1 © 2008 Thomson South-Western

MANAGEMENT OF FINANCIAL RESOURCES AND

PERFORMANCE

SESSIONS 5 & 6

FINANCIAL DATA, PERFORMANCE ANALYSIS & MANAGEMENT

AND DECISION MAKING

June 10 to 24, 2013

CA. Sonali Jagath Prasad

ACA, ACMA, CGMA, B. Com.

WESTFORD SCHOOL OF MANAGEMENT

Know how to assess the performance of

organisations

Session –Learning Outcome

Session -Takeaways

Understand sources of financial data and

justify selection of data

Evaluate performance using various

analytical tools

Analyse business information to support

strategic decisions

Make recommendations on improving

business performance

I. SOURCES OF FINANCIAL

DATA

Need for Data

Data is required to :

– Apply performance analytical tools

– Understand market trends

– Compare historical performance of company to see trends

– Compare a company’s performance with industry

– Compare performance with competitor

– Analyse areas of improvements in revenues or costs

Data/information is also required for taking strategic

management decisions like:

– Expansion

– Capital budgeting

– Lease or buy an asset

– make or buy product or sub-component

– Discontinue a product or service etc.

Evaluate managerial or divisional performance

Sources of Data

Internal Sources of Data:

– Financial Statements

– Cost reports

– Sales reports

– Management reports

– Internal audit reports

External Sources of Data

– Market intelligence

– Government agencies such as Ministry of Industry,

Central Banks

– Industry associations

– Stock markets for listed companies

II. PERFORMACE ANALYSIS

TOOLS

Application of

analytical tools

Involves

transforming data

Reduces

uncertainty

Basics of Analysis

Internal Users External Users

Financial statement analysis helps users

make better decisions.

Managers

Officers

Internal Auditors

Shareholders

Lenders

Customers

Purpose of Analysis

Objectives of Performance

Analysis

What are the assets that the firm has in place already, and how

much are they worth?

What are the growth assets of the firm and what is their value?

What is the mix of debt and equity that the firm is using to

finance these assets?

What is the firm earning on its assets in place, and what can it

expect to earn on these same assets as well as its growth

assets?

How much risk is there in this firm?

What is the growth potential of the firm?

What is the cost of its debt and equity financing?

Is the firm earning enough for its stakeholders?

Is the firm doing as well as its peers?

Is the market valuing the firm as well as its peers?

Comparative Analysis

There are three types of comparisons

to improve decision usefulness of

financial information:

Intra company basis

Inter company basis

Industry averages

Intracompany Basis

Comparisons within a company are often useful

to detect changes in financial relationships and

significant trends.

A comparison of Microsoft's current year's cash

amount with the prior year's cash amount shows

either an increase or a decrease.

A comparison of Microsoft's year-end cash

amount with the amount of total assets at year-

end shows the proportion of total assets in the

form of cash.

Intercompany Basis

Comparisons with other companies

provide insight into a company's

competitive position.

Microsoft's total sales for the year

can be compared with the total sales

of its competitors such as Apple Inc.,

Google Inc, Oracle Corporation etc.

Industry Averages

Comparisons with industry averages provide information about a company's relative position within the industry.

Microsoft's financial data can be compared with the averages for its industry compiled by financial ratings organizations such as Dun & Bradstreet, Moody's, and Standard & Poor's.

Statements in Comparative

and Common-Size Form

Dollar and percentage changes on statements

Common-size statements

Ratios

Analytical

techniques used to

examine

relationships among

financial statement

items

Dollar and Percentage

Changes on Statements

Comparing statements underscores

movements and trends and may provide

valuable clues about what to expect in the

future.

Horizontal analysis Trend

analysis

Horizontal Analysis

Horizontal analysis shows the changes

between years in the financial data in

both dollar and percentage form.

Horizontal Analysis

Example

The following slides illustrate a horizontal

analysis of Clover Corporation’s

December 31, 2000 and 1999 comparative

balance sheets and comparative income

statements.

Horizontal Analysis

CLOVER CORPORATION

Comparative Balance Sheets

December 31, 2000 and 1999

Increase (Decrease)

2000 1999 Amount %

Assets

Current assets:

Cash 12,000$ 23,500$

Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000

Prepaid expenses 3,000 1,200

Total current assets 155,000 164,700

Property and equipment:

Land 40,000 40,000

Buildings and equipment, net 120,000 85,000

Total property and equipment 160,000 125,000

Total assets 315,000$ 289,700$

Horizontal Analysis

Calculating Change in Dollar Amounts

Dollar

Change

Current Year

Figure

Base Year

Figure = –

The dollar

amounts for

1999 become

the “base” year

figures.

