ANALYSIS OF FINANCIAL STATEMENT BASIC FINANCIAL ACCOUNTING MGT 2304 MOHD ZARIR YUSOFF

What is Financial statement analysis? Is the process of understanding the risk and profitability of a firm (business or project) through analysis of reported financial information by using different accounting tools and techniques.

Who normally do or interested in the financial analysis and why? Top Management Decision making process Investor Potential Return Government Business performance Lenders Dividend Researchers Comparative Industries Media Public information

Question we would like to answered Assets Liabilities 1. What are the assets in place? 2. How valuable are these assets? 3. How risky are these asset? 1. What is the value of the debt? 2. How risky is the debt? 1. What are the growth Assets? 2. How valuable are these asset? 1. What is the value of the equity? 2. How risky is the equity?

How to do the analysis? Involve 3 major steps. Reformulating Financial Statement. Analysis and adjustments of measurement errors Financial ratio analysis Analysis of Risk. Analysis of Profit

Introduction to financial ratio analysis The main purpose of ratio analysis is enable users of financial statement (internal and external users) to evaluate a firm’s financial performance and financial position over time and/ or relation to other firm Also provide the basis of answering some important questions How liquid is the firm? Is management generating sufficient profits from the firm’s assets? How does the firm’s management finance its investment?

Types of comparison using financial ratios Intra-company Comparison of a firm’s financial data at difference points of time. Ex: Net profit for the company in year 2005 and 2006 Inter-company Comparison between companies in the form of competitors. Ex. Sales value between Magnolia Ice cream & Nestle Ice cream Industry Average Performance is compared with the performance of industry as a whole.

Benefits of ratio analysis Can be used to compare company’s performance either inter-times or inter- companies Problems or critical areas that need attention and action in a company can be indentified Can be used in forecasting a company’s performance

The limitations of ratio analysis Ratio is not useful on its own. It should be compared to whether with inter-times or intercompany Comparisons between companies and for particular company over time may be misleading if difference accounting policies has been used to calculate profits and value of assets

Categories of financial ratio 1. Liquidity Ratio Measure the ability of a firm in repaying its short-term liabilities 2. Efficiency Ratio Also known as activity ratio and measure how well and how efficient a firm manage its current assets and its current liabilities 3. Leverage Ratio Also known as gearing ratios and measure a firm’s ability to pay long term liability 4. Profitability Ratio Measure the profits of a firm in relation to its sales and assets (capital employed)

1.0 LIQUIDITY RATIO 1.1 Current Ratio 1.2 Quick Ratio Current Ratio = Current Asset/ Current Liabilities x no. of times High- good quality, efficient use of capital e.g stock and debtors Low – firm is weak lack of liquidity to pay debt 1.2 Quick Ratio Quick Ratio = (Current Asset – Closing Stock)/ Current Liabilities Closing stock excluded as it is least liquid among the current assets.

2.0 Efficiency ratios 2.1 Average Collection Period Debtors Amount x 360 days/ Annual Credit Sales x no. of days High- not efficient because debtor are slow settle their debt Low – very efficient in collection debts from debtor 2.2 Inventory/Stock Turnover Ratio Cost of Goods Sold / Average Stock x no. of times High – very efficient because sales are increasing Low – not efficient as because sales are slow

2.0 Efficiency ratios cont… 2.3 Debtors Turnover Ratio Annual sales credit / Debtors Amount x no. of times High – Very efficient in collection Low – Slow in collection

3.0 Leverage ratio 3.1 Debt Ratio Total Liabilities Total Asset x 100 High – Less risky as owner investment is more than outsiders Low - Greater risk of not being able to pay fixed- interest, financing and owner investment

4.0 Profitability ratio 4.1 Gross Profit Ratio/Margin Gross Profit / Sales x 100% x% Result indicate how much gross profit can be obtained from every one ringgit of sales 4.2 Operation Profit Margin Net Operating Profit / Sales x 100% Result indicate how much Operating profit can be obtained from every one ringgit of sales

4.0 Profitability ratios cont… 4.3 Net Profit Margin Net Profit / Sales x 100% x% Result indicate how much Net profit can be obtained from every one ringgit of sales. 4.4 Return on Investment (ROI) Net Profit after tax/ Total Assets x 100% Result indicate how much Net profit after tax can be obtained from every one ringgit of total assets