Financial Analysis Methods Overview

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Questions and Answers

Match the financial concepts with their descriptions:

Dividends = Cash paid to shareholders from profits Debentures = Long-term securities yielding a fixed rate of interest Liquidity = Ability of a firm to meet its short-term obligations Flexible Budgets = Budgets that adjust based on varying levels of output

Match the financial impacts with their consequences:

Issuing bonus shares = No cash outflow from the company Declining liquidity = Potential difficulty in meeting obligations Higher interest payments on debentures = Increased long-term financial burden Disclosure of discontinued activities = Helps in accurately predicting future performance

Match the ratios with their definitions:

Current ratio = Measures a company's ability to cover short-term liabilities Acid test ratio = Assesses immediate short-term liquidity without inventory Dividend yield = Annual dividends per share relative to the share's market price Debt-to-equity ratio = Indicates the proportion of company financing from debt

Match the financing sources with their characteristics:

Bank loans = May require collateral and can have strict credit requirements Debentures = Generally issued at a lower interest rate if credit conditions are favorable Bonus shares = Can increase shares outstanding without cash outflow Final dividends = Provide a return to shareholders while maintaining equity control Signup and view all the answers

Match the factors that affect liquidity with their outcomes:

High dividend payouts = Can reduce available cash for operations Issuing new shares = Improves cash liquidity Debenture repayments = Worsens cash flow due to interest obligations Recent profits = Have a positive effect on liquidity levels Signup and view all the answers

Match the advantages and disadvantages of flexible budgets:

Advantage of flexible budgets = Allows for comparison at different output levels Disadvantage of flexible budgets = Requires significant preparation time Advantage of variances in flexible budgets = More meaningful insights into performance Disadvantage of estimates = May result in misleading management decisions Signup and view all the answers

Match the implications of dividend policies:

Final dividends = Do not dilate control of existing shareholder equity Issuing bonus shares = Can lead to a reduction in share price due to oversupply Good dividend yield = Usually results in an increase in share price Dividend per share = Influences the attractiveness of the company to investors Signup and view all the answers

Match each financial performance evaluation with its description:

Healthy levels of cash = Indicates good liquidity and financial stability Current ratio of x:1 = Measurement of firm's current assets vs. liabilities Acid test ratio of x:1 = Provide insight into liquidity without relying on inventory Worsening liquidity = Due to increased bank loans and dividends paid Signup and view all the answers

Match the following financial terms with their definitions:

Limiting factor = A factor of production which restricts the level of activity or quantity of output Provision = Provision is a liability of uncertain timing or amount Net present value = Takes into account the time value of money thus inflation is accounted for Payback method = Simple to calculate and easy to understand, hence preferred by managers and non-accountants Signup and view all the answers

Match the following methods with their pros and cons:

Average rate of return = Focuses on profit, often a firm’s primary objectives Internal rate of return = Takes into account the time value of money, hence inflation is taken into account Profitability index = Allows for the comparison of returns of different projects Decrease in inventories = Less cost of storing large amounts of inventory Signup and view all the answers

Match the following share actions with their explanations:

Purchase of shares in another company = They expect share price to increase in the future and profits may be made Issue additional shares = Raise capital Pay premium on redemption of shares = Write off preliminary expenses on formation of company Write off preliminary expenses = Reduce gearing ratio Signup and view all the answers

Match the following budgeting steps with their descriptions:

Consult with department = Receive feedback and determine realistic figures Produce a master budget = A budgeted statement of comprehensive income Identification of limiting factors = Determine other budgets such as production budget Feedback incorporation = Consult with the production department head to see if budgeted level is achievable Signup and view all the answers

Match the following goodwill factors with their explanations:

Annual profits = Calculated where higher profits lead to higher goodwill Reputation = Better brand reputation equals higher goodwill Brand awareness = Higher awareness can enhance goodwill valuation Customer loyalty = Strong loyalty can positively influence perceived goodwill Signup and view all the answers

Match the following inventory costing methods with their characteristics:

Marginal costing = Costs allocated to a time period Absorptional costing = Sees costs allocated to products Prudence concept = Often shows lower figures for closing inventory Matching concept = Matches costs with revenues earned for a specific product Signup and view all the answers

