Financial Statement Analysis Final (1)
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Transcript of Financial Statement Analysis Final (1)
Welcome to AIBF
Financial Statement Analysis Training
Asalamualikum!
Khalid Zarif Current engagements
Deputy Director & Academic Head of AIBF
President of Afghanistan Association of Professional
Accountants (AAPA)
Bank Millie Afghan (BMA) Supervisory Board Member
President of Afghan Social Researchers Association (ASRA)
Work Experiences
Business Unit Manger & adjunct Trainer, AUAF-PDI
Technical Adviser, FinTRACA- Da Afghanistan Bank
Custom Analyst- Ministry of Finance
Official of Treasury Department- Ministry of Finance
Education:
Global MBA plus finalist of ACCA- Continuous
BSc from Oxford Brookes University
Certified Accounting Technician (CAT)
INTERPRETATI
ON OF
FINANCIAL
STATEMENTS
1. Purpose and format of the
financial statements
2. Users of the financial
Statements
3. Profitability Ratios &
Interpretation
4. Liquidity Ratios &
Interpretation
5. Gearing Ratios &
Interpretation
6. Limitations of ratio analysis
Accounting: Definition
Is the process of
Recording in journal
Classifying in ledger and
Summarizing in Financial Statements
Interpreting financial information in
order to make decisions
Financial Statements
Financial Statements present information about
The financial position of an entity
Its financial performance during accounting period
Its cash flow
Financial statements are
1. Statement of Financial Position
2. Statement of Comprehensive Income/income statement
3. Statement of Cash Flow
4. Statement of changes in Equity
5. Notes to the Financial Statements
Elements of Financial Statements
Statement of Financial Position
shows the financial position of an entity as at a particular date.
The financial position is shown by assets, liabilities and
equity (capital)
Income statement
shows the financial performance of an entity during an
accounting period
The financial performance is shown by income and
expenses
Continued
Elements of Statement of Financial Position
Asset
An asset is a resource controlled by the entity as a result of past event and from which future economic benefits are expected to flow to entity.
Examples of assets are factories, office buildings, warehouses, delivery vans, lorries, plant and machinery, computer equipment, office furniture, cash and goods held in store
Assets are of two types
Current Assets: are those assets that are cash, will be converted into cash or will be used up within one year
Cash, Accounts Receivables, Inventory
Non-Current (Fixed) Assets: are assets that will be used in more than one accounting period
Building, vehicles, machines, plant and equipment
Elements of Statement of Financial Position
Liability is a present obligation arising from past events, the settlement
of which will result in an outflow of economic benefits from the entity.
'Liabilities' is the accounting term for the debts of a business.
Liabilities are of two types: Current Liability: is an obligation to others which is payable in 12
months Accounts payable, bank overdrafts, short term loans
Non-current liability: is an obligation to others payable in more than 12 months Long term loans from banks
Capital/Equity/net assets Is the amount invested in business by owners(capital)
Consists of amount invested by owner and profits of business
Format of Statement of Financial Position
Statement of Financial position is in vertical format and is divided into two parts
The top half of the statement shows the assets of the business with non current asset first and current assets below the non current assets
The lower of half of the statement shows the capital followed by liabilities. The liabilities are shown with non-current liabilities first and then current liabilities
The total of assets must equal the total of capital and liabilities
Statement of financial position
Statement of profit or loss and other
comprehensive income
Changes in equity
Format of Statement of Financial Position 1. Business Name- Statement of Financial Position
Assets
Non-current Assets
Property, plant and equipment (IAS-16)
+Borrowing Cost (IAS-23)
Goodwill (IFRS-3)
Other intangible assets (IAS-38)
-Impairment (IAS-36)
Investment in Associates (IAS-28)
Investment property (IAS-40)
Investment in equity instruments (IAS-38)
Biological Assets (IAS-41)
Current Assets
Inventories (IAS-2)
Trade Receivable
Assets held for sale (IFRS-5)
Other current Assets
