Financial Statement Analysis Final (1)

Welcome to AIBF

Financial Statement Analysis Training

Asalamualikum!

Khalid Zarif Current engagements

Deputy Director & Academic Head of AIBF

President of Afghanistan Association of Professional

Accountants (AAPA)

Bank Millie Afghan (BMA) Supervisory Board Member

President of Afghan Social Researchers Association (ASRA)

Work Experiences

Business Unit Manger & adjunct Trainer, AUAF-PDI

Technical Adviser, FinTRACA- Da Afghanistan Bank

Custom Analyst- Ministry of Finance

Official of Treasury Department- Ministry of Finance

Education:

Global MBA plus finalist of ACCA- Continuous

BSc from Oxford Brookes University

Certified Accounting Technician (CAT)

INTERPRETATI

ON OF

FINANCIAL

STATEMENTS

1. Purpose and format of the

financial statements

2. Users of the financial

Statements

3. Profitability Ratios &

Interpretation

4. Liquidity Ratios &

Interpretation

5. Gearing Ratios &

Interpretation

6. Limitations of ratio analysis

Accounting: Definition

Is the process of

Recording in journal

Classifying in ledger and

Summarizing in Financial Statements

Interpreting financial information in

order to make decisions

Financial Statements

Financial Statements present information about

The financial position of an entity

Its financial performance during accounting period

Its cash flow

Financial statements are

1. Statement of Financial Position

2. Statement of Comprehensive Income/income statement

3. Statement of Cash Flow

4. Statement of changes in Equity

5. Notes to the Financial Statements

Elements of Financial Statements

Statement of Financial Position

shows the financial position of an entity as at a particular date.

The financial position is shown by assets, liabilities and

equity (capital)

Income statement

shows the financial performance of an entity during an

accounting period

The financial performance is shown by income and

expenses

Continued

Elements of Statement of Financial Position

Asset

An asset is a resource controlled by the entity as a result of past event and from which future economic benefits are expected to flow to entity.

Examples of assets are factories, office buildings, warehouses, delivery vans, lorries, plant and machinery, computer equipment, office furniture, cash and goods held in store

Assets are of two types

Current Assets: are those assets that are cash, will be converted into cash or will be used up within one year

Cash, Accounts Receivables, Inventory

Non-Current (Fixed) Assets: are assets that will be used in more than one accounting period

Building, vehicles, machines, plant and equipment

Elements of Statement of Financial Position

Liability is a present obligation arising from past events, the settlement

of which will result in an outflow of economic benefits from the entity.

'Liabilities' is the accounting term for the debts of a business.

Liabilities are of two types: Current Liability: is an obligation to others which is payable in 12

months Accounts payable, bank overdrafts, short term loans

Non-current liability: is an obligation to others payable in more than 12 months Long term loans from banks

Capital/Equity/net assets Is the amount invested in business by owners(capital)

Consists of amount invested by owner and profits of business

Format of Statement of Financial Position

Statement of Financial position is in vertical format and is divided into two parts

The top half of the statement shows the assets of the business with non current asset first and current assets below the non current assets

The lower of half of the statement shows the capital followed by liabilities. The liabilities are shown with non-current liabilities first and then current liabilities

The total of assets must equal the total of capital and liabilities

Statement of financial position

Statement of profit or loss and other

comprehensive income

Changes in equity

Format of Statement of Financial Position 1. Business Name- Statement of Financial Position

Assets

Non-current Assets

Property, plant and equipment (IAS-16)

+Borrowing Cost (IAS-23)

Goodwill (IFRS-3)

Other intangible assets (IAS-38)

-Impairment (IAS-36)

Investment in Associates (IAS-28)

Investment property (IAS-40)

Investment in equity instruments (IAS-38)

Biological Assets (IAS-41)

Current Assets

Inventories (IAS-2)

Trade Receivable

Assets held for sale (IFRS-5)

Other current Assets

Cash and cash equivalents

Total assets

Equity and liabilities

Equity attributable to owners of the parent

Share Capital

Retained earnings

Other components of equity

Non-controlling interest

Total equity

Non-current liabilities

Long term borrowings IAS-32 (IFRS-9)

Preferred Share IAS-32 (IFRS-9)

Deferred tax (IAS-12)

Long-term provisions (IAS-37)

Government grants (IAS-20)

