Financial Ratio Analysis and Management

The provided document presents a detailed report on the financial performance of Alpha Limited. It includes an analysis of various financial ratios such as current, quick, cash conversion cycles, average collection period, payment period, and debt equity ratio. The report also discusses the importance of financing decisions in maintaining profitability and stability within the firm. Accounting and financing departments play a crucial role in managing financial transactions and making major decisions related to financing, investment, dividend, and working capital. The calculation of financial ratios helps Alpha Limited understand its financial performance in terms of liquidity, efficiency, and profitability.

Financial Decision Making

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
TASK 2............................................................................................................................................4
a. Calculation of the ratio analysis of Alpha Limited.................................................................4
b. Analysing the performance of the Alpha Limited in terms of its ratios evaluated.................5
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................10

INTRODUCTION
Financial decision making means selecting the best option or source for raising the funds,
allocating those funds to highly profitable projects and utilizing the funds in a way that facilitates
larger returns. It acts as the crucial decision that the financial manager has to take in relation to
its sufficient availability of the funds in the future so that changing conditions can be met
effectively and efficiently. The present study is based on two tasks where in the first task it
includes the information relating to the Nestle company and deep insights has been thrown on
the importance of the accounting and finance department within the Nestle company. Task two is
based on the Alpha Limited, formed in 1975, set up in UK, deals in the business of
manufacturing and the company has plans for expanding its business in various segments of UK.
Furthermore, the task two includes the computation of the ratios of the Alpha Limited for
assessing its financial performance.
TASK 1
Significance of the accounting and the finance department
Nestle is the multinational company formed in the year 1905 by merger of Anglo-Swiss
milk corporate which is set up during the year 1866 by the brothers Charles page and George
page, founded by Henri Nestle. The company deals in various range of the products that includes
medical food, breakfast cereals, baby food, bottled water, coffee, tea, dairy products, snacks, pet
foods, ice-cream and frozen food. The company operates over worldwide and offers its products
in all the countries across the world. The employees of the enterprise are said to be around
308000 presently. Annual turnover of the company ascertained as 91.43 billion which leads to
higher revenue and the market share of an entity is large including the Europe and United states.
The major strengths of the Nestle is it is one of the leading and highly diversified firm which is
operating in several markets with the functioning in the sectors of different markets. Serving the
various segments with its wide range of brands creates the strong ability of the company to the
weather economics. It is called as the most trusted and the recognized brand worldwide and has
attained the customer loyalty. The main weaknesses of the company that can be analyzed are the
marketing cost of the corporate is so high as it is highly dependent on its advertisement for
shaping the opinion of the consumers and in meeting the sales target. Lot of opportunities are
present for the brands like it could have chosen for online retail which results in opening up of
the newer channels of distribution such as Amazon, Flip-kart etc. Major factors that leads to
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threats for Nestle are its competitors such as Walmart which highly pressurizing the brand in
cutting down its prices and this results in lower profitability for the firm in the overall market.
Importance of accounting and finance department-
1. Accounting department- This department plays a crucial role for the Nestle company as
it relates with several activities which are very much essential for the firm to run its
operations smoothly. It involves the financial accounting, management accounting, tax
functions and the auditing function.
Financial accounting- Accounting department ensures the effectiveness and efficiency
in performing these functions which leads to adequate reporting of the financial transactions. In
financial accounting the department looks towards the past data with the purpose of determining
the value of the company as a whole which in is essential for creating the well known image of
the brand all over the world. Accounting function is important for the reporting the financial
information to the shareholders and the investors so that they can use that information for
making suitable decisions regarding their investment made in the company. This department
helps the firm in knowing its financial performance and the financial position across the world.
Accounting department ensures the planning and the controlling process by providing the
necessary documents such as profit and loss statement, balance sheet, cash flow statement etc.
with full of accuracy and fairness.
Management accounting- This leads to the effectiveness of the management accounting
as well which is also a major role that the accounting department plays with the Nestle. Through
the better flow of the transactions of the business management could make right decisions and
effective planning which results in more productivity. Management could plan for the budgets in
such a manner that helps the Nestle in developing the strategies, controlling the cost and
eliminates unnecessary spending. For preparing the budget, prior records are needed which are
well maintained by the accounting department. For ascertaining the cost, performance and
information regarding the inventory, accounting function is important in the organization.
Thus, financial accounting and managerial accounting are the two major function that the
accounting department is responsible for. The other functions that are tax and auditing are also
one of the significant function and the part of the Nestle company.
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Tax function- This department facilitates for the timely payment of the taxes with
compliance of all the accounting standards which is very important for Nestle to function its
business ethically across the globe.
Auditing function- It also provides for appropriate auditing of the financial which helps
the firm in enhancing the reliability and validity of the information. Auditing is made keeping in
account all the principles and the standards that are mentioned or provisioned which assists
Nestle company in building its reputation or goodwill in the international market. Auditing of the
financial information states that the company is running its operations with compliance of all the
accounting rules and regulations. This function of the accounting department ensures that the
statement are formulated with fairness and integrity which attracts large investors showing
interest in the management of the Nestle. For performing all these functions with proficiency,
accounting department is of great importance for the organization.
