Importance of Financial Management and Ratio Analysis for Business Finance

This report discusses the importance of financial management and ratio analysis for businesses to improve their financial performance. It covers the concept of financial management, financial statements, and the use of ratios in financial management. The report also includes a case study analysis of a company's profitability, liquidity, and efficiency. Finally, it suggests processes that businesses can use to improve their financial performance. This study material is relevant for BSc (Hons) Business Management with Foundation course code BMP3005.

BSc (Hons) Business Management with
Foundation
BMP3005
Applied Business Finance
The concept and importance of financial
management and the processes
businesses might use to improve their
financial performance
Submitted by:
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Table of Contents
Introduction................................................................................................................................2
Section 1.....................................................................................................................................2
Definition and discussion of the concept and importance of financial management.............2
Section 2.....................................................................................................................................3
Description and discussion of the main financial statements and explain the use of ratios in
financial management............................................................................................................3
Section 3.....................................................................................................................................4
Completing the Information on the ‘Business Review Template (Ensure that you display
your calculations for this detail).............................................................................................5
Using Excel producing an Income Statement for the Sample Organisation (see Case Study)
................................................................................................................................................7
Using Excel completing the Balance Sheet...........................................................................7
Using the Case study information describing the profitability, liquidity and efficiency of
the company based on the results of ratio analysis................................................................8
Section 4.....................................................................................................................................9
Using examples from the case study describing and discussing the processes this business
might use to improve their financial performance.................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
Appendix..................................................................................................................................12
Income Statement.................................................................................................................12
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Introduction
Business finance refers to the credit and corpus of funds employed in the business for
buying raw materials and assets in order to initiate economic activities. Therefore, the
required amount of fund must be provided beforehand for the effective as well as smooth
business operations. To manage this finance, the concept and importance of financial
management practices and techniques have emerged (Vernimmen, Quiry and Le Fur, 2022).
The present report would include the discussion related to how financial management is
important for the contemporary businesses along with the describing the several statements
that businesses prepared for displaying their financial health & performance at a point of time
or during the period respectively. Also, how financial managers uses ratio analysis for the
evaluation of business performance between years and between the business & other players
in the same industry will be explained. Further, by referring to the case study information, the
income statement and balance sheet will be prepared along with calculating different
financial metrics to analyze the performance of business in the case on several grounds such
as efficiency, liquidity and profitability. At last, the processes or steps the business could take
to improvise their performance will be discussed.
Section 1
Definition and discussion of the concept and importance of financial management
Financial management is defined as the managerial role of planning, directing, organizing
and controlling the activities of financial nature that is, effective procurement as well as
utilization of funds available with the business. In other words, while managing finance of the
business, management resorts to applying general principles of management to the
organization’s financial resources Quiry, Le Fur and Vernimmen, 2022 ().
Financial management can be explained differently as the managerial activity meant
for efficient procurement and allocation of funds to different activities like operating and
investing with the motive of getting the desired profitability at the end of the period.
The financial management includes two key aspects, such as the following:
Procurement of funds: From which source the funds should be obtained is the key concern
for every business and through financial management mobilization of financial resources in
an innovative manner is possible. The financial management offered several techniques with
the help of which it is determined that how much funds should be obtained from different
sources keeping in mind low risk and low costs to the business.
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Utilization of funds: Whatever funds does the business have availed must be utilized in
effective manner and the financial management aims to allocate funds for operational
requirements, investment purposes and servicing funds that have obtained from external
sources. The techniques such as capital budgeting are used to determine the right or profitable
investment proposal.
Financial manager takes three different decisions to ensure effective acquisition & allocation
of funds:
 At first hand, they make financing decision to determine the right source from which
the required funds could be availed.
 Secondly, after getting required funds, investment decisions are made where it has
been decided that where to invest the money by applying investment appraisal
techniques (Minh and Quang, 2022).
 At last, the decision is taken for distribution of surpluses to determine how much out
the profit should be distributed among shareholders as dividend and how much should
be retained with the business.
Importance of financial management
 It is helpful in attaining the goal of profit maximizing through facilitating efficient
fund acquisition & allocating the same towards different business use.
 It ensures that there would be no condition like over funding or under funding within
the business both in the short as well as the long run.
 Required level of working capital has been maintained by the business is also ensured
through financial management which allows for establishing balance between cash
inflows and outflows.
 It facilitates financial planning where managers decide on matters like how much
capital is required, the proportion of equity & debt in the capital structure of the
enterprise and from where the funds should be obtained.