Match the following record card features with their benefits or drawbacks:

Pro of record card = Clearly shows receipts, issues, and running balance Con of record card = Only shows issues and not how much inventory is used Running balance indication = Indicates clearly when inventory is low Up-to-date records = Less variances calculations will be wrong Signup and view all the answers

Match the following decisions regarding trade payables with their pros and cons:

Decrease in trade payables = Credit rating/trust to supplier may be improved Less liquidity = Firm has less liquidity to spend in other areas Improved credit acquisition = May be easier to acquire more credits in the future Narrower inventory range = May result in failure to meet larger orders Signup and view all the answers

Match the following investment appraisal methods with their features:

Net present value = May be difficult to set cost of capital Payback method = Does not account for profits after payback period Average rate of return = Does not take into account the time value of money Internal rate of return = Complicated and may not be easily understood Signup and view all the answers

Match the uses of Share Premium Account with their purposes:

Bonus shares = Issue of bonus shares Premium payment = Pay premium on redemption of shares Preliminary expenses = Write off preliminary expenses on formation of company Raising additional funds = Utilized for funding new projects Signup and view all the answers

Match the following aspects of ICT with their pros and cons:

Pro: Reduces need for costly accountant = Con: Expensive hardware may be required Pro: Keeps financial records orderly = Con: Software requires constant updates Pro: Reduces workload = Con: Understanding ICT may be difficult Pro: Automatic calculations = Con: Computer crashes may lead to data loss Signup and view all the answers

Match the budget evaluation points with their advantages and disadvantages:

Accurate forecasting of labour rates = Forecasting may not be accurate Coordination of departments for smooth operation = Some costs are out of management control Variances can be analyzed = Some figures are always constant, making budgeting pointless Insight into costs impacting profits = Budgets may not consider unexpected variables Signup and view all the answers

Match the project evaluation metrics with their descriptions:

Net Present Value = Indicates project profitability ARR = Comparison with cost of capital Payback Period = Time until investment is recovered Gearing Ratio = Measure of financial risk based on debt Signup and view all the answers

Match the auditor roles with their responsibilities:

Leadership = Evaluate division of responsibilities Effectiveness = Check regular intervals for board re-election Accountability = Assess risk management during mergers Relations with shareholders = Ensure shareholders are informed about meetings Signup and view all the answers

Match the redemption of shares evaluation points with their outcomes:

Improves ROCE = May deter future investments Reduces future dividends = Worsens liquidity May enhance profitability = Increases gearing ratio Appeals to investors = Potential negative impacts on shares Signup and view all the answers

Match the implications of purchasing on credit with their effects:

Increases sales = Irrecoverable debts may arise Expands customer base = Insurance for non-payment may be costly Enhances market share = Court cases can be lengthy Strengthens cash flow = May lead to bad debt expenses Signup and view all the answers

Match the merger evaluation points with their potential outcomes:

Allows for diversification = May dilute ownership if shares are used Benefits from economies of scale = Cash payments may worsen liquidity Increases potential profits = Goodwill may be overvalued Strengthens market position = Integration may lead to conflict Signup and view all the answers

Match the strategies to improve Earnings Per Share (EPS) with their descriptions:

Increase net profit = Directly enhances earnings Reduce loan interest payments = Improves overall cash flow Move to lower tax locations = Lowers tax liabilities Decrease number of ordinary shares = Distributes earnings among fewer shares Signup and view all the answers

Match the considerations in evaluating the gearing ratio:

Use of debt can be beneficial = Higher interest costs can cut profits Risk of debt failure = Potential collateral loss Impact on share prices with unpaid dividends = May indicate financial health Need for reliable financing sources = Highly geared companies face capital raising challenges Signup and view all the answers

Match the advantages of dividend payments with their effects:

Keeps shareholders satisfied = Important with recent share issues Provides financial stability = Crucial in maintaining investor relations Maintains company credibility = Helps sustain stock prices Reflects company profitability = Reassures future investments Signup and view all the answers

Match the labour variance types with their indicators:

