FINANCIAL STATEMENT ANALYSIS

• FS analysis can be referred as a process of

understanding the risk and profitability of a company by
analyzing reported financial information.


• Financial analysis is the assessment of the company
past, present and anticipated future performance.


• Allows for comparisons over time/benchmark between


industry.
• Principal tool of financial analysis is the financial ratios.



















• Ratios are mathematical aids for evaluation and
comparison of financial performance.



• Financial ratios look at the relationship between

individual values and relate them to how the company


have performed in the past and might be performed in
the future.

To standardize
financial

information for
comparison

purposes











To assess To evaluate
current
efficiency and
risk of the performance
of the
business company






Importance


of FS

Analysis














To compare the
performance of
the company

with other firms To compare
present
performance

with past
performance

1 2










LIQUIDITY PROFITABILITY















3


4








EFFICIENCY LEVERAGE

LIQUIDITY

1

RATIO






Liquidity ratios measure the ability of a business in settling its current

obligation or current debt. These ratios used to be the main concern of

creditors. Considering the capability of paying debt as soon as possible is

a way to avoid bad debt, the creditors will look into these ratios for credit

sales’ permission. Banks and financial institutions will also refer to these

ratios for any loan or borrowing approval purposes.



General principle of these ratios is higher ratio indicates better

performance. However, if these ratios beyond the normal circumstance or

become out of league, further analysis is necessary to tell what is actually

taking place. For instance, if the liquidity ratios are too high, it tells that the

business does not efficient in utilizing its current assets to generate future

return. Huge cash in hand is not necessarily important rather than

investing that cash, hoping for higher future return on investment.



prompt
payment to
creditors

Liquidity

Ratio







Acid

Current Test
Ratio Ratio







This ratio is also called as
This ratio is also known acid-test ratio. The
as working capital evaluation of this ratio is
ratio. If the business’s
more reliable compared to
current ratio is more
than one, it indicates current ratio as this ratio
excludes all least liquid
that the company has assets. The least liquid
sufficient sources to
cover its current debt. assets such as prepayment
and inventory are not taken

into account in computing
quick ratio. This is due to
the nature of those assets

which are generally more
difficult to turn into cash.

Formula: Current Assets
Current Liability


Example: RM30,000

RM10,000

= 3 : 1


Interpretation: For every RM1.00 of current liability, the company has
RM3.00 of current assets to repay the current liability














Formula: Current Assets – Inventory Prepayment
Current Liability


Example: RM30,000 – RM3,000 – RM2,000
RM10,000

= 2.5 : 1



Interpretation: For every RM1.00 of current liability, the company has
RM2.50 of its liquid assets to repay the current liability

PROFITABILITY

2

RATIO






Profitability ratios assess the ability of a business in generating or making

profit. These ratios tell whether the business is profitable or not. Hence,

profitability ratios always capture the attention of investors, owners,

partners or any parties who will entitle to the return. There is no guarantee

that higher gross profit margin leads to higher net profit margin.



High net profit ratio depends on the ability of the business in managing

and controlling its operating or daily expenditures. Due to that, net profit


margin provides more accurate measurement rather than gross profit

margin in terms of evaluating credibility to generate net profit.

Gross Profit Margin


This ratio shows how much the business gain from the

products/services sold after deducting cost of goods sold.
It shows the relationship between gross profit and net

sales
















Example: RM130,000 x 100
RM180,000

= 72.20%


















For every RM1.00 of sales, the company is able to
generate RM0.72 of gross profit

Net Profit Ratio


This ratio shows the ability of a business to generate profit

from the sales made. This ratio is crucial for investors as it
predicts the dividend distribution















Example: RM80,000 x 100
RM180,000

= 44.40%





























For every RM1.00 of sales, the company is able to
generate RM0.44 of net profit

Return On Asset


This ratio measures the profitability of a business in
relation to its total assets. This ratio indicates how well

a company is performing by comparing the profit (net
income) it is generating to the capital it was invested

in assets









Formula: Net Profit x 100
Total Assets

Example: RM80,000 x 100
RM280,000


= 28.50%























Company earn RM0.29 for every RM1.00 of assets

Return On Capital Employed





This ratio identifies the efficiency of utilization of a
business’ resources and profitability of the business’
capital investment. It provides better indication of
financial performance for a business funded by both
equity and debt




















Example: RM45,000 x 100
RM120,000

= 37.50%























For every RM1.00 of sales, the company is able to
generate RM0.67 of operating profit

EFFICIENCY

3
RATIO








Efficiency ratios are important to evaluate the capability of a business in
managing its business resources and transform them to income. These


ratios help in analysing a business ability to employ its resources such as

capital and assets to produce income. In other words, these ratios show

how long period is needed to generate income. Length of time/period is

the most essential for these ratios.




