Financial Statement Analysis

1
Financial Statement Analysis

• Ratio Analysis and Related Techniques

2
Financial Ratios

• Liquidity Ratios
• Profitability Ratios
• Efficiency Ratios
• Investment Ratios

3
Liquidity Ratios

• Measure the ability of the organisation to meet
  immediate liabilities
• Address the question Can the company keep
  trading in the short term?
• Examples -
• Current ratio ratio of current assets to
  current liabilities
• Acid test ratio of current assets except
  stock
• to current liabilities

4
Profitability Ratios

• Measure ability of the organisation to generate a
  profit
• Address the question Can the company generate
  funds?
• Examples
• Net profit profit before tax/sales
• Gross Profit gross profit/sales
• Return on Capital Employed profit / assets ...
• N.B. Gross Profit Sales - Direct cost of Goods
  Sold

5
Efficiency Ratios

• Measure ability of the organisation
• to work assets
• Address the question
• Is the company well managed?
• Examples
• Stock Turnover Cost of Goods Sold / Stock
• Asset Turnover Sales / Assets
• Age of Debt Debtors / Sales x 365 (days)

6
Investment Ratios

• Measure the quality of the company as an
  investment - measure security and return
• Address the question
• Should you buy shares in this company?
• Examples
• Dividend Yield Dividend / Share Price ()
• Earnings per Share Attributable Profit / Number
  of Shares
• Price/Earnings Ratio Share Price/ Earnings per
  Share ()
• Dividend Cover Attributable Profit / Dividends
• Capital Gearing Borrowing / Total Assets

7
Uses of ratios

• Cross Sectional analysis
• Comparison of different companies within a sector
• Longitudinal analysis
• (over a period of time)
• Comparison of different years for the same
  company - trend analysis
• Combinations
• Inter company trend comparisons

8
Problems with ratios

• They consider only past accounting
  information
• Quality of information, depends on
• - accounting policies
• - trading practices (hire or buy)
• Basis of calculation
• Year end focus

9
External factors are also an issue

• Market conditions
• Management policies / changes
• Technological changes
• etc.

10
Accounting policies

• Accounting standards provide some consistency
• International harmonization?
• But are still areas of uncertainty
• Depreciation policies
• Different valuation methods for assets
• Provisions and Accruals

11
Trading practices -

• Hire or buy?
• Transport business with own lorries vs. transport
  business with many subcontractors

12
Inventing Ratios

• Overheads as a percentage of turnover, or profit
• Net current assets as a proportion of assets
• Work in progress as a proportion of assets or
  stock or profit
• etc.