Labour efficiency variance = Measures productivity changes Labour rate variance = Tracks wage changes Material usage variance = Examines raw material consumption Material price variance = Assesses costs of raw materials Signup and view all the answers

Match the auditor’s key roles with their main focus:

Leadership = Guidance on corporate governance Effectiveness = Assessment of board practices Accountability = Examination of financial integrity Remuneration = Review of compensation structures Signup and view all the answers

Match the project appraisal metrics with their evaluations:

Net Present Value = Finds profitability over time ARR = Evaluates average return Payback Period = Identifies recovery timeframe Profitability Index = Compares investment returns with costs Signup and view all the answers

Match the operational advantages of ICT with their effects:

Automated reporting = Improves record accuracy Streamlined processes = Reduces human error Data security improvement = Minimizes loss instances Time savings on tasks = Increases overall efficiency Signup and view all the answers

Match the financial evaluation tools with their applications:

Variance analysis = Examines budget variances Forecasting models = Predict future performance Financial ratio analysis = Assesses company health Cost-benefit analysis = Supports decision-making Signup and view all the answers

Study Notes

Limiting Factor Definition

A limiting factor restricts the level of activity or output.

Provision Definition

Provision is a liability with uncertain timing or amount.

Net Present Value (NPV)

Pros:
- Considers the time value of money, accounting for inflation.
Cons:
- Cost of capital estimation can be challenging and subjective, potentially leading to inaccuracies.

Payback Method

Pros:
- Straightforward calculation; easy to understand and use, making it manager-friendly.
Cons:
- Ignores profits beyond the payback period.

Average Rate of Return (ARR)

Pros:
- Focuses on profit, a key objective for many firms.
Cons:
- Doesn't account for the time value of money, thus neglecting inflation.

Internal Rate of Return (IRR)

Pros:
- Accounts for the time value of money, considering inflation.
Cons:
- Complex calculation, potentially less intuitive for non-financial professionals.

Profitability Index

Pros:
- Enables the comparison of different projects, even when their sizes vary.

Decrease in Inventories

Pros:
- Lower storage costs (warehouse, security).
Cons:
- Potentially limits order fulfillment ability.

Decrease in Trade Payables

Pros:
- Potentially improved credit rating with suppliers, leading to easier future credit access.
Cons:
- Reduced liquidity for other business activities.

Purchase of Shares in Another Company

Reasons:
- Anticipated increase in the share price for future profit.
- Potential for increased control over other companies, especially suppliers.

Issuing Additional Shares

Reason:
- Raises capital.
- Reduces the gearing ratio.

Budget Preparation Process

Steps:
- Identify limiting factors affecting other budgets (like production).
- Consult relevant departments for realistic figures.
- Prepare a master budget (budgeted income statement).

Goodwill Factors

Goodwill calculation depends on annual profits; higher profits typically imply higher goodwill (e.g., goodwill might be 3 times annual profit).
Firm reputation and brand awareness also influence goodwill (stronger brand = higher goodwill).

Marginal vs. Absorption Costing

Marginal Costing:*
Pros:
- Cost allocation ties to a specific period, potentially resulting in a more accurate profit measure for that period. Often reflects the prudence concept for lower closing inventory figures.
Cons:
- N/A
Absorption Costing:*
Pros:
- Cost allocation ties to products, aiding management in assessing product profitability. Reflects the matching concept, by aligning costs with revenues for a specific product.
Cons:
- N/A

Record Card (Inventory Management)

Pros:
- Clearly shows receipts, issues, and balances, potentially reducing theft.
- Running balance assists in identifying low stock and enabling timely reordering.
Cons:
- Doesn't directly show inventory use by production, only issues. Requires constant updating for accurate calculations.

Uses:
- Issuing bonus shares.
- Paying premiums during share redemptions.
- Writing off preliminary expenses related to company formation.

Using ICT in Business (General)

Financial:
- Pros: Streamlines recording, potentially reducing accountant costs for annual reports.
- Cons: High initial and ongoing costs for hardware, software, updates, training, and maintenance.
Technical:
- Pros: Improves record-keeping, reduces errors, automates financial statements generation.
- Cons: May not be essential for small bookkeeping volumes; potential for data loss through technical problems.
Human:
- Pros: Might reduce workload and provide a more efficient financial structure.
- Cons: Implementing ICT may be initially challenging; smaller businesses might face disproportionately high costs relative to revenue.

