Finance And Accounting Strategy: The Use Of Accounting Data And Ratio Analysis In Strategic Decision-Making (Copy)

1. Assessment Of Business Performance Over Time And Against Competitors

• Trend analysis:
  • Compare ratios over several years to identify patterns.
  • Helps assess whether performance is improving or deteriorating.
• Benchmarking against competitors:
  • Ratios compared with industry averages or rival firms.
  • Identifies strengths and weaknesses in relation to the market.
• Stakeholder value:
  • Shareholders look at profitability and return ratios.
  • Banks focus on liquidity and gearing ratios.

Example:

• If a firm’s current ratio rises from 1.2:1 to 1.8:1 over 3 years, it shows improved liquidity.
• If competitor’s ROCE = 20% but the business ROCE = 10%, performance is relatively weaker.

2. Impact Of Accounting Data And Ratio Results On Business Strategy

• Profitability ratios (ROCE, Gross Profit Margin, Net Profit Margin):
  • Low profitability may lead to strategies like cost reduction, efficiency improvements, or price increases.
• Liquidity ratios (Current ratio, Acid-test ratio):
  • Poor liquidity may require better cash flow management or reducing credit given to customers.
• Efficiency ratios (Inventory turnover, Receivables/Payables days):
  • Slow inventory turnover may lead to reducing stock levels or adopting JIT.
• Investment ratios (Dividend yield, Dividend cover, P/E ratio):
  • Influence dividend policy and investor confidence.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course

3. Impact Of Debt Or Equity Decisions On Ratio Results

• Debt (loan capital):
  • Increases gearing ratio (riskier).
  • May reduce liquidity if interest costs are high.
  • Can improve ROCE if return > interest rate.
• Equity (issuing shares):
  • Reduces gearing ratio (lower risk).
  • But dilutes ownership and control.
  • May reduce EPS and dividend per share.

Example:

• If a firm raises $1m via loans, long-term liabilities rise → gearing ratio increases.
• If it raises $1m via shares, equity rises → gearing ratio decreases.

4. Impact Of Changes In Dividend Strategy On Ratios

• Higher dividends:
  • Increases dividend yield → attractive for investors.
  • Reduces retained earnings → lowers future growth potential.
  • Reduces dividend cover ratio.
• Lower dividends / higher retention:
  • Improves long-term growth potential.
  • May disappoint shareholders expecting income.
  • Increases dividend cover ratio.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course

5. Impact Of Business Growth On Ratio Results

• Positive impact:
  • Higher sales revenue → improved profitability ratios.
  • Larger scale → potential economies of scale → lower unit costs.
• Negative impact:
  • Expansion funded by debt → increases gearing ratio.
  • Rapid growth may strain liquidity (cash tied up in inventory).
• Example:
  • Amazon’s growth led to high gearing initially but later improved profitability with scale.

6. Impact Of Other Business Strategies On Ratios

7. Limitations Of Using Published Accounts And Ratio Analysis

• Historical data → may not reflect future performance.
• Window dressing → accounts may be manipulated to look better.
• Do not show qualitative factors (e.g., employee morale, brand image).
• Different accounting policies make comparisons difficult.
• Does not capture external factors like economic conditions or competition.
• Ratios alone are insufficient → need to be combined with other analysis.

8. Quick Revision Table

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course