Strategic Financial Analysis Assignment

Strategic Financial Analysis

Contents
1. Introduction..................................................................................................................................4
2. Critical Review of Traditional Methods of Financial Analysis...................................................4
2.1 Horizontal Analysis................................................................................................................4
Description of Analysis Method...............................................................................................4
Supporting the Analysis Method with using empirical academic literature............................4
Shortcomings............................................................................................................................5
Horizontal Analysis of two Selected Companies (See Appendix 1)........................................5
2.2 Vertical Analysis....................................................................................................................5
Description of Analysis Method...............................................................................................5
Supporting the Analysis Method with using empirical academic literature............................5
Shortcomings............................................................................................................................6
Vertical analysis of two Selected Companies (See Appendix 2).............................................6
2.3Traditional Ratio Analysis......................................................................................................6
Description of Analysis Method...............................................................................................6
Supporting the Analysis Method with using empirical academic literature............................6
Shortcomings............................................................................................................................7
Ratio Analysis of the two selected companies (See Appendix 3)............................................7
3. Contemporary Method of Financial Analysis..............................................................................8
3.1 Capital Asset Pricing Model (CAPM)...................................................................................8
Description of Analysis Method...............................................................................................8
Supporting the Analysis Method with using empirical academic literature by illustrating it
effectiveness in overcoming the drawbacks of traditional financial analysis method.............8
Criticism of the Model.............................................................................................................9
3.2 Divided Growth Model (DGM).............................................................................................9
Description of Analysis Method...............................................................................................9
Supporting the Analysis Method with using empirical academic literature by illustrating it
effectiveness in overcoming the drawbacks of traditional financial analysis method.............9
Criticism of the Model...........................................................................................................10
3.3 Effective Market Hypothesis...............................................................................................10

Description of Analysis Method.............................................................................................10
Supporting the Analysis Method with using empirical academic literature by illustrating it
effectiveness in overcoming the drawbacks of traditional financial analysis method...........10
Criticism of the Model...........................................................................................................10
Conclusion.....................................................................................................................................11
References......................................................................................................................................12
Appendixes....................................................................................................................................13
Appendix 1.....................................................................................................................................13
Horizontal analysis Booker............................................................................................................13
Horizontal analysis Tate & Lyle....................................................................................................15
Appendix 2.....................................................................................................................................18
Vertical analysis Booker................................................................................................................18
Vertical analysis Tate & Lyle........................................................................................................20
Appendix 3:...................................................................................................................................23
Ratio Analysis of Booker...............................................................................................................23
Ratio Analysis of Tate & Lyle.......................................................................................................24

1. Introduction
The present report is developed for providing a critical analysis of the accounts of
selected business organizations on the perspective of an external user. The report emphasizes on
the deficiencies present in the traditional method of financial analysis through carrying out the
financial analysis of two selected companies. The report proposes the use of contemporary
analysis methods for financial analysis in order to overcome the shortcomings of the traditional
analysis. The financial analysis can be described as method of developing an understanding of
the financial position of an entity through evaluating its general purpose financial statements
such as balance sheet, income statement, cash flow statement and others (Brigham and Ehrhardt,
2007). In this context, the report demonstrates a critical review of traditional method of financial
analysis such as horizontal, vertical and ratio analysis. The contemporary methods of financial
analysis examined under the report are capital asset pricing model (CAPM), dividend growth
model (DGM) and effective market hypothesis.
2. Critical Review of Traditional Methods of Financial Analysis
2.1 Horizontal Analysis
Description of Analysis Method
The horizontal analysis also known as trend analysis is a technique used for fundamental
analysis of business companies by financial analysts in which they compare the ratios and line
items over accounting periods. It is also known as time series analysis that emphasizes on change
in accounting numbers over certain period of time. It helps the potential investors and creditors
to analyse the growth incurred by a company over the number of years. It also analyses the
growth rate of a company through comparing it with its competitors and industry. It analyses the
performance of companies through evaluating the percentage change occurred in any item of its
financials such as revenues, earnings per share (EPS) and others. The major assumption used in
the analysis method is that it is based on evaluation of the financial data of past and therefore
cannot be regarded as accurate technique of analyzing the financial position of a company (Griff,
2014).
Supporting the Analysis Method with using empirical academic literature
The horizontal analysis method involves evaluating a consistent pattern within the
financial accounts and thus the results provided by it are based on percentage increase or
decrease and thus are reliable. Also, the horizontal analysis method enables the analysts to
compare the financial position of different companies irrespective of their size. This is because
the method provides the financial results on the basis of percentage increase or decrease and
therefore appropriate to evaluate the financial position of companies of different size. The
method is also useful for analyzing the large changes in each line item of the financial account of