Calculating Change as a Percentage

Percentage

Change

Dollar Change

Base Year Figure 100% = ×

Horizontal Analysis

Horizontal Analysis

CLOVER CORPORATION

Comparative Balance Sheets

December 31, 2000 and 1999

Increase (Decrease)

2000 1999 Amount %

Assets

Current assets:

Cash 12,000$ 23,500$ (11,500)$ (48.9)

Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000

Prepaid expenses 3,000 1,200

Total current assets 155,000 164,700

Property and equipment:

Land 40,000 40,000

Buildings and equipment, net 120,000 85,000

Total property and equipment 160,000 125,000

Total assets 315,000$ 289,700$

($11,500 ÷ $23,500) × 100% = 48.9%

$12,000 – $23,500 = $(11,500)

Horizontal Analysis

CLOVER CORPORATION

Comparative Balance Sheets

December 31, 2000 and 1999

Increase (Decrease)

2000 1999 Amount %

Assets

Current assets:

Cash 12,000$ 23,500$ (11,500)$ (48.9)

Accounts receivable, net 60,000 40,000 20,000 50.0

Inventory 80,000 100,000 (20,000) (20.0)

Prepaid expenses 3,000 1,200 1,800 150.0

Total current assets 155,000 164,700 (9,700) (5.9)

Property and equipment:

Land 40,000 40,000 - 0.0

Buildings and equipment, net 120,000 85,000 35,000 41.2

Total property and equipment 160,000 125,000 35,000 28.0

Total assets 315,000$ 289,700$ 25,300$ 8.7

Horizontal Analysis

We could do this for the liabilities

& stockholders’ equity, but now

let’s look at the income statement

accounts.

Horizontal Analysis

CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Increase

(Decrease)

2000 1999 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3

Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)

Operating expenses 128,600 126,000 2,600 2.1

Net operating income 31,400 39,000 (7,600) (19.5)

Interest expense 6,400 7,000 (600) (8.6)

Net income before taxes 25,000 32,000 (7,000) (21.9)

Less income taxes (30%) 7,500 9,600 (2,100) (21.9)

Net income 17,500$ 22,400$ (4,900)$ (21.9)

Horizontal Analysis CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Increase

(Decrease)

2000 1999 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3

Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)

Operating expenses 128,600 126,000 2,600 2.1

Net operating income 31,400 39,000 (7,600) (19.5)

Interest expense 6,400 7,000 (600) (8.6)

Net income before taxes 25,000 32,000 (7,000) (21.9)

Less income taxes (30%) 7,500 9,600 (2,100) (21.9)

Net income 17,500$ 22,400$ (4,900)$ (21.9)

Sales increased by 8.3% yet

net income decreased by 21.9%.

Horizontal Analysis CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Increase

(Decrease)

2000 1999 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3

Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)

Operating expenses 128,600 126,000 2,600 2.1

Net operating income 31,400 39,000 (7,600) (19.5)

Interest expense 6,400 7,000 (600) (8.6)

Net income before taxes 25,000 32,000 (7,000) (21.9)

Less income taxes (30%) 7,500 9,600 (2,100) (21.9)

Net income 17,500$ 22,400$ (4,900)$ (21.9)

There were increases in both cost of goods sold (14.3%) and

operating expenses (2.1%). These increased costs more than offset

the increase in sales, yielding an overall decrease in net income.

Trend Percentages

Trend percentages

state several years’

financial data in terms

of a base year, which

equals 100 percent.

Trend Analysis

Trend

Percentage

Current Year Amount

Base Year Amount 100% = ×

Trend Analysis

Example

Look at the income information for

Berry Products for the years 1998

through 2002. We will do a trend

analysis on these amounts to see

what we can learn about the company.

Trend Analysis

Berry Products

Income Information

For the Years Ended December 31,

The base

year is 1998, and its amounts

will equal 100%.

Year

Item 2002 2001 2000 1999 1998

Sales 400,000$ 355,000$ 320,000$ 290,000$ 275,000$

Cost of goods sold 285,000 250,000 225,000 198,000 190,000

Gross margin 115,000 105,000 95,000 92,000 85,000

Trend Analysis

Berry Products

Income Information

For the Years Ended December 31, Year

Item 2002 2001 2000 1999 1998

Sales 105% 100%

Cost of goods sold 104% 100%

Gross margin 108% 100%

1999 Amount ÷ 1998 Amount × 100%

( $290,000 ÷ $275,000 ) × 100% = 105%

( $198,000 ÷ $190,000 ) × 100% = 104%

( $ 92,000 ÷ $ 85,000 ) × 100% = 108%

Trend Analysis

By analyzing the trends for Berry Products, we can see that cost of

goods sold is increasing faster than sales, which is slowing the increase

in gross margin.

