Importance of Financial Management and Ratio Analysis for Business Finance

This report discusses the importance of financial management for effective business operations and highlights the analysis of financial statements and the use of ratio. It includes the preparation of income statements and balance sheets, and the calculation of liquidity, profitability, and efficiency ratios. Suggestions for improving financial performance are also provided.

Business Finance

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
SECTION 1......................................................................................................................................3
Concept and importance of financial management ....................................................................3
SECTION 2......................................................................................................................................4
Main financial statements and use of ratio within financial management..................................4
SECTION 3......................................................................................................................................5
Business review template............................................................................................................5
Income statement .......................................................................................................................6
Balance sheet...............................................................................................................................6
Profitability, liquidity and efficiency ratios................................................................................7
SECTION 4......................................................................................................................................9
Suggestion for improving the financial performance of the company........................................9
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11
APPENDIX....................................................................................................................................12

INTRODUCTION
Business finance is the amount of money which is necessary for the business to manage
and run its operations effectively. Without finance no work or activity can be completed. Hence,
it is necessary for business to manage finance in such a manner that working is effectively being
done. The current study will outline the importance of financial management for successfully
managing the business along with this analysis of financial statements and the use of ratio will
also be highlighted. Moreover, the income statement and balance sheet will be prepared and on
basis of that ratios will be calculated. In the end, the suggestion for improvement will be
provided to the company.
SECTION 1
Concept and importance of financial management
Financial management is being defined as the process involving planning, controlling and
monitoring all the financial resources for the attainment of the objectives of business
(Holynskyy, 2017). For success of business it is necessary that effective financial management is
being implemented within the business. The growth and development of enterprise can be
hindered if finance is not managed properly. Organizations maintain a separate department to
facilitate all the financial affairs. Importance of financial management for the company are as
follows-
 The major importance of financial management for business is that is provides direction
for managing the finance in proper and effective manner.
 Further, with help of the financial management the company can effectively plan all the
activities of the business and ensure effective and efficient working (Damayanti, Murtaqi
and Pradana, 2018).
 The FM aids in proper implementation of controlling measures in each unit of the
organization to operate within the limited funds.
 The proper balance must be maintained between owner's capital and borrowed capital
which is attained with proper management of finance.
 FM does a favour to achieve sustainable growth of company by maintaining profitability
of the concern.

SECTION 2
Main financial statements and use of ratio within financial management
Financial statements prepared shows business activities carried out and accurate financial
condition of company. These are as follows:
Income statement:
This statement represents financial performance and records all expenses incurred and
income generated over a time period to calculate net profit or net loss. Company performs
operations to generate income and earn profits which is assessed through Profit and Loss
statement (Hasanaj and Kuqi, 2019). Business can point out to this statement to see whether
strategies adopted are doing well or not.
Balance sheet:
It gives an account about company's liabilities, assets and share capital on a particular
day. The corporate assets are balanced with the liability and equity fund. The two sides of
balance sheet always matches (Prodanova, and et.al. 2019). For example, if the firm takes a loan
of £10000, then cash on the assets side will increase from £10000 as well as liability to pay debt
will also increase by the same amount. It gives deeper knowledge about financial health of firm.
Through this, investors can analyse whether to invest in company or not. The company can also
make a better overall strategy. However, it is based on past information to forecast future. Past
records does not always produce assured future outcomes.
Cash Flow Statement:
The statement assesses complete flow of cash over a period of one year. It calculates how
much cash is generated from various activities and how it is employed. It records the flow of
fund from, mainly 3 activities i.e. Operating (acquiring or producing and selling goods and
services), Investing (buying and selling fixed assets) and Financial activities (issue and buy back
of equity), A positive balance exhibits that more cash is flowing into company than going out
(Wei and et.al., 2019), CFS is prepared to measure liquidity of company. Statement can disclose
in which direction company is moving i.e. whether it is a growing and profitable or at a stage of
stagnation and decline.

