Topic 10 Financial Statement Analysis

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  • 1. 1
    TOPIC 10: FINANCIAL STATEMENT ANALYSIS
  • 2. 2
    Introduction
    Interpretation is when users evaluate financial information to make judgements
    It is the key to any in-depth understanding of an organisation’s performance.
    Basically, the users evaluate an organisation’s performance and financial position using the information from INCOME STATEMENT and BALANCE SHEET.
    The value of the analysis is depends on the value of the financial statements.
  • 3. 3
    Techniques (types) of analysis:
    1.HorizontalAnalysis
    Comparing key figures in financial statement
    Evaluates a series of financial statement over a period of time.
    2. Vertical Analysis
    Evaluates financial statement by expressing each item in a financial statement as a percent of the base amount (key figure)
    Key-figure (such as sales in IS and total assets on BS) are set to 100%
    Other items are then expressed as percentage of 100
  • 4. 4
    Techniques (types) of analysis: (cont.)
    3. Trend analysis
    Similar to horizontal analysis, except that the first set of account in the series is given a base of 100
    4. Ratio Analysis
    It expresses the relationship among selected items of financial statement data.
  • 5. 5
    Horizontal Analysis
    It’s an analysis of the percentage increases and decreases of related items in comparative financial statements.
    What is horizontal analysis?
  • 6. 6
    14-7
    HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    Assets
    Current assets $10,361 $ 7,777 $2,584 33.2%
    Property and equipment, net 15,375 13,068 2,307 17.7
    Other assets 658 540 118 21.9
    Total assets $26,394 $21,385 $5,009 23.4
    Liabilities
    Current liabilities $ 6,501 $ 4,385 $2,116 48.3
    Long-term debt, excluding
    current installment 1,250 1,545 (295) (19.1)
    Other long-term liabilities 372 256 116 45.3
    Deferred income taxes 189 195 (6) (3.1)
    Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3)
    Total liabilities $ 8,312$ 6,381$1,931 30.3
    The stockholders’ equity section is not displayed.
  • 7. 7
    Horizontal Analysis:
    Difference $2,584
    Base year $7,777
    = 33.2%
    14-8
    HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    Assets
    Current assets $10,361 $ 7,777 $2,584 33.2%
    Property and equipment, net 15,375 13,068 2,307 17.7
    Other assets 658 540 118 21.9
    Total assets $26,394 $21,385 $5,009 23.4
    Liabilities
    Current liabilities $ 6,501 $ 4,385 $2,116 48.3
    Long-term debt, excluding
    current installment 1,250 1,545 (295) (19.1)
    Other long-term liabilities 372 256 116 45.3
    Deferred income taxes 189 195 (6) (3.1)
    Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3)
    Total liabilities $ 8,312$ 6,381$1,931 30.3
    33.2%
  • 8. 8
    Horizontal Analysis:
    Difference $2,307
    Base year $13,068
    = 17.7%
    14-9
    HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007
    Condensed
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    Assets
    Current assets $10,361 $ 7,777 $2,584 33.2%
    Property and equipment, net 15,375 13,068 2,307 17.7
    Other assets 658 540 118 21.9
    Total assets $26,394 $21,385 $5,009 23.4
    Liabilities
    Current liabilities $ 6,501 $ 4,385 $2,116 48.3
    Long-term debt, excluding
    current installment 1,250 1,545 (295) (19.1)
