AGENDA

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AGENDA
1. Auditors and Accountants Reports 2. Users
of Financial Statements 3. Constraints of
Financial Statements 4. Business Approach to
Understanding Financial Statements
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Auditors / Accountants Report
Review engagement report Notice to Reader -
Compilation Auditors Report
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Users of Financial Statements

• Owners
• Management
• Creditors
• Government
• Others

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Business Approach to Understanding Financial
Statements
1. Analyse business Key success
factors Sudden death factors Business
constraints 2. Analyse financial
statements Ratio analysis Vertical/horizontal
analysis Search for more information
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Constraints of Financial Statements

• Based on numerical analysis
• Past oriented
• Other factors affect performance
• Other measures of performance
• Do not measure risk
• Not a cause / effect analysis

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Key Success Factors

• Low cost
• Quality of product / service
• Expertise
• Quality of management
• Cash flow / financing

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Sudden Death?

• Legislation
• Financing conditions
• Catastrophes
• Labour unrest
• Supplier/customer reliance

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Early Warning Signals
Two Stages 1. Near death 2. Declining
fortunes
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Early Warning Signals

• Near Death
• Lack of current financial statements
• Undercapitalization
• Lack of management depth
• History of continuing losses

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Early Warning Signals

• Declining fortunes
• Gross margin declining
• Receivables collection becoming slower
• Inventory is increasing - product not selling
• Current ratio is declining
• Sales declining

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Early Warning Signals
1999 1998 Gross Margin 240M 225M Gross
margin 42.8 45.0 Inventory 85M 65M Curr
ent ratio 1.691 1.671 Sales 560M 500M
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Business Constraints

• Cash
• Lack of trained personnel
• Production / service capacity
• Limited market

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Financial Statement Analysis

• Ratio analysis
• Trend analysis

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Types of Ratios

• Liquidity
• Leverage
• Profitability
• Efficiency

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Liquidity Analysis

• Current ratio
• Quick ratio

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Leverage
Current liabilities / Shareholders equity Total
liabilities / Shareholders equity Sales /
Shareholders equity Capital assets /
shareholders equity
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Profitability Analysis

• Analysis of other items
• The income statement
• Return on investment

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Efficiency Ratios

• Days sales uncollected
• Turnover of merchandise inventory

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Limitations of Ratios

• Window dressing
• Snapshot reporting

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Comparative Statements
Horizontal analysis - percentage change -
trend percentage Vertical analysis -
common-size statements
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Standards of Comparison for Ratios

• Personal experience
• Industry comparison
• Published data
• Rules of thumb
• Trade associations