Financial Statement Analysis Techniques

This assignment delves into the world of financial statement analysis, exploring various techniques used to evaluate a company's performance and financial health. It covers key concepts like ratio analysis, liquidity assessment, and investment appraisal methods such as Net Present Value (NPV) calculations. The provided sources offer insights into different applications of these techniques across diverse industries, including housing regeneration, State Universities, agriculture, and renewable energy.

ACCOUNTING AND FINANCE FOR
MANAGERS

Table of Contents
INTRODUCTION......................................................................................................................3
TASK 1 COMPARATIVE RATIO ANALYSIS.......................................................................3
Non-financial ratios.............................................................................................................12
Recommendations...............................................................................................................12
Limitations of ratio analysis................................................................................................13
TASK 2 Project evaluation techniques...................................................................................14
Net cash flow.......................................................................................................................14
Pay back period (PP)...........................................................................................................15
Project Net Present Value....................................................................................................15
Interpretation:......................................................................................................................16
Project Accounting rate of return........................................................................................16
Limitations of investment appraisal techniques..................................................................16
CONCLUSION........................................................................................................................17
REFERENCES.........................................................................................................................17

INTRODUCTION
Finance is a crucial elements for all the business functions because no one can survive
without having appropriate quantity of funds. In the present project report, two global
companies Next Plc and Hennes & Mauritz's financial performance will be analysed through
ratio analysis. Worst performing company will be recommended through such evaluation and
well performing business will be selected by Asol Ltd for investment purpose. At the end,
two capital projects available to Hilltop Ltd, should be evaluated through project evaluation
techniques. So that, best proposal can be identified which will be more viable and provide
more benefits.
TASK 1 COMPARATIVE RATIO ANALYSIS
Financial strength:
Liquidity refers to the ability to satisfy all the short-term business liability such as
accounts payables. Current ratio and quick ratio are two of the most important ratios that
helps to determine that how much companies are able to discharge their short-term
obligations effectively and efficiently (Chaney, 2013). It has been selected to test the short-
term payment ability. Suppliers who provide credit to the business mainly use this ratios to
assess credit worthiness and secure their funds.
Current ratio (CR):
In Next Plc, the ratio is increasing consistently and comes to 1.82 in 2015 while, in
H&M, it has been reduced to 2.11. Rising trend indicates that Next Plc increased its current
assets nearest to the idle industrial ratio which is 2:1. So that, firm will have enough resources
to meet their current liabilities effectively and timely. On contrary, H&M's CR is greater
than idle level but still, declined trend indicates that in future, it may goes beyond the
acceptable level and impact liquidity position adversely.

Column chart:
Bar chart:
Quick ratio:
This ratio has been selected to determine ability in absence of inventory. Next Plc
ratios has been improved from 0.72 to 1.16 whereas H&M has declined ratio to 1.07. The
ratio is higher in Next Plc indicates high liquidity position as compare to H&M. But still, it
must be kept in mind that consistently increase in ratio also is a sign of inefficient uses hence,
2010 2011 2012 2013 2014 2015
0
0.5
1
1.5
2
2.5
3
3.5
0
1.28
1.54 1.48
1.76 1.82
2.96
2.71 2.66
2.25 2.11
0
2010
2011
2012
2013
2014
2015
0 0.5 1 1.5 2 2.5 3 3.5
0
1.28
1.54
1.48
1.76
1.82
2.96
2.71
2.66
2.25
2.11
0

it can arise short-term financing problems due to lack of funds (Shi, 2015). Therefore, it can
be said that liquidity position of Next Plc is much better than H&M so, it must be advised
that Asol Ltd, should buy shares in Next Plc.
Column chart:
Bar chart:
Efficiency ratios:
Assets turnover ratios: This ratio measure the manager's ability to utilize company's
assets so as to drive profitability in the business (Healy and Palepu, 2012).
2010 2011 2012 2013 2014 2015
0
0.5
1
1.5
2
2.5
0
0.72
0.91 0.97
1.18 1.16
2.06
1.69
1.49
1.22
1.07
0
2010
2011
2012
2013
2014
2015
0 0.5 1 1.5 2 2.5
0
0.72
0.91
0.97
1.18
1.16
2.06
1.69
1.49
1.22
1.07
0