Inventory Turnover


Ratio





Average Collection


Period







Total Asset


Turnover

Inventory Turnover
Ratio





This ratio indicates the time needed for a business to convert its inventory

into sales. The higher ratio tells that the business is more often replacing

its inventory which depicts the efficiency in selling its product, hence

capable to generate income within a short period of time. The situation

indirectly tells us that the business may have good marketing strategy,

high quality product at reasonable price and easy accessibility to the

products.







*



**





COSG = beginning inventory + purchase – ending inventory

Average inventory = (beginning inventory + ending inventory) ÷ 2





Example: Within an accounting
period, the company has
RM50,000 replaced its average
RM5,000 inventory 10 times


=10 times

Average Collection

Period




This ratio shows the length of time needed for a business to collects all its

money from its debtors. Specifically, this ratio shows the association

between average account receivable and total credit sales. Short average

collection period indicates that the business is efficient to avoid any

possibility of bad debt. Nevertheless, too short average collection periods

defines that the business is stringent in dealing with its debtors.






















Example: The company is able to

RM20,000 x 365 days collect its debt within 41
RM180,000 days of the accounting

= 40.5 days or 41 days period

Total Asset

Turnover




This ratio is used to measure how efficiently the business uses its assets

to generate sales. The higher the ratio, the more efficient the business is

in utilizing its assets to generate sales and increase productivity.






















Example: For every RM1.00 of

RM180,000 average total assets, the
company can generate
RM450,000

RM0.40 net sales
= 0.4

LEVERAGE


4

RATIO







Leverage ratios are used to determine the relative level of debt load that
a business has incurred. These ratios compare the total debt obligation to


either the assets or equity of a business. A high ratio indicates that a

business may have incurred a higher level of debt than it can be

reasonably expected to service with ongoing cash flows. This is a major

concern, since high leverage is associated with a heightened risk of

bankruptcy.






Debt to Equity

Ratio




Time Interest

Debt Ratio Earned








Leverage

Ratio

Definition


This ratio indicates the proportion

between business’ debt and its total assets.

A business with higher debt is considered
highly leverage or geared and riskier.

The ratio shows how much the company
relies on debt to finance its assets.



Formula















Example


RM30,000 x 100

RM90,000

= 33.3%




Interpretation



• The more debt compared to assets a
company has, which is signaled by a

high debt ratio, the riskier it is
considered to be.
• The assets were financed by debt
33.3%.

• 33.3% of total assets are financed by
creditors.

Definition



This ratio helps to know the proportion of
equity and debt to finance the total assets.
High debt-to-equity ratio means that the
business is being financed more by
creditor rather than shareholders.

Similar with debt ratio, higher debt-to-
equity ratio indicates that the business has
higher possibility to bankruptcy.




Formula






















Example



RM30,000 x 100
RM50,000

= 60%





Interpretation




• This ratio measures the relationship
between the capital contributed by
creditors and the capital contributed by
shareholders.
• Contribution of creditors is only 50%
from contribution of investor.

Definition




This ratio shows the ability of a business to
cover its interest expense using its
operating income. Higher times interest
earned indicates that the company has no
problem to pay its borrowing or loan,
including both principal and interest.

The bank or creditor feel more confident to
approve loan or borrowing if the business
has consistent high times interest earned
ratio.





Formula























Example



RM45,000
RM7,500

= 6 times




Interpretation




• Determines the interest payment
ability of the company against the
debt it owes.

Distorted by inflation




• Since the information is historical,

inflation may have occurred and the
figures may be distorted.






Different accounting practices
distorts comparison




• Different accounting practices will make
comparison less accurate and invalid.





Information can be manipulated





• Ratio analysis is based entirely on the data
found in business firms' financial

statements.



• Management has opportunity to

manipulate the figures to make the
company’s performance looks good.

CONCLUSION





Higher ratio is better Lower ratio is better

Current ratio 
Quick ratio 

Gross profit ratio 

Net profit ratio 
Return on asset ratio 

Return on capital employed 

Inventory turnover ratio 
Average collection period 

Total asset turnover 

Debt ratio 
Debt-to-equity ratio 

Times interest earned 




Financial ratios are commonly used as a means of

financial statements analysis to identify or evaluate

financial performance and position. Interpretations
of the ratios will always be carried out with care due

to limitations such as different accounting policies,
fiscal years and manipulations.