Berry Products

Income Information

For the Years Ended December 31, Year

Item 2002 2001 2000 1999 1998

Sales 145% 129% 116% 105% 100%

Cost of goods sold 150% 132% 118% 104% 100%

Gross margin 135% 124% 112% 108% 100%

Trend Analysis

We can use the trend percentages to

construct a graph so we can see the trend

over time.

100

110

120

130

140

150

160

1998 1999 2000 2001 2002

Year

Perc

en

tag

e

Sales

COGS

GM

Common-Size Statements

Common-size

statements use

percentages to express

the relationship of

individual components to

a total within a single

period. This is also

known as vertical

analysis.

Vertical Analysis

(Cross Sectional Analysis)

Shows relationship of each item to a

base amount on financial statements

Income statement – each item

expressed as percentage of net sales

Balance sheet – each item expressed

as percentage of total assets

Common-Size Statements

Example

Let’s take another look at the

information from the comparative

income statements of Clover

Corporation for 2000 and 1999.

This time let’s prepare common-size

statements.

Common-Size Statements

CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Common-Size

Percentages

2000 1999 2000 1999

Net sales 520,000$ 480,000$ 100.0 100.0

Cost of goods sold 360,000 315,000

Gross margin 160,000 165,000

Operating expenses 128,600 126,000

Net operating income 31,400 39,000

Interest expense 6,400 7,000

Net income before taxes 25,000 32,000

Less income taxes (30%) 7,500 9,600

Net income 17,500$ 22,400$

Net sales is

usually the base

and is expressed

as 100%.

Common-Size Statements

CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Common-Size

Percentages

2000 1999 2000 1999

Net sales 520,000$ 480,000$ 100.0 100.0

Cost of goods sold 360,000 315,000 69.2 65.6

Gross margin 160,000 165,000

Operating expenses 128,600 126,000

Net operating income 31,400 39,000

Interest expense 6,400 7,000

Net income before taxes 25,000 32,000

Less income taxes (30%) 7,500 9,600

Net income 17,500$ 22,400$

1999 COGS ÷ 1999 Net Sales × 100%

( $315,000 ÷ $480,000 ) × 100% = 65.6%

2000 COGS ÷ 2000 Net Sales × 100%

( $360,000 ÷ $520,000 ) × 100% = 69.2%

Gross Margin Percentage

Gross Margin

Percentage

Gross Margin

Sales =

This measure indicates how much

of each sales dollar is left after deducting the cost of

goods sold to cover operating expenses and a profit.

Common-Size Statements

CLOVER CORPORATION

Comparative Income Statements

For the Years Ended December 31, 2000 and 1999

Common-Size

Percentages

2000 1999 2000 1999

Net sales 520,000$ 480,000$ 100.0 100.0

Cost of goods sold 360,000 315,000 69.2 65.6

Gross margin 160,000 165,000 30.8 34.4

Operating expenses 128,600 126,000 24.8 26.2

Net operating income 31,400 39,000 6.0 8.2

Interest expense 6,400 7,000 1.2 1.5

Net income before taxes 25,000 32,000 4.8 6.7

Less income taxes (30%) 7,500 9,600 1.4 2.0

Net income 17,500$ 22,400$ 3.4 4.7

What conclusions can we draw?

Financial Ratios

Financial Ratios can be used to compare performance of

– A company at a current point of time on a stand-alone basis

– A company over a period of time

– A company with its peers or with other companies

– Different industries

– A company and its industry average

Financial Ratios, per se, may have no meaning, unless,

benchmarked or compared with something

When doing ratio analysis, be careful of

– Changes in accounting policies across a company’s history

– Differences in accounting policies between companies

– Differences across geographies

– Accounting earnings v/s financial earnings

Liquidity

and

Efficiency Solvency

Profitability Market

Prospects

Ability to meet

short-term

obligations and

to efficiently

generate

revenues

Ability to

generate future

revenues and

meet long-term

obligations

Ability to

generate

positive

market

expectations

Ability to provide

financial rewards

sufficient to

attract and retain

financing

Building Blocks of Analysis

Income Statement

Balance Sheet

Statement of

Changes in Stockholders’ Equity

Statement of Cash

Flows

Notes

Information for Analysis

Current

Ratio

Acid-test

Ratio

Accounts

Receivable

Turnover

Inventory Turnover

Days’ Sales

Uncollected

Days’ Sales in

Inventory

Total Asset

Turnover

Liquidity and Efficiency

NORTON CORPORATION

Balance Sheet

December 31,

2004 2003

Assets

Current assets:

