1.

INTRODUCTION:
Finance is the life blood of business. Finance is required for establishing, developing and operating
the business efficiently. Finance means money or theacts of providing the means of payments. It
may deal with the ways in which businessmen, investors, governments, financial institutions and
individuals handle their money. Thus finance is the study of money management. Every business
activity requires financial support, hence finance is related to different specialized areas. The main
objective of financial performance analysis to judge the financial health the undertaking and to judge
the earning performance of the organization and to provide the company with appraise for
investment opportunity or potentiality. This analysis is carried over about five years. This project
deals with the financial performance analysisin the organization. The ratio analysis, comparative
analysis and trend analysis are the tools to analyze the financial performance of the company. The
study reveals that the financial performance of the organization has been better. But the company's
profit over the last two years has been decreasing when compared to previous years. So the
management should take necessary steps to improve their financial position.

As a manager, you may want to reward employees based on their performance. How do
you know how well they have done? How can you determine what departments or divisions
have performed well? As a lender, how do decide the borrower will be able to pay back as
promised? As a manager of a corporation how do you know when existing capacity will be
exceeded and enlarged capacity will be needed? As an investor, how do you predict how
well the securities of one company will perform relative to that of another? How can you tell
whether one security is riskier than another? We can address all of these questions through
financial analysis.
Financial analysis is the selection, evaluation, and interpretation of financial data, along with
other pertinent information, to assist in investment and financial decision-making. Financial
analysis may be used internally to evaluate issues such as employee performance, the
efficiency of operations, and credit policies, and externally to evaluate potential investments
and the credit-worthiness of borrowers, among other things. The analyst draws the financial
data needed in financial analysis from many sources. The primary source is the data
provided by the company itself in its annual report and required disclosures. The annual
report comprises the income statement, the balance sheet, and the statement of cash
flows, as well as footnotes to these statements. Certain businesses are required by
securities laws to disclose additional information. Besides information that companies are
required to disclose through financial statements, other information is readily available for
financial analysis. For example, information such as the market prices of securities of
publicly-traded corporations can be found in the financial press and the electronic media
daily. Similarly, information on stock price indices for industries and for the market as a
whole is available in the financial press. Another source of information is economic data,
such as the Gross Domestic Product and Consumer Price Index, which may be useful in
assessing the recent performance or future prospects of a company or industry. Suppose
you are evaluating a company that owns a chain of retail outlets. What information do you
need to judge the company's performance and financial condition? You need financial data,
but it doesn't tell the whole story. You also need information on consumer Financial ratios, a
reading prepared by Pamela Peterson Drake 2 spending, producer prices, consumer prices,
and the competition. This is economic data that is readily available from government and
private sources. Besides financial statement data, market data, and economic data, in
financial analysis you also need to examine events that may help explain the company's
present condition and may have a bearing on its future prospects. For example, did the
company recently incur some extraordinary losses? Is the company developing a new
product? Or acquiring another company? Is the company regulated? Current events can
provide information that may be incorporated in financial analysis. The financial analyst
must select the pertinent information, analyze it, and interpret the analysis, enabling
judgments on the current and future financial condition and operating performance of the
company. In this reading, we introduce you to financial ratios -- the tool of financial analysis.
In financial ratio analysis we select the relevant information -- primarily the financial
statement data -- and evaluate it. We show how to incorporate market data and economic
data in the analysis and interpretation of financial ratios. And we show how to interpret
financial ratio analysis, warning you of the pitfalls that occur when it's not used properly.
We use Microsoft Corporation's 2004 financial statements for illustration purposes
throughout this reading. You can obtain the 2004 and any other year's statements directly
from Microsoft. Be sure to save these statements for future reference.

History of Finance

Finance as a study of theory and practice distinct from the field of economics arose
in the 1940s and 1950s with the works of Markowitz, Tobin, Sharpe, Treynor, Black,
and Scholes, to name just a few. But particular realms of finance—such as banking,
lending, and investing, of course, money itself—have been around since the dawn
of civilization in some form or another.