Cash and cash equivalents
Total assets
Equity and liabilities
Equity attributable to owners of the parent
Share Capital
Retained earnings
Other components of equity
Non-controlling interest
Total equity
Non-current liabilities
Long term borrowings IAS-32 (IFRS-9)
Preferred Share IAS-32 (IFRS-9)
Deferred tax (IAS-12)
Long-term provisions (IAS-37)
Government grants (IAS-20)
Leasing obligation (IAS-17)
Total non-current liabilities
Current liabilities
Trade and other payables
Short-term borrowings
Current portion of long-term
Borrowings
Current tax payable
Short-term provisions
Total current liabilities
Total liabilities
Total equity and liabilities
Format of Income Statement Business Name- Statement of Comprehensive Income for the year ended
Revenue/ Sales/ turnover (IAS-18)
Less Cost of Sales
Gross Profit
Other income
Administrative expenses
Distribution Expenses
Financial Cost (Interest Expenses)
Profit before tax (PBT)
Tax expenses (IAS-12)
Profit after tax (PAT)
Profit/ Loss from discounted operation (IFRS-5)
Other Comprehensive Income
Revaluation gain/ loss (IAS-16)
Actuarial gain/loss (IAS-19)
Fair value thought OCI (IFRS-9)
Cash flow hedge gain/loss (IAS-39)
Total Comprehensive Income
Elements of Income Statement
Income : consists of
Revenue from sale of goods
Other items of income such as interest received
Gains from disposing of assets
Expense: consists of
Expenses arising in the ordinary course of activities such as
cost of sales, wages and salaries
Losses from disposing of assets
Format of Income Statement Business Name- Statement of Comprehensive Income for the year ended
Revenue/ Sales/ turnover (IAS-18)
Less Cost of Sales
Gross Profit
Other income
Administrative expenses
Distribution Expenses
Financial Cost (Interest Expenses)
Profit before tax (PBT)
Tax expenses (IAS-12)
Profit after tax (PAT)
Profit/ Loss from discounted operation (IFRS-5)
Other Comprehensive Income
Revaluation gain/ loss (IAS-16)
Actuarial gain/loss (IAS-19)
Fair value thought OCI (IFRS-9)
Cash flow hedge gain/loss (IAS-39)
Total Comprehensive Income
QUESTION
In the month of January, a business had these transactions:
Sales $150,000
Purchases $70,000
Returns inwards $5,000
Returns outwards $1000
If the opening inventory was $12,000 and closing inventory
was $14,000
Requirement: calculate the gross profit for the month
QUESTION
The following information relates to Minnie’s hairdressing business in the year ended 31 August 20X7: Expenses 7,100
Opening inventory 1,500
Closing inventory 900
Purchases 12,950
gross profit 12,125
Inventory drawings 75
What is the sales figure for the business:
A $32,700
B $25,600
C $25,675
D $25,750
Relationship between Statement of Financial
position and Income Statement
The income statement and statement of financial position
are separate statements but they are also related to each
other
The income statement ends with net profit or loss. This
profit or loss belongs to the owner. Profit/loss for
the year is added to or subtracting from owner’s capital in
statement of financial position at the end of the year.
The result of the income statement either profit/ (loss) will
be reflected in the statement of financial position
Users of the financial statement
Information required by users
As well as:
Employees - will I get paid?
Governments - tax, regulations compliance
Suppliers / lenders - will we get paid?
Customers - can we rely on this company?
Information required by users
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Purpose
Analysis of a company’s financial statements is
performed by the following:
—Management
— Interested parties
How Financial Information Analysis?
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Financial statements can be assessed using ratio
analysis
Past trends of the same business (analysis through
time) and compare to budget
Comparative information for similar businesses
(analysis by competitors)
Ratio Analysis Is a tool for measuring a firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s resource utilization.
How the ratio means are enhanced? if we compare with:
Past performance (i.e. past years’ ratios)
Target Ratios
Other companies ratios (i.e. competitors’ ratios)
Industry as a whole
Ratio Analysis
In order to make sense of whether ratios are
good or bad, we need to answer the below
questions: -
What does the ratio literally mean?
What does the change in the ratio mean?
What is the norm in the industry?
What are the limitation of the ratio?
