Olympia College

Diploma in Business Management

1. Accounting Ratios

1.1 Introduction
1.1.1 Definition of Accounting Ratio Ratios can be calculated by specific formula through division among numbers. Ratios analyze how one figure related to another. It can be presented in the different methods such as co-efficient, percentage, proportion, or rate. Generally, accounting ratios used to analyze relationship among figures that found on the balance sheet. It other word, these ratios measure the relationship between accounting data taken from financial statements presented by the company for measuring the business performance. Thus, accounting statement always reflects the financial statement of a company.

The accounting ratios can be analyzed and collect from company: 1.) Income statement : it also known as profit and loss statement. It states revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company's stock is publicly traded, earnings per share must appear on the face of the income statement.

2.) Balance Sheet: a report states about relevant assets, liabilities, and stockholders' equity with specific date.

3.) Cash Flows Sheet: a report shows the usage of companys fund on business activities such as operating, investing, financing activities, and certain supplemental information for the period specified in the heading of the statement.

Introduction to Finance

1|P age

Olympia College

Diploma in Business Management

1.1.2 Purposes of Accounting Ratio Ratio analysis helps the creditors, shareholders, debenture-holders, bankers to understand the companys potential and make investment decision by: 1.) Profitability: help the investor to measure the profitability of the company to calculate the actual performance of the company. 2.) Solvency: show the ability of the company to deal with the long term debts. It shows the company condition in term of cash flow. 3.) Comparison: help to compare figures between companies to measure which company perform better. Ratio analysis helps the managers of the company in business management by: 1.) Improvement: Comparative reports of financial statement to the past years. The company may measure weakness of management be able to solve them. 2.) Forecast: These ratio help trend analysis for the business. It helps to estimate future performance. The company can have preparation, planning, budgets adjustment and possible solutions for the future.

Introduction to Finance

2|P age

Olympia College

Diploma in Business Management

1.1.3 Types of Accounting Ratios There are five broad aspects in accounting ratios: 1.) Profitability Ratios: Profitability of company Purpose: calculate the ability of the company to produce profits and positive cash flows. Ratios with formula: Gross profit markup, Gross profit margin, Operating profit margin on sales, Profit margin on sales, Basic earning power, Return on total assets and Return on common equity 2.) Liquidity Ratios: Liquidity of company Purpose: measure the amount of assets available to meet short-term cash requirements. Ratios with formula: Current ratio and Acid-test ratio. 3.) Efficiency Ratios: Asset management of company Purpose: measure the values of a company by using its assets to generate revenue or cash flow. Ratios with formula: Inventory turnover, Fixed assets turnover, Total assets turnover, Debtor ratio, Debtor payment period and Day sales outstanding. 4.) Solvency Ratios: Debts management and capital gearing of company Purpose: measure companys ability to manage long-term debt obligations over the long run. It measure the relationship between the liabilities and assets. Ratios with formula: Debt ratio, Capital gearing ratio, Debts equity ratio, Times interest earned, Creditor ratio and Creditor payment period. 5.) Market Prospects Ratios: Market value of investment to ordinary shareholders. Purpose: measure investors expectations for the company based on prior periods results of operations. Ratios with formula: Earnings per share, Price earnings ratio, Dividend cover, Earning yield, Dividend yield, Price/cash flow ratio and Market/book value price ratio.

Introduction to Finance

3|P age

Olympia College

Diploma in Business Management

1.1.4 Comparison of Accounting Ratio for Business Performance Measurement Inter-temporal: Compare financial statement and analyze trends of ratios past few years with the latest data. Adjust price level changes before any comparison to increase accuracy. Inter-firms: Compare financial statement between companies. The companies chosen for comparison must have similar accounting policies and lesser differences of nature. Besides, it is necessary to get the exact complete data of each company to avoid misleading result. Industry averages: Ratios of a company have meaning only when they are compared with some standards. It is recommended that ratios should be compared with industry averages however the industry averages are not easily available. 1.1.5 Business Performance Measurement Companies chosen: IJM Corporation Berhad : 1.) Construction company: civil engineering, building and infrastructure construction. 2.) Industry: Industrial Concrete Products, Steel Products 3.) Plantation: Oil palm Plantation 4.) Property: Residential project, industrial and commercial parks WCT Berhad: 1.) Engineering & Construction: large-scale building, infrastructure construction 2.) Property Development: Integrated township, Residential housing, Commercial center Data required for business performance measurement : Income statements and balance sheets of both companies. The data resources : Annual report, financial report, and through official website for investor relations of related companies.

