Methods of Investment Appraisal and Financial Statement Analysis
The purpose of this report is to assess various method of investment appraisal and financial statement analysis and and finaly recommendation on choosing stratefic portfolio.
Task 1
Forcasting
There are various to forecast from the past result and find out what is going to happen future
The simplest method for forcasting revenue and cost through time series analysis with simple moving average for example
Using moving average the forcast for next months will be Forcast jan+feb……..to dec divided by 12 months and answer is for July the forcast would be 31.58 or 32 and so on.
Trend is systermatic (gradual) increase or decrease in average over time while seasonal forcasting is the predictable short term cycling behaviour for whatever reason day month week etc
For example assume the following market share of tesco in the next year
Seasonal Factor
Average Seasonal factor
Month
2007
2006
2007
2006
Jan
31
30.6
1.02
1.02
1.02
Feb
32
30.4
0.99
1.03
1.01
Mar
35
30.6
0.91
1.02
0.96
Apr
33
31
0.96
1.01
0.98
May
31
31.4
1.02
0.99
1.01
Jun
29
31.5
1.10
0.99
1.04
Jul
30
31.6
1.06
0.99
1.02
Aug
31.4
31.4
1.01
0.99
1.00
Sep
33.1
31.2
0.96
1.00
0.98
Oct
32.2
31.4
0.99
0.99
0.99
Nov
32.34
31.4
0.98
0.99
0.99
Dec
31.1
31.4
1.02
0.99
1.01
Average
£31.76
£31.16
Now if we want to find market share of tesco in January of 2008
January forcast = Average forcast multiply by seasonal factor which is 1.02
If average mothly forcast for the year is 30 then forcast for January will be 30*1.02 =
30.6
Task 1 part 2
Its very know and understandable fact that start a new business or growing it require a lot of hard work ,planning and right kind of financing with a team of dedicated peoples.
There are all source of finance which can be used to finance but each of them has some benefit or edge over in some way or other.
Therefore deciding which source of financing should we use is a lots home work together ability to face issues coming up and ability to take decisions.
Money (Capital) is life blood of any business and business cannot survive without capital.
Keeping plan flexible
Thinking big and move fast
Business should move on when raising capital
Strong management team
What amount capital required depended what we want to achieve and our experience e and credit worthiness and stage of growth at which we stand together general factor such market trends and economic condition.
There are various sources of finance depend on business
1) Self Financing:
Self Financing
Financing through credit card and is the most riskiest option and costly as interest rate on credit cards are very high and amount available is normally low subject credit evaluation conducted by bank.
Start up Financing is another method whereby a business can put cash into the new business generated through various different source till it is reach to level to generate further financing itself.
2) Commercial Financing by Bank
Business can get commercial financing if they have track record or they have something to give as security to bank.
Commercial financing is very important and fundamental way to finance a specific project and normally bank will agree to finance if there is home work done with regards to feasibility.
The disadvantage is company has to bear risk of loss and bank will charge interest which is great cost
Though these are disadvantages still commercial finance through bank most widely use to finance a specific project.
3) Share Issue
A newly establish company can issue Initial public offering to raise finance from public but a lot of home work require. Private Companies can issue new shares in the form rights issue or bonus issue but can’t advertise them.
Initially company can finance itself equity investment by investors. Later on merger or acquisition of limited company is very good source raising finance by issuing shares.
Share issue is quite unusual way to raise money for specific project its time consuming and lengthy process but its one the less riskiest way.
5) Finding Investor/Partner
Finding a person, group or organization to fund business is another form of financing to raising capital .the advantage if this method is risk is shared between partners and disadvantage is worth generates from business is divided between one more peoples according partnership agreement.
There are many other sources of finance for small business like local government initiatives on lending program and commercial companies providing finance etc.
Some big companies are really cash rich and therefore they look opportunities to invest cash and therefore they can act as strategic investors.
Task 2
There are vaious method appraise financial returns on various competing project. The most important of them are
1) Payback period
2) Net present value
1 Pay back period
Lets take a example if there are two projects where initial investment is 60m while one give return as following
Year Amount
1 10
2 25
3 30
4 28
While another project give returns as
Year Amount
1 13
2 20
3 25
4 50
Solution
Project One
Year Amount Remaining Investment
0 60
1 10 50
2 25 25
3 30 25 —————
4 28
Project Two
Year Amount Remaining Investment
0 60
1 13 47
2 20 27
3 25 2
4 50 2 iniital investment returne
The first project here pay its entire investment in three years while the second projecgt pay its entire investment four year time so according payback period method project two should be selected.