Budget Evaluation

Pros:
- Useful forecasting tool for informed planning.
- Aids in identifying variances for effective corrective actions.
- Encourages inter-departmental coordination.
Cons:
- Forecasting inherent uncertainties.
- Some costs outside management control.
- Fixed costs (e.g., rent) may be a wasted effort for budgets that don't change significantly.

Project Appraisal Evaluation

Factors to consider:
- NPV (positive or negative).
- ARR relative to the cost of capital (discount factor).
- Payback period matching projected lifespan.
- Gearing ratio (near or under 50%).
- Profitability index (above or below 1).
- Potential for inaccuracies in figures and estimations.

Standard Costing Evaluation

Analyzing variances: Compare standard costs with actual costs to identify discrepancies in labor efficiency, labor rate, material usage, and material price.

Auditor Role Evaluation

Key roles:
- Leadership: Assesses responsibility divisions (e.g., CEO as chairman).
- Effectiveness: Reviews board member re-election processes.
- Accountability: Evaluates risk management strategies.
- Remuneration: Examines potential conflicts of interest in compensation structures.
- Relations with shareholders: Assesses shareholder communication practices.

Pros:
- Potential improvement in Return on Capital Employed (ROCE).
- May decrease future dividend payments.
Cons:
- Worsens gearing ratio. Concerns for future investment.
- Potential effect on company liquidity.

Credit Purchases Evaluation

Pros:
- Potential boost in sales.
- Expansions in customer base and market share.
Cons:
- Risk of uncollectible debts resulting in costly litigation.
- High insurance costs.

Merger Evaluation

Pros:
- Potential diversification and expansion.
- Possibility of economies of scale.
- Increased profitability.
- Goodwill implications
Cons:
- Potential dilution in ownership.
- Potential decrease in liquidity when paid in cash

Methods:
- Increase net profit.
- Reduce interest expense.
- Reduce taxes.
- Reduce number of outstanding shares.

Gearing Ratio Evaluation

Advantages of debt:
- Possible benefits assessed.
Disadvantages of high debt:
- Higher debt loads mean lower profit levels due to interest expenses.
- Loss prevention and mitigation strategies.
- Difficulty in procuring additional funds if highly geared.
- Potential liquidity challenges.

Dividend Payments Evaluation

Pros:
- May improve shareholder satisfaction.
- Potentially positive impacts on share price.
Cons:
- Reduced liquidity; funds unavailable for other investments.

Debentures Evaluation

Pros:
- Potentially lower interest rates than bank loans.
- Often an option for firms with limited borrowing opportunities.
Cons:
- Collateral requirements.
- Regular payment scheduling versus other finance options.

Liquidity Performance Evaluation

Key measures/analysis:
- Cash and cash equivalents levels.
- Current ratio and acid-test ratio values.
- Trend analysis of liquidity.
- Factors influencing liquidity (e.g., loan repayment, share issues, profits).

Disclosure of Discontinued Activities Evaluation

Pros:
- Helps readers in assessing future performance and making better projections.
- Presents a true and fair picture of the business.
Cons:
- Adding complexity to financial statements.
- Increased time and cost burdens for reporting.

Flexible Budgets Evaluation

Pros:
- Aids in decision-making in various scenarios.
- Efficient use of resources by identifying adverse variances and management action points.
- Enables accurate predictions for different sales levels, avoiding limitations of a fixed budget.
Cons:
- Significant time and effort required in development.
- Use of estimations, possibly leading to inaccurate calculations.

Bonus Shares vs. Final Dividends

Bonus Shares: No cash outflow, but may negatively impact share price (supply increase).
Final Dividends: Cash outflow, potentially improving share price, but less dilution of current share control.

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Description

Explore various financial analysis methods including Net Present Value, Payback Method, Average Rate of Return, and Internal Rate of Return. This quiz will test your understanding of the advantages and disadvantages of each method. Ideal for students in finance or business courses.