Introduction to Finance

4|P age

Olympia College

Diploma in Business Management

1.2 Body of Contents 1.2.1 Ratios Calculation Profitability Ratios

Ratios with Formula (%) Gross Profit Markup Calculation for IJM (%) Calculation for WCT (%)

x100 x100 =31.16 =8.23

x100

Gross profit margin

x100 x100 =23.76 =7.60

x100

Operating profit margin on sales

x100 x100 =18.65 =5.23%

x100

Profit margin on sales

x100 x100 =8.29 =3.15

x100

Basic earning power

x100 x100 =5.96 =5.45

x100

Return on Total assets

x100 x 100 =2.65 =3.28

x100

Return on common equity

x100 x100 =6.48 =11.77

x100

Introduction to Finance

5|P age

Olympia College

Diploma in Business Management

Liquidity Ratios
Ratios with Formula (%) Calculation for IJM (%) Calculation for WCT (%)

Current ratio

=2.09:1
Acid-test ratio

=1.41:1

=1.89:1

=1.35:1

Efficiency Ratios
Ratios with Formula (%) Inventory Turnover Calculation for IJM (%) Calculation for WCT (%)

or

=5.78times

=37.92times

Total Assets Turnover

=0.32times
Debtor Ratio

=1.04times

=0.54:1

=0.32:1

Day Sales Outstanding

0.54 X 365 days =197.1days

0.32 X 365days =116.8days

Introduction to Finance

6|P age

Olympia College

Diploma in Business Management

Solvency Ratios
Ratios with Formula (%) Debts Ratio Calculation for IJM (%) Calculation for WCT (%)

=0.67:1 =0.49:1
Debts Equity ratio

=2.39:1 =1.19:1
Times interest earned or Interest cover

=3.72times

=4.85times

Market Prospects Ratios

Ratios with Formula (%) Earnings per share Calculation for IJM (%) Calculation for WCT (%)

=RM0.25 Price earnings ratio=

per share

=RM0.19 per share

=19.2 times
Earnings yield ( )

=13.68times
[ ( ]

=6.94%
Market price per book value ratio

=9.74%

=1.24:1

=1.61:1

Introduction to Finance

7|P age

Olympia College

Diploma in Business Management

1.2.2 Ratios Comparison A set of accounts can only tell us what happened during that year but cannot tell us whether IJM Corporation Berhad (IJM) or WCT Berhad (WCT) is doing better. Hence, it is necessary to calculate suitable ratios for comparison. Financial ratios are the analysts microscope. We can get a better view of their financial health than just looking at the raw financial statements. Profitability: Gross profit markup and gross profit margin of IJM are 31.16% and 23.76%. Both of the ratios are highly greater than WCTs gross profit markup of 8.23% and gross profit margin of only 7.60%. It shows that IJM had properly managed its purchase costs and relationship with suppliers, and also fully utilized its production costs like material and labor, thus pushed up its markup and margin more efficient and effectively than WCT. IJMs operating profit margin on sales of 18.65% and profit margin on sales of 8.29% are higher than WCTs operating profit margin on sales of 5.23% and profit margin on sales of 3.15%. The extraordinary high cost of goods sold of WCT caused the companys low profit, hence reduced its operating profit margin on sales and profit margin on sales even though it had a higher amount of sales. WCT should improve their cost controlling skill and reduce wastage in order to achieve higher profit. BEP of IJM is slightly greater than WCTs. However, ROA and ROE of IJM are significantly lower than WCTs. It indicates that WCT is better in managing and utilizing its assets in generating sales to gain profit than IJM.

