Financial Statement Analysis Final (1)

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Welcome to
AIBF
Financial Statement
Analysis Training
Asalamualikum!

Khalid Zarif
Current engagements
Deputy Director & Academic Head of AIBF
President of Afghanistan Association of Professional
Accountants (AAPA)
Bank Millie Afghan (BMA) Supervisory Board Member
President of Afghan Social Researchers Association (ASRA)
Work Experiences
Business Unit Manger & adjunct Trainer, AUAF-PDI
Technical Adviser, FinTRACA- Da Afghanistan Bank
Custom Analyst- Ministry of Finance
Official of Treasury Department- Ministry of Finance
Education:
Global MBA plus finalist of ACCA- Continuous
BSc from Oxford Brookes University
Certified Accounting Technician (CAT)

1.

INTERPRETATI
ON OF
FINANCIAL
STATEMENTS

Purpose and format of the
financial statements

2.

Users of the financial
Statements

3.

Profitability Ratios &
Interpretation

4.

Liquidity Ratios &
Interpretation

5.

Gearing Ratios &
Interpretation

6.

Limitations of ratio analysis

Accounting: Definition
Is the process of






Recording
Classifying
Summarizing
Interpreting

in journal
in ledger and
in Financial Statements
financial information in
order to make decisions

Financial Statements


Financial Statements present information about






The financial position of an entity
Its financial performance during accounting period
Its cash flow

Financial statements are
1.

2.
3.
4.
5.

Statement of Financial Position
Statement of Comprehensive Income/income statement
Statement of Cash Flow
Statement of changes in Equity
Notes to the Financial Statements

Elements of Financial Statements


Statement of Financial Position





shows the financial position of an entity as at a particular date.
The financial position is shown by assets, liabilities and
equity (capital)

Income statement




shows the financial performance of an entity during an
accounting period
The financial performance is shown by income and
expenses

Continued

Elements of Statement of Financial Position


Asset






An asset is a resource controlled by the entity as a result of past
event and from which future economic benefits are expected to
flow to entity.
Examples of assets are factories, office buildings, warehouses,
delivery vans, lorries, plant and machinery, computer equipment,
office furniture, cash and goods held in store

Assets are of two types


Current Assets: are those assets that are cash, will be converted
into cash or will be used up within one year




Cash, Accounts Receivables, Inventory

Non-Current (Fixed) Assets: are assets that will be used in more
than one accounting period


Building, vehicles, machines, plant and equipment

Elements of Statement of Financial Position


Liability






is a present obligation arising from past events, the settlement
of which will result in an outflow of economic benefits from the
entity.
'Liabilities' is the accounting term for the debts of a business.

Liabilities are of two types:


Current Liability: is an obligation to others which is payable in 12
months




Non-current liability: is an obligation to others payable in more
than 12 months




Accounts payable, bank overdrafts, short term loans
Long term loans from banks

Capital/Equity/net assets



Is the amount invested in business by owners(capital)
Consists of amount invested by owner and profits of business

Format of Statement of Financial Position




Statement of Financial position is in vertical format and is
divided into two parts


The top half of the statement shows the assets of the business
with non current asset first and current assets below the non
current assets



The lower of half of the statement shows the capital followed
by liabilities. The liabilities are shown with non-current liabilities
first and then current liabilities

The total of assets must equal the total of capital and
liabilities

Statement of financial position

Statement of profit or loss and other
comprehensive income

Changes in equity

Format of Statement of Financial Position
1.

Business Name- Statement of Financial Position
Assets
Non-current Assets
Property, plant and equipment
+Borrowing Cost
Goodwill
Other intangible assets
-Impairment
Investment in Associates
Investment property
Investment in equity instruments
Biological Assets

(IAS-16)
(IAS-23)
(IFRS-3)
(IAS-38)
(IAS-36)
(IAS-28)
(IAS-40)
(IAS-38)
(IAS-41)

Current Assets

Inventories
Trade Receivable
Assets held for sale
Other current Assets
Cash and cash equivalents
Total assets

(IAS-2)
(IFRS-5)

Equity and liabilities
Equity attributable to owners of the parent
Share Capital
Retained earnings
Other components of equity
Non-controlling interest
Total equity
Non-current liabilities
Long term borrowings IAS-32 (IFRS-9)
Preferred Share
IAS-32 (IFRS-9)
Deferred tax
(IAS-12)
Long-term provisions (IAS-37)
Government grants
(IAS-20)
Leasing obligation
(IAS-17)
Total non-current liabilities
Current liabilities
Trade and other payables
Short-term borrowings
Current portion of long-term
Borrowings
Current tax payable
Short-term provisions
Total current liabilities
Total liabilities
Total equity and liabilities

