Interpreting Accounting Information for Decision Making

Subject: Financial Management
Pages: 6
Words: 1698
Reading time:
7 min
Study level: PhD

Introduction

The role of a financial manager in any company can be discussed as important to influence a firm’s development, profitability, and position in the market. While being responsible for managing finance of a company, a financial manager conducts the analysis of a current situation, makes significant decisions, and determines the targets for corporate strategies and plans in terms of improving a firm’s financial health (Finkler, Smith & Calabrese 2018; Ross et al. 2016). From this perspective, it is important to analyse the role of a financial manager in treating the finances of a firm and focus on specific tools and techniques used in a decision-making process.

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The Role of a Financial Manager

A financial manager is responsible for performing a variety of tasks associated with using and organising a firm’s finance. These tasks include financial forecasting, the analysis of budgeting approaches, cash management and the analysis of cash flows, the analysis of accounting data, as well as the investment analysis (Leach & Melicher 2018; McKinney 2015; Tulsian & Tulsian 2017). All these tasks are completed in the context of decision making and developing a plan and a strategy for improving a firm’s current financial position (McKinney 2015; Mehta 2016). Therefore, it is possible to identify three major functions of a financial manager that include conducting financial analyses, making strategically significant financial decisions, and making efficient investment decisions.

Thus, a financial manager realises decision making in three important spheres that influence the overall strategy of a company to lead it to high profitability and stability. Depending on the above-mentioned functions of a financial manager, these spheres are the investment decision making, finance decision making, and decision making related to asset management (Ross et al. 2016). Investment decision making is associated with determining how many assets a company should possess in order to guarantee its value creation, address liabilities, and meet shareholders’ interests (Zietlow et al. 2018). Finance decision making is related to how many assets and short-term and long-term liabilities are appropriate for a certain firm to guarantee earnings and payments to shareholders (Tulsian & Tulsian 2017). The focus is also on determining the ways of acquiring the necessary resources and planning strategies to attract the required funds. Decision making related to asset management is essential to determine how the acquired assets need to be managed in order to contribute to a firm’s profitability and liquidity (Pandey 2015). The associated decisions include focusing on the management of working capital and the dividend policy followed in a firm.

Financial Techniques and Tools for Managers

In order to develop a certain business strategy and plan effective financial steps depending on forecasting and decision making, a financial manager is expected to apply specific techniques and tools to address his or her needs. In the context of their daily activities and the completion of working tasks, financial managers use tools and programmes for analysing financial statements, apply different valuation techniques, and refer to the Monte Carlo simulation to analyse financial risks (Karadag 2015; Robinson et al. 2015). In addition, they also apply linear programming and forecasting techniques in order to predict further changes in a company’s development in the context of market trends to win better positions and generate more revenue.

The most typical tools for financial analysis are the financial ratio analysis, DuPont analysis, the break-even analysis, and the analysis of a company’s financial leveraging. Although these types of analysis are oriented towards retrieving and evaluating different types of financial information regarding a company, all these approaches are aimed at assessing the current financial position of a firm to identify its strengths and weaknesses (Collier 2015; Leach & Melicher 2018). The results of these analyses are used in order to solve the issues related to a firm’s investment, optimisation of resources, and planning (Martin 2016; Tulsian & Tulsian 2017). As a result of conducting a series of financial analysis and referring to the ratio analysis, a financial manager is able to apply other tools to address the determined weaknesses in the financial performance (Finkler, Smith & Calabrese 2018). Thus, they can plan the mix of investments to improve a situation, use the evaluation of capital projects, determine the optimal capital structure, and refer to cash management techniques.

Conclusion

The discussed responsibilities of a financial manager and the focus on techniques and tools that can be used to contribute to planning with reference to decision making support the idea that a financial manager’s role is mainly to preserve and increase shareholders’ wealth. As a result, financial managers spend much attention while analysing financial statements and finding the perspectives for the most efficient investment and asset management decision making. Much attention should also be drawn to assessing a firm’s financial position in the context of the market and its trends to understand what financial paths a company should follow in the future.

The purpose of this report is to inform the Board of Directors regarding the company’s financial state and market position. The analysis of the financial situation is based on the data for the 2010-2011 fiscal year. In this report, the detailed examination and interpretation of the company’s current ratio, acid test ratio, asset turnover ratio, net worth to total assets ratio, non-current assets to net worth ratio, debt ratio, capital gearing ratio, and debt-equity ratio is presented along with the recommendations for future development.

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Current Ratio

The current ratio for the company has been calculated using the following formula: current assets/current liabilities = $8,685/$6,787 = 1.28. This ratio is used to assess the company’s liquidity in terms of its capacity to address current obligations. The current ratio related to this company is higher than 1 that indicates that the company possesses enough liquid assets to address its short-term liabilities (Martin 2016; Myšková & Hájek 2017). Thus, according to the current ratio, the company’s liquidity is comparably high to meet short-term obligations.

Acid Test Ratio

The acid test ratio is usually calculated referring to the following formula: (current assets – inventories)/current liabilities. For this company, the acid test ratio = ($8,685 – $104)/$6,787 = 1.26. The received ratio is higher than 1, and this measure also describes the company’s liquidity. Despite the fact that, depending on the industry, the received ratio can be both comparably low and high, the fact that it is higher than 1 emphasises the ability of the company to meet its current obligations while using available liquid assets.