Introduction to Finance

8|P age

Olympia College

Diploma in Business Management

Liquidity: Current ratio of IJM, 2.09 times is higher than current ratio of WCT, 1.41 times. This is because of IJM is superior in using current assets to finance current liabilities as it has more cash and debtors than WCT. Inventory of IJM is much greater than WCT. Moreover, IJMs acid-test ratio of 1.89 times is still higher than WCTs acid-test ratio of 1.35 times due to the reason stated above. Therefore, IJM is more liquid than WCT. Asset Management: Inventory turnover of IJM, 5.78 times is lower than the figure of WCT, 37.92 times. Cost of sales of IJM is lower than WCT. However, its stock value is higher than WCT. As a result, IJM had slower stock turnover than WCT. The goods purchased kept in store are not fast taken out for resale. Therefore, the stock of IJM is accumulated and the money tied up. This makes IJM having lower financial stability than WCT. Total assets turnover of IJM, 0.32 times is lower than WCT, 1.04 times. This is because IJMs net sales is higher than total assets while WCTs net sales and total assets are quite average. This indicates that IJM had lower sales generated from the assets for the ineffective use of assets in business activities. IJM had larger amount of debtor than WCT while its credit sale is lower than WCT. Therefore, Debtor ratio of IJM, 0.54:1 is higher than WCT, 0.32:1. IJM had larger size of debtor accumulated from the credit sale. Due to the debtor ratio of IJM is higher than WCT. Day sales outstanding of IJM, 197.1 days is higher than WCT, 116.8 days. Therefore, IJM took longer time to collect money from debtors. This tied up IJMs money and this will cause a short-term financial problem. As a result, IJMs financial efficiency is lower than WCT.

Introduction to Finance

9|P age

Olympia College

Diploma in Business Management

Debts Management: The total debts of IJM is larger than WCT while its total assets is smaller than WCT. Therefore, Debts ratio of IJM , 0.49:1 is lower than WCT, 0.67:1. IJM had smaller debts burden than WCT. This indicates that IJM is more financial stability and had to bear lower interest cost than WCT. Debts equity ratio of IJM, 1.19:1 is lower than WCT, 2.39:1. Due to the figures of IJMs total debts and its common equity is closer than WCT. IJM is operated in lower gear than WCT. Somehow, rates of interest charges of IJM are much higher than WCT while their rates of differences in profit before interest and taxation is not that high. Times interest earned/ Interest cover of IJM, 3.72 times is lower than WCT, 4.85 times. This indicates that WCT larger ability to meet its interest obligations with room to spare. Therefore, IJM is more solvency than WCT. Market value of investment to stockholders: IJM had higher rate between net income available to common stockholders and number of ordinary shares in issue than WCT. Earnings per share of IJM, RM0.25 is higher than WCT, RM0.19. It means that IJM had more potential for common stockholders. Somehow, the rates between market price per ordinary share and its earnings per share of IJM also higher than WCT. In other words, Price earnings ratio of IJM, 19.2 times is higher than WCT, 13.68 times. It makes WCT more attractive to common stockholders as they take lesser tomes using their profit earning to recover back their share investment. Moreover, IJMs gross earnings per share is not very high while its market price per ordinary is much higher than WCT. As a result, Earnings yield of IJM, 6.94% is lower than WCT, 9.74%. It indicates that IJM provides lower net income return than WCT. Market price per book value of IJM, 1.24:1 is lower than WCT, 1.61:1. This indicates that the share market price drops below its real assets value. Hence, IJM had higher market value to common shareholders than WCT.

Introduction to Finance

10 | P a g e

Olympia College

Diploma in Business Management

1.3 Conclusion 1.3.1 Recommendations From the findings above, it shows that: 1.) Profitability of IJM is higher than WCT 2.) Liquidity of IJM is higher than WCT. 3.) Efficiency of IJM is lower than WCT. 4.) Solvency of IJM is higher than WCT. 5.) Market value of investment to common stockholders of IJM is higher than WCT. Overall, IJM has better business performance than WCT. However, it still has to improve its financial efficiency. It needs to increase its ability to use its assets to generate revenue or cash flow. IJM should figure the solution to increase its cost of sales to raise the rates of stock turnover. Its clear that IJM is weak in dealing with sales as the total net sales are not satisfying. Its necessary for IJM to figure out how to effectively use total assets in business activities to increase the production volume and sales volume. Furthermore, IJM needs to solve the bad debts as large amount of debtors accumulated from credit sales to avoid short-term financial difficulty. In the other hand, although WCT is good in dealing with asset management and sales, its necessary to improve its profitability, liquidity, solvency and market value to achieve better business performance. It must discuss strategies to properly managing its purchase costs and relationship with suppliers, and also fully utilized its production costs like material and labor. In addition, the ability of handling debts of WCT have to improve and come out with better solution to mange long-term liabilities and current liabilities to reduce debts burden.

