Financial Management and Ratios Analysis

The assignment delves into the concepts of financial management, emphasizing its role in decision-making regarding dividend declaration and resource allocation. It conducts a comparative analysis of Zurich Plc.'s financial performance using key ratios like profitability, liquidity, solvency, and efficiency over two fiscal years (2015 and 2016). Furthermore, it examines an investment appraisal technique to evaluate the viability of purchasing a machine by Johnson Limited, considering factors such as payback period and rate of return. The assignment concludes with recommendations for both companies based on their financial health and investment prospects.

FINANCIAL
MANAGEMENT AND
CONTROL

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INTRODUCTION
Finance is a key aspect of every business organisation which helps to produce production,
operate in the industry. In the company if there are financial resources are not available then it
cannot exists as well as sell products and services to the customers. In addition to this, it is very
necessary to manage and control over the financial resources by which business able to perform
well and generate higher profit at the end of an accounting period. The current study is divided
into two parts such as financial ratio analysis and investment appraisal techniques. In the part one
financial performance of Zurich public limited company is to be analysed using financial ratios,
which is operating in the manufacturing of office equipments and distributing in the market.
Further, it shows limitations of financial ratio analysis for the company. In the second part it
shows feasibility of project using financial tools and provide decisions to Johnson Limited
company. At the end, it focuses on critically evaluation of various investment appraisal methods
and source of finance.
PART 1
1.1 Preparation of a report for the board of directors of Zurich Plc.
In the current scenario management of the Zurich Plc wants to analyse its financial
performance in the industry. For that various types of financial ratios are to used and calculated
using its financial statements. Such ratios are defined as below:
Profitability ratios
The ratio which helps to the company in order to determine position of its in the industry
in terms of generating profit is identified as profitability ratios. Higher the values or outcomes of
such kinds of ratios indicates that the company is too much able and efficient for selling its
products and services for generates high level of profit (Brigham and Ehrhardt, 2013). There are
different profitability ratios are used by the management of Zurich Plc using income statement.
These are like as gross profit, net yield as well as operating income. Various ratios of profit for
the Zurich Plc are computed as below:
Table 1: Computation of profitability ratios
Name of ratios Formula 2015 (in £000) 2016 (in £000)
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Gross income 7382 5825
Operating income 2582 1783
Net income 972.84 570.17
Net sales 18920 16243
Gross profit ratio Gross income / net sales * 100 39.02% 35.86%
Operating profit ratio Operating income / net sales * 100 13.65% 10.98%
Net profit ratio Net income / net sales * 100 5.14% 3.51%
Liquidity ratio
Another financial ratios and liquidity which shows ability of the entity in terms of meet
with the short term obligations which are taken from external financing sources. It includes
mainly two kinds of ratios such as current and acid test or quick ratio. As the value of such ratios
comes higher, then it can be said that Zurich Plc performing well in the industry (Petty and et.al.,
2015). Further, calculation of liquidity ratios for the entity Zurich Plc is as below:
Table 2: Computation of liquidity ratios
Name of ratios Formula 2015 (in £000) 2016 (in £000)
Current assets 7006 6503
Current liabilities 24927.6 27528
Inventory 1320 1543
Prepaid expenses 0 0
Current ratio Current assets / current liabilities 0.28:1 0.24:1
Quick ratio Current assets – (inventory + prepaid 0.23:1 0.18:1
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expenses) / current liabilities
Gearing ratios
As per the ratio it helps to the firm in order to determine level of long term debt that it has
how much debt as compare to the equity share capital. Apart from this it helps to know that firm
is how much able pay cost of debt using operating profit in a fiscal year. Most widely used ratio
of gearing is debt to equity where Zurich Plc can easily determine that it has appropriate capital