Asset Turnover

The asset turnover has been applied to assess the efficiency of using assets to generate the company’s sales. It has been calculated referring to the formula: revenue/total assets = $86,321/$56,904 = 1.5. This figure means that each dollar related to the company’s assets is used to generate $1.5 in sales. This ratio can be increased for the company to guarantee that it will produce more sales using assets efficiently (Goyal 2016; Tulsian & Tulsian 2017). The possible target for this area of improvement can be the ratio in 2.

Net Worth to Total Asset

To calculate the net worth to total asset ratio (the solvency ratio), it is necessary to determine net worth in relation to the company. Net worth = total assets – total liabilities = $56,904 – $21,728 = $35,176. Solvency ratio = net worth/total assets = $35,176/$56,904 = 0.62 = 62%. This solvency ratio is higher than 20%, thus, it can be discussed as appropriate for the company to address its long-term debt obligations. Therefore, the company demonstrates its comparably high ability to survive in the long-term perspective.

Non-Current Asset to Net Worth

The non-current asset to net worth ratio is effective to indicate how the company’s investments depend on its non-current assets. For this company, the non-current asset to net worth ratio = 48,219/35,176 = 1.4. This figure is higher than 1 in contrast to the acceptable range between 1 and 1.25, as well as lower measures. Thus, the company’s liquidity is high, but its vulnerability to unexpected financial events is also comparably high in this case (Collier 2015; Nuhu 2014). Thus, investors can discuss the company as an inappropriate option because this business relies significantly on low liquid assets.

Debt to Assets Ratio

The debt to assets ratio has been calculated with the help of this formula: total liabilities/total assets = 21,728/56,904 = 0.4 = 40%. This ratio is effective to demonstrate how much financing in the company is provided by creditors. Referring to the company’s ratio in 40%, it is possible to state that its degree of financial leveraging is comparably low. Thus, the equity position can be described as rather strong as the company possesses enough assets to address its obligations.

Capital Gearing Ratio

The company’s capital gearing ratio has been calculated using the next formula: long-term liabilities/capital employed = 14,941/35,176 = 0.4 = 40%. Referring to the number of the company’s borrowed funds, it is possible to state that the ratio is comparably low (Ross et al. 2016). However, it still represents a financial risk for the company related to having a high proportion of debt in comparison to its equity.

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Debt-to-Equity Ratio

The debt-to-equity ratio measures the company’s ability to produce cash in order to cover its debt obligations. The following formula has been used to calculate this measure: total liabilities/total shareholders’ equity = 21,728/35,176 = 0.6. This ratio cannot be discussed as good from a risk perspective because it is higher than 0.4. Thus, there are signs that the company is not efficient in generating cash to address the debt.

Recommendations and Conclusion

The overall financial situation in the company is appropriate, and it indicates the firm’s capacity to address its liabilities while generating revenues and using assets. However, it is possible to improve the company’s financial health while increasing the asset turnover to 2, making the non-current asset to net worth ratio more attractive to investors, and decreasing the debt-to-equity ratio. It is recommended to complete the following steps to make the company more profitable:

  1. To use assets more efficiently through developing a strategy for this step.
  2. To limit purchasing inventories for a certain period of time along with improving its management.
  3. To increase sales without depending on acquiring new assets and reduce costs.
  4. To restructure debts.

Reference List

Collier, PM 2015, Accounting for managers: interpreting accounting information for decision making, John Wiley & Sons, London.

Finkler, SA, Smith, DL & Calabrese, TD 2018, Financial management for public, health, and not-for-profit organizations, 6th edn, CQ Press, Thousand Oaks, CA.

Goyal, PK 2016, ‘A study of ratio analysis as a technique of financial performance evaluation’, KAAV International Journal of Law, Finance & Industrial Relations, vol. 3, pp. 56-65.

Karadag, H 2015, ‘Financial management challenges in small and medium-sized enterprises: a strategic management approach’, EMAJ: Emerging Markets Journal, vol. 5, no. 1, pp. 26-40.

Leach, JC & Melicher, RW 2018, Entrepreneurial finance, 6th edn, Cengage Learning, Boston, MA.

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Martin, LL 2016, Financial management for human service administrators, Waveland Press, Long Grove, IL.

McKinney, JB 2015, Effective financial management in public and nonprofit agencies, 4th edn, ABC-CLIO, Santa Barbara, CA.

Mehta, BK 2016, Cost and management accounting, SBPD Publications, New Delhi.

Myšková, R & Hájek, P 2017, ‘Comprehensive assessment of firm financial performance using financial ratios and linguistic analysis of annual reports’, Journal of International Studies, vol. 10, no. 4, pp. 96-108.

Nuhu, M, 2014, ‘Role of ratio analysis in business decisions: a case study NBC Maiduguri Plant’, Journal of Educational and Social Research, vol. 4, no. 5, pp. 105-118.

Pandey, IM 2015, Financial management, 11th edn, Vikas Publishing House, New Delhi.

Robinson, TR, Henry, E, Pirie, WL & Broihahn, MA 2015, International financial statement analysis, 3rd edn, John Wiley & Sons, New York, NY.

Ross, SA, Trayler, RM, Van de Venter, G, Bird, R, Westerfield, R & Jordan, BD 2016, Essentials of corporate finance, 4th edn, McGraw-Hill Education, Sydney.

Tulsian, PC & Tulsian, B 2017, Tulsian’s financial management, 5th edn, S. Chand Publishing, New Delhi.

Zietlow, J, Hankin, JA, Seidner, A & O’Brien, T 2018, Financial management for nonprofit organizations: policies and practices, 3rd edn, John Wiley & Sons, New York, NY.