Format of Income Statement
Business Name- Statement of Comprehensive Income for the year ended
Revenue/ Sales/ turnover (IAS-18)
Less Cost of Sales
Gross Profit
Other income
Administrative expenses
Distribution Expenses
Financial Cost (Interest Expenses)
Profit before tax (PBT)
Tax expenses (IAS-12)
Profit after tax (PAT)
Profit/ Loss from discounted operation (IFRS-5)
Other Comprehensive Income
Revaluation gain/ loss (IAS-16)
Actuarial gain/loss (IAS-19)
Fair value thought OCI (IFRS-9)
Cash flow hedge gain/loss (IAS-39)
Total Comprehensive Income

Elements of Income Statement


Income : consists of






Revenue from sale of goods
Other items of income such as interest received
Gains from disposing of assets

Expense: consists of



Expenses arising in the ordinary course of activities such as
cost of sales, wages and salaries
Losses from disposing of assets

Format of Income Statement
Business Name- Statement of Comprehensive Income for the year ended
Revenue/ Sales/ turnover (IAS-18)
Less Cost of Sales
Gross Profit
Other income
Administrative expenses
Distribution Expenses
Financial Cost (Interest Expenses)
Profit before tax (PBT)
Tax expenses (IAS-12)
Profit after tax (PAT)
Profit/ Loss from discounted operation (IFRS-5)
Other Comprehensive Income
Revaluation gain/ loss (IAS-16)
Actuarial gain/loss (IAS-19)
Fair value thought OCI (IFRS-9)
Cash flow hedge gain/loss (IAS-39)
Total Comprehensive Income

QUESTION
In the month of January, a business had these transactions:
Sales $150,000
Purchases $70,000
Returns inwards $5,000
Returns outwards $1000

If the opening inventory was $12,000 and closing inventory
was $14,000


Requirement: calculate the gross profit for the month

QUESTION
The following information relates to Minnie’s hairdressing
business in the year ended 31 August 20X7:
Expenses
7,100
Opening inventory
1,500
Closing inventory
900
Purchases
12,950
gross profit
12,125
Inventory drawings
75
What is the sales figure for the business:
A
$32,700
B
$25,600
C
$25,675
D
$25,750

Relationship between Statement of Financial
position and Income Statement
The income statement and statement of financial position
are separate statements but they are also related to each
other

The income statement ends with net profit or loss. This
profit or loss belongs to the owner. Profit/loss for
the year is added to or subtracting from owner’s capital in
statement of financial position at the end of the year.
The result of the income statement either profit/ (loss) will
be reflected in the statement of financial position

Users of the financial statement

Information required by users
As well as:
 Employees - will I get paid?


Governments - tax, regulations compliance



Suppliers / lenders - will we get paid?



Customers - can we rely on this company?

Information required by users
Purpose
Analysis of a company’s financial statements is
performed by the following:
— Management

— Interested

parties

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

How Financial Information Analysis?


Financial statements can be assessed using ratio
analysis



Past trends of the same business (analysis through
time) and compare to budget



Comparative information for similar businesses
(analysis by competitors)

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Ratio Analysis
Is a tool for measuring a firm’s liquidity,
profitability, and reliance on debt financing,
as well as the effectiveness of management’s
resource utilization.
 How the ratio means are enhanced? if we
compare with:
 Past performance (i.e. past years’ ratios)
 Target Ratios
 Other companies ratios (i.e.
competitors’ ratios)
 Industry as a whole

Ratio Analysis
In order to make sense of whether ratios are
good or bad, we need to answer the below
questions: 

What does the ratio literally mean?



What does the change in the ratio mean?



What is the norm in the industry?



What are the limitation of the ratio?

TYPES OF RATIOS
Category

Ratio

Description

Profitability
Ratio

Gross profit
Net profit
Asset turn over
Return of capital employed
Return on Equity

Gross profit divided by sales
Net profit divided by sales
Sales divided by capital employed
PBIT divided by capital employed
PAT & Pre Dividend divided by capital emp

Current ratio
Liquidity Ratio
Quick(acid test) ratio

Liquidity
(Efficiency)
Ratio

Inventory turn over
Receivables turn over
Payables turnover

Current assets divided by current liabilities
Current assets (minus inventory) divided
by current liabilities

Inventory divided by cost of sales x 365
Receivables divided by sales x 365 days
Payables divided credit purchases x 365

Gearing Ratio

Debt to equity ratio
Long term debt to equity
Interest Cover

Total liabilities divided by equity
Long term divided by equity
PBIT divided by interest payable

Investor Ratio

Earning per share (EPS)
Price/Earnings(P/E) ratio
Dividend Cover

Profit after tax divided by ordinary shares
Market value of shares divided by EPS
Profit after tax divided by dividends

Profitability
Profit margin



This is the margin that the company makes on its sales,
and would be expected to remain reasonably constant.

