Strategic finance management refers to the procedures, systems, and practices established by an institution to aid in reaching its goals, such as expansion, stakeholder’s wealth maximization, and corporate social responsibility. The executives develop insights from business activities, its capabilities, stakeholder expectations, as well as the available opportunities. Hence, the strategies have to be based on a well-formulated game-plan, which has a clear vision (Deloitte, 2019).
An appropriate strategic finance management scenario defines an elaborate picture of the organization’s target, lays down the courses of action to lead the entity there, brings work satisfaction and morale, as well as brings together finance officials through fast communication, and timely decision making (Deloitte, 2019).
Ratio Computation and Analysis for Redding and Neaves Companies – Using Strategic Finance Management Techniques
1. Profitability Ratios
This refers to financial computations that investors and business advisers apply while determining an institution’s revenue (Clear Tax, 2018). To get the profit realized, the metrics asses the difference between the receipt and payments made within a particular financial period, such as a year. For the two competing manufacturers, returns on investment and returns on capital employed are used.
a. Return on Investment
It is a ratioused to compute the gains of an investor concerning the amount of theirinvestment. A high ratio, the more the benefits to be earned by the investor(Schmidt, 2019). With this ratio, investors can eliminate the projectspromising low profits and focus on those that have a likelihood of raisinghigher returns.
Return on Investment Redding Co. = Revenue after Tax × 100
Capital Employed
ROI = 49 × 100 = 40.49%
121
ROINeaves Co.
= 379 × 100 = 65.34%
580
Conclusion: Neaves has a higher ROI,hence is earning more revenue compared to Redding by 24.84%. Thus, Neaves ismore appealing to an investor.
b. Return on Capital Employed
Itis a ratio that is used in determining a company’s profitability due to itsefficiency in capital utilization. A company with a higher ROCE means that ithad a more economical use of capital that realized maximum gains (Daniel,2018).
ROCE = Earnings before Interest and Tax × 100
Capital Employed
Redding: = 80 × 100 = 66.11%.
121
Neaves ROCE = 503 × 100 = 104.79%
480
Conclusion: bothorganizations have a significant amount of returns on the capital they have putto use. However, with Neaves having a higher return, investors can prefer it astheir investment of choice because it will utilize their funds better.
2. Efficiency Ratios Strategic Finance Management
They arefinancial metrics that inform on a company’s ability to utilize its assetswhile keeping an eye on its liabilities in both the short and long terms(Peavler, 2019). It is the efficiency ratios that ensure an organization is notexperiencing over investment or under investments. Fixed assets turnover andinventory turnover are the ratios to be used in this analysis.
a. Fixed Assets Turnover
It looks into how a form utilizes the available fixed assets like plants and equipment to increase sales. A firm that has a low number of fixed assets turnover in under utilizing its assets and should work towards optimizing the usage of fixed assets (Peavler, 2019).
Fixed Assets Turnover = (Sales ÷ Fixed Assets)
Redding Co.
FAT = (195 ÷ 255) = 0.764
Neaves Co.
FAT = (1050 ÷ 1026) = 1.033
Conclusion: Neaves Companyhas a higher fixed assets turnover, meaning that it utilizes its fixed assets inmaking sales, better compared to Redding Company.
b. Inventory Turnover
Also known asstock turnover, inventor turnover is a financial metric that is used in determiningthe number of times that a business has ordered a new batch of inventory after sellinga previous batch (Nicasio, 2019). It is computed on pre-determined periods suchas semiannually, annually, monthly, or weekly.
InventoryTurnover = Cost of Sales.
Average Stock
Redding Co. = 78 = 5.2 Times
15
Neaves Co. = 273 = 8.03 Times
34
Conclusion: Neaves Co. has a higher inventory turnover ratio than Redding Co. it implies that Neaves has more sales; hence, more promising returns or revenue.
3. Liquidity Ratios
They are ratios used in measuring the ability of an organization to settle its short-term liabilities when they are due without necessarily having to raise capital from lenders (Kenton, and Hayes, 2019). The quick ratio and Current ratio are used in this analysis and commonly found in strategic finance management.
a. Quick Ratio
It is afinancial ratio used in determining the ability of an entity to meet itscurrent liabilities using its liquid assets only. In this case, the stock iseliminated from the liquid assets category because it is time-consuming toconvert it into cash (Eliodor 2014, P. 5).A company that is at optimal performance should have a quick ratio of 1:1, whichshows its ability to pay for the liabilities due using its liquid assets.
Quickratio = Current Assets – Stock
Current Liabilities
Redding Co. = 65 – 15 = 1.67
30
Neaves Co. = 198 – 34 = 1.07
153
Conclusion: Since the optimal quick ratioshould be 1:1, and both have a quick ratio of more than 1, they can readilyservice their obligations when due. However, Redding Co has a higher quickratio and is, therefore, better positioned to convert its liquid assets fastercompared to Neaves Co.
c. Current Ratio
Itis a liquidity ratio, which is used in measuring an entity’s ability to pay forits short-term liabilities that is the debts due within a year. It informs theinvestors about how well a company realizes optimal benefits from its currentassets so that it can meet its current debts and other payables (Kenton, 2019).Theoptimal current ratio should be 2:1 that is two current assets for one currentliability
Current Ratio = Current Assets
Current Liabilities
Redding Co.