structure or not (Financial Ratio Analysis, 2017). Another kind of gearing ratio is interest
coverage which helps to know that it how much able to pay interest amount from the operating
profit generated by it. Such both the ratios for Zurich Plc are stated as below:
Table 3: Computation of gearing ratios
Name of ratios Formula 2015 (in £000) 2016 (in £000)
Debt 2130 3578
Equity 19635.16 20108
Debt to equity ratio Debt / equity 0.11 0.18
EBIT 2582 1783
Interest expenses 1130 932
Interest coverage ratio EBIT / expenses on interest 2.28 1.91
Asset utilization ratios
Financial ratios which help to the management to derive efficiency of the firm in terms of
generating sales and revenue by utilizing fixed and total assets are known as asset utilization
ratios. When the ratios are higher, then it clearly indicates that management of Zurich Plc is
highly efficient for proper utilizing assets which it has in the firm (Hendriks, 2013). Different
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ratios of such measurement are like as fixed and total assets turnover ratio which are computed
for Zurich Plc are as follows:
Table 4: Computation of asset utilization ratios
Name of ratios Formula 2015 (in £000) 2016 (in £000)
Net sales 18920 16243
Fixed assets 20331.6 25726
Fixed assets turnover ratio Net sales / fixed assets 0.93 0.63
Net sales 18920 16243
Total assets 27337.6 32229
Total assets turnover ratio Net sales / total assets 0.69 0.50
Investor ratios
Moreover, the ratios which are most helpful for the investor and company both in terms
of knowing return of initial investment are identified as an investor ratios. Higher the outcome of
such ratios show that company is more able to give return of the investment which is made by
investors in the firm. It consists various ratios and among them here EPS and return on equity
ratio are selected by Zurich Plc (Finkler and et.al., 2016). On the basis of investor ratios people
are able to take decisions that whether they should invest money in it or not. Such ratios for
Zurich Plc are calculated as below:
Table 5: Computation of investor ratios
Name of ratios Formula 2015 (in £000) 2016 (in £000)
Net profit 972.84 570.17
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Number of shares
outstanding 12410 12410
Earning per share Net profit / EPS 0.08 0.05
Net profit 972.84 570.17
Shareholder's equity 19635.16 20108
Return on equity Net profit / shareholder's equity 0.05 0.03
To,
Board of Directors,
Zurich Plc.
Date: 20th March 2017
Profitability ratios:
 Gross profit ratio:
2015 2016
34.00%
35.00%
36.00%
37.00%
38.00%
39.00%
40.00%
39.02%
35.86%
Illustration 1: GP ratio
Findings: From the above graph it can be analysed that gross profit ratio declines from 39.02%
to 35.86% from the financial year 2015 to 2016. The declining ratio is clearly indicates that
management of Zurich Plc has not control over the cost and expenses which occurs in goods
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sold. Here the company needs to take and frame those kinds of strategies which helps to control
on the expenses. In the year 2015 the management was able to sale more number of products in
comparison to the fiscal year 2016.
 Operating profit ratio:
2015 2016
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
13.65%
10.98%
Illustration 2: OP ratio
Findings: It can be analysed from the operating profit ratio that, in the year 2015 it was 13.65%
which reduce in further year and comes up to 10.98% which is the worse situation for Zurich
Plc. For calculating OP ratio all the operating expenses incurred in business process are to be
used such as production, selling and distribution, labour, material, utility, maintenance etc. It
can be said from the respective ratio that Zurich Plc is not able to reduce various kinds of such
mentioned costs by which operating profit reduces in the year 2016.
 Net profit ratio:
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2015 2016
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
5.14%
3.51%
Illustration 3: NP ratio
Findings: Another kind of profitability ratio is net profit which is declines from 5.14% to
3.51% which is the adverse situation and shows that financial performance of Zurich Plc
reduces from the year 2015 to 2016. Lower the net profit ratio shows that Zurich Plc is not able
to control over the indirect expenses like as interest, depreciation, rent, insurance etc. In order to
combat and increase net profit ratio the Zurich Plc needs to reduce debt amount and control to
the indirect expenditures incur in business process.
