The Analysis and Interpretation of Financial Statements
The Analysis and Interpretation of Financial Statements
The Analysis and Interpretation of Financial Statements
The result of dividing one financial statement item by another is called a financial
ratio. Ratios help analysts interpret financial statements by focussing on
specific relationships.
Analysing this data in order to help the user obtain relevant information is the
function of accounting ratios and ratio analysis.
Accounting ratios and ratio analysis is the key to analysing and interpreting financial
statements. They add life to a set of numbers in such a way that numbers reveal
those
details which even words would find difficult to reveal.
A. Profitability ratios
1. Gross profit Gross profit X 100 Reflects gross margin
margin Sales revenue made on sales
2. Operating Operating profit X 100
Reflects operating
profit margin Sales revenue margin
made on sales
3. Net profit Net profit (PBT) X 100 Reflects net margin
margin Sales revenue made
on sales
4. Return on Operating profit Reflects relationship
Capital Capital employed X between profits earned
employed 100 and
size of company
(measures
overall performance of
company)
5. Return on Operating profit X 100 Reflects relationship
assets Total assets between profits earned
and
total assets
B. Liquidity ratios
1. Current ratio Current assets Measures ability to pay
Current liabilities current liabilities from
the
current assets
2. Quick ratio Quick assets Indicates the ability to
Current liabilities pay
all current liabilities if
they
become due for
payment
immediately
C. Efficiency ratios
1. Asset Sales revenue Shows how much
turnover Total assets revenue
(times p.a) generated by a $1
worth of
assets
2. Inventory Cost of sales Indicates how many
turnover Inventory times
(times p.a) the inventory is being
turned over in a year
3. Receivable Receivable Reflects the number of
days Credit sales X 365 days it takes for a
days customer
to pay
4. Payable days Payables Reflects the number of
Credit purchases X days it takes for a
365 days company
to settle its bills
5. Working Inventory turnover Approximate number of
capital cycle days + days it takes to
Receivable days - purchase
Payable days the inventory, sell the
inventory and receive
cash.
D. Financial position
Ratios
1.Capital gearing ratio Total long - term debt It expresses the
Shareholders funds X relationship between a
100 company’s borrowings and
its own funds
2. Debt ratio Total liabilities Indicates the percentage of
Total assets assets financed with debt
3. Interest cover Profit before interest Indicates the number of
and tax times, the profit covers the
Interest expenses interest charge
E. Investment/shareholder ratios
1. Earnings per Net profit after interest and tax and preference
share (EPS) dividends
Number of ordinary shares issued
2. Price/earnings Market price per share
ratio (P/E) Earnings per share
3. Dividend yield Gross dividend per share
Market price per share
4. Dividend cover Net profit after tax and preference dividends
Ordinary dividends paid and proposed