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Week 9: Interpretation of FinancialStatements


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An attempt by users toevaluate the financialinformation of an

organisation in order tomeasure theperformance of thoseorganisationsThis evaluation isusually done throughratio analysis


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Users Yardsticks of comparison

Areas of analysis

Ratio analysis

Interpret results

Write report


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Shareholders Loan creditors

Employees

Analysts & advisers

Business contacts

Government Public


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Past performance

Budgeted Performance

Industrial Sector Performance


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Before carrying out any ratio analysis,review the financial statements for any

major movements. Where relevant, calculate the major %

movements.


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Profitability ratios Short-term solvency ratios

Efficiency ratios Long-term solvency ratios

Investment ratios


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Company B : Sales revenue 200,000; profit 6,000Company C : Sales revenue 300,000; profit 4,500

Which of the 3 organisations is best?That depends on what the user is looking for.Looking for:

Highest revenue?....................... = company CHighest profit?............................ = company BMost successful in terms of profit?...... = company A (half level of sales of B, but only 1,000 less profit)

We are now starting comparison we are comparingprofit with sales revenue, and we are comparing one firmwith another.


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It might also be useful to compare the profit withother figures, apart from sales.Suppose that the capital employed in company Ais 50,000.A profit of 5,000 is a 10% return on that capital.

Suppose that company Cs capital employed isonly 30,000.Its return on that capital is 15% So, an investor might prefer to choose company Cwhile a lender might prefer company B.


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http://www.majestic2.co.uk/results2011.pdf

http://www.mulberry.com/about/PDF/Investor/Mulb

erryGroupPLC_AnnualReport_2011.pdf

http://www2.accaglobal.com/pubs/students/publications/student_accountant/archive/pyke0207.pdf
http://www.majestic2.co.uk/results2011.pdfhttp://www.mulberry.com/about/PDF/Investor/MulberryGroupPLC_AnnualReport_2011.pdfhttp://www.mulberry.com/about/PDF/Investor/MulberryGroupPLC_AnnualReport_2011.pdfhttp://www2.accaglobal.com/pubs/students/publications/student_accountant/archive/pyke0207.pdfhttp://www2.accaglobal.com/pubs/students/publications/student_accountant/archive/pyke0207.pdfhttp://www2.accaglobal.com/pubs/students/publications/student_accountant/archive/pyke0207.pdfhttp://www2.accaglobal.com/pubs/students/publications/student_accountant/archive/pyke0207.pdfhttp://www.mulberry.com/about/PDF/Investor/MulberryGroupPLC_AnnualReport_2011.pdfhttp://www.mulberry.com/about/PDF/Investor/MulberryGroupPLC_AnnualReport_2011.pdfhttp://www.majestic2.co.uk/results2011.pdf


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PROFITABILITY RATIOS


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How much profit per of sales the

business makes after deducting

the direct production costs from the

selling price?

Gross Profit / Revenue


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2010

Gr. Profit 60-----Revenue 180

= 33.3%

2009

Gr. Profit 64------Revenue 160

= 40.0%


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How much, per of sales, the

business spends on selling,

distribution and administrationexpenses?

Operating expenses / Revenue


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2010

Op Exp 40

------Revenue 180

= 22.2%

2009

Op Exp 30

------Revenue 160

= 18.75%


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How much profit per of sales thebusiness makes after all expenses

(other than finance costs) havebeen deducted?

Profit before interest and tax / Revenue


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2010

Op Profit 20

------Revenue 180

= 11.1%

2009

Op Profit 34

------Revenue 160

= 21.25%


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How much return per on the longterm capital invested in the

business?Profit before interest and tax /Capital employed (CAPITAL EMPLOYED = Share capital +Reserves + Long term (non-current) liabilities)


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2010

OP 20

----Cap Emp 98

= 20.4%

2009

OP 34

----Cap Emp 92

= 36.9%


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SHORT-TERM SOLVENCY RATIOS


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How many times do the entitys current assets cover its current

liabilities?

Current assets / Current liabilities(times)


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2010

CA 85

----CL 73

= 1.16 times

2009

CA 37

-----CL 33

= 1.12 times


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2010

CA - inventories 61

----CL 73

= 0.84 times

2009

CA inventories 23

-----CL 33

= 0.7 times


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EFFICIENCY RATIOS


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How many days does it take thecompany to collect the cash

from its credit sales?

Trade receivables / Revenue X 365 (days)


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2010

Trade recbles 60 365

----- X -----Revenue 180 1

= 122 days

2009

Trade recbles 20 365

----- X -----Revenue 160 1

= 46 days


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How many days does it take thecompany to pay its short-term

suppliers for credit purchases?

Trade payables / Cost of sales X 365 (days)


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2010

Trade Paybles 62 365

----- x -----Cost of sales 120 1

= 189 days

2009

Trade Paybles 10 365

----- X -----Cost of sales 96 1

= 38 days


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LONG-TERM SOLVENCY RATIOS


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What % of the long-term capitalinvested in the business is

borrowed monies?(Gearing ratio = Long-term (non-current)

liabilities

------------------------------------Share capital + Reserves +Long-term (non-current) liabilities)


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2010

Non-current liabilities 20-----

Capital Employed 98

= 20.4%

2009

Non-current liabilities 20-----

Capital Employed 92

= 21.7%


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How many times does theoperating profit cover the net

finance costs?Profit before interest and tax / interestcharges (times)


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2010

Oper Profit 20--------

Finance costs 1

= 20 times

2009

Oper Profit 34-------

Finance costs 1

= 34 times


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What % of our assets would weneed to cash in to settle all our

liabilities?

Total Debt / Total Assets (%)


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2010

Total Liabs 93

-----Total Assets 171

= 54.4%

2009

Total Liabs 53

-----Total Assets 125

= 42.4%


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Dividend per share------------------------------- X 100Market value per share

2010: 11.67p / 1.50 = 7.78%

2009: 16.67p / 2.50 = 6.67%


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Profit attributable to ordinary shareholders-------------------------------------------------------- penceNumber of ordinary shares

2010: 13,000,000 / 60,000,000 = 21.67p

2009: 18,000,000 / 60,000,000 = 30p


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Market value per share------------------------------- timesEarnings per share

2010: 1.50 / 21.67p = 6.92 times

2009: 2.50 / 30p = 8.33 times


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Need 3 to 4 years of figures to establish trends. Valid comparisons can only be made between

firms of similar size and activity.

Ratios relate to a particular point in time.Seasonal factors can distort them.

When comparing with other companies, ensurethat the bases upon which the ratios have beencalculated are the same.

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