Leasing obligation (IAS-17)

Total non-current liabilities

Current liabilities

Trade and other payables

Short-term borrowings

Current portion of long-term

Borrowings

Current tax payable

Short-term provisions

Total current liabilities

Total liabilities

Total equity and liabilities

Format of Income Statement Business Name- Statement of Comprehensive Income for the year ended

Revenue/ Sales/ turnover (IAS-18)

Less Cost of Sales

Gross Profit

Other income

Administrative expenses

Distribution Expenses

Financial Cost (Interest Expenses)

Profit before tax (PBT)

Tax expenses (IAS-12)

Profit after tax (PAT)

Profit/ Loss from discounted operation (IFRS-5)

Other Comprehensive Income

Revaluation gain/ loss (IAS-16)

Actuarial gain/loss (IAS-19)

Fair value thought OCI (IFRS-9)

Cash flow hedge gain/loss (IAS-39)

Total Comprehensive Income

Elements of Income Statement

Income : consists of

Revenue from sale of goods

Other items of income such as interest received

Gains from disposing of assets

Expense: consists of

Expenses arising in the ordinary course of activities such as

cost of sales, wages and salaries

Losses from disposing of assets

Format of Income Statement Business Name- Statement of Comprehensive Income for the year ended

Revenue/ Sales/ turnover (IAS-18)

Less Cost of Sales

Gross Profit

Other income

Administrative expenses

Distribution Expenses

Financial Cost (Interest Expenses)

Profit before tax (PBT)

Tax expenses (IAS-12)

Profit after tax (PAT)

Profit/ Loss from discounted operation (IFRS-5)

Other Comprehensive Income

Revaluation gain/ loss (IAS-16)

Actuarial gain/loss (IAS-19)

Fair value thought OCI (IFRS-9)

Cash flow hedge gain/loss (IAS-39)

Total Comprehensive Income

QUESTION

In the month of January, a business had these transactions:

Sales $150,000

Purchases $70,000

Returns inwards $5,000

Returns outwards $1000

If the opening inventory was $12,000 and closing inventory

was $14,000

Requirement: calculate the gross profit for the month

QUESTION

The following information relates to Minnie’s hairdressing business in the year ended 31 August 20X7: Expenses 7,100

Opening inventory 1,500

Closing inventory 900

Purchases 12,950

gross profit 12,125

Inventory drawings 75

What is the sales figure for the business:

A $32,700

B $25,600

C $25,675

D $25,750

Relationship between Statement of Financial

position and Income Statement

The income statement and statement of financial position

are separate statements but they are also related to each

other

The income statement ends with net profit or loss. This

profit or loss belongs to the owner. Profit/loss for

the year is added to or subtracting from owner’s capital in

statement of financial position at the end of the year.

The result of the income statement either profit/ (loss) will

be reflected in the statement of financial position

Users of the financial statement

Information required by users

As well as:

Employees - will I get paid?

Governments - tax, regulations compliance

Suppliers / lenders - will we get paid?

Customers - can we rely on this company?

Information required by users

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Purpose

Analysis of a company’s financial statements is

performed by the following:

—Management

— Interested parties

How Financial Information Analysis?


Financial statements can be assessed using ratio

analysis

Past trends of the same business (analysis through

time) and compare to budget

Comparative information for similar businesses

(analysis by competitors)

Ratio Analysis Is a tool for measuring a firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s resource utilization.

How the ratio means are enhanced? if we compare with:

Past performance (i.e. past years’ ratios)

Target Ratios

Other companies ratios (i.e. competitors’ ratios)

Industry as a whole

Ratio Analysis

In order to make sense of whether ratios are

good or bad, we need to answer the below

questions: -

What does the ratio literally mean?

What does the change in the ratio mean?

What is the norm in the industry?

What are the limitation of the ratio?