Current Ratio = 65 = 2.167
30
Neaves Co.
Current Ratio= 198 = 1.294
153
Comparison: Redding Company has a highercurrent ratio of 2.17:1, while Neave’s Company’s current ratio is 1.29:1. Itimplies that Redding can quickly pay for its current liabilities while Neavesis going to experience challenges paying for the obligations because it has notmet the optimal current ratio.
4. Gearing Ratios.
Itis a business assessment ratio that is concerned with the business’s capitalstructure. The ratio determines the amount and impacts of financing contributedby the stakeholders compared to external funding, such as the use of debt(Bragg, 2019). If a company has a high gearing ratio, it implies that thecompany has used more of debt capital and less of equity capital. Besides, lowgearing means that the company has employed more equity and less of debt in itscapital. A highly leveraged/geared company uses debt capital to meet dailyobligations, which poses a threat of bankruptcy to the organization (Bragg,2019). In this comparison, the equity ratio and debt ratio will be used to assessthe gearing of the two companies.
a. Equity Ratio/ Net worth to total assets ratio
Itis a financial arithmetic that indicates the relative amount of equity that isused in paying for a company’s assets. It informs shareholders about theirfunds compared to the institution’s total assets, thereby showing thebusinesses’ solvency position in the future (Ready ratios, 2013).
Equity ratio = Equity ÷ Total Assets
Redding Co.
Equity ratio = 121 ÷ 320 = 0.378 or 37.8 %.
Neaves Co.
Equity ratio = 480 ÷ 1214 = 0.395 or 39.5 %
Comparison: both companies have an equityratio of less than 51%. It means that their equity has funded a low amount oftheir assets, while a significant amount is funded using borrowed funds. Thetwo companies are leveraged and are going to pay a significant amount ofinterest on the borrowed funds.
b. Debt Ratio
Itis a financial leverage arithmetic that is used to measure the amount of acompany’s assets that have been purchased using debt capital. If a company hasa debt ratio of more than 1, it implies that it has a higher number ofliabilities compared to its assets. Conversely, a ratio that is less than 1indicates that the company has a high proportion of its assets purchased usingequity (Investors answers, 2019).
Debt Ratio = Debt
Total Assets
Redding Co.
Debtratio = 199 = 0.62 or 62%
320
Neaves Co.
Debt ratio = 634 = 0.52 or 52%
1214
Comparison: Redding Co. has a higher debt ratio, meaning that a significant proportion of its assets are acquired using debt capital other than equity. Therefore, Redding Company is more leveraged compared to Neaves Company.
5. Ratios by Investors to Determine Performance
They are financial arithmetic ratios that are used in determining the amount of returns an investor expects if they obtain a company’s stock at the current market prices. The ratio help in determining whether the shares are under priced or overpriced (Peavler, 2019). The ratios to be used are the interest coverage ratio and preference dividend coverage ratio.
a. Interest Coverage Ratio
Itis used in determining the ease of a business in servicing the interest of itsborrowed funds from the realized revenue (Ready Ratios, 2013). The higher theratio, the better the financial stability of an institution. If a company has aratio of less than 1.0, it is facing challenges in making ales to raiserevenue.
Interest Coverage Ratio = Earnings Before Interest and Tax
Interest Expense
Redding Co.
ICR = 80 ÷ 19 = 4.21
Neaves Co.
ICR = 503 ÷ 29 = 17.34
Comparison: Both companies have an ICR ofmore than 1. Therefore, they can pay their interest expenses quickly from therevenue realized. Neaves Company is better positioned to pay for interestexpenses because it has a higher ICR compared to Redding Co.
b. Preference Dividends Coverage Ratio
Itis a financial ratio used in determining the organization’s ability to for itspreference dividends. A company that hasissued preference dividends determines its ability to pay the dividends on suchshares using this ratio.
Preference dividends coverage ratio = Profits After Tax.
Preference Dividends
Redding Co.
= 49 ÷ 0 = 0
Neaves Co.
379 ÷ 100 = 3.79
Comparison: Redding Company has not issuedany preference shares; hence, it doesn’t pay any preference dividends. NeavesCo. has issued preference shares and has a preference dividends coverage ratioof 3.79. The latter company can, therefore, pay for the preference easily whenthey are due.
References – Strategic Finance Management Essential Reading
Bragg, S. (2019)Gearing ratio, Accounting Tools
Clear tax,(2018) Profitability Ratio Formula with Examples
Daniel, E.(2018) Return on Capital Employed
Deloitte (2019)Finance Strategy solutions
Eliodor, T. (2014) Financial Statement Analysis, Journal of Knowledge Management,Economics, and IT.
Investing Answers (2019). Debt Ratio
Kenton, W. (2019) Current ratio Analysis – Strategic Finance Management
Kenton,W. (2019) Strategic Financial Management
Nicasio, F.(2019) Inventory Turnover Definition and How to get it Right
Peavler, R.(2019). Asset Management ratios in Financial Analysis
Ready Radios, (2013) The definition and application of equity ratio – Strategic Finance Management
Schmidt, M. (2019) Returns on Investment Metric for measuring profitability
Strategic Finance Management Relevant Posts
Finance Dissertation Topics Financial Ratios Financing Constraints
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