ACCT10001 Lecture Notes - Lecture 7: Financial Analysis, Trend Analysis, Financial Statement
12 May 2018
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Accounting Week 7
8.1 USERS AND DECISION MAKING
Profitability: A etits pefoae pofit duig the epotig peiod easued i
relative terms
• Financial statements are employed by a range of users making a variety of decisions
• Purpose of financial statements is to provide information useful for decision making
• Financial analysis is an analytical tool that involves expressing the reported financial
numbers in relative terms
• Fiaial aalsis helps stateet uses to ealuate a etits past decisions and
fo a opiio as to the etits futue fiaial health
8.2 NATURE AND PURPOSE OF FINANCIAL ANALYSIS
• Analysis involves expressing reported numbers in financial statements in relative
terms
• Absolute values in statements not meaningful whe tig to ealuate a etits
past decisions and predict future rewards and risk
• There is a need to express reported numbers in relation to other numbers in order to
properly compare between periods/companies/etc
• Typically involves comparing figures to:
o Equivalent figures from previous years
o Other figures in financial statements
• Process of comparison can be categorised as horizontal analysis, trend analysis,
vertical analyses and ratio analysis
8.3 ANALYTICAL METHODS
Horizontal analysis: Analysing a series of financial statement data over a period of time
• Financial statements usually presented in two columns to compare current with
previous reporting period
• Horizontal analysis compares numbers in statements horizontally
Dollar change is calculated as: uet peiods ue less peious peiods ue
Percentage change is calculated as
Cuet peiods ue less peious peiods ue/Peious peiods ue
Trend analysis: Method of examining changes, movements and patterns in data over a
number of time periods
• Tries to predict future direction of various items on the basis of the direction of
items in past
• At least three years of data required to calculate a trend
• Trend figures can be graphed visually to depict direction and magnitude of financial
items
• Trend analysis of a particular item involves expressing item in subsequent years
relative to a selected base year. The base year is typically given a value of 100
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Vertical analysis: Analysing financial statement data by expressing each item in a financial
statement as a percentage of a base amount
• Compares item to another item in in the same financial statement
• Whe epessed this a, fiaial stateets ae ofte efeed to as oo
size stateets
• When performing vertical analysis on the P/L Statement, the anchor point is the
revenue figure and every item in the P/L Statement is expressed as a percentage of
the income item
• When performing vertical analysis on balance sheet, anchor point is Total Assets and
every item in BS is expressed as percentage of Total Asset figure
Ratio analysis: An examination of the relationship between two quantitative amounts with
the objective of expressing the relationship in ratio or percentage form
• Compares on item in statements with another item in financial statements, with aim
of expressing a relationship between two relevant items that is easy to interpret
• Comparison between statements not always straightforward because P/L and CS
Statement involve Flow Items while BS report Stock Items
• Whe alulatig atios iolig opaiso of a stok ad flo ite, the
aeage of stok ite ite duig the ea is ofte used istead of ed of ea
figure
Flow items: Item in the financial statements that is generated over a period of time
Stock items: Item in the financial statements as at a point in time
Ratio Analysis 3-Step Process
1. Calculate a meaningful ratio by expressing the dollar amount of an item in a financial
statement by the dollar amount of another item in a financial statement
2. Compare the ratio with a benchmark
3. Interpret the ratio and seek to explain why it differs from previous years, from
comparative entities or from industry averages
Types of Ratios
Profitability ratios: Measure of the profit relative to the resources available to generate the
profit
Efficiency Ratios: Measure of sales generated per dollar invested in assets
Liquidity Ratios: Measure of the short-term ability of the entity to pay its maturing
obligations and to meet unexpected needs for cash
Capital Structure Ratios
Market Performance Ratios/Market Test Ratios: ‘atios that geeall elate the etits
fiaial ues to the etits shae pie.
