Lecture 1 Afs

8/8/2019 Lecture 1 Afs

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Financial Statement Analysis

By Aditi Rode


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Basic of Financial Statement

Analysis What are the components of Financial

Statement?

What is the objective of a FinancialStatement Analysis?

Who are the users of Financial Statement?

What are the elements of FinancialStatement?


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What are the components of

Financial Statement? Balance Sheet

Income Statement

Cash Flow Statement Notes to Accounts and Accounting

Policies


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Objective of Financial Statement

Analysis To provide information about the financial

position, performance and cash flow of anenterprise

However they do not provide all theinformation because

1.They largely portray the financial

effects of past events 2.They do not provide information of non-

financial nature


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Users of Financial Statement

Investors

Lenders

Management and Owners Suppliers and Creditors

Government and Regulatory

Employees

Security Analysts and Advisers


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Elements of Financial Statement

Financial Position

-- Assets

-- Liabilities--Equity

. Performance

-- Income

-- Expenses

. Cash Flows


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Ratio Analysis

Ratios provide a quick and simple means ofexaminingexamining the financial healthfinancial health of a business

A ratio simply expresses the relationshiprelationshipbetween oneone figure appearing in the financial

statements with anotheranothereg net profit in relationto capital employed

Ratios are simplesimple enough to calculate, and agood picture can be built up with just a few,however, ratios can be difficultdifficult to interpret

Can be expressed in variousvarious forms egpercentages, fractions, proportions, dependingon the need and use for the information


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ProfitabilityProfitability - Measure of success in wealth

creation

EfficiencyEfficiency - Effectiveness of utilisation of

resources

LiquidityLiquidity - The ability to meet short-term

obligations

GearingGearing - Measure of degree of risk to do with

the amount of leverage used to finance the

business

InvestmentInvestment - Measure of the returns and

performance of shares held by a business


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The Key Steps in Financial Ratio

Analysis

Step 1: Identify which keykey indicators and

relationshipsrelationships require examinationexamination

Identify whowho needs the information and why

they need itStep 2:

Choose the most relevantrelevant set of ratios that will

accomplish the desired purposes

CalculateCalculate and recordrecord the results using theselected ratios

Step 3:

InterpretInterpret and evaluateevaluate the results


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Profitability ratios

Some profitability ratios include the

following:

Return on ordinary shareholdersordinary shareholders funds Return on total assetstotal assets

Return on capital employedcapital employed

Net profitNet profit margin Gross profitGross profit margin


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The Ratios Calculated - Profitability Ratios

Return on shareholders funds (ROSFROSF):

Compares the amount ofprofitprofit for the period

available to the ownersto the owners with the ownersowners

stakestake in the business

Normally expressed as a percentagepercentage

ROSF = NP after taxation & preference div (if any) x 100

Average ord share capital plus reserves


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The Ratios Calculated - Profitability

Ratios contd

Return on total assets (ROAROA):

Compares the net profitnet profit generated by the

business with the assetsassets owned by the

business


ROA = NP before interest & taxation x 100Average total assets


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The Ratios Calculated - Profitability Ratioscontd

Return on capital employed (ROCEROCE):

Expresses the relationship between the netnet

profitprofit generated and the average long termaverage long term

capitalcapital invested


ROCE = NP before interest and taxation x 100

(Share capital + long term loans)


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The Ratios Calculated - Profitability Ratioscontd

Net profitNet profit margin:

Relates the PATPAT for the period to the salessales

during that period


NP = Profit after taxx 100

margin Sales


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The Ratios Calculated - Profitability

Ratios contd

Gross profitGross profit margin:

Relates the gross profitgross profit of the business to

the salessales generated during the same period

Gross profitrepresents the differencedifference

between sales and COSsales and COS


Gross profit (GPGP ) margin = Gross profit x 100

Sales


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Efficiency ratios

EfficiencyEfficiency ratios include the following:

Average inventory turnover period

Average settlement period for debtors Average settlement period for creditors

Asset turnover


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The Ratios Calculated - Efficiency

Ratios

Average inventory turnover periodAverage inventory turnover period:

Measures the averageaverage periodperiod inventory washeldheld

Normally expressedexpressed in terms ofdaysdays

Average inventoryis the simple averageaverage ofopeningopening and closingclosing inventory for the period

Inventory Average inventory held x 365 turnover = Cost of sales

period


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Ratios contd

Average settlement period foraccountsaccounts

receivable/debtorsreceivable/debtors

Calculates an average ofhow longhow long credit

customers take to pay amounts owed

Normally expressed in terms ofdaysdays

Average = Average trade debtors x 365

settlement period Credit sales


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Ratios contd

Average settlement period foraccountsaccounts

payable/creditorspayable/creditors:

Calculates how longhow long, on average the

business takes to paypay its creditors Normally expressed in terms ofdaysdays

Average Average trade creditors x 365

settlement = Credit purchasesperiod


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Ratios contd

Asset turnover :Asset turnover :

Examines how effectivelyeffectively the assets of the

business are being employed in generating

sales revenuesales revenue

Average asset = Average total assets employedturnover Sales


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The Relationship Between Profitability and

Efficiency

The overall return on funds employed in the

business will be determined bothboth by the

profitabilityprofitability ofsalessales, and by efficiencyefficiency in

the use of assets


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Liquidity ratios

Liquidity ratios include the following:

Current ratio

Acid test ratio Cash flow from operations ratio


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The Ratios Calculated - Liquidity Ratios

Current ratio:Current ratio:

Compares the businesss liquid assetsliquid assets with

its short-term liabilities (currentcurrent liabilities)

Expressed in terms of the number of timesnumber of timesthe current assets will covercoverthe current

liabilities

Current ratio = Current assets (CA)Current liabilities (CL)


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The Ratios Calculated - Liquidity Ratioscontd

Acid testAcid test (also known as the quick/liquid ratioquick/liquid ratio):

Represents a more stringentstringent test ofliquidityliquidity

than the currentcurrent ratio

Expressed in terms of the number of times theliquidliquid current assets will covercoverthe currentcurrent

liabilities

Acid test = CA (excl. inventory & prepayments)

CL


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The Ratios Calculated - Liquidity Ratioscontd

Cash flows from operations ratio:Cash flows from operations ratio:

Compares the operating cash flowsoperating cash flows with the

current liabilitiescurrent liabilities of the business

Expressed in terms of the number of timesnumber of timesthe operating cash flows will covercoverthe

currentcurrent liabilities

Cash flows from = Operating cash flowsoperations ratio CL


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Financial Gearing ratios

Financial gearing or leverage ratios include

the following:

Gearing ratio Interest cover ratio


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The Ratios Calculated - Financial Gearing

(Leverage) contd

Gearing ratio:Gearing ratio:

Measures the contribution oflonglong--termterm

lenderslenders to the longlong--term capital structureterm capital structure of

the business Expressed in terms of a percentagepercentage

Gearing ratio = Long-term liabilities

x 100 Share capital + Reserves +L/term liab


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Investment ratios

Investment ratios include the following:

Dividends per share

Dividend payout ratio Dividend yield ratio

Earnings per share

Operating cash flow per share Price/earnings ratio


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The Ratios Calculated - Investment

Ratios contd

Dividends per share:

Relates the dividends announceddividends announced to the

number of shares on issuenumber of shares on issue of the business

during a period NotNot a measure of total return of the business

Dividends = Dividends announced during period

per share No. of shares on issue during period


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Ratios contd

Dividend payout ratio:Dividend payout ratio: Measures the proportion of earningsproportion of earnings

that a company pays outpays out to

shareholders in the form ofdividendsdividends Expressed as a percentagepercentage

Dividend = Dividends announced for the year

x 100 payout ratio Earnings for year available for

dividends


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Ratios contd

Dividend yield ratio:Dividend yield ratio: Relates the cash returncash return from a share to its

current market valuecurrent market value

Expressed as a percentagepercentage

Dividend yield = Dividends per share/(1 - t) x 100Market value per share

where: t = company tax ratecompany tax rate


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Ratios contd

Earnings per share:Earnings per share:

Relates the earningsearnings generated by the

company during a period to the numbernumber

of shares on issueof shares on issue during the period

Expressed as an amountamount

Earnings per share = Earnings available to ord.s/holders Number of ordinary shares

on issue


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Ratios contd

Operating cash flow per share:Operating cash flow per share: Relates the operating cash flowoperating cash flow of the

business during a period to the numbernumber

ofshares on issueshares on issue during the period Expressed as an amountamount

Operating cash = Operating cash flows - Prefdividends

flow per share Number of ord. shares on issue


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Ratios contd

Price earningsPrice earnings ratio:ratio:

Relates the market valuemarket value of a share to the

earningsearnings per share

Expressed in terms of the number oftimestimesthe share price is greatergreaterthan the currentcurrent

earnings per share

Price earnings ratio = Market value per shareEarnings per share

Lecture 1 Afs

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