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P3 BUSINESS ANALYSIS

LECTURER: Stanford Allen


Class Notes 9
Objectives
To examine the link between finance and strategy
To explore funding options
To review standard costs and variances
To examine ratios and techniques in performing financial comparisons between companies

1 FINANCE
In commercial organizations, managing for value is about creating shareholder value, while in the public sector, it is about
obtaining value for money. Managers must understand the key cost and value drivers affecting their operations. Financial risk is
determined exclusively by gearing, but there are several sources of business risk. Financial risk may be balanced against business
risk, so that the overall risk is managed.
1.1 Finance and strategy
JS&W suggest organizations of all types must deal with three broad issues of finance
1.1.1 Managing for value
1.1.1.1 Shareholder value (commercial organizations)
Shareholder value depends on long-term capacity to generate cash., which will enable dividend payments which will
in turn drive up market value of the business. Three factors influence this ability:
Funds from operations, which are determined by sales revenues and costs
The net cost of financing the capital base of fixed and current assets required to support operations
Capital structure (gearing), which will determine the companys cost of capital and its financial risk
1.1.1.2 Best value in the public sector
While most public sector managers are concerned with managing their budgeted cash spending, they should bear the
efficient exploitation of their fixed assts in making decisions.
1.1.1.3 Drivers of cost and value
Value creation does not occur and costs do not arise evenly across the organization. Managers should
therefore have a firm grasp of the key cost and value drivers affecting their operation
Some of these may be outside the immediate control of the managers and may occur elsewhere in the value
network
Choice of strategy interacts with cost and value
1.1.2 Funding strategies
Funding arrangements can be a major influence on strategy:
A highly geared company is likely to avoid high levels of business risk
A form of ownership may be changed in order to gain access to new sources of funds
A strategy base on acquisition may be driven by the need to reinvest surplus funds or to demonstrate a high
level of growth of the market. Wider strategic considerations may be neglected as a result
1.1.3 Managing risk
JS&W point out that financial risk can, to some extent be balanced against business risk in order to produce an
acceptable level of risk overall. If business risk is perceived as being low, a higher level of financial risk may be
acceptable and gearing increased. Similarly, if business risk increases, a proportionate response might be to aim to
pay off an element of debt.
JS&W illustrates this relationship in the table below based on the BCG matrix.

Richmond Academy Page 1 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
Launch Growth Maturity Decline
(Question Mark) (Star) (Cash Cow) (Dog)
Business risk Very High High Medium to low Low
Financial risk Keep very low Keep low May be increased Can be high
therefore
Funding Venture Capital Equity Debt & Equity Secured Debt
Dividends Nil Nominal if any High Total

1.1.4 Financial expectations of stakeholders


Dividends and wealth creation - shareholders
Proper wages and salaries - employees
Socially responsible actions
Solvency and liquidity trading partners
Good value customers

1.2 Financial management decisions


1.2.1 Investment decisions
Financial manger will need to identify investment opportunities, evaluate and decide on the optimum
allocations of scarce funds available between investments
Investment decisions may be new projects, takeovers or mergers or selling part of the business
1.2.2 Financing decisions
Financing decisions include those for long term (capital structure) and the short term (working capital management)
1.2.3 Dividend decisions
These may affect the view that shareholders have of the long-term prospects of the company, and thus the market
value of the shares
.
1.3 Cash forecasts
Cash forecasting should ensure that sufficient funds will be available when needed, to sustain the activities of an
enterprise at the acceptable costs.
1.3.1 Cash budgets
A cash budge t (or forecast) is a detailed budget of estimated cash inflows and outflows incorporating both
revenue and capital items
Cash budgets are used to plan the structure of an organisations finances in terms of how much cash is
required, when it is required, how long it is required for & whether it will be available for the anticipated
sources
1.3.2 Cash forecasts based on the statement of financial position (balance sheet)
This is produced for management accounting purposes and not for external or statutory reporting
It is not an estimate of cash inflows and outflows
It can be used to produced a number of sequential forecast e.g. a forecast of the financial position at the end
of the next five years
This can be used to identify either cash surplus of the funding shortfall in the companys statement of
financial position at the forecast date
1.3.3 Sensitivity analysis
Sensitivity analysis can be used to answer what if questions. Managers are able to determine how changes in
economic and business variables can affect investment decisions.

