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Mnemonics and Charts Paper ACCA Paper F9: Financial Management
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ACCA Paper F9 FINANCIAL MANAGEMENT
MNEMONICS AND CHARTS

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ACCA Paper F9 Financial Management Mnemonics and Charts

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Main page
ISBN and Copyright statement
For the ladies only
Why study from a computer screen?
Memorising: Tips and techniques
Writing or saying things over and over again .
Vocalising
Initial letters and making phrases
The use of mnemonics
The use of jingles
Word association
Visualising
Link/story technique
Do I need to memorise all your mnemonics?
Disguise your use of mnemonics in the exam
Charts
Colour codes
Electronic links within the database
Symbols and notations

Syllabus
The structure of the syllabus
Intellectual levels
Learning hours
Guide to exam structure
Guide to examination assessment
Aim
Main capabilities
Relational diagram of main capabilities
Rational
Detailed syllabus
Approach to examining the syllabus

Sections
Contents page: Charts and Mnemonics

Contents page: Practice Questions and Answers

Divided into:

Financial management function
Financial analysis
Financial management environment
Working capital management
Nature and role of financial markets and institutions
Business finance
Investment appraisal
Business and asset valuations
Cost of capital
Risk management

Additional study text:
Islamic finance

ACCA Paper F9
Financial Management

Mnemonics and Charts
+AddVance
Syllabus Study guide
A. Financial management function
B. Financial management environment
C. Working capital management
D. Investment appraisal
E. Business finance
F. Cost of capital
G. Business valuations
H. Risk management

These two Contents screens are
activated for this free sample

5


Financial analysis
ACCA Paper F9

6


Financial
Analysis
Who needs
to
analyse?
Management
Investors
Potential investors
Creditors
Other lenders
Employees
What data is
used for the
analysis?
Profit and Loss Account
(Income statement)
Financial position

Other data are also useful:

Cash flow forecasts
Industrial statistics
Details of accountancy policies
Post-balance sheet events
Government statistics
Inflation adjusted figures
What basis of
analysis?
Internal/
external
Stakeholders
Appraisal/
evaluation
Comparisons
Main comparisons:

Time series analysis
(over different periods of
time)
Interfirm comparison
Against objectives
(budgets, etc.)
What to
measure?
Criteria
How to
measure?
Analytical
techniques
What to
learn?
Information
Five main areas of appraisal:

Earnings
- profitability
- capital efficiency
Growth
Risk
Control
Shareholders investments
Three main techniques:

Common sizing
(vertical analysis)
Horizontal analysis
Ratio analysis
Scope for
improvement
Control
action
required
Financial
problems
Management
action
required
Overtrading
Danger of
liquidation
Financial performance
analysis - overview
Start here and
follow the
numbers .
1
2
3
4 5 6 7
8 9

7


FINANCIAL
ANALYSIS
Vertical analysis
(Common-sizing)
Horizontal analysis
(Side-by-side)
Ratio analysis
Financial performance analysis categories of ratios
Usually based on:

Income statement
1 year
Balance sheet
Assets

Basis for performance
comparisons:

Time-series analysis
(Trend analysis over
periods)
Cross-sectional analysis
(inter-firm analysis)

Budgets
Other objectives
Inter-unit/ division/
department
Geographical
Performance is
normally conducted by
comparisons
CRITERIA
used for
comparisons
EARNINGS
MEASURES
RONA (Net profit x 100/net assets)
NET MARGIN (Net profit x 100)/
sales revenue)
NET ASSET TURNOVER
(Profit x 100/net assets employed)

PROFITABILITY
GROSS MARGIN (Gross profit x 100/
sales revenue)
OPERATING MARGIN
(Profit before interest and tax x 100/
sales revenue)
COST OF SALES PERCENTAGE
(Cost of sales x 100/sales)
COST MEASURES (Each element of cost
x 100/sales)
CAPITAL
EFFICIENCY
NON-CURRENT ASSET TURNOVER
(Profit x 100/non-current assets employed)
CURRENT ASSET TURNOVER
(Profit x 100/current assets)
INVENTORY TURNOVER
THROUGH SALES
(Profit x 100/inventory)

GROWTH
MEASURES
EARNINGS-PER-SHARE GROWTH (%)
SALES REVENUE GROWTH (%)
DIVIDEND COVER
(Profit after interest and
tax/total dividend) (times)
RETENTION %
(1 (Dividends for the year x 100%/
profits after interest and tax))
DIVIDEND YIELD
(Total dividend x 100/
earnings for ordinary shareholders)
RISK MEASURES
GEARING (Debt/equity value) (times)
(There are other ways of
calculating this ratio)
INTEREST COVER
(Profit before interest and tax/
interest payable)
GEARING
LIQUIDITY
CURRENT RATIO
(Current assets/current liabilities) (times)
QUICK RATIO
((Current assets inventory)/
current liabilities)
WORKING CAPITAL
CONTROL
MEASURES
INVENTORY TURNOVER
((Inventory value x 365)/purchases) (days)
CREDITORS PAYMENT PERIOD
(Accounts payable x 365/purchases) (days)
RECEIVABLES COLLECTION PERIOD
(Accounts receivable x 365/sales) (days)
INVESTORS
RATIOS
DIVIDEND YIELD
(Dividend per share x 100/
market price per share)
PRICE EARNINGS RATIO
(Market price per share/
earnings per share)
DIVIDEND COVER
(Earnings per share/
dividend per share) (times)
EARNINGS YIELD
(Earnings per share x 100/
Market price per share)
RETURN ON EQUITY
(Net profit x 100/
equity value (book or market value)
Start
here
and
follow
the
arrows
Practice question which considers
ratio analysis:
AIS Co Page 363
THIS QUESTION IS ACTIVE HERE

8


RETURN
ON NET ASSETS
Profit margin
Capital turnover
(Activity)
Sub-analysis
Sub-analysis Sub-analysis
Total cost/Sales x 100
Sales/Non-current assets
= times
Fixed costs/Sales x 100 Variable cost/Sales x 100
Sub-analysis
Rent/Sales x 100 = %
Rates/Sales x 100 = %
Deprec./Sales x 100 = %
Insurance/Sales x 100 = %
Etc.
Material costs/Sales x 100 = %
Labour costs/Sales x 100 = %
Variable overhead/Sales x 100 = %
Insurance/Sales x 100 = %
Etc.
Sub-analysis
Sales/Land value = times
Sales/Property value = times
Sales/Plant & Equip. value = times
Sales/Vehicle values = times
Sales/Fix. and Fittings = times
Etc.
Sales/Inventory value = times
Sales/Receivables = times
Sales/Cash = times
Etc.
Net profit/Net assets x 100 = %
The RONA Pyramid
Sub-analysis
Sales/Current assets
= times
Profit/Sales x 100 = % Sales/Net assets = times
Practice question which considers
ratio analysis:
Middlesburg Furniture Page 369.

9


Implications/issues of the ROI measure
The ROI ratio (sometimes called RONA [return on net assets] or ROCE [return on capital employed])
measures the overall effectiveness of management in generating profits with its available resources. It is
a key, but rough, measure of performance. Although ROI shows the extent to which earnings are
achieved on the investment in the business, the actual value is generally somewhat distorted.
There are basically three ratios that evaluate the ROI. They are: net profit margin, net assets turnover, and
return on equity.

The implications/issues of the ROI measure are:

C Companys cost of capital. Is the ROI high enough with regard to the company's marginal cost
of capital (say the bank's overdraft rate)?
O Other companies/competitors/industrial norm. How does the ROI compare against other
companies (competitors) or divisions (within the company)?
A Asset valuation. Are assets correctly valued? (The ROI ratio is overstated if the assets are
under-valued.)
S Shareholders cost of capital. Consider the overall return. Is the ROI high enough with regard
to shareholders' cost of capital? (The return the shareholders could earn elsewhere at the same
level of risk.)
T Trend of the ROI. Is the trend satisfactory/unsatisfactory?

A company cant COAST along happily even when the ROI is high!

The very best financial presentation is one
thats well thought out and anticipates any
questions answering them in advance.

