Professional Documents
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Learning objectives
Introduction
Comparing Figures:
It is essential in financial analysis to compare figures with:
the equivalent figures from previous years
other figures in the financial statements
industry averages
Why do we analyse
financial statements?
Context / Environment /
Industry
Initial
look
Types of
Revenues/expenses
Types of
Assets/Liabilities
Deeper
look
Vertical Analysis
Horizontal Analysis
Trend Analysis
Deeper
Again
Profitability
Liquidity
Capital Structure
Market Performance
Asset Efficiency
Financial statements
include all of the
following:
Income Statement
Balance Sheet
Directors Declaration
Independent Auditors
Report and Directors
Declaration
Opinion based on their audit process that the financial statements are in
accordance with:
Remember
(greater
2.
3.
Ratio analysis
An expression of one item in the financial statements
relative to another item in the financial statements
The ratio comparison can be between two different
statements, or within one statement
1 Horizontal Analysis
Eves Enterprises
Income Statement for years ending 30 June
20X4
20X3
20X2
($ M)
($ M)
($ M)
Sales revenue
800
350
200
352
147
80
Gross Profit
448
203
120
Less Expenses
217
142
103
Wages
90
70
60
Rent
22
16
10
Other expenses
20
12
Advertising
64
28
16
Depreciation expense
10
Administration expense
11
231
62
17
EBIT
What
can you
make of
these
figures
?
13
Horizontal Analysis
Frequently expressed as
a monetary value or
as a percentage
14
Horizontal analysis
Freds Enterprises - Income Statement for years ending 30 June
Where change % =
(Yr 2 Yr 1)/Yr 1 x
100
or
(2013-2012)/2012
Sales revenue
x 100
Horizontal Analysis
2014
2013
2012
2014
2013
Change
($ M)
($ M)
($ M)
($ M)
2013
2012
Change
2014
2013
Change
2013
2012
Change
($ M)
800
350
200
450
150
128.6
75.0
352
147
80
205
67
139.5
83.8
Gross Profit
448
203
120
245
83
120.7
69.2
Less Expenses
217
142
103
76
39
53.6
37.4
Wages
90
70
60
20
10
28.6
16.7
Rent
22
16
10
37.8
60.0
Other expenses
20
12
66.7
100.0
Advertising
64
28
16
36
12
128.6
75.0
Depreciation expense
10
25.0
33.3
Administration expense
11
50.0
50.0
231
62
17
169
45
275.1
261.8
EBIT
Horizontal Analysis
contd
An example of a trend
Vertical analysis
2014
2013
2012
2014
2013
2012
($ M)
($ M)
($ M)
Sales revenue
800
350
200
100.0
100.0
100.0
352
147
80
44.0
42.0
40.0
Gross Profit
448
203
120
56.0
58.0
60.0
Less Expenses
217
142
103
27.2
40.4
51.5
Wages
90
70
60
11.3
20.0
30.0
Rent
22
16
10
2.8
4.6
5.0
Other expenses
20
12
2.5
3.4
3.0
Advertising
64
28
16
8.0
8.0
8.0
Depreciation expense
10
1.3
2.3
3.0
Administration expense
11
1.4
2.1
2.5
231
62
17
28.8
17.6
8.5
EBIT
Vertical Analysis
Vertical analysis
Where % =
Each item/ Sales Rev
20X4
20X3
20X2
20X4
20X3
20X2
($ M)
($ M)
($ M)
Sales revenue
800
350
200
100.0
100.0
100.0
352
147
80
44.0
42.0
40.0
Gross Profit
448
203
120
56.0
58.0
60.0
Less Expenses
217
142
103
27.2
40.4
51.5
Wages
90
70
60
11.3
20.0
30.0
Rent
22
16
10
2.8
4.6
5.0
Other expenses
20
12
2.5
3.4
3.0
Advertising
64
28
16
8.0
8.0
8.0
Depreciation expense
10
1.3
2.3
3.0
Administration expense
11
1.4
2.1
2.5
231
62
17
28.8
17.6
8.5
EBIT
20
Vertical Analysis
example contd
21
Ratio analysis
Topic 7: 2 of 5
Financial Statement Analysis
Ratios - liquidity
Learning Objectives
Liquidity Ratios
Liquidity Ratios
A) Current ratio
B) Quick or Acid test ratio
C) Cash ratio
D) Cash flow to sales ratio
E) Cash flow to Total debt
Payment
to
suppliers
Creditors
Turnover
Sale of
goods on
credit
Cash
received
from debtors
Debtors
turnover
Inventory
turnover
A)
Current ratio
Current Assets
Current Liabilities
B)
BEWARE!!
