Post on 19-Jan-2015
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FINANCIAL STATEMENTS ANALYSIS
• Is an assessment of the financial position of a business in past, present and future
FINANCIAL RATIOS ANALYSIS
• Is a relationship of one number with another number
2 TYPES COMPARISON i. INDUSTRY AVERAGES
- Ratios of one firm are compare with other firms within the same size & at the same time.
ii. TREND ANALYSIS
- Compare ratios of present with previous years CATEGORIES OF RATIOS
a. Liquidity Ratios b. Efficiency Ratios c. Leverage Ratios d. Profitability Ratios e. Market Ratios
a. Liquidity Ratios
Purpose – to determine firm’s ability to meet its maturing obligation (pay its current liabilities)
i. Current Ratio (CR) = Current assets Current Liabilities
ii. Quick Ratio/Acid test Ratio
= CA – Inventories – Prepaid expenses CL
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Low ratio- indicate firm may have difficulty to pay current liabilities on time (less liquid) High ratio – firm may sacrificing some return because too much financial capital is tied up in CA (more liquid) If CR is high but QR very low – indicate that firm may have too much stock b. Efficiency Ratios/assets management ratio/activity
ratios Purpose – to measure how effective firm in managing its assets to generate sales i. Inventory Turnover Ratio (IT)
= COGS OR = Sales Closing Stock Closing Stock
- IT shows number of times inventory is sold out
and re-stock or “Turned over” per year - High IT – is good, it may indicate high sales
volume/superior selling practices - Low IT – indicate excess or obsolete inventories
ii. Average Collection period (ACP)
ACP = Account Receivable X 360 days Credit Sales
- measure length of time taken to collect money from debtors Low ACP – is good, it indicate that firm manage to collect money in a short period i.e credit policy is good High ratio – contra from the above
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iii. Fixed Assets Turnover (FAT)
FAT = Sales. Net Fixed Assets -Low FAT – indicate firm not fully utilized it fixed assets to generate sale.
iv. Total Assets Turnover (TAT) TAT = Sales Total Assets Low ratio- indicate firm not generating sufficient volume of sales in relation to its total assets investments.
c. Leverage Ratios/gearing ratios
Purpose – to measure how much debts (liabilities) is use in business to buy (finance) assets i. Debt ratio (DR) = Total Liabilities
Total Assets
High ratio – is not good because the firm expose to high financial risk - firm may have problem to borrow money in the
future
ii. Time Interest Earn (TIE) = EBIT Interest Expense
Low TIE – indicate firm is less ability to pay its interest by using EBIT
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d. Profitability Ratio Purpose – to measure the effectiveness of the firm to generate profit in relation to sales, assets employed and shareholders investment.
i. GPM = Gross Profit
Sales Low ratio- may indicate excessive sales discount
ii. Net Profit margin (NPM) NPM = Earning available to common s/holders
Sales
- high ratio indicate firm is good in controlling administration expenses
iii. Return on Assets (ROA)
ROA = Earning available to common s/holders Total assets Low ratio may indicate
– assets is not efficiently utilized or - profit is very low
However, further analysis is necessary If NPM is not good – it could be because:
- high COGS (i.e markup is not sufficient) or - if GPM is adequate- low NPM is because of
high administration expenses If NPM is good but GPM is low- it could be because of low sale or high COGS.
iv. Return on Equity (ROE) ROE = Earning available to common s/holders Common Equity
= ROA (Du Pont equation) 1 – Debt ratio
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** Common equity = OSC + Reserves + Retained profit - it measure the firm’s return compare to total
equity.
e. Market Ratios - To measure the firm’s stock price to its earnings,
cash flow and book value per share i. EPS = Earning available to common
s/holders Number of ordinary share issued
- Shows number of ringgit earned for each share for the period
ii. Dividends per share (DPS) DPS = Ordinary dividends Number of shares issued
- indicates the actual cash received by investor on their investment.
iii. Price/Earnings (P/E) Ratio PE = Market price per share EPS
- Shows how much investors are willing to pay per dollar of reported profit
Limitations of Ratios Analysis – page 58
i. Multiple lines of business ii. Different accounting practices iii. Industry average may not provide a desirable target
standard iv. Seasonal factors v. Ratios can be too high or too low vi. “Window dressing” techniques. vii. Combination of good and bad ratios.
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User of Ratios Analysis i. Creditors
Short term creditors – interested in firm’s ability to pay loan promptly i.e liquidity ratio is important to them Long term creditor - interested in firm’s ability to pay interest regularly & principle once matured
- also on liquidating value of the firm - i.e interested in debt ratio & TIE ii. Management - to analyze, plan & control - interested in all of the ratios iii. Equity Investors
- interested in firm’s efficiency & growth prospects & high dividends
iv. Others – government, IRB, suppliers, employees &
public at large
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