FANUEL KASAMBA

R2305D16624906
Financial Management
UU-MBA-710-MW- 64976

4/2/2024

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Table of Contents
Introduction ......................................................................................................................................... 3
1. Profit and loss statement financial analysis .................................................................................. 3
Gross Profit Ratio. ........................................................................................................................... 4
Expense-to-Sales Ratio .................................................................................................................... 4
Net Profit Ratio................................................................................................................................ 5
Operating (Net) Profit Ratio ............................................................................................................ 5
2. Balance sheet financial ratio analysis ........................................................................................... 7
The Current Ratio ............................................................................................................................ 7
Quick Ratio ..................................................................................................................................... 8
Debt-Equity Ratio ............................................................................................................................ 9
Proprietary Ratio ........................................................................................................................... 10
3. Capital Investment and acquisition ............................................................................................ 12
Acquisition Process ....................................................................................................................... 12
4. Profitability, solidarity and solvency, and liquidity .................................................................... 15
Profitability.................................................................................................................................... 15
Solidity and Solvency .................................................................................................................... 15
Liquidity ........................................................................................................................................ 15
References ......................................................................................................................................... 17

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Introduction
Financial analysis is one key to assess the performance and position of an entity in its
financial standing. Peterson & Fabozzi (2003) discussed that financial analysis consists of
the evaluation of the financial condition and operating performance of a business firm, an
industry, or even the economy, and the forecasting of its future condition and performance.
This paper highlights some key facets of financial analysis approaches and procedures.

1. Profit and loss statement financial analysis

Profit and loss statement is a financial report that is produced to provide information on how
an entity is performing in terms of its incomes and spending. To analyze this statement is so
imperative to all stakeholders and impacts greatly on informed decision making.
Below is an extract of profit and loss account with ratios that can aid to analyze it.

Profit and Loss Account of ABC Ltd for the year ended 31‐12‐2019
Particular MK Particular MK.
Opening Stock 76,250 Sales 500,000

Purchases 315,250 Closing stock 98,500

Carriage and Freight 2,000
Wages 5,000
Gross Profit 200,000 Gross Profit 200,000

Non‐operating incomes:

To Administration 101,000 Interest on Securities 1,500

expenses
Selling and Dist. 12,000 Dividend on shares 3,750
Expenses
N0on‐operating 2,000 Profit on sale of shares 750
expenses
Financial Expenses 7,000

Net Profit 84,000

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From the above statement we are going to do some financial ratios which are so critical in
assessing financial performance. as cash flow ratios can measure a company’s performance
more accurately compared with traditional ratios (Nor Farizal Mohammed, et al 2022)

Gross Profit Ratio.

This is a financial ratio that measures the profitability of a company's core business activities
by expressing the relationship between gross profit and net sales.
Gross Profit Ratio= (Gross Profit/Net Sales) × 100
= (200,000/500,000) × 100
= 40%
The Gross Profit Ratio provides insights into the efficiency of a company's production and
manufacturing processes. While a smaller ratio could point to problems with cost control, a
greater ratio shows that a business is successfully managing its manufacturing costs.
The Gross Profit Ratio is a tool used by analysts and investors to evaluate a company's
profitability, evaluate its performance over time, and compare it to rivals in the industry.

Expense-to-Sales Ratio
This ratio assesses the efficiency of a company in managing its total expenses relative to its
net sales. It provides insights into how much of the revenue generated is being consumed by
various expenses.

Expense-to-Sales Ratio= (Total Expenses/ Net Sales) × 100

= (122,000/500,000) x 100
= 24.4%
A lower ratio is generally preferable, as it indicates that a smaller percentage of revenue is
being used to cover operating expenses. As in this case the ratio is preferably better.

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Net Profit Ratio
A financial indicator called the net profit ratio expresses the relationship between net profit
and net sales and is used to evaluate a company's profitability.
The amount that remains after all costs, taxes, and interest are subtracted from the total
revenue is known as net profit. It stands for the profit that the company's stockholders can
take home, whereas net sales are the entire sales less any allowances, returns, or discounts.

Net Profit Ratio = (Net Profit / Net Sales ) ×100

= (84,000/500,000) x100
=16.8%

The Net Profit Ratio sheds light on a company's overall profitability and effectiveness in
making money from its main lines of operation. A higher net profit ratio means that a
business is keeping a bigger percentage of its income in net profit by efficiently managing its
costs, taxes, and interest.
The Net Profit Ratio is a tool that analysts and investors use to evaluate a company's
operational profitability, compare it to other industry players, and assess its overall financial
health. The Net Profit Ratio, like other profitability ratios, can be interpreted differently in
different industries, thus while interpreting the ratio, it's important to take the unique features
of the company and industry into account.