Introduction to Finance

11 | P a g e

Olympia College

Diploma in Business Management

1.3.2 Limitations of ratio and trend analysis Although accounting ratio and trend analysis helps to measure the business performance, there are limitations of this analysis. There limitations are: Information problems: 1.) Past data: The data is based on historical financial statement. The analysis is making for the future while the information is taken from the past. The data is not accurate enough as past information cant predict the future. 2.) Misleading Results: In the absence of absolute data, the result may be misleading. 3.) Balance sheet ratios: The ratio based on the figures contained in the Balance Sheet may not be representative of the financial position of the company for the year as a whole. Comparison Problems: Inter-temporal: 1.) Price Level Changes: Price level changes often make the comparison of figures difficult over a period of time. Changes in price affect the cost of production, sales and also the value of assets. 2.) Situations changes: The ratios do not have much use if they are not analyzed over years. The ratio at a moment in time may suffer from temporary changes. Inter-firm: 1.) Different capital structures and size: Companies may have different capital structures and to make comparison of performance when one is all equity financed and another is a geared company it may not be a good analysis. 2.) Different accounting policies: Choices in accounting policies impact reporting of income and assets and affect ratios. Companies being compared won't necessarily be using the same rules.

Introduction to Finance

12 | P a g e

Olympia College

Diploma in Business Management

2. Financial Market 2.1 Definition of Financial Market Financial market provide a marketplace for the buyers to get potential sellers to purchase financial instrument such as stocks, commodities, equities, bonds, currencies and derivatives at low transaction costs and at prices that reflect the efficient market hypothesis. It is a place to exchange capital and credit. The potential traders can be individuals, enterprises, bankers, institutions and even the government. At the beginning, buyers and seller can only trade via physical financial market center; nowadays buy and sell financial instrument can held via inter-networking by computer. Financial market is different with physical asset market which involved physical product such as cars, houses and other properties. 2.2 Types of Financial Market 1.) Money markets: It allows investors to borrow of large sums of money in a short term which is not more than a year of debt securities. The trading is highly liquid, short-term assets and securities. It involved frequent trading of short-term liquid investment. 2.) Capital markets: Its trading center that allow investors to borrow long-term debt and corporate stocks. It a marketplace for the buyers and sellers to trade stocks, bonds, and marketable securities with maturities greater than one year. It is quite contrast with money market. 3.) Mortgage market: It can be divided to primary mortgage market and secondary mortgage market. Primary mortgage market where borrowers and mortgage originators including institutional lenders, such as savings and loan associations and banks, and mortgage bankers and brokers come together to negotiate terms and effectuate mortgage transaction. The secondary mortgage market thus encompasses all activity beyond the primary market, which is between the homebuyers and the originating mortgage lender.
Introduction to Finance 13 | P a g e

Olympia College

Diploma in Business Management

4.) Consumer credit markets: It provides short-term loans to enable individuals and household to purchase goods or services primarily for personal, family, or household purposes. 5.) Primary market: It is part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. Primary markets create long term instruments through which corporate entities borrow from capital market. 6.) Secondary market: A marketplace to trade used issued securities, stock, bonds, options, and futures. Secondary markets provide an avenue for resale and help in reducing the risk of investment and in maintaining liquidity in the financial system. 7.) Initial public offering (IPO) market: It is where the corporation's first offering of common stock or shares to the public. It usually offered by new, small company which collecting capital to expand their company. 8.) Private market: A marketplace where two involved parties having direct financial transactions which is carry out privately. The transaction can be in any form which agreed by both parties.

Introduction to Finance

14 | P a g e

Olympia College

Diploma in Business Management

2.3 Financial Markets Capital Transfer methods between savers and borrowers

Direct Transfers
Business Corporation (Borrower) Capital or fund Issue Securities (stocks or bonds)

Savers

1.) Direct transfer from savers to borrowers Process: When a company sells its new securities such as stock or bond to savers. The savers will then directly transfer the fund back to the borrowers. **This process done without any financial institution involved as middleman. This is a direct transfer of money and securities occur when a business sells its stocks or bonds directly to savers, without going through any type of financial institution. The business delivers its securities to savers, who in turn give the firm the money it needs. It mainly used by small company and a small capital is raised by direct transfer. Direct transfer of capital from savers to borrowers can avoid waste of time. Sometimes, when the borrowers hired investment bank or any other financial intermediaries to manage the securities and resell to savers, the transfer takes longer time than the usual direct transfer. As a result, the longer time it takes, the transfer will become more risky for the capital value might not as the same as it issues. Moreover, direct transfer can save cost for both of the savers and borrowers. The company can direct issues the securities to savers without paying money to investment bank or other financial institution to transfer the securities.

