1、M17EFA Financial Statement Analysis and ValuationInterpretation of financial statements using trend and ratio analysisLearning objectives By the end of this session students should be able to:Understand why interpretation of financial statements is necessary Be aware of the difference between horizo
2、ntal analysis,trend analysis,vertical analysis,and ratio analysis Explain the limitations of ratio analysisInterpretation of financial statements It is not easy to evaluate performance just by looking at an organisations financial statements Financial statements provide absolute figures which make m
3、eaningful comparison difficult For example a profit before tax of 100,000 might appear adequate but:What does this represent as a percentage of revenue?What percentage return does it represent to an investor?Are resources being used efficiently?How does performance compare with previous accounting p
4、eriods/industry averages/competitors?Interpretation We can gain a better understanding of performance by examining financial statements using a range of techniques including:Horizontal analysis Trend analysis Vertical analysis Ratio analysisInterpretation These techniques look at the relationship be
5、tween figures in an entitys financial statements and allow us to make comparisons with:previous accounting periods similar businesses/industry averages This allows us to:Establish trends Highlight significant differences in performance Forecast future performanceHorizontal analysis Line by line comp
6、arison of an organisations financial statements for each accounting period under review Calculate%change from one period to the next Focus on key areas:Revenue Gross profit Operating profit Staff costs Clearly indicates significant changes from one period to the nextNext plcHorizontal analysis of re
7、venue and operating profit 2006-2011(Annual Report 2011,page 86 and 2010,page 87)201120102009200820072006mmmmmmRevenue3,453.73,406.53,271.53,329.13,283.83,106.2%change on previous year1.394.12-1.73+1.38+5.71-Working for 20073,283.8 3,106.23106.2Operating profit(m)574.8529.8478.3537.1507.5470.7%chang
8、e on previous year8.4910.77(10.94)5.837.81-Working for 2007507.5-470.7470.7Horizontal analysis-Comments From the income statement we can see that revenue in 2011 is 47.2 million higher than in 2010(3,453.7-3,406.5)Using horizontal analysis we can express this as an increase of 1.39%This is more easi
9、ly comparable with previous periods/competitors Between 2006 and 2011 revenue increased by 347.5 mil or 11.2%(3,453.7-3,106.2)/3,106.2)Operating profit in 2011 is 574.8 million.This is 8.49%higher than 2010 Trend analysis Similar to horizontal analysis Uses indices instead of%change Figures from fir
10、st accounting period are given an index of 100 Relate figures from subsequent periods to base index Again clearly indicates significant changes from one period to the nextNext plcTrend analysis of revenue and operating profit 2006-2011(Annual Report 2011,page 86 and 2010 page 87)20112010200920082007
11、2006mmmmmmRevenue3,453.73,406.53,271.53,329.13,283.83,106.2Trend analysis111.19109.67105.32107.18105.72100.00Working for 20073,283.8 x1003106.2Operating profit(m)574.8529.8478.3537.1507.5470.7Trend analysis122.12112.56101.61114.11107.82100.00Working for 2007507.5 x100470.7Trend analysis-Comments Fro
12、m the income statement we can see that revenue in 2011 is 347.5 million higher than in 2006(3,453.7 3,106.2)From our trend analysis we see that this represents an increase of 11.19 compared to the base index Again this is more easily comparable with previous periods/competitors Between 2006 and 2011
13、 operating profit increased by 22.12 index pointsVertical analysis Useful technique that expresses individual figures as a%of totals Clearly indicates significant changes from one period to the next allowing managers to investigate why these have occurredNext plcVertical analysis of income statement
14、 2010-2011(Annual Report 2011,page 43)20112010m%m%Revenue3,453.71003,406.5100Cost of sales(2,445.0)70.8(2,409.6)70.7Gross Profit1,008.729.2996.929.3Distribution costs(223.2)6.5(232.1)6.8Admin expenses(214.7)6.2(236.6)6.9Operating profit574.816.6529.815.6Net finance costs(23.4)0.7(24.5)0.7Taxation(15
15、0.5)4.4(141.3)4.2Profit after tax400.911.6364.010.7Vertical Analysis of Next plcs Income statement From our vertical analysis for Next plc we can see that:As a percentage of revenue,gross profit has fallen slightly from 29.3%to 29.2%(may be due to reduction in selling prices/increases in supplier co