Liquidity ratio:
 Current ratio
2015 2016
0.21
0.22
0.23
0.24
0.25
0.26
0.27
0.28
0.29
0.28
0.24
Illustration 4: Current ratio
Findings: Key ratio of liquidity is current which was 0.28:1 in the fiscal year 2015 and in the
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next year i.e. 2016 it goes down up to 0.24:1. The current ratio clearly indicates that Zurich Plc
has higher amount of debt and lower profit in the financial year 2016 as compare to 2015 by
which it cannot meet with short term debts. Along with this as per the standard ratio 2:1
business performance of Zurich Plc is very poor and hamper overall financial performance. It
can be said from the ratio that in order to fulfil 1 liability it has only 0.24 current asset which is
very poor for Zurich Plc. It needs to increase profit at the end of year and enhance current
assets.
 Quick ratio
2015 2016
0
0.05
0.1
0.15
0.2
0.25 0.23
0.18
Illustration 5: Quick ratio
Findings: Reducing quick ratio indicates cash convertible assets are very low in the year 2016
as compare to year 2015. At the current, acid test ratio of Zurich Plc is 0.18:1 and in the past
accounting year it was 0.23:1 which is declining. It shows that management of the firm is not
able to pay short term debts in favourable way which lead to reduce liquid position at the end of
year 2016. Here it is very necessary for managers of Zurich Plc in order to generate high level
of net profit and reduce long term and short term debt. On the basis of overall liquidity ratios
the business performance of Zurich Plc is very poor in the overall manufacturing industry.
Gearing ratios:
 Debt to equity ratio:
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2015 2016
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
0.18
0.2
0.11
0.18
Illustration 6: Debt to equity ratios
Findings: It has been assessed from above graph that debt to equity ratio of Zurich Plc is 0.11:1
and 0.18:1 in the financial year 2015 and 2016 respectively. On the basis of standard ratio i.e.
0.5:1 the company is performing well in the industry because lower the debt equity ratio is
better for the firm. On the other side in terms of capital structure Zurich Plc is better because
level of debt reduces and equity enhance at the end of accounting period 2016.
 Interest coverage ratio:
2015 2016
1.7
1.8
1.9
2
2.1
2.2
2.3
2.4
2.28
1.91
Illustration 7: Interest coverage ratio
Findings: Declining ratio of interest coverage indicates that amount of interest reduces which is
the better situation for the Zurich Plc. Value of respective ratio was 0.28 in the year 2015 which
decreases up to 0.91 in the financial year 2016. It can be said from the analysis that
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management of Zurich Plc is less able to cover interest amount due to reducing operating and
net profit in the fiscal year 2016.
Asset utilization ratios:
 Fixed assets turnover ratio:
2015 2016
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1 0.93
0.63
Illustration 8: Fixed assets turnover ratio
Findings: As per the fixed assets turnover ratio it can be depicted that Zurich Plc is unable to
utilize all the fixed assets which it has in business in proper manner. Due to this reason sales
and turnover at the end of financial year 2016 is reduces and affects overall performance
adversely. The ratio is in the accounting year 2015 and 2016 is 0.93 and 0.63 times which clear
indication of reducing business performance. Management of Zurich Plc needs to make
effective strategies by which it able to utilize fixed assets for generating sales properly.
 Total assets turnover ratio:
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2015 2016
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.69
0.5
Illustration 9: Total assets turnover ratio
Findings: Reducing total assets turnover ratio shows that Zurich Plc has not ability to manage
and utilize its assets in order to manufacture products and sell in the market. In the present case,
such ratio was 0.69 in the year 2015 which declines and reaches up to 0.5 times in further year.
It can be said that the company is very less efficient for generating sales and revenue in the year
2016.
Investor ratios:
 Earning per share:
2015 2016
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.08
0.05
Illustration 10: Earning per share
Findings: On the basis of EPS, Zurich Plc not able to earn high earning by which number of
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shareholders reduce and it cannot raise fund properly. In the financial year 2015 and 2016 EPS
of the firm is 0.08 and 0.05 respectively which indicates that level of profit is lower compare to
previous year. In this case, it not able to provide return in terms of dividend to the shareholders
by which their interest to make investment in the firm reduces. Hence, in order to enhance EPS
Zurich Plc needs to attract more number of customers by which it will be able to earn high
amount profit.
