Lecture 7/8: Financial Statement Analysis

Question 1

Absolute change

Answer 1

Amount in current period - amount in previous period

Question 2

Relative change

Answer 2

[(Amount in current period - amount in previous)/amount in previous] x100

Question 3

Horizontal analysis

Answer 3

1. Absolute change year to year
2. Relative change (%) year to year

Question 4

Vertical analysis

Answer 4

Compare to a base within the same statement
=next line item/base item
the base item is usually the larges line item

Question 5

Trend analysis

Answer 5

Index the base year (earliest year) as 100 and then then do next year/indexed year value x100 to get the next indexed value

Question 6

Ratio analysis

Answer 6

[One line item/other line item]*100

Question 7

Return on equity (ROE)

Answer 7

Tells how well the entity is generating profits relative to the amount of equity invested by shareholders.
[Profit available for distribution/average ordinary equity]*100

Question 8

Return on assets (ROA)

Answer 8

Ability of a business to use its assets to generate a return
= EBIT/Average Total Assets

Question 9

Gross profit margin

Answer 9

= gross profit/sales revenue*100

Question 10

EBIT profit margin

Answer 10

The rate at which sales revenue is converted into profit
= EBIT/sales revenue*100

Question 11

Expense ratio

Answer 11

The extent to which sales revenue is consumed by one particular expense or one cost centre
= ()expense/sales revenue*100 - can be conducted for any expense occuring in the statement

Question 12

Cash flow to sales ratio

Answer 12

The rate at which sales revenue generates operating cash flow
= Net operating cash flows/sales revenue

Question 13

Asset turnover

Answer 13

Indicates how well a business can generate sales revenue from assets
= Sales revenue/average total assets

Question 14

Inventory turnover/days inventory

Answer 14

Average number of days inventory is held
= average inventory/cost of sales *365

Question 15

Days sales outstanding

Answer 15

= Average trade receivables / sales revenue

Question 16

Days purchases outstanding

Answer 16

= average trade payables / (cost of sales + net increase in inventory)

Question 17

Current ratio or working capital ratio

Answer 17

number of times over current assets could meet current liabilities
= CA/CL

Question 18

Quick ration or acid test ratio test

Answer 18

Number of times quick assets could service CL
= (cash + receivables)/(CL - overdrafts)

Question 19

Cash flow ratio

Answer 19

The amount of cash flow available in a period to service CL
= Net operating cash flows / CL

Question 20

Debt ratio

Answer 20

The extent to which the entity has used debt to finance their investment in assets (60% is considered high)
= total liabilities/total assets

Question 21

Equity ratio

Answer 21

= 100% - debt ratio

Question 22

Debt to equity ratio

Answer 22

= Debt ratio/equity ratio

Question 23

Interest coverage ratio

Answer 23

=EBIT/finance costs
finance costs = interest expense - interest revenue

Question 24

Average interest rate

Answer 24

= finance costs x average interest bearing liabilites

Question 25

Debt coverage ratio

Answer 25

= Non-current liabilities/net operating cash flows
(cash flows generated from operations)

Question 26

Net tangible asset backing per share (NTAB)

Answer 26

Question 27

Earnings per share (EPS) / Diluted EPS

Answer 27

Profit avail to ordinary shareholder / WAVE no. of ordinary shares on issue **OR **

Question 28

Dividend payout ratio

Answer 28

Question 29

Price Earnings Ratio (P/E Ratio or PER)

Answer 29

Question 30

Limitations of financial statement analysis

Answer 30

• Agency issues - choices, estimations and judgements thar apply to figures in the analysis which may skew the ratios
• Disclosure - issues relating to what is disclosed and in what levels
• Timing - of access of information - may be outdated by the time the reports are released
• Change in accounting standards and policies over time