    Other long-term liabilities 372 256 116 45.3
    Deferred income taxes 189 195 (6) (3.1)
    Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3)
    Total liabilities $ 8,312$ 6,381$1,931 30.3
    33.2%
    33.2%
    17.7
  • 9. 9
    14-10
    HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007
    Condensed
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    Assets
    Current assets $10,361 $ 7,777 $2,584 33.2%
    Property and equipment, net 15,375 13,068 2,307 17.7
    Other assets 658 540 11821.9
    Total assets $26,394 $21,385 $5,009 23.4
    Liabilities
    Current liabilities $ 6,501 $ 4,385 $2,116 48.3
    Long-term debt, excluding
    current installment 1,250 1,545 (295) (19.1)
    Other long-term liabilities 372 256 116 45.3
    Deferred income taxes 189 195 (6) (3.1)
    Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3)
    Total liabilities $ 8,312$ 6,381$1,93130.3
  • 10. 10
    Horizontal Analysis:
    Difference $7,815
    Base year $45,738
    = 17.1%
    14-11
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    17.1%
    Sales (net) $53,553 $45,738 $7,815
    Cost of merchandise sold 37,406 32,057 5,349
    Gross profit $16,147$13,681$2,466
    Selling and store operating exp. 10,280 8,655 1,625
    General and administrative exp. 935 835 100
    Total operating expenses $11,215$ 9,490$1,725
    Income from operations $ 4,932 $ 4,191 $ 741
    Other income and expenses:
    Interest and investment inc. 53 47 6
    Interest expense (28) (21) (7)
    Income before income tax $ 4,957 $ 4,217 $ 740
    Income taxes 1,913 1,636 277
    Net income $ 3,044 $ 2,581 $ 463
  • 11. 11
    Horizontal Analysis:
    Difference $5,349
    Base year $32,057
    = 16.7
    14-12
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    17.1%
    Sales (net) $53,553 $45,738 $7,815
    Cost of merchandise sold 37,406 32,057 5,349
    Gross profit $16,147$13,681$2,466
    Selling and store operating exp. 10,280 8,655 1,625
    General and administrative exp. 935 835 100
    Total operating expenses $11,215$ 9,490$1,725
    Income from operations $ 4,932 $ 4,191 $ 741
    Other income and expenses:
    Interest and investment inc. 53 47 6
    Interest expense (28) (21) (7)
    Income before income tax $ 4,957 $ 4,217 $ 740
    Income taxes 1,913 1,636 277
    Net income $ 3,044 $ 2,581 $ 463
    16.7
  • 12. 12
    17.1%
    16.7
    14-13
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    Increase (Decrease)
    Dec 31, 2007Dec 31, 2006 Amount Percent
    Sales (net) $53,553 $45,738 $7,815
    Cost of merchandise sold 37,406 32,057 5,349
    Gross profit $16,147$13,681$2,466
    Selling and store operating exp. 10,280 8,655 1,625
    General and administrative exp. 935 835 100
    Total operating expenses $11,215$ 9,490$1,725
    Income from operations $ 4,932 $ 4,191 $ 741
    Other income and expenses:
    Interest and investment inc. 53 47 6
    Interest expense (28) (21) (7)
    Income before income tax $ 4,957 $ 4,217 $ 740
    Income taxes 1,913 1,636 277
    Net income $ 3,044 $ 2,581 $ 463
    18.0
    18.8
    12.0
    18.2
    17.7
    12.8
    33.3
    17.5
    16.9
    17.9
  • 13. 13
    Vertical Analysis
    A percentage analysis can be used to show the relationship of each component to a total within a single statement.
  • 14. 14
    Vertical Analysis
    The total, or 100% item, on the balance sheet is “total assets.”
    The total, or 100% item, on the income statement is “total sales.”
