CHAPTER 2 :
FINANCIAL STATEMENT
ANALYSIS
INTRODUCTION

Financial statements can be used to measure the company financial performances.

Financial performance is not limited to company profit, but it also cover to asset and liability performance,
cash liquidity and more.

Financial statements consist of:
1.
Statements of Comprehensive Income (SOCI)
2.
Statements of Financial Position (SFP)
3.
Cash Flow Statement
OBJECTIVES

Technique for analyzing the financial statements. A process of expressing financial data
into standardized terms.

Objectives of financial ratios analysis :
i.
Better understanding of business activities and performance.
ii.
Simplify accounting information.
iii.
Assess the operating efficiency of the business.
iv.
Help in comparative analysis such as inter-firm and intra-firm comparisons.
IMPORTANCE OF RATIO
Helpful in assessing operating efficiency of the business
a.
o
Helpful in measuring financial solvency.
b.
o
c.
Rod of efficiency. The evaluation of changes during different period can be performed.
Suitable tools for evaluating the liquidity and solvency position of a concern.
Helpful in decision making
o The
information provided by ratio analysis is very useful for making decision on any
financial activity.
IMPORTANCE OF RATIO
Helpful in communication
d.
Different financial ratios communicate the strength and financial standing of the firm to the
internal and external parties.
o
Helpful in future forecasting.
e.
o
Calculation of past years works guide line for the future.
Helpful in comparing inter firm performance.
f.
Ratio analysis also serves as a stepping stone to remedial measures. It helps management
evolving future 'market strategies‘.
o
APPROACH IN RATIO ANALYSIS
a.
Trend Analysis / Time Series Analysis

b.
Comparison of financial performance of the company based on ratios of the current
year with the previous years.
Comparative Analysis / Cross Sectional Analysis

Firm can evaluate their financial performance by comparing ratios with other
companies in the same industry using industry average ratios.
Ratios can be classified into five areas :
TYPES OF
RATIO
ANALYSIS
a.
Profitability – This ratio indicate business
success in generating profit.
b.
Activity – measures the efficiency company
managed short term assets and liabilities.
c.
Liquidity – measures company’s ability to meet
its financial obligations when it due.
d.
Leverage – measures how a company is financed
with respect debt and equity as well to evaluate
financial risk.
e.
Investor – Common use to valuing target
company in takeover, analyzing dividend policy
and investor return.

Gross profit margin
Gross Profit
X 100
Sales

PROFITABILITY
RATIO
Operating profit margin
Operating Profit
Sales
X 100
 Net Profit Margin
Profit after tax
Sales
X 100
PROFITABILITY
RATIO

Return on Capital Employed
Profit before tax and interest
X 100
Capital employed

Return On Asset (ROA)
Profit after tax
Total Assets
X 100
 Return on Equity
Net Profit – preferred shares dividends
Common Equity
X 100
 Trade Receivables days =
Debtor
X 365
COGS
ACTIVITIY
RATIO
 Trade Payables Days = Creditor
COGS
 Inventory Turnover =
Inventory
COGS
X 365
X 365
 Cash Conversion Cycle
= Trade receivable days + Inventory turnover – Trade
payables days
Sales
 Sales/net working capital =
Current Assets
ACTIVITIY
RATIO
 Fixed Asset Turnover =
Sales
Fixed Assets

Current ratio
Current Asset
Current Liabilities
LIQUIDITY
RATIO

Quick or acid test ratio
Current Assets - Inventories
Current Liabilities

Debt-to-equity ratio
Total Liabilities
Total Equity
LEVERAGE
RATIO

Debt-to-capital ratio
Total Liabilities
Total Debt + Equity
 Times
interest earned (TIE)
Earnings before interest and tax (EBIT)
Interest Expenses
 Earning per share (EPS)
Net Profit for common shareholders
Number of common shares outstanding
VALUATION
RATIO
 Price per earnings ratio (P/E ratio)
Price per share
Common Equity
LIMITATION OF RATIO ANALYSIS
1.
Ratio only concern on number that appears in financial statement (quantitative data). It
omits other factors such as policies, competition, natural disaster and so on.
2.
Ratio only use financial data. Price and value might be changes due to factors of
economic situation, demand and supply etc.
3.
Complexity in accounting, thus, proper presentation are needed so easy to explain