Nathan Collins
Executive Vice
President
Valley National Bank
CFO, August 1985

10


So

There are 5 main criteria for measuring financial
performance

1. Earnings measures
- principal measures, sub-analysed as:
- profitability
- capital efficiency
2. Growth measures
3. Risk measures
- gearing
- liquidity
4. Working capital control measures
5. Investors ratios

And

There are 3 techniques for measuring
financial performance

1. Vertical analysis (Common-sizing)
2. Horizontal analysis (Side-by-side)
3. Ratio analysis
5 criteria .
3 techniques .
Measuring
financial
performance -
overview

11


The FIVE main groupings for financial
performance analysis
There are many ratios that an analyst can use, depending on what he or she considers to be important
relationships. For our purposes we will classify ratios into five groups:

S Shareholders investment measures. The main measures are:
- Dividend yield (Dividend per share/market price per share x 100).
- Earnings per share (Earnings for ordinary shareholders/number of shares eligible for dividend).
- Price earnings ratio (Market value per share/earnings per share).
- Dividend cover (Earnings per share/dividend per share).
- Earnings yield (Earnings per share/market price per share x 100).
- Return on equity (Earnings for ordinary shareholders/equity (book or market) value x 100).
U Underlying control measures. The main measures are:
- Inventory turnover (Inventory value x 365/purchases) (days).
- Payables period (Payables value x 365/purchases) (days).
- Receivables (Receivables value x 365/sales) (days).
R Risk measures. The main measures are:
- Gearing (Debt/equity). (There are other ways of calculating this ratio.)
- Interest cover (Profit before interest and tax/interest payable).
- Current ratio (Current assets/current liabilities)
- Quick ratio (sometimes called Acid test) (Current assets inventory value/current liabilities)
G Growth measures. The main measures are:
- Earnings-per-share growth (%).
- Sales revenue growth (%).
- Dividend cover (as shown above)
- Retention % (1 (dividends for year x 100/profits for ordinary shareholders).
- Dividend yield (as shown above).
E Earnings measures. The main measures are:
- ROI (or RONA or ROCE) (Net profit/net assets x 100).
- Net margin (Net profit/sales revenue x 100).
- Net asset turnover (Net profit x 100/net assets employed).
(Operating profit may be used in place of net profit in all three of these ratios.)

A companys share price will SURGE ahead when these measures are
consistently favourable.

12


The implications of the growth measures used by financial
managers

R Retention percentage ratio. The retentions percentage is the inverse of the dividend cover
(explained below) and provides much the same information.

E Earnings per share growth %. This is an important ratio for the present and prospective
shareholders and management. The earnings per share represent the number of $s earned on
behalf of each outstanding share of equity capital. They are closely watched by the investing
public and are considered an important indicator of corporate success. The value does not
represent the amount of earnings actually distributed to shareholders. Growth (year by year)
suggests strong corporate performance.

D Dividend cover ratio. The dividend cover indicates (a) the proportion of distributable profits for
the year that is being retained by the company; and (b) the level of risk that the company will not
be able to maintain the same dividend payments in future years, should earnings fall. A high
dividend cover means that a high proportion of profits are being retained, which might indicate
that the company is investing to achieve earnings growth in the future.

S Sales revenue growth %. The sales growth when measured against industry growth for the
same period can provide useful information about the company's share of the market. Sales
growth can also be used to evaluate the company's marketing, such as the effectiveness of an
advertising campaign run during the period of report.

A company will usually keep out of the REDS on the stock exchange board
when these measures are strong.
Growth for the sake of growth is the ideology of
the cancer cell.

Edward Abbey

13


Reasons/benefits of financial ratio analysis
Ratio analysis is widely used for analysing a company and is frequently employed by external stakeholders -
creditors, investors and financial institutions, as well as by senior management for internal performance
appraisal. In more detail, the technique can help in the following ways:

I Identifies a moving picture of trends. A 'moving picture of the company', i.e. trends over a
period of years can be analysed (time-series analysis).
S Segregates performance. It segregates performance into distinct groups such as: earnings,
growth, control, risk and investment.

M Models and simulates. Ratios can be used for modelling and simulation purposes. Many large
corporate finance models are based on ratios.
A Accounting software facilitates the quick production of ratios.
G Government statistics. Ratios allow a company to compare its performance against macro-
economic indices produced by government.
I Industrial norms. Ratios allow for comparison of the companys performance with other
companies or the industry average, and hence for management to make judgement about the
company's position in the competitive arena. Most inter-firm comparison schemes are based on
ratios. Internal comparisons (between divisions/departments) are also made possible.
C Comparison with the budget for the same period. Management can use ratios to compare
results with the budget covering the same period.

It IS MAGIC the way ratios can reveal a picture of performance results.

14


Limitations of ratio analysis
The analytic approach used in ratio analysis must be used with circumspection and in conjunction with other
analytical tools and techniques as it has a number of limitations. The limitations include the following:

O Orientation that is historical. The approach is based on historical data and thus the ratios may
not be a good guide to the future;
F Financial measures are used. Ratios are normally based exclusively on finance, and reflect
only financial indicators of performance. There are, of course, non-financial implications
associated with performance.
T Trading environments change over time. The changing value of money and differences in
trading environments over time influence the ratios.

S Sub-optimal results might be encouraged. The use of ratios to measure performance may
encourage sub-optimal behaviour by managers, e.g. short term manipulation of results.
A Accountancy practice influences the ratios. Differences in accounting practices adopted by
companies over the treatment of fixed asset depreciation and revaluation, inventory valuation,
research and development expenditure, goodwill, write-off and profit recognition affect the ratios.
I Interpretation of change. Difficulties in deciding on a suitable yardstick and the interpretation of
change, e.g. is a higher return on net assets (ROI) good or bad?
D Distortion can be a result. The quality of the analysis is determined by the quality of the
accounting information upon which it is based (consider here the distortion that can result from
'creative accounting', such as 'window dressing' of financial statements to hide short-term
fluctuations).

Its OFT SAID that too much emphasis is placed on only using ratio
analysis.

The numbers tell you how your business is going, not why.

Jonatghan P. Siegel
Speech, McLean, Virginia, 12 September, 1987

15


Information required for meaningful ratio analysis
For meaningful financial ratio analysis and other performance analysis the following information would be
useful:

I Information and details concerning future plans of the company.
F Non-current assets. Details of non-current assets, with projected remaining lives and likely
replacement costs.

A Accounts adjusted to take account of inflation during the period under review.
C Cash flow forecasts.
C Current financial statements. Balance sheet [Statement of Affairs], Profit and Loss Statement
[Income Statement] and Cash Flow Statement.
A Accountancy policy and changes to it. Details of the company's accounting policies and
changes to any basis of accounting.

B Budgets and associated variances. Details of the company's budget plans with a schedule of
variances.
A After balance sheet events (post-balance sheet). Details of any post-balance sheet events,
and of any contingencies.
S Statistics provided within the industry. Statistics of the industry as a whole, and in particular
financial and other ratios showing best, industry average and worst results.
E Economic indicators and other macro-environmental factors. Government statistics
concerning inflation and interest levels and other economic indicators.

IF ACCA BASE a question on what information is required for financial
performance analysis to be meaningful then this is a useful list.
Practice question which refers
to overtrading: RZP Co.
Page 468.

16


70

60

50

40

30

20

10

0
2009 2010 2011 2012
Year
A
v
e
r
a
g
e

c
o
l
l
e
c
t
i
o
n

p
e
r
i
o
d

(
d
a
y
s
)

Fairy Nuff Engineering Company
Industry average
Combined cross-sectional and time-series analysis of the
average collection for the period 2009 - 2012
Average collection period for Fairy Nuff Engineering Company
The most informative approach to ratio analysis is one that combines cross-sectional (inter-firm)
and time-series analysis. A combined view permits assessment of the trend of behaviour of the
ratio in relation to the trend for the industry. The diagram below depicts this type of approach
using a company's average accounts receivable collection period in the years 2009 to 2012.

Combined analysis

Theres few things as uncommon as common sense.