The ratio has been selected to reflect that which firm is using its assets more
efficiently. In Next Plc, assets turnover ratio has been declined from 1.89 to 1.81 by 0.08.
However, in H&M, it has been improved from 1.91 to 2.14 which is good as high ratio tells
that firm is using assets more effectively and efficiently.
Column chart:
Bar chart:
2010 2011 2012 2013 2014 2015
0
0.5
1
1.5
2
2.5
0
1.89 1.89 1.89 1.85 1.81
1.91 1.84
2.01 2.04 2.14
0
2010
2011
2012
2013
2014
2015
0 0.5 1 1.5 2 2.5
0
1.89
1.89
1.89
1.85
1.81
1.91
1.84
2.01
2.04
2.14
0

Inventory turnover ratio: It indicates the time period in which inventory can be sold
out in the market place. This ratio has been chosen to determine the inventory using
efficiency of both the companies (Schroeder, Clark and Cathey, 2013). High ratio is a good
sign as indicates high efficiency and vice-versa.
In both the business, ratio have been fallen to 6.62 and 3.46 respectively which
exhibits that both the using stock at declined rate. But still, in Next Plc, it is 6.62 entails that
managers are quickly converting goods into sales whilst in H&M, movement of stock into
sales is slow. Hence, it can be said that stock using efficiency in Next Plc is much better than
H&M. Quickly movement of stock helps to enlarge sales revenues and cash flow as well. So
that, Next Plc will not face operational difficulties due to lack of sufficient cash sources.
While, in H&M, cash is blocked into closing inventory bring a possibility of arising cash
problems in future period.
Column chart:
Bar chart:
2010 2011 2012 2013 2014 2015
0
1
2
3
4
5
6
7
8
0
6.89 6.47
6.91 6.97 6.62
3.7 3.47 3.37 3.29 3.46
0

Inventory days: This ratio reflects the time period in which inventory converted into
sales.
It is lower in Next Plc as it takes only 55 days to sale its stock into market while
H&M takes 106 days to sell inventory. It is better in Next Plc because it lower the storage
cost and enhance profit. However, high ratio in H&M is a sign of inefficiency and high
storage cost. Hence, Asol Ltd, should invest in Next Plc.
Profitability ratios: All the business organizations have first objective to generate large
amount of profitability in the business. Profitability ratios enable analysts to evaluate
performance of both the companies and determine well performing organization in which
funds can be invested (Ligan, de Guzman and Lopez, 2015). The ratio has been selected to
identify that which of the among two companies generated large return through its sales and
other business operations.
Gross profit ratio (GM): It indicates the proportion of gross profits on total sales
revenues. High mark-up percentage helps to generate large GM and vice versa (Norsworthy
and Oliver, 2001). The ratio helps to determine that which firm gathered large revenues
through its sales operations.
2010
2011
2012
2013
2014
2015
0 1 2 3 4 5 6 7 8
0
6.89
6.47
6.91
6.97
6.62
3.7
3.47
3.37
3.29
3.46
0

In Next Plc, the ratio has been increased from 29.27% to 33.59% whereas in H&M, it
is consistently declining. It indicates that Next Plc enhanced its revenues and established an
effective control over direct expenditure resulted in higher GM. However, in H&M, declined
ratio is a sign of adverse business performance which is not good. Lower turnover and higher
direct expenses because of high transportation expense, fuel costs and high supplier's prices
are some of the reasons behind declined GM. Thus, it can be said that Asol Ltd, should invest
funds in Next Plc.
Column graph:
Bar graph:
2010 2011 2012 2013 2014 2015
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0
29.27% 30.38% 31.48% 33.16% 33.59%
62.93% 60.13% 59.50% 59.13% 58.81%
0