Around 3000 BC, banking seems to have originated in the Babylonian/Sumerian

empire, where temples and palaces were used as safe places for the storage of
financial assets—grain, cattle, and silver or copper ingots. Grain was the currency of
choice in the country, while silver was preferred in the city.

The financial transactions of the early Sumerians were formalized in the Babylonian
Code of Hammurabi (circa 1800 BC). This set of rules regulated ownership or rental
of land, employment of agricultural labor, and credit. Yes, there were loans back
then, and yes, interest was charged on them—rates varied depending on whether
you were borrowing grain or silver.

By 1200 BC, cowrie shells were used as a form of money in China. Coined money
was introduced in the first millennium BC. King Croesus of Lydia (now Turkey) was
one of the first to strike and circulate gold coins around 564 BC—hence the
expression, “rich as Croesus.

2.1 Definitions of Finance:

“Financial may be defined as that administrative area or the set of administrative functions in an
organization which relates with the arrangement of cash and credit so that organization may have
the means to carry out its objective as satisfactorily as possible.”
Functions of finance
Investment Decision

One of the most important finance functions is to intelligently allocate capital to long term assets. This
activity is also known as capital budgeting. It is important to allocate capital in those long term assets
so as to get maximum yield in future. Following are the two aspects of investment decision

a. Evaluation of new investment in terms of profitability

b. Comparison of cut off rate against new investment and prevailing investment.

Since the future is uncertain therefore there are difficulties in calculation of expected return. Along
with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a
very significant role in calculating the expected return of the prospective investment. Therefore while
considering investment proposal it is important to take into consideration both expected return and the
risk involved.

Investment decision not only involves allocating capital to long term assets but also involves decisions
of using funds which are obtained by selling those assets which become less profitable and less
productive. It wise decisions to decompose depreciated assets which are not adding value and utilize
those funds in securing other beneficial assets. An opportunity cost of capital needs to be calculating
while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the
required rate of return (RRR)

Financial Decision

Financial decision is yet another important function which a financial manger must perform. It is
important to make wise decisions about when, where and how should a business acquire funds.
Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an
equity and debt has to be maintained. This mix of equity capital and debt is known as a firm’s capital
structure.

A firm tends to benefit most when the market value of a company’s share maximizes this not only is a
sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt
affects the risk and return of a shareholder. It is more risky though it may increase the return on equity
funds.

A sound financial structure is said to be one which aims at maximizing shareholders return with
minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum
capital structure would be achieved. Other than equity and debt there are several other tools which
are used in deciding a firm capital structure.

Dividend Decision

Earning profit or a positive return is a common aim of all the businesses. But the key function a
financial manger performs in case of profitability is to decide whether to distribute all the profits to the
shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the
other half in the business.

It’s the financial manager’s responsibility to decide a optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common
practice to pay regular dividends in case of profitability Another way is to issue bonus shares to
existing shareholders.

Liquidity Decision

It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s profitability,
liquidity and risk all are associated with the investment in current assets. In order to maintain a
tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But
since current assets do not earn anything for business therefore a proper calculation must be done
before investing in current assets.

Current assets should properly be valued and disposed of from time to time once they become non
profitable. Currents assets must be used in times of liquidity problems and times of insolvency

Types of Finance
Because individuals, businesses, and government entities all need funding to
operate, the finance field includes three main subcategories:

 Personal finance
 Corporate finance
 Public (government) finance

1. Personal Finance
Financial planning involves analyzing the current financial position of individuals to
formulate strategies for future needs within financial constraints. Personal finance is
specific to an individual’s situation and activity. Therefore, financial strategies
depend largely on the person’s earnings, living requirements, goals, and desires.

Individuals must save for retirement, for example, which requires saving or investing
enough money during their working lives to fund their long-term plans. This type of
financial management decision falls under personal finance.