Frank McKinney Hubbard, 1868 1930
American caricaturist and humorist

17


Key amounts, measure and ratios would be: YEAR 1 YEAR 2

Increase in sales revenue (%) XX %
Gross margin (Gross profit x 100)/sales revenue) XX % XX %
Increase in non-current assets ($) $XX
Non-current asset turnover ratio (Sales revenue x 100/
non-current assets employed) XX %
Total working capital ($) $XX $XX
Inventory turnover through sales (Sales revenue/average inventory) XX times XX times
Inventory turnover ((Inventory value x 365)/purchases) XX days XX days
Payables period ((Payables value x 365)/purchases) XX days XX days
Receivables collection period ((Receivables value x 365)/sales revenue) XX days XX days
Reduction in liquidity (cash and bank overdraft levels) $XX $XX
Current ratio (Current assets/current liabilities) XX times XX times
Quick ratio (Current assets inventory value)/current liabilities) XX times XX times
Financial gearing (Debt x 100/equity funds) XX % XX %

An exam question that requires you to assess the extent of a firms overtrading position would need to present;

Two or more years of financial data, and/or data concerning industrial/sector averages.
CHARACTERISTIC OF
OVERTRADING
The characteristics, or features of an overtrading situation
include the following:

The firm is under-capitalised (i.e. there are
insufficient funds or credit lines).
The firm is probably profitable.
The firm has problems maintaining its asset base
(non-current and current assets) with the level of its
activities.
Management may be focusing on sales (top line) at
the expense of the costs (middle line) and profit
(bottom line).
The firms sales may be growing too fast and
outstripping the available working capital.
The firms quality is suffering (because of some of
the points raised above).
Inflation simply exacerbates the problems

SYMPTONS OF
OVERTRADING
Over the period .

Growth in sales.
Growth in the volume of assets.
Reduction in the firms liquidity.
Increase in inventory turnover period (days).
Increase in debtors assets (including the
Accounts receivable collection period [days]).
More use made of short-term credit (e.g.
increase in Accounts payable payment period
[days]).
Increase in financial gearing.
Quality problems
Measures for assessing the
extent of overtrading
Extending turnover too quickly
Overtrading is a problem which arises from a firm extending its turnover at too rapid a rate. The ultimate result is a serious
shortage of cash which means that wages, creditors and corporation tax cannot be met.
A typical pattern of events
A typical pattern of events commence when a firm takes on additional orders. This would then be followed by engaging
additional workers or working overtime. At the same time, extra materials would be purchased on credit. If the working capital
cycle is fairly long this means that although extra cash has to be paid out more or less immediately, additional revenue may not
be forthcoming for a considerable period. This assumes that the additional production will be sold without delay, but in some
circumstances the process may take the form of build up of inventory. If this is the case, then the shortage of cash may
necessitate an emergency sale at greatly reduced prices and this is likely to have adverse effects on profitability.
YOUR COMMENTS WOULD BE AN IMPORTANT PART OF AN EXAM ANSWER.
Overtrading

18


Characteristics of overtrading
Overtrading is a problem which arises from extending turnover at too rapid a rate. The ultimate result is a
serious shortage of cash which means that wages, creditors and corporation tax cannot be met.

When a company is overtrading this is marked by large increases in sales which are not matched by
increases in the asset base to support the greater level of activity. Working capital is used more
intensively and there is little increase in the level of fixed assets. Expansion is financed by short term
credit, and inventory and receivables turnover can slow as the company tries to secure additional sales on
the basis of improved credit terms and as it tries to manufacture ahead of demand.

When analysing the situation shown on a Statement of Financial Position/Income Statement it is very
important to watch for signs of overtrading. Some of the more important of these signs are summarised
below.

S Sales growing too fast. Very rapid growth in sale turnover. The Growth of sales ratio
would be a useful indicator.
A Asset maintenance. Inventories may increase more proportionately than the increase in sales
turnover with a deterioration in Inventory turnover ratios. Rapid growth in the volume of current
assets and possibly non-current assets. Consider here the Asset turnover ratio.
L Liquidity problems. Increased significance of credit in financing along with the growth in assets.
This may show in slower payment of payables and a bank overdraft which is close to its
limit. Similarly, a comparison of the period of credit being taken by the company with the norm for
the particular industry will be a guide. Look to see if there has been an increase in the Payables
turnover ratio. Also, look for any sudden upward or downward swing in cash figures, or the
appearance of new items such as short-term loans. The Current ratio and Quick ratio would
indicate the liquidity problem.
E Excessive inflation causing capital replacement problems.
S Sales focus to the exclusion of other factors. Management focusing on sales (advertising
expenditure, generous credit terms, price reductions, etc.) possibly at the expense of profits and
cash flow. The Gross profit margin is an important indicator of sales to costs.

U Undercapitalisation. This often occurs because of a growth in the rate of borrowing so that the
proportion of borrowing in relation to the assets owned by shareholders is excessive.
Reductions in the current and quick ratios, possibly leading to a liquid deficit. The Gearing ratio
and Cash Flow would be used here.
P Profitable, but! Total profit, gross and/or net, begins to diminish

A companys SALES may be UP but its cash could be seriously down. It
might be overtrading.
to overtrading: AMC Company.
Page 468.

19


Ratios/measures that can be used to indicate overtrading
When a company is overtrading this is marked by large increases in sales which are not matched by
increases in the asset base to support the greater level of activity. Working capital is used more
intensively and there is little increase in the level of fixed assets. Expansion is financed by short term
credit, and inventory and receivables turnover can slow as the company tries to secure additional sales on
the basis of improved credit terms and as it tries to manufacture ahead of demand.

To carry out a meaningful appraisal two or more years of data are required including industry/sector
statistics.

Signs that a company may be overtrading include the following:

G Gross margin. (Gross profit/sales revenue x 100).
I Increase in bank overdraft $. (Current level previous level).
A Asset turnover ratio (particularly fixed asset turnover) (Gross profit/non-current assets employed x 100)
N Net working capital size. (Current assets Current liabilities). (Current compared with previous).
T Turnover of inventory through sales. (Sales revenue/inventory) (times)

C Current ratio. (Current assets/current liabilities) (times)
A Acid test (often called Quick ratio). Now (Current assets inventory/current liabilities) (times).
R Reduction in liquidity ($). (Bank + cash overdraft) (current compared with previous).

T Turnover of inventory in days. (Inventory value x 365/purchases or cost of goods sold) (days).
R Receivables payment days. (Receivables value x 365/sales) (days).
I Increase in non-current assets %. (Current fixed asset value previous fixed asset value/previous
fixed asset value x 100)
P Payments days. (Payables x 365/purchases) (days).
S Sales revenue increase%. (Current sales previous sales/previous sales x 100).

GIANT CAR TRIPS dont have anything to do with overtrading, but the
mnemonic does give you a list of 13 ratios or other measures than can be used to
assess whether a company is overtrading.

20


Parties who need to analyse corporate financial figures in
addition to management
Financial analysis is an evaluation of both the company's past financial performance and its prospects for the
future. Typically, it involves an analysis of the company's financial statements and its flow of funds. Financial
statement analysis involves the calculation of ratios and also uses other ways of measuring.

The analysis of a firm's financial statements is of interest to a number of different groups including present and
prospective shareholders, creditors, and the firm's own employees.

S Shareholders - current. The present shareholders are interested in the current and future level
of risk, liquidity, activity, debt and return (profitability). These are the dimensions which
influence share price.
C Creditors. The firm's creditors, such as the bank, are primarily interested in the short-term
liquidity of the firm and its ability to service its debts over the long run. Present creditors want
to assure themselves that the firm is liquid and that it will be able to make scheduled interest
and principal payments. Prospective creditors are concerned with determining whether the firm
can support the additional debt that would result if they extended credit to the firm.
O Other lenders, such as customers who pay forward on a contract would want to assess the
financial stability of the company.
P Potential investors. In the same way as the companys present shareholders, prospective
shareholders are interested in the current and future level of risk, liquidity, activity, debt and
return (profitability). For this reason, the business advisory group is also interested in carrying
out performance analysis.
E Employees. Employees (present, past with pension, and potential)), like the shareholders, are
concerned with all aspects of the firm's financial situation. Employee representatives (such as
trade unions) would need to evaluate the companys position with regard to negotiating pay rises
(pay increments).

There is a big SCOPE of different people who have an interest in the
financial standing and performance of a company

EVER ONWARD EVER ONWARD

Thats the spirit that brought us fame!
Were big, but bigger we will be.
We cant fail for all to see,
That to serve humanity has been our aim.
Our products are now known in every zone.
Our reputation sparkles like a gem.
Weve fought our way through, and new
Fields were sure to conquer too.
Forever onward IBM.
IBM Company Song

to stakeholder groups:
Page 387.

21


Reasons why comparisons should be based on companies
in the same industry or market sector
Comparison of the companys performance with that of other companies operating in the same industry or
market sector is a significant part of performance assessment. By carrying out inter-firm assessment
management is able to (i) compare operating and financial performances and identify strengths and
weaknesses in the organisation; (ii) contrast strategic structures and detect threats and opportunities,
product-market gaps, competitive moves and market movements; (iii) plot take-over bids, or alternatively
plan defensive measures to avert possible take-over strikes by other companies; (iv) assess the
company's worth (or the disposal worth of divisions) and (v) view the company through the eyes of
interested parties, e.g., the capital market, trade unions, employees and creditors.