Net margin (NM): It has been chosen to determine net return after paying all the
direct as well as indirect expenses.
In Next Plc, ratio has been improved by 3.94 and reached at 15.87 which is good
whereas in H&M, it has been reduced to 13.19. High growth in sales and control over both
the direct and indirect business expenses are the reasons for higher return. Hence, it can be
said that Next Plc is well performing organization as compare to H&M.
Column graph:
2010 2011 2012 2013 2014 2015
0
2
4
6
8
10
12
14
16
18
20
0
11.93 12.62
14.34 14.79
15.87
17.22
14.38 13.96 13.3 13.19
0
2010
2011
2012
2013
2014
2015
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
0
29.27%
30.38%
31.48%
33.16%
33.59%
62.93%
60.13%
59.50%
59.13%
58.81%
0

Bar graph:
Manager's effectiveness:
ROE: It tells about the return on total equity capital invested in the business, used by
investors to determine their future earnings.
Next Plc's ROE is 208.75% while in H&M, it is only 44.07% indicates that Next Plc
is providing more return to the equity investors. Lower profitability return and having only
the equity capital are the reasons for lower ROE. Henceforth, it can be said that Asol Lts,
should buy shares in Next Plc.
Valuation ratios:
FCF/Share: The ratio has been selected to assess shareholder's earning per share. Free
cash flow are the actual cash flows that are earning by the businesses (Chu and Liu, 2016). It
does not consider all the non-cash related transactions such as depreciation.
2010
2011
2012
2013
2014
2015
0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2
0
11.93%
12.62%
14.34%
14.79%
15.87%
17.22%
14.38%
13.96%
13.30%
13.19%
0

Next Plc's FCF to share has been reduced increased from 1.83 to 4.14 whereas in
H&M, it has been reduced from 0.93 to 0.76 respectively. Hence, it is much better in Next
Plc as indicates that large amount of cash flow is available for each share.
OCF/Share: The ratio has been selected to determine that which company generated
more cash flows for each share through its operating functions. In Next Plc, ratio has been
improved from 2.49 to 4.85 whereas in H&M, it is only 1.25. Hence, it can be said that Next
Plc generated larger cash flows for each share.
Non-financial ratios
Next Plc
H & M
Next Plc's staff turnover ratio has been increased from 0.16 to 0.21 because its total
staff has been increased from 44287 to 47562 and Absenteeism increased from 7300 to 9855.
However, in H&M, employee turnover has been improved from 0.17 to 0.22, staff increased
from 47524 to 55430 and absenteeism is significantly enhanced from 8030 to 12045 which is
not good. Liberal HR policies may be the reasons for adverse employee's turnover in H&M.
Hence, it becomes clear that NFP of Next Plc is much better than H&M.
Decision
By, considering all the financial as well as non-financial aspects, it can be concluded
that Asol Ltd, should acquire shares in Next Plc because it is performing well.
Recommendations
 H&M should enlarge its revenues through discount offerings and implement an
effective cost controlling strategy so that company can get high profitability and
improve potential performance. Moreover, warranties schemes can also be offered
helps to retain its existing customer and increase customer loyalty. Through enlarging