Operating (Net) Profit Ratio

Operating Profit Margin is a financial ratio that illustrates the relationship between operating
profit and net sales in order to assess how profitable a company's core business operations
are.
The profit obtained from regular business operations before interest and taxes are subtracted
is known as operating profit, also known as net operating profit. It is computed as the
difference between operating costs and gross profit. Conversely, net sales are the total sales
less any allowances, discounts, or returns.

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Operating Profit Ratio= (Operating Profit (earnings before interest and tax) / Net Sales) ×100
= (84,000-2000-7000)/ (500,000) x100
= (75,000/500,000) x100
= 15%

The Operating Profit Ratio focuses specifically on the profitability of a company's operating
activities, excluding non-operating items such as interest and taxes. This ratio provides
insights into how efficiently a company is managing its core business operations to generate
profit.

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 2. Balance sheet financial ratio analysis

This statement shows the financial condition of a company for a particular period or date. It
has three major sections: assets (resources of the company), liabilities (debts of the
company), and stockholders’ equity (the owners’ interest in the firm).

Particular Rs. Particular Rs.

Equity Share Capital 40,000 Plant andMachinery 24,000
Capital Reserve 8,000 Land andBuildings 40,000
8% Loan on Mortgage 32,000 Furniture & Fixtures 16,000

Creditors 16,000 Stock 12,000

Bank overdraft 4,000 Debtors 12,000
Taxation: Investments (Short‐ 4,000
term)
Current 4,000 Cash in hand 12,000
Future 4,000
Profit and Loss A/c 12,000

120,000 120,000
The Balance Sheet below is that of ABC Auto Limited as of 31‐12‐2020

From the above statement the following ratios can be analyzed with the ratio formulas as
showed by Penman, (2013)

The Current Ratio

The Current Ratio is a liquidity ratio that measures a company's ability to cover its short-term
liabilities with its short-term assets.

Current Ratio=Current Assets/ Current Liabilities

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 = (12000+12000+4000+12000)/(16000+4000+4000)
=40,000/24,000
=1.67

Current Assets are the assets that are expected to be converted into cash or used up within
one year. This includes items like cash, accounts receivable, and inventory. While Current
Liabilities are the company's obligations that are due within one year. This includes items like
accounts payable, short-term debt, and other liabilities maturing in the short term.

A company's short-term financial health and ability to pay short-term debts are gauged by its
current ratio. If the ratio is greater than 1, it means the business has more current assets than
current liabilities, which suggests it should be able to pay for its immediate liabilities. A very
high ratio, however, can indicate that the business is not making the best use of its resources.
Generally speaking, a current ratio between 1.5 and 2 is generally regarded as healthy, though
this depends on the industry. It's crucial to remember that although the current ratio shows a
company's liquidity in the moment, it doesn't reveal anything about the cadence or quality of
its assets.

Quick Ratio
The Quick Ratio, also known as the Acid-Test Ratio, is a financial ratio that measures a
company's ability to meet its short-term obligations with its most liquid assets. It is a more
conservative measure of liquidity than the current ratio because it excludes inventory from
current assets.

Quick Ratio = (Current Assets – Inventory)/ Current Liabilities

= (40,000-12000)/ 24,000
= 28,000/24,000
= 1.17

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A ratio of one or greater is typically regarded as healthy for the Quick Ratio, which is
expressed as a ratio. It shows that the business's liquid assets are sufficient to pay for its
immediate liabilities. A ratio less than 1 can indicate possible problems with liquidity.
It's crucial to remember that the Quick Ratio has limits and that, for a thorough assessment of
a company's financial health, it should be used in conjunction with other financial metrics.
Furthermore, different industries might have different standards for what constitutes a
suitable Quick Ratio.

Debt-Equity Ratio
The Debt-Equity Ratio is a financial metric that provides insights into the proportion of a
company's financing that comes from debt compared to equity. It is calculated by dividing a
company's total debt by its total equity.

Debt-Equity Ratio=Total Debt/Total Equity

= (32,000+16,000+4000)/ 40,000
=52,000/40,000
=1.3

Total Debt: This sums up all of the short- and long-term debt owed by a business. It includes
all types of borrowing, including bonds and loans.
Total Equity: This denotes a company's ownership stake. It consists of retained earnings,
preferred stock, common stock, and additional equity components.

