Financial Analysis & Management

This document provides a comprehensive study material on financial analysis and management. It covers topics such as capital investment appraisal methods, accounting rate of return, payback period, internal rate of return, net present values, and more. The document also includes an illustration and analysis of different investment projects. It is suitable for students studying financial analysis and management in various courses and programs.

Financial Analysis &
Management

Table of Contents
1. INTRODUCTION.......................................................................................................................1
2. SD Ltd – A Small Company........................................................................................................1
3. Investment And Concept of Wealth Maximisation.....................................................................1
4. Capital Investment Appraisal Methods........................................................................................2
Accounting Rate of return......................................................................................................2
Pay back period......................................................................................................................4
Internal Rate of Return...........................................................................................................6
Net present values...................................................................................................................8
Profitability Index.................................................................................................................11
Risk and risk management in Investment appraisal.............................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

1. INTRODUCTION
The term of capital investment is a sum of money provided to a business to further its
business objectives. It is mainly related with the fixed assets that required to achieve the mission
and vision of business (Altman and et.al., 2017). It is defined as money invested into project to
analysis the profitability and money will be used to buy fixed assets in order to cover day to day
operating expenses of business. To conduct decision in context of company apply 5 famous
method of capital investment and take decision on basis of G120 and Z 125. In this report
consist of financial and non financial factors to take effective decision.
2. SD Ltd – A Small Company
SD limited wants to invest amount in a new machinery in which consist of automate
production and save the company a significant amount of money. At this stage a small
organisation can face challenges in regard of investment such as: Limited capital: It is not easy to moving a small business with limited capital because it
is the single largest factor which is analysing how much company can, can't to do meet
the requirements of the customer. Having limited fund create problem in investment and
according to that can decision for business.
 Cost of capital: The cost of capital of money utilise by business for financing procedure.
The small business SD Ltd use only current liabilities like supplier credit, long term debt
to finance and many others.
3. Investment And Concept of Wealth Maximisation
Concept of shareholder wealth maximization: This concept apply by the business for
maximum return to shareholders is and ought to be the objective of all corporate activity. As per
the financial management perspective require to enhance price of a firm's common stock. The
shareholder wealth maximization can set a particular criteria in which a business only focus on
the decisions that increase the market value of the share as well as wealth of shareholders
(Ashmarina, Zotova and Smolina, 2016).
Value of shareholders: The value of shareholders based on the reputation of an
organisation and according to that they are generating money. It is most important for the
management system due to have interest of shareholders in mine due to make effective decision.
The higher value of shareholders is better for the company as well as management. The value of
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Shareholders mainly depended on the strategic decision that taken by the board of management
where consist of capability of investment and generate a healthy return on invested capital.
4. Capital Investment Appraisal Methods
To invest into different project an organisation apply different types of capital investment
techniques with challenges, justification and application of theories.
Accounting Rate of return
Explanation: The accounting rate of return is defined that average of net income is
expected to generate by company that is classified into its average capital cost, presented an
annual percentage. In this method does not focus on the time value of money or cash flows
which is internal part of maintaining a business. It is important method of investment appraisal
techniques. The formula used for this method to make decision in regard of capital budgeting and
according to that select right project which is more beneficial for the company (Chen, Ong and
Hsu, 2016). These mainly consist of particular situation in which company decide to invest into
machine or not that is based on the future earning as compare with the capital cost. In the
context of SD Ltd apply this method to select one machine in order to invest and take effective
decision.
Illustration: To better understand of this method take a example
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As per the above example it is understanding that the Project A generate greater returns
as compare with Project B. With ARR method in Project a get return 10.34% while project B get
7.63%. So company must invest into Project A for higher returns.
18.00%
14.70%
Accounting Rate of Return
G120 Z125
As per the above chart it has been analysed that SD Ltd wants to invest into G 120 & Z
125. For this purpose calculated average rate of return of both projects and get results that
18.00% from G120 and 14.70% from Z125. To get higher returns company should invest into
G120 and increase profitability of the business.
Key Challenges: The company face many key challenges due to apply this method so
require to focus in this such as:
 This method does not consider on cash flow timing.
 It is linked with measurement instead of an absolute measure and it takes no account of
size of the investment (Cuthbertson, Nitzsche and O'Sullivan, 2016).
 This method does not focus on the value of money and ignore at the time of calculation.
