Week 8 - Analysis and interpretation of financial statements: analysing profitability Flashcards
internal users of accounting information
Internal users of accounting information include: marketing managers, production supervisors, chief financial officers, and other employees to: plan organise, and run the business
external users of accounting information
External users of accounting information Investors to make decisions to buy, hold or sell shares. Creditors to evaluate risks of giving credit and lending money. e.g. suppliers, bankers Government and regulatory bodies. e.g. ATO, ASIC
explain horizontal analysis
Compares the reported numbers in the current period with the equivalent numbers for a previous period
usually the immediate preceding period(e.g.. sales, profit etc.)
also known as trend analysis
ideally, 2-4 years of data
Predicts the future direction of analysed items based on past information
Highlights magnitude and significance of changes
calculate dollar change
Accounting number in current period
minus Accounting number inprevious reporting period
calculate % change
Dollar change (formula above) x 100 divided Accounting number inprevious reporting period
explain vertical analysis
Comparing the items in a financial statement to a benchmark in the same financial statement:
Revenue and expense items could be expressed as a percentage of sales or revenue Asset, Liability and Equity items could be expressed as a percentage of total assets Also known as common size statements
Vertical analysis allows the comparison between financial statements of different companies with different sizes
explain ratio analysis
An expression of one item in the financial statements as compared to another item in the financial statements
One item is divided by another to create the ratio
Expressed in terms of a
ratio (1:x); or a
percentage (x%) form
Ratios in various categories help users in their decision making
Ratios provide clues or symptoms of underlying conditions
Point to areas requiring further investigation
explain benchmarks
Ratios are of limited usefulness unless compared to relevant benchmarks
Comparisons may be made of the entity’s ratios:
over time (identify trends)
against other entities in same industry(intra-industry analysis)
against industry averages
against entities operating in different industries(inter-industry analysis)
against arbitrary standards
what is profitability analysis
Profitability analysis
Informs users how well an entity has met its profit objectives, in relation to the
resources invested, and
Helps users evaluate returns
compared with the risk associated with their investment
explain return on equity
Indicates the percentage of return in investment to shareholders
involves the measure of
Profitability
Efficiency; and
Capital Structure
the higher the ratio, the greater the return
A sustained high ROE attracts potential investors
(Profit (Loss))/(Average (total)Owner^′ s Equity) * 100 = ROE %
explain return on assets
Indicates how efficient managers are in using total assets to generate profit
the higher the ratio, the
more efficient the management of the business
(Profit (Loss))/(Average (total)Assets) * 100 = ROA %
explain gross profit margian
surplus of revenue over cost of goods sold
a measure of a company’s
pricing policy (mark-up, or margin on sales)
sales volume; and
buying policy (cost of goods sold)
(Gross Profit (Loss))/(Sales Revenue) * 100 = GP %
explain profit margin
Proportion of profit left over from sales revenue after deducting all expenses
indicator of how effective a company is at cost control
the higher the net profit margin, the
more effective the company is at converting revenue into actual profit
(Net Profit (Loss))/(Sales Revenue) * 100 = NP %
see slide 28 for practice
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