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Rotman Commerce (1,103)
RSM219H1 (86)

chapter 13

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Rotman Commerce
Alexander Edwards

Introduction to Financial Analysis – ch.13 Accounting provides information for decision-making. Based on the data gathered, informed decisions are made. We can use the figures for one year to compare with the figures of another year, for example, for expenses, revenue, sales, liability and so on. Why do we need to analyze? We can analyze a company for internal and external purposes. For internal purposes we can observe trends for these figures, which we can use to improve our business. Users of Financial Analysis Internal Users We can observe trends from these figures, which we can use to improve our business. External Users – - Bankers and Large Creditors Bankers and large creditors would analyze the company’s figures to determine their ability to repay loans. - Potential Investors They want to see the trend in growth, income, and net worth, to determine if it’s a worthwhile venture. - Labour Union Labour unions examine the profit of the company and compare this with the salaries the employees receive. Accounting Analysis Ways of Analysing Figures 1. Analysis of Comparative Financial Statements – Page 659 This is done by comparing a company’s financial data for two or more years e.g. 1996 to that of 1998. This would show a trend in profitability, growth, areas of improvements needed. Things to look for: 1  Items with unusual changes – analyse exceptions i.e. very high or very low differences.  Then look closer to find out what could have caused these changes Management uses this information to make vital changes to weak areas or if it was a positive change then they are used to make the system even better by increasing the practice. Page 659 2. Condensed Statement Analysis This is a condensed statement analysis gives selected or key statement amounts as a percentage of a base figure e.g. operating expense, net sales, net income, are given and a comparative percentage is given beside it. E.g. 662 -663 Horizontal Analysis A Horizontal Analysis is now shown on page 664 Vertical Analysis Vertical analysis is a method used to present the common-sized income statement. The main items on the income statements or balance sheet are shown as a percentage of one major item. Common-sized income statement - shows only the percentage of the income statement so that the dollar values are left out. Page 665 3. Trend Analysis Trend analysis is done by careful examination of percentage changes on a condensed financial statement. This would show the percentage changes of the main items so that the analyst can get an understanding of what might have caused these changes. The analyst may be carried out over a 10 years period. Using this information of the past the future can be forecasted. A based year is used i.e. that year represents 100% as on Page 665. The figures of the other years would fluctuate around this one-year – 2001, which is the base year. Trend analysis is used: 1. To give trend analysis information of the company to users of the financial statements 2. To give a picture of a financial position and performance over a number of years 2 3. To analyze a company’s strengths and weaknesses, and based on this a forecast can be prepared. 4. To gather as much information as possible from the analysis before making final decisions 5. There may be External factors too, which may be causing poor performances e.g. a slump in the economy. Page 666 - 673 4. Ratio Analysis The purposes of ratio analysis: - For decision-making, so accurate, relevant, information is given. - The figures are used to analyze a firm’s liquidity (i.e., how much cash is available to pay debts), borrowing capacity and profitability. - To give the above information to Users both internal and external to the company. Liquidity Ratio - Liquidity ratio tells or indicates how much fund the company has to pay off its debts or current liabilities without having to borrow or sell assets. - Bankers and creditors use this information to decide if they should lend the company their money, and based on this, they can decide if the company will be able to repay and how quickly. - To achieve good results, the company must manage the current assets efficiently. The ratios used to analyse liquidity are: a) Working capital Working capital = current assets – current liability Working Capital shows the company’s ability to pay its short-term debts or current liabilities. The sum remaining shows how much fund the company has after covering its current liabilities so it gives the liquidity information. Prior to an investment decision, it’s good to look at the working capital trends over a time period. b) Current ratio Current ratio = Total Current Assets / Total Current Liabilities E.g., 2.6 : 1 3This is another way to determine if the company can repay its current debt. In the example above, it means that the company has $2.60 worth of current asset for every $1 of current liability. The company should be able to generate or get enough cash from its current assets to cover its current liabilities. The general rate is, 2: 1 is satisfactory and means that the company can pay its debts; 1: 1 is poor; 6: 1 is not necessarily good as this maybe due to poor management allowing too much money to be tied up in inventory or n
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