As a result it take more time in strategic decision that become reason of loss opportunity.
 Many times it is not calculate right rate of return that impact on the management
decisions.
Recommendations:
 As per the above evaluation of both projects and challenges it is suggested that company
must focus on time to take further steps.
 It is advised that estimate amount in realistic amount basis otherwise company face huge
losses and fall down image.
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 The manger of company must understand the concept of profit and interpreted all the
results by experts after that company take appropriate decision in regard of investment.
Justification: As per the over all analysis it is justified that company should invest their
amount into G 125 in order to get higher rate of returns. It helps to SD Ltd into to build up good
image in the market and easily get finance from other companies to expend business activities at
large level. It is justified that this method is good but also try some other method where most
chances to get accurate results.
Pay back period
Explanation: This method involves the time taken for recovering the amount which has
been used as an investment. It shows the duration which reflects the break-even point. Every
business makes initial investment for staring the operations (Feng and Wang, 2016).
Furthermore, shorter period indicates attractive investments and longer tenure shows that
investment is not attractive enough. It is a method of capital budgeting which provides
information about the profitable project so that management can make the right decision. The
formula for the same is cost of investment divided by annual cash flow. In the context of SD Ltd
apply this method in order to get effective result and decide in which project company invest
amount to get effective returns in less period of time.
Illustration:
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As per the this example it is understanding that the company wants to invest into different
projects like A, B & C. In three projects have different cash flow and according to that company
get return in different period of time. So company should select Project B in order to early get
return from this project about 2.33 years. In this project company invest amount $40000 into
project A & B but get return in different period of time while in Project C invest about $200,000
but get return in 3.64 time so it is suggested that company must invest into Project B to get
effective outcomes.
G120
Z125
00.511.522.533.54
2.1
3.8
Pay Back Period
As per the above chart it is analysed that From G120 company get return in 2.1 years
while from Z125 get result in 3.8 years. So according to this method SD Ltd must invest into
G120 to get returns earlier then invest into other machine. It is better option to select and proceed
further action to set good image at the market.
Key Challenges: The main challenge discussed of this method that face by the organisation:
 It ignores time value of money which is one of the important factors. Time value of
money is significant for cash flow which is received in the beginning of year in which
investment is made (Grafova and et.al., 2017).
 Furthermore, there is no relation of maximisation of shareholder's wealth. It is one of the
drawback which does not include profitability of project.
 This means that no project shows the actual amount of profit which can be gained with
the investment made the particular project.
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 It should not be opted for the business as there is no consideration of time value of
money.
Recommendation:
 It is suggested that there is selected that project which is provided returns in lesser period
of time.
 According to time vale company take right decision and invest amount in the selected
machine.
 It is easy method which is apply by most of the company so other organisation easily
estimate about the investment so must try other method to get accurate result in regard of
company.
 There is focused on the return time as per the investment.
Justification: It is justified that company apply effective method that provide great
results to an organisation. It Supports to SD Ltd to analysis the effective results that helps to take
strategic decision in regard of business condition.
Internal Rate of Return
Explanation: This technique used in capital budgeting to find out whether investment in
any particular project would be profitable for a company or not. If different projects have same
cost then the project which has the highest IRR would be selected (Hang and et.al., 2018). Once
it has been determined it is compared with the company's cost of investment. This method ranks
various projects on the basis of their yield value. It is used in analysis of investments for private
equity and venture capital. However it is possible for a small project to have a high IRR.
Therefore, to select the right project for investment purposes it is essential that NPV and
payback period are examined alongside with it. This will help in making a right decision which
will be beneficial for company in the long-run.
Illustration:
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As per the above example an investor can invest into two projects and apply IRR method
to calculate result which are 27.3% & 38.5%. In this method selected high IRR because it is
beneficial for business to conduct activities for longer period of time. On the basis of these
results an investor can take decision regarding making investment in one of the alternative
projects.
25%
20%
Internal Rate Of Return
G120 Z125
As per the graph analysis it is interpreting that if SD Ltd can invest amount into G120 to
get internal rate of return 25% and 20% from Z125. According to this method highest IRR is
selected that provides effective result and shows that company can survive for longer period of
time. The finance director of SD capital assure about the excess of IRR about 15% in the both
machine so according to that company should select G120 for business.
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Key challenges:
 In this method does not focus on the project duration and size of project.