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Profitability
Return on capital employed

— Measures

overall efficiency of company in employing
resources available to it

— Examine
— Change

year to year
— Comparison to similar entities
— Comparison with current market borrowing rates
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Profitability
Asset turnover

= times pa

It measures management’s efficiency in generati
ng revenue from the net assets at its disposal:


the higher, the more efficient
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Profitability
Relationship between ratios
ROCE can be subdivided into profit margin and asset turnover.

Profit margin
PBIT
––––––––––––
Sales revenue

× Asset turnover =
Sales revenue

×

––––––––––––

ROCE
PBIT

=

Capital employed

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

––––––––
Capital employed

Profitability
Return on equity



More restricted view of capital than ROCE, but same
principles

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios

There are two ratios used to measure overall
working capital:

• the current ratio
• the quick or acid test ratio.

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios

Liquidity and working capital ratios
Current ratio



The current ratio measures the adequacy of current a
ssets to meet the liabilities as they fall due.

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios
Quick ratio




Eliminates illiquid and subjectively valued inventory
Could be high if overtrading with rec’bles, but no
cash

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios
Inventory Turnover
Cost of sales
Inventory turnover is defined as: –––––––––––– = time
Inventory

An alternative is to express the inventory turnover as so
many days

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios

Inventory turnover period

— Higher

the better? But remember:
— Lead times
— Seasonal fluctuations in orders
— Alternative uses of warehouse space
— Bulk buying discounts
— Likelihood of inventory perishing or becoming
obsolete
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios
A/cs receivable collection period



Consistent with quick/current ratio? If not,
investigate.

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Liquidity and working capital ratios
Accounts payable payment period



Use cost of sales if purchases not disclosed



This represents the credit period taken by the
company from its suppliers

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Long term financial stability

The main points to consider when assessin
g the longer-term financial position are:
1.

gearing

2.

overtrading

Gearing ratios indicate:
• the degree of risk attached to the company and
•the sensitivity of earnings and dividends to changes in profit

ability and activity level

Measuring gearing
There are two methods commonly used to express gea
ring as follows.
Debt/equity ratio:
Loans + Preference share capital
––––––––––––––––––––––––––––––––––––––––
Ordinary share capital + Reserves + Non
controlling interest

Percentage of capital employed represented by borrowi
ngs:
Loans + Preference share capital
–––––––––––––––––––––––––––––––––––––––––
Ordinary share capital + Reserves + Non
controlling interest + Loans + Preference share capital
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Long term financial stability
Interest cover



Company must generate enough profit to cover
interest

FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

Long term financial stability

Overtrading:
Overtrading arises where a company expands its s
ales revenue fairly rapidly without securing additio
nal long-term capital adequate for its needs.

Activity: Classwork Assignment

Investors’ ratios
Introduction
Earnings per share (EPS) is widely regarded as the most
important indicator of a company’s performance. It is im
portant that users of the financial statements:
1. are able to compare the EPS of different entities and
2. are able to compare the EPS of the same entity in dif
ferent accounting periods.
Basic EPS
The basic EPS calculation is simply:

Earnings
–––––––––
Shares

Investors’ ratios-Test your understanding


Gerard's earnings for the year ended 31 December
20X4 are $2,208,000. On 1 January 20X4, the issued
share capital of Gerard was 9,200,000 6% preferenc
e shares of $1 each and 8,280,000 ordinary shares o
f $1 each. The company issued 3,312,000 shares at fu
ll market value on 30 June 20X4.



Calculate the EPS for Gerard for 20X4

Investors’ ratios

Activity:

Limitations of ratio analysis
Limitations
 Comparative information is not always
available.
 They sometimes use out of date information.
 Interpretation requires thought and analysis.
Ratios should not be considered in isolation.
 The exercise is subjective, for example not all
companies use the same accounting policies.
 Ratios are not defined in standard form.
FIA FFA ACCA PAPER F3 FINANCIAL ACCOUNTING

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