Financial Statement Analysis

Analysis of Financial Statements

• Financial statements provide valuable insight into a company's financial health.
• Accounting standards dictate the format of financial disclosures, which may not be the most useful for financial statement analysis.
• Ratios are used to present financial data in a simple format that enables comparison across time, industries, and businesses.
• Examining the meaningful relationships between items in financial statements involves computing a ratio.
• An overview of major financial ratios are provided with formulas and examples.

Requirements for Ratios

• Comparisons must be logical and meaningful to be effective, using useful data.
• Ratios must reflect the true financial performance of the company.
• Calculations should only include amounts from normal operations, excluding one-time events.
• Ratios must be calculated consistently to ensure comparability over time and across different entities.
• It is important to consider when calculating and comparing ratios whether a company changes it's accounting policies.

Norms of Comparison

• Ratios should be used in relation to other ratios.
• Viability of a company's position can be determined by comparing the ratio with other ratios.
• Major norms of comparison are considered conventions, time comparisons, and industry standards.

Conventions

• Ratio values have certain conventions, like a current ratio of 2 typically signaling an acceptable level.
• These conventions can vary based on industry.

Comparison Over Time

• Financial performance can be investigated over a period of time through ratios.
• The financial situation can be determined to be improved or deteriorated by investigating ratios over time.
• Trends in ratio values can be determined by accounting for the annual values.

Industry Norms

• Ratios can be interpreted by comparing similar companies operating in the same industry.
• A company's competitive position can be determined relative to competitors.
• Determining a company's position within an industry involves using industry averages.

Types of Ratios

• Ratios are classified by the characteristics they investigate:
  • Profitability
  • Liquidity
  • Solvency
  • Investment

Nutra LTD Information

• Average values are used to properly calculate the ratio and ensure accurate comparison.
• Net revenues have two parts; cash, and credit.
• There were credit purchases.
• Total rent was paid.
• Market has a share price.
• Financial year consists of 360 days.

Profitability

• Profitability assess how well a business uses its capital to produce revenue.
• It's important to make sure there is a clear link between a capital item and the related revenue or profit number.
• The more efficiently a business uses capital, the higher the return on its capital item.

Profitability Return Ratios

Return on Total Assets

• How efficiently the total assets of a business are being used to generate income is measured by the returns on total assets.
• Formula: (Operating profit + Investment income) / Average total assets
• A higher return on total assets is more efficient.
• Improvements in the efficacy with which assets are being used are indicated by comparing the values of the ratio over time.
• Either the income or the amount of assets must be improved in order to raise the return on total assets, or any profitability ratio.

Profitability In Broader and Narrower Sense

• When comparing the return on total assets ratio, a distinction can be made between numbers calculated in the broader or narrower sense.
  • Broader: all investments and assets are taken into consideration.
  • Narrower: only incomes generated by assets utilized are taken into account.

Return on Equity

• Equity consists of ordinary share capital plus preference shares and the non-controlling interest.
• Equity is the own capital contributed by the owners of the company.
• The compensation to debt capital providers(finance costs) are excluded when calculating the return on equity.
• Operating profit + Investment income - Finance costs / Average equity = Return on equity

Return on Shareholders' Equity

• How much profit was created from the shareholders' equity invested in the firm is shown by the return on shareholders' equity.
• Any company's primary goal should be to increase shareholder value.
• The ratio is calculated by comparing the earnings attributable to all owners to the capital they have invested.

Return on Ordinary Shareholders' Equity

• This ratio measures the returns garnered on the equity of ordinary shareholders. Ordinary share equity excludes preference shareholders.
• The preference dividends are subtracted during the computation of the ratio, similar to the non-controlling interest.

Cost of Debt

• The average cost connected with the debt capital utilized by the corporation is calculated as the cost of debt.
• All interest-bearing borrowings make up the debt capital.
• Deferred tax liabilities and retirement obligation benefit do not form of the debt capital.
• All interest paid on the debt capital is included in the finance cost.
• Finance cost / Average debt capital = Cost of debt.

Return on Financial Assets

• The average return made on the external assets of the business is shown by the return on financial assets.
• All investments, including share and debenture investments, are included in the financial assets.

Financial Leverage Factor

• Impact of debt capital usage on return on equity is referred to as financial leverage.
• Effective debt capital use can lead to higher shareholder returns.
• Inefficient debt capital use can negatively affect return on equity.
• The operation of financial leverage is determined by calculating the financial leverage factor.
• Companies must determine whether there is positive, negative, or no financial leverage.
• Additional debt capital decisions can be made by analyzing the financial leverage factor.
• Return on Equity / Return on Total Assets = Financial leverage factor.
• Positive financial leverage occurs when the financial leverage factor is greater than one.

Profit Margins

• Profit margins show how much of the revenue turns into profit after all deductions.

Gross Profit Margin

• The amount of revenue that is accrued as gross profit is indicated by the gross profit margin.
• (Gross profit / Revenue) * 100 = Gross profit margin.

Markup Percentage

• The selling price of the product is estimated relative to its cost using the markup percentage.
• (Gross profit / Cost of sales) * 100 = Markup percentage.

