MANAGEMENT DEVELOPMENT PROGRAMME

OF
LUDHIANA MANAGEMENT ASSOCIATION
MODERN TOOLS OF FINANCIAL ANALYSIS
TRADITIONAL METHODS /TOOLS MODERN METHODS/TOOLS
1. COMPARATIVE
FINANCIAL STATEMENT
2. COMMON SIZE
STATEMENTS
3. RATIO ANALYSIS
4. CASH FLOW/FUNDS
FLOW ANALYSIS
1. ECONOMIC VALUE
ADDED
2. DATA ENVELOPMENT
ANALYSIS
3. BALANCE SCORE CARD
DEFICIENCIES IN TRATIONAL SYSTEM OF
FINANCIAL ANALYSIS
Paradigm shift in setting corporate objectives
and performance measurement.
Maximisation of Profit Vs Maximisation of
Shareholders wealth
Inconsistencies in the accounting figure as
well as the inconsistencies in the valuation
method used by accountants in the valuation
of assets and liabilities and measurement of
income of the firm.
DEFICIENCIES IN TRATIONAL SYSTEM OF
FINANCIAL ANALYSIS
Financial data typically reflect an organiza-
tions past performance. Therefore, they may
not accurately represent the current state of
the organization or what is likely to happen to
the organization in the future.
ECONOMIC VALUE ADDED - THE CONCEPT

EVA is a term developed and used by a US
based consulting firm named Stren Stewart &
Co. This measure is its registered trademark
EVA is a measure to assess the extent to
which companies have succeeded in
achieving the objective of enhancing
shareholders' wealth.
ECONOMIC VALUE ADDED - THE CONCEPT
EVA is a method of ascertaining whether and to what
extent a company has been able to enhance shareholder
value at the end of a particular year.
A firm creates value only if it can generate return higher
than its cost of capital.
Cost of capital is the weighted average cost of capital.
The rationale of EVA is that shareholders have an
expectation about what to expect from the company at the
initial period.
This is based on well-known principles of calculation of
equity cost of capital which is given by a company.
However, EVA measures what shareholders get over and
above cost of equity capital.

COMPUTATION OF ECONOMIC VALUE ADDED
(EVA):

There are three methods of computing EVA
or for judging whether management of the
company has increased shareholder value.

METHOD I

Under this method, EVA is computed based
on net return on investment. In this method,
the EVA is calculated by multiplying spread
between return on investment (ROI) and
weighted average cost of capital with capital
employed. i.e. EVA = (ROI Weighted
Average Cost of Capital) Capital Employed

METHOD II

Under this method, EVA is computed based on residual income.
This method calculates a net income return to shareholders. EVA
is the difference between adjusted net profit before interest (after
tax) and Product of WACC and Capital Employed.
i.e. EVA= Adjusted Net Profit before Interest (After Tax) Capital
Employed WACC Where, Adjusted NPBI = Net Profit after
Interest and Tax + Interest. Here, interest is added back to NPAT.
This effectively adjusts the tax liability for the effect of leverage to
arrive at adjusted net profit before interest (after tax). The
weighted average cost of capital represents the totality of what
the company has to pay out to its lenders and shareholders.
The total capital employed regardless of whether it is financed by
debt or equity is multiplied by the WACC to ascertain what the
company must earn to meet its cost of capital obligations. The
surplus is the EVA.

METHOD III


Under this method, EVA = Net Profit after
Interest and Tax (NPAIT) Shareholders
Fund Cost of Equity. Here, the interest and
tax liabilities are deducted from the
Operational Profit to arrive at NPAIT.

DATA ENVELOPMENT ANALYSIS
The DEA methodology is a mathematical
programming technique introduced by
Charnes,Cooper and Rhodes (1978) to evaluate
the relative efficiency of production units and
can accommodate multiple inputs and outputs.
The DEA is a linear programming based
technique for measuring the relative efficiency
and management performance of firms where
presence of multiple inputs and outputs makes
comparison difficult
It uses the observed values of inputs and
outputs and attempts to find which of the
firms in the sample determine an
envelopment surface. The DEA measure
compares each of the firms in the sample
with the best practice ones known as peers
or role models.
A DEA model can be analysed in two ways, an input
orientation and an output orientation.
An input orientation provides information as to how
much proportional reduction of inputs is necessary
while maintaining the current levels of outputs for an
inefficient fund to become DEA-efficient.
On the other hand, an output orientation analysis
provides information on how much augmentation to
the levels of outputs of an inefficient fund is
necessary while maintaining current input levels for it
to become DEA-efficient.

A NUMERICAL EXAMPLE
Following problem is formulated for running the
DEA frontier analysis with the help data of 12 housing
finance companies as DMUs , taken from Cooper et
al (1999), each of which has 5 inputs and 4 outputs.
Here the problem for the year 1999-00 is given to
exemplify the problem formulation. Similar problem
for other financial years upto 2006-07 were
formulated to run the DEA frontier analysis to analyse
the efficiency of selected HFCs


WHAT IS A BALANCED SCORECARD?
A Measurement
System?
A Management
System?
A Management
Philosophy?
TRANSLATING VISION AND STRATEGY:
FOUR PERSPECTIVES
Vision and
Strategy
Objectives Measures Targets Initiatives
FINANCIAL
To succeed
financially,
how should
we appear to
our
shareholders?

Objectives Measures Targets Initiatives
LEARNING AND GROWTH
To achieve
our vision,
how will we
sustain our
ability to
change and
improve?
Objectives Measures Targets Initiatives
CUSTOMER
To achieve
our vision,
how should
we appear to
our
customers?
Objectives Measures Targets Initiatives
INTERNAL BUSINESS PROCESS
To satisfy our
shareholders
and
customers,
what business
processes
must we excel
at?
.
THE BALANCED SCORECARD FOCUSES ON
FACTORS THAT CREATE LONG-TERM VALUE
Traditional financial reports look backward
Reflect only the past: spending incurred and revenues earned
Do not measure creation or destruction of future economic value
The Balanced Scorecard identifies the factors that create long-term economic
value in an organization, for example:
Customer Focus: satisfy, retain and acquire customers in targeted segments
Business Processes: deliver the value proposition to targeted customers
innovative products and services
high-quality, flexible, and responsive operating processes
excellent post-sales support
Organizational Learning & Growth:
develop skilled, motivated employees;
provide access to strategic information
align individuals and teams to business unit objectives
Processes
Customers
People
THE FOUR PERSPECTIVES APPLY TO MISSION DRIVEN AS WELL AS PROFIT
DRIVEN ORGANIZATIONS
What must we do to satisfy our financial
contributors?
What are our fiscal obligations?

Who is our customer?
What do our customers expect from
us?

What internal processes must we excel
at to satisfy our fiscal obligations, our
customers and the requirements of our
mission?

How must our people learn and develop
skills to respond to these and future
challenges?
Profit Driven Mission Driven
What must we do to satisfy our
shareholders?


What do our customers expect from
us?


What internal processes must we
excel at to satisfy our shareholder and
customer?


How must our people learn and
develop skills to respond to these and
future challenges?
Financial Perspective



Customer Perspective



Internal Perspective




Learning & Growth
Perspective
Answering these questions is the first step to develop a Balanced
Scorecard