Lecture 9 - Financial Analysis pt2

Question 1

3 forms of financial statement analysis:

Answer 1

• Horizontal analysis (trend analysis)
• Vertical analysis
• Ratio analysis

Question 2

5 key areas of financial analysis:

Answer 2

• Profitability
• Liquidity
• Efficiency
• Solvency
• Investors’ return

Question 3

Why is financial analysis valuable?

Answer 3

• Assess the financial health of a company
• Helps us make investment decisions
• It allows comparison across time, planned performance and different organisations.

Question 4

Why is ratio analysis important?

Answer 4

• Isolated values don’t have much value therefore they can be contextualized through ratio analysis to offer more value.

Question 5

Profitability ratio analysis: 4 key ratios

Answer 5

• Return on shareholders funds
• Return on capital employed
• GPM
• OPM

Question 6

Return on shareholders funds (return on equity: Equation and further detail

Answer 6

• Expressed as a percentage
• Is the amount of net income returned as a % of shareholders equity, the higher the better.
• Tells us how profitable a company is and how efficient they generate profits.

Equation:
Profit for the year/equity X100
Equity = ordinary share capital + reserves

Question 7

Return on Capital employed (ROCE):

Answer 7

• Expressed as a percentage
• Is a fundamental measure of business performance and is a key ratio for providers of capital.
• Tells us how efficiently a company can generate profit from their capital employed.
• Changes in capital employed may occur due to: changes in operating profit and changes to CE (new loans taken out, repayment of loans and issued shares).

Question 8

Equation of ROCE:

Answer 8

OP/CE X100

CE = Equity (shareholders funds) + long term debt (non-current liabilities)

Question 9

GPM (equation and further detail):

Answer 9

• Expressed as a percentage
• GP/Revenue X 100
• Helps evaluate production process efficiency.
• A measure of profitability before any other expenses are considered

Question 10

Why might GPM change?

Answer 10

• Changes in revenue (Sales prices and volumes)
• Changes in costs of sales (purchase prices and inventory levels)

Question 11

OPM (equation and further detail):

Answer 11

• Expressed as a %

OP/Revenue X 100

• Tells us how well a company is performing in relation to their operations.
• It provides an indication of the company’s ability to maintain its selling margin and control its costs.

Question 12

Liquidity ratio analysis:

Answer 12

• Liquidity refers to the company’s ability to meet it’s current liabilities (short term, within next 12 months)
• To understand liquidity it is important to look at the statement of cashflows and the statement of financial position.

Question 13

2 key liquidity ratios:

Answer 13

• Current ratio
• Quick ratio

Question 14

Current ratio:

Answer 14

• Express as a proportion e.g. 2:1
  Equation = CA/CL
• Can business survive in short term, is a concern for the firm if it is below 1