Richmond Academy Page 2 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.3.4 Changes in economic variables
Economic variables such as changes in inflation, interest rates and taxes and so on are important to
managers because of the impact they can have on business performance. Businesses will therefore need to
forecast:
o How the predicted changes will affect demand
o How the business will respond to changes in variables
1.3.5 Changes in business variables
Economic variables will have impact on sales volumes or profit margins
Managers should be aware of changes in the competitive environment and the effect these may have on
sales volume and profit margins

1.4 Financing requirements


Any forecasted deficiency of cash will have to be funded:
o Borrowing.
o Sale of short-term marketable financial investments
For forecasted cash surpluses, the size and how long are useful in determining how best to invest it.

1.5 Obtaining equity funds


Companies seeking extra equity finance can obtain it by retaining cash in the business for investment or by issuing
shares.
1.5.1 Retained profits
1.5.1.1 Advantages
Flexible source of finance. Companies are not tied to specific amounts or repayment patterns
Does not involve a change in the pattern of shareholdings
1.5.1.2 Disadvantages
Shareholders may be sensitive to the loss of dividends that will result from re-investment
There is an opportunity cost that is involved as the funds could be invested by shareholders to earn a return.
1.5.2 Ordinary (equity) shares. Equity share capital is a companys issued share capital less capital which caries
preferential rights. Reasons for new shares:
To raise more cash to example to expand its operations
To obtain a stock market listing
To take over another company (new shares issues to shareholders of another company)

1.6 Bank loans


1.6.1 Loan or overdraft.
Overdraft may be appropriate for short term, day-to-day cash flow needs
If the amount can only be repaid over the course of a few years then a loan is preferable.
1.6.2 Advantages of an overdraft over loan
The customer only pays interest when it is overdrawn
The bank has the flexibility to review the customers overdraft facility periodically. This may result in an
increase or decrease of the facility.
An overdraft can do the same job as a loan facility.
Being short term debt, overdraft will not affect the calculation of a companys gearing
1.6.3 Advantages of loan over overdraft
Both bank and customer know the terms: repayments, interest rates etc
The customer does not have to worry about the withdrawal of an overdraft facility

Richmond Academy Page 3 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.7 Loan capital
Includes bonds, debentures or other long term loans
1.7.1 Advantages of bank loan over other forms of loan capital
Flexibility. Its may be possible to change the terms of the bank loans as the finance requirements of the
company changes
Confidentiality. The company will not have to fulfill the publicity requirements that an issue of loan stock on
the financial markets would require
Speed. Quicker to meet bank requirements that those of a public issue
Costs. A bank loan will mean that the issue costs of loan stock are avoided.
1.7.2 Disadvantages of bank loan over other forms of loan capital
Restrictions such as collateral and possible restrictive covenants are required, as oppose to none for certain
types of loan capital.
Financial information such as budgets and management accounts may have to be periodically submitted to
the bank s, whereas other lenders will not require this detailed information.