Section 2
Description and discussion of the main financial statements and explain the use of ratios in
financial management
Financial statements show the financial records of the business activities and accordingly
indicate the financial performance of an entity. The most common financial statements that
businesses prepare includes the following:
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Income statement: This financial statement is prepared for the period of time which may be a
quarter or year. Through this statement, the overview of expenses, revenues and net income
generated during the period is demonstrated (Stulz, 2022). The purpose for which this
statement is prepared involves the details of financial results in terms of profitability and
allows investors in comparing the profits between multiple periods as well as determining the
ability of the company’s management in establishing effective control in minimizing costs of
operation.
Balance sheet: It is prepared on a particular point of time and indicates the financial position
of the business by displaying the balances in assets, shareholder’s equity and liabilities. The
statement has the date written on the top which indicates when the statement is prepared
which is usually the end of the financial period. Through balance sheet, it can be determined
what the business owns which is included in assets, what the business owes to the outsiders
which is included in liabilities and the different between the assets & liabilities is
shown as the shareholder’s equity. The reason for this statement being called as the balance
sheet is that it is always balanced liabilities + shareholder’s equity is equivalent to the total
assets held by the company.
Cash flow statement: Through this statement, one can identify the liquidity position of the
entity by taking into account the cash balances at the end of the period along with showing
from where does the cash comes into the business & how it has been utilized for investment
as well as operational purposes. Creditors & suppliers uses this statement to determine the
capability of business in meeting their debt obligations on time.
Uses of ratio – Financial management
 Through ratios, it is possible for the investors and management to compare the
financial performance between two years of the company. Also, the comparison can
be done with the peer businesses as well.
 Ratios are also helpful to the managers in measuring relationship existing between
different elements of the financial statements (Al-Abedi and et.al., 2022). This would
give more effective results when the financial information for multiple periods are
available.
 Financial managers are able to make effective decisions on the basis of getting useful
insights on different aspects through ratio such as profitability, liquidity & solvency.
Section 3
Using the template provided:
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Completing the Information on the ‘Business Review Template (Ensure that you display your
calculations for this detail)
Calculation of Gross profit for 2016
Turnover in 2016 – (COGS) - (total of overheads)
= 189711 – 108586 – 38068
= 43057.
% change in net profit from 2015 to 2016
= net profit earned during 2016 – net profit earned during 2015 / net profit earned for the
financial year 2015 (i.e., base year) * 100
= [(43057 – 18987) / 18987] * 100
= +126.77%.
Shareholder’s equity in 2016
= Equity of shareholders at the ending of 2015 / 100 * 132.9 = 83803.
Current assets as % of current liabilities for the year ending 2016
= Current assets % of current liabilities in 2015 * (100 - 82) %
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= 304%
or 3.04 * 18%
= 0.5472%.
Gross Profit calculation for the financial period ending 2016
= Turnover – cost of goods sold
= 189711 – 108586
= £81125
Net Profit calculation for the financial period ending 2016 =
Gross profit in 2016 (as identified above) – total overheads incurred in 2016
= 81125 – 38068
= £43057
% Increase in Net Profit in 2016 from 2015 is found out as 126.77 % .
Increase in Shareholders’ equity at the end of financial period 2016 was identified as
32.9% which has been determined as follows:
83803 – 63057
= £20746
Increase in equity of shareholder / equity in base year i.e. 2015 * 100
20746 / 63057 * 100 = 32.9%.
Quick ratio of the company = (Current assets – Stock in hand) / Current liabilities
84349 – 28571 / 37928
= 55778 / 37928
= 1.47 times
Current ratio of the company = (Current Assets / Current Liabilities)
= 84349 / 37928
= 2.22 times
Note:
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 The information pertaining to stock, current liabilities & current assets have been
obtained from the balance sheet of the organization given in the case study.
Using Excel producing an Income Statement for the Sample Organisation (see Case Study)
This is included within appendix
Using Excel completing the Balance Sheet
Balance sheet as at 31 December 2016
2016
Total
£0
Non - Current assets
Intangible assets 5,793
Tangible assets 52,812
Investments 10,693
69,298
Current assets
Stocks 28,571
Trade debtors 26,367
Short term deposits 14,779
Cash at bank and in hand 14,632
84,349
Current liabilities
Bank loans & overdrafts 9,610
Trade creditors 19,493
Other Creditors 678
Income tax payable 3,585
Other creditors including tax and social 4,562
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security
37,928
working capital 46,421
Total assets less current liabilities 1,15,719
Non - Current Liabilities
Bank loans and overdrafts 16,506
Other Liabilities 7,304
23,810
Provisions for liabilities 8,094
Net assets 83,815
Capital and reserves
Called up share capital 39,436
Reserves 1322
Retained earnings 43,057
Total equity 83,815
Using the Case study information describing the profitability, liquidity and efficiency of the
company based on the results of ratio analysis
Profitability analysis: The analysis of profitability can be done through gross profit and net
profit margins. In the given case, the gross profit of the business has reduced from 44.88% to
42.8% in current year because of rise in cost of sales. This indicates poor efficiency of the
entity in generating sales. Moreover, the net profits have risen by 126% during 2016 as a
result of decrease in operating expenses such as administrative expenses of the business
(Saputra, 2022).