Category Ratio Description

Profitability Ratio

Gross profit Net profit Asset turn over Return of capital employed Return on Equity

Gross profit divided by sales Net profit divided by sales Sales divided by capital employed PBIT divided by capital employed PAT & Pre Dividend divided by capital emp

Liquidity Ratio Current ratio Quick(acid test) ratio

Current assets divided by current liabilities Current assets (minus inventory) divided by current liabilities

Liquidity (Efficiency) Ratio

Inventory turn over Receivables turn over Payables turnover

Inventory divided by cost of sales x 365 Receivables divided by sales x 365 days Payables divided credit purchases x 365

Gearing Ratio Debt to equity ratio Long term debt to equity Interest Cover

Total liabilities divided by equity Long term divided by equity PBIT divided by interest payable

Investor Ratio Earning per share (EPS) Price/Earnings(P/E) ratio Dividend Cover

Profit after tax divided by ordinary shares Market value of shares divided by EPS Profit after tax divided by dividends

TYPES OF RATIOS

Profitability


Profit margin

This is the margin that the company makes on its sales,

and would be expected to remain reasonably constant.

Profitability


Return on capital employed

—Measures overall efficiency of company in employing

resources available to it

—Examine

—Change year to year

—Comparison to similar entities

—Comparison with current market borrowing rates

Profitability


Asset turnover

It measures management’s efficiency in generati

ng revenue from the net assets at its disposal:

the higher, the more efficient

= times pa

Profitability


Relationship between ratios

ROCE can be subdivided into profit margin and asset turnover.

Profit margin × Asset turnover = ROCE

PBIT Sales revenue PBIT

–––––––––––– × –––––––––––– = ––––––––

Sales revenue Capital employed Capital employed

Profitability


Return on equity

More restricted view of capital than ROCE, but same

principles

Liquidity and working capital ratios


There are two ratios used to measure overall

working capital:

• the current ratio

• the quick or acid test ratio.




Current ratio

The current ratio measures the adequacy of current a

ssets to meet the liabilities as they fall due.



Quick ratio

Eliminates illiquid and subjectively valued inventory

Could be high if overtrading with rec’bles, but no

cash



Inventory Turnover

Cost of sales

Inventory turnover is defined as: –––––––––––– = time

Inventory

An alternative is to express the inventory turnover as so

many days



Inventory turnover period

—Higher the better? But remember:

—Lead times

—Seasonal fluctuations in orders

—Alternative uses of warehouse space

—Bulk buying discounts

—Likelihood of inventory perishing or becoming

obsolete



A/cs receivable collection period

Consistent with quick/current ratio? If not,

investigate.



Accounts payable payment period

Use cost of sales if purchases not disclosed

This represents the credit period taken by the

company from its suppliers

Long term financial stability

The main points to consider when assessin

g the longer-term financial position are:

1. gearing

2. overtrading

Gearing ratios indicate:

• the degree of risk attached to the company and

•the sensitivity of earnings and dividends to changes in profit

ability and activity level


Measuring gearing

There are two methods commonly used to express gearing as follows.

Debt/equity ratio:

Loans + Preference share capital

––––––––––––––––––––––––––––––––––––––––

Ordinary share capital + Reserves + Non controlling interest

Percentage of capital employed represented by borrowings:

Loans + Preference share capital

–––––––––––––––––––––––––––––––––––––––––

Ordinary share capital + Reserves + Non controlling interest + Loans + Preference share capital



Interest cover

Company must generate enough profit to cover

interest


Overtrading:

Overtrading arises where a company expands its s

ales revenue fairly rapidly without securing additio

nal long-term capital adequate for its needs.

Activity: Classwork Assignment

Investors’ ratios

Introduction

Earnings per share (EPS) is widely regarded as the most important indicator of a company’s performance. It is important that users of the financial statements:

1. are able to compare the EPS of different entities and

2. are able to compare the EPS of the same entity in different accounting periods.

Basic EPS Earnings

The basic EPS calculation is simply: –––––––––

Shares

Investors’ ratios-Test your understanding

Gerard's earnings for the year ended 31 December

20X4 are $2,208,000. On 1 January 20X4, the issued

share capital of Gerard was 9,200,000 6% preferenc

e shares of $1 each and 8,280,000 ordinary shares o

f $1 each. The company issued 3,312,000 shares at fu

ll market value on 30 June 20X4.

Calculate the EPS for Gerard for 20X4

Investors’ ratios

Activity:

Limitations of ratio analysis


Limitations

Comparative information is not always

available.

They sometimes use out of date information.

Interpretation requires thought and analysis.

Ratios should not be considered in isolation.

The exercise is subjective, for example not all

companies use the same accounting policies.

Ratios are not defined in standard form.

Documents

Financial Statement Analysis Final (1)