Personal finance includes a range of activities, from purchasing financial products

such as credit cards, insurance, mortgages, to various types of investments.
Banking is also considered a component of personal finance because individuals
use checking and savings accounts as well as online or mobile payment services
such as PayPal and Venmo.

2. Corporate Finance
Corporate finance refers to the financial activities related to running a corporation,
usually with a division or department set up to oversee those financial activities.

One example of corporate finance: a large company may have to decide whether to
raise additional funds through a bond issue or stock offering. Investment banks may
advise the firm on such considerations and help it market the securities.

Startups may receive capital from angel investors or venture capitalists in exchange

for a percentage of ownership. If a company thrives and decides to go public, it will
issue shares on a stock exchange through an initial public offering (IPO) to raise
cash.
In other cases, a company might be trying to budget its capital and decide which
projects to finance and which to put on hold in order to grow the company. All these
types of decisions fall under corporate finance.

3. Public Finance
Public finance includes taxing, spending, budgeting, and debt-issuance policies that
affect how a government pays for the services it provides to the public. It is a part
of fiscal policy.

The federal and state governments help prevent market failure by overseeing the
allocation of resources, the distribution of income, and economic stability. Regular
funding is secured mostly through taxation. Borrowing from banks, insurance
companies, and other nations also helps finance government spending.

In addition to managing money in day-to-day operations, a government body also

has social and fiscal responsibilities. A government is expected to ensure adequate
social programs for its taxpaying citizens and to maintain a stable economy so that
people can save and their money will be safe.
Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial activities
such as procurement and utilization of funds of the enterprise. It means applying general
management principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working capital
decisions.
2. Financial decisions - They relate to the raising of finance from various resources which will
depend upon decision on type of source, period of financing, cost of financing and the returns
thereby.
3. Dividend decision - The finance manager has to take decision with regards to the net profit
distribution. Net profits are generally divided into two:
a. Dividend for shareholders- Dividend and the rate of it has to be decided.
b. Retained profits- Amount of retained profits has to be finalized which will depend
upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial
resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning capacity,
market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in
maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital so
that a balance is maintained between debt and equity capital.
Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with

regards to capital requirements of the company. This will depend upon expected costs and
profits and future programmes and policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity analysis.
This will depend upon the proportion of equity capital a company is possessing and additional
funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many
choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of
financing.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This
can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits
like bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintainance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds
but he also has to exercise control over finances. This can be done through many techniques
like ratio analysis, financial forecasting, cost and profit control, etc.

Importance of Financial Management

Solid financial management provides the foundation for three pillars of

sound fiscal governance:

Strategizing, or identifying what needs to happen financially for the

company to achieve its short- and long-term goals. Leaders need insights
into current performance for scenario planning, for example.
Decision-making, or helping business leaders decide the best way to
execute on plans by providing up-to-date financial reports and data on
relevant KPIs.

Controlling, or ensuring each department is contributing to the vision and

operating within budget and in alignment with strategy.

With effective financial management, all employees know where the

company is headed, and they have visibility into progress.

Objectives of Financial Management

Building on those pillars, financial managers help their companies in a

variety of ways, including but not limited to:

Maximizing profits by providing insights on, for example, rising costs of

raw materials that might trigger an increase in the cost of goods sold.

Tracking liquidity and cash flow to ensure the company has enough
money on hand to meet its obligations.

Ensuring compliance with state, federal and industry-specific regulations.

Developing financial scenarios based on the business’ current state and

forecasts that assume a wide range of outcomes based on possible market
conditions.

Dealing effectively with investors and the boards of directors.

Ultimately, it’s about applying effective management principles to the

company’s financial structure.

Current Ratio

 Current ratio measures the ability of a business to repay current liabilities with current
assets.
 Current assets are assets that are expected to be converted to cash within normal
operating cycle, or one year. Examples of current assets include cash and cash equivalents,
marketable securities, short-term investments, accounts receivable, short-term portion of
notes receivable, inventories and short-term prepayments.