1.8 Budgetary process


A budget is a short term plan expressed in financial terms. It converts strategic plans into specific targets.
Budgets help organizations as they promote forward thinking, assist in the coordination of different aspects
of the organization, motivate managers and provide a basis for systems of control and authorization
1.8.1 Budgets, long term plans and corporate objectives
Budget is short term usually one year, expressed in financial terms and targets being connect to strategy
The budget must be controlled to ensure the planned events actually occur
A periodic budget covers a period e.g. a year. A continual or rolling budget is continually updated.
Different budgets are usually prepared for each specific aspect of the business. These budgets are then
summarized into a master budget.
Sales budget is usually the first budget prepared as the level of sales determine the overall level of activity for
the period
Planning, including budgeting is the responsibility of managers not accountants. Management accountants
will provide the necessary information and assist in decision making.
1.8.2 Benefits of budgets
Promotes forward thinking. Potential problems are identified early.
Helps to coordinate the various aspects of the business.
Motivates performance.
Provides a basis for a system of control.
Provides a system of authorization.
1.8.3 Making budgetary control effective
Senior management takes the system seriously
Accountability. Clear responsibilities as to which manager is responsible for each business area
Targets are challenging but achievable
Established data collection, analysis and reporting routines including actual vs budget
Targeted reporting. Reports specific to manages and their areas of responsibilities
Short reporting periods to quickly identify things going wrong
Timely reporting. Variance reports provided as soon as possible after the end of the reporting period
Provokes action. Managers must act on the variance reports to create change.
1.8.4 Behavioural aspects of budgets
They have been found to improve performance

Richmond Academy Page 4 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
They are most effective when targets are demanding yet achievable.
Are most effective when managers have participated in the setting of their own targets.

1.9 Standard costing and variance analysis


1.9.1 Standards and budget
Budgets are often structured as standards.
Standards are a set of carefully predetermined quality target which can be achieved in certain conditions
Similar in the following ways:
o Look to the future and what is likely to happen in a given set of circumstances
o Used for control purposes
o A standard unit production cost can act as the basis for a product cost budget
Differences:
Budgets Standards
Gives planned total aggregate costs for a function Shows the unit resource usage for a single task e.g.
or cost centre standard labour hours for a single unit of production
Can be prepared for all functions, even where Limited to situation where repetitive actions are
output cannot be measured performed and output can be measured
Expressed in monetary terms Need not be expressed in monetary terms.

1.9.2 Standard quantities and costs


Standard costs is an estimate of unit cost
Standard costing. Establishment of predetermined estimates of the costs of products or services
Variance. The difference between standard costs and actual costs
Standard costing have two principal uses:
o To value inventories and cost production for accounting purposes
o To act as a control device by establishing standards
Standards can be set as:
o Ideal. Assumes no inefficiency due defects, downtime etc. Encourages employees to strive for
excellence. Not however useful for day-to-day control processes
o Practical. High efficiency without perfect conditions. Challenging but achievable.
Usefulness of standards:
o Carefully planned standards aids budgeting making it more accurate
o Provides a yardstick by which actual costs can be measured
o Efficiency targets for employees are set and cost-consciousness stimulated
o Variances can be calculated enabling management by exception
o Standard cost and variance analysis can provide a way to motivate managers to achieve better
performance
1.9.3 Variance analysis
This is the process by which total differences between standard and actual results is analyzed
Differences may be favorable or adverse depending on whether they result in an increase to or a decrease
from the budgeted figure.
1.9.3.1 Sales variances
Sales volume variance is the difference between the original and the flexed budget profit figures.
Sales price variance is the difference between actual sales revenue and actual volume at the standard sales
price. Higher sales price (everything else being constant) means an increase in profit.

Richmond Academy Page 5 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.9.3.2 Materials variances
Total direct material variances. Difference between actual and direct materials cost and the direct materials
cost according to the flexed budget. Higher actual costs to budget is adverse to profit.
Direct materials usage. Difference between actual and budgeted usage for the actual volume of output,
multiplied by the standard materials costs. Higher actual usage will adversely affect profits
Direct materials price variance. Difference between actual materials cost and the actual usage multiplied by
the standard materials cost.
1.9.3.3 Labour variances
Total direct labour variance. Difference between actual direct labour cost and the direct labour cost
according to the flexed budget.
Direct labour efficiency variance. Difference between actual labour time and budgeted time, for actual
volume of output, multiplied by the standard direct labour rate.
Direct labour rate variance. Difference between the actual labour cost and the actual labour time multiplied
by the standard labour rate.
1.9.3.4 Fixed overhead variances
Difference between the actual and budgeted spending on fixed overheads.

