2. Analytical Techniques permit
businesses to study end of period
reports in order to base decisions for
the future. Techniques may include:
• Ratio analysis
• Vertical and horizontal analysis
• Trend analysis
3. Ratio Analysis
• Valuable tool for interpreting financial
ratios
• Efficient way to express relationship
of one number to another
• 3 areas of analysis:
– Profitability
– Financial stability
– Management effectiveness
4. Vertical Analysis
• Analysis of items or a
group of items in the
same financial period.
– Eg comparison of Net
Sales to Expense groups
5. Horizontal Analysis
• Analysis of items or a group of items across
consecutive accounting periods.
– Eg comparison of Sales in ’07 to ‘08
6. Trend Analysis
• Analysis of items across at least three
consecutive accounting periods.
– Eg Sales are progressively increasing over the five
year period.
7. RATIOS
• Presented as % or as ratios
• Assist in:
– decision making
– Interpreting financial reports
– Assessment of enterprise’s:
• Profitability
• Stability
• Effectiveness
10. Profitability Ratios
• Gross profit ratio
• Net profit ratio
• Ratio of expenses to sales
• Return on equity ratio
• Return on total assets ratio
11. Gross Profit Ratio
Indicates the ability of a
trading enterprise to
generate gross profit
from sales.
Gross Profit
x100
Compare result to Net Sales
industry benchmarks to
determine suitability of
business performance
12. Result indicates:
• for every $ of sales – number of cents
retained as gross profit
• how effective business is in passing
on increases in COGS to customers
13. High result may indicate:
• ability of business to cover all costs
• capacity to earn acceptable net profit
and return to owner
Low result may indicate inability to:
• meet further costs
• return satisfactory net profit
• return satisfactory rate to owner
14. Recommendations
Improve sales
• Ascertain:
– stock levels - should be high enough to meet
demand
– appropriateness of stock to appeal to market
– demand for stock held
– Appropriateness of selling price
• Conduct market research/analysis to assist
with the above.
15. Institute policy to minimise COGS
• Investigate alternative suppliers selling
similar quality products for less
• Take advantage of discounts offered to
lower costs
16. Net Profit Ratio
•Indicates the ability of a
trading enterprise to
generate a return on the
owner’s investment.
Net Profit
•Compare result to x100
industry benchmarks to Net Sales
determine suitability of
business performance
17. • Result indicates:
• for every $ of sales – number of cents
retained as net profit
• how effective business is in
minimising expenses
• poor GP ratio will impact on NP ratio
18. High result may indicate:
• High operating revenue
• Low operating expenses
Low result may indicate:
• inappropriate pricing policy
• inadequate stock
• inappropriate stock
• expenses too high
19. Recommendations
Improve sales
• as per Gross Profit recommendations
Minimise expenses
• Set budgets for departments
• Investigate alternative suppliers to lower
costs
• As per Gross Profit recommendations
20. Expense Groups to Sales
Indicates the amount of
the sales dollars needed
to cover expenses.
Group of Expenses
Compare result to x100
industry benchmarks to Net Sales
determine suitability of
business performance.
21. High result may indicate:
• weak control over expenses in proportion
to the sales
Low result may indicate:
• tight control over the expenses in
proportion to the sales
22. Recommendations
Investigate unusually high or low expense
items to ensure errors have not been made in
recording.
Increase net profit while retaining expense
levels at current level.
Decrease expenses while retaining or
improving sales.
23. Rate of Return on Equity
Ratio
Indicates the return to
the owner on the
amount invested in the
business
Net Profit
x100
Aim for a return of, Average Owner' s Equity
around, 14% which
allows funding for future
growth and a return on
investment.
( OE beg + OE end) /2 = Avg OE
24. High result may indicate:
• efficient operation
• business may be under-capitalised (owner
has not contributed equity to the optimum
level)
– Under-capitalisation can be identified when NP
ratio is close to or under industry benchmark
yet ROE is well above industry benchmark
25. Low result may indicate:
• owner’s money may perform better
invested elsewhere
• business may be over-capitalised (if owner
has invested over the optimum sum into
the business)
– Can be identified when NP ratio is close to
industry benchmark yet the ROE result is well
below industry benchmark
• management may take little risk therefore
business is cautiously run
• inefficient management making poor
decisions, lack of foresight.
26. Recommendations
Improve net profit result using previous
recommendations.
Check level of capitalisation to ensure
appropriateness for industry.
– If under-capitalised owner should consider
investing further funds into the business.
– If over-capitalised owner should consider
investing excess funds into alternative
investments.
27. Rate of Return on Total
Assets Ratio
Indicates the ability
of the enterprise to
generate profits
using its assets. Net Profit + Interest Expense
x100
•Compare result to
Average Total Assets
industry benchmarks
to determine
suitability of
business
(AssetsBeg + AssetsEnd) / 2 = Avg Total Assets
g l
performance.
