Corporate Financial Accounting
Making sense, drawing insights, arriving at reasonable conclusions and making informed decisions from an analyzed financial statement, asking pertinent questions on differences and variations in values in the form of comparative analysis like percentages or ratios is very necessary.
Computational Analysis
It entails computation and interpretation of results and weighing the implications of the figures on the business. A good manager must be able to use data to explain, justify and communicate business performance. It is also pertinent for sound organisations to always know and massage the drivers of their performance.
Computational analysis is often done in the form of financial ratios which express relations between numbers for financial data standardization in percentages, days or time and can comparatively facilitate trend analysis across business lines and companies.
Financial Ratios Categories
- Valuation ratios – these show the firm’s performance or financial position in comparison to its market value.
- Profitability ratios – these show how the organisation is earning returns on its investments and the value of such returns.
- Solvency ratios -these show the firm’s position to meet its long-term obligations.
- Liquidity ratios – these show the firm’s position to meet its short-term obligations.
- Activity ratios – these show the efficiency of the operations of the firm and the management of its assets.
Measure of Profitability
A company’s profitability can be measured by its return on equity, ROE which is net income divided by average equity.
Similarly, the rate of return can be computed as the ratio of the amount of return and the amount invested.
For ROE to be good, the majority of the firm’s assets must be income-generating assets. The ROE can be increased with a business strategy that increases its return on asset, ROA and/or with a financial strategy by increasing its leverage that ensures its returns on the incremental investment exceed the cost of borrowing.
A situation where the organisation uses most of its income to service debt rather than paying higher dividends to its shareholders puts the company on the brink of collapse if not remedied.
Class Exercise
To appreciate and apply the theory of computational analysis, the class broke into rooms of four groups. All groups were presented with a statement of financial position and a balance sheet with 2009 as the current year and 2008 as the comparator.
Each group was asked to use horizontal analysis to determine which expense item increased by the highest percentage from 2008 to 2009. Also, each group was asked to use vertical analysis to determine whether the inventory balance is a higher percentage of total assets in 2008 or 2009. Finally, my group (Group 3) was asked to calculate the net margin, working capital, current ratio and acid test ratio
Our Approach to Doing the Class Exercise
Our group has two accounting experts, one of them took the lead in doing the computation while the rest of us figured out and dictated the formula and values across the various statements to him.
We finished on time and had explanations of our solutions given by the experts.
The practical and group approaches to help us appreciate and apply the subject are rewarding.
