Financial Statement Analysis
Profitability
Analyses the entity’s ability to generate income, to e0ectively control its expenses
and to generate an acceptable profit compared to the performance of prior years,
budget, industry and competitors.
Ratio Formula Interpretation
GP margin This % reflects how much a company
(SP-CP) ÷ SP
(margin means makes after paying o0 the costs of
\ GP ÷ sales
over sales) goods sold.
Operating profit An indication of the profit a company
EBIT ÷ sales
margin makes after paying its variable costs.
Poor financial indicator as di0erent
NP(after interest & tax) accounting policies are used by
Net profit margin
÷ sales di0erent entities, which complicates
and compromises its comparability.
Return on total Measures how e0ective assets were
EBIT ÷ total assets
assets used to generate profit (EBIT).
Earnings(net income) ÷ How e0ective the entity used its
Return on equity total shareholders’ shareholders’ investment to generate
equity a profit.
Operating leverage measures the
Degree of Total contribution ÷
extent to which an entity incurs a
operating leverage operating profit
mixture of fixed and variable costs.
Compared to current prime rate of
11.75%. If calc is higher, indicates a
Total finance cost ÷ high (expensive) finance cost.
E0ective interest
total interest-bearing
rate (%)
debt @previous YE This indicates a high finance risk as
financiers want to be compensated for
their risk in investment.
Du Pont Model
, Liquidity
Measures the entity’s ability to pay its debts as and when they fall due.
As an entity’s working capital directly a0ects its short-term cash flow from the ordinary
course of business, it is closely linked to liquidity
Note:
In practise SFP: (open+close)/2
vs in test use Closing Balance
Ratio Formula Interpretation
Indicates entity’s ability to use current
assets to repay current liabilities.
If current ratio is too low or below 1
(meaning CL>CA), it’s an indication for
concern.
Compare to industry.
Current assets ÷ Supermarkets have a norm ration of
Current ratio
current liabilities 0.7:1 but still get credit financing due
to their high cash flow.
However, if a current ratio is too high,
indicates ine0icient use of CA or ST
financing facilities, indicating
ine0icient working capital
management.
Or poor credit history/rating.
Inappropriate for service entity’s with
limited inventory.
Compare to industry.
RATIO below 1 indicates entity relies
Current assets- too much on inventory to pay o0 ST
Quick ratio inventory ÷ current liabilities.
liabilities
If too high, indicates debtors
collection di0iculty (high debtors
balances) and di0iculty to obtain
credit from suppliers (low payables
balances)
[Cash & cash equiv. + Measures the entity’s ability to cover
Cash ratio marketable securities] its ST obligations using only cash and
÷ current liabilities cash equivalents.
Profitability
Analyses the entity’s ability to generate income, to e0ectively control its expenses
and to generate an acceptable profit compared to the performance of prior years,
budget, industry and competitors.
Ratio Formula Interpretation
GP margin This % reflects how much a company
(SP-CP) ÷ SP
(margin means makes after paying o0 the costs of
\ GP ÷ sales
over sales) goods sold.
Operating profit An indication of the profit a company
EBIT ÷ sales
margin makes after paying its variable costs.
Poor financial indicator as di0erent
NP(after interest & tax) accounting policies are used by
Net profit margin
÷ sales di0erent entities, which complicates
and compromises its comparability.
Return on total Measures how e0ective assets were
EBIT ÷ total assets
assets used to generate profit (EBIT).
Earnings(net income) ÷ How e0ective the entity used its
Return on equity total shareholders’ shareholders’ investment to generate
equity a profit.
Operating leverage measures the
Degree of Total contribution ÷
extent to which an entity incurs a
operating leverage operating profit
mixture of fixed and variable costs.
Compared to current prime rate of
11.75%. If calc is higher, indicates a
Total finance cost ÷ high (expensive) finance cost.
E0ective interest
total interest-bearing
rate (%)
debt @previous YE This indicates a high finance risk as
financiers want to be compensated for
their risk in investment.
Du Pont Model
, Liquidity
Measures the entity’s ability to pay its debts as and when they fall due.
As an entity’s working capital directly a0ects its short-term cash flow from the ordinary
course of business, it is closely linked to liquidity
Note:
In practise SFP: (open+close)/2
vs in test use Closing Balance
Ratio Formula Interpretation
Indicates entity’s ability to use current
assets to repay current liabilities.
If current ratio is too low or below 1
(meaning CL>CA), it’s an indication for
concern.
Compare to industry.
Current assets ÷ Supermarkets have a norm ration of
Current ratio
current liabilities 0.7:1 but still get credit financing due
to their high cash flow.
However, if a current ratio is too high,
indicates ine0icient use of CA or ST
financing facilities, indicating
ine0icient working capital
management.
Or poor credit history/rating.
Inappropriate for service entity’s with
limited inventory.
Compare to industry.
RATIO below 1 indicates entity relies
Current assets- too much on inventory to pay o0 ST
Quick ratio inventory ÷ current liabilities.
liabilities
If too high, indicates debtors
collection di0iculty (high debtors
balances) and di0iculty to obtain
credit from suppliers (low payables
balances)
[Cash & cash equiv. + Measures the entity’s ability to cover
Cash ratio marketable securities] its ST obligations using only cash and
÷ current liabilities cash equivalents.
