Finance and AccountingBudgeting and ForecastingFinancial Analysis

• Income Statement:
• Key Point: It summarizes revenues, expenses, and profits over a period.

• Action: Regularly review income statements to understand revenue streams and cost structures. For instance, if you notice rising operational costs, consider cost-cutting strategies.

• Balance Sheet:

• Key Point: It provides a snapshot of a company’s financial position at a specific point in time, showing assets, liabilities, and shareholders’ equity.

• Action: Check the balance sheet to gauge liquidity (current ratio) and leverage (debt-to-equity). If your debt levels are high, plan to increase equity to balance your financial structure.

• Cash Flow Statement:

• Key Point: It tracks the cash inflows and outflows from operating, investing, and financing activities.
• Action: Monitor the cash flow statement to ensure sufficient cash for day-to-day operations. For example, if operating cash flow is consistently negative, investigate improving receivables collection or reducing overdue payables.

• Profitability Ratios:
• Key Example: Return on Equity (ROE) measures the return generated on shareholders’ equity.

• Action: Use ROE to assess whether your equity investments are yielding satisfactory returns. If ROE is low, evaluate your business strategy or operational efficiencies.

• Efficiency Ratios:

• Key Example: Inventory Turnover Ratio illustrates how quickly inventory is sold.

• Action: Aim to optimize inventory turnover. A slow turnover suggests overstocking or obsolescence, while an excessively fast turnover might indicate issues like stockouts.

• Liquidity Ratios:

• Key Example: Current Ratio (Current Assets / Current Liabilities) indicates the ability to cover short-term obligations.

• Action: Maintain a current ratio above 1 to ensure liquidity. If your ratio is too low, consider restructuring short-term debts or converting non-liquid assets into cash.

• Leverage Ratios:

• Key Example: Debt-to-Equity Ratio reflects the degree to which a company is financing its operations through debt versus wholly-owned funds.
• Action: Keep the debt-to-equity ratio at manageable levels to avoid excessive interest burdens. If currently high, strategize debt reduction or equity financing options.

• Key Example: Higgins discusses creating a cash budget that estimates future cash inflows and outflows.
• Action: Develop a rolling three-month cash forecast to anticipate cash shortages and surpluses. Regularly update it based on the latest financial data and trends.

• Key Example: Higgins describes the importance of zero-based budgeting, where every expense must be justified.
• Action: Implement zero-based budgeting to eliminate unnecessary expenses. Re-evaluate the budget annually, questioning the necessity and efficiency of each cost.

• Key Example: Higgins explains Net Present Value (NPV) and Internal Rate of Return (IRR) as tools to evaluate investment opportunities.
• Action: Use NPV and IRR for capital budgeting. For example, calculate the NPV of a potential project to determine its profitability. Only undertake projects where NPV is positive.

• Key Example: Higgins outlines the use of sensitivity analysis to assess financial risks.
• Action: Conduct sensitivity analysis on major financial projections. For example, analyze how changes in interest rates or sales volumes impact profit margins, and develop strategies to mitigate these risks.

• Key Example: Higgins discusses the Modigliani-Miller theorem, which, under certain conditions, suggests that the value of a firm is unaffected by its capital structure.
• Action: Analyze the cost of debt versus equity to determine the optimal capital structure. Use cost-benefit analysis to decide on the proportion of debt and equity that minimizes the weighted average cost of capital (WACC).

• Key Example: The book discusses the residual dividend theory, where dividends are based on earnings left after all suitable investment opportunities are funded.
• Action: Implement a residual dividend policy. Pay dividends from residual earnings after funding all profitable investment projects, ensuring optimal growth and shareholder wealth maximization.

• Key Example: Economic Value Added (EVA) is depicted as a metric to measure a company’s true economic profit.
• Action: Adopt EVA to evaluate performance. Use it to set performance targets and managerial incentives, ensuring actions are geared towards value creation.

• Key Example: Higgins highlights the importance of due diligence in M&A.
• Action: Conduct thorough due diligence before pursuing M&A deals. Examine the financial health, market position, and potential synergies of the target company to make informed decisions.

Finance and AccountingBudgeting and ForecastingFinancial Analysis