INTRODUCTION TO

INTERPRETATION &
INDICATORS 1-5
GRADE 11
ACCOUNTING
 INTRODUCTIO
N
• FINANCIAL STATEMENTS ARE PREPARED WITH A MAJOR PURPOSE:

• TO PROVIDE INFORMATION
• THAT ENABLES OWNERS & OTHER
STAKEHOLDERS
• TO ASSESS THE PERFORMANCE OF THE
BUSINESS
• TO MAKE APPROPRIATE DECISIONS BASED
ON THAT INFORMATION
 4 MAIN
QUESTIONS
When inspecting financial statements the
readers will be interested in answering these
4 questions:
1. Is the business profitable?
 Is the business able to make a good profit each year
 How well are the expenses controlled
2. Is the business earning a good return
for the owners?
 Is the business a good investment for the
owners
 OR could they earn a better return in another
 4 MAIN QUESTIONS
3. IS THE BUSINESS SOLVENT?
• CAN THE BUSINESS COMFORTABLY PAY OFF ALL ITS
DEBTS
4. IS THE BUSINESS LIQUID?
• CAN THE BUSINESS COMFORTABLY PAY OFF ITS DEBTS IMMEDIATELY

• AFTER CONSIDERING THESE – 2 FURTHER QUESTIONS AS TO

WHETHER THE BUSINESS IS SUSTAINABLE IN THE FUTURE:
1. DOES THE BUSINESS EXERCISE GOOD INTERNAL
CONTROL?
2. DOES THE BUSINESS EXERCISE RESPONSIBLE
CITIZENSHIP?
 USING ABSOLUTE FIGURES IS NOT
RELIABLE
• WHEN ANALYSING FINANCIAL STATEMENTS
• NOT DESIRABLE TO MERELY CONSIDER THE ABSOLUTE FIGURES
CONTAINED IN THE FINANCIAL STATEMENTS

• E.G. CAN’T ASSESS IF R50 000 IS GOOD OR BAD

• UNLESS IT CAN BE RELATED TO SOME OTHER FIGURE
• SUCH AS AMOUNT OF CAPITAL INVESTED BY OWNERS
• IF CAPITAL INVESTED WAS R100 000 THEN R50 000 NET PROFIT IS
GOOD
• IF CAPITAL INVESTED WAS R1 000 000 THEN R50 000 NET PROFIT
IS NOT SATISFACTORY
• COMPARISON MAKES AMOUNTS MEANINGFUL :)
 INTERPRETATIO
N
• INDICATORS 1-5 ARE FOR CALCULATING PROFITABILITY &
EFFICIENCY
• ONCE THE INDICATOR HAS BEEN CALCULATED THEY NEED TO BE
INTERPRETED BY COMPARING 1 OR MORE:
• INDICATORS FROM PREVIOUS YEAR
• INDICATORS OF COMPETITORS
• ALTERNATIVE COURSE OF ACTION
• SOME DESIRED AIM OR OBJECTIVE
INDICATOR 1–GROSS PROFIT ON
SALES
• GROSS PROFIT = AMT BY WHICH SALES EXCEEDS COST OF SALES
FOR A SPECIFIC PERIOD
• GP % DEPENDS ON BUSINESS ACTIVITIES & POLICY
• E.G. IF THE GROSS PROFIT IS R750 & SP IS R3750 CALCULATE THE
%:
• 750 X 100 = 20%
3750 1

• IF THIS PROFIT MARK UP ON SALES IS MAINTAINED ON ALL SALES

THE SAME %WILL BE OBTAINED ON FINAL FIGURES FROM THE
INCOME STATEMENT
INDICATOR 1–GROSS PROFIT ON
SALES
• IF SALES FOR THE YEAR WAS R900 000 AND THE GROSS PROFIT
WAS R180 000 WHAT WOULD THE GROSS PROFIT EXPRESSED AS A
% OF SALES BE?
• 180 000 X 100 = 20%
900 000 1

GROSS PROFIT ON SALES = GROSS

PROFIT X 100
SALES
1
 INDICATOR 2 –GROSS PROFIT ON COST OF
SALES
• SAME FORMULA TO CALCULATE PROFIT MARK UP %
• E.G. IF THE GROSS PROFIT IS R750 & COS IS R3000 CALCULATE THE
%:
• 750 X 100 = 25%
3000 1

• A PROFIT MARK-UP OF 20% ON SALES IS THUS = TO PROFIT MARK-

UP OF 25% ON COST OF SALES
 INDICATOR 2–GROSS PROFIT ON
COS
• IF COS FOR THE YEAR WAS R720 000 AND THE GROSS PROFIT WAS
R180 000 WHAT WOULD THE GROSS PROFIT EXPRESSED AS A % OF
COST OF SALES BE?
• 180 000 X 100 = 25%
720 000 1

GROSS PROFIT ON COST OF SALES =

GROSS
• MUST ENSURE PROFIT
THERE X 100
IS NO VARIATION BETWEEN MARK-UP
COST of SALES
ACHIEVED 1
AND MARK-UP ACCORDING TO THE POLICY.
• IF THERE IS IT MUST BE INVESTIGATED POPULAR QUESTION :)
 INDICATOR 3–OPERATING
PROFIT ON SALES
• OPERATING PROFIT = OP INCOME – OP EXPENSES