 Return on equity (ROE):
2015 2016
0
0.01
0.02
0.03
0.04
0.05
0.06
0.05
0.03
Illustration 11: Return on equity
Findings: Last type financial ratio is return on equity which describes that Zurich Plc is how
much able to generate and provide return to the shareholders on amount by which equity shares
are purchased by them. ROE of Zurich Plc reduces from 0.05 to 0.03 which is worse situation
for the firm and reduce attraction of existing and new shareholders.
From the above overall analysis it can be concluded that, business and financial
performance of Zurich Plc is very poor and not well in the fiscal year 2016 compare to 2015.
Hence, the company needs to take corrective actions and frame effective business strategies to
enhance profit level.
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1.2 Critically evaluation of drawbacks of financial ratio analysis
The financial ratios are helpful to assess performance of business in terms of finance.
However, the ratios have some limitations when the business firm using it which are explained as
below:
 The data for calculating financial ratios are historical and derived from financial
statements by which historical results are measures. Further, it is not compulsory that in
the future fiscal year the company will perform same (Peavler, 2017).
 More number of information and data are required for the ratio analysis and sometimes in
the financial statements such data are not adequate which lead to hamper overall analysis
and cannot asses performance in proper manner.
 For calculating the financial ratios there is highly qualified employees has to higher in the
company who will charge higher payment which lead to impact on the profitability ratios
adversely.
 Using financial ratios two or more companies are to be compared but it is not necessary
that all the firms uses same accounting policies, standards and treatments to determine
selling price and prepare financial statements (Baxter and et.al., 2013). For instance, an
entity uses straight line method and another uses accelerated techniques of depreciation
then amount will differ.
 Further, it can be critically evaluated that financial ratios not use any kind of qualitative
approach by which reliable and proper data are not determined.
PART 2
2.1 Calculation on the basis of different investment appraisal techniques
Techniques which help to the firm such as Johnson limited in order to take effective and
profitable investment decisions in one project among two or more simultaneously projects is
identified as an investment appraisal methods. In the present case Johnson limited is going to
purchase a new machine at the cost worth of £2000000. In order to know that it will be profitable
in the future or not different financial tools are used such as NPV, ARR, IRR, payback period
and discounted period which are calculated as below:
A. Payback period:
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Table 6: Computation of payback period
Year Cash flow of machine (in £) Cumulative cash flow (in £)
Initial investment -£2000000
1 870000 870000
2 870000 1740000
3 870000 2610000
4 870000 3480000
5 870000 4350000
6 870000 5220000
PP 2.30 years
B. Discounted payback period:
Table 7: Computation of discounted payback period
Year
Cash flow of
machine (in £)
Discounting
factor @ 10%
Discounted
cash flow
Cumulative
discounted cash flow
Initial investment -£2000000
1 870000 0.9091 790909 790909
2 870000 0.8264 719008 1509917
3 870000 0.7513 653644 2163561
4 870000 0.6830 594222 2757783
5 870000 0.6209 540202 3297984
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6 870000 0.5645 491092 3789077
DPP 2.75 years
C. Accounting rate of return:
Table 8: Computation of ARR
Year Cash flow of machine (in £)
Initial investment -£2000000
1 870000
2 870000
3 870000
4 870000
5 870000
6 870000
Total 5220000
Average 870000
Initial investment 2000000
ARR 43.50%
D. Net present value:
Table 9: Computation of NPV
Year Cash flow of machine Discounting factor Present value of
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(in £) @ 10% machine
Initial investment -£2000000
1 870000 0.9091 790909
2 870000 0.8264 719008
3 870000 0.7513 653644
4 870000 0.6830 594222
5 870000 0.6209 540202
6 870000 0.5645 491092
Total 3789077
Less: initial investment 2000000
NPV £1789077
E. Internal rate of return:
Table 10: Computation of IRR
Year Cash flow of machine (in £)
Initial investment -£2000000
1 870000
2 870000
3 870000
4 870000
5 870000
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6 870000
IRR 36.89%
Analysis and Recommendations:
From the above computed capital budgeting techniques it can be said that, cost and
investment of machine recovers within 2.30 years and 2.75 years on the basis of payback and
discounted payback period respectively. Estimated life of the machine is for total 6 years and
recover period is very lower which is highly better for the Johnson limited. Apart from this, on
the basis of net present value return on the cost of machine is worth of £1789077 which is
profitable for it. In addition to this, according to the internal rate of return as well as accounting
rate of return values are such as 36.89% and 43.50%. It can be said that on the basis of each and
every investment appraisal methods and tools the machine provides positive and higher return of
the initial investment at the end of six years (Kerr and Murthy, 2013). If the Johnson limited
undertaking or purchase the respective machine that it highly able to generate positive return.
