Financial Analysis & Planning: Tools, Ratios, Budgets & Forecasting

Core Concepts

1. Financial Analysis: The Foundation

Financial analysis is the systematic examination of a company’s financial health using historical data (income statements, balance sheets, cash flow statements) to assess profitability, liquidity, efficiency, and solvency. It answers:

• Are we making money? (Profitability)
• Can we pay our bills? (Liquidity)
• Are we using assets efficiently? (Efficiency)
• Do we have too much debt? (Solvency)

Why it matters:

"You can’t manage what you can’t measure." — Peter Drucker Financial analysis turns raw numbers into actionable insights for investors, managers, and creditors.

2. Key Financial Statements (The Building Blocks)

Every analysis starts with these three statements. Below are real-world examples from Nepali businesses formatted as tables.

A. Income Statement (Profit & Loss Statement)

Shows revenue, expenses, and net profit over a period (e.g., fiscal year). Example: Kathmandu’s Retail Shop (FY 2023-24)

| Particulars               | Amount (NPR '000) |
|---------------------------|-------------------|
| **Sales Revenue**         | 50,000            |
| Less: Cost of Goods Sold  | (30,000)          |
| **Gross Profit**          | 20,000            |
| Less: Operating Expenses  | (12,000)          |
| **Operating Profit**      | 8,000             |
| Less: Interest Expense    | (500)             |
| **Net Profit Before Tax** | 7,500             |
| Less: Tax (27.5%)         | (2,062)           |
| **Net Profit**            | **5,438**         |

B. Balance Sheet (Financial Position)

Shows assets, liabilities, and equity at a specific date (e.g., 31 Dec 2023). Example: Same Kathmandu Shop

| **Assets**                | Amount (NPR '000) | **Liabilities + Equity** | Amount (NPR '000) |
|---------------------------|-------------------|--------------------------|-------------------|
| **Current Assets**        |                   | **Current Liabilities**  |                   |
| Cash                      | 2,000             | Accounts Payable         | 5,000             |
| Accounts Receivable       | 3,000             | Short-term Loan          | 2,000             |
| Inventory                 | 8,000             | **Total Current Liab.**   | **7,000**         |
| **Total Current Assets**  | **13,000**        |                          |                   |
| **Non-Current Assets**    |                   | **Non-Current Liab.**    |                   |
| Furniture & Fixtures      | 10,000            | Long-term Loan           | 15,000            |
| Land                      | 20,000            | **Total Liabilities**    | **22,000**        |
| **Total Assets**          | **43,000**        | **Equity**               |                   |
|                           |                   | Capital Stock            | 10,000            |
|                           |                   | Retained Earnings        | 11,000            |
|                           |                   | **Total Equity**         | **21,000**        |
|                           |                   | **Total Liab. + Equity** | **43,000**        |

C. Cash Flow Statement

Tracks actual cash inflows/outflows (operating, investing, financing). Example: Kathmandu Shop’s Cash Flow (FY 2023-24)

| Category               | Amount (NPR '000) |
|------------------------|-------------------|
| **Operating Activities**|                   |
| Net Profit             | 5,438             |
| + Depreciation         | 1,000             |
| - Increase in Inventory| (1,000)           |
| **Net Cash from Ops.** | **5,438**         |
| **Investing Activities**|                   |
| Purchase of Furniture  | (3,000)           |
| **Net Cash from Inv.** | **(3,000)**       |
| **Financing Activities**|                   |
| Loan Repayment         | (2,000)           |
| **Net Cash from Fin.** | **(2,000)**       |
| **Net Change in Cash** | **438**           |
| **Opening Cash Balance**| 1,562             |
| **Closing Cash Balance**| **2,000**         |

In the Real World

1. Ncell’s Debt Ratios Ncell (Nepal’s largest telecom) uses debt-to-equity ratios to decide how much to borrow for 5G expansion. In 2023, their ratio was 0.8:1 (NPR 80 debt for every NPR 100 equity), signaling controlled leverage. Investors monitor this to assess risk.

2. Daraz’s Inventory Turnover Daraz (Alibaba’s Nepal arm) tracks inventory turnover to avoid stockouts or overstocking. A turnover ratio of 8 times/year means they sell inventory every ~45 days—faster than many Nepali retailers, reducing storage costs.