Cash 30,000 $ 20,000 $

Accounts receivable, net 20,000 17,000

Inventory 12,000 10,000

Prepaid expenses 3,000 2,000

Total current assets 65,000 $ 49,000 $

Property and equipment:

Land 165,000 123,000

Buildings and equipment, net 116,390 128,000

Total property and equipment 281,390 $ 251,000 $

Total assets 346,390 $ 300,000 $

NORTON CORPORATION

Balance Sheet

December 31,

2004 2003

Liabilities and Shareholders' Equity

Current liabilities:

Accounts payable 39,000 $ 40,000 $

Notes payable, short-term 3,000 2,000

Total current liabilities 42,000 $ 42,000 $

Long-term liabilities:

Notes payable, long-term 70,000 78,000

Total liabilities 112,000 $ 120,000 $

Shareholders' equity:

Common stock, $1 par value 27,400 17,000

Additional paid-in capital 158,100 113,000

Total paid-in capital 185,500 $ 130,000 $

Retained earnings 48,890 50,000

Total shareholders' equity 234,390 $ 180,000 $

Total liabilities and shareholders' equity 346,390 $ 300,000 $

NORTON CORPORATION

Income Statement

For the Years Ended December 31,

2004 2003

Revenues 494,000 $ 450,000 $

Cost of sales 140,000 127,000

Gross margin 354,000 $ 323,000 $

Operating expenses 270,000 249,000

Net operating income 84,000 $ 74,000 $

Interest expense 7,300 8,000

Net income before taxes 76,700 $ 66,000 $

Less income taxes (30%) 23,010 19,800

Net income 53,690 $ 46,200 $

Current

Ratio

Current Assets

Current Liabilities =

This ratio measures the short-term

debt-paying ability of the company.

Current Ratio

Current

Ratio

$65,000

$42,000 = = 1.55 : 1

Quick assets are Cash, Short-Term Investments,

and Current Receivables (excl. inventory)

This ratio is like the current

ratio but excludes current assets such as inventories

and prepaid expenses that may be difficult to quickly

convert into cash.

Acid-Test Ratio / Quick Ratio

Quick Assets

Current Liabilities = Acid-Test

Ratio

$53,000

$42,000 = 1.26 : 1 = Acid-Test

Ratio

Cash

Ratio

Cash + Marketable securities

Current Liabilities =

This ratio is an indication of the firm’s

ability to pay off its current liabilities If

for some reason immediate payment

were demanded

Cash Ratio

Current

Ratio

$30,000

$42,000 = = 0.71 : 1

NWC

Ratio

Net Working Capital

Total Assets =

This ratio is an indication of the firm’s

ability to pay off its current liabilities If

for some reason immediate payment

were demanded

Net Working Capital ratio

Current

Ratio

$23,000

$346,390 = = 0.07 : 1

This ratio measures how many times a company

converts its receivables into cash each year.

Accounts Receivable

Turnover

Sales on Account

Average Accounts Receivable

Accounts

Receivable

Turnover

=

= 26.7 times $494,000

($17,000 + $20,000) ÷ 2

Accounts

Receivable

Turnover

=

This ratio measures the number

of times merchandise

is sold and replaced during the year.

Cost of Goods Sold

Average Inventory

Inventory

Turnover =

= 12.73 times $140,000

($10,000 + $12,000) ÷ 2 =

Inventory

Turnover

Inventory Turnover

This ratio measures the liquidity of receivables.

Days’ Sales

Uncollected =

Accounts Receivable

Net Sales 365

Days’ Sales

Uncollected =

$20,000

$494,000 365 = 14.8 days

Days’ Sales Uncollected /

Average Collection period

This ratio measures the liquidity of inventory.

Days’ Sales

in Inventory =

Ending Inventory

Cost of Goods Sold 365

Days’ Sales

in Inventory =

$12,000

$140,000 365 = 31.29 days

Days’ Sales in Inventory /

Inventory period

This ratio measures the efficiency of assets in

producing sales.