1.9.4 Reasons for variances


Variances Possible reasons for variance
Sales volume Poor performance by sales staff
Changes of market conditions between budget preparation and actual event
Lack of goods or services to sell due to production issues
Sales price Poor performance by sales staff
Changes of market conditions between budget preparation and actual event
Direct materials usage Poor performance by production staff causing high rates of scrap
Substandard material, leading to high rates of scrap
Faulty machinery, leading to high rates of scrap
Direct materials price Poor performance by the buying dept staff
Using higher quality material than was planned
Changes of market conditions between budget preparation and actual event
Direct labour efficiency Poor supervision
A worker with a lower skill grade taking longer to do the work than was envisaged
for the correct skill grade
Low grade material, leading to high levels of scrap & wasted labour time
Problems with a customer for whom a service is being rendered
Problems with machinery leading to wasted labour time
Dislocation of materials supply, causing production downtime
Direct labour rate Poor performance by the HR dept
Using a higher grade of worker than was planned
Change in the labour market conditions between budget preparation and the
actual event
Fixed overhead spending Poor supervision of overheads
General increase in costs overheads not taken into account in the budget

Richmond Academy Page 6 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.9.5 Investigating variances
Significant adverse variances should be investigated. If it continues it come become very costly
Significant favorable variances should be investigated but the lower priority to the previous point. Maybe the
targets were set too low
Insignificant variances should be kept under review as the cumulative effect may be significant.
1.9.6 Limitations of control through variances and standards
Standards can quickly be outdated. Regular monitoring and updating of standards can be costly and time
consuming
Variances under the managers control can be influenced by other factors outside his control
Lines of responsibility between managers can be difficult to define
Once a standard has been met there is no incentive to improve
May encourage undesirable behavior such as bulk purchases to obtain price discount and a favourable direct
materials price variance but which may lead to excessive inventories which in turn may cause significant
storage and financing costs.

1.10 Decision trees


A decision tree is a pictorial method of showing a sequence of interrelated decisions and their expected
outcomes. Decision trees can incorporate both the probabilities of, and values of, expected outcomes, and
are used in decision-making.
All the possible choices that can be made are shown as branches on the tree.
All the possible outcomes of each choice are shown as subsidiary branches on the tree.
There are two stages in preparing a decision tree.
o Drawing the tree itself to show all the choices and outcomes
o Putting in the numbers (the probabilities, outcome values and EVs)
1.10.1 Decision tree example
Beethoven has a new wonder product, the vylin, of which it expects great things. At the moment the company has two
courses of action open to it, to test market the product or abandon it. If the company test markets it, the cost will be
$100,000 and the market response could be positive or negative with probabilities of 0.60 and 0.40.

If the response is positive the company could either abandon the product or market it full scale. If it markets the vylin
full scale, the outcome might be low, medium or high demand, and the respective net gains/(losses) would be (200),
200 or 1,000 in units of $1,000 (the result could range from a net loss of $200,000 to a gain of $1,000,000). These
outcomes have probabilities of 0.20, 0.50 and 0.30 respectively.

If the result of the test marketing is negative and the company goes ahead and markets the product, estimated losses
would be $600,000. If, at any point, the company abandons the product, there would be a net gain of $50,000 from
the sale of scrap. All the financial values have been discounted to the present.
Required
(a) Draw a decision tree.
(b) Include figures for cost, loss or profit on the appropriate branches of the tree.

