BU1002 Lecture 7: Analysis and Interpretation of Financial Statements

102 views11 pages

amaranthleopard138

14 Jun 2018

School

James Cook University

Department

Course

BU1002

Professor

Jodi Maxfield

For unlimited access to Class Notes, a Class+ subscription is required.

Week 7: Analysis and interpretation of financial statements (part 1)

Ratio Analysis

• A ratio is meaningless unless it is compared to something

• An expression of one item in the financial statements as another item in the financial

statements – one item is divided by another to create the ratio

• The ratio comparison can be between two different statements

• But income statement and statement of cash flows involve flow items while balance

sheet reports stock items

• Ratio analysis is a 3-step process

1. Calculate a meaningful ratio by expressing $ amount of an item by $ amount

of another item

2. Compare the ratio with a benchmark

3. Interpret the ratio and seek to explain why it differs

• From previous years, comparative entities or industry averages

Ratio Analysis Aspects

• Ratios in various categories help users in their decision making

• Profitability ratios – inform users as to the profit associated with their equity

investment.

• efficiency ratios – measure the effectiveness in managing the assets of the

entity.

• liquidity ratios – idiate the etity’s aility to eet its shot te

commitments.

• capital structure ratios – indicate the long term stability and financing

decisions, how assets are financed.

• market performance ratios (relevant to companies listed on an organised

stock exchange) – elate the etity’s fiaial ues to the etity’s shae pie

Benchmarks

• Ratios are of limited usefulness unless compared to relevant benchmarks

• Comparisons may be made of:

• the etity’s atios oe tie (idetify teds)

• the etity’s atios ith those of othe etities i sae idusty (ita-industry

analysis)

• the etity’s atios ith idusty aeages

• the etity’s atios ith those of etities opeatig i diffeet idusties

(inter-industry analysis)

• the etity’s atios with arbitrary standards

Performing ratio analysis (PART 3 ASSIGNMENT)

1. Describe the change

a. In the previous year the ratio was..this year the ratio is

2. Explain the change plain the change

a. The numerator moved at greater rate than the denominator (or vice-versa)

3. Suggest a cause:

• What would make the denominator/numerator move up or down.

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 11 pages and 3 million more documents.

Already have an account? Log in

• For example if the numerator was current assets then what accounts had the

greatest impact on current assets; Cash? Inventory? Sales? Look for the

Why?

Profitability Analysis - Return on equity (ROE):

• Captures profitability, efficiency and capital structure

• Upward trend is advantageous for an entity

• But, a sustained high ROE attracts new competitors to industry and eventually

erodes excess ROE

Profitability Analysis – Return on assets (ROA):

• Reflets the esults of etity’s aility:

• To convert sales revenue into profit

• To geeate ioe fo it’s asset iestets

• Net profit / average assets

• Item from profit and loss and item from balance sheet – two flow items

Again negative values in ABT

Return on assets similar to equity, over 3 years but assets have improved

Largely due to improvement of the recumination of net loss: not has high as it was in

2015, total av assets flunicated but still lower in 2015 – individual change of assets

how they impact

Profitability Analysis – Profit Margin Ratios:

• Ratios that relate profit to sales revenue generate by the entity include the gross

profit margin and the profit margin

• Service based; do not have gross profit margin

• Gross profit: cost of sales - cost of profits

• Revenues in expenses

• If cost price increases obviously margin will be less, in 2017 not making as much

money on each cost of sales

• 42c per $1 in 2017

• significant increase in sales revenue

• gross profit increase,

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 11 pages and 3 million more documents.

Already have an account? Log in

Profitability Analysis – Dividend Payout Ratio

• not expected on assignment

• Measures the percentage of profit distributed in the form of dividends

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 11 pages and 3 million more documents.

