The important techniques of financial management are summarized as follows:- 1. Common-Size Statements 2. Trend Ratios 3. Funds Flow Analysis 4. Cash-Flow Analysis 5. Ratio Analysis 6. Working Capital Management 7. Capital Structure 8. Capital Budgeting Techniques.
Technique # 1. Common-Size Statements:
The common-size financial statements are those in which figures reported are converted into percentage to some common base. Common-size balance sheet and income statement are prepared for vertical analysis and interpretation is done for identification of causes for changes taken place over a period of time.
The items in the financial statements are presented as percentages or ratios to total of items and a common base for comparison is provided. Each percentage shows the relation of the individual item to its respective total.
Technique # 2. Trend Ratios:
Trend ratios are the index numbers of the movements of financial figures reported in the financial statements for more than one accounting period.
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It is a statistical technique adopted to reveal the trend of financial items which are used in analysis of behaviour of financial items and for preparation of projected financial statements. In preparation of trend ratios, the base accounting period should be selected and the financial figures of that base period should be given the index number of 100.
The trend ratios are calculated for the subsequent accounting periods taking the base period trend ratio as 100. The trend percentages are calculated for select major financial items in the financial statements to arrive at the conclusions for important changes.
Technique # 3. Funds Flow Analysis:
The funds flow analysis gives the details of changes in financial position of a concern between two balance sheet dates. It is based on net working capital concept which is termed as ‘fund’. The funds flow statement contains the details of financial resources which have become available during the accounting period and the ways in which those resources have been used up.
The flow of funds refers to movement of funds which cause a change in working capital of the organization. The net increase or decrease in working capital will be further analyzed through preparation of Statement of changes in working capital position. Funds flow statement is a parameter for testing of the effective use of working capital. The analysis is particularly useful for long range planning where projections of liquid resources are vital.
Technique # 4. Cash-Flow Analysis:
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The preparation of cash-flow statements has been made mandatory. A statement of cash-flow reports the cash receipts and cash payments and net changes in cash resulting from operating, investing and financing activities of an enterprise during the period.
The cash-flow statement reconciles the opening and closing balances of cash and cash equivalents for the reported accounting period. It reports a net cash inflow or outflow for each activity and for the overall business.
Technique # 5. Ratio Analysis:
Ratio analysis is used as an important tool in analysis of financial statements. Ratios are used as an index or yardstick for evaluating the financial position and performance of a firm. Ratio is the expression of one figure in terms of another. It is the expression of the relationship between mutually independent figures. Ratio analysis used financial report and data and summarizes the key relationship in order to appraise financial performance.
It helps the analysts to make quantitative judgment about the financial position and performance of the firm. There are various ratios which are used by different parties for different purposes and can be calculated from the information given in financial statements. The comparison of past ratios with future ratios shows the firm’s relative strength and weaknesses.
Technique # 6. Working Capital Management:
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In the efficient working capital management, some of the techniques like economic order quantity, ABC analysis, fixation of inventory levels, cash management models are adopted.
Technique # 7. Capital Structure:
The Finance manager has to decide an optimum capital structure to maximize the wealth of shareholders. In capital structure decisions – analysis of operating and financial leverages, cost of different components of capital, EPS – EBIT analysis, ascertainment of EPS of different financing alternatives, determination of financial break-even point, indifference point analysis and other mathematical models are used.
Technique # 8. Capital Budgeting Techniques:
Investment in long-term assets for increasing the revenue of firm is called as ‘capital budgeting’. It is a decision to invest funds in long-term activities for future benefits that increase the wealth of the firm thereby increase the wealth of owners. Capital budgeting refers to long-term planning for proposed capital outlays and their financing.
The future growth of a firm depends on capital expenditure decisions. Capital budgeting involves large amount of funds, risk and uncertainty and they are of an irreversible nature. Estimation of cash-flow is very important for evaluating the investment proposals. Capital budgeting results the exchange of current fund for future benefits which will occur over a series of years to come.