financial statement analysis

							   Rhys Johnson
   Head of Education
     Asia Pacific

rhys.johnson@sg.accaglobal.com
Analysis and
Interpretation of
Financial Statements
Financial statement analysis
in perspective

• Financial statement analysis is only a
  toolkit within a broader objective of
  company analysis

• First of all, need to determine the
  objective of company analysis

• To do a proper company analysis, we
  need to understand the business
Understanding the business
• The way a company performed is
  a result of two factors:
   – the economic and industry
                                        Macroeconomic
     environment in which the company      analysis
     operates; and
                                          Industry
   – the company’s own financial          analysis
     characteristics
                                          Analysis
                                          of asset
• Understanding the business
  involves financial statement
  analysis combined with an
  evaluation of industry prospects,
  competitive position and corporate
  strategies
Importance of industry prospects

• Industry attractiveness indicates the likely
  average profitability of firms in the
  industry

• Industry analysis is important because a
  bad company in a good industry has
  more upside potential than a good
  company in a bad industry
 Use of financial statement analysis
Analyse a single company                  Comparison of companies
• Mainly interested in financial health   • Comparison of competitors in
  and performance                           the same industry
                                             – Could use ratios to analyze
• Analyse balance sheet                        relative performance and
    – Level of debt                            financial attractiveness
    – Level of short-term liquidity
• Analyse P&L Account                     • Comparison of companies in
    – Profitability                         different industries
    – Ability to service debt cost           –   Depends on objectives
                                             –   Balance sheet focus
• Using both
                                             –   P&L focus
    – Assess efficiency in utilising
                                             –   Analyze using actual numbers
      resources
                                             –   Careful when using ratios as
    – Assess return on investment eg             companies may not be
      ROE                                        comparable
• Common analytical tool – ratios
Types of ratios
• Short-term liquidity ratios

• Finance ratios

• Performance ratios

• Investor ratios

• Ratios for credit analysis
Short-term liquidity ratios
• Current and quick ratios
  – measures of short term liquidity
  – indicate extent to which current assets can pay off
    current liabilities

                             Current assets
             Current ratio =
                           Current liabilities

                       Current assets – Stocks
         Quick ratio =
                        Current liabilities
Finance ratios
• Balance Sheet: gearing of a          Debt
  company                             Equity

• High levels will require high interest
  payments and will put pressure on
  the earnings for shareholders

• Ability to pay interest:
                   Profit before interest and tax
  Coverage ratio 
                          Interest expense
Performance ratios
• Management and shareholders are interested
  in the performance of the company


• Profit and Loss Account is a dynamic
  statement showing performance over the past
  year


• It is therefore used to generate a number of
  performance metrics
Performance ratios –
Profit margins
• An indicator of the profitability of the business

• Can be calculated on a gross and net or
  operating basis

• Look at profitability on a segmental basis
  (if available) – by product or geography
Performance ratios –
Profit margins
• Gross profit margin
                          Net Profits
                          Gross Profit
      Net profit margin 
      Gross Profit Margin              x 100
                            Sales

• Operating profit margin

                          Operating Profits
Operating profit margin                    x 100
                               Sales
Performance ratios –
return on capital employed
(ROCE)


       Profit before interest & tax
ROCE                               x 100
            Capital employed
Interlocking ratios

        Profit before interest & tax
 ROCE                               x 100
             Capital employed



Profit before interest & tax               Sales
                             x 100                    x 100
           Sales                     Capital employed
Investor ratios
• A number of ratios are used to assess
  the market performance of a company

• They are used to try and identify
  investment opportunities
Typical ratios
                            Dividend
• Dividend yield   =
                           Market price


                            Price per share
• Price earnings   =
                                 EPS
  ratio
                            Price per share
                       =
                            Sales per share
• Price to sales
                           Price per share
                   =
                           Book value per share
• Price to book
  value
Ratios for credit analysis
• Profitability ratios
   – Eg: ROE, asset turnover, profit margin


• Debt and coverage ratios
   – Short-term liquidity ratios: eg current ratio
   – Finance ratios
   – Coverage ratios: eg EBITDA interest coverage,
     CFO/Total debt ratio
Ratios used in credit rating –
Example

 S&P’s financial ratios across ratings for industrial corporations


Rating                    Leverage                     Cash flows
         Total debt/Capital   LT debt/Capital   EBIDTA/Interest   EBIT/Interest

AAA            31.8               21.4              18.7                 12.9
AA             37.0               29.3              14.0                   9.2
A              39.2               33.3              10.0                   7.2
BBB            46.4               40.8               6.3                   4.1
BB             58.5               55.3               3.9                   2.5
B              71.4               68.8               2.3                   1.2
Limitations of ratio analysis

• Dependent on the accounting policies
  adopted

• Financial statements reflect activities
  which can be expressed in money terms

• Financial statements reflect historical
  information
CASE STUDIES
          ACCA
        membership




Exams     Ethics     Experience
Financial Reporting

     FUNDAMENTALS           PROFESSIONAL

Knowledge   Skills   Essentials    Options
F1          F4       P1            P4
F2          F5       P2            P5
F3          F6       P3            P6
            F7                     P7
            F8
            F9