Methods of conducting inter-firm comparisons include: (i) subscription to a formal scheme; (ii) informal and
internal research (which uses data provided by the relevant trade association and central government);
and (iii) benchmarking exercises.

It is centrally accepted that comparisons should be made with companies operating in the same industry or
sector for the following reasons.

W Working capital. Different industries have different working capital requirements. For example,
the retail sector will have a much lower level of receivables than the manufacturing sector due to the
different levels of inventory. Similarly, manufacturing concerns generally require a much greater
investment in inventory than do service providers.
A Applicable for the investor group. Investors often group in sectors, and therefore the internal
comparison will be similar to the comparisons made by the companys investors.
F Fixed costs level. Different industries have different levels of fixed costs. For example, the fixed
costs of service providers are generally a lot lower than for companies involved in heavy
engineering.
E Earnings volatility. There will be different levels of earnings volatility in different industries and
market sectors influenced by seasonal fluctuations and cyclical changes. For example, the
furniture retail sector is more influenced by the business cycle (say a downturn in the economy)
than the food retail sector.
R Risk. Leading from the last point, business risk is also different between industries making it
impossible to compare important performance indicators.
Without inter-firm (or inter-sectional) comparison within the same industry or
market sector the exercise of financial performance analysis is WAFER thin.

22


The difficulties involved in inter-firm comparison
The comparison of financial information (such as ratios) from one firm to another, even in the same industry,
involves a number of difficulties, particularly in the following.

I Inventory valuation. The method of accounting for inventory (FIFO, average cost, etc.) may
vary.
D Depreciation. Depreciation calculations and rates may differ.
E Expenses. When comparison of different items of expense is possible, then there might be
inconsistency in the classification of costs under the main headings of operating costs, marketing
costs and administration costs, etc. and also in the method of apportioning common costs.
A Asset valuation. Where historical values are used the asset-based ratios will vary according to the
average age of the assets held which would be different company by company.
S Several ways of valuing work in progress and finished goods. The cost content of work in
progress and finished goods inventory may differ. Some companies will include a share of
administration costs, others will cut off at factory cost or include direct costs only.

A number of trade associations or federations have prepared manuals of standard practices in accounting for
their members (which are in additional to the GAAP standards) and these help to make reported results
more suitable for comparative analysis.
Financial managers need IDEAS on how to make the necessary corrections
for distortions caused by lack of uniformity in the way that financial information is
reported by different companies.
A problem well stated is a problem half solved.

Charles F. Kettering

23


ACCA Paper F9
Exam Status Questions
Financial analysis
Questions and Answers

24


The following are summary financial statements for Associated International Supplies Co, an unquoted
company.

2006 2011
$000 $000
Non-current assets 115 410
Current assets 650 1,000
Current liabilities (513) (982)
Long term liabilities (42) (158)
Total 210 270

Capital and reserves 210 270

Sales 1,200 3,010
Cost of sales, expenses and interest (1,102) (2,860)
Profit before tax 98 150
Tax and distributions (33) (133)
Retained earnings 65 17

Notes:
Cost of sales was $530,000 for 2006 and $1,330,000 for 2011.

Accounts receivables are 50% of current assets and accounts payable are 25% of current liabilities for both
years.

Required:

(a) You are a consultant advising Associated International Supplies Co. Using suitable financial
ratios, and paying particular attention to growth and liquidity, write a report on the significant
changes faced by the company since 2006. The report should also comment on the capacity
of the company to continue trading, together with any other factors considered appropriate.

An appendix to the report should be used to outline your calculations. (17 marks)

(b) Explain and evaluate the sources of finance available to small businesses for non-current assets.
(8 marks)
(25 marks)

Associated International Supplies Co.: Question 1 of 1
A question which covers ratio analysis and business finance.

A
A

25


(a) To: Board of directors, Associated International Supplies Co.
From: Consultant
Date: 18 February 2012

Subject: Development and trading position of the company 2006 2011

Introduction

The purpose of this report is to identify the significant changes in the financial position of the company
since 2006, and to consider the future trading capacity. Financial analysis of the information provided
is included in Appendix A of this report.

Changes faced by the company since 2006

1. Growth and profitability

The company has experienced a high level of growth during the five year period. Sales have
increased by 150% to just over $3m. However, although there has been an increased in the
level of profits before tax, this has only amounted to 53% and has not matched the growth in
sales.

Return on sales over the period has fallen from 8% to just 5%. This is a low margin at which to
be operating, and it would be interesting to have further information on the components of the
cost of sales figure. It is probable that the two main factors have been:

(a) An inability to raise prices at the same time as increasing sales.

(b) An increase in the level of interest costs. Long term liabilities have increased by nearly
four times, and given the working capital position (discussed below), it is likely that the
level of overdraft interest has also risen.

Return on capital employed was high at 47% in 2006, and this has risen further by 2011 to
56%. Given the low level of return on sales, this is entirely due to the increase in the rate of
asset turnover, which is now very high at 11 times. While in the short-term this is a very
efficient operating position, it must be questioned whether such a high level of sales can be
sustained on this amount of assets in the longer term.
Tutorial comment

Tutorial comment. In part (a) there are a number of issues that need to be discussed.
You may find it helpful to prepare the appendix first, and to structure it into the areas of
growth, profitability and liquidity/working capital.

Remember that the company is small and unquoted, and tailor your suggestions
accordingly.

In part (b) you may find it helpful to think about the sorts of non-current assets that a
small business might wish to acquire, and to base your list around this.

End of Tutorial comment

Associated International Supplies Co.: Answer 1 of 5

Q
Q

26


The rate of retentions has fallen by 74% over the period to just $17,000 in 2011. This is
worrying because it suggests that earnings are not going to be adequate to finance continued
high growth. The main reason for the drop in the level of retentions is the increase in the level
of tax and distributions from $33,000 to $133,000. This appears higher than can be accounted
for by the likely increase in the level of tax on earnings, and it suggests that the level of
dividends has risen significantly. This is a dangerous trend, given that the level of debt is rising.
A lower payout ratio and a higher level of retained earnings would help the company to finance
the fast rate of growth.

2. Liquidity and working capital

The current ratio has fallen from 1.27 to 1.02 over the five years. Most trading companies
would expect to see a ratio comfortably in excess of one for safety. To be operating at this
level of current ratio is therefore a financially risky strategy. It would be very interesting to
know what the level of inventories are, but given the financial position it is unlikely that there is a
high level of cash, and therefore inventories are probably approaching 50% of current assets.
If this is the case, this would mean that the quick ratio (current assets excluding inventory : current
liabilities) is only in the region of 0.5 ((1,000 - 500/982). This would certainly suggest that the
company is facing liquidity problems.

Possibly the most worrying ratio is the level of net working capital as a percentage of sales.
At just 0.6% this is extremely low, and not likely to be sustainable in the longer term. Debtors
and creditors both appear to be under control; receivables days have fallen from 99 to 61, which
is a significant reduction that has probably made a major contribution to the liquidity of the
company over the period. However, it is unlikely that further reductions of this scale are
achievable, given that the company must remain competitive in the terms that it offers.
Payables days have also reduced to 67 days, which is still in excess of two months credit. It is
unlikely that they can be increased much further again without jeopardising relationships with
suppliers.

The debt ratio has increased from 73% to 81%. This highlights the fact that the expansion
appears to have been financed entirely from tighter control of working capital and from an
increase in the level of debt. However, the company will not be able to continue this approach
indefinitely. Further long-term capital is needed urgently if it is not to run into serious liquidity
problems that could force it out of business.

More information on the maturity of debt obligations and also the problem of debt financing in
the industry would help to indicate the severity of the position.

Further trading capacity

It is clear from the foregoing discussion that the company will not be able to continue trading at the
current level of sales and profits without a major change to the capital structure. If things continue
as they are, interest charges are likely to wipe out any further increases in profit. The company
should consider the following possible courses of action as a matter of urgency.

1. Prepare a cash flow forecast
A cash flow forecast is urgently required for the coming year in order to assess the liquidity
position and the financing needs.


Q
Q

27


2. Inject additional equity
The company needs to consider some form of capital restructuring that will increase the level
of equity. Since the business appears to be expanding strongly, there may be scope for the
use of venture capital. Alternatively, it may be possible to raise funds on the Alternative
Investment Market (AIM). If the company wishes to remain private, then the existing
shareholders may have to consider investing further funds, or perhaps help could be sought
from a business angel.