a company. It is the most useful method for analyzing the growth in the financial performance of
a company over large number of accounting periods (Megginson, Lucey and Smart, 2008).
Shortcomings
The horizontal analysis provides the results about the financial performance of a
company through the use of past financial data. Thus, the method is not useful for predicting the
present financial performance of a company. The method involves aggregating the financial
information of the past that may have changed over the period of time. The method prove to be
useful only when the analysis of financial statements of all the companies are carried out at the
same time in order to completely assess the complete impact of operational results on the
financial performance of a company. The results obtained from the use of horizontal analysis can
be modified by the analysts for intentionally mis-reporting the financial results (Bierman and
Smidt, 2003).
Horizontal Analysis of two Selected Companies (See Appendix 1)
As per the horizontal analysis carried out of Booker and Tate & Lyle given in the
appendix, it can be said that Booker depicts an increasing trend while Tate and Lyle have shown
a decreasing trend from the period 2012-2015. The Booker has shown an increasing trend in the
revenue generation while Tate & Lyle shows a decreasing trend of revenue generation. Similarly,
the trend analysis of the balance sheet of the two companies depicts that Booker records an
increase in the assets and liabilities while Tate & Lyle depicts a decreasing trend from the period
2012-2016. Thus, the trend analysis of the two companies has depicted the percentage changes in
the components of the income statement and the balance sheets in comparison to the originating
year for depicting the financial growth in the consecutive years.
2.2 Vertical Analysis
Description of Analysis Method
The vertical analysis can be described as a method of analyzing the financial position of a
company through assessing the proportion of the total account of assets, liabilities and equities in
the financial statements. The vertical analysis uses the base figures of total assets, total liabilities
and stakeholder’s equity in order to develop an individual statement depicting the financial
performance of a firm. The key assumption that is used in the method is that all asset groups are
condensed to depict the percentage of total assets that is used as a base figure for comparison.
For example, the vertical analysis of income statement uses sales figure as a base figure and all
other components such as cost of sales, gross profit, operating expenses, income tax are depicted
as sales percentage (Henderson et al., 2015).
Supporting the Analysis Method with using empirical academic literature
The vertical analysis also known as common-size analysis method helps in analyzing the
financial position of a company through evaluating the percentage of a base figure of each item
within the statement. This helps in predicting the percentage growth realized by a company in

each item of its balance sheet by illustrating the relative sizes of different accounts. The
percentage in the method of vertical analysis is calculated through the use of following formula:
The use of vertical analysis helps in restating the financial statements of a company in the
percentage format that helps in comparing the results obtained in the present year with that of the
previous year. The use of vertical analysis helps in carrying out inter-company transactions of
enterprises having varied sizes as all the financial items are expressed as percentage of common
number. For example, there are two companies A and B operating in the same industry out of
which company A is small and company B is large. As such, the vertical analysis through the use
of sales figure as base can help in comparing the gross profit percentage for both the companies
(Besley and Brigham, 2014).
Shortcomings
The common size statement lacks standardizations as there is not standard method of
calculating the percentage change in different items of the financial statements. It is based on
historical costs and therefore provides misleading financial information. It is not helpful in
providing useful financial information during seasonal fluctuations such as closing stocks. It
does not help in assessing the liquidity and solvency position of a company (Bender, 2013).
Vertical analysis of two Selected Companies (See Appendix 2)
As per the vertical analysis of two companies depicted in the appendix section, the
Booker and Tate & Lyle income statement and balance sheet depicts different growth patterns.
The operating profit is showing an increasing trend as a percentage of the total sales for Booker
while it is depicting a decreasing trend for the Tate and Lyle. The balance sheet vertical analysis
represents the percentage changes in each line item in comparison to the total assets. The current
assets for the Booker represent an increasing trend while that for Tate and Lyle depicts a
decreasing trend. Therefore, it can be said from the vertical analysis of the two companies that
Booker financial performance is much better than Tate & Lyle over the financial period of 2012-
2016.
2.3Traditional Ratio Analysis
Description of Analysis Method
The ratio analysis method is used for analyzing the financial performance of a company
though examining its efficiency, liquidity, profitability and solvency condition. The ratios are
compared over the period of time to predict the financial growth or devaluation in a company
value (Horngren et al., 2012).