, be performed by executives and employees of the organization as well as government agencies which have statutory powers vested in them. Horizontal analysis:Horizontal analysis refers to the comparison of financial data of a company for several
years. The figures for this type of analysis are presented horizontally over a number of columns. The figures of the various years are compared with standard or base year. Comparative statements and percentages are two tools employed in horizontal analysis. Vertical analysis:Vertical analysis refers to the study of relationship of the various items in the financial statements of one accounting period. In this type of analysis the figures from financial statement of a year are compared with a base selected from the same years statement. Common-size financial statements and financial ratios are the two tools employed in vertical analysis.
TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS A number of tools are available for analyzing the financial statements. The important tools are as follows: Comparative Financial Statement Analysis The comparative financial statements are statements of the financial position at different periods of time. The elements of financial position are shown in a comparative form so as to given an idea of financial position at two or more periods. The comparative statement may show absolute figures, changes in absolute figures absolute data in terms of percentage and increase or decrease in terms of percentages. The two comparative statements are balance sheet and income statement. Trend Analysis
The financial statements may be analyzed by computing trends of series of information. This method determines the direction upwards or downwards and involves the computation of the percentage relationship that each statement item bears to the same item in base year. The information for a number of years is taken up and one year, generally the first year, is taken as a base year. Common-size statement The common-size statements, balance sheet and income statement are shown in analytical percentages. The figures are shown as percentages of total assets, total liabilities and total sales. These statements are also known as component percentages or 100 percent statements because every individual item is stated as a percentage of the total 100. Ratio Analysis Ratio is a simple arithmetic expression of the relationship of one number to another. Ratio is an expression of the quantitative relationship between two numbers. It is a technique of analysis and interpretation of financial statements. It helps in making decisions regarding the financial strengths and weaknesses of firm. Fund flow Analysis The term flow means movement and includes both inflow and outflow. The term flow of fund means transfer of economic values from one asset of equity to another. Fund flow statement is a statement which shows the movement of funds and reports the financial operations of the business. It is statement showing the sources and application of funds for a period of time. Cash flow Analysis A cash flow statement is a statement that summarizes sources of cash (cash inflow) and uses of cash (cash outflow) during a particular period of time a month or a year. Cash includes cash on hand and demand deposits with banks. Cash equivalent includes short term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.
Financial analysis is a powerful mechanism of determining financial strengths and weaknesses of a firm. But, the analysis is based on the information available in the financial statements. Thus, the financial analysis suffers from serious inherent limitations of financial statements. Some of the limitations of financial analysis are: It is only a study of interim reports Financial analysis is based upon only monetary information and non-monetary factors are ignored It does not consider changes in price levels As the financial statements are prepared on the basis of a going concern, it does not give exact position. Thus accounting concepts and conventions cause a serious limitation of financial analysis. Changes in accounting procedure by a firm may often lead to misleading financial analysis. The analyst has to make interpretation and draw his own conclusions. Different people may interpret the same analysis in different ways.
PART B
OVERVIEW OF RATIO ANALYSIS
OVERVIEW OF RATIO ANALYSIS
Ratio analysis is a very powerful analytical tool useful for measuring performance of an organization. The ratio analysis concentrates on the inter-relationship among the figures appearing in the financial statements. The ratio analysis helps the management to analyze the past performance of the firm and to make further projections. Ratio analysis allow interested parties like shareholders, investors, creditors, Government and analysts to make an evaluation of certain aspects of firms performance. Ratio analysis is a process of comparison of one figure against another, which makes a ratio and the appraisal of the ratios to make proper analysis about the strengths and weaknesses of the firms operations. The calculation of ratios is a relatively easy and simple task but the proper analysis and interpretation of the ratios can be made only by the skilled analyst. Ratio analysis is extremely helpful in
providing valuable insight into a companys financial picture. Ratios normally pinpoint a business strengths and weakness in two ways: Ratios provide an easy way to compare present performance with the past. Ratios depict the areas in which a particular business is competitively advantaged or disadvantaged through comparing ratios to those of other businesses of the same size within the same industry.
