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Unit 5 - Finance (Continued) - Coggle Diagram
Unit 5 - Finance (Continued)
Lesson 5.5: Profitability and Liquidity Ratio Analysis
Main topics: Ratio analysis: financial analysis tool used in the interpretation and assessment of a firm’s statement
Profitability ratios: assess the performance of a firm in terms of ability to generate profits / Two main types: gross profit margin (GPM) and net profit margin (NPM) / GPM = gross profit divided by sales revenue x 100 / NPM = net profit before interest and tax divided by sales revenue X 100
Efficiency ratios: assess how well assets and liabilities are used / return on capital employed (ROCE) / Capital employed = long-term liabilities + share capital + retained profit / ROCE = net profit before interest and tax divided by capital employed X 100
Liquidity ratios: measure the ability of a firm to pay its short-term debt obligations / current ratio: Current ratio = current assets divided by current liabilities /acid test ratio: Acid test ratio = current assets – stock divided by current liabilities
Lesson 5.6: Cash Flow
Main topics: Cash is any sort of money into business: sales, borrowing from institutions, investment by shareholders. It keeps the smooth running and when it lacks it might happen failure or bankruptcy. Cash is asset in the balance sheet. // Cash flow is money in and out of the business over a period of time / cash inflow: money received / cash outflow: money spent in payments
Calculations: Profit = sales revenue – total costs / Net cash flow = cash inflow – cash outflow
Lesson 5.7: Efficiency Ratio Analysis
Main topics: Stock turnover ratio: measures how quickly a firm’s stock is sold and replaced over a given
period / stock turnover ratio (number of times) = cost of goods sold divided by average stock /
average stock = (opening stock + closing stock) divided by 2 / stock turnover ratio (number of
days) = average stock divided by cost of goods sold X 365 / debtor days : measures the
number of days it takes an average for a firm to collect / debtor days ratio (number of days) =
debtors divided by total sales revenue X 365 / creditors days: measures the average number of
days a firm takes to pay its creditors / creditor days ratio (number of days) = creditors divided
by cost of goods sold X 365 / gearing ratio: measures the extent to which the capital employed
is financed from loan capital / gearing ratio = loan capital divided by capital employed X 100.
Lesson 5.8: Investment Appraisal
Main topics: Investment appraisal refers to quantitative techniques used in evaluating the viability or
attractiveness of an investment proposal / three main forms of appraisal: payback period: this
method estimates how long it takes for a business to pay back its initial cost outlay /
calculation: payback period = initial investment cost divided by annual cash flow from
investment / when exactly? calculation: extra cash flow required divided by annual cash flow in
year ‘payback period’ X 12 months/ average rate of return: measures the annual net return on
an investment as a percentage of its capital cost / calculation: average rate of return (ARR) =
(total returns – capital cost) divided by years of usage and divided by capital cost X 100 / net
present value: it is the difference and summation of present values of future cash inflows or
returns and the original cost of investment /when it takes longer than a year, we use the
discounted cash flow method (discount factors table) / to get present value of future cash
flows , the appropriate discount factor is multiplied by the net cash flow in the given year/
calculation of net present value: NPV = total present values – original cost
Lesson 5.9: Budgets
Main topics: Budget is a quantitative financial plan that estimates revenue and expenditure over a specified future time. It enables the efficient allocation of resources and setting targets as it is aligned with the company’s objectives / importance of budgets: planning / motivation / resource allocation / coordination / control
Cost and profit centers: Cost centers are sections of a business where costs are incurred and
recorded / cost centers divided: by departments / by product / by geographical location //
profit centers are sections of a business where both costs and revenues are identified and
recorded // role of cost and profit centers: helping decision making / better accountability /
tracking problem areas / increasing motivation / benchmarking // problem of cost and profit
centers: indirect cost allocation / external factors / center conflicts / staff stress