Financial+Ratio (1)

7/30/2019 Financial+Ratio (1)

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Interpretation of Accounting

Information

Comparative Analysis

Evaluating the Performance and

Financial PositionProfitability (Keberuntungan)

Liquidity (Kecairan)

Solvency (Mampu bayar)

Limitations of financial statement

analysis


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Interpretation and Analysis ofAccounting Information

Interpretation of financial information:users evaluate and analyse financialinformation to make

judgements/conclusion about financialperformance or position

Key to any in-depth understanding of

an organisations performance.


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Interpretation and Analysis ofAccounting Information (contd)

Basically, the users evaluate anorganisations performance using the

information from INCOME STATEMENT

and BALANCE SHEET.

The value of the analysis depends on thevalue of the financial statements.


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Comparative analysis

Every item in financial reportsrepresents something important.

It existed and was material at some

time and in some quantity.

Its significance can be determinedonly in relation to something else

Single numbers on their own do notprovide useful information


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Comparative analysis

3 types of useful comparative information:Intra-entity basis

Comparisons within a single entity (detectschanges in financial relationships and

trends)Industry averages

Between entities in same industry(determines position relative to others)

Inter-entity basis

Between other entities (indicatescompetitive position)


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Comparative Analysis Techniques

Horizontal Analysis

Vertical Analysis

Trend AnalysisRatio Analysis


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Horizontal Analysis

Used to evaluate a series of financialstatement data over a period of time.

Analyses increases ordecreases that have

occurred from a particular base year. Figures are stated as both dollar amounts

and as percentages.

Percentages removes the effect of size, sorelative magnitude of change is revealed.


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Horizontal Analysis

One year is selected as the base yearand then increases or decreases are

based on the formula:

Change since base year

= current yr amt base yr amtBase year amount


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Vertical Analysis

It evaluates financial statement byexpressing each item in a financialstatement as a percent of the base

amount (key figure) Key-figure (such as sales in IS and Total

assets on BS) are set to 100%

Other items are then expressed aspercentage of 100


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Vertical Analysis (cont..)

Evaluates financial statement data byexpressing each item as a percentageof a base amount to indicate relative

magnitude.Useful for comparing companies ofdifferent sizes.

Calculated percentages can also betracked over time to determinepatterns of change.


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Trend Analysis

Similar to horizontal analysis,

except that the first set ofaccount in the series is given abase of 100


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Ratio Analysis

Useful tool for financial analysisUsed to evaluate the financial

performance and position of a business

entityRatio expresses the relationship among

selected items of financial statement data.

Absolute accounting figures do give

meaningful picture


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Ratio Analysis (cont..)

May be used to compare one year withanother for the same business (Intra-

company comparisons) or

one business with another similar business(Inter-entity comparisons)


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Ratio analysis (cont..)

Commonly used group of financial

ratios:

Profitability ratios

Liquidity ratios

Efficiency ratios

Solvency ratios


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Profitability Ratios

Profitability ratios measure the profit oroperating success of an entity for a given

period of time.

Size of entitys profit affects its: Ability to obtain debt and equity financing.

Liquidity position.

Ability to grow.

Profitability is often regarded as the ultimatetest of managements operatingeffectiveness.


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Gross profit Marginindicates entitysability to maintain an adequate selling

price above its costs.

Ratio declines as industry becomes more

competitive.


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Gross profit ratio

Gross Profit /Sales

Gross profit margin lower than industry averagemay indicate low selling price , or

high cost of goods sold or both


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Net profit ratio

Net Profit before taxSales

May reveal the extent to whichthe firms expenses are under control


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Asset turnover

Measures how efficiently assets are used

to generate sales.

Formula:

Net SalesAverage Total Assets


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Return on Assets ratio

Measures overall profitability with respect toinvestment in assets.

Affected by: Degree of leverage (interest expense)

Profit margins

Asset base

Formula: Net ProfitAverage Total Assets


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Profitability ratios (cont..)

Relationship between profitability ratios:

Return on assets

= profit margin x asset turnover= net profit x net sales .

net sales average

total assets


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Liquidity Ratios

Liquidity ratios measure the short-termability of an entity to pay its debts andmeet unexpected needs for cash.

Important to bankers, suppliers and other

short-term creditors.


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Liquidity ratios

Current ratio

Current Assets / Current Liabilities

Measure the firms ability to meet its short term

financial obligations out of its current assets


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Quick Ratio

Measure of an entitys immediateshort-term liquidity.

Often called the acid test ratio.

Excludes inventory and prepaid assetswhich are the least liquid current assetsFormula:

Cash + marketable securities + net receivablescurrent liabilities


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Liquidity ratios (cont.)

Quick asset /acid test ratio formula:

Current Assets InventoryPrepaid Exp.Current Liabilities

A severe test of liquidity


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Liquidity Ratios (cont..)

Inventory turnover

Reflects the effectiveness of inventorymanagement.

Formula: Cost of Goods SoldAverage Inventory


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Average days in inventory

Converts inventory turnover into a

measure of days for inventory to be sold.

Formula: 365 daysInventory Turnover


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Efficiency Ratios

Inventory turnover ratio

Inventory holding period

Cost of goods sold/Average Inventory

365/ Inventory turnover ratio

Indication of the efficiency with whicha business entity manages its inventory


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Receivables/ Debtors Turnover RatioIndicates the effectiveness of creditcollection policies.

Measures the number of times tradereceivables are converted into cashduring the period.

Formula: Net credit salesAverage net trade receivables


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Liquidity ratios (cont..)

Average collection period

Converts receivables turnover figureinto a measure of days for receivablescollection.

Formula:

365 daysAcc. Receivables turnover


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Efficiency Ratios

Debtors Turnover ratio

Debtor collection period

Net credit salesAverage Debtors Control Account

356/ Debtors Turnover ratio

Measures the average number of days which elapsebetween making a credit sale and receiving

payment from customer


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Solvency Ratios

Solvency ratios measure the ability ofan entity to survive over a long periodof time.

Important to long-term creditors andshareholders.

8.


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Solvency ratios

Debt to Equity ratio

Total Liabilities/ Total Assets

Indicate the extent to whichthe firm is financed by debts

(the degree of leverage)


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Limitations of Financial Statement

Analysis

1. Estimates

Financial statements contain many estimates.

e.g. - allowance for doubtful debts- depreciation expense

- costs of warranties

If estimates are inaccurate, the financial ratios

and percentages will also be inaccurate.


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Limitations of FinancialStatement Analysis

2. Cost

Many items are carried at historic cost.

This does not account for price-level changes.

3. Alternative accounting methods

Differences in accounting policies for the similar

financial activities are often allowed.

e.g. methods of depreciation


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Limitations of FinancialStatement Analysis

4. Atypical data

Some end-of-period data may not represent

normal business conditions.

5. Diversification

Diversification within entities limits usefulness of

financial statement analysis.

Segment data may provide more relevant andcomparable information.


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Limitations of AccountingRatio Analysis

Inflation is ignored

Unrepresentative balance sheet figures. Year

end data may not reflect the firm positionthrough out the year

Difficult to find a firm for meaningful comparison

due to different accounting policies

Basis of measurement used is historical cost.

Financial analysis based on past data

Documents

Financial+Ratio (1)