Ratios of one firm can also be compared with the ratios of some other selected firms in the same industry at the same point of time. This kind of comparison helps in evaluating relative financial position and performance of the firm.
Step 1:- Collecting information from the financial statements and then calculating different Ratios
accordingly.
Step 2:- Comparison of computed ratios with post ratios of the same organization. Step 3:- Interpretation, drawing interferences and reporting.
CLASSIFICATION OF RATIO
From the view point of financial management ratios are classified into four groups. They are as follows
1) Liquidity ratios
a) current ratio b) liquidity ratio c) absolute ratio
3) Profitability ratios
a) Gross profit ratio b) Net profit ratio c) Operating profit ratio d) Return on capital ratio
4) Turnover ratios
a) debtors turnover ratio b) creditors turnover ratio c) total assets turnover ratio d) fixed assets turnover ratio e) working capital turnover ratio f) current assets turnover ratio
LIQUIDITY RATIOS
Liquidity means ability of a firm to meet its current obligations. Therefore liquidity ratios try to establish a relationship between current liabilities, which are the obligations and current assets, which provide the sources from which these obligations are met. If it is decided to study the liquidity position of the concerns, in order to highlight the relative strength of the concerns in meeting their current obligations to maintain sound liquidity and also to pinpoint the difficulties if any in it, then liquidity ratios are calculated. These ratios are used to measure the firms ability to meet short terms obligations. From these ratios, much insight can be obtained into the present cash solvency of the firm and the firms ability to remain solvent in the event of adversity.
CURRENT RATIO
This is the most widely used ratio. It is the ratio of current assets to current liabilities. It shows a firms ability to cover its current liabilities with its current assets. It is expressed as follows:
LIQUID RATIO
This is the ratio of liquid assets to liquid liabilities. It shows a firms ability to meet current liabilities with its most liquid (quick) assets, 1:1 ratio is considered ideal ratio for concern because it is wise to keep the liquid assets at least equal to the liquid liabilities at all times. Liquid assets are those assets which are readily converted into cash and will include cash balances, bills receivables and sundry debtors and short term investments. Liquid liabilities include all items of
current liabilities except bank overdrafts. This ratio is the acid test of a concerns financial soundness. It is calculated as under: Liquid ratio= liquid assets/ current (or liquid) liabilities
ABSOLUTE RATIO
Though receivables are generally more liquid than inventories, there may be debts having doubts regarding their real stability in time. So, to get idea about the absolute liquidity of the concern, both receivables and inventories are excluded from current assets and only absolute liquid assets such as cash in hand, cash at bank are readily realizable securities are taken into consideration.
PROPRIETARY RATIO A variant of debt or equity ratio is the proprietary ratio which shows the relationship between shareholders funds and total tangible assets. This ratio is worked out as follows:
PROFITABILITY RATIOS
It is calculated to measure the efficiency of a business and profitability of a business in relation to sales and investment. Profitability is the overall measure of the companies with regard to efficient and effective utilization of resources at their command. It indicates in a nutshell the effectiveness of the decisions taken by the management from time to time. Profitability ratios are of utmost importance for a concern. These ratios are calculated to enlighten the end results of business activities, which is the sole criterion of the overall efficiency of a business concern. The following are the important profitability ratios.
Higher the ratio, the better it is. A low ratio indicates unfavorable trends in the form of reduction in selling prices not accompanied by proportionate decrease in cost of goods or increase in cost of production. The gross profit should be adequate to cover fixed expenses, dividends and building up of reserves. Where this occurs, management should keep a record of mark-ups and mark downs. So that when the trading statement is completed according to actual figures, the gross profit can be tested for regularity. It is important that a business keeps up its margin of gross profit; otherwise it may not cover its operating expenses and thus provide an adequate return to proprietors. In many industries there is more or less recognized gross profit and experience will indicate whether the ratio of the enterprise being analyzed is satisfactory or not.