Explaining the importance of ratios analysis in financial management
 Ratio analysis helps in analysing and understanding balance sheet and income statement
information.
 It is important to evaluate how investors' money is used to give rise to profits. i.e. to
calculate profitability of the business.
 Analysis is also used to determine liquidity of the firm. Firm is able to settle its short term
dues within 12 months or not.
 The ratio analysis is also beneficial to assess the dependency of company on loans and
advances to raise funds and also to pay interest on time.
 It also aids in financial forecasting and provides right direction to execute plans in
effectual manner.
 Ratio reveals trends to be followed by managers to implement the corrective measures. Another importance of such analysis is that firms can compare the performance with
other competitors in the same industry.
SECTION 3
Business review template
The Net Profit for the year 2016, is £43057 (2015: £18,987,000).
The Company’s key financial and other performance indicators during the year were as follows:
2016
£’000
2015
£’000
Change
%
Turnover (continuing operations) 189,711 179,587 +5.6%
Profit for the financial year 43057 18987 27.30%
Shareholder’s equity 83815 63,057 +32.9%
Current assets as % of current liabilities 222.3 % 304% -82%
Customer satisfaction 4.5 4.1 +10%
Average number of employees 649 618 +5%

Turnover from continuing operations increased by 5.6% during the year, primarily due to the
acquisition of the Extinguishers business on 1 May 2015, which made a full year’s contribution
in 2016.
Gross Profit = £81125
Net Profit = £43057
Net Profit increased in 2016 by 27.3 % during the year.
Shareholders’ equity increased by 32.9% by £20758.
The company’s “quick ratio” (Current Assets (excluding stock) divided by Current Liabilities) is
1.47
The company’s “current ratio” (Current Assets divided by Current Liabilities.) is 2.22
Income statement
Attached in appendix
Balance sheet
Particular Amount
Non- Current assets
Intangible assets 5,793
Tangible assets 52,812
Investments 10,693
69,298
Current assets
inventory 28,571
Receivables 26,367
Short term deposits 14,779
Cash at bank and in hand 14,632
84,349
Current liabilities
Bank loans and overdrafts 9,610
Trade payables 19,493
Creditors 678
Income tax payable 3,585

Other creditors including tax and social
security 4,562
37,928
Working capital 46,421
Total assets less current liabilities 115,719
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 and surplus 1322
Retained earnings 43,057
Total equity 83,815
Profitability, liquidity and efficiency ratios
Liquidity ratios
Current ratio 2.22
Formula = Current asset/ current liabilities
CA 84349
CL 37928
Quick ratio 1.47
Formula = (Current asset- stock)/ current liabilities
Current asset 84349
Stock 28571
Current liability 37928
Current ratio and quick ratio computed above is 2.22 and 1.47 respectively. Liquidity of
company as calculated above shows a better liquid condition of company. It shows that firm has

enough liquid assets to settle its dues on time without any delay. However, business entity has
more current assets in comparison to current liabilities. After paying all current liabilities,
company is left with abundant current assets. Such assets should be properly utilized to generate
more profits to company. Company should try to maintain current ratio of 2:1 (Bunker, Cagle
and Harris, 2019).
Profitability ratios
Gross profit 42.76
Formula = (Gross profit / sales) * 100
GP 81125
Sales 189711
Net profit ratio 22.70
Formula = (Net profit / sales)*100
NP 43057
Revenue 189711
With the analysis of profitability ratios, gross profit ratio and net profit ratio accounts to
42.76 and 22.70 respectively. Organization is earning a good amount of gross profit which shows
that company is generating enough revenue from sales. However, there is a huge difference
between ratio which shows that company is incurring a lot of indirect expenses which leads to
decrease in net profit ratio. Company should try to curb its unnecessary indirect expenses to
improve profitability of company (Husain and Sunardi, 2020). Company can cut down its
expenditure over power consumption, decrease the workforce, etc.
Efficiency ratio
Inventory turnover 3.80
Formula = COGS/ inventory
COGS 108586
Inventory 28571
Fixed asset turnover ratio 0.62
Formula = Revenue/ total asset
Revenue 43057
Fixed asset 69298
Inventory turnover and fixed asset turnover ratio determined above is 3.80 and 0.62 each.
Efficiency ratios presents the productivity and capability of firm (Ningsi, 2021). Inventory
turnover ratio of company is not satisfactory. It depicts that just 3.8 times the stock has been sold
over a time period. It shows that goods are not managed properly. Correct inventory control