OPERATING PROFIT ON SALES = OPERATING

PROFIT X 100
SALES
1 CONCLUSIONS BY COMPARING
• CAN DRAW
OPERATING PROFIT ON SALES & GROSS PROFIT
ON SALES:
• INFLUENCED BY OPERATING EXPENSES ON THE PROFIT

• DIFFERENCE -/- % INDICATES WHETHER THE OPERATING PROFIT

EXPENSES ARE IN PROPORTION TO THE VOLUME OF BUSINESS
ACTIVITY
• SAY THE FORMULA....OPERATING PROFIT IS ON SALES AS YOU SAID
 INDICATOR 3–OPERATING PROFIT
ON SALES
• SALES R540 000
• GROSS PROFIT R270 000
• OPERATING PROFIT R120 000
• GROSS PROFIT EXPRESSED AS % OF SALES
• 270 000 X 100 = 50%
540 000 1

• OPERATING PROFIT AS A % OF SALES

• 120 000 X 100 = 22.2 %
540 000 1
 INDICATOR 3–OPERATING PROFIT ON SALES

• COMPARISON OF THE % OPERATING PROFIT ON SALES FROM YEAR

TO YEAR WILL INDICATE A POSITIVE OR NEGATIVE TREND
• THE DIFFERENCE -/- 50% & 22.2% REPRESENTED THE EFFECT OF
OPERATING EXPENSES (ASSUME NO OP INCOME)
• OBVIOUS OP EXPENSES ARE HIGH (ALMOST HALF
GROSS PROFIT)
• MAY BE IRREGULARITIES IN THE ADMINISTRATION
• PRECAUTIONARY MEASURES - CUT BACK ON CERTAIN
EXPENSES
• AN ANALYSIS OF THE COMPARISON INDICATES:
• WHAT % OF GROSS INCOME IS SPENT ON OP EXPENSES
• WHETHER THE BUSINESSIS PROSPERING OR DETERIORATING
• HOW EFFICIENT DIFF POLICIES ARE & CONTROLLING OF EXPENSES
 INDICATOR 4–OPERATING
EXPENSES ON SALES
OPERATING EXPENSES ON SALES = OPERATING
EXPENSES X 100
• ALLOWS OWNER TO COMPARE FROM YEAR TO YEAR OR SALES
WITH
COMPETITION1
• HE CAN DETERMINE WHETHER
• EXPENSES HAVE REMAINED CONSTANT IN RELATION TO SALES
• HE HAS EFFICIENTLY CONTROLLED THE OPERATING EXPENSES

• OPERATING EXPENSES EXPRESSED AS A % OF SALES:

• 20 000 X 100 = 5%
400 000 1
 INDICATOR 4–OPERATING
EXPENSES ON SALES
• IF INDICATOR FLUCTUATES FROM YEAR TO YEAR
• CONTROL OVER EXPENSES WILL NEED TO BE TIGHTENED

• OP EXPENSES – FURTHER ANALYSED

• E.G. BAD DEBTS EXPRESSED AS A % OF SALES MAY BE:
• 2 000 X 100 = 0.5%
400 000 1
• IF 1% IS TAKEN AS STANDARD MEASURE OF BAD DEBTS

• OWNER CAN USE THIS COMPARISON TO

DETERMINE WHETHER THE CREDIT
POLICY/SCREENING POLICY OF DEBTORS IS
ADEQUATE
INDICATOR 5–NET PROFIT ON
SALES
NET PROFIT ON SALES = NET PROFIT
X 100
• NET PROFIT = ALL INCOME – ALL EXPENSES SALES
• 1OP PROFIT + INTEREST INCOME - INTEREST EXPENSE
• = BOTTOM LINE

• THIS INDICATOR GIVES AN INDICATION OF OPERATING EFFICIENCY

• OPERATING PROFIT CAN'T INDICATE OPERATING EFFICIENCY AS
FINANCING & INVESTING ACTIVITIES ARE NOT TAKEN INTO ACCOUNT
 INDICATOR 5–NET PROFIT ON
SALES
• THIS INDICATOR IS LIMITED IN APPLICABILITY IN ANALYSING
RESULTS
• HOWEVER – IT MAY BE USED TO COMPARE BOTTOM-LINE PROFITABILITY
FROM YEAR TO YEAR & WITH COMPETITORS

• DIFFERENCE: OPERATING PROFIT ON SALES & NET PROFIT ON

SALES
• IS THE INFLUENCE OF FINANCING & INVESTING ACTIVITIES HAVE ON
THE FINAL PROFIT

• CONSIDER THE FOLLOWING FIGURES:

SALES R540 000 OPERATING PROFIT R120

000
INTEREST INCOME R 15 000 INTEREST
 INDICATOR 5–NET PROFIT ON
SALES
• NET PROFIT EXPRESSED AS A % OF SALES IS:
90 000 X 100 = 16.7%
540 000 1

• OWNER EARNS 16.7 CENTS FOR EVERY R1 SALES

• NP & OP DIFFER BY R30 000 = INVESTING – FINANCING
• COMPARISON INDICATES THE INFLUENCE OF INTEREST INCOME &
INTEREST EXPENSE ON FINAL PROFIT
• COMPARE THE NP ON SALES WITH PREVIOUS YEARS OR COMPETITORS