Payback period doesn’t account for time value of money therefore not very effective method
2. Net Present Value
Taking the same example above if we analyse them (we need discount factor which cost of capital to discount future cash flows. Lets assume it as 10%
Year Amount Discount Factor Present Vaue
1 10 0.909 9.09
2 25 0.826 20.65
3 30 0.751 22.53.
4 28 0.683 19.124
71.394
Project Two
Year Amount Remaining Investment Present Vaue
0 1
1 13 0.909 11.817
2 20 0.826 16.52
3 25 0.751 18.775
4 50 0.683 34.15
81.262
The Net present value of second project is more than first one therefore e according to npv method second project is more profitable.
Select appropriate and relevant financial information for use in the process of making strategic decisions on investment
There are vaious ways to analyse investment each has it own merit and demerit but mostly to analyse investment we required some basic information to make our decision on.
If we are comparing two or more competing projects we can do by using investment appraisal techniques like net present value etc
We need some basis information to calculate and appraise and finally take investment decision which
Approximate amount of total investment required for the project
The future cash flow whether inflow or outflow that can be generated from the project.
The minimum required return .
If we are going to invest in a company we need to focus on two main factor which are how much dividend it pays through ratios called dividend cover and dividend yield and how much capital gain we can get by movement in share price relevant ratios are price earning ratio, earning per share etc.
For the above calculation we need exact amount of
Dividend paid during the year
Share price
Profit after tax
Number of ordinary share issued
This information can be drawn from the financial statement of targeted company.
The future investment can be based on basis of past performance of selected companies
The investment in company to acquire needs other consideration which is based on various financial as well as non financial factors but mostly following factors are taken into account .
Company financial health through calculation of various ratio profitability, gearing , liquidity and efficiency etc
The vision, mission , goals and objectives of the acquiring company and strategies to achieve those and many more. Therefore decision regarding acquisition or mergers required comprehensive analysis.
Make recommendations based on a post-audit appraisal on the appropriateness of selected investment project decisions
The payback period is simplest method to decide between competing project which one is the best but it ignore time value of money
Net present value account for time value of money and is one of the mostly used way to appraise competing projects but it is complex and and require some figures to give correct answer like discount rate etc
For investment in the shares of company we need financial information such as share price dividend eps etc but selection of company to invest in its share depends on many other factors like if the investing entity want to invest for long term or short term
For long term investements share price moment is more important than dividend or vice versa.
Task 3
Financial Statements
Analyse financial statements using relevant techniques to assess the financial viability of an Tesco for 2008
The financial statement of any organization can be analysed by calculation of ratio and each ratio has its own significance and importance. There is hard and fast rule and no parameters to judge performance of each and every company against but its very subjective and depend on company and industry in which it operates.
Let assume the following financial statement belong to company called Simon Sparks and analyse its financial statement.
Simon Sparks
Profit and Losss Account
the period ended 30June 200X
£
£
£
Sales
292,000.00
Less Sales returns
13,800.00
Net Sales
278,200.00
Carriage outwards
15,000.00
263,200.00
Less cost of good sold
S
Opening stock
15,100.00
Purchases
135,600.00
Less Purchase returns
– 5,200.00
130,400.00
Less Closing Stock
16,200.00
129,300.00
Gross Profit
133,900.00
Bad debts
2,200.00
Advertising
6,000.00
Electricity & Gas
11,100.00
Salaries and wages
37,200.00
Insurance
5,700.00
Motor expenses.
16,600.00
Postage & stationery
2,400.00
Rent & rates
20,900.00
102,100.00
Net Profit
31,800.00
Less Drawings
15,800.00
Retained Profit
Balance Sheet as at 30 June
as of 30 June 200X
Non Current Asset
( . Fixtures & Fittings @ cost
60,300.00
Motor vehicle @ cost
42,000.00
Total Non Current Asset
102,300.00
Current Asset
Cash
600.00
Trade debtors
24,000.00
Closing stock
16,200.00
Total Current Asset
40,800.00
Total Asset
143,100.00
Liabilities and Owners Equity
Capital
83,800.00
Retained Profit
16,799.00
100,599.00
Non Current Liabilities
Current Liabilities
Bank Overdraft
5,600.00
Trade Creditors
36,901.00
Total liabilities plus capital
143,100
126,699.00
All businesses exist to make profit in some way or other and to measure profitablilty we have many ratio to analyse same data from different aspects. Retuen on capital employeed is a primary ratio to assess profitablitly of any orgnization and its one of most widly used ratio.It is calculated by
Dividing Profit before interest and tax with capital plus long term liability In the case of Simon spark it is 32% which can be assume as very good performance interims of profitability but ratio can’t be analyses in standalone way they must be compared with some industry average competitor or past performance to evaluate and we don’t ant information available here.
