1 Analyzing Financial Statements Dr. Jatin Pancholi Website: http://www.jatinpancholi.com Dr. Jatin Pancholi has compiled and prepared this teaching note from various sources, as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The handling of a management situation requires personal guidance by a professional. To obtain copies, request permission to reproduce and to send feedback, please contact on website http://www.jatinpancholi.com . Those wishing to co-author next edition of this handout may also contact.
Transcript
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Analyzing Financial Statements
Dr. Jatin PancholiWebsite: http://www.jatinpancholi.com
Dr. Jatin Pancholi has compiled and prepared this teaching note from various sources, as the basis for class discussion rather than to illustrate either effective or ineffective
handling of a management situation. The handling of a management situation requires personal guidance by a professional. To obtain copies, request permission to reproduce and to send feedback, please contact on website http://www.jatinpancholi.com. Those
wishing to co-author next edition of this handout may also contact.
Financial Statement Analysis (1)
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Stakeholders get information from a company’s Published Accounts:Level of salesAmount of cash availableValue of debtors and creditorsLevel of Debt and EquityRevenues generatedCosts and Expensesetc
This information is available for the last and for previous years
Financial Statement Analysis (2)
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But:Sales of £1,000,000 is good or bad?Debtors of £500,000 is good or bad?Revenue increase of 15% is good or bad?
Absolute values are difficult to judgeEven an increase or decrease rate may be
misleading
Financial Statement Analysis (3)
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In order to achieve meaningful conclusions on a company’s performance, there is a need to make comparisons:vs. previous yearsvs. projectedvs. competitorsvs. industry averagesvs. known good performers (benchmark)
Ratio Analysis
Ratio Analysis (1)
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Functions:Aids understanding of accountsIndicates relationshipsAllows for comparisons Shows trends over timeProvides additional information to the
Financial Statements
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Is a three step process:
Calculate appropriate
ratios
Identify users and their
information needs
Interpret and evaluate results
Ratio Analysis (2)
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Categories of Ratios
Profitability
Efficiency (activity)
Liquidity
Gearing
Investment
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Profitability Ratios
Return on ordinary shareholders’ funds
Return on capital employed
Net profit margin
Gross profit margin
Formula
Net profit after taxation and preference dividend (if any) x 100 Ordinary share capital + Reserves
Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans
Net profit before interest and taxation x 100 Sales
Gross profit x 100 Sales
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ROCE – Main Elements
Sales Long-term capital
employed
Return on capital employed
multiplied by
equals
Net profit before interest and taxation
sales
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Efficiency Ratios
Average stock turnover period
Average settlement period for debtors
Average settlement period for creditors
Fixed Asset Turnover
Formula
Average stock held x 365 Cost of sales
Sales per employee
Trade debtors x 365 Credit sales
Trade creditors x 365 Credit purchases
_______Sales_______ Number of employees
_______ Sales__________
Fixed Assets
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Liquidity Ratios
Current ratio
Acid test ratio
Operating cash flows to maturing obligations
Formula
Current assets_______________ Current liabilities (creditors due within one
year)
Operating cash flows Current liabilities
Current assets (excluding stock) Current liabilities
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Gearing ratio
Interest cover ratio
Formula
Profit before interest and taxation_ Interest payable
Long-term liabilities _______ Share capital + Reserves + Long-term
liabilities
Gearing Ratios
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Effect of Financial Gearing
Profit beforeinterest and tax
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Investment Ratios
Dividend per share
Dividend payout ratio
Dividend yield ratio
Earnings per share
Formula
Dividends announced during the period Number of shares in issue
Dividends announced for the year x 100 Earnings for the year available for dividends
Dividend per share/(1-t) x 100 Market value per share
Price/earnings ratio (P/E)
Earnings available to ordinary shareholders Number of ordinary shares in issue
Market value per share Earnings per share
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0
1
2
6
5
4
3
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3.67
4.35 4.42
5.15
2.85
4.52
3.98
4.29
3.35
6.32
3.16
4.83
Source: Constructed from data appearing in the Financial Times, 18 January 2003
Average Dividend Yield Ratios
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Average Price/Earnings Ratios
0
5
10
30
25
20
15
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22.86
8.45
16.77
12.87
18.62
12.54
18.83
12.93 14.06
22.6323.18
12.67
Source: Constructed from data appearing in the Financial Times, 18 January 2003
Ratio Comparisons
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In isolation ratios’ benefits are very limited, as with absolute numbers
Conclusions can be drawn by comparisons against:The company’s budget / forecastExternal observers prior expectationsPrevious years ratiosOther companies ratios (current and prior
year)Industry averages
Limitations of Ratios (1)
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Ratios don’t give you answers, they give you cluesThese clues need to be investigated to find the
reasonsFor example: stock days have doubled. Is that a
problem?Yes, if they went from 50 to 100No, if they went from 2 to 4Yes, if obsolete stock is the cause of the increaseNo, if the company is about to open a number of new
shopsTrying to take conclusions from the ratios alone,
may lead to the wrong decisions being made
Limitations of Ratios (2)
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Ratios may also have intrinsic problems:They are calculated from accounting data,
and if there are mistakes in this…The comparisons may be made against the
wrong benchmarksRatios (as the Balance Sheet) are calculated
at a point in time and significant changes may occur within a short period
Relying only on ratios when analysing a company’s performance is dangerous
Thank you…
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Dr. Jatin PancholiWebsite: http://www.jatinpancholi.com
Dr. Jatin Pancholi has compiled and prepared this teaching note from various sources, as the basis for class discussion rather than to illustrate either effective or ineffective
handling of a management situation. The handling of a management situation requires personal guidance by a professional. To obtain copies, request permission to reproduce
and to send feedback, please contact on website http://www.jatinpancholi.com. Those wishing to co-author next edition of this handout may also contact.