Richmond Academy Page 7 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9

1.10.2 Limitations of using a decision tree


The time value of money may not be taken into consideration
Decision trees are not suitable for use in complex situations
The outcome with the highest EV may have the greatest risks attached to it. Managers may be reluctant to
take risks which may lead to losses
The probabilities associated with different branches of the tree are likely to be estimates, and possibly
unreliable or inaccurate.
1.11 Evaluating strategic options using marginal and relevant costing techniques
1.11.1 Costs, output and breakeven
Fixed costs are costs that do not change no matter how many units of a product are produced. They are
affected by inflation and are usually time-based.
Variable costs. These vary with the volume of activity. Some costs have an element of fixed and variable cots.
These are called semi-fixed or semi-variable.
Breakeven analysis. Breakeven point occurs where total sales revenue equals total costs.
o The contribution per unit is sales revenue variable costs
o The margin of safety is the extent to which the planned volume of output or sales lies above the
breakeven point.
o An activity with high fixed costs compared with its variable costs is said to have high operational
gearing. Increasing the level of operational gearing makes profits more sensitive to changes in the
volume of capacity.
1.11.1.1 Popularity and weaknesses of breakeven analysis
It provides useful insights into the relationships between an organizations fixed costs, variable costs and
level of activity.
It assumes linear (straight line) relationships. This is unlikely in real life.
Most fixed costs are not fixed over all volumes of activity and are more likely to be stepped
Most businesses have more than one product or service. It may be difficult to identify which fixed costs
belong to which product, and the effect that the sale of one product may have on the sales of another
1.11.2 Marginal Analysis
When deciding between two or more possible courses of action, only costs that vary with the decision should
be included in the decision analysis i.e. only relevant costs
The key strategic decision should be the enhancement of shareholders wealth. As these decisions are short
term, the wealth will normally increase by trying to generate as much net cash inflow as possible.

Richmond Academy Page 8 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
Marginal costs (the cost of producing one additional unit)usually equals the variable costs per unit, unless
there is a step in the fixed costs
1.11.2.1 Accepting/rejecting special contracts
Marginal analysis can be used with this decision by determining the contribution (revenue less cost) that the
price offered would yield. Positive contributions suggest that the company would be better off accepting the
special contract.
Example:
Picture This Ltd makes photo frames. The fixed cost of operating the workshop for a month is $600. Each frame
requires materials that cost $2.49. Each frame takes one hour to make, and the frame makers are paid $12 per hour.
They are employed on a contract basis, so that they are only paid if they work. The frames are sold wholesale for
$16.80.

The frame makers currently have some spare time available and an overseas retail chain has offered the business an
order of 400 frames at a price of $15.60 each. Without considering the wider issues, should the business accept this
order?

1.11.2.2 Efficient use of resources


Usually output is restricted by level of demand, rather than the organizations ability to produce. Other times
there are limits on the amount can that be produced due to scarce (limiting) factor, such as labour, space or
machinery.
The most profitable combination of products will occur where the contribution oer unit of the scarce factor is
maximized.
Example:
A business makes three different products as follows:
Product A B C
Selling price per unit ($) 20 25 23
Variable cost per unit ($) 10 8 12
Weekly demand (units) 25 20 30
Machine time per unit (hours) 4 3 4

Fixed costs are not affected b the choice of product because all three products use the same machine. Machine time
is limited to 148 hours a week.
Which contribution of products should be manufactured if the business is to produce the highest profit?

1.11.2.3 Make or buy decisions


Marginal costing can assist with decisions as to whether a business should produce the product or service
themselves or buy it from another business.
Of course other factors affect the decision including loss of control quality, potential unreliability of supply,
and access to expertise and specialization.
Example:
Shark Ltd needs a component for one of its product. It can purchase the component from Ray Ltd ( a subcontractor)
for $20 each, or it can produce them internally for total costs of $16per component. Shark Ltd has the spare capacity
available. Should the component be produced internally or subcontracted to Ray Ltd?

Answer: It should be produced internally as this is $5 cheaper than subcontracting.