 This method consider on positive as well as negative cash flow that create problem in
calculation (Karna, Richter and Riesenkampff, 2016).
Recommendation:
 It is suggested that company analysis both options effectively and calculate from different
point of view. As a result it helps to finance manager to take right decision.
 If manager confident about the excess so according to that apply changes in the cost and
other things and calculate again that are helping to take effective decision in right time.
The manager invest in right machine and conduct further activities of production.
Justification: As per the overall analysis it is justified that positive and negative cash
flow leaves impact upon the project investment. It is mainly utilised to analyse the attractiveness
of a project or investment.
Net present values
Explanation: It is a method which is applied to examine the actual value of all future
cash flows prepared by a project, consisting the initial capital investment. This method is mostly
used in the capital budgeting to set up projects which are likely to generate more profit margin.
In different cases the organisation select this method, to take effective decision for investment
(Malyshenko, 2016). Through this method differences between the present value of cash inflows
as well as cash outflows could be analysed for specific period of time. It is one of the most
reliable approach that depends upon the discounted cash flow method. While calculating results
of this method managers are required to follow three particular inputs such as:
 Estimated net cash flows after tax in every period of the project.
 Initial investment outlay
 Reliable discount rate like hurdle rate.
Additionally, to resolving all the cost and revenues can take time for cash flow and focus
on outcome that impact on the present value of an investment. Such as it is good to see cash
inflows earlier and cash outflows later compare to the opposite (Net Present Value, 2020).
Illustration:
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From the above example it has been analysed that an investor can select three projects
and apply NPV method to get effective results. From project B get higher NPV which is good for
the investor. From Project B get outcomes 1896309 (12.64%) that is good as compare other
projects A & B.
284864
420194
Net Present Value
From the above chart it is analysed that G120, NPV is 284864 and Z125 NPV is 420194.
So company should select Z125 machine due to highest NPV of this machine. This method focus
on the time value of money and supports management in better decision making.
Key challenges:
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 In this method companies may face the problem of sensitivity to the discount rate. NPV is
a summation of different discounted cash flows that are shown in positive as well as
negative manner (Myšková and Hájek, 2017).
 This method is only based on cash inflows and outflows. If outflow is negative then it
will result in negative values.
 This method is not applicable when comparing two projects both have different
investment amount.
Recommendation:
 It is suggested that as company wants to purchase a machine with NPV 140800 but with
this option also selected Z125 because of more NPV as compare with G120.
 Company should invest their amount into Z125 because of high NPV of this machine.
Justification: It is justified that NPV analysis is utilised to help and analysis how much
an investment, project or any series of cash flow is valuable. This method based on broad metric
where focus on the different accounts and consist on revenues, capital costs and expenses that
connected with investment in its free cash flow.
Profitability Index
Explanation: This method measures ratio between the present value of future cash flows
and the initial investment. Profitability index can help to provide ranking to investment projects.
It is an effective method that is also known as profit investment ratio or the value investment
ratio (O’Neill, Sohal and Teng, 2016). To calculate this method a manager is required to focus
on future cash flows from the starting of project.
Illustration:
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As per the above illustration it is understanding that there is calculated cash flow on the
basis of different discounted rate and get different results that helps in investment decision.
Key challenges:
 For the profitability index managers are required to forecast the cost of capital in order to
calculate accurate profitability index of different projects which is not accurate every
time.
 In reciprocally unshared projects where the initial investment are different it may get
failed to provide guidance for right decision (Siekelova and et.al., 2017).
Recommendation:
 It is suggested that this method should be applied by company because it provides the
information about that investment is increasing or decreasing.
 This method is mainly focused with all cash flow of the project which is beneficial for
firm.
Justification: From the overall analysis it has been determined that this method is good
for company as it helps to know about investment procedure and focus upon time value of
money. On the basis of this technique a financial analyst can take right decisions in regard of SD
Ltd.
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Risk and risk management in Investment appraisal
Risk: It is an uncertain event or situation that can impact on any project and on
organisational objectives.
Risk management: It is defined as a procedure where recognising, analysing and
controlling threats of a business's capital and earnings related activities are performed (Steinker,
Pesch and Hoberg, 2016). Different risks as well as threats are categorised as per the sources
which consist financial uncertainty, legal liabilities, major risks, natural disasters and many
others. When any type of risk occur in the business then it may leave negative impact on the
performance of the organisation so for this managers are required to manage all the risk in
appropriate manner. For this purpose, organisation should prepare different strategies and
provisions for risk which could be used at the time of risk management.