Simon Park has managed to generate gross sale of £292,000 which is really commendable as long as data is reliable and comparable. The Gross profit ratio shows company’s profit margin when selling price is compared with cost of sale. The GP ratio of Simon spark is 51% which is really commendable and appreciatable but remember we are assuming that data is not only reliable but trustable.
The other factor to measure profitability is net profit 6% here we see how effectively and efficiently day to day operation are run by management.
Surprisingly the net profit margin is just 6% it is definably not very good indication of good performance but due to limitation of information for comparison we are unable to give conclusive remarks but 6% is very low and it shows though company is earning profits but it’s not working efficiently and effectively.
The most significant expenses are salaries and wages followed by rent and rates. We don’t know if it’s inefficient management but definitely I think there is enough room for improvement
Liquidity
Liquidity ratios are very important as company can be profitable but if not liquid enough can run to insolvency or at least find it self in big problems.
Liquid assets are those which can easily convert in to cash with in short duration of time. The examples are cash, debtor, stock etc.
The most important of liquidity ratio is current ratio which shows current assets as number of times to current liabilities and it is very widely used in business world.
There is no specific ratio which can be said as good enough or bad as it varies from industry to industry and company to company.
Simon Sparks current ratio is 1.5 times it mean it has 50% more liquid asset to meet it immediate needs. It’s not bad but considering limitation of information we can assume it’s up to standard of industry.
But there is more important ratio coming out of current ratio it is quick ratio. In quick ratio we don’t consider stock as quickly convertible into cash asset and therefore remove it.
The quick ratio of simpn spark is 0.94 times which can’t be said either good enough or bad for the reason mention above.
Carry out a performance audit of an organisation including reference to internal and external factors
Performance audit is audit of mainly(management operations ,function or procedures of) not for profit or governmental organization to ensure value for money (economy efficiency and effectiveness ) in utilization of resource by using systematic professionally designed and conduct methodologies which are generally accepted and well structured.
Few benefits of performance audit is
Improving organisational performance
A tool to increase efficiency
Policy and performance
Legal imperative
Performance audit may include detection of fraud and error but its not included everytime there fore scope of permance audit must define and given in writing prior to start of work
Performance audit using internal factors might be for example in production it may number of units produce in a one hour compare with standared or ideal performance
For financial performance profit can be compare from period to another with cost of sale and revenue to ensure resource are used properly and generate value for money
External factors to consider for performance audit are comparision of per unit cost with major competitor to ensure VFM (value for money economy, efficiency and effectiveness is achieved .
Comparision of number of staff with equivalent or similar company or employee productivity with similar organization
Performance audit is not define in any standered and can include anything but it is different from performance measurement.
Use appropriate calculations to improve the quality of financial information used
The quality of information is very important because its not reliable and relevant than its useless most business try to spend thousand to avoid the lost of money but unfortunately lack of focus on right cause more loss.
The reliable and timely financial information is essential for success and to avoid loss and making wrong decision on the basis of misleading information.
Financial in itself is very vast and full of useful information but its generall and everyone has to take this information and use it assess their own purpose for example a company can generate huge profits say
Company A has revenue of £100 million while gross profit is £50 million and net profit £25 million.
A lay men can conclude fromthis information that companys is performing really well and generating good profits but what if we got data the competitor of same size earn profit £1000 m with Gross profit ratio of 70% unlike our 50%.
Even worse can happen like company is generating huge profits but its running out of cash to pay its immediate liabilities . Creditors have right to appeal in court and prove company as defaulter and therefore cease its existence.
So calculation of various ratio from the broad set of financial statement help in understanding actual position of company regarding its competitors.
I
Make recommendations on the strategic portfolio of an organisation based on the interpretation of financial and ancillary information
The world is moving very fast and there is increasing competition with increasing globalization and opening of borders therefore organization need to update themselves with latest information and predict future and prepare for it
Organizations have many reason to believe that they have to prepare themselves before the storm and therefore they are required to identify, find and use the required information whether financial or other to prepare themselves for the future.
There are various strategies an organization can follow to achieve its objectives. A company should diversify if they have access to adequate resource (financial or other)and technical capability to achieve success.
Diversification bring competitive advantages as with mergers as economies of scale and information asymmetry can achieved .
Strategic portfolio may include developing and investing in new technologies to achieve competitive advantage as technology as key to success.
The factor which can be consider for strategic portfolio is to develop new products and or improve exsiting one to compensate those products whose lifecycle is about to finish .
Partnership with international companies or local companies to enter new ventures is also a great option and by doing this organization can not diversify but loss in case of failure is share between partners and there will be access to new and usesful information by working with another organization.
These are the few reformation which an organization should consider to develop there strategic portfolio and its quite subjective and can vary from one organization to another.
30.6
30.4
30.6
31
31.4
31.5
31.6
31.4
31.2
31.4
31.4
31.4
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