analysing and interpreting financial statements Flashcards
external users of financial information
public investors lenders suppliers customers employees government agencies
needs of users
investors:
- return
- quality of profit
- dividends
Holder of debentures
- ability to pay interest
- ability to repay debentures
- liquidity
- security
define trend analysis
performed by users to help them make decisions about their interaction with the company
define ratio analysis
shows the relationship between two or more figures within the same set of financial statements
ratio point of references:
- ratios from past years
- ratios of other businesses in the same industry
- specified standard ratios
categories of ratios
profitability
-investors, lenders, employees, suppliers, customers, government and their agencies
liquidity
-lenders, suppliers, investors, customers
efficiency/ activity
-investors, suppliers
gearing
-investors, lenders
investor/stock market
-investors
define key profit figure
tells the user about the performance of the business
define ROCE
return on capital employed
- how much profit business has generated from the capital invested in it
define net profit margin
the profit business has earned on its sales
define asset turnover
show the levels of revenue generated per £1 of net assets employed by the business
define liquidity
the ability of a business to meet its liabilities as they fall due
i. e. ability to pay bills
- ability to pay interest
- ability to repay loans/ debentures
- ability to stay within overdraft facility
define gearing
the balance between equity financing and debt financing
a measure of the risk in an investment for the equity investor
e.g. companies w/ high debt financing = highly geared/ leveraged + riskier investment
limitations of ratio analysis
retrospective nature
business-to-business compromises- differences in accounting policies
impact on inflation on financial data
economic climate
what is the return on equity
ROE
a measure of the total return to the equity investor as a percentage of their investment- before any actual returns are given
what are earnings per share
eps
earnings available to each equity shareholder
what is the price/earnings ratio
the number of times the market price exceeds current earnings
an indicator of market confidence in the company
what are dividends per share
total dividends for the financial year usually used i.e. current year interim and proposed
what is dividend cover
the number of times earnings available for equity dividends exceeds the amount of the equity dividend
what is dividend yield
the actual dividend return on an actual investment in equity shares.
financial info required by investors
decisions:
Continuation of investment?
Withdrawal of investment?
Increase investment?
info needed: Return from investment Ability to pay amounts to investors Value of investment Performance of management Risk in investment
financial info required by lenders
decisions:
Lend or not?
Interest rate to be charged?
Security required?
info needed:
Ability to repay loans when due
Ability to pay interest when due
Security for loans
financial info required by employees
decisions:
Continuation of employment?
info:
Long-term future and stability of business
Ability to provide appropriate level of remuneration
Retirement and other benefits
Employment opportunities
financial info required by government
decisions:
HMRC – has the business paid the appropriate taxes it owes?
Other departments / agencies – has the business carried out its business properly and made appropriate information available?
info:
Business profits
Employee details
Various reports and statistics
Limitations of Ratio Analysis
- Ratios do not give the whole picture of the firm’s condition
- may not be comparing like with like. The underlying accounting policies used may vary= distort comparisons
- Ratios cannot be used to interpret non-financial information
- Firms with different accounting policies will end up with different ratios making comparison meaningless
- The statement of financial position is only a ‘snapshot’ of the firm at a moment in time and may not be fully representative of a “normal” position
- Ratios do not take into account the changing business environment
- Short-term fluctuations in the market may distort the ratios
- The calculation of ratios does not take into account the change in the value of money
advantages of ratio analysis
- it synthesizes the accounts into certain key ratios which can then be used to compare one set of results with another
- It is a widely used, well integrated and well used technique that is relatively inexpensive and easy to perform.
- There is some evidence of solid user understanding.
Horizontal analysis
which may be just looking at changes / differences from one year to the next / one company to the other in key figures such as revenues, PBIT, non-current assets
Vertical analysis
each financial statement a key figure is identified, such as revenue for the income statement and total assets for the statement of financial position, and all other figures are expressed as a percentage of this figure.