Strategic issues: It is a fundamental policy of question or critical challenge that impact
on organisation's mandates, values, stakeholders, structure or product or service level and mix.
Non financial factors: These factors have impact on the financial decision of business
and should always be taken into account to make sure that right decisions are made. Such as, a
full revealing of an organisation will outcome in job losses. To purchase or sell decision under
focus on different non financial factor such as: Capacity: It is a measurement of the value creating capacity of a machine or system. It is
required to pay attention towards practical and theoretical ability at the time of
operational and strategic decision (Talonpoika and et.al., 2016) . Quality: It is analysed by comparing two projects with their characteristics and set of
necessities. In this factor managers should focus on quality of machine which may leave
impact upon the decision making procedure.
 Process Control: It is defined as a combination of people, materials, equipment,
atmosphere and many others. These are applying on the product manufacturing as well as
on two middle outputs that acquirable for the particular procedure (Zalata, Tauringana
and Tingbani, 2018).
CONCLUSION
As per the above report it has been concluded that the assessment of any business based
on the financial activities in which manage all the activities in appropriate manner. A company
want to invest into a machine but they have two option so through different appraisal techniques
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calculate return and get results. It is getting that company should purchase G120 which have
good IRR and pay back period. In the manner of non financial factor this machine easily control
by the company and other factor favour in this.
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REFERENCES
Books and Journal
Altman, E. I. and et.al., 2017. Financial distress prediction in an international context: A review
and empirical analysis of Altman's Z‐score model. Journal of International Financial
Management & Accounting. 28(2). pp.131-171.
Ashmarina, S., Zotova, A. and Smolina, E., 2016. Implementation of financial sustainability in
organizations through valuation of financial leverage effect in Russian practice of
financial management. International Journal of Environmental & Science Education.
11(10). pp.3775-3782.
Chen, P. H., Ong, C. F. and Hsu, S. C., 2016. Understanding the relationships between
environmental management practices and financial performances of multinational
construction firms. Journal of cleaner production. 139. pp.750-760.
Cuthbertson, K., Nitzsche, D. and O'Sullivan, N., 2016. A review of behavioural and
management effects in mutual fund performance. International Review of Financial
Analysis. 44. pp.162-176.
Feng, T. and Wang, D., 2016. The influence of environmental management systems on financial
performance: A moderated-mediation analysis. Journal of business ethics. 135(2).
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Grafova, T. O. and et.al., 2017. Tools of financial management of reputational risks.
Hang, M. and et.al., 2018. Economic Development Matters: A Meta‐Regression Analysis on the
Relation between Environmental Management and Financial Performance. Journal of
Industrial Ecology. 22(4). pp.720-744.
Karna, A., Richter, A. and Riesenkampff, E., 2016. Revisiting the role of the environment in the
capabilities–financial performance relationship: A meta‐analysis. Strategic Management
Journal. 37(6). pp.1154-1173.
Malyshenko, V., 2016. A Model of System and Strategic Financial Analysis of the Crimean
Health Resorts. Economy of region. 1(2). pp.510-525.
Myšková, R. and Hájek, P., 2017. Comprehensive assessment of firm financial performance
using financial ratios and linguistic analysis of annual reports. Journal of International
Studies. volume 10. issue: 4.
O’Neill, P., Sohal, A. and Teng, C. W., 2016. Quality management approaches and their impact
on firms׳ financial performance–An Australian study. International Journal of
Production Economics. 171. pp.381-393.
Siekelova, A. and et.al., 2017. Receivables management: the importance of financial indicators in
assessing the creditworthiness. Polish Journal of Management Studies. 15.
Steinker, S., Pesch, M. and Hoberg, K., 2016. Inventory management under financial distress: an
empirical analysis. International Journal of Production Research. 54(17). pp.5182-
5207.
Talonpoika, A. M. and et.al., 2016. Defined strategies for financial working capital management.
International Journal of Managerial Finance.
Zalata, A. M., Tauringana, V. and Tingbani, I., 2018. Audit committee financial expertise,
gender, and earnings management: Does gender of the financial expert
matter?. International review of financial analysis. 55. pp.170-183.
Online
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Net Present Value. 2020. [Online]. Available through.
<https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-present-
value-npv/>
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