The Debt-Equity Ratio shows how much of a business is funded by debt as opposed to
equity. A lower ratio denotes a greater reliance on equity, whereas a higher ratio indicates
that a larger portion of the company's financing comes from debt. The industry norms and the
company's risk tolerance are two important factors that influence how the ratio should be
interpreted.
A Debt-Equity Ratio less than 1 typically implies that the company has more equity than
debt, which may be seen as a conservative financial structure.

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A ratio greater than 1 indicates that the company has more debt than equity. This could mean
higher financial leverage, which may lead to higher financial risk but could also enhance
returns for shareholders if the company can generate a higher return on the borrowed funds.

Extremely high debt-to-equity ratios could be a sign of impending financial trouble because it
can be difficult to service large debt loads.
For a more insightful analysis, it is imperative to take into account industry norms and
compare the Debt-Equity Ratio with those of peer companies. To fully grasp a company's
financial health and risk profile, the ratio should also be evaluated in conjunction with other
financial metrics.

Proprietary Ratio
The Proprietary Ratio, also known as the Equity Ratio or Net Worth to Total Assets Ratio, is
a financial metric that measures the proportion of a company's total assets that are financed
by its equity. It provides insights into the level of financial risk and leverage in a company's
capital structure. The formula for the Proprietary Ratio is:

Proprietary (Equity) Ratio= Shareholders’ Equity/Total Assets

=40,000/120,000
=0.33
=33%

The ownership stake in a company is represented by its shareholders' equity, which also
includes retained earnings, preferred stock, and other equity components.
All of a company's assets, both tangible and intangible, current and non-current, are included
in its total assets.

A higher percentage denotes a larger share of assets financed by equity, which is regarded as
a more cautious and secure financial position. The Proprietary Ratio is expressed as a
percentage. Conversely, a smaller percentage denotes a greater dependence on debt financing.

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A higher proprietary ratio (nearer 100%) indicates that equity funds a sizable portion of the
company's assets. Given that it suggests less financial leverage and possibly less financial
risk, this could be seen favorably.

A lower Proprietary Ratio suggests a higher proportion of debt in the capital structure, which
can increase financial risk. However, it might also indicate a more leveraged position,
potentially leading to higher returns on equity if the company generates a return on assets
higher than the cost of debt.

As with any financial metric, it's crucial to consider industry benchmarks and compare the
Proprietary Ratio with those of peer companies. Additionally, this ratio should be analyzed
alongside other financial indicators for a comprehensive assessment of a company's financial
health and risk profile.

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 3. Capital Investment and acquisition

The acquisition of a majority stake in a company involves a series of key stages in the
transaction process. Vojislav Maksimovic, et al (1999) suggested that Capital budgeting and
investment frequently involves decisions about the amount of information which should be
acquired before the investment is undertaken. These stages can vary depending on the
specifics of the deal, but here is a general overview

Acquisition Process

Strategic Planning and Target Identification

Identifying possible acquisition targets in accordance with strategic objectives is the task of
this stage. The acquiring company outlines its goals, which may include growing its product
line, breaking into new markets, or advancing technologically.

Due Diligence
To evaluate the target company's operational, legal, financial, and strategic aspects, extensive
research and analysis are carried out. Finding any possible risks and opportunities related to
the acquisition is crucial at this point.
Examining the target company's contracts, liabilities, and financial statements closely can be
part of financial due diligence to make sure everything is accurate and to find any possible
problems.

Valuation
The acquiring company determines the fair value of the target company. Various valuation
methods, such as discounted cash flow (DCF) analysis, comparable company analysis (CCA),
and precedent transactions, are used.
If a manufacturing company is acquiring another firm, it may use a combination of financial
metrics and industry benchmarks to estimate the target company's value.

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Negotiation and Structuring the Deal
After the valuation is finished, talks start. Terms, including the purchase price, payment
schedule, and any conditions or contingencies, are negotiated by the acquiring and target
companies.
Determining whether the transaction will be an all-cash deal, a stock swap, or a combination
of the two may be the subject of negotiations.

Documentation and Legal Agreements

Legal teams draft and review all legal documents, including confidentiality agreements,
regulatory filings, and acquisition agreements. At this point, it is made sure that everyone is
on the same page regarding the terms and conditions of the purchase.
The terms of the transaction, such as the purchase price, closing requirements, representations
and warranties, and any indemnity clauses, are described in an acquisition agreement.

