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# Topic 10 Financial Statement Analysis

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### Topic 10 Financial Statement Analysis

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