Introduction to Finance

15 | P a g e

Olympia College

Diploma in Business Management

Indirect Transfers through investment Bankers

Business Corporation (Borrower)

Issue Corp. Securities

Investment Banks

Resell Corp. Securities

Savers

Receive Fund

Receive Fund

2.) Indirect transfer from savers to borrowers through Investment banking house: Process: The company will issues new securities to investment bank. The investment bank will then underwrites the securities and resell the securities to savers. The investment bank act as a middleman to underwrite the issuance of the companys securities as the bank will buy the securities from the company and then resell the exact securities of the company to potential savers. Then, the funds received by investment bank from savers will then return back to the company, the borrower. **Due to transfers go through the investment banking house which underwrites the issue. Therefore, the investment bank also known as an underwriter. An underwriter serves as a middleman and facilitates the issuance of securities. The company sells its stocks or bonds to the investment bank, which in turn sells these same securities to savers. The businesses securities and the savers money merely pass through the investment banking house. However, because of the investment bank buys and holds the securities for a period of time, it makes the transfer more risky. It might not be able to resell at the same value as it paid.

Introduction to Finance

16 | P a g e

Olympia College

Diploma in Business Management

Indirect Transfers through Financial Intermediary

Business Corporation (Borrower) Receive Fund Issue Corp. Securities

Financial Intermediary

Issue Intermediarys Securities Receive Fund

Savers

3.) Financial intermediary: Process: The financial intermediary will issues its own securities and sell them to savers. The funds received from the savers will then invested by the financial intermediary to purchased securities from the company. The savers are actually attracted by the issuance of financial intermediarys securities but not the borrowers securities. This is because their securities not as risky as the borrowers own securities. The financial intermediary collect the fund will then analyze, decide which borrowers securities are worth to invest. Transfers can also be made through a financial intermediary such as chartered banks, insurance companies, investment dealers, mutual funds, and pension funds. Here the intermediary obtains funds from savers in exchange for its own securities. The intermediary uses this money to buy and hold businesses securities. Intermediaries literally create new forms of capital. The existence of intermediaries greatly increases the efficiency of money and capital markets.

Introduction to Finance

17 | P a g e

Olympia College

Diploma in Business Management

2.4 Investment Banking House and Financial Intermediaries 1.) Investment bank: a organization that underwrites and distributes new investment securities and help business to obtain financing. It traditionally company raise capital. They help corporations design securities with features that are currently attractive to investors. They also buy these securities from the corporation and resell them to savers. Since the investment bank generally guarantees that the firm will raise the needed capital, the investment bankers are also called underwriters. 2.) Financial intermediaries: 2a.) Commercial banks: Traditional bank such as CIMB bank, Maybank which serve variety of savers and borrowers. It offering checking accounts, savings accounts, certificates of deposit, personal and business loans, and other, similar services. Commercial banks charge fees and/or interest for many of their services, though they may pay interest on other services. Most commercial banks also sell certain investments and many offer full brokerage and financial planning services. 2b.) Savings and loan associations: In short, it also known as S&L associations. It accepts savings deposits and invests the bulk of the funds thus received in mortgages. It is a deposit-gathering financial institution that is primarily engaged in making loans on real estate. c.) Mutual saving fund: It also known as unit trust. It allows individuals to save money with high interests and then use the funds to buy stocks, long-term bonds and short-term debt instruments issued by businesses or government units. d.) Credit unions: A cooperative organization that makes loans to its members at low interest rates. The members are supposed to have a common bond such as being employees of the same firm. The members will save money and the fund will be loaned to other members for unto purchases, home improvement loans and home mortgages. It usually the cheapest source of funds available to individual borrowers.

Introduction to Finance

18 | P a g e

Olympia College

Diploma in Business Management

e.) Pension funds: A fund reserved to pay workers' pensions when they retire from service. Pension funds invest primarily in bonds, stocks, mortgages and real estate. f.) Life insurance companies: It is similar with mutual saving fund where the savings collected annually from savers. The funds collected will then invest in stocks, bonds, real estate and mortgages. They also administer individual and group annuities. Their major liabilities are reserves set aside for future benefit payments.

Introduction to Finance

19 | P a g e