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Benchmarks
• A opaiso of the etits atios oe tie to idetif teds
• A comparison of the etits atios ith those of othe etities opeatig i the sae
industry, referred to as intra-industry analysis
• A opaiso of the etits atios ith the idust aeages
• A opaiso of the etits atios ith those of etities opeatig i different
industries or with the norms of other industries, referred to as inter-industry analysis
• A opaiso of the etits atios ith aita stadads
8.4 PROFITABILITY ANALYSIS
Return on equity (ROE): Profitability ratio measuring profit earned for each dollar invested
by the owners, calculated as profit available to owners divided by average equity
• Profit from P/L Statement, Equity from BS
• Exclude dividends
• Indicates annual return (in cents) that the entity is generating for owners for each
dolla of oes fuds iested i the etit
• Assessed by comparing to returns on alternative investment opportunities avail.
• ‘eflets etits pofitailit, effiie ad apital stutue
ROE: (Profit Available to Owners / Avg. Equity) x 100 = x%
Return on assets (ROA): Profitability ratio calculated as profit divided by average total
assets
• ‘eflet esults of etits ailit to oet sales eeue ito pofit ad ailit to
generate income from its asset investment
• Change in ROA can be explained by chages i etits pofitailit ad asset
efficiency
ROA: (Profit (Loss) / Avg. Total Assets) x 100 = x%
Profit Margin Ratios
• Ratios that relate profit to sales revenue
Gross profit margin (GPM): Profitability ratio calculated as gross profit divided by sales
revenue
• Reflect proportion of sales revenue that results in gross profit
• ‘eflets goss pofit i ets pe dolla of sales eeue ad eflets a etits
pricing strategy
• Not possible to specify desirable GPM: Gross profit is interrelated with sales volume
GPM: (Gross Profit / Sales Revenue) x 100 = x%
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Document Summary
Horizontal analysis: analysing a series of financial statement data over a period of time: financial statements usually presented in two columns to compare current with previous reporting period, horizontal analysis compares numbers in statements horizontally. Dollar change is calculated as: (cid:272)u(cid:396)(cid:396)e(cid:374)t pe(cid:396)iod(cid:859)s (cid:374)u(cid:373)(cid:271)e(cid:396) less p(cid:396)e(cid:448)ious pe(cid:396)iod(cid:859)s (cid:374)u(cid:373)(cid:271)e(cid:396) Percentage change is calculated as (cid:894)cu(cid:396)(cid:396)e(cid:374)t pe(cid:396)iod(cid:859)s (cid:374)u(cid:373)(cid:271)e(cid:396) less p(cid:396)e(cid:448)ious pe(cid:396)iod(cid:859)s (cid:374)u(cid:373)(cid:271)e(cid:396)/p(cid:396)e(cid:448)ious pe(cid:396)iod(cid:859)s (cid:374)u(cid:373)(cid:271)e(cid:396)(cid:895) (cid:454) (cid:1005)(cid:1004)(cid:1004) The base year is typically given a value of 100. Statement involve flow items while bs report stock items: whe(cid:374) (cid:272)al(cid:272)ulati(cid:374)g (cid:396)atios i(cid:374)(cid:448)ol(cid:448)i(cid:374)g (cid:272)o(cid:373)pa(cid:396)iso(cid:374) of a (cid:858)sto(cid:272)k(cid:859) a(cid:374)d (cid:858)flo(cid:449)(cid:859) ite(cid:373), the a(cid:448)e(cid:396)age of (cid:858)sto(cid:272)k(cid:859) ite(cid:373) ite(cid:373) du(cid:396)i(cid:374)g the (cid:455)ea(cid:396) is ofte(cid:374) used i(cid:374)stead of e(cid:374)d of (cid:455)ea(cid:396) figure. Flow items: item in the financial statements that is generated over a period of time. Stock items: item in the financial statements as at a point in time. Profitability ratios: measure of the profit relative to the resources available to generate the profit.