3. Reduce the level of dividends
This would increase the amount of money retained to finance the business.

4. Increase the profit margin
Since profitability is relatively low and has fallen, the company should consider whether it has
the scope to push through a price increase. Alternatively, it could try to concentrate on areas
of the market where it is possible to earn a higher return, even though this may be at the
expense of continued strong sales growth.

5. Negotiate with the lenders
The company is in danger of being swamped by interest costs. It may be possible to negotiate
a deferral of some of the charges while additional equity capital is sought. In any event, the
company must keep the bank informed of what it is doing, since there is the risk that the bank
could look at the figures and foreclose on the overdraft in order to minimise its own risk of loss.

6. Sale or merger
The company could consider selling out to or merging with a larger company as a means of
securing additional finance for the business.

Appendix A to this Report is shown on the next screen


If two men on the same job agree all the time, then one is
useless. If they disagree all the time, then both are useless.

Darryl F. Zanuck
Q
Q

28


Appendix A: Ratio calculations

Growth levels

Growth in sales (3,010 - 1,200)/1,200 151%
Growth in profit before tax (150 - 98)/98 53%
Reduction in retained earnings (65 - 17)/65 74%
Growth in non-current assets (410 - 115)/115 257%
Growth in current assets (1,000 - 650)/650 54%
Growth in current liabilities (982 - 513)/513 91%
Growth in long term liabilities (158 - 42)/42 276%

Profitability ratios 2006 2011
Return on capital employed (ROCE)
98/210 47% 150/270 56%

Return on sales
98/1,200 8% 150/3,010 5%

Asset turnover
1,200/210 6 times 3,010/270 11 times

Liquidity and working capital ratios
Current ratio

650/513 1.27 1,000/982 1.02

Net working capital to sales 137/1,200 11.4% 18/3,010 0.6%

Receivables days
Receivables (50% current assets) 325,000 500,000
Daily sales (Sales/365) 3,288 8,247
Receivables days 99 days 61 days

Payables days
Payables (25% current liabilities) 128,250 245,500
Daily cost of sales (Cost of sales/365) 1,452 3,644
Payables days 88 days 67 days

Debt ratio

555/765 73% 1,140/1,410 81%

employed Capital
tax before Profit
Sales
tax before Profit
employed Capital
Sales
s liabilitie Current
assets Current
assets Total
debts Total


Q
Q
29


(b) A general principle of financing is that the funding term should match the asset life. Therefore, fixed
assets should normally be financed by using long-term sources of funds.
There is a wide variation in the size and type of non-current assets, from photocopiers to new
buildings, and therefore the relative amount of funds required, and the most appropriate form of funding
will vary.

However, the following sources of finance could be considered by a small business.

1. Retained earnings
Relatively small asset purchases, such as a new computer, can often be financed using cash
arising from retentions, and thus no additional external funds will be required.

2. Leasing and hire purchase
These can also be considered for smaller assets. They can be used to spread the cost of the
asset over its useful life. The main types of agreement available are:

(a) Operating leases. These are generally for a period less than the economic life of the
asset. The risks and rewards of ownership remain with the lessor. However, in areas
where there is a fast rate of technological change, such as computers, they have the
advantage of giving flexibility to the lessee.

(b) Finance leases. These generally cover the whole economic life of the asset, and the
risks and rewards of ownership are transferred to the lessee.

(c) Hire purchase. This is a form of instalment credit, whereby the ownership of the goods
passes to the customer on payment of the final credit instalment.

3. Secured loan
Depending on the nature of the asset, it may be possible to obtain a secured bank loan (either
medium or long-term) against the asset being purchased.

4. Mortgage
This may be appropriate if the assets being acquired are land or buildings.

5. Grants
These may be available from the government or other agencies for certain types of
development. For example, in certain areas of the country, funds may be available for
redevelopment costs under regional assistance programmes such, in the UK, as the Single
Regeneration Budget. Also, in the UK, Smart awards are available to small businesses
developing innovative technology.

6. Venture capital
The form of finance may be appropriate for larger investments related to expansion or new
product development. Venture capital is essentially risk capital, and has the advantage that
new equity funds are provided, generally for a restricted time period at the end of which the
investor will seek an exit from the business. The benefit of this that in the longer term the
ownership structure of the business is unchanged.

7. Other sources of equity
These include further investments from the existing shareholders, the use of a business
angel, or possibly some form of junior market flotation. In the UK this would be on the
Alternative Investment Market (AIM). The AIM route is only likely to be appropriate for
significant long-term expansions.

If the company does not go down the AIM route, it may have difficulty in obtaining
equity finance, because of its liquidity problems or because shareholders will find it
difficult to sell their shares.


Q
Q
30


Type of
presentation
Title Topic covered (briefly) Screen
number
FINANCIAL MANAGEMENT FUNCTION
Chart What is corporate finance? Financial management function
34
Chart 3 main financial decisions Financial management function
35
Chart Capital structure Financial management function
36
Chart The financial management function Financial management function
37
Chart Finance function within a large
company/group
38
Mnemonic The role of the Financial Controller Financial management function
39
Mnemonic The role of the Treasurer Financial management function
40
Chart The scope of financial management
+AddVance activities - introduction
41
Chart The scope of financial management
activities - overview
42
Chart Cash flows between the firm and the
financial markets
43
Chart The scope of financial management -
recap
44
Chart The financial management planning
process
45
Mnemonic The financial management process Financial management function
46
Chart The financial management planning
process - overview
47
Chart A firms liquidity cycle Financial management function
48
Mnemonic Benefits of centralised treasury
management
49
Mnemonic Disadvantages of centralised treasury
management
50
Chart/mnemonic The principal financial objectives Financial objectives
51
Chart Stakeholder analysis for a typical
company
Financial objectives
52
Mnemonic Concept of Principal-agency Theory
(PAT) applied to shareholders and
directors
53
Mnemonic Difficulties associated with managing
organisations with multiple objectives
54
Mnemonic Reasons why maximising shareholders
profits is not the same as maximising
shareholders wealth
55
CONTENTS SHEET 1 OF 13

31


Type of
presentation
number
Mnemonic The main Corporate Governance
proposals
56
Mnemonic Main focus of the LSEs Combined Code
of Corporate Governance
57
Mnemonic The distinctive characteristics of public
services in the context of corporate
governance
58
Mnemonic Remuneration schemes for managers Financial objectives
59
Chart Value for Money (VFM) Objectives in not-for-profit
organisations
60
Chart Measuring performance in a not-for-profit
organisation
Objectives in not-for-profit
organisations
61
FINANCIAL ANALYSIS IS ACTIVATED FOR THE PURPOSE OF THIS FREE SAMPLE
62
Chart Financial performance analysis - overview Financial ratio analysis
63
Chart Financial performance analysis
categories of ratios
Financial ratio analysis
64
Chart The RONA Pyramid Financial ratio analysis
65
Mnemonic Implications/issues of the ROI measure Financial ratio analysis
66
Chart Measuring financial performance -
overview

67
Mnemonic The FIVE main groupings for financial
performance analysis

68
Mnemonic The implications for the growth measures
used by financial managers

69
Mnemonic Reasons/benefits of financial ratio
analysis

70
Mnemonic Limitations of ratio analysis Financial ratio analysis
71
Mnemonic Information required for meaningful ratio
analysis

72
Chart Combined analysis (Collection period) Financial ratio analysis
73
Chart Overtrading Financial ratio analysis
74
Mnemonic Characteristics of overtrading Financial ratio analysis
75
Mnemonic Ratios/measures that can be used to
indicate overtrading

76
Mnemonic Parties who need to analyse corporate
financial figures in addition to
management

77
Mnemonic Reasons why comparisons should be
based on companies in the same industry
or market sector

78

32


Type of
presentation
number
Mnemonic The difficulties involved in inter-firm
comparison
79
FINANCIAL MANAGEMENT ENVIRONMENT
80
Mnemonic Macroeconomics Financial management
environment
81
Chart The economic goals of government Financial management
environment
82
Mnemonic Main economic goals of most
governments
Financial management
environment
83
Chart Main sources of inflation Financial management
environment
84
Mnemonic Sources of inflation Financial management
environment
85
Mnemonic Government policy : Full employment Financial management
environment
86
Mnemonic Examples of potential conflict within
government economic policies
environment
87
Chart The Bank of Englands (Central Bank)
Repo rate of interest
environment
88
Chart Economic objectives of Government Financial management
environment
89
Chart Fiscal policies of central government Financial management
environment
90
Mnemonic Gilts Financial management
environment
91
Mnemonic The effects of a high PSBR (Public Sector
Borrowing Requirement) on private sector
businesses
environment