2. Finance department- This department is necessary for Nestle company for managing its
money. The major functions that the finance department involves are planning, auditing,
organizing and accounting for controlling the finances of the company. It plays an
essential role in performing the functions relating to the investment, financing, dividend
and the working capital. These functions are considered as the critical part of the Nestle
which helps in meeting the uncertainty in the future and in attaining the stability in the
long run.
Investment function- One of the most important function of the finance department is to
allocate the capital of the company into the long term or non-current assets so that maximum
returns can be generated in the near future. Performing the investment function effectively
mainly two aspects are considered that include the decision regarding the evaluation of the new
investments in context of the profitability and the comparison between cutoff rate and the
prevailing rate of the investment. Finance department while computing the expected return also
considers the risk factor which plays a crucial role in evaluating the accurate returns from the
prospective investments.
Financing function- It is another important function that the finance department
performs. For making the wise decisions in relation to the acquisition of the funds, financing
function is of major importance. It states that the correct ratio of the equity and the debt is to be
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maintained for attaining the optimal capital structure. This function benefits the Nestle company
when the market value of its shares increases which leads to the wealth maximization of the
stakeholders. It helps in developing the sound financial structure that aims for maximizing the
returns for the shareholders and minimizing the risk.
Dividend function- Earning the profits and the positive returns is the common goal of all
businesses. It is the key function of the finance department to decide whether the profits gained
need to be distributed wholly to the shareholders of the Nestle or retaining the profits entirely or
in part for reinvesting in the new projects or business for making more expansion and
diversification. It is the foremost responsibility of the finance mangers to decide for the optimum
level of the dividend policy which helps in gaining the maximum value of firm in the overall
market. An optimum dividend policy can be achieved by adopting the common practice of
paying the regular dividends in the case of the profitability and the another way is issuing the
bonus shares to the existing shareholders.
Working capital function- For maintaining the liquidity position of Nestle it is very
essential for the finance managers to manage the current assets and the liabilities of the company
effectively so that insolvency can be avoided. Working capital function ensures the smooth
functioning of the routine activities of the business in terms of meeting the day to day expenses
and better availability of the cash. In order to manage the trade-off in between the liquidity and
the profitability it is essential for the finance department of the Nestle to invest for the adequate
funds in the current assets. Short-term assets must be appropriately valued and to be disposed off
timely as they became non-profitable for the business.
TASK 2
a. Calculation of the ratio analysis of Alpha Limited
Ratio analysis of Alpha Limited
Particulars Formula Amount
2017 2018
Operating profit 300 262.5
Total assets 2235 4035
Current liabilities 322.5 1110
Capital employed Total assets-current 1912.5 2925
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liabilities
Return on capital
employed
Operating
profit/capital
employed*100 15.69% 8.97%
Net profit 300 262.5
Revenue 2400 3000
Net profit margin
ratio
Net
profit/revenue*100 12.50% 8.75%
Current assets 757.5 1035
Current liabilities 322.5 1110
Current ratio
Current
assets/current
liabilities 2.35 0.93
Trade receivables 450 600
Revenue 2400 3000
Debtors collection
period.
Trade
receivables/revenue*3
65 68.4 73
Trade payable 285 1050
Revenue 2400 3000
Creditors payable
period.
Trade
payable/revenue*365 43.3 127.8
b. Analysing the performance of the Alpha Limited in terms of its ratios evaluated
Particulars Formula 2017 2018
Return on capital Operating 15.69% 8.97%
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employed
profit/capital
employed*100
Return on capital employed- It is the most appropriate ratio that states the earning power
of the capital employed in the business. It acts as the tool for the management as it shows the
progress or the deterioration in earning capacity and the efficiency of the business. It is computed
by dividing the operating or net profit by the capital employed. Capital employed is ascertained
by the reducing the current liabilities from the total assets. It relates with the returns generated
from the common equity and the debts or other liabilities of Alpha Limited. The objecting behind
evaluating this ratio is to find the sufficient use of the funds that are supplied by the shareholders
and the creditors of the company. Return on capital employed measures the relationship between
the net income before the payment of the taxes, interest and the capital invested by the firm. The
above table interprets that the Return on capital employed ration of Alpha Limited for the year
2017 resulted as 15.69% and 8.97% for the year 2018 which clearly shows the declining trend of
earnings which in turn leads to poor performance of an entity. In the year 2017 the ratio
evaluated is close to the ideal ratio that is 15% which indicates that greater productivity is been
achieved from the capital employed. However, in the year 2018 the earnings decreases which
means the equities and the debts are not managed effectively. The proportion of the profit is less
in proportion to the capital employed which is not good. Reasons behind decrease in the ratio is
fewer profits are available with the firm for reinvesting into the other projects because of the low
prices, use of unnecessary assets and the use of the outdated machinery. For improving the
performance and the ratio Alpha Limited can go for corrective measures such as selling the
outdated machinery, setting the higher price and removing or selling off the irrelevant assets.