OR
Gross profit Operating Expenses
TURNOVER RATIOS
They are used to indicate the efficiency with which assets and resources of a firm are being utilized. A higher turnover ratio indicates the better use of capital resource, which in turn has a favorable affect of profitability of a firm. These ratios are very important for a concern to judge how well facilities at the disposal of the concern are being used to measure the effectiveness with which a concern uses its resources at its disposal. In short, these will indicate position of assets usage. These ratios are usually calculated on the basis of sales or cost of sales and are expressed in number of times rather than as a percentage. Such ratios should be calculated separately for each type of asset. The greater the ratio more will be the efficiency of asset usage. The ratio will reflect the under utilization of the resources available at the command of the concern. The concern must always plan for efficient use of the assets to increase the overall efficiency. The following are the important turnover ratios usually calculated by a concern:
Balance Sheet of Dena Bank Mar '09 12 mths Capital and Liabilities: Total Share Capital Equity Share Capital Share Application Money Preference Share Capital Reserves Revaluation Reserves Net Worth Deposits Borrowings Total Debt Other Liabilities & Provisions Total Liabilities Assets Cash & Balances with RBI Balance with Banks, Money at Call Advances Investments Gross Block Accumulated Depreciation Net Block Capital Work In Progress Other Assets Total Assets Contingent Liabilities Bills for collection Book Value (Rs) 526.30 526.30 0.00 0.00 23,545.84 0.00 24,072.14 367,047.53 19,184.31 386,231.84 49,578.89 459,882.87
------------------- in Rs. Cr. ------------------Mar 10 12 mths 526.30 526.30 0.00 0.00 27,117.79 0.00 27,644.09 380,046.06 30,641.24 410,687.30 55,538.17 493,869.56 Mar 11 12 mths 526.30 526.30 0.00 0.00 Mar 12 12 mths 631.47 631.47 0.00 0.00 Mar 13 12 mths 634.88 634.88 0.00 0.00 57,312.82 0.00 57,947.70 742,073.13 53,713.68 795,786.81 110,697.57 964,432.08
30,772.26 48,401.19 0.00 0.00 31,298.56 49,032.66 435,521.09 537,403.94 39,703.34 51,727.41 475,224.43 589,131.35 60,042.26 83,362.30
566,565.25 721,526.31
16,810.33 22,511.77 202,374.45 197,097.91 6,691.09 4,114.67 2,576.42 121.27 18,390.71 459,882.86 131,325.40 44,794.10 457.39
21,652.70 22,907.30 261,641.53 162,534.24 7,424.84 4,751.73 2,673.11 79.82 22,380.84 493,869.54 191,819.34 57,618.44 525.25
29,076.43 22,892.27
51,534.62 15,931.72
55,546.17 48,857.63 542,503.20 275,953.96 10,403.06 6,828.65 3,574.41 263.44 37,733.27 964,432.08 614,603.47 152,964.06 912.73
337,336.49 416,768.20 149,148.88 189,501.27 8,061.92 8,988.35 5,385.01 2,676.91 141.95 5,849.13 3,139.22 234.26
25,292.31 44,417.03 566,565.24 721,526.32 259,536.57 736,087.59 70,418.15 93,652.89 594.69 776.48
Mar 09 Income Interest Earned Other Income Total Income Expenditure Interest expended Employee Cost Selling and Admin Expenses Depreciation Miscellaneous Expenses Preoperative Exp Capitalised Operating Expenses Provisions & Contingencies Total Expenses 18,483.38 6,907.35 2,634.64 752.21 6,465.82 0.00 11,278.18 5,481.84 35,243.40 32,428.00 7,119.90 39,547.90
Mar 10
Mar 11
Mar 12
Mar 13
Mar 09 Net Profit for the Year Extraordionary Items Profit brought forward Total Preference Dividend Equity Dividend Corporate Dividend Tax Per share data (annualised) Earning Per Share (Rs) Equity Dividend (%) Book Value (Rs) Appropriations Transfer to Statutory Reserves Transfer to Other Reserves Proposed Dividend/Transfer to Govt Balance c/f to Balance Sheet Total 3,552.89 0.01 751.62 81.79 125.00 457.39 4,304.52 0.00 0.34 4,304.86 0.00 657.87 93.75
0.34 4,304.86
0.34 4,407.01
0.34 4,541.65
0.34 6,729.46
0.34 9,121.57