92
Mnemonic Factors that regulate the size of the Bank
reserve requirement
environment
93
Mnemonic Characteristics of the perfectly
competitive market
environment
94
Mnemonic Basis of monopoly power Financial management
environment
95
Mnemonic The effect of green policies on
companies
environment
96
Mnemonic Ways that inflation can affect a company Financial management
environment
97
WORKING CAPITAL MANAGEMENT
98
Mnemonic The central role of working capital
management in financial management
99

33


Type of
presentation
number
Mnemonic Potential conflict between functional
managers and financial managers in
working capital decisions
100
Chart Example of the need for working capital
investment
101
Chart Working capital investment has a cost but
there is no direct money return
102
Chart The constituents of Working capital
management

103
Mnemonic Sources of information available to help
credit assessment

104
Mnemonic Reasons for delays in invoicing Working capital management
105
Mnemonic Possible actions for dealing with slow
payers

106
Mnemonic Debtor management general factors Working capital management

107
Mnemonic Steps that a company could use to reduce
bad debts

108
Chart Derivation of formula for calculating the
average Accounts payable balance

109
Chart Offering discounts for early payment Working capital management
110
Chart Receiving payments from overseas sales Working capital management

111
Mnemonic Managing payments from overseas
customers

112
Mnemonic The workings of an effective credit control
department

113
Chart Factoring book debts Working capital management
114
Chart Factoring book debts: Ups and Downs Working capital management
115
Mnemonic Benefits of factoring debts Working capital management
116
Chart Overview on the management of accounts
receivable

117
Chart Overview on the management of accounts
receivable - 2
118
Mnemonic How risks of foreign trade (excluding
foreign exchange risks) might be
managed
119
Mnemonic Terms of trade for overseas customers Working capital management
120

34


Type of
presentation
number
Chart Three main types of trade credit Working capital management
121
Chart Control of trade credit Working capital management
122
Chart Taking discount for early payment Working capital management
123
Mnemonic Advantages of using trade credit to
finance working capital
124
Mnemonic Factors that influence the amount of
trade-credit period taken

125
Chart Levels of inventory Working capital management
126
Mnemonic The costs of holding inventory (stock) Working capital management
127
Mnemonic Costs of acquiring inventory (purchase
order costs)

128
Mnemonic Benefits of holding high levels of inventory
(stock)

129
Mnemonic Disadvantages of holding high levels of
inventory (stocks)

130
Mnemonic Ways a manufacturing company can use
to reduce its average raw material
inventory

131
Chart Characteristics of JIT systems Working capital management
132
Mnemonic The nature and characteristics of supply
in JIT

133
Mnemonic JIT. What is planned to be available just
in time?

134
Mnemonic Aims of Just-In-Time (JIT) Working capital management
135
Mnemonic Pre-requisites for a successful JIT system Working capital management
136
Mnemonic Advantages associated with JIT systems Working capital management
137
Mnemonic Toyota Production System (TPS) Working capital management
138
Mnemonic Examples of waste (non-value-adding
activity and costs)

139
Chart The concept of pull production linked to
just in time (JIT)

140
Chart Cash management Working capital management
141
Chart Calculation of Cash conversion cycle
period

142
Mnemonic Releasing cash from working capital to
deal with short-term cash deficits

143

35


Type of
presentation
number
Mnemonic Reasons for a company to hold liquid
assets
144
Chart 6 Steps for cash budgeting Working capital management
145
Chart Cash budgeting: Receipts and payments
model

146
Chart Cash flow statement Working capital management
147
Chart Baumol Cash Budget Model Working capital management
148
Mnemonic Potential problems associated with the
Baumol model

149
Chart Miller-Orr Cash Budget Model Working capital management
150
Chart Management of short-term surplus cash Working capital management
151
Mnemonic Factors to consider before investing
surplus short-term funds on the money
market

152
Chart Management of short-term deficit cash Working capital management
153
Mnemonic Reasons why there are cash problems
(cash deficits)

154
Mnemonic Overcoming short-term deficit cash Working capital management
155
Chart Dynamics between short- and long-term
interest rates

156
Chart Market segmentation theory Working capital management
157
Mnemonic 3 reasons why under normal economic
conditions short-term interest rates are
lower than long-term rates.

158
Chart Financing working capital: Three
approaches

159
Chart Financing working capital Working capital management
160
Mnemonic 3 different financing policies for working
capital

161
Mnemonic The factors to consider before adopting
an aggressive financing policy

162
Mnemonic Balance between cash and short-term
investments

163
Mnemonic Explanations for the shape of the Normal
Interest Yield Curve

164
Chart Financial instruments (paper) in the
money markets
Nature and role of financial
markets and institutions
166

36


Type of
presentation
number
NATURE AND ROLE OF FINANCIAL MARKETS AND INSTITUTIONS
165
Mnemonic Financial instruments used in the money
market
167
Chart The Bill of Exchange mechanism Nature and role of financial
168
Chart Letter of Credit Nature and role of financial
169
Mnemonic The main organisations acting as financial
intermediaries
170
Mnemonic The main functions (roles) served by
financial intermediaries in the market
171
Chart Organisations operating as financial
intermediaries
172
Chart The role of financial intermediaries - 1 Nature and role of financial
173
174
175
Chart The role of financial intermediaries - 4

176
177
Mnemonic Ways that investors benefit from financial
intermediation
178
Chart The financial markets Nature and role of financial
179
Chart Money Nature and role of financial
180
Chart The role of the Central Bank in the money
market
181
Chart The London Stock Exchange (LSE) - 1

182
Chart The London Stock Exchange (LSE) - 2

183
Chart The London Stock Exchange (LSE) - 3 Nature and role of financial
184
Chart Risk/return trade-off - 1 Nature and role of financial
185
Chart Risk/return trade-off - 2

186

37


Type of
presentation
number
Mnemonic Types of risks concerning financial and
investment decisions
187
BUSINESS FINANCE
188
Mnemonic Key factors in choosing sources of
finance
Business finance
189
Mnemonic The relative merits of short-term debt
compared with long-term debt
Business finance

190
Mnemonic The problems of using short-term debt
sources compared with long-term debt
Business finance

190
Mnemonic Sources of short-term finance Business finance
191
Mnemonic Bank investigation concerning a loan
application
Business finance

192
Mnemonic Danger signs for a bank when assessing
a bank loan application
Business finance

193
Mnemonic Factors that influence the rate of interest
charged on a new bank loan
Business finance

194
Mnemonic The Sale and lease-back decision Business finance
195
Chart Public equity company raising long-term
finance
Business finance

196
Chart Ordinary shares and their characteristics -
1
Business finance

197
Chart Ordinary shares and their characteristics -
2
Business finance

198
Chart Ordinary shares and other things to know
- 1
Business finance

199
- 2
Business finance

200
- 3
Business finance

201
- 4
Business finance

202
Mnemonic Factors affecting a share price Business finance
203
Mnemonic Retained earnings compared with a new
issue of equity
Business finance

204
Mnemonic Factors relating to a public issue of equity Business finance

205
Chart Rights issue - overview Business finance
206
Chart Rights issue - 1 Business finance
207
208

38


Type of
presentation
number
209
Mnemonic Contents of a Prospectus for a Rights
issue
Business finance

210
Mnemonic Benefits of a rights issue in a bull market Business finance
211
Mnemonic The drawbacks of a rights issue Business finance
212
Chart Initial Public Offering (IPO) - 1 Business finance
213
214
215
Mnemonic Advantages of getting listed on a stock
exchange
Business finance

216
Mnemonic Disadvantages of getting listed on a stock
exchange
Business finance

217
Mnemonic Methods for a company to obtain a listing
on a stock exchange
Business finance
218
Mnemonic Costs of an issue on the stock exchange Business finance
219
Mnemonic Ways investors use to assess a company
that is making an initial public offer (IPO)
Business finance

220
Mnemonic Ways an unquoted company might
restructure its balance sheet prior to the
initial offer (IPO)
Business finance

