Chapter 11 - Analysis and Interpretation

Question 1

What is meant by the analysis and interpretation of financial statements?

Answer 1

The financial statements and annual report contain a lot of financial and non-financial information about a company. Users of this information need to analyse and interpret it to understand it fully. Analysing both financial and non-financial information is essential for comprehensive decision-making, offering a complete picture of a company’s performance beyond just numbers.

In FAR we will consider the analysis and interpretation of financial and non-financial
information from an internal perspective, with the aim of identifying inconsistencies and
errors and analysing trends

Question 2

What are the key ratio types we look at in this course (slightly different to AA)? State what aspect of financial statements they help the user assess

Answer 2

• Profitability / efficiency ratios - help users assess the company’s ability to generate profit.
• Liquidity ratios - help users assess how easily a company can meet its obligations, and how the company manages its working capital
• Gearing ratios - help users assess what proportion of a company’s total capital structure is financed by debt

Question 3

Outline the profitability/efficiency ratios

Answer 3

• Gross profit margin
• Operating profit margin
• Return on capital employed (ROCE)
• Asset turnover/Non-current asset turnover

Question 4

Define gross profit margin, including the equation, and state what factors can cause this to change from year to year

Answer 4

Measures the percentage of revenue remaining after deducting the direct costs of earning that revenue (cost of sales).

Question 5

Define operating profit margin, including the equation, and state what factors can cause this to change from year to year

Answer 5

Measures the percentage of revenue remaining after deducting cost of sales, administrative costs, distribution costs, and other operating costs.

Question 6

Define return on capital employed, including the equation, and state what factors can cause this to change from year to year

Answer 6

Measures how efficiently a company uses its resources to generate profits. Capital employed refers to the amount of money a company has invested in its operations and is using to generate profits.

Question 7

Define asset turnover, including the equation, and state what factors can cause this to change from year to year

Answer 7

Measures how efficiently the company is using its resources to generate revenue.

Question 8

Outline the liquidity ratios

Answer 8

• Inventory turnover
• Inventory days
• Trade receivables collection period
• Trade payables collection period

Question 9

Define inventory turnover, including the equation, and state what factors can cause this to change from year to year

Answer 9

Measures the number of times inventories are turned over each year.

Question 10

Define inventory days, including the equation, and state what factors can cause this to change from year to year

Answer 10

Measures the number of days on average that an item is in inventories before it is sold.

Question 11

Define trade receivables collection period, including the equation, and state what factors can cause this to change from year to year

Answer 11

Measures the number of days it takes credit customers to pay the company.

Question 12

Define trade payables collection period, including the equation, and state what factors can cause this to change from year to year

Answer 12

Measures the number of days it takes the company to pay its credit suppliers.

Question 13

Outline the gearing ratios

Answer 13

Measures the proportion of a company’s total capital structure that is financed by debt.

Question 14

FACTORS THAT CHANGE THEM

Question 15

Why might companies produce non-financial performance measures?

Answer 15

Accounting ratios alone don’t provide a complete view of a company’s performance and the value it creates. To get a fuller understanding, companies use non-financial performance measures to track important aspects of their operations and strategies. These measures are often included in annual reports, sustainability reports, and other communications to help stakeholders understand the company’s performance, progress toward strategic goals, and alignment with its values.

Question 16

What are the main types of non-financial performance measures? Give examples of each type

Answer 16

• Customer-related measures
• Employee-related measures
• Sustainability-related measures
• Social-relate measures