 Current liabilities are obligations that require settlement within normal operating cycle or
next 12 months. Examples of current liabilities include accounts payable, salaries and wages
payable, current tax payable, sales tax payable, accrued expenses, etc. Formula Current
Ratio = Current Assets/Current
Liabilities Analysis

 Current ratio matches current assets with current liabilities and tells us whether the
current assets are enough to settle current liabilities.

 A current ratio of 1 or more means that current assets are more than current liabilities
and the company should not face any liquidity problem.

 A current ratio below 1 means that current liabilities are more than current assets, which
may indicate liquidity problems.

 In general, higher current ratio is better.

 Current ratios should be analyzed in the context of relevant industry. Some industries for
example retail, have very high current ratios. Others, for example service providers such as
accounting firms, have relatively low current ratios because they do not have any significant
current assets.

 An abnormally high value of current ratio may indicate existence of idle or underutilized
resources in the company.
Quick Ratio

 Quick ratio is a stricter measure of liquidity of a company than its current ratio.

 Quick ratio is most useful where the proportion of illiquid current assets to total current
assets is high. Formula Quick Ratio = (Cash + Marketable Securities + Receivables)/Current
Liabilities Another approach to calculation of quick ratio involves subtracting all illiquid
current assets from total current assets and dividing the resulting figure by total current
liabilities. Quick Ratio = (Current Assets − Inventories – Prepayments)/Current Liabilities
Analysis

 Quick ratio is particularly useful in assessing liquidity situation of companies in a crunch

situation, i.e. when they find it difficult to sell inventories.

 Quick ratio should be analyzed in the context of other liquidity ratios such as current ratio,
cash ratio, etc., the relevant industry of the company, its competitors and the ratio’s trend
over time.
 A quick ratio lower than the industry average might indicate that the company may face
difficulty honoring its current obligations. Alternatively, a quick ratio significantly higher
than the industry average highlights inefficiency as it indicates that the company has parked
too much cash in low-return assets.
Ratio Debt

 Debt ratio (also known as debt to assets ratio) measures debt level of a business as a
percentage of its total assets.

 It is calculated by dividing total debt of a business by its total assets.

 Debt ratio finds out the percentage of total assets that are financed by debt.

 A too high percentage indicate that it is too difficult for the business to pay off its debts
and continue operations. Formula Debt Ratio = Total Debt/Total Assets

 Total debt equals long-term debt and short-term debt.

 Total assets include both current assets and non-current assets. Analysis

 Debt ratio is a measure of a business’s financial risk, the risk that the business’ total assets
may not be sufficient to pay off its debts and interest thereon.

 While a very low debt ratio is good, it may indicate underutilization of a major source of
finance which may result in restricted growth.
Times Interest Earned Ratio

 Times interest earned ratio (also called interest coverage ratio) is an indicator of the
company’s ability to pay off its interest expense with available earnings.

 It is a measure of a company’s solvency, i.e. its long-term financial strength.

 It calculates how many times a company’s operating income (earnings before interest and
taxes) can settle the company’s interest expense.

 A higher times interest earned ratio indicates that the company’s interest expense is low
relative to its earnings before interest and taxes (EBIT) which indicates better long-term
financial strength, and vice versa. Formula Times Interest Earned = Earnings before Interest
and Tax (EBIT)/Interest Expense Analysis

 While debt ratio indicates total debt exposure relative to total assets, times interest
earned (TIE) ratio assesses whether the company is earning enough to pay off the associated
interest expense.

 Higher value of times interest earned (TIE) ratio is favorable as it shows that the company
has sufficient earnings to pay off interest expense and hence its debt obligations.

 Lower values highlight that the company may not be in a position to meet its debt
obligations.
Net Profit Margin

 Net profit margin (also called profit margin) is the most basic profitability ratio that
measures the percentage of net income of an entity to its net sales.

