B415 Finance Lecture 3

1. Principles of
Business
Introduction to Finance –
lecture 3

2. Overview
2
• Developing financial fluency
• Interpreting financial statements
- Profitabilty
- Liquidity
- Gearing
- Investors
• Budgeting

3. Learning outcomes
By the end of this session you should be able to:
3
• Analyse a company using financial statements
• Apply key ratios
• Understand the role and purpose of budgets
• Prepare a cash budget

4. Recap from finance week 1
4
The key financial statements:
Income statement
Balance Sheet /
Statement of
Financial Position
Statement of
Cashflows
Financial Performance Financial Position Cash inflows and
outflows
Revenue – costs = Profit Assets – Liabilities = Equity Inflow – outflow = net

5. 5
Financial fluency
• Making the numbers talk…
• What is the story of the company that the financial statements are
telling us?
• Do the financial statements show that the company has been
successful? How?
• What do your calculations mean?
• What potential issues can we identify from the financial statements?

6. Developing financial fluency
How to analyse financial statements:
6
Step 1: Scan through each financial statement, and identify:
- Large numbers
- Significant variances from prior year
- Inconsistencies (e.g. between revenue growth and movements in
costs of sales).
Step 2: Identify areas of the financial statements to focus on (eg. risky areas,
profitability, liquidity)
Step 3: Calculate appropriate ratios
Step 4: What do those ratios tell you?
- How do they compare to prior year or other organisations?
- How do they relate to qualitative information that you have?
- What are the implications for the company?

7. Key ratios
7
1. Profitability ratios
Gross Profit
GROSS PROFIT
SALES REVENUE
Net Profit
NET PROFIT
SALES REVENUE
Sales Revenue per Employee
SALES REVENUE
NUMBER OF EMPLOYEES

8. Key ratios
8
Profitability ratios
Return on Capital Employed
OPERATING PROFIT
TOTAL CAPITAL EMPLOYED (long term debt plus equity)
Asset Turnover
(Asset Utilisation)
SALES
TOTAL CAPITAL EMPLOYED
Return on Shareholder’s funds
OPERATING PROFIT
SHAREHOLDER’S FUNDS (EQUITY)

9. Key ratios
9
2. Liquidity ratios
Current Ratio
= Current Assets : Current Liabilities
Liquidity/Quick/Acid Test Ratio
= Liquid Current Assets (ie. Exclude inventory) : Current Liabilities
Ability to pay debts as they fall due:
= Cash Generated from Operations/Current Liabilities

10. Key ratios
10
3. Gearing: debt/equity ratio
Total Capital Employed
Equity
for Ordinary
Shareholders
External Debt
including any
redeemable
preference
shares

11. Key ratios
11
4. Investor ratios
Dividend yield:
Dividend per Share net of base income tax rate
Market Value per Share
Earnings Per Share
Ordinary Shareholder’s Earnings
Number of Shares in Issue
PE Ratio
Market Price Per Share
Earnings Per Share

12. Budgeting
12
A Budget is a short-term business
plan, designed to link planning and
decision making to strategic objectives
NB. It is not a Forecast, which is an
estimate of future financial outcomes

13. Budgeting
13
Perform review and
control
Select strategic options
and formulate plans
Identify and assess the
strategic options
Undertake a position
analysis
Establish mission and
objectives
Evaluate options and make a selection
Respond to variances
Revise plans (and budgets) if necessary
Consider options
Identify business objectives
Prepare long-term (strategic) plan
Prepare budgets
Measure actual performance

14. Budgeting
14

15. Budgeting approaches
15
Top down budgeting: Top management impose the budget
that the organisation must work to.
Bottom up budgeting: Developed by lower-level managers
who submit to top management.
Incremental budgeting: Modification of current year actual
results.
Zero-based budgeting: budget prepared from scratch each
period.
Rolling budget: continuous budgeting

16. 16
Pre-seminar work
• Read Chapters 7 and 12 of core textbook and attempt the questions at the back
of the chapter.
• You will need access to a FTSE 100 company’s financial statements for the
seminar!