Financial Statements Analysis Flashcards
Why do we need to analyse financial statements?
To examine a firm’s financial performance in relation to risk with the view to forecasts, enhance decision making and identify and correct problem areas
Who are the users of financial statements?
Shareholders
Credit suppliers
Employees
Management
Auditors
SARS
Name The Limitations of Accounting Data
Inflation-Comparing prior years’ info with current year without catering inflation could be misleading.
Flexible accounting policies-Differences in accounting policies may lead to info between to similar companies not being comparable
Monetary expression (Quantitative Factors Only)-AFS cater for financial information only, non-monetary information is often left out (this gap is closed by the integrated report for listed companies)
Omitted Information-Information have to be summarized to make it usable, therefore this could lead to other important information being left out
Name and explain techniques used to analyse financial statements
Comparatives-Comparing current year results/figures with the prior years. This is where we also establish if there are any trends. We need to find out reasons for the movement in our balances/transactions.
Index-This where the prior year figures are expressed as 100% and the movement to the current year is determined using the prior year base of 100%
Common size-This is when we express different line items as a percentage of one group/line item. For statement of profit & loss we put our sales figure as 100% and every line item will be expressed as a percentage of sales while for statement of comprehensive income we use total assets. This method is not that useful as not all items are not directly related to the group used e.g depreciation expressed as a % of sales gives little value in terms of analysis.
Ratio analysis – Commonly used analysis.Computing the ratios is only a part of the solution the most important thing is “interpretation” of ratios or any other type of analysis. Indicate to the marker that you know and understand what you are doing
Name and explain liquidity ratios
Current Ratio = (Current assets / Current Liabilities )
This reflects the companies ability to settle short term liabilities using the company’s short term assets.
Acid Test Ratio = Current assets–inventory/Current liabilities)
Inventory is not that liquid as it cannot be easily converted into cash.
Debtors collection period = (Accounts receivable/sales)*365days
How long does it take before we recover our money from debtors?
Name and explain profitability ratios
Gross Profit % = Gross Profit / Total Sales
What is our margin on sales just considering our cost to sell?
Operating profit % = EBIT / Total Sales
What is the true reflection of operating income and expenses without tax and interest
Net Profit % = Net Profit / Total Sales
What is our net profit after taking all operating costs into account?
Return on Assets = Net Profit/ Total Assets
What return are we getting from the assets we are utilising?
Name and explain debt management ratios
Debt ratio = total debt / total assets
This measures the total debt we have over the assets we have. The higher the ratio the higher our financial risk. Effectively measures how much of our assets are financed through debt.
Debt to equity = same ratio as above only here we measure the total amount of debt versus our own equity.
Interest cover = EBIT / Interest paid
This measures the company’s ability to settle its interest. The higher the ratio the more stable the company in terms of settling interest.
Name and explain asset management ratios
Inventory turnover = (COS / Inventory )
How many times are we selling stock per year/period. The higher the ratio in a given period the better as it indicates efficiency.
Debtors collection period = (Accounts receivable/sales)*365days
How long does it take before we recover our money from debtors?
Fixed Asset turnover = sales / fixed assets
Are we utilizing our fixed assets fully to generate maximum amount of sales, ratio mainly relevant for manufacturing entities?
Name and explain market ratios
Dividend yield = Dividend per share / price per share
Indicates the return an investor is earning on the share price in a form of a dividend.
Earnings yield = Earnings per share / price per share
Possible amount that investors are demanding on their investment
Price-earnings ratio (P/E) = Price per share / earnings per share
This is the inverse of the earnings yield. It shows how much are investors willing to pay for the share based on earnings.
Dividend cover = Earnings per share / dividend per share
How much of our dividends are we paying out. The higher the ratio the possible indication that profits are retained in the company instead of being paid our as dividends and vice-versa.
Name and explain the du pont analysis
The objective of Financial Management is to maximize shareholder wealth and this is measured with a key ration being ROE (RETURN ON EQUITY). DuPont model recalculates this ratio however it shows the break-down into 3 key categories being
Income
Activity
Capital structure