3. Nepal Rastra Bank’s Liquidity Rules Banks like NMB or Global IME must maintain a cash reserve ratio (CRR) of 3% (as of 2024). This ratio (calculated as Cash Reserves / Deposits) ensures they can cover withdrawals during crises like the 2023 fuel shortage.

3. Financial Ratios: The Metrics That Matter

Ratios standardize financial data for comparison across time or companies. They fall into 4 categories:

Worked Example: Nepal Electricity Authority (NEA) vs. Private Solar Companies Assume:

• NEA: Current Ratio = 0.8 (NPR 800M assets vs. NPR 1B liabilities).
• Private Solar Firm: Current Ratio = 1.6.

Analysis:

• NEA’s ratio <1 signals liquidity crisis (e.g., 2023 load-shedding delays payments to suppliers).
• Solar firms’ ratio >1.5 shows they can pay bills on time, even during monsoon outages.

4. Horizontal vs. Vertical Analysis

A. Horizontal Analysis (Trend Analysis)

Compares absolute changes in financial items over time (e.g., 2022 vs. 2023). Example: Kathmandu Shop’s Sales Growth

| Year       | Sales (NPR '000) | % Change vs. Prior Year |
|------------|-------------------|-------------------------|
| 2022       | 40,000            | —                       |
| 2023       | 50,000            | **+25%**                |
| 2024       | 60,000            | **+20%**                |

Insight: Sales grew 25% in 2023 (post-pandemic recovery), but growth slowed to 20% in 2024 (market saturation?).

B. Vertical Analysis (Common-Size Statements)

Expresses each item as a percentage of a base (e.g., sales for income statement, total assets for balance sheet). Example: Kathmandu Shop’s Vertical Income Statement (2023)

| Particulars               | Amount (NPR '000) | % of Sales |
|---------------------------|-------------------|------------|
| Sales Revenue             | 50,000            | 100%       |
| Cost of Goods Sold        | 30,000            | 60%        |
| Gross Profit              | 20,000            | 40%        |
| Operating Expenses        | 12,000            | 24%        |
| Net Profit                | 5,438             | 10.9%      |

Insight: Gross profit margin (40%) is healthy, but operating expenses (24% of sales) are high—target for cost-cutting.

5. Financial Planning: Budgets and Forecasts

Planning turns analysis into action. Two key tools:

A. Budgets (Short-Term Plans)

• Master Budget: Combines all departmental budgets (sales, production, cash).
• Types:
  • Operating Budget: Revenue, expenses, profit (e.g., Daraz’s monthly sales targets).
  • Financial Budget: Cash flow, capital expenditures (e.g., Ncell’s 5G tower funding).

Example: Kathmandu Shop’s Sales Budget (Next Quarter)

| Month       | Expected Sales (NPR '000) | % of Annual Target |
|-------------|---------------------------|--------------------|
| Jan 2024    | 15,000                    | 30%                |
| Feb 2024    | 14,000                    | 28%                |
| Mar 2024    | 16,000                    | 32%                |
| **Total**   | **45,000**                | **90%**            |

Why? Ensures the shop meets its NPR 50M annual target while accounting for Jan’s festival season and Feb’s post-holiday slump.

B. Forecasting (Long-Term Projections)

Uses historical data + assumptions to predict future performance. Methods:

1. Qualitative: Expert opinions (e.g., NMB’s economists predicting inflation).
2. Quantitative:
   • Time-Series Analysis: Extends past trends (e.g., NEPSE index growth).
   • Regression Analysis: Links sales to factors like population growth.

Example: Pathao’s Driver Demand Forecast Pathao uses regression analysis to predict rides:

Demand = 500 + 20 × (Temperature °C) – 10 × (Rainfall mm)

• If Kathmandu sees 25°C and 5mm rain, forecasted demand = 500 + 500 – 50 = 950 rides/day.