Total Asset

Turnover =

Net Sales

Average Total Assets

= 1.53 times $494,000

($300,000 + $346,390) ÷ 2 =

Total Asset

Turnover

Total Asset Turnover

Operating cycle =

Days in Cash + Days In Accounts

Receiveable + Days in

Inventory - Days in Accounts Payable

Operating Cycle

The average time between

purchasing or acquiring

inventory and receiving

cash proceeds from its

sale. A long operating cycle tends

to reduce profitability by increasing

borrowing requirements and interest

expense

Debt

Ratio

Equity

Ratio

Pledged Assets to

Secured Liabilities

Times Interest

Earned

Solvency / Financial

Leverage

Use this information to calculate the

solvency ratios for Norton Corporation.

NORTON CORPORATION

2004

Net income before interest

expense and income taxes 84,000$

Interest expense 7,300

Total shareholders' equity 234,390

Total liabilities 112,000

Total assets 346,390

Solvency

Total debt = Total Assets

Debt

Ratio

This ratio measures what portion of a company’s assets

are contributed by creditors.

$112,000 = $346,390

Debt

Ratio = 32.3%

Debt Ratio

This ratio measures what portion of a company’s assets

are contributed by owners.

Total Equity = Total Assets

Equity

Ratio

$234,390 = $346,390

Equity

Ratio = 67.7%

Equity Ratio

Total Debt = Total Equity

Debt-

Equity

Ratio

Debt-Equity Ratio

This ratio measures the protection to secured creditors.

Book Value of Pledged Assets = Book Value of Secured Liabilities

Pledged

Assets to

Secured

Liabilities

Pledged Assets to Secured

Liabilities

This is the most common measure of the ability of a firm’s

operations to provide protection to the long-term creditor.

Times

Interest

Earned

Net Income before Interest Expense

and Income Taxes

Interest Expense =

Times

Interest

Earned

$84,000

$7,300 = = 11.51

Times Interest Earned /

Interest coverage

Profit

Margin

Gross Margin

Return on Total

Assets

Basic Earnings per

Share

Book Value per

Common Share

Return on Common

Stockholders’ Equity

Profitability

This ratio describes a company’s ability to earn

a net income from sales.

Profit

Margin

Net Income

Net Sales =

= 10.87% Profit

Margin

$53,690

$494,000 =

Profit Margin

This ratio measures the amount remaining from $1 in

sales that is left to cover operating expenses and a profit

after considering cost of sales.

Gross

Margin

Net Sales - Cost of Sales

Net Sales =

= 71.66% Gross

Margin

$494,000 - $140,000

$494,000 =

Gross Margin

This ratio is generally considered

the best overall measure of a

company’s profitability.

= 16.61% $53,690

($300,000 + $346,390) ÷ 2 =

Return on

Total Assets

Return on

Total Assets

Net Income

Average Total Assets =

Return on Total Assets

Return on

Common

Stockholders’

Equity

Net Income - Preferred Dividends

Average Common Stockholders’

Equity

=

= 25.9% $53,690 - 0

($180,000 + $234,390) ÷ 2 =

Return on

Common

Stockholders’

Equity This measure indicates how well the company employed

the owners’ investments to earn income.

Return on Common Stockholders’

Equity / Return on equity

Book Value

per

Common

Share

Shareholders’ Equity Applicable to

Common Shares

Number of Common Shares

Outstanding

=

This ratio measures liquidation at

reported amounts.

Book Value per Common

Share

This measure indicates how much

income was earned for each share of common stock

outstanding.

Basic

Earnings

per

Share

Net Income - Preferred Dividends

Weighted-Average Common

Shares Outstanding

=

Basic

Earnings

per

Share

$53,690 - 0

27,400 = = $1.96 per share

Basic Earnings per Share

Price-Earnings

Ratio

Dividend Yield

Market Prospects / Dividend

Policy

Dividend Payout

NORTON CORPORATION

December 31, 2004

Earnings per Share 1.96$

Market Price 15.00

Annual Dividend per Share 2.00

Use this

information

to calculate

the market

ratios for

Norton

Corporation.

Market Prospects

This measure is often used by investors as a general guideline in gauging stock

values. Generally, the higher the price-earnings ratio, the more opportunity a

company has for growth.

Price-Earnings

Ratio

Market Price Per Share

Earnings Per Share =

Price-Earnings

Ratio

$15.00

$1.96 = = 7.65 times

Price-Earnings Ratio

This ratio identifies the return, in terms of cash dividends, on

the current market price of the stock.

