The document outlines methods of financial decision-making, emphasizing the importance of financial ratios and investment appraisal in supporting sustainable performance. It explains various financial ratios, including liquidity, activity, solvency, and profitability ratios, as well as techniques for investment appraisal such as net present value, payback period, and internal rate of return. These tools assist businesses in making informed financial decisions to optimize their performance.

1. FINANCIAL
MANAGEMENT
RAGILA KANA
FACULTY MEMBER
Unit-15

2. EVALUATE WAYS IN WHICH FINANCIAL
DECISION-MAKING SUPPORTS
SUSTAINABLE PERFORMANCE
LO4

3. KEY TOPICS
Using information from financial ratios to inform decisions
Using investment appraisal to inform decisions
Appreciate the value of cash flow statements, trial balances and break even
to financial decision-making

4. FINANCIAL RATIOS/
ACCOUNTING RATIOS
1

5.  Financial ratios- meaning & definition
Types of financial ratios
Interpretations of ratios and decision making
USING INFORMATION FROM FINANCIAL RATIOS
TO INFORM DECISIONS

6. I. FINANCIAL RATIO
Ratio analysis is a commonly used tool of financial statement analysis.
Ratio is a mathematical relationship between one number to another
number. Ratio is used as an index for evaluating the financial
performance of the business concern.
An accounting ratio shows the mathematical relationship between two
figures, which have meaningful relation with each other. Ratio can be
classified into various types
(SUBRAMANYAM, n.d.)

7. TYPES OF RATIOS
Liquidity ratio
Activity ratio
Solvency ratio
Profitability ratio

8. 1.1 LIQUIDITY RATIO
Liquidity Ratio It is also called as short-term ratio. This ratio helps to
understand the liquidity in a business which is the potential ability to
meet current obligations. This ratio expresses the relationship between
current assets and current assets of the business concern during a
particular period. The following are the major liquidity ratio
(SUBRAMANYAM, n.d.)

9. (SUBRAMANYAM, n.d.)

10. 1.2 ACTIVITY RATIO
It is also called as turnover ratio. This ratio measures the efficiency of
the current assets and liabilities in the business concern during a
particular period. This ratio is helpful to understand the performance
of the business concern. Some of the activity ratios are given below:
(SUBRAMANYAM, n.d.)

11. (SUBRAMANYAM, n.d.)

12. 1.3 SOLVENCY RATIO
It is also called as leverage ratio, which measures the long-term
obligation of the business concern. This ratio helps to understand, how
the long-term funds are used in the business concern. Some of the
solvency ratios are given below:
(SUBRAMANYAM, n.d.)

13. (SUBRAMANYAM, n.d.)

14. Debt to Equity Ratio = (short term debt + long term debt + fixed
payment obligations) / Shareholders’ Equity

15. 1.4 PROFITABILITY RATIO
Profitability ratio helps to measure the profitability position of the
business concern. Some of the major profitability ratios are given
below.
(SUBRAMANYAM, n.d.)

16. (SUBRAMANYAM, n.d.)

17. EXERCISE: 1
(SUBRAMANYAM, n.d.)

18. (SUBRAMANYAM, n.d.)

19. INVESTMENT APPRAISAL
2

20.  Investment Appraisal- Meaning & definition
Pros and cons of Investment appraisal
 Techniques of Investment appraisal
Investment appraisal and decision making
USING INVESTMENT APPRAISAL TO INFORM
DECISIONS

21. II. INVESTMENT APPRAISAL
A means of assessing whether an investment project is worthwhile or
not.
Investment project could be the purchase of a new PC for a small
firm, a new piece of equipment in a manufacturing pant, a whole new
factory, etc.

22. TECHNIQUES
OF INVESTMENT APPRAISAL

23. 2.1 NPV (NET PRESENT VALUE)
 NPV means the difference between the present value of cash outflow and cash inflows.
 Since cash outflow takes place at the initial time, there is no need of calculating the present
value of cash outflow.
 But inflow takes place in the future, the present value of future cash inflows need be calculated.
 for calculating the present value, appropriate discount rate is used. The discount rate can be the
overall cost of capital or the standard rate determined by the management.
 After discounting the cash flows, the sum of the cash inflows will be determined for comparison
with the cash outflows.

25. 2.2 PAYBACK PERIOD METHOD
 The most popular and widely used method.
 Payback period is the period (number of years) required to recover the original cash outlay
invested in the project.
 The number of years required to recover the cost of the investment.
 At the end of the period, the accumulated cash inflows from the project will be equal to the
cash outflows.

26. Payback period= initial investment annual cash inflows

27. Projects with shortest payback period will be selected. Or compared
with standard payback period set by management. Ranked according
to the PBP.
Decision rule

28. If a company makes an investment of $1,000,000 in new equipment which is
expected to generate $250,000 in revenue per year, the calculation would be:
Payback period= initial investment/ annual cash inflow
=$1,000,000 / $250,000
= 4 years payback period
Sample
Question
Ans:
Q:

29. 2.3 IRR METHOD
 IRR- INTERNAL RATE OF RETURN METHOD
 This is the rate of return that equates the initial capital invested on a project to its estimated
cash inflows.
 So, it is the rate at which the difference between cash outflows and cash inflows of the
investment is equal to zero. i.e. rate at which NPV is 0. However, the internal rate of return
(IRR) is usually used jointly with NPV.

30. Where:
• A represents the lower rate of return that gives positive NPV
• B represents a higher rate of return that gives negative NPV
• P represents positive NPV N represents Negative NPV

31. The higher the investment’s IRR, the more attractive the project will be.
IRR is calculated using the trial and error method.
Decision rule

32. 2.4 ROCE METHOD
 ROCE- Return on Capital Employed is also known as ARR (Accounting Rate of
Return).
 Return on Capital Employed (ROCE), a profitability ratio, measures how efficiently a
company is using its capital to generate profits. The return on capital employed metric
is considered one of the best profitability ratios and is commonly used by investors to
determine whether a company is suitable to invest in or not.

33. Where:
•Earnings before interest and tax (EBIT) is the company’s profit, including all expenses except interest and tax
expenses.
•Capital employed is the total amount of equity invested in a business. Capital employed is commonly calculated as
either total assets less current liabilities or fixed assets plus working capital.

34. Let us compute the return on capital employed for Apple Inc. We will look at the
financial statements of Apple for 2016 and 2017 and calculate the ROCE for each year.
The following information is taken from Apple’s financial statements:
Apple’s capital employed is calculated as total assets minus total current liabilities:
Sample
Question

35. Therefore:
•Capital employed in 2017: 375,319,000,000 – 100,814,000,000 = 274,505,000,000
•Capital employed in 2016: 321,686,000,000 – 79,006,000,000 = 242,680,000,000
The returns on capital employed for Apple Inc. for 2016 and 2017 are as follows:
•ROCE in 2017: 64,089,000,000 / 274,505,000,000 = 0.23 = 23%
•ROCE in 2016: 61,372,000,000 / 242,680,000,000 = 0.25 = 25%
Answer:

36. Decision rule
The decision rule for ROCE is:
If the expected ROCE for the investment is greater than the target or hurdle
rate (as decided by management) then the project should be accepted.

37. REFERENCES:
 SUBRAMANYAM, S. &. T., n.d. FINANCIAL MANAGMENT. 1 ed. CHENNAI: NEW AGE
INTERNATIONAL PUBLISHERS.