Financial Accounting Acc1011 SX Week 7 Financial Analysis Read Chapter 13: Accounting an introductio

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Financial Accounting (Acc1011 S/X) Week 7
Financial AnalysisRead Chapter 13 Accounting
an introduction

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Objective of business

• Maximise shareholder wealth
• HOW?
• Paying a dividend and/or increasing the net
  assets of the business

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Financial analysis

• Examine the financing, investing and dividend
  (distribution) decision
• Has shareholder wealth increased and will it
  continue to increase in the future?

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Financial analysis

• 3 key decisions
• Financing Investing
• Dividend
• (distribution)

Firm
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Financial analysis

• Objective
• To examine a firms financial position and
  returns in relation to risk, with a view to
  forecasting the firms future prospects and
  future cash flows

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Financial position

• Look at the Balance Sheet financing decision
• Capital Equity
• Structure Debt

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Financing decision

• How are the assets in the business
• financed Debt or equity or both
• An increase in the use of debt has
• the potential to increase returns
• BUT it can increase the financial
• risk of the business

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What is financial risk

• Will the business generate a higher return from
  the funds used than the interest payable
• Will the business be able to pay the regular
  interest payments and repay the capital sum when
  they fall due
• Potential bankruptcy (insolvency)

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Risk and return

• Business A
• Assets R8m
• Equity R8m
• Profit before interest 2m
• Interest 15

• Business B
• Assets R8m
• Equity R4m
• Debt R4m
• Profit before interest 2m
• Interest 15

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Risk and return

• Business A
• PBI 2m
• Interest ___
• Profit

• Business B
• PBI 2m
• Interest ____
• Profit

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SO

• Business A
• Return on equity
• Profit x 100
• Equity

• Business B
• Return on equity
• Profit x 100
• Equity

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BUT what if?

• Business A
• PBI 0.6m
• Interest 0
• Profit 0.6m
• ROE

• Business B
• PBI 0.6m
• Interest (0.6m)
• Profit 0
• ROE

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Investing decision Type of assets(depends on
nature of business Manufacturing, retailing or
servicing)

• Non current
• PPE
• Vehicles
• Investments

• Current
• Accounts receivable
• Inventory
• Cash

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Investing decision

• What type of assets has the business invested in?
• How effective is the business in generating
  income (creating wealth) from these assets?

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Returns

• What returns has the company generated?
• Find this information on the
• Income statement
• Cash flow statement
• Quality of earnings
• (What of sales or profit is converted to
  cash?)

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Dividend distribution decision

• What portion of net profit is paid out as a
  dividend?
• Could the business pay a cash dividends in a year
  when the business made a loss?
• Liquidity solvency requirements?

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What information is important?

• WHY are you analysing the business?
• WHAT are you trying to understand
• about the business?
• Who is the User, i.e. suppliers, bank, investor,
  employee, SARS
• Huge amount of information available
• identify information that is useful in
• addressing your needs?
• GIGO