profitability, H&M will be able to enhance its ROE and potential operational
performance.
 Working capital management strategies through prompt receipts and delayed
payments helps to avail better cash availability and resulted in improve liquidity
position. So that, firm will not face cash flow problems in future and enhance its
FCF/share.
 H&M should be advised to use stock efficiently so that H&M can enhance its stock
turnover ratio and reduce inventory days as well. It helps to have better cash surplus
available to support daily business operations.
Limitations of ratio analysis
 It is based on the historical trading affairs reported in the financial statements. Hence,
can not be useful to assess future performance.
 Inaccurate or misleading information may prone to take harmful decision because of
wrong interpretation.
 It only analyse quantitative information not the qualitative such as employees
turnover, customer satisfaction, new product development and competitive strength as
well (John, 2012).
 Sometimes, it is not possible to achieve standard CR of 2:1 hence, in this case, it can
not be said that business is performing worst because of prevailing market conditions.
 Ratio's interpretation is very difficult. In the given scenario, Next Plc's profitability
ratio is increasing but still, it is lower than declined ratio of H&M. In this case, it is
quite difficult to decide that whose company is performing well.
 Ratio do not take into consideration the market changes such as inflation rate, interest
rate and other which have an huge impact on revenues and profitability as well (Ratio
analysis: application, Limitations and Dangers-A perspective, n.d.). Thus, ratio
analysis will not provide assistance to evaluate the volatility in market environment
and its impact on business performance.
 Accounting principles, concept, conventions and policies are the guidelines used to
record business affairs in the financial statements which may be vary in Next Plc and
H&M. Thus, in this case, comparison may not provide meaningful results and harmful
decisions can be made.

TASK 2 PROJECT EVALUATION TECHNIQUES
This techniques provide great assistance to finance manager to determine most viable
project through which return can be maximized in a great extent.
Net cash flow
NCF is the surplus or deficit of difference between total cash inflow and cash outflow
without considering the non-cash affecting transactions.
Formula for depreciation computation = Initial investment – scrap value/Estimated useful life
Particulars Calculation Answer
Depreciation (1st Machine) (£120000 - £21000/3 years) £33000
Depreciation (2nd Machine) (£50000/5 years) £10000
NCF for the project A
Year 2016 2017 2018 2019 2020 2021 Total
Net profit for the
year
40000 40000 40000 30000 30000 20000 200000
Depreciation 33000 33000 33000 10000 10000 10000
Cash inflow through
machinery sale
21000
Cash outflow from
machinery purchases
-50000
NCF 73000 73000 44000 40000 40000 30000 300000
Particulars Calculation Answer
Depreciation (£120000 /6 years) £20000
NCF for the project B
Year Profits Depreciation NCF

2016 10000 20000 30000
2017 20000 20000 40000
2018 30000 20000 50000
2019 60000 20000 80000
2020 700000 20000 90000
2021 55000 20000 75000
Total 245000 365000
Pay back period (PP)
It indicates the time lag in which Hilltop Ltd, will recover its project costs over its
estimated project life (Higham, Fortune and Boothman, 2016).
Year Project A Cumulative cash flow
(CCF)
Project B Cumulative cash flows
(CCF)
2016 73 73 30 30
2017 73 146 40 70
2018 44 190 50 120
2019 40 230 80 200
2020 40 270 90 290
2021 30 300 75 365
Pay back period of project A = 1 year + (£120000-£73000)/(£73000) = 1.64 years
Pay-back period of project B = 3 year as CCF = project cost
Interpretation:
PP is shorter in project A to 1.64 year while in project B, it is 3 year. Hence, it must
be recommended that Hilltop senior manager should invest funds in project A as it will
recover its project cost earlier.
Project Net Present Value
It indicates the actual project return by subtracting total discounted values from the
initial project investment (Petkovic and et.al., 2016). This method is considered more
superior than others because it provides more realistic results by taken into consideration the
future values of cash flows.

Year Project A
Disounted
factor @20%
Discounted
cash flow Project B
Discounted
cash flows
2016 73000 0.833 60809 30000 24990
2017 73000 0.694 50662 40000 27760
2018 44000 0.579 25476 50000 28950
2019 40000 0.482 19280 80000 38560
2020 40000 0.402 16080 90000 36180
2021 30000 0.335 10050 75000 25125
Total 182357 365000 181565
Less: Project
investment 120000 120000
NPV 62357 61565
Interpretation:
Project A has NPV worth £62357 whereas in project B, it is comparatively lower to
£61565. It indicates high possibility of return in project A so, it can be recommended that
Hilltop Ltd, should select project A and invest funds worth £120000.
Project Accounting rate of return
Accounting rate of reurn (ARR) indicates the potential profitability return on initial
cash outlay (Oral, 2016).
Project A Project B
Initial investment 120000 120000
1 40000 10000
2 40000 20000
3 40000 30000
4 30000 60000
5 30000 700000