 It represents the proportion of sales that is left over after all relevant expenses have been
adjusted.

 A high ratio indicates that the company is profitable. Formula Net Profit Margin = Net
Income/Net Sales
Return on Equity (ROE) Ratio

 Return on equity is the ratio of net income to stockholders' equity.

 It is a measure of profitability of stockholders' investments.

 It shows net income as percentage of shareholder equity. Formula ROE = Net

Income/Stockholders' Equity

 Net income is the after tax income, whereas

 Shareholder equity is common stock fund plus retained earnings Analysis

 High ROE value means that the firm is efficient in generating income on stock investment.

 Investors should compare the ROE of different companies and check the trend over time.

 ROE can be artificially influenced by the management, for example, when debt financing is
used to reduce share capital there will be an increase in ROE even if income remains
constant.
Earnings per Share (EPS)

 Earnings per share (EPS) is a profitability indicator which shows dollars of net income
earned by a company per share of its common stock

 EPS is a very important profitability ratio, particularly for shareholders of a company,

because it is a direct measure of dollars earned per share. Analysis

 EPS standardizes earnings with reference to number of shares outstanding.

 However, EPS alone too is not very useful because different companies have different
number of shares. Price/Earnings (P/E) Ratio

 Price/Earnings or P/E ratio is the ratio of a company's share price to its earnings per share.

 It tells whether the share price of a company is fairly valued, undervalued or overvalued.

 A high P/E ratio indicates high growth prospects for the company. Formula P/E Ratio =
Current Share Price/Earnings per Share
Dividend Payout Ratio
 Dividend payout ratio is the percentage of a company’s earnings that it pays out to
investors in the form of dividends.

 It is calculated by dividing dividends paid during a period by net earnings for that period.
Formula Dividend Payout Ratio = Dividend per Share/Earnings per Share Analysis

 People invest in a company expecting a return on their investment which comes from two
sources: capital gains and dividends.

 A high dividend payout ratio means that the company is reinvesting less earnings in future
projects, which in turn means less capital gains in future periods.

 Similarly, low payout ratio today may result in higher capital gains in future.

 Some investors prefer companies that provide high potential for capital gains while others
prefer companies that pay high dividends.

 Dividend payout ratio helps each class of investors identify which companies to invest in.
Inventory Turnover Ratio

 Inventory turnover is an asset efficiency ratio which calculates the number of times per
period a business sells and replaces its entire batch of inventories. Formula Inventory
Turnover = Cost of Goods Sold/Average Inventories Analysis

 Inventory turnover ratio assesses how efficiently a business is managing its inventories.

 In general, a high inventory turnover indicates efficient operations.

 A low inventory turnover compared to the industry average and competitors means poor
inventories management.

 However, a very high value of this ratio may result in stock-out costs, i.e., when a business
is not able to meet sales demand due to non-availability of inventories.

 Invntory turnover is a very industry-specific ratio. Businesses which trade perishable goods
have very higher turnover compared to those dealing in durables. Hence a comparison
would only be fair if made between businesses in the same industry.
Days' Sales Outstanding (DSO) Ratio

 Days' sales outstanding ratio (also called average collection period or days' sales in
receivables) is used to measure the average number of days a business takes to collect its
trade receivables after they have been created.

 It gives information about the efficiency of sales collection activities. Formula Days Sales
Outstanding is calculated using following formula: DSO = Accounts Receivable × Number of
Days Credit Sales Analysis

 A low value of Days Sales Outstanding is favorable indicating that the firm is collecting
money faster.
Total Assets Turnover Ratio

 Fixed assets turnover ratio measures how successfully a company is utilizing its assets in
generating revenue.

 It calculates the dollars of revenue earned per one dollar of investment in assets.

 A higher asset turnover ratio is generally better. Formula Assets Turnover Ratio =
Sales/Fixed Asset