On the basis of such analysis it can be recommended to the management of Johnson
limited that, it should purchase the machine in the business process which provides future value
worth of £3789077 including initial cost. Along with this rate of return are also higher and total
cost of machine will be recover within very short period of time i.e. 2.30 or 2.75 years.
2.2 Key advantages and limitations of each investment appraisal techniques
The above mentioned investment appraisal tools are very helpful for the Johnson limited
in order to determine and take effective decisions to put money. In contrary to this such methods
have some limitations which are explained as below:
Payback period:
Advantages:
 It is very easy and simple method to calculate and assessing time period which will take
to recover initial investment.
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 It is clearly understood method by employees and helps to take effectual investment
decisions. Helps to compare two or more simultaneous projects and derive decisions.
Disadvantages:
 Key disadvantage of the payback period is that it not uses time value of money which
lead to hamper decision.
 Further payback period does not consider those cash flows which are occurred after that
year at which initial investment is covered (Payback period, 2013). It does not consider value of cost of capital which is also one of important for firm.
Discounted payback period:
Merits:
 It is updated solution or tool of the payback period which involves time value of money. The discounted payback period is more reliable and give better decisions as compare to
simple payback period method.
Limitations:
 However, the current method also not uses cash flows which are comes into consideration
after recovering investment which is made at initial stage (Arjaliès and Mundy, 2013). Further, it is little typical compare to simple payback period.
Accounting rate of return:
Benefits:
 Benefit of ARR is same as payback period which is that easy to make calculation and
take decisions.
 It uses the key factor such as profitability in order to make an investment. It considers cash flows of all the years of project life.
Drawbacks:
 Same as payback period that it does not consider an aspect i.e. time value of money.
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 There are different ways to calculate ARR which lead to differ rate of return.
Net present value:
Advantages:
 It is most reliable method and provide better and proper decisions as compare to another
techniques (Fourcade and Khurana, 2013).
 Helps to compare two or more mutually exclusive projects and give suggestion for
feasibility of project. It uses time value of money, cash inflows of every year as well as discounting factor.
Demerits:
 It does not consider size of project in terms of initial investment. Discounting factor is taken same for every year and in case if inflation rate gets changes
then lead to hamper future value or return.
Internal rate of return:
Merits:
 The tool is very simple among all the investment appraisal techniques. It takes very less time to calculate by which quick decisions are made by management
(Cangiano, Curristine and Lazare., 2013).
Demerits:
 It ignores cost of capital or discounting factor.
 IRR ignores size and of project when there are two or more simultaneous projects.