Particulars Formula 2017 2018
Net profit margin
ratio
Net
profit/revenue*100 12.50% 8.75%
Net profit margin ratio- It is one of the major profitability ratio that measures the profits
generated against the total revenue after paying off all the taxes and the interest expenses. The
higher the net profit margin ratio, the better it is as it indicates that the reasonable profits earned
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by the Alpha Limited on its sales after the planning relating to tax concern. This ratio is
calculated by dividing the net income with that of the net sales. From the above table it has been
analyzed that the net profit ratio of the Alpha Limited for the both the years equates to 12.50%
and 8.75% which means that the ratio is decreasing from one accounting period to another. This
shows that the income of the company is reducing over its sales which means that total revenue
incurred is facilitating lower returns due to the increase in the interest and the tax expenses.
Other reasons for poor profit margins are increase in the operating expenses and decline in the
price of the product. Net profit margin ratio can be improved by reducing the insurance
premiums and the lowering the cost of the production so that sales revenue can be increased
which in turn leads the Alpha Limited in gaining higher profit margins. By reducing the utilities
and the cost of labor with the outsourcing also enables the firm in getting improved returns.
Making strategic decisions like entering into the new market helps in attaining the new
customers which results in achieving growing success and thus the ratio of net profit margin
shows improved performance.
Particulars Formula 2017 2018
Current ratio
Current
assets/current
liabilities 2.35 0.93
Current ratio- It is defined as the liquidity ratio which depicts the relationship in between
the current assets and the current liabilities of the business concern. It helps the firm in
measuring its ability in meeting its current financial obligations that is the commitments that are
due in current accounting year. Current ratio describes the liquidity position of the company that
means the capability of the firm in paying off its short term obligations so that working capital
can be improved and smooth functioning of the routine operations is ensured. It is evaluated by
dividing the current liabilities with that of the current assets. The current ratio of the Alpha
Limited during the year 2017 resulted as 2.35 which means a better liquidity position as it is
close to the ideal current ratio that is 2:1. This reflects that the company has efficiently managed
its current assets over the current liabilities as by this number it meant that the short term assets
are just doubled the short term liabilities. This means sufficient funds was available wit the
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enterprise to meet its dues and also to incur larger profits. On the other hand in the year 2018 the
ratio resulted as 0.93 which indicates the liquidity position of the Alpha Limited is getting poor
and this number shows that current liabilities of the entity are more than its assets due to the
ineffective management of its working capital. The main reasons for downfall is increase in the
dues, selling of the assets which reduces the ability of the company in generating sufficient cash.
Alpha Limited has to take appropriate measures for improving its liquidity position that include
submitting the invoices as soon as possible to its customers, getting rid of the useless assets,
keeping control over the overhead expenses and switching from the current debt to the non-
current debt.
Particulars Formula 2017 2018
Debtor collection
period
Trade
receivables/revenue*3
65 68.4 73
Debtors collection period- It is the efficiency ratio that looks at the time taken by the
company in collecting its money owed from its debtors or the customers. The lower the period,
the better it is because in limited duration the cash could be ascertained by the firm. It is
computed by dividing the trade receivables with the revenue or the sales, multiplying it by the
total number of days in a year. The debtor collection period for the Alpha Limited in the year
2017 equates to 68.4 and in 2018 evaluated as 73 which means that the period is increasing, this
clearly states that in the next year more time in relation to the credit term is offered to its
customers so that sales can be increased whereas it also increases the risk of the non payment on
the side of the customers. Several ways that the Alpha Limited need to adopt for improving its
average collection period such as creating an account receivable aging report, by being proactive
in their invoicing and the collection efforts, Offering the discount for the early payment and
moving fast on the receivables that are due in the past.
Particulars Formula 2017 2018
Creditors payable
period
Trade
payable/revenue*365 43.3 127.8
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Creditors payable period- It refers to the number of days that an entity takes to payoff its
dues against its credit purchases. Lower the average payment period means quick payment of the
dues awhile higher the period reflects the longer time taken by the company in paying to its
creditors. It is computed by dividing the revenue with the trade payable and multiplying its by
the total number of days. The payable period of the Alpha Limited is increasing from the year
2017 to the year 2018 as it computed as 43.3 in former year and 127.8 in the latter year which
means that the company preferred for longer time in repaying to its creditors which depicts the
increase in the financial burden. Reasons behind longer period is more credit purchases from the
side of the Alpha Limited. This increasing period can be improved by availing the discount for
the early repayment and negotiating the term of payment with their suppliers in exchange of
buying the raw material. By improving the inventory control and the external credit control,
Alpha Limited can pay its dues timely.
CONCLUSION
From the above report it can be concluded that financing decisions are important for the
firm as it directly linked to the profitability and the functioning of the firm with stability and in
reaching success in the future. Accounting and financing department plays a crucial role in the
management of the Nestle as it enables the firm in maintaining its financial transactions and
making major decisions in context of financing, investment, dividend and working capital.
Calculation of the ratio analysis helps the Alpha Limited in knowing its financial performance in
terms of its profitability, liquidity and efficiency.
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