Week 10 - Interpretation of Financial Statements Flashcards
Who interprets financial statements?
Investors, Lenders, Competitors, Analysts, Directors, Managers, Regulators, Auditors
What is interpreted?
PnL, SFP, Cash flow, Notes to accountants, Industry information, Economic information, Wider Context, Non-financial information
What are some examples of non-financial information that is interpreted?
Strategy, Cooporate Governance, Risk Management, Sustainability Credentials, Audit Report
How can financial statements be interpreted?
Horizontal analysis, Vertical Analysis, Ratio analysis, identifying trends, extrapolating
What is the blueprint you follow when analysing/interpreting changes in stuff?
What? -> Why? -> So what? -> Now what?
What has happened?
Why has this happened?
Why does this matter?
What further information do we need?
Define financial ratio
A quantitative metric used to analyse and evaluate the financial performance of a company
What are the profitability ratios?
Shows insight into how successful a company is at generating profit.
Gross Profit Margin:
Gross Profit / Revenue = %
Operating profit margin:
Operating profit / Revenue = %
Net profit margin:
Net profit / Revenue = %
Return on Assets:
Net profit / Total Assets = %
What are efficiency ratios? What do they each show?
Shows how efficiently a company uses its resources to generate sales, profits and cash flow.
Inventory days
(Inventory/COS) x 365 = Days
shows how many days it takes to sell inventory on average
Trade receivable days
(Tr. Receivables / Revenue) x 365 = Days
shows average time taken to collect money from customers
Trade payable days
(Tr.Payables / COS) x 365 = Days
shows average time taken to pay suppliers
Asset Turnover
Sales / Total Assets = N of times
*Shows how efficiently a company is using its assets to generate sales
Working capital Cycle
Inventory days + receivable days - Payables days = N of days
Measures time it takes for a company to convert its current assets into cash, and then use this cash to pay off current liabilities
What are the liquidity ratios? What do they show?
They asses the ability of a company to meet short-term obligations as they fall due
Current Ratio
Current Assets / Current Liabilities = X:1
shows how a company can cover short term liabilities, higher=more liquid
Quick Ratio
(Current Assets - Inventory) / Current Liabilities = X:1
more conservative ratio, taking inventory out of equation as it can sometimes be illiuid
What are the gearing ratios? What do they show?
They measure the degree of risk in how a business is funded
Gearing
(Current + Non-Current debt) / (Current + non-current equity) = %
shows portion of funding that is debt
Interest Cover
Profit b4 interest + tax / interest = N of times
Shows how easily business can settle interest payments
When can being highly geared be beneficial?
In times if increasing profit, as dividends as a portion of profit will be lower compared to if fully funded by equity becasue interest payments stay the same
The opposite is true when times are hard
When assesing gearing in exam, what liabilities are included as debt?
Both current and non-current:
Borrowings
Lease liabilities
What are the investor ratios? What do they show?
Asses returns and performance from the POV of investors
Earnings per share
Net profit / N of ordinary shares = Pence per/Share
Dividend per share
Total dividends paid / N of ordinary shares = Pence per/Share
Good to compare with EPS to see retention strategy of company
P/E Ratio
Current Share price / EPS = n/a
Shows confidence the market has in the company
Dividend Yield
Dividend per Share / Current Share Price = %
Return per share, good to compare between companies
What is horizontal analysis?
Analysing a companies performance overtime:
Compare performance in year X to Year X-1
1st) Look at changes in £ and change to %
2nd) Use What? Why? So what? What next?
What is vertical analysis?
Calculates the relative portion of different items within a financial statement
SFP -> Take total assets as 100%, asses each item as a % of that
PnL -> Look at all items as a % of revenue