2.3 Critically evaluation of source of finance
When the business going to expand firm, purchase new property, machine, equipment
etc. it needs capital which is provided by different financing sources. In the present case, Johnson
Limited is going to purchase a new machine in the firm for which it needs amount worth of
£2000000. There are mainly three sources of finance are appropriate for the Johnson Limited
which are such bank loan, venture capitalists as well as sale of assets. These financing sources
are critically evaluated as below:
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 Bank loan: It is the best suitable source of finance for Johnson Limited which provides
fund to it for purchasing new machine in the business process. Further, it provides
amount or capital after making valuation of the entity and on the basis of this fund is to
be allotted. However, it can be critically evaluated that it is long process and charges
higher cost of finance in terms of interest (Nicolăescu, 2013). When interest rate in the
economy is high then Johnson Limited has to pay higher charges of the fund taken from
bank. Another limitation of bank loan is that, if Johnson Limited not able to pay loan
amount then bank can cease or wound up overall entity. Venture capitalists: Another appropriate source of finance for Johnson Limited is
venture capitalists which provides fund for business expansion at the lower cost in
comparison to bank loan. It is the source which has experience of business and give
effective suggestions also to management. In contrary to this, it can be said that charges
of venture capitalists are in terms of stake and further it becomes shareholder of Johnson
Limited. After that the firm has to give dividend amount from the profit generated by it
which lead to reduce net profit at fiscal year ending. In regard to this, it can be critically
evaluated that, it Johnson Limited takes loan from venture capitalists then control over
the business diluted in hand of ventures (Selfano, Peninah and Sarah, 2014).
 Sale of assets: It is internal financing source where fund and capital is to be raised within
business process. As per such source Johnson Limited sales those kinds of assets and
equipments which are unused as well as unproductive and sum of money comes from
selling is used for purchase new machine. It can be criticized that, when Johnson Limited
uses the source then amount of total assets reduces from balance sheet. Further, affects to
the liquidity position in adverse manner and then it cannot repay amount of short term
debt and obligations.
Financial management is a key concept of each and every business organisation which
helps to managers in order to plan, organise, directing as well as controlling over the various
financial activities. Apart from this with the support of financial management entity such as
Zurich Limited and Johnson Limited for manager procurement as well as utilizing the financial
resources in the optimum way. By considering the respective concept the company able to take
mainly three kinds of decisions such as financing, investment as well as dividend which are
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necessity part of the company. There are various kinds of the functions of financial management
which are highly important and used by the company which are provided as below:
 For estimating as well as forecasting the requirements of the capital and financial
resources.
 For selecting the appropriate source of finance in order to raising fund.
 In order to take decisions for making investment in the project where capital budgeting
methods are to be used.
 Apart from this on the basis of financial ratios which is the part of financial management,
firm able to take decisions for declaring dividend amount for the shareholders.
 Further, another function of financial management is to control as well as manage the
financial resources up to the high level.
There are several kinds of concepts are comes under the financial management by which
both he companies take different decisions as well as assess the financial performance up to the
higher level. By considering the concepts of financial management the company such as Zurich
and Johnson limited calculate financial ratios and assess viability of the project. Different kinds
of key concepts of the financial management are such as cash management, planning, estimating
and forecasting, reporting the financial data and information, make the appropriate capital
structure etc.
It has been critically analysed that when the company apply financial management at the
workplace then it has to appoint the manager who belongs from the core finance. Further,
amount in form of charges and salary also higher which is not beneficial for it. Further, the
financial ratios calculation is one of the time consuming method which falls under the financial
management by which productivity and efficiency of the employees reduce. Moreover, it is
typical to grasp and understand concepts and different accounting standards which are used in
financial management.
CONCLUSION
From the above analysis of financial management and control it can be analysed that to
manage financial resources is very important part of the firm. On the basis of financial ratio
analysis it can be depicted that financial performance of the Zurich Plc is poor in the fiscal year
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2016 as compare to 2015. Profitability, liquidity, solvency, efficiency, investor all the ratios are
in the adverse and worse situation in the firm. Apart from this, it can be concluded as per
investment appraisal techniques that the machine provides positive and profitable return of the
initial investment. Hence, it can be suggested to the management of Johnson Limited that, it
should put money and purchase the machine which gives positive future value and rate of return
along with lower payback period. In addition to this, Zurich Plc needs to frame effective
strategies to enhance level of profit or yield at the end of fiscal year.
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