28. High result may indicate:
• efficient use of assets
• wise decisions made regarding asset
acquisition
Low result may indicate:
• inefficient use of assets
• inappropriate levels/types of assets leading
to poor performance
• high purchase price for assets
32. Current Ratio
Measures the ability of the enterprise to meet
its short-term financial obligations; that is,
commitments due in the current financial year.
CA
Ideal result = 2:1; for every $1 of CL (short-term
financial obligations) business carries $2 CA to CL
cover.
33. High result indicates:
• assurance that obligations can be met
• if too high (3:1+) may indicate ‘idle funds’.
Funds better invested in higher interest
bearing assets.
Low result may indicate:
• inability to meet obligations
34. Recommendations
Pay off bank overdrafts as soon as possible.
Investigate alternative suppliers (accounts
payable) to lower cost of stock.
Invest ‘idle funds’ in areas likely to attract a
higher return.
35. Quick Ratio
Indicates the entity’s ability to meet its
immediate financial obligations such as
accounts payable from its immediately CA - (Inventories + Prepayments)
accessible or quickly converted assets such as CL - Bank Overdraft
cash and accounts receivable.
Does not include inventories and prepayments
because they are difficult to convert to cash in
the short term. Bank overdrafts are usually not
due in the next accounting period, therefore;
not included.
Ideal result = 1:1; for every $1 of CL (immediate
financial obligations, not including bank
overdraft) business has $1 CA (not including
stock/prepaids) to cover.
36. High result indicates:
• High degree of assurance that immediate
debts can be paid
• Excessive levels of quick assets held eg
cash
Low result may indicate:
• inability to meet immediate debts
• Business is relying on turnover of stock to
meet obligations
37. Recommendations
Consider level of accounts payable
Ensure cash flow is optimal – accounts
receivable pay on time.
Maintaining adequate levels of cash rather
than excessive (better invested in higher
returning applications)
38. Equity Ratio
Indicates the extent to which the owner has
financed the business’s assets as opposed to
using alternative source of finance –
borrowings (debt).
Mirror of Debt Ratio – both ratios should equal
100%.
Total Owner' s Equity
A = L + Oe * 100
Total Assets
Ideal is 50% - that is business assets are half
funded by equity and half by debt.
Finance companies will “move in” when ratio
reaches 70:30 debt to equity.
39. High result indicates:
• Most funds provided by owner to finance
business
Low result may indicate:
• Most funds provided by borrowings to
finance business
40. Recommendations
Heavy dependence on equity indicates
business is not highly geared. (Gearing refers
to level of debt).
In times of low interest rates on money
market and if business is performing well
owner should invest further in business.
Decrease debt through repayment to achieve
50:50 balance of debt/equity.
Minimise need to carry hold/own large
assets.
41. Debt Ratio
Indicates the way in which business is financed
and extent of borrowing in relation to assets.
Total Liabilitie s
* 100
Total Assets
42. High result indicates:
• Most funds provided by borrowings to
finance business
Low result may indicate:
• Most funds provided by owner to finance
business
43. Recommendations
Heavy dependence on debt indicates business
is highly geared.
Places high burden on business to meet
repayments.
Repay as soon as possible.
Carefully consider any further investment in
future beyond the 50:50 balance of
debt/equity.
44. Effectiveness of
Management
Policies
Management effectiveness is a
measurement of how successfully
managers have been in directing and
maintaining the set policies of an
enterprise.
46. Turnover of Accounts
Receivable Ratio
Average Accounts Receivable
e s
*365
Net Credit Sales
t t
Measures the efficiency of the business in
managing its accounts receivable.
Business operations are dependant upon the
collection of this debt.
Cash flow into the buisness is required to
maintain operations eg pay wages, bills etc.
47. High result indicates:
• Inefficient Collection Policy – should state
collection rate between 20-40 days – if
number of days too high strong possibility
of high bad debts figure.
• Poor cash flow
• Loose credit policy
Low result may indicate:
• Effective credit policy, efficient collection
of Accounts Receivable
48. Recommendations
Tighten credit policy and communicate to
debtors. All business offering credit should
establish a credit policy.
– Policy conditions include:
• Repayment time (usually 30 days)
• Discounts offered for prompt payment
• Interest to be charged on overdue account
• Method to determine credit worthiness of applicant.
– Business should issue monthly statements
which serve as a reminder
49. Factor Accounts Receivable – debts are sold
to financial institute for 90-85% of value.
– Attractive option because it offers immediate
cash flow
– Saves the business the cost of phone calls,
reminders legal action etc.
50. Turnover of Inventories
Ratio
Measures how efficiently the inventory of the
business is being managed.
Comparison against industry averages will
indicate acceptable turnover.
Cost of Goods Sold
365/
Average Inventory
51. High result indicates:
• Slow-moving inventory
• Large holding of inventory ready for sale
Low result may indicate:
• Fast-moving inventory
• Shortage of inventory available for sale