measures should be adopted to enhance inventory management. Apart from this ratio, fixed asset
turnover ratio is also not up to the mark and need improvement. It shows that firm is earning
only 62 cents for each pound of asset. Unused assets must be put to fruitful uses to increase
efficacy of the company.
SECTION 4
Suggestion for improving the financial performance of the company
 For company's profitability, around 65% gross profit ratio is assumed to be beneficial as
per industry norms. Undertaking can improve its gross profit ratio which is 42.76% either
by reducing costs or by increasing prices. Unwanted costs can be avoided with efficient
methods of production. It is advised to evaluate pricing policies because of changes in
market trends.
 Percentage change (increase) of 5.6% in turnover from 2015 to 2016 depicts that enough
revenue is generated by corporation. It can be suggested that company should lap new
markets and new customer base along with retaining old customers to increase its
revenue (Ha and et.al., 2019). It can also increase revenue by monitoring competitor's
move and taking counter move.
 Customer satisfaction index shows an upward trend of 10 % for company which is quite
favourable. It can be proposed to company to be more active in listening and fulfilling
customers need and demands. Satisfaction level can also be enhanced by giving discounts
and offers.
 Fixed asset turnover ratio as calculated above is 0.62 for concern which need to improve.
It can be recommended to enhance sales or to add a new product to product line which
will attract new customers. In addition to this, assets with good operating condition
should be used and obsolete assets should be disposed off.
 Inventory turnover ratio as computed for company is 3.80 which should be enhanced.
Generally, a healthy ratio to be assumed by industry is between 5-10. It can be advised to
upgrade demand forecasting techniques and focus on promotional measures to increase
sales. In addition to this, bulk ordering of goods should be avoided because cost of
carrying the goods in warehouses increases.

 Current ratio is very important for business organization and it is accounted to 2.22 for
company. It shows that company has excess assets that are kept idle and utilized
optimally. These assets and resources should be utilized, for example, in purchasing new
assets which will increase the productivity so that sufficient profits are generated.
 Company's quick ratio is 1.47 which provides a better and clear view of firm's ability to
pay its short term debts. Normally, a 1:1 ratio is considered optimum by business as it is
sufficient to settle the liabilities on time. Inactive assets can be put to productive uses to
improve profit levels.
 Average no. of employees has increased by 5% from previous year. Company is
increasing employee base because of the new business acquired. It can be advised that
company should build trust and understanding with employees to engage with them and
make employees believe that the company cares for them (Baah, Jin and Tang, 2020).
CONCLUSION
By summing up this report, it can be said that with the assistance of financial
management, organization can perform effectively and efficiently to yield good profits. Besides
this, it can also be concluded that major financial statements prepared at year-end provide
organization with useful information. It can also seen within report that with the help of various
ratio calculations and analysis, true financial condition of company and reasons behind such
performance can be identified. It can make better decisions and implement strategies to improve
performance of enterprise. Apart from this, many suggestions are given at the end to enhance
profitability, liquidity and operational efficiency of business.

REFERENCES
Books and Journals
Baah, C., Jin, Z. and Tang, L., 2020. Organizational and regulatory stakeholder pressures friends
or foes to green logistics practices and financial performance: investigating corporate
reputation as a missing link. Journal of cleaner production. 247. p.119125.
Bunker, R. B., Cagle, C. and Harris, D., 2019. A liquidity ratio analysis of lean vs. not-lean
operations. Management Accounting Quarterly. 20(2). pp.10-16.
Damayanti, S. M., Murtaqi, I. and Pradana, H. A., 2018. The importance of financial literacy in a
global economic era. The Business & Management Review. 9(3). pp.435-441.
Ha, T. V. and et.al., 2019. Determinants influencing financial performance of listed firms:
Quantile regression approach. Asian Economic and Financial Review. 9(1). pp.78-90.
Hasanaj, P. and Kuqi, B., 2019. Analysis of financial statements. Humanities and Social Science
Research. 2(2). pp.p17-p17.
Holynskyy, Y., 2017. The importance of financial management principles in the State budget
execution. Annals of Spiru Haret University. Economic Series. 17(4). pp.19-28.
Husain, T. and Sunardi, N., 2020. Firm's Value Prediction Based on Profitability Ratios and
Dividend Policy. Finance & Economics Review. 2(2). pp.13-26.
Ningsi, E. H., 2021. The Effect Of Working Capital Efficiency And The Level Of Liquidity On
Profitability In The Mining Industry Registered In Indonesia Stock Echange. Enrichment:
Journal of Management. 12(1). pp.302-308.
Prodanova, N. A. and et.al. 2019. Methodology for assessing control in the formation of
financial statements of a consolidated business. International Journal of Recent
Technology and Engineering. 8(1). pp.2696-2702.
Wei, L. and et.al., 2019. Discovering bank risk factors from financial statements based on a new
semi‐supervised text mining algorithm. Accounting & Finance. 59(3). pp.1519-1552.

APPENDIX
Profit and loss
Revenue 189711
Less: COGS
Material Cost 42597
Production Cost 15231
Labor Cost 50758
108586
GP 81125
Less Expenses:
Administrative
expenses 13751
Other operating
expenses 22374
Interest 1943
Total expenses 38068
Profit/(loss) for
the financial
year 43057