Richmond Academy Page 9 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
What if Shark Ltd has no spare capacity and could only produce the component internally by educing its output of
another its products. Shark Ltd will lose contributions of $12 from the other product
Answer:
Variable cost of production of the component $15
Opportunity cost of lost production of the other product $12
$27

Shark Ltd should subcontract the component to Ray Ltd as this would be $7 cheaper than producing it internally.
1.11.2.4 Closing or continuation decisions
Many organizations produce separate financial statements for each department or section in order to attempt to
assess the relative effectiveness of each one. By looking at these to look at variable costs, contribution can be
determined. Departments that make a positive contribution should not be closed even if individually it makes a loss.
This as the fixed costs would still be incurred and the organization would be worse off without it.
Example:
MogTown Ltd is a retail shop with three departments all located in the same premises. The three departments
occupy similar sized areas of the premises. The results for the year just ended are as follows:

Total Cat Food Cat Toys Cat furniture


$000 $000 $000 $000
Sales 534 254 183 97
Costs (482) (213) (163) (106)
Profit/loss 52 41 20 9

This suggests that if the cat furniture department was closed, the company as a whole would be $9000 more
profitable per year. However, when the fixed and variable costs are analyzed, the contribution of each department
can be determined. This gives the following results:

Total Cat Food Cat Toys Cat furniture


$000 $000 $000 $000
Sales 534 254 183 97
Variable costs (344) (167) (117) (60)
Contribution 190 87 66 37
Fixed costs (138) (46) (46) (46)
Profit/loss 52 41 20 9

This shows the cat furniture department actually makes a positive contribution of $37,000 and should not be closed.
Closing would make the company as a whole $37,000 worse off per year. The fixed costs would continue to be
incurred whether or not the department is closed.

1.12 Ratio analysis


Ratios provide a means of systematically analyzing financial statements. They can be grouped under the headings
profitability, liquidity, gearing and shareholders investment. There are however limitations such as availability of
comparable information, use of historical/out-of-date information, ratios are not definitive, need for careful
interpretation, manipulation and ratios lack standard form

Richmond Academy Page 10 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.12.1 Limitations of ratios
Availability of comparable information. Industry averages may hide wide variances in figures. Figures from
similar companies may prove problematic
Use of historical/out of date information
Ratios are not definitive. Ideal levels vary from industry to industry and even these are not definitive
Need for careful interpretation. A company with a better liquidity ratio may have higher inventory and
receivable levels which are a result of poor working capital management.
Manipulation. These can be distorted by choice of accounting policies
Ratios lack standard form e.g. for calculating gearing some companies will include bank overdrafts, other will
exclude them.
1.12.2 Profitability ratios: The Return On Capital Employed
ROCE = PBIT
Capital Employed
Capital employed = Shareholders funds + current liabilities + long term provisions for liabilities and charges
1.12.3 Evaluating the ROCE (comparisons that could be made)
The change in ROCE from year to the next
The ROCE being earned by other companies, if the information is available
A comparison of the ROCE with the current market borrowing rates

1.12.4 Secondary ratios


1.12.4.1 Profit margins
Both gross profit and net profit margins can be calculated using turnover.
1.12.4.2 Asset turnover
This measures how well the assets are being used to generate sales. Asset turnover is calculated as
Sales/Capital Employed
1.12.5 Debt and gearing ratios
Debt ratio is the ratio of a companys total debts to total assets
o Assets consist of non-current assets at their balance sheet value plus current assets
o Debts consist of all payables, whether current or non-current
o If the companys debt ratio is over 50% and rising its debt position should be carefully examined
Capital gearing
o This is concerned with the amount a debt in a companys long term structure.
o Gearing ratio = prior charge capital (long term debt)/ prior charge capital + equity
o Prior charge capital is long term debt + preference shares (if any). It does not include loans payable
within one year and bank overdraft, unless overdraft finance is a permanent part of the businesss
capital structure
Operating gearing
o This measures the proportion of fixed costs to total costs.
o High operating gearing means a high proportion of cost is fixed. Implication here is that if turnover
falls there is little automatic relief in the reduction of variable cost.
o Operating gearing = Contribution/PBIT
Interest cover
o This shows whether a company is earning enough profits before interest and tax to pay it interest
costs comfortably.
o Interest cover = PBIT/Interest charges
o Interest cover of 2 times or less is considered low.