  • 15. 15
    14-18
    14-18
    HOME DEPOTComparative Balance Sheets (in Millions) December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    100.0%
    Total assets is 100.0%
  • 16. 16
    Vertical Analysis:
    Current assets $10,361
    Total assets $26,394
    = 39.3%
    14-19
    HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    39.3%
    100.0%
  • 17. 17
    14-20
    HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    39.3%
    58.2
    2.5
    100.0%
    24.6%
    6.9
    31.5%
    20.9%
    47.6
    68.5%
    100.0%
  • 18. 18
    39.3%
    58.2
    2.5
    100.0%
    24.6%
    6.9
    31.5%
    20.9%
    47.6
    68.5%
    100.0%
    14-21
    HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    100.0%
    Total assets is 100.0%
  • 19. 19
    39.3%
    58.2
    2.5
    100.0%
    24.6%
    6.9
    31.5%
    20.9%
    47.6
    68.5%
    100.0%
    Vertical Analysis:
    Current assets $7,777
    Total assets $21,385
    = 36.4%
    14-22
    HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    36.4%
    100.0%
  • 20. 20
    39.3%
    58.2
    2.5
    100.0%
    24.6%
    6.9
    31.5%
    20.9%
    47.6
    68.5%
    100.0%
    14-23
    HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006
    Condensed
    December 31, 2007 December 31, 2006
    Amount Percent Amount Percent
    Assets
    Current assets $10,361 $ 7,777
    Property and equipment, net 15,375 13,068
    Other assets 58 540
    Total assets $26,394 $21,385
    Liabilities
    Current liabilities $ 6,501 $ 4,385
    Long-term liabilities 1,811 1,996
    Total liabilities $ 8,312$ 6,381
    Stockholders’ Equity
    Common stock/paid-in capital $ 5,529 $ 4,926
    RE & accumulated comp. loss 12,553 10,078
    Total stockholders’ equity $18,082$15,004
    Total liabilities and SE $26,394 $21,385
    36.4%
    61.1
    2.5
    100.0%
    20.5%
    9.3
    29.8%
    23.0%
    47.1
    70.2%
    100.0%
  • 21. 21
    14-24
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    2007 2006
    Amount Percent Amount Percent
    Sales (net) $53,553 100.0% $45,738 100.0%
    Cost of merchandise sold 37,406 32,057
    Gross profit $16,147$13,681
    Selling and store operating exp. 10,280 8,655
    General and administrative exp. 935 835
    Total operating expenses $11,215$ 9,490
    Income from operations $ 4,932 $ 4,191
    Other income and expenses:
    Interest and investment inc. 53 47
    Interest expense (28) (21)
    Income before income tax $ 4,957 $ 4,217
    Income taxes 1,913 1,636
    Net income $ 3,044 $ 2,581
    Net sales is 100.0%
    Net sales is 100.0%
  • 22. 22
    2006
    Vertical Analysis:
    Cost of Merchandise Sold $32,057
    Net Sales $45,738
    = 70.1%
    14-25
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    2007 2006
    Amount Percent Amount Percent
    Sales (net) $53,553 100.0% $45,738 100.0%
    Cost of merchandise sold 37,406 32,057
    Gross profit $16,147$13,681
    Selling and store operating exp. 10,280 8,655
    General and administrative exp. 935 835
    Total operating expenses $11,215$ 9,490
    Income from operations $ 4,932 $ 4,191
    Other income and expenses:
    Interest and investment inc. 53 47
    Interest expense (28) (21)
    Income before income tax $ 4,957 $ 4,217
    Income taxes 1,913 1,636
    Net income $ 3,044 $ 2,581
    70.1
  • 23. 23
    2007
    Vertical Analysis:
    Cost of Merchandise Sold $37,406
    Net Sales $53,553
    = 69.9%
    14-26
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    2007 2006
    Amount Percent Amount Percent
    Sales (net) $53,553 100.0% $45,738 100.0%
    Cost of merchandise sold 37,406 32,057
    Gross profit $16,147$13,681
    Selling and store operating exp. 10,280 8,655
    General and administrative exp. 935 835
    Total operating expenses $11,215$ 9,490
    Income from operations $ 4,932 $ 4,191
    Other income and expenses:
    Interest and investment inc. 53 47
    Interest expense (28) (21)
    Income before income tax $ 4,957 $ 4,217
    Income taxes 1,913 1,636
    Net income $ 3,044 $ 2,581
    69.9
    70.1
  • 24. 24
    14-27
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    2007 2007
    Amount Percent Amount Percent
    Sales (net) $53,553 100.0% $45,738 100.0%
    Cost of merchandise sold 37,406 32,057
    Gross profit $16,147$13,681
    Selling and store operating exp. 10,280 8,655
    General and administrative exp. 935 835
    Total operating expenses $11,215$ 9,490
    Income from operations $ 4,932 $ 4,191
    Other income and expenses:
