Analysis of Financial Performance and Position

Question 1

Gartner Data Analytics Maturity Model - 4 step approach.

Answer 1

Descriptive - What happened?
Diagnostic - Why it happened?
Predictive - What is going to happen?
Prescriptive - How can we make/prevent it happening?

Question 2

Key areas to consider when analysing financial statements

Answer 2

1. Identify the users of the analysis.
   
   • Present/Potential investors
   • Present/potential lenders
   • Suppliers and other creditors
   • Employees
   • Customers
   • Government agencies
   • General public
2. Understand the nature of the business, industry and organisation.
   
   • Looking beyond the numbers to provide narrative insight into the performance and position of the entity. Using in conjunction with if available.
   • Understanding the products, services and operating characteristics of the specific entity, will aid in understanding data such as revenue, profitability, inventories, and working capital.
   • If analysis requires comparison of the entity with the industry norms, it is important to identify key characteristics of the industry and to establish benchmarks such as gross profit ratios, receivables collection days etc.
3. Identify relevant sources of data for analysis
   
   • The analyst needs to carefully consider the possible sources of information available, starting with the annual report.
   • The annual report may include voluntary disclosures that will be useful to the analyst. such as:
     - Environmental impact
     - Employment reports
     - Graphs
     - Pie Charts
     - Ratio Calculations
4. Numerical analysis of the data available
   
   • Financial statements can be used to analyse:
     - Performance - profitability in the year, SOPL
     - Position - Ownership of assets and obligations, SOFP
     - Adaptability - Ability to take advantage of opportunities, [cash positions, working capital structure and profitability]
     - Prospects - predicted success of investments and projects, [profits, cash flows, asset base and financing structure]
5. Interpretation of the results of the analysis.

Question 3

Ratio Analysis

Answer 3

Fall into four broad categories:

1. Profitability/performance ratios
   
   • Gross profit margin, operating profit margin, net profit margin.
   • return on capital employed (ROCE)
2. Liquidity ratios
   
   • Current ratio, quick (acid test) ratio
3. Efficiency/activity ratios
   
   • Working capital ratios
   • Asset turnover ratios
4. Capital structure ratios
   
   • Gearing
   • Interest cover

Question 4

Ratios for profitability and performance

Answer 4

Gross profit / sales * 100
GP = Sales - CoS

Gross profit margin is the percentage of revenue that is retained after costs of sale are deducted. Changes in gross profit may be due to a change in the product mix, for instance selling more of a product with a higher profit margin or conversely bringing in a new product with a lower margin to gain market share.

Operating profit / sales * 100
Op Profit = PBIT (Profit Before Interest and Tax)

Operating profit margin is the trading profit in relation to revenue, or GP less Opex. Operating margin is expected to decline compared to prior years however changes in this ration could indicate:
- Increase/decrease in administration costs (revaluations)
- Restructure resulting in redundancy payments (Admin costs)
OP% is useful when used in conjunction with GP%
as, if OP% performs in a similar fashion to GP% then whatever causes the momvent in GP% will be the driving force begind the OP% movements. If not then further investigation is required.

ROCE (Return On Capital Employed)
Operating Profit / Capital Employed * 100
Capital Employed = Equity + Liabilities

ROCE shows he overall performance of the entity as a percentage return on the total investment and measures the managements ability to generate profits with the resources available.

Question 5

Liquidity ratios

Answer 5

Current Ratio
Current Assets / Current Liabilities

Quick (Acid test) Ratio
(Current Assets - Inventory) / Current Liabilities

Question 6

Efficiency and activity ratios

Answer 6

Working Capital Ratios - Working capital cycle

Inventory holding period (days) - Inventory/CoS *365
Receivables collection period - Receivables/Revenue *365
Payables payment period - Trade Payables/CoS *365

Inventory + Receivables - Payables = Working Capital Cycle

Asset Turnover
Revenue / Capital Employed

This calculation shows how much revenue is produced per unit of capital invested and therefore shows the productivity of assets in generating sales.

Question 7

Capital Structure ratios

Answer 7

Gearing - 2 methods

1. as n:1 ratio - Debt/Equity
2. as % - Debt/(Debt+Equity) *100

Gearing is a measure of risk, by analysing the proportion of capital that is driven by debt. The higher this ratio the greater the risk, as payments to debt financers are a legal obligation whereas dividends are discretionary and therefore lower risk when the entity needs to hold on to cash.

Interest Cover (# times covered)
Operating Profit /Finance Costs
Finance cost = proceeds of loan * rate of interest

The number of times the operating profit is able to cover the cost of finance.

Average rate of borrowing %
Finance costs/Borrowings (NCL and CL)

The average cost of borrowings.

Dividend cover (# times covered)
Profit for the year/Dividend