1、Lesson Nine:Interpretation of Financial Statements Aims:1.To explain the basic source of financial statement analysis.2.To calculate accounting ratios and know how are these ratios used to analyze financial statements.3.To develop the ability to analyze the financial statements of an organization.4.
2、To describe the importance of financial analysis when making decisions.9.1Introduction to Financial Statement Analysis(1)An appreciation of how the figures in the financial statements have been compiled.i.e.a thorough knowledge of basic bookkeeping and the fundamental accounting concepts;(2)An aware
3、ness of the users of financial statements and their specific needs;(3)An understanding of the deficiencies of the financial statements,especially where historical cost accounting has been used;(4)The ability to analyze and question the information given.The figures in the financial statements should
4、 rarely be taken at face value;(5)An appreciation of the type of business undertaken by the company and an awareness of internal and external factors which may affect the business;(6)The ability to communicate information in a clear and concise manner in the form of written reports or business lette
5、rs,or orally in meetings.9.2Ratio Analysis The users of financial statements will analyze and appraise the statements by examining the figures and making comparisons with:(1)Corresponding figures from different accounting periods.(2)Forecast or budgeted figures;(3)The same figures in the accounts of
6、 a similar organization.9.3The Uses of Ratio Analysis Ratio analysis is a useful tool to indicate specific areas of a business which merit further investigation.The calculation of relevant ratios will provide the user with a number of pertinent questions to which there may be a number of alternative
7、 answers.9.4The Limitations of Ratio Analysis Ratios will suffer from the same deficiencies as the information from which they are calculated.The financial statements of most organizations have major drawbacks:1.Historical Cost Accounting 2.Seasonal Fluctuations 3.Time Lag 4.Aggregation 5.Window Dre
8、ssing 6.Non-standardization of Accounting Policies 7.Different Patterns of Asset Ownership9.6Profitability Ratios Profitability is the ability of an entity to earn profits.This ability to earn profits depends upon the effectiveness and efficiency of operations as well as resources available to the e
9、nterprise.These are usually expressed as a percentage and are used to comment on the profit and loss account figures.9.7Return on Capital Employed(ROCE)or Return on Net Assets(RONA)It is an important ratio and is often known as the primary ratio.It is a measure of the overall profitability of the bu
10、siness.It shows the percentage return on the capital invested in the business.It shows how much profit has been earned for every$100 invested.It indicates how efficiently management is using the business resources to earn profits.9.8Net Profit Ratio The net profit ratio is net profit as a percentage
11、 of sales.It shows how much net profit is earned for every$1 of sale revenue.20122013Profit140160Sales8001 000Net Profit Margin17.5%16%9.9Gross Profit Margin The gross profit margin is the gross profit as a percentage of sales.It shows how much gross profit has been made for every$100 of sales.Sales
12、 margins vary widely between different industries but tend to be similar within industries.20122013Gross Profit250300Sales8001 000Gross Profit Margin31.25%30%9.10Overheads to Sales Ratio The overheads to sales ratio is the overheads as a percentage of sales.As sales volume increases,this ratio shoul
13、d decrease.20122013Overheads120150Sales8001 000Overheads to sales15%15%9.11Investors Ratios and Gearing Gearing measures the proportion of capital employed subscribed by debt capital(borrowing plus preference shares)as opposed to equity(ordinary shares plus reserves).20122013Debt capital(100+100)(10
14、0+100)Total capital employed506580Gearing Ratio39.5%34.5%9.12Dividend Yield Dividend yield is a measure of the revenue earning capacity of a share to its shareholder.It relates the dividend for the year to the market value of the share.20122013Dividend for year7.510 100Market value200250Dividend Yie
15、ld3.75%4%9.13Earnings Per Share(EPS)Earnings per share relates the profits earned by the ordinary shares(irrespective of the size of the dividend)to the number of issued ordinary shares.20122013Profit for the financial year(after tax)90100Less Preference dividend66Ordinary share earnings8494Number o
16、f ordinary shares200200Earnings per ordinary share42479.14Price Earnings Ratio(P/E)The price/earnings ratio relates the market value of a share to the earnings per share.This facilitates the comparison of the performance of the shares of different companies.20122013Market Value200250Earnings per sha
17、re4247P/E4.85.39.15Liquidity Ratios These ratios are used to assess the ability of the organization to meet its financial obligations i.e.assess whether the organization has sufficient liquid resources(cash)to pay its creditors.9.16Current Ratio The current ratio is the ratio of Current Assets to Cu
18、rrent Liabilities.20122013Current assets150230Current liabilities144220Current Ratio1.04 11.05 19.17Quick Ratio The quick ratio(Acid Test Ratio)is the ratio of Current Assets excluding stock to Current Liabilities.If the ratio is too high,the company may be holding excessive liquid assets.If the rat
19、io is too low,the company may have a liquidity problem.20122013Current assets excluding stock090160Current liabilities144220Quick Ratio0.63 10.73 19.18Stock Turnover This ratio shows the number of time the average stock is being sold in a period.Stock Turnover=9.19Debtors Collection Period This rati
20、o is used to appraise the company performance in its debt collection ability.It is a rough measure of the average length of time it takes for a company to collect trade debts from debtors.The shorter the collection period the better.20122013Debtors90160Sales8001 000Debtor Collection Period41 days58
21、days9.20Creditors Payment Period This ratio shows how long it takes a firm on average to pay its creditors.20122013Creditors57060 Purchases570710Creditors Payment Period37 days31 days9.22Working Capital Working capital is made up of various items that must be controlled:(1)Stock:(2)Debtors:(3)Creditors:(4)Cash:Working capital=current assets current liabilities
