Chapter 19 Analysis and interpretation of financial statements PowerPoint presentation by Anne Abraham University of Wollongong 2009 John Wiley & Sons Australia, Ltd SOURCES OF FINANCIAL INFORMATION Financial statements Accompanying schedules Explanatory notes Financial advisory services Australian Stock Exchange (ASX) Dun & Bradstreet Stockbroking firms 2 In what ways can the performance of a business be assessed? 3 1
THE NEED FOR ANALYTICAL TECHNIQUES Information usually expressed in monetary terms Limited usefulness on its own Percentage and analysis Identifies relationships among data Reduces data to an understandable basis Used to forecast performance 4 PERCENTAGE ANALYSIS Horizontal analysis Uses preceding years financial statements Focuses on change from year to year Compare % changes rather than dollars 5 PERCENTAGE ANALYSIS Horizontal analysis example From 2011 to 2012 the cash at bank of Gordon Ltd increased by $30 000, from $740 000 to $770 000 The percentage change is calculated as follows: 30 000 % increase 740 000 x 100% 4.7% 6 2
PERCENTAGE ANALYSIS Trend analysis Needs 3 or more years Used to assess growth prospects Each year compared to base year 7 PERCENTAGE ANALYSIS Trend analysis example 2009 2010 2011 2012 2013 Revenue $1 000 000 $1 050 000 $1 120 000 $1 150 000 $1 220 000 Profit 200 000 206 000 218 000 222 000 232 000 2009 2010 2011 2012 2013 Revenue 100 105 112 115 122 Profit 100 103 109 111 116 8 PERCENTAGE ANALYSIS Vertical analysis Restates $ amount of each item as a % of a specified base item (e.g. sales or total assets) Also referred to as common size statements Useful to negate impact of entity size differences 9 3
RATIO ANALYSIS Profitability s Return on total assets Profit before income tax + Finance costs Average total costs Return on ordinary equity Profit Preference dividends Average ordinary equity Profit margin Profit (after income tax) Revenues 10 RATIO ANALYSIS Earnings per share Price-earnings Profit (after income tax) Preference dividends Weighted avg no. of ordinary shares issued Market price per ordinary share Earnings per ordinary share Earnings yield Earnings per ordinary share Market price per ordinary share 11 RATIO ANALYSIS Dividend yield Dividend payout Annual dividend per ordinary share Market price per ordinary share Total dividends to ordinary shareholders Profit preference dividends 12 4
RATIO ANALYSIS Liquidity s Current Current assets Current liabilities Quick or acid test Receivables turnover Inventory turnover Cash assets + Receivables Current liabilities Net sales revenue Average receivables balances Cost of sales Average inventory balance 13 RATIO ANALYSIS Financial stability s Debt Total liabilities Total assets Equity Total equity Total assets Capitalisation Total assets Total equity 14 RATIO ANALYSIS Times interest earned Profit before income tax + Finance costs expensed Finance costs expensed + Finance costs capitalised Asset turnover Revenues Average total assets 15 5
SOME IMPORTANT RELATIONSHIPS Return on total assets Profit margin x Asset turnover Profit x Revenues Revenues Avg total assets Return on ordinary equity Return on assets x Capitalisation (avgd) Profit margin x Asset turnover x Capitalisation Profit x Revenues x Avg total assets Revenues Avg total assets Total ordinary equity 16 ANALYSIS USING CASH FLOWS Cash sufficiency s Cash flow adequacy (Repayment of long-term borrowings + Assets required + Dividend paid) Repayment of long-term borrowings Repayment of long-term borrowings Dividend payment Dividends paid 17 ANALYSIS USING CASH FLOWS Reinvestment Purchase of property, plant and equipment Debt coverage Non-current liabilities 18 6
ANALYSIS USING CASH FLOWS Cash flow efficiency s Cash flow to revenues Revenues Opens index Profit Cash flow return on assets ( + income tax paid + interest paid) Average total assets 19 LIMITATIONS OF RATIO ANALYSIS Performed on historical data Historical cost used for measurement base Year-end data may not be representative Lack of disclosure in GPFR s One-off, non-recurring items Entities may not be comparable 20 CAPITAL MARKETS RESEARCH AND STATEMENT ANALYSIS This analysis assumes capital markets are inefficient However, research has shown that share markets are efficient in terms of incorporating all publicly available information into the share price of an entity This research encourages shareholders to diversify their portfolio of investments 21 7
22 8