Already have an account? Log in

Document Summary

Week 7: analysis and interpretation of financial statements (part 1) A ratio is meaningless unless it is compared to something. An expression of one item in the financial statements as another item in the financial statements one item is divided by another to create the ratio. The ratio comparison can be between two different statements. But income statement and statement of cash flows involve flow items while balance sheet reports stock items. Calculate a meaningful ratio by expressing $ amount of an item by $ amount of another item. Interpret the ratio and seek to explain why it differs. From previous years, comparative entities or industry averages. Ratios in various categories help users in their decision making. Ratios are of limited usefulness unless compared to relevant benchmarks. Performing ratio analysis (part 3 assignment: describe the change. In the previous year the ratio wasthis year the ratio is.

Related Questions

This term you have learned to understand a companyâs financial story using the language of accounting. The recording and reporting of information is essential to decision makers and other users of financial information; numbers on the various financial statements are used to help further understand the financial condition of the business. This process is known as financial ratio analysis and allows us to analyze the companyâs financial position in relation to other organizations in the industry. In this final assignment, you will apply the concepts you have learned throughout the term to perform financial statement analysis and to offer some recommendations.

Assume that you are a health care consultant hired by the Dependable DME Company. DME is Durable Medical Equipment and includes all equipment that benefits patients who have certain medical conditions. The owner of the company, David Smith, is interested in applying for a loan to expand his business; he desires to open a second location in another city. He is preparing to apply to a local bank for a loan.

The bank will base its decision on the following averages for the DME industry:

Ratio	Industry Average
Current ratio	1.50
Quick ratio	0.80
Receivables turnover ratio	18.0
Inventory turnover ratio	20.0
Debt to assets ratio	0.56
Profit margin	10.25%

The balance sheet data for Dependable DME Company follows:

	December 31, 2017	December 31, 2016
Cash	$75,000	$60,000
Accounts receivable	40,000	20,000
Inventory	30,000	20,000
Prepaid insurance	5,000	5,000
Total current assets	140,000	105,000
Property and equipment	600,000	550,000
Accumulated depreciation	140,000	110,000
Total property and equipment	460,000	440,000
Total assets	$600,000	$545,000
Accounts payable	$60,000	$60,000
Other current liabilities	40,000	45,000
Total current liabilities	100,000	105,000
Bonds payable	150,000	150,000
Total liabilities	250,000	255,000
Common stock	250,000	250,000
Retained earnings	100,000	40,000
Total stockholdersâ equity	350,000	290,000
Total liabilities and stockholdersâ equity	$600,000	$545,000

The income statement data for Dependable DME Company follows:

Sales	$600,000
Cost of goods sold	350,000
Gross profit	$250,000
Operating expenses	100,000
Operating income	$150,000
Interest expense	25,000
Income before taxes	$125,000
Income tax expense	65,000
Net income	$60,000

Required:

Calculate the following six (6) ratios: Current Ratio, Quick Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio, Profit Margin Ratio and Debt to Assets Ratio. Be sure to show the actual calculation as well as your final answer.

You are only required to calculate the ratios for 2017; however, for two of the ratios (Receivables Turnover Ratio and Inventory Turnover Ratio), you will need data from 2016 for the formula. When calculating the Quick Ratio, please note that Short-Term Investments are $0 in this scenario. (24 points; 4 points for each ratio calculation)

Below each ratio, comment on the interpretation of the ratio. In other words, what does the result tell you, specifically? (8 points)

Based upon the industry averages upon which the bank relies, should they approve the loan to Mr. Smith? Why or why not? (7 points)

In one-half page, comment on what financial aspect of Dependable DME Company looks good and where can Mr. Smith make some improvements. Specifically identify at least two recommendations to Mr. Smith that can be made to improve the financial position of his business. (8 points)

BU1002 Lecture 7: Analysis and Interpretation of Financial Statements

Document Summary

Get access

Related Documents

BU1002 Lecture Notes - Lecture 8: Financial Statement Analysis, Financial Statement, Trend Analysis

BU1002 Lecture Notes - Lecture 4: Balance Sheet, Cash Flow Statement, Financial Statement

BU1002 Lecture Notes - Lecture 5: Accrual, Financial Statement, Income Statement

Related Questions