Category Ratio Description
Profitability Ratio
Gross profit Net profit Asset turn over Return of capital employed Return on Equity
Gross profit divided by sales Net profit divided by sales Sales divided by capital employed PBIT divided by capital employed PAT & Pre Dividend divided by capital emp
Liquidity Ratio Current ratio Quick(acid test) ratio
Current assets divided by current liabilities Current assets (minus inventory) divided by current liabilities
Liquidity (Efficiency) Ratio
Inventory turn over Receivables turn over Payables turnover
Inventory divided by cost of sales x 365 Receivables divided by sales x 365 days Payables divided credit purchases x 365
Gearing Ratio Debt to equity ratio Long term debt to equity Interest Cover
Total liabilities divided by equity Long term divided by equity PBIT divided by interest payable
Investor Ratio Earning per share (EPS) Price/Earnings(P/E) ratio Dividend Cover
Profit after tax divided by ordinary shares Market value of shares divided by EPS Profit after tax divided by dividends
TYPES OF RATIOS
Profitability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Profit margin
This is the margin that the company makes on its sales,
and would be expected to remain reasonably constant.
Profitability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Return on capital employed
—Measures overall efficiency of company in employing
resources available to it
—Examine
—Change year to year
—Comparison to similar entities
—Comparison with current market borrowing rates
Profitability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Asset turnover
It measures management’s efficiency in generati
ng revenue from the net assets at its disposal:
the higher, the more efficient
= times pa
Profitability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Relationship between ratios
ROCE can be subdivided into profit margin and asset turnover.
Profit margin × Asset turnover = ROCE
PBIT Sales revenue PBIT
–––––––––––– × –––––––––––– = ––––––––
Sales revenue Capital employed Capital employed
Profitability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Return on equity
More restricted view of capital than ROCE, but same
principles
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
There are two ratios used to measure overall
working capital:
• the current ratio
• the quick or acid test ratio.
Liquidity and working capital ratios
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Current ratio
The current ratio measures the adequacy of current a
ssets to meet the liabilities as they fall due.
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Quick ratio
Eliminates illiquid and subjectively valued inventory
Could be high if overtrading with rec’bles, but no
cash
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Inventory Turnover
Cost of sales
Inventory turnover is defined as: –––––––––––– = time
Inventory
An alternative is to express the inventory turnover as so
many days
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Inventory turnover period
—Higher the better? But remember:
—Lead times
—Seasonal fluctuations in orders
—Alternative uses of warehouse space
—Bulk buying discounts
—Likelihood of inventory perishing or becoming
obsolete
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
A/cs receivable collection period
Consistent with quick/current ratio? If not,
investigate.
Liquidity and working capital ratios
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Accounts payable payment period
Use cost of sales if purchases not disclosed
This represents the credit period taken by the
company from its suppliers
Long term financial stability
The main points to consider when assessin
g the longer-term financial position are:
1. gearing
2. overtrading
Gearing ratios indicate:
• the degree of risk attached to the company and
•the sensitivity of earnings and dividends to changes in profit
ability and activity level
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Measuring gearing
There are two methods commonly used to express gearing as follows.
Debt/equity ratio:
Loans + Preference share capital
––––––––––––––––––––––––––––––––––––––––
Ordinary share capital + Reserves + Non controlling interest
Percentage of capital employed represented by borrowings:
Loans + Preference share capital
–––––––––––––––––––––––––––––––––––––––––
Ordinary share capital + Reserves + Non controlling interest + Loans + Preference share capital
Long term financial stability
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Interest cover
Company must generate enough profit to cover
interest
Long term financial stability
Overtrading:
Overtrading arises where a company expands its s
ales revenue fairly rapidly without securing additio
nal long-term capital adequate for its needs.
Activity: Classwork Assignment
Investors’ ratios
Introduction
Earnings per share (EPS) is widely regarded as the most important indicator of a company’s performance. It is important that users of the financial statements:
1. are able to compare the EPS of different entities and
2. are able to compare the EPS of the same entity in different accounting periods.
Basic EPS Earnings
The basic EPS calculation is simply: –––––––––
Shares
Investors’ ratios-Test your understanding
Gerard's earnings for the year ended 31 December
20X4 are $2,208,000. On 1 January 20X4, the issued
share capital of Gerard was 9,200,000 6% preferenc
e shares of $1 each and 8,280,000 ordinary shares o
f $1 each. The company issued 3,312,000 shares at fu
ll market value on 30 June 20X4.
Calculate the EPS for Gerard for 20X4
Investors’ ratios
Activity:
Limitations of ratio analysis
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING
Limitations
Comparative information is not always
available.
They sometimes use out of date information.
Interpretation requires thought and analysis.
Ratios should not be considered in isolation.
The exercise is subjective, for example not all
companies use the same accounting policies.
Ratios are not defined in standard form.