221
Mnemonic Dividend policy the practical
considerations
Business finance
222
Chart The dividend decision - 1 Business finance
223
224
225
226
227
Mnemonic Different dividend policies Business finance
228
Mnemonic Reasons why dividend policy is important Business finance
229
Chart Main characteristics of bonds Business finance
230
Chart Bonds - 1 Business finance
231
232
233
Mnemonic Different forms of corporate bond Business finance
234

39


Type of
presentation
number
Chart Internal sources of finance and dividend
policy
Business finance

235
Chart The influence of interest rates on the
market value of bonds
Business finance

236
Chart Convertible bonds Business finance
237
Chart The floor value of a convertible bond Business finance
238
Mnemonic Factors relating to a public issue of
corporate bonds
Business finance

239
Mnemonic Advantages of eurobonds Business finance
240
Mnemonic Drawbacks in the eurobond market Business finance
241
Mnemonic Factors that should be considered by a
listed company when choosing between
the issue of debt and an issue of equity
Business finance

242
Mnemonic Ways by which an unlisted company can
obtain funds
Business finance
243
Chart The financing of SMEs

Business finance

244
Mnemonic Reasons why SMEs have difficulty in
raising finance
Business finance

245
Mnemonic Source of funds for SMEs using UK as
an example
Business finance

246
Mnemonic Problems faced by SMEs in respect of
credit management
Business finance

247
Mnemonic Steps that could be taken by SMEs to
minimise the effects of their poor credit
management
Business finance

248
Mnemonic Purposes of venture capital Business finance
249
Chart The main financial markets Business finance
250
INVESTMENT APPRAISAL 251
Chart The capital budgeting process Investment appraisal
252
Chart The rolling capital budget system Investment appraisal
253
Mnemonic Seven steps involved in successfully
evaluating and controlling a capital budget
254
Mnemonic Component parts of a Business Case for
an investment proposal

255
Mnemonic Possible benefits of an investment project Investment appraisal
256

40


Type of
presentation
number
Mnemonic Main responsibilities of the Capital
Expenditure Committee
257
Mnemonic Relevant (or opportunity) costs that would
affect the future cash flow of a project

258
Mnemonic Costs which are not relevant when
carrying out a DCF appraisal

259
Chart Capital investment appraisal techniques Investment appraisal
260
Mnemonic The main capital investment evaluation
techniques and criteria

261
Mnemonic Limitations of the payback period method
of capital investment appraisal

262
Mnemonic Advantages of the payback period method
of capital investment appraisal

263
Mnemonic Limitations of the Accountants Rate of
Return (ARR) measure for evaluating
capital investment proposals
264
Mnemonic Strengths of the ARR measure Investment appraisal
265
Mnemonic Advantages of using discounted cash flow
(DCFR) techniques for capital investment
appraisal
266
Mnemonic Data required to calculate the net present
value (NPV) of an investment project
267
Mnemonic Advantages of IRR over NPV Investment appraisal
268
Mnemonic Limitations of using the IRR measure for
capital investment appraisal
269
Mnemonic Advantages of NPV over other investment
appraisal techniques
270
Mnemonic General limitations of net present value
(NPV) when applied to investment
appraisal
271
Mnemonic Steps taken to address the limitations of
NPV analysis
272
Chart Capital investment appraisal applications Investment appraisal
273
To manage a business well is to manage its future: and to manage the future is to
manage information.

Marion Harper

41


Type of
presentation
number
Chart Effects of inflation on NPV Investment appraisal
274
Chart NPV and risk Investment appraisal
275
Chart Business and financial risks Investment appraisal
276
Mnemonic Factors contributing to business risk Investment appraisal
277
Mnemonic Factors contributing to financial risk Investment appraisal
278
Mnemonic Ways that risk can be managed in capital
investment
279
Mnemonic Problems of using the expected value
approach when making investment
decisions
280
Mnemonic Limitations of sensitivity analysis Investment appraisal
281
Chart The lease or borrow-to-buy decision Investment appraisal
282
Mnemonic Advantages of leasing assets Investment appraisal
283
Mnemonic Disadvantages of leasing assets Investment appraisal
284
Chart Capital rationing: Overview Investment appraisal
285
Mnemonic Hard capital rationing:
characteristics and reasons for

286
Mnemonic Soft capital rationing:
characteristics and reasons for
287
Mnemonic Exploiting opportunities which are
rejected because of capital rationing
288
Mnemonic Limitations of using the Profitability index
(PI) in a capital rationing situation
289
Chart Capital Replacement Theory - 1 Investment appraisal
290
Chart Capital Replacement Theory - 2 Investment appraisal
291
Mnemonic The factors to consider in a replacement
decision
292
Chart The process of capital budgeting and
investment appraisal: overview
293
BUSINESS AND ASSET VALUATION
294
Mnemonic Four different ways of valuing a company
(or an equity share)
Business valuations
295
Mnemonic Purpose of company or share valuation Business valuations
296
Mnemonic The main implications of the Efficient
Market Hypothesis
Business valuations
297
Chart Different methods of valuing a company
or its shares
Business valuations
298

42


Type of
presentation
number
Mnemonic Weaknesses of the dividend valuation
model
Business valuations
299
COST OF CAPITAL
300
Mnemonic Assumptions underlying CAPM Cost of capital
301
Chart Systematic and unsystematic risk Cost of capital
302
Mnemonic Limitations of using the beta factor Cost of capital
303
Chart Traditional gearing Cost of capital
304
Chart Traditional gearing ratios Cost of capital
305
RISK MANAGEMENT 306
Chart Managing foreign currency risk Cost of capital
307
Mnemonic The uniqueness of the foreign exchange
(FE) market
Risk management
308
Mnemonic Factors that affect a currencys supply
and demand and thus its price
Risk management
309
Mnemonic Forecasting exchange rates Risk management
310
Mnemonic Four ways of forecasting (estimating)
future currency rates
Risk management
311
Chart Four-way Equivalence Model Risk management
312
Mnemonic Techniques available to help reduce
foreign exchange risk involved in foreign
trade or business
Risk management
313
Mnemonic The steps involved when using a money
market hedge to cover foreign currency
payments
Risk management
314
Mnemonic Advantages of using futures to hedge
risks compared with a forward exchange
contract
Risk management
315
Mnemonic Difficulties of using futures to hedge risks Risk management
316
Mnemonic The reasons for using currency options Risk management
317
Mnemonic Benefits of currency swaps Risk management
318
Mnemonic Drawbacks of currency options Risk management
319
Chart Currency and interest rate management Risk management
320
Mnemonic Pattern of interest rates Risk management
321
Mnemonic Reasons why interest rates may be
expected to fall
Risk management
322

43


Complementary Questions and Answers: 1 of 6
(Note: These Questions and Answers are also hyper-linked from appropriate teaching screens.)
Title Page

FINANCIAL MANAGEMENT FUNCTION

348
Question Role of the financial manager
A question covering responsibilities of the financial manager
in different organisations
349
Answer Role of the financial manager
350
Question Corporate objectives
A question covering corporate and financial objectives
353
Answer Corporate objectives
354
Question Not-for-profit organisation
A question covering a not-for-profit making organisation, etc.
358
Answer Not-for-profit organisation
359

FINANCIAL ANALYSIS

362
Question Associated International Supplies Co
363
Answer Associated International Supplies Co
364
Question Middlesburg Furniture Company
A question covering a cash-flow forecast and ratio analysis.
369
Answer Middlesburg Furniture Company
371
Question RZP Co
A question covering financial performance analysis and
remuneration schemes.
377
Answer RZP Co
378

FINANCIAL MANAGEMENT ENVIRONMENT

383
Question Economic and financial environment
A question covering monopoly, new equity finance and debt
versus equity finance.
384
Answer Economic and financial environment
385
Question Stakeholders groups
A question covering stakeholder groups and corporate
governance
387
Answer Stakeholders groups
388
Question Mazzaron Company
A question concerning inflation and inflationary conditions
390
Answer Mazzaron Company
391
Please go to the next
screen
Activated
for this
free
sample