    Interest and investment inc. 53 47
    Interest expense (28) (21)
    Income before income tax $ 4,957 $ 4,217
    Income taxes 1,913 1,636
    Net income $ 3,044 $ 2,581
    69.9
    70.1
    29.9%
    18.9%
    1.8
    20.7%
    9.2%
    0.1
    (0.1)
    9.2%
    3.6
    5.6%
  • 25. 25
    14-28
    HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
    2007 2006
    Amount Percent Amount Percent
    Sales (net) $53,553 100.0% $45,738 100.0%
    Cost of merchandise sold 37,406 32,057
    Gross profit $16,147$13,681
    Selling and store operating exp. 10,280 8,655
    General and administrative exp. 935 835
    Total operating expenses $11,215$ 9,490
    Income from operations $ 4,932 $ 4,191
    Other income and expenses:
    Interest and investment inc. 53 47
    Interest expense (28) (21)
    Income before income tax $ 4,957 $ 4,217
    Income taxes 1,913 1,636
    Net income $ 3,044 $ 2,581
    70.1
    30.1%
    19.2%
    1.7
    20.9%
    9.2%
    0.1
    (0.0)
    9.3%
    3.6
    5.7%
    69.9
    29.9%
    18.9% 1.8
    20.7%
    9.2%
    0.1
    (0.1)
    9.2%
    3.6
    5.6%
  • 26. 26
    Types of ratio analysis
    Profitability Ratio
    Efficiency/activity/asset management Ratio
    Liquidity Ratio
    Solvency Ratio
    Cash flow
    Investment
  • 27. 27
    1. Profitability
    1. Return on capital
    employed
    2. Gross profit ratio
    3. Net profit ratio
    2. Liquidity
    1. Current ratio
    2. Quick ratio
    3. Efficiency
    1. Debtors turnover
    2. Debtors collection period
    3. Stock turnover ratio
    4. Asset turnover ratio
    4. Solvency/financial leverage management ratio
    1. Debt to Equity ratio
    2.Debt ratio
  • 28. 28
    Continue………..
    6. Investment
    1. Dividend yield
    2. Dividend cover
    3. Earnings per share
    4. Price/earnings ratio
    5. Interest cover
    5. Cash Flow
    1. Cash flow ratio
  • 29. 29
    Importance of Ratios
    • Quick and easy snapshot of an organisation’s achievements
    • 30. Aid for comparisons
    Ratio provide benchmark to compare on
    company with another (inter-firm comparison) or to compare the same company over period of time (intra-firm comparison).
  • 31. 30
    PROFITABILITY RATIO
    • It measures the income or operating effectiveness of an organisation for a given period of time.
    • 32. A low value of this ratio will affect the company ‘s ability to obtain debt, equity financing and the ability to grow or expand.
    i Return on capital employed (ROCE)
    • measures effective use of capital
    • 33. It measures the profitability from the shareholder view point.
    • 34. It shows how many ringgit of the net income were earned for each ringgit invested by the owner.
    = Profit or earning after tax x 100%
    Average capital employed
  • 35. 31
    Continue…
    ii. Gross Profit Margin
    • It measures the percentage of one ringgit of sales that results in gross income.
    =Sales – Cost of Goods Sold x 100% Sales
    = Gross Profit x 100%
    Sales
    iii. Net Profit Margin
    It measures the percentage of one ringgit of sales that results in net income.
    = Profit or earning after tax x 100%
    Sales
  • 36. 32
    LIQUIDITY RATIO
    It measure the short term ability of the organisation to pay debt and to meet unexpected need for cash.
    i. Current Ratio
    To measure the ability of current asset that the company have to pay back the short term debt.
    = Current Asset
    Current Liability
  • 37. 33
    Continue…
    ii. Quick Ratio
    • It measures the company’s immediate short term liquidity.
    Current Asset – Stock – Prepayment
    Current Liability
    • This ratio indicates whether current liabilities could be paid without having to sell the inventory
    • 38. This ratio is useful for companies which cannot convert inventory into cash quickly if necessary.
  • 34
    Cont….
    This ratio indicates whether the business has enough short-term assets to cover its short-term liabilities.
    A ratio above 1 indicates that working capital is positive (Current assets exceed current liabilities)
    A ratio below 1 indicates that working capital is negative.
    Many large companies regularly operate with current ratio closer to 1 and 2
  • 39. 35
    Generally the higher the ratio, the greater the financial stability and the lower the risk for both creditors and owners.
    However, the ratio should not be too high because that may indicate that the business is not reinvesting in long-term assets to maintain future productivity.