Richmond Academy Page 11 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
o It is usual to exclude preference dividends from interest charges
Cash flow ratio
o The cash flow ratio is the ratio of a companys net annual cash inflows to its total debts
o Cash flow ratio = net annual cash inflow/total debts
o Net annual cash inflow is the amount of cash which the company has coming into the business each
year from its operations. This will be shown in the companys statement of cash flows for the year.
o Total debts are short & long term payables, together with provisions for liabilities and charges.
1.12.6 Liquidity ratios: cash and working capital
A company needs liquid assets so that it can meet its debts when they fall due.
The current ratio is current assets/current liabilities
The quick ratio or acid test is (current asset inventory)/current liabilities. This should ideally be 1 for
companies with slow inventory turnover. Companies with fast inventories may have a ratio of less than 1
without it indicating cash flow difficulties.
1.12.7 Stock market ratios
Dividend yield = Dividend per share/market price per share
Interest yield = Interest payable/market value of loan stock
Earnings per share = profit after tax, extraordinary items and preference dividends
Number of equity in issue and ranking for dividend
Price/Earnings ratio = Market value per share/Earnings per share
Dividend cover = Earnings available for distribution to ordinary shareholders
Actual dividend for ordinary shareholders

1.12.8 Comparison of accounting figures


1.12.8.1 Useful comparisons over time include:
Percentage growth in profit (before and after tax) and percentage growth in turnover
Increases/decreases in the debt ratio and the gearing ratio
Changes in current ratio, the stock turnover period and the debtors payment period
Increases in EPD, the dividend per share, and the market price
1.12.8.2 Weakness to note
The effects of inflation should not be forgotten.
The progress must be set in the context of what other companies have done, as well as special
environmental or economic influences on the companys performance.
1.12.8.3 Comparisons between different companies in the same industry
Even where two companies are in the same broad industry, they might not be direct competitors. They might
however, be expected to show broadly similar performance in terms of growth
Where two companies are direct competitors then comparisons become particularly interesting.
o A large company and a small company in the same industry might be expected to show different
results, not just in terms of size, but in terms of: Percentage rates of growth in sales and profits,
percentages of profits re-invested, fixed assets
1.12.8.4 Comparisons between companies in different industries
Determine whether sales growth and profit is higher in some industries than in others
How the return on capital employed and return on shareholder capital compare between different industries
How the P/E ratios and dividend yields vary between industries

Richmond Academy Page 12 of 13 June 2015


P3 BUSINESS ANALYSIS
LECTURER: Stanford Allen
Class Notes 9
1.13 Integrated reporting
This is concerned with conveying a wider message on organizational performance. It is fundamentally concerned with
reporting on the value created by the organizations resources. Resources are referred to as capitals. In Integrated
Reporting there are six types of capital:
Financial: This looks at the funds available for production of goods or provision of services obtained through
financing (debt), equity, earnings or grants
Manufactured: These are physical objects for use by organizations for production and include buildings,
equipment and infrastructure.
Intellectual. Knowledge-based intangibles which provide competitive advantage such as intellectual
properties, tacit knowledge. It involves patents, copyrights, software, rights and licences.
Human capital: Peoples competencies, capabilities and experiences and their motivation to innovate
Social and relationship capital: The Institution and relationship within and between communities, groups,
stakeholders and other networks, and the ability to share information to enhance individual and collective
well-being.
Natural: All renewable and non-renewal environmental resources and processes that provide goods and
services that support the past, present and future. E.g. Air, water, land, mineral, forests, bio-diversity and
eco-system health.

Richmond Academy Page 13 of 13 June 2015