Liquidity analysis: In the above template, the current assets as a percentage of current
liabilities is showing negative movement between two years. However, the liquidity ratio i.e.
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quick & current ratio calculated for the given business case comes as 1.47 & 2.22 times
respectively which is above the ideal requirement that is 1 and 2 respectively. This means that
the business position is quite well in terms of liquidity and accordingly, the obligations that
would arise in the short duration could be met easily.
Efficiency analysis: Movement in costs between 2015 & 2016 are useful for the
determination of business’s efficiency during this period. Through the financial statements of
the business case, it has been identified that several operating costs & administration
expenses has reduced in 2016 which shows that there is an improvement in the business
efficiency. Customer satisfaction score have also increased in 2016 which is also an indicator
of efficiency because higher efficiency leads to reduction in costs of operation which in turn,
facilitate reduction in the price of products & services (Sadiq and et.al., 2022). Accordingly,
by providing same value and quality to customer at a lower rate, their satisfaction gets
increased.
Section 4
Using examples from the case study describing and discussing the processes this business
might use to improve their financial performance.
The following processes might be useful for the given business in improving its financial
performance due to financial matrices lacking on several grounds:
 Through the case study, it has been determined that costs associated with production
activity have increased which can be reduced by switching between high rate supplier
and low rate supplier. This would facilitate getting the same quality of materials at a
lower cost leading to improvement in company’s efficiency towards generating
revenue (Shim, 2022). Also, by adopting efficient technology, providing sufficient
training and incentivizing employee’s performance would be helpful in reducing the
cost of labor.
 Also, it has been identified that current assets as a percentage of current liabilities has
reduced by large proportion of 82% indicating liquidity risk for the business in future.
Accordingly, it would be recommended to the organization to adopt such credit
policies through which they can get payment from their account receivables as earlier
as possible along with getting better terms from suppliers to make delay in payment.
 The rising interest costs is the indicator of business being more dependent on debt
capital as compared to equity capital. On this ground, it could be suggested to the
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business that they should go for financing its operations through retained earnings or
by issuing equity instruments. By doing so, their burden of meeting interest
obligations would be reduced.
Conclusion
Through the report prepared above, it has been determined that the effective financial
management must be in place for the identification of right amount of capital and most
efficiency capital structure for the business. In this report, the discussion has been done
pertaining to the concept as well as the importance of financial management, the key
financial statements prepared by businesses, use of financial ratios by the management in
conducting their decision making activities effectively, etc. Moreover, on the basis of
financial information obtained through balance sheet and income statement, the financial
analysis has been done with respect to the profitability, efficiency and liquidity of the
business along with recommending processes to be used for improving the financial
performance.
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References
Al-Abedi, T. K., and et.al., 2022. The Impact of Corporate Governance on Accounting
Conservatism in the Financial Statements of Justice Shareholders: https://doi.
org/10.37178/ca-c. 23.1. 025. Central Asia and the Caucasus, 23(1), pp.272-281
Minh, T. N. and Quang, T. T., 2022. The effects of corporate social responsibility on firm
efficiency: Inside the matrix of corporate finance. Finance Research Letters, 46,
p.102500.
Quiry, P., Le Fur, Y. and Vernimmen, P., 2022. Corporate finance: theory and practice. John
Wiley & Sons.
Sadiq, M., and et.al., 2022. Impact of credit, liquidity, and systematic risk on financial
structure: comparative investigation from sustainable production. Environmental
Science and Pollution Research, 29(14), pp.20963-20975.
Saputra, F., 2022. Analysis of Total Debt, Revenue and Net Profit on Stock Prices of Foods
And Beverages Companies on the Indonesia Stock Exchange (IDX) Period 2018-
2021. Journal of Accounting and Finance Management, 3(1), pp.10-20.
Shim, J. K., 2022. Financial management. Professor of Finance and Accounting Queens
College City University of New York.
Stulz, R., 2022. Applied corporate finance. Journal of Applied Corporate Finance, 34(1).
Vernimmen, P., Quiry, P. and Le Fur, Y., 2022. Corporate finance: theory and practice. John
Wiley & Sons.
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Appendix
Income Statement
Income statement for the year ended 31st December 2016
2016
Turnover 3 189711
Less cost of sales:
Material Cost 42597
Production Cost 15231
Labour Cost 50758
108586
Gross profit 81125 GP % = 42.8
Less Expenses:
Administrative expenses 13751
Other operating overheads 22374
Interest 1943
Total Overheads 4 38068
Profit/(loss) for the financial year 43057 NP %= 22.7
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