6. The Accounting Cycle: How Data Flows

Every transaction follows this 8-step cycle, visualized below:

flowchart TD
    A["1. Journalize Transactions"] --> B["2. Post to Ledger (T-Accounts)"]
    B --> C["3. Prepare Unadjusted Trial Balance"]
    C --> D["4. Record Adjusting Entries"]
    D --> E["5. Prepare Adjusted Trial Balance"]
    E --> F["6. Prepare Financial Statements"]
    F --> G["7. Close Temporary Accounts"]
    G --> H["8. Prepare Post-Closing Trial Balance"]
    H -->|"Repeat"| A

Key Step: Adjusting Entries Example: Kathmandu Shop’s Year-End Adjustments

| Date       | Description                          | Debit (NPR) | Credit (NPR) |
|------------|--------------------------------------|-------------|--------------|
| 31-Dec-2023| Accrued Salary (unpaid wages)        | 200,000     | Salary Payable |
| 31-Dec-2023| Depreciation (Furniture)             | 1,000,000   | Depreciation Expense |
| 31-Dec-2023| Prepaid Rent (expired portion)      | 500,000     | Rent Expense  |

7. Limitations of Financial Analysis

No tool is perfect. Common pitfalls:

• Historical Data ≠ Future: Past profits don’t guarantee future success (e.g., Nepal’s real estate bubble of 2008).
• Window Dressing: Companies manipulate ratios (e.g., delaying payments to improve current ratio).
• Industry Differences: A gross profit margin of 20% is great for retail but poor for telecom (Ncell’s margin: ~35%).
• Inflation Distortion: Comparing 2010 vs. 2024 sales without adjusting for inflation is misleading.

Exam Tip

What Examiners Want to See

1. Structure: Always label ratios clearly (e.g., "Current Ratio = Current Assets / Current Liabilities = 1.6:1").
2. Units: Show calculations in NPR (not percentages alone) unless the question specifies otherwise.
3. Real-World Links: Connect answers to Nepali contexts (e.g., "Like Ncell, this company should maintain a debt ratio <1 to avoid bankruptcy").
4. Comparisons: Use tables to contrast two companies (e.g., NEA vs. private solar firms).
5. Assumptions: If forecasting, state assumptions explicitly (e.g., "Assuming 5% inflation and 10% sales growth").

Common Mistakes to Avoid

• Ignoring the Question: If asked for liquidity ratios, don’t calculate profitability ratios.
• Incorrect Formulas: Memorize:
  • Current Ratio = Current Assets / Current Liabilities
  • Debt-to-Equity = Total Debt / Total Equity
  • ROE = Net Profit / Shareholders’ Equity
• Skipping Workings: Always show steps, even if the answer is in the question.
• Overcomplicating: Stick to 2–3 key ratios per question unless asked for a full analysis.

Practice Question (PU-Style)

Question: "The balance sheet of a Kathmandu-based garment exporter shows:

• Current Assets: NPR 20M
• Current Liabilities: NPR 10M
• Total Assets: NPR 50M
• Total Equity: NPR 25M Calculate:

1. Current Ratio
2. Debt-to-Equity Ratio
3. Interpret the results for the company’s short-term and long-term health."

Model Answer:

1. Current Ratio = Current Assets / Current Liabilities = 20M / 10M = 2:1 Interpretation: The company can cover short-term obligations twice over—strong liquidity (like Daraz’s inventory turnover efficiency).

2. Debt-to-Equity Ratio = Total Debt / Total Equity

   • Total Debt = Total Assets – Total Equity = 50M – 25M = 25M
   • Ratio = 25M / 25M = 1:1 Interpretation: The company uses equal parts debt and equity—moderate risk (similar to Ncell’s 2023 ratio).

3. Overall Health:

   • Short-term: Healthy (current ratio >1.5).
   • Long-term: Neutral (debt ratio =1 is safe but not optimal; aim for <0.7 like private solar firms).

Visual Summary: The Financial Analysis Toolkit

mindmap
  root((Financial Analysis))
    Ratios
      Liquidity
        Current Ratio
        Quick Ratio
      Profitability
        Gross Margin
        Net Margin
      Efficiency
        Inventory Turnover
        Receivables Turnover
      Solvency
        Debt-to-Equity
        Interest Coverage
    Statements
      Income Statement
      Balance Sheet
      Cash Flow Statement
    Techniques
      Horizontal Analysis
      Vertical Analysis
    Planning
      Budgets
      Forecasts