Operating Profit Margin

• The operating profit margin is the amount of revenue that is still profit after accounting for all regular operating costs.
• Operating profit margin = (Operating profit/Revenue) * 100

EBIT Margin

• The profit margin shows the profit realized before considering any finance costs or taxes.
• EBIT -margin = Profit before tax + Finance cost / Revenue * 100

Net Profit Margin

• The net profit margin indicates which part of revenue is available to the enterprise's shareholders.
• Net profit margin = Profit after tax / Revenue * 100

Turnover Ratios

• Turnover ratios indicate the rate at which an investment in assets turns into revenue.
• Higher values indicate more revenue generation per year, benefiting the enterprise.

Total Assets

• Total asset turnover ratio = Revenue / Average total assets
• How well a company uses its total assets to generate revenue is indicated by the total asset turnover ratio.

Current Assets

• Calculation of current assets turnover ratio = Revenue / Average current assets
• The amount of times each year that current assets are turned into revenue is indicated by the turnover ratio.

Inventory

• Formula = Cost of sales/ Average inventory
• Focuses on the investment in inventory

Trade Receivables

• An investigation into the amount of instances per year that a company's trade receivables are turned into credit revenue.
• Credit revenue / Average trade receivables

Liquidity

• Liquidity is the ability of an enterprise to honour short-term obligations.
• Sufficient liquidity is achieved when enough current assets are available to cover current liabilities.

Current Ratio

• Current assets/ Current liabilities
• If a company maintains acceptable levels of liquidity, the value of this ratio should be more or less equal to 2.

Acid Test (Quick Ratio)

• (Current assets- Inventory -prepayments) / current liabilities
• Focuses on the company's current liabilities.

Cash Ratio

• Formula = Cash and cash equivalents / Current liabilities
• The focus is placed on cash and cash equivalents.

Turnover Times

• A component that is important when evaluating a company's liquidity is the turnover time of its current assets and current liabilities.

Turnover Time of Trade Receivables

• Monitors the average period of time needed in order to transform trade receivables into earnings from credit.
• Average trade receivables/ Credit revenue * 360/1

Turnover Time of Inventory

• Calculates the average amount of time it takes to convert inventory investments into revenue.
• Average inventory/ Cost of sales * 360/1

Turnover Time of Trade Payable

• The ratio indicates the average period of time that it takes before the trade payables are repaid.
• Average trade payables/ Credit purchases * 360/1

Solvency

• Solvency refers to an enterprise's ability to cover all its obligations when it eventually closes down its operating activities.
• The comparison between the total assets and the total debt capital is of great importance.

Debt-To-Assets Ratio (Debt Ratio)

• Debt/ Total assets * 100/1
• The relationship between the debt capital and the total assets provides an indication of the portion of the total capital requirement that is being financed by debt capital.

Debt-To-Equity Ratio

• Debt capital / Equity capital * 100/1
• Place the debt capital in direct relation to equity.

Coverage Ratios

• Another aspect that needs to be considered when evaluating the solvency of a company is its ability to meet certain obligations.

Finance Cost Coverage

• Profit before finance cost and tax / Finance cost
• The finance cost coverage indicates if sufficient profits are available to pay the finance cost.

Fixed Obligation Coverage

• Profit before tax + finance cost + rent paid / Finance cost + rent paid + Capital redemption / (1-t)
• Fixed obligations consist of finance cost, the rent paid, and capital redemption.

Preference Dividend Coverage

• Determines if sufficient earnings are available to pay the preference dividends.
• Profit after tax- non-controlling interest/ Preference dividend

Ordinary Dividend Coverage

• The ordinary shareholders have the last claim on the earnings of an enterprise.
• Profit after tax - non-controlling interest - PS div/ Ordinary dividend

Investment Ratios

• The following group of ratios is of great importance to the current and potential shareholders of an enterprise.

Earnings Per Share

• An indication of the attributable earnings that was earned per ordinary share during the year.
• Profit after tax - non-controlling interest - PS div/ Average number of issued ordinary shares

Earnings-Yield

• Compares the EPS with the market price per share.
• EPS/ Market price per share * 100/1

Dividend Per Share

• Indicates what amount investors received per share in the form of dividends.
• Ordinary dividends declared/ Average number of issued ordinary shares

Dividend-Yield

• Compares the market value of the share with the dividend per share received.
• Provides an indication of the percentage return earned on the investment in the form of dividends.
• Dividend per share/ Market price per share * 100/1

Dividend payout Ratio

• This ratio indicates the percentage of the attributable earnings that is paid out as dividends.
• Ordinary dividends declared/ Attributable earnings * 100/1

Price-Earnings Ratio

• Indicates how many Rands investors are prepared to pay for each R1 earnings per share that is earned by the company.
• Market price per ordinary share/ Earnings per share

Market-To-Book Value

• Is predominantly utilized to gauge how investors in the market perceive a company's share value.
• Market capitalisation of ordinary shares/ Book value of ordinary shares

Net Tangible Asset Value Per Ordinary Share

• Calculates the statement of financial position value of the ordinary share if all debt capital is redeemed.
• Ordinary shareholders' equity - Intangible assets/ Number of issued ordinary shares