• 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

efficiency and current

risk of the performance

business of the

company

Importance

of FS

Analysis

To compare the To compare

performance of present

the company performance

with other firms 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

Current Acid

Ratio Test

Ratio

This ratio is also known This ratio is also called as

as working capital

ratio. If the business’s acid-test ratio. The

current ratio is more

than one, it indicates evaluation of this ratio is

that the company has

sufficient sources to more reliable compared to

cover its current debt.

current ratio as this ratio

excludes all least liquid

assets. The least liquid

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

RM5,000 replaced its average

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

collect its debt within 41

RM20,000 x 365 days days of the accounting

RM180,000

period

= 40.5 days or 41 days

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

average total assets, the

RM180,000 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

Debt Ratio Time Interest

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

Current ratio Higher ratio is better Lower ratio is better

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.