44


Title Page

WORKING CAPITAL MANAGEMENT

397
Question Mar Engineering Company
A question concerning working capital management and cash
budgeting
398
Answer Mar Engineering Company
400
Question EFG Company
Question concerning working capital management
403
Answer EFG Company
404
Question Shorncliffe Company
A question which concerns invoice speeding and discounts
and factoring
405
Answer Shorncliffe Company
406
Question Broomfield Company
A question which concerns discounting, factoring and
extending credit (which includes the user of probabilities)
410
Answer Broomfield Company
412
Question White Fish Supplies Company
A question which concerns factoring and credit control
management.
416
Answer White Fish Supplies Company
417
Question Hexicon Company
A question which concerns inventory management - EOQ
calculations and JIT discussion
422
Answer Hexicon Company
423
Question Staley Company
A question which concerns factoring and discounts
427
Answer Staley Company
429
Question CFMC Company
A question which concerns factoring and discounts
434
Answer CFMC Company
435
Question Extra credit
A question which concerns a policy of increasing credit,
establishing creditworthiness and offering discounts
438
Answer Extra credit
439
Question Trade credit
A question which concerns a policy of increasing credit,
establishing creditworthiness and offering discounts
442
Answer Trade credit
443
screen

45


Title Page

CASH MANAGEMENT

447
Question Delcars Company
A question which concerns cash management a and treasury
management generally.
448
Answer Delcars Company
449
Question Christmas Company
A question which covers management and surplus cash.
452
Answer Christmas Company
453
Question Newingelm Company
A question which covers working capital estimation and bank
overdraft finance.
456
Answer Newingelm Company
457
Question Surtan Company
A question which covers cash budgeting and cash
management.
460
Answer Surtan Company
461
Question Investment of short-term cash
A question which covers the management of surplus cash.
465
Answer Investment of short-term cash
466
Question AMC Company
A question which covers over-trading and cash management.
468
Answer AMC Company
469

CAPITAL INVESTMENT APPRAISAL

472
Question Jinga Company
A question which covers various capital investment appraisal
techniques.
473
Answer Jinga Company
474
Question Zambab Company
A question which covers payback period and NPV.
480
Answer Zambab Company
481
Question Burley Company
A question which covers NPV, IRR and sensitivity analysis.
486
Answer Burley Company
487
Question UgChem Company
A question which covers expected NPV and corporate social
responsibility.
490
Answer UgChem Company
491
screen

46


Title Page

CAPITAL INVESTMENT APPRAISAL (CONTINUATION)

Question Playwell Company
A question which covers expected NPV .
495
Answer Playwell Company
496
Question Carew Company
A question which covers leasing .
501
Answer Carew Company
502
Question Rangex Company
A question which covers NPV, IRR and sensitivity analysis.
506
Answer Rangex Company
507
Question Howden Company
A question which covers the impact of inflation on capital
investment appraisal.
510
Answer Howden Company
511

NATURE AND ROLE OF FINANCIAL MARKETS AND INSTITUTIONS

514
Question Functions of a stock exchange
A question which covers the functions of a stock exchange
including its junior market.
515
Answer Functions of a stock exchange
516

BUSINESS FINANCE

518
Question Sellinge Industrial
A question which covers a small company applying to renew
its bank overdraft facility.
519
Answer Sellinge Industrial
520
Question Cadmol Company
A question which covers a cash-flow forecast and leasing as a
form of business finance
523
Answer Cadmol Company
524
Question Tirwen Company
A question which covers a rights issue and debt financing.
527
Answer Tirwen Company
528
Question Arwin Company
A question which covers debt versus equity finance.
532
Answer Arwin Company
533
screen

47


Title Page

BUSINESS FINANCE (CONTINUATION)

Question Barton Company
A question which covers a small company seeking expansion
finance.
536
Answer Barton Company
537
Question Techfools.com
A question which covers convertible bonds and the role of
intermediation.
540
Answer Techfools.com
541
Question Dividend policy
A question which covers dividend policy.
544
Answer Dividend policy
545
Question Black Fish (BF) Co
A question which covers decisions concerning cash surplus.
548
Answer Black Fish (BF) Co
549
Question Market hypothesis
A question which covers market hypothesis.
552
Answer Market hypothesis
553
Question Folkesdown Co
A question which covers a rights issue.
556
Answer Folkesdown Co
558
Question Winifred Co
A question which covers financial gearing.
560
Answer Winifred Co
562
Question Green Co
A question which covers convertibles and warrants.
566
Answer Green Co
567
Question Samian Co
A question which covers a company seeking a stock market
listing
570
Answer Samian Co
572

COST OF CAPITAL

576
Question Burmarsh Co
A question which covers weighted average cost of capital
(WACC) calculations .
577
Answer Burmarsh Co
578
Question X Company
A question which covers cost of equity capital calculations.
581
Answer X Company
582
screen

48


Title Page

COST OF CAPITAL (CONTINUATION)

Question Tanner-Hawkinge (TH)
A question which covers CAPM and the cost of capital.
584
Answer Tanner-Hawkinge (TH)
585
Question Seely Company
A question which covers capital investment appraisal.
589
Answer Seely Company
591
Question Burse Co
calculations.
594
Answer Burse Co
595
Question Rupab Co
A question which covers WACC and project-specific discount
discussion.
598
Answer Rupab Co
599
Question AS Company
A question which covers project-specific weighted average
cost of capital calculations.
602
Answer AS Company
603
Question Harvey-O Inc
A question which covers project-specific weighted average
cost of capital calculations.
606
Answer Harvey-O Inc
607
Question TSOL Inc
calculations.
612
Answer TSOL Inc
614

BUSINESS AND ASSET VALUATION

619
Question Conapanic Co
A question which covers the calculations for the value of a
share price.
620
Answer Conapanic Co
621

RISK MANAGEMENT

625
Question Aybe Company
A question which covers foreign exchange risk management.
626
Answer Aybe Company
627
Question Zencom Co
A question which covers foreign exchange risk management.
631
Answer Zencom Co
632
Question Afrus Inc
A question which covers transactions and economic
currency exchange exposure.
635
Answer Afrus Inc
636

49


Economic order quantity

Miller-Orr Model

The capital Asset Pricing Model

The asset beta formula

The Growth Model

Gordons growth approximation

The weighted average cost of capital

The Fisher formula

Purchasing power parity and interest rate parity

H
C
D
0
2C
=
|
|
.
|
\
|
+ = spread x
3
1
limit Lower point Return
( ) ( ) ( )
f
R -
m
r E
i

f
R
i
r E + =
3
1
rate interest
flows cash of ariance cost x v action x trans
4
3
3 Spread
|
|
|
|
.
|
\
|
=
( ) ( ) ( ) ( )

T - 1
d
V
e
V
T) - (1
d
V

T - 1
d
V
e
V
e
V

a
(
(
(
(
+
+
+
+
=
d
e

( )
( ) g -
e
r
g 1
0
D

0
P
+
=
e
br = g
( ) ( )
( ) T - 1
d
k
d
V
e
V

d
V

e
k
d
V
e
V
e
V
WACC
(
(
(
(
+
+
+
=
( ) ( )( ) h 1 r 1 i 1 + + = +
( )
( )
( )
( )
b
i 1
c
i 1
x
0
s
1
f
b
h 1
c
h 1
x
0
s
1
s
+
+
=
+
+
=

50


payment until periods of number n
rate discount r here

n -
r) (1 i.e. 1 of value Present
Table Value Present
=
=
+

51


It has always been an axiom of mine that the little
things are infinitely the most important.

Sherlock Holmes
Arthur Conan Doyle, 1859 - 1930
( )
periods of number n
rate discount r Where
r
n -
r) 1 - 1
i.e. 1 of annuity an of value Present
Table Annuity
=
=
+

52


List of important Symbols

d
0
Current dividend
d
1
Next dividend
d
n
Dividend in year n
g Expected annual percentage growth in dividends
i Annual interest payment
P
0
Current market value of a security
V
e
Market value of equity
V
d
The market value of debt
V
b
The market value of a bond
V
a
Total market value of a firm
T Rate of corporation (or corporate) tax
k
e
Cost of equity
k
p
Cost of preference shares
k
d
Cost of debt
WACC Weighted average cost of capital
r
e
Expected return of equity
r
p
Expected return of preference shares
r
d
Expected return of debt
r
f
Risk-free interest rate
r
m
Expected return on the market portfolio
Beta factor

a
Asset beta

e
Equity beta

d
Debt beta
PV Present value
NPV Net present vale
IRR Internal rate of return
EPS Earnings per share
ROE Return on equity
PBIT Profit before interest and tax
R Real rate of return
M Nominal (or money) rate of return
P Inflation rate that affects purchasing power
C
h
Cost of holding inventory
C
0
Cost of a purchase receipt
D Annual demand for material
JIT Just in time
EOQ Economic order quantity
F
0
Expected spot rate
S
0
Current spot rate
i
c
Interest rate of country C
i
b
Interest rate of country B
h
c
Interest rate of country C
h
b
Interest rate of country B

53


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