Regulatory Approval
Depending on the industry and geographical location, regulatory approvals may be required.
This stage involves submitting necessary documentation to relevant regulatory bodies and
obtaining their approval.
In the financial sector, acquisitions often require approval from regulatory bodies such as the
Securities and Exchange Commission (SEC) or other financial market authorities.

Closing the Deal

Once all conditions are met, and approvals are obtained, the deal is closed. This involves the
transfer of ownership, payment of the agreed-upon purchase price, and the fulfillment of any
remaining obligations outlined in the acquisition agreement.
On the closing day, the acquiring company may wire the funds to the sellers, and the legal
transfer of assets and control takes place.

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Integration
Following the acquisition, the emphasis turns to combining the two businesses' systems,
cultures, and operations. A seamless transition and the realization of synergies depend on this
phase.
To create a cohesive and effective organization, integration efforts may involve integrating IT
systems, resolving organizational and cultural differences, and aligning business processes.
These phases offer a well-organized structure for handling the intricacies of a majority
acquisition deal. Every step calls for considerable thought and knowledge in a number of
fields, such as finance, law, and strategic management.

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 4. Profitability, solidarity and solvency, and liquidity
Since solvency, liquidity, and profitability are interdependent, a all-inclusive analysis takes
these relationships into account. Maintaining a company's long-term financial stability and
prosperity requires finding the correct balance. Stakeholders are better able to comprehend
these relationships and make wise decisions when financial statements are thoroughly
analyzed.

Profitability
The ability of a business to turn a profit relative to its outlays and other costs over a given
time frame is referred to as profitability. It is a crucial indicator of a company's effectiveness
and ability to make a profit on its investments. Ratios that measure profitability, like net
profit margin, return on equity, and return on assets, provide information about a company's
performance and financial health. In general, higher profitability ratios signify superior
financial performance and efficacious management.

Solidity and Solvency

Solidity and solvency are related but distinct concepts.
• Solidity: Solidity refers to the financial strength of a company in terms of its equity or
net worth. It reflects the proportion of a company's total assets financed by equity
capital. A solid financial position implies that a significant portion of the company's
assets is funded by equity, which provides a cushion against financial risks.
• Solvency: Solvency, on the other hand, is the ability of a company to meet its long-
term obligations and liabilities. It assesses whether a company has enough assets to
cover its long-term debts. Solvency ratios, like the debt-to-equity ratio and interest
coverage ratio, help evaluate a company's long-term financial viability.

Liquidity
Liquidity refers to a company's ability to convert its assets into cash quickly without
significant loss of value. It is crucial for meeting short-term obligations and ensuring the
smooth operation of day-to-day activities. Liquidity ratios, such as the current ratio and quick
ratio, help assess the short-term financial health of a company. Maintaining adequate liquidity
is essential to cover short-term liabilities and unexpected expenses.

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The importance of liquidity, solidarity, solvency, and profitability
Examining a company's profitability, solidity, solvency, and liquidity all at once offers a
complete picture of its financial performance and state. Here's why each factor matters:

Comprehensive Evaluation: Every facet (profitability, solidity, solvency, and liquidity) offers
distinct perspectives on various facets of a business's financial state. Analysts can get a more
comprehensive picture of the company's overall financial situation by taking them all into
account.

Handling Risk: Finding a company's potential long-term financial risks can be aided by
evaluating its solvency and solidity. On the other hand, short-term risks are addressed by
liquidity analysis. Effective risk management requires an understanding of financial risks
over the long term as well as the short term.

Operational Resilience: Financial metrics show how well a business is doing in terms of
Profitability and liquidity need a delicate balance; excessive focus on one may compromise
the other. High profitability can contribute to long-term solvency, but excessive debt for
short-term profits can pose solvency risks. Adequate liquidity is a prerequisite for
maintaining both short-term stability and long-term solvency.

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References
Nor Farizal Mohammed, N. A. (2022). Comparison of Liquidity, Solvency, and Profitability
Analyses Using Traditional and Cash Flow Ratios on the MSWG’s Top 100
Companies. International Journal of Business and Management Science.
Pamela P Peterson, F. J. (2003). Financial Management and analysis. New Jersey: John
Wiley & Sons, Inc.
Penman, S. H. (2013). Financial Statement Analysis and Security Valuation. new york:
TheMcGraw·Hill Companie.
Robert E Hall, M. L. (2012). Microeconomics: Principles and applications. Cengage
Learning.
VOJISLAV MAKSIMOVIC, A. S. (1999). Capital Structure, Information Acquisition and
Investment Decisions in an Industry Framework. European Finance Review , 251–
271.

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