Dividend

Yield

Annual Dividends Per Share

Market Price Per Share =

Dividend

Yield

$2.00

$15.00 = = 13.3%

Dividend Yield

It is important to consider the prospects for continuing and

increasing dividend in future

Dividend

Payout

Annual Dividends Per Share

Earnings Per Share =

Dividend

Payout

$2.00

$10.00 = = 20%

Dividend Payout

Market

To book

Market price per share

Book value Per Share =

Market

To book

$2.00

$10.00 = = 20%

Market to book ratio

This ratio indicates the market sentiment

DuPont Analysis…

The DuPont model separates finance from operations.

It has three primary components:

Financial analysis using the DuPont model

Profitability

Activity

ROCE - Return on capital employed

By examining each input individually, we can

discover the sources of a company's return on

equity and compare it to its competitors.

DuPont Analysis…

The DuPont model financial components are discussed

below.

Income

Statement

Balance

sheet

ROCE = ROE

Performance

measure is :

Profitability

×

Performance

measure is :

Activity

=

Profitability x

Activity

Cash flow ratios

Cash Flow from Operations to Net Income =

(cash flow from operations) / net income

The cash flow from operations to net incomes ratio indicates the extent to which

net income generates cash in a business.

Cash Flow from Sales to Total Sales =

(cash flow from operations - dividends) / total sales

The cash flow from sales to sales ratio indicates the degree to which sales

generate cash retained by the business

Cash Flow Coverage Ratio = net income + depreciation and amortization

/total debt payments.

The cash flow coverage ratio indicates the ability to make interest and

principal payments as they become due.

A cash flow coverage ratio of less than one indicates bankruptcy within two years.

III. STRATEGIC DECISION

MAKING

Types of Strategic Decisions

Typical management decisions required to be made include:

– Restructuring the Company

– What should be the optimal capital structure?

– Optimal level of dividends to be paid

– Make or Buy a product/service

– How to price a product or service

– Adding or dropping a product or service

– Accepting or rejecting a one-time special order

Types of Restructurings

Restructuring - Mergers

Rationale for Mergers

– Economies of scale

– Complementary resources

– Use of surplus funds

– Sales enhancement

– Management improvements

– Tax reasons

– Financial leverage

Types of Merger

– Horizontal Merger

– Vertical Merger

– Conglomerate Merger

Modes of Mergers

– Combination – Acquisition of Shares

Restructuring - Others

Rationale for Acquisition

– Integrate forward or backward

– Obtain a source of material or other resource

– Obtain economies of scale

– Tap into newer markets, products etc.

Rationale for Divestment

– Sell non core businesses

– Raise cash for other uses

Spin-offs

– Unlock value

– Induction of strategic/financial investors

– Regulatory reasons

Optimal Capital Structure

The optimal allocation of financing between the different types of

capital takes many different factors into account:

– Future prospects of the company

– State of Equity Markets : if the equity market is doing poorly, the cash

received from the sale of stock will be less than in a period of a strong

market

– Composition of the company’s assets

– Amount of risk that the company is willing to accept : Debt is inherently

more risky to the firm than equity

– Reputation of the issuer (company)

– The cost of each source of capital

Optimal Dividend Policy

The optimal dividend policy would be arrived at after considering:

– Shareholder preferences : current income v/s growth

– Liquidity requirements

– Debt/borrowing capacity

– Earnings stability

– Growth opportunities

– Restrictive covenants

Pricing a product/service

Pricing Parameters

– Profit maximisation

– Returns on investment/ shareholders' funds

– Achieving a target sales volume

– Achieving target market shares

– Keeping in line with competition

– Control competition

– Entering new markets

– Stabilising prices and margins

Pricing Methods

– Cost based

– Demand based

– Target pricing

Make or Buy Decision

Make-or-buy decisions usually involve whether the company should

produce something itself or by it from outside

If the cost to purchase the product from outside is lower that the

avoidable cost of internal production, the company should buy the

product from the outside.

Relevant costs to be considered for analysis:

– Direct variable cost of in-house production

– Avoidable fixed costs saving

Qualitative Issues to be considered

– Allows access to specialized knowledge or technology

– Benefit from economies of scale of the supplier

– Access to raw materials

– Quality control

– Supply chain management

Make or Buy Decision -

Example

Special Orders

Special orders revolve considers whether to accept a one-off order at

lower than normal selling price

Key considerations for the decision:

– Difference in prices

– The opportunity cost of accepting the order

– Is the company operating at below or at full capacity

– Break-up of costs between variable and fixed costs

Special Orders - Example

Continue or Drop a Product