If a company
has anything
less than a 2:1
current ratio
they are in a
BAD place and
will be unable
to pay their
Wow!! Way to
debts!!! generalise!!
C)
Cash ratio
D) Cashflow to Sales
ratio
Cashflow from operating activities
Sales
Higher is better
E)
Exercise time
Questions 1 & 2, Week 7
35
Topic 7: 3 of 5
Financial Statement Analysis
Ratios - efficiency
LB5212: Accounting and Finance for Managers
Learning Objectives
Efficiency ratios
Efficiency Ratios
A) Asset turnover
B) Days Inventory
C) Days Debtors
D) Days Creditors
A)
Why use Average Total Assets? Static start and end of year
figures, so use the mid point provided the environment is
reasonably stable.
If you have only one balance sheet, then you cannot average, so
use the end of year figure
544 / ((142 +
B)
Inventory efficiency
Interpretation
Average period of time it takes for a firm to
sell its inventory will depend on industry
C)
Debtors efficiency
D) Number of Days of
Creditors
Accounts Payable Days
Trade creditors / Purchases (credit if possible)*365
60/500*365 = 43.8 days
or
365 / 8.33 = 43.8 days
Sale of
goods on
credit
Payment
for goods
Credito
rs
Turnove
r
Stock turnover
Cash received
from debtors
Debtor
s
turnov
er
Exercise time
Questions 3 - 5, Week 7
50
Topic 7: 4 of 5
Financial Statement Analysis
Ratios - profitability
Learning Objectives
Profitability Ratios
Profitability Ratios
A) Return on Equity (ROE)
B) Return on Assets (ROA)
C) Gross Profit margin
D) Net profit margin
E) Expense Ratios
A) Return on Equity
(ROE)
Profit available for distribution * 100
Average Equity
Generally stated as % (sometimes as a decimal)
Relates profit attributable to owners to their investment
Usual to exclude extraordinary items & Preference Dividend
Should show trend upwards over time
Will be compared with other investments
Reflects businesss profitability, efficiency and capital
structure
B) Return on Assets
(ROA)
EBIT * 100
Average Total Assets
Compares the businesss EBIT profits to the assets
available to generate them
Looks at the generation of profit i.e.
generate sales from the assets at its disposal
convert sales into profits (revenue less
expenses)
C)
C)
EBIT * 100
Sales or Revenue
Indicates what percentage of sales dollars
remains as profits after all expenses, but before
interest and tax.
Why do we remove these from the calculation?
Due to variations in capital structures & taxation
allowances within an industry, inter-firm
comparisons are only meaningful if they use EBIT
i.e. before interest and tax is deducted
EBIT is a performance benchmark for most
business, it is close to the cash profit of a
business
NOTE: EBIT = Earnings before interest and tax
E)
Expense ratios
Expense
Revenue
Exercise time
Questions 6 - 9, Week 7
61
Topic 7: 5 of 5
Financial Statement Analysis
Ratios capital structure
Learning Objectives
Capital Structure or
Solvency Ratios
Remember.
B) Debt ratio:
Total Liabilities * 100
Total Assets
C) Equity ratio:
Total Equity * 100
Note that the Debt ratio plus the Equity ratio must always add
toTotal
total ofAssets
1.00
These three ratios are alternative measures of the same thing
gearing
D) Interest Coverage
Ratio
EBIT
Net Interest
Exercise time
Questions 10 & 11, Week 7
71
Next Week
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