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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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Profitability Ratios
Gross profit Marginindicates entitysability to maintain an adequate selling
price above its costs.
Ratio declines as industry becomes more
competitive.
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Profitability Ratios
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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Profitability ratios
Net profit ratio
Net Profit before taxSales
May reveal the extent to whichthe firms expenses are under control
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Profitability ratios
Asset turnover
Measures how efficiently assets are used
to generate sales.
Formula:
Net SalesAverage Total Assets
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Profitability ratios
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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Liquidity Ratios (cont..)
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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Liquidity Ratios (cont..)
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
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