Analysis and Interpretation of Financial Statements

Question 1

sources of information

Answer 1

financial advisory services

public libraries and libraries of universities

databases such as the ASX

stockbroking firms

Question 2

need for analytical techniques

Answer 2

the information found is used mainly to forecast an entity’s ability to pay its debts when due and to operate at a satisfactory level of profitability

Question 3

horizontal analyses

Answer 3

an analysis of the change from year to year in individual statement items

in calculating the increase or decrease in dollar amounts, the earlier statement is used as the base year

calculated by dividing the increase or decrease from the base year in dollars by the base-year amount

Question 4

trend analyses

Answer 4

when financial data are available for 3 or more years, trend analysis is a technique commonly used by financial analysts to assess the entity’s growth prospects

the earliest period is the base period, with all subsequent periods compared with the base

Question 5

vertical analyses

Answer 5

involves restating the dollar amount of each item reported on an individual financial statement as a percentage of a specific item on the same statement, referred to as the base amount

Question 6

profitability ratios

Answer 6

return on assets

return on ordinary equity

profit margin

gross profit margin

expense ratio

earnings per share

price earnings ratio

earnings yield

dividend yield

payout ratio

Question 7

relationships among ratios

Answer 7

the return on assets, calculated in the section on profitability ratios, may also be determined as the product of the profit margin and asset turnover ratios

return on assets and return on ordinary equity

Question 8

interpreting ratio information from cash flows

Answer 8

help the analyst evaluate the cash sufficiency of the entity

Question 9

limitations of financial analysis

Answer 9

year-end data may not be typical of the entity’s position during the year

lack of disclosure in general purpose financial reports may inhibit the extent of the analysis

existence of one-off, or non-recurring, items in a statement of profit or loss and other comprehensive income

information may be subject to modifications

entities may not be comparable

Question 10

impact of capital markets research

Answer 10

the evidence from capital markets research is not conclusive, as some researchers appear to have developed strategies which suggest that abnormal profits can still be made by analysing publicly available information