6 20000 55000
Total profit 200000 245000
Average profit 33333.33 40833.33
ARR 27.78% 34.03%
Interpretation:
ARR is higher in project B indicates that if Hilltop Ltd, intends to desire high profit
return and does not consider cash flows, than project B will be more viable. It is because this
project will generate ARR of 34.03% which is greater than those of project A to 27.78%.
Recommendation
By, considering all the results, it can be said that project A seems to be more
beneficial as it reover its project cost earlier and also provide higher NPV worth £62357.
Therefore, senior managers of Hilltop Ltd, should invest funds worth £120000 in project A.
Limitations of investment appraisal techniques
Pay-back period: Ignoring project return and the time value of money are the
limitation of PP. However, in the present age, market is full of uncertainties henceforth, it can
dramatically changes forecasted cash flows (Schönbohm and Zahn, 2016). As a result, it can
not be said that project will recover its initial costs exactly in the identified time period.
ARR: It takes into consideration the accounting profits not the cash flows. However,
profitability provides manipulative results through taken into consideration all the non-cash
based transactions. Thus, decisions taken on the basis of ARR can proven to be harmful. Due
to this limitation, Hilltop Ltd, has not been advised on the basis of ARR. Another limitation is
it also ignore time value of money and does not determine future values of accounting profits.
NPV: As already said, this method is comparatively better than others, But still,
discounting rate use to predict future values is uncertain because of changing market
behaviour. Volatility in inflation rate, interest rate and political instability are some of the
factors that may change discount rate (Turner, 2016). Henceforth, using a standard rate of
cost of capital over project's useful life can not be relevant and prone to take inaccurate
decisions.

CONCLUSION
In conclusion, it can be said that Next Plc is performing much better so Asol Ltd,
should purchase share in this company. The reasons is this company is financially sound and
earned good return through its sales operation. Thus, as an investor, Asol ltd, can earn greater
return in this organization. Last part concluded that Hilltop ltd, should consider project A as it
will be more viable and provide greater return in future.

REFERENCES
Books and Journals
Chaney, T., 2013. Liquidity constrained exporters (No. w19170). National Bureau of
Economic Research.
Chu, Y. and Liu, P., 2016. A Direct Test of the Free Cash Flow Hypothesis: Evidence from
Real Estate Transactions. The Journal of Real Estate Finance and Economics. pp. 1-
16.
Healy, P. and Palepu, K., 2012. Business Analysis Valuation: Using Financial Statements.
Cengage Learning.
Higham, A.P., Fortune, C. and Boothman, J.C., 2016. Sustainability and investment appraisal
for housing regeneration projects. Structural Survey. 34(2).
Ligan, D.C., de Guzman, A.B. and Lopez, E.J., 2015. Financial statement analysis of a select
group of State Universities and Colleges (SUCs) in the Philippines. The Asian
Journal of Educational Research and Synergy. 3(2).
Norsworthy, J.K. and Oliver, L.R., 2001. Effect of Seeding Rate of Drilled Glyphosate-
Resistant Soybean (Glycine max) on Seed Yield and Gross Profit Margin 1. Weed
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Oral, C., 2016. Analytical Hierarchy Process as a Tool for Investment Appraisal.
International Journal of Economics and Finance. 8(4). p. 306.
Petković, D. and et.al., 2016. Survey of the most influential parameters on the wind farm net
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analysis: text and cases. Wiley Global Education.
Shi, S., 2015. Liquidity, assets and business cycles. Journal of Monetary Economics. 70. pp.
116-132.
Turner, J.A., 2016. Net Operating Working Capital, Capital Budgeting, And Cash Budgets: A
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