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Analysis & Interpretation of Financial Statements

This document discusses various methods for analyzing financial statements, including profitability ratios, liquidity ratios, and rates of return. It defines key ratios like stock turnover, gross profit percentage, net profit percentage, current ratio, acid test ratio, and return on investment. These ratios are used to evaluate aspects of a business like profitability, liquidity, and efficiency in using capital over time from the financial statements. Working capital and the differences between mark-up and margin are also outlined.

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Jeff Lacasandile
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67 views10 pages

Analysis & Interpretation of Financial Statements

This document discusses various methods for analyzing financial statements, including profitability ratios, liquidity ratios, and rates of return. It defines key ratios like stock turnover, gross profit percentage, net profit percentage, current ratio, acid test ratio, and return on investment. These ratios are used to evaluate aspects of a business like profitability, liquidity, and efficiency in using capital over time from the financial statements. Working capital and the differences between mark-up and margin are also outlined.

Uploaded by

Jeff Lacasandile
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ANALYSIS & INTERPRETATION OF

FINANCIAL STATEMENTS
Obj.9 Analysing Profit Results

• The Trading, Profit & Loss a/c should be


examine to make meaningful deductions
concerning the business.
•
• The following ratios can be used -:
– Stock turn [rate of stock turnover]
– Gross profit percentage
– Net profit percentage
Stock turn

• The stock turn ratio tells us how many times


during the year stocks had to be replenished.
Using the formula
cost of sales / average stock
Where average stock is -:
• (opening stock + closing stock)/ 2 and
• cost of sales = cost of goods sold

• 365/stock turn = number of days stock was held before it was sold.
Gross/Net profit percentages
• Gross/Net profit percentages tell us what portion of
the sales for the period resulted in a profit.
• Increased sales does not always mean an increase in
profits.
• Gross profit percentage (GPP)
gross profit x 100
sales
• Net profit percentage (NPP)
net profit x 100
sales
Obj.12 Analysing the Balance Sheet
• The Balance Sheet should be examined to
make meaningful deductions about the
business’ financial status as at a given point in
time.
• The following ratios can be used -:
• Current ratio
• Acid test ratio
• Return on investment
The Current Ratio

• The current ratio is a measure of liquidity (how quickly


cash can be obtained to settle debts or pay expenses)
• The current ratio seeks to match those assets that can
be easily converted to cash with those debts which
have to be paid with the next 12 months.
• The current ratio formula is -:
current assets
current liabilities
• An acceptable current ratio should be 1.5:1 or better
The Acid Test Ratio

• The acid test ratio is a measure of liquidity (how


quickly cash can be obtained to settle debts or pay
expenses)
• The acid test ratio seeks to match those cash or near
cash assets with those debts which have to be paid
with the next 12 months. [current assets less stock]
• The acid test ratio formula is -:
current assets - stock
current liabilities
• An acceptable acid test ratio should be 1:1 or better
The Rate of Return On Investment

• The rate of return on investment is a measure of the


profit (returns) the owner gained from putting his
capital into the business.
• The rate of return on investment identifies the
percentage of profits gained from the capital which
had to be used during that year.
• The rate of return on investment formula is -:
net profits x 100
capital employed
• An acceptable rate of return should be 20% or better
Obj.10 & 11 Working Capital

• Working capital is the amount of resources used to


keep the business operational (on a day to day basis).
• Working capital is like a current asset – since it value
changes continually (from day to day).
• Working capital is a quick reference to the level of
liquidity in a business.
• Working capital can be calculated as -:
• current assets – current liabilities
• Where current liabilities are debts due within 1 year
Mark-up & Margin
• Mark-up is
– The profit described as a percentage/fraction of the
cost price.
profit
–= Cost price

• Margin is
– The profit described as a percentage/fraction of the
selling price.
profit
– = selling price
• Note: if a/b is the mark-up then a/b+a is the margin
• Also: cost price + profit = selling price

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