    High current ratio can actually indicate problems if inventories are getting larger than they should be or collections of receivables are slowing down.
  • 40. 36
    EFFICIENCY RATIO
    Debtors turnover
    Measures how many times it takes customers to pay
    Credit sales
    Average debtors
  • 41. 37
    EFFICIENCY RATIO
    1. Debtors collection period
    Measures how long it takes customers to pay
    = Average debtors x 365 days OR365 days
    Credit salesdebtors turnover
    This ratio indicates how many days it takes, on average to collect a day’s sale revenue.
    The quicker a business collects and bank the money, the better it is to the company
    Large numbers of days is a negative signal, raising questions about the company’s policies of granting credit such as;
    Unrestricted credit policies
    Longer credit limit
    Collection attempts is not very strength
  • 42. 38
    Efficiency Ratio
    3. Stock turnover ratio
    measures how quickly stock moves through business
    This ratio means that the average length of time that the stocks are held before being sold.
    = Cost of goods sold
    Average stock
    It can also be calculated in days
    = Average stock x 365 days OR 365 days Cost of goods sold stock turnover
  • 43. 39
    Efficiency Ratio
    Asset turnover ratio
    • compares sales to total assets employed
    • 44. Measures how efficient the assets in generating sales
    = Sales x 100%
    Average total assets
  • 45. 40
    SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO
    1. Debt to Equity ratio
    = Total liabilities
    Total Equity
    2. Debt ratio
    Also call debt to assets ratio
    = Total liabilities
    Total Asset
  • 46. 41
    SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO
    • This is to measure the ability of the company to survive over a long period of time
    • 47. The ability to pay interest as it come due/mature
  • 42
    Income Statement for the year ended 31 Dec 2007
    Sales 200
    Less: Cost of goods sold (100)
    Gross profits 100
    Less expenses
    General 40
    Interest 10(50)
    Profit before tax 50
    Less: Taxation(15)
    Profits after tax 35
    Less: Dividends(15)
    Retained profits 20
  • 48. 43
    Balance Sheet as at 31 Dec 2007
  • 49. 44
    1. Profitability Ratios
    a. Return on Capital Employed
    Profit after tax = 35 = 16.3%
    Average capital employed 215
    b. Gross Profit Ratio
    Gross profit= 100 = 50%
    Sales 200
    c. Net Profit Ratio
    Net profit after taxation = 35 = 17.5%
    sales 200
  • 50. 45
    2. Liquidity Ratios
    a. Current Ratio
    Current assets = 120 = 2:1
    Current liabilities 60
    b. Quick Ratio
    Current assets - stock = 120-60 = 1:1
    Current liabilities 60
  • 51. 46
    3. Efficiency Ratios
    Debtors Collection Period
    Average debtors x 365 = 40 x 365 = 73 days
    Credit sales 200
  • 52. 47
    c. Stock Turnover
    COGS = 100 = 1.66 times
    Average stock 60
    d. Asset Turnover Ratio
    Sales x 100% = 200 x 100%
    Average total assets 395
    = 51%
  • 53. 48
    4. Financing ratio
    a) Debt to equity ratio
    Total liabilities = 180 = 0.837
    Total equity 215
    b) Debt ratio
    Total liabilities = 180 = 0.456
    Total assets 395
  • 54. 49
    Limitations of the Accounting Information
    Estimates
    The financial statement contains numerous estimates. Eg. Provision for doubtful debt, depreciation and contingent loss.
    Cost
    The traditional financial statements are based on historical cost, it is not adjusted for price-level change. Eg. Inflation affects the sales growth.
    Alternative Accounting Method
    A comparison may be misleading as different companies use different accounting method. Eg. FIFO and LIFO.
    Diversification of firms
    This diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).
  • 55. 50
    CONCLUSION
    • Ratio analysis is a good way to overview an organisation’s activities
    • 56. Ratio analysis must be compared with past result or industry norms, not in isolation
    • 57. Things to be taken into account in using ratio analysis:
    • 58. size of the organisation
    • 59. Method used in accounting treatment
    • 60. Same industry
    • 61. Same country