16、sts/a combination)This means that in 2011,for every 100 of revenue,Next generates a gross profit of 29.20(10 pence less than 2010)Vertical Analysis of Next plcs Income statement As a percentage of revenue operating profit has increased from 15.6%to 16.6%This means that for every 100 of revenue,Next
17、generates an operating profit of 16.60(1 more than 2010)As a%or revenue both admin and distribution costs have decreased,suggesting tighter control of operating expensesNext plcVertical analysis of total revenue by geographical location 2010-2011(Annual Report 2011,page 57)20112010m%m%United Kingdom
18、3,261.294.43,228.594.8Rest of Europe153.54.5143.14.2Middle East21.70.623.60.7Asia and rest of World17.30.511.30.3Total Revenue3,453.71003,406.5100From this we can see that almost 99%of total revenue is generated in the UK and EuropeRatio analysis In general ratios are broken into five groups dealing
19、 with:Profitability Efficiency Liquidity Capital structure(gearing)Investors Some overlap between these areas Note that in order to make use of ratios we must have something to compare them againstRatio analysis During the next few sessions we will examine in detail some of the most commonly used ra
20、tios Let us start by looking at how the calculation of a few ratios can enhance our understanding of how Next has performed during 2011Next plcExtracts of figures for Next plc 2010-2011(Annual Report 2011)20112010mmRevenue(page 43)3,453.73,406.5Gross profit(page 43)1,008.7996.9Operating profit(page
21、43)574.8529.8Staff costs(note 4 page 59)675.2678.2No.of employees(FTE)(note 4 page 59)37,22035,619Gross profit margin(%)-Formula=Gross Profitx 100%RevenueGross profit margin(%)-Calculation2011=1,008.7 x100%=29.2%3,453.72010=996.9 x100%=29.3%3,406.5Gross profit margin(%)-Comments Only takes into acco
22、unt cost of goods sold In 2011,for every 100 of sales,Next plc made a gross profit of 29.20 Slight decline on 2010(0.1%decrease)May be due to:Decrease in selling prices Change in sales mix Slight increase in supplier prices More items that are not sold at full price Combination of the above factorsP
23、rofit from operations(%)-Formula=Profit from operations x100%RevenueProfit from operations(%)-Calculation2011=574.8 x100%=16.6%3,453.72010=529.8 x100%=15.6%3,406.5Profit from operations(%)-Comments Takes into account cost of sales and all other operating expenses In 2011,for every 100 of revenue,Nex
24、t plc makes a profit from operations of 16.60 Alternatively for every 100 of revenue,83.40 covers cost of goods sold,wages and other operating expenses,the balance is profit from operations Significant improvement on 2010(1%higher)Impressive given decline in gross margin Breakdown of expenses requir
25、edControl of staff costs-Formula=Staff costsx 100%RevenueControl of staff costs-Calculation2011=675.2x 100%=19.6%3,453.72010=678.2x 100%=19.9%3,406.5Control of staff costs-Comments Indicates how well the company is controlling employee costs In 2011 for every 100 of revenue,19.60 was spent on wages
26、and salaries Significant improvement on 2010,especially since no of FTE staff has increased from 35,619 to 37,220Revenue per employee-Formula=Revenue Number of employees Revenue per employee-Calculations2011=3,453.7=92,79237,220 2010=3,406.5=95,63735,619Revenue per employee Comments In 2010 each FTE
27、 employee generated on average 95,637 of revenue Increase in the number of FTE employees in 2011 means average revenue generated by each FTE employee fallen to 92,792 This indicates a decline in the efficiency of FTE employees(but this ratio is easily distorted)Ratio analysis-Summary From our brief
28、ratio analysis for Next plc we can see that:Slight decline in the gross profit margin Significant improvement in operating profit margin Staff costs remain at less than 20%of revenue Further analysis of operating expenses is necessary to establish why the operating profit margin has improved Revenue
29、 generated by each FTE employee has fallen,but needs further investigation before we can comment furtherLimitations of ratio analysis Financial statements are historic in nature(backward rather than forward looking/out of date)Comparison of results made difficult by:Use of different accounting polic
30、ies One off items that distort results(eg:large bad debt,restructure,redundancy)Definition used(eg:ROCE,Gearing,capital employed)Year end balances not always representative of period as a whole(eg:high inventory levels before Xmas)Ratio analysis may indicate problems,it wont necessarily recommend solutionsReading Atrill and McLaney(2011)Chapters 7 and 8 McKenzie Chapter 6 and 8 Melville(2009)Chapter 22 Next annual report 2011
