Component 1 – Accounting Classification of Financial Statements
Chapter 2 – Financial Statements
Financial Statements need to be comparable
• Statements of companies may not be comparable as a result of different accounting
standards
• SA companies converted to IFRS after 2005; comparison to previous years where other
accounting standards were used may be problematic; IFRS is only a guideline, open for
interpretation
• Multinational firms: US GAAP vs. IFRS
Solution?
Standardise published financial statements
• Facilitate comparisons between companies and over time
• Simplifies the calculation of financial ratios
Statement of profit or loss
Income = expenses + retained earnings
Statement of financial position
Non-current assets + current assets = ordinary shares, reserves, preference shares, non-
controlling interest (equity) + non-current liabilities + current liabilities (debt)
Statement of cash flow
Cash at the beginning of the year + movement in cash during the year = Cash at the end of
the year
Movement in cash during the year = cash from operating/investing/financing activities
Formats of standardises financial statements:
• Need to understand the relationship between the elements that form part of each
statement and be able to identify all items included within these elements
Chapter 3 – Ratio Analysis
DuPont Analysis
Provides a breakdown of the components that contribute to a company’s ROE in order to
evaluate changes in the ratio
• Possible to identify the individual components that contribute to the overall value of the
return ratio
• Also possible to evaluate changes in the values of the ratios over time to determine
where possible problem areas exist
• Could also compare the ratios of similar firms to investigate where value is created
,Unless the tax rates are indicated in a question the following rates should be used:
Corporate tax rate = 28%
Capital gains inclusion rate = 80%
Value added tax (VAT) = 15%
1. PROFITABILITY RATIOS
-Evaluates the efficiency with which a company utilises its capital to generate revenue
o Small investment in assets generates large income: company is highly profitable
o Large investment in assets generates small income: assets are not utilised efficiently
-Possible to calculate the profitability of different capital items
-Ensure a relevant comparison between capital item and corresponding income/profit
Return on Assets (ROA)
• Measures the return earned on the total assets that are utilised to generate revenue
• Compares profit after tax with total assets
• In order to improve ROA: Improve profit figure
Reduce amount of assets
Combination
ROA = Profit after tax x 100
Total assets 1
Return on Equity (ROE)
• Indicates return generated on total equity
• Total equity includes ordinary shareholders’ equity, preference share capital and non-
controlling interest
• Profit after tax represents profit available to all equity providers
ROE = Profit after tax x 100
Equity 1
, 2. SOLVENCY RATIOS
-Solvency refers to a company’s ability to cover all its obligations when it eventually closes
down its operating activities
-Comparisons between total assets (Kt), equity (Ke) and debt (Kv) capital
o If value of assets exceeds the value of liabilities: solvency level would most probably
be sufficient
o If this is not the case: long term survival of the company might be at risk
-Kv/Kt or Kv/Ke
Financial Leverage Ratio
• The amount of total assets is compared with the amount of equity capital included in a
company’s capital structure
• The higher the value of this ratio, the weaker the solvency position
Financial Leverage Ratio = Total assets
Equity
Debt: Asset Ratio
• Relationship between debt capital and total assets
• Provides indication of the portion of the total capital requirement that is financed by
means of debt capital
• The higher the value of this ratio, the weaker the solvency position
Debt: asset ratio = Total debt
Total assets
Debt: Equity Ratio
• Compares amount of debt capital with equity capital
• The higher the value of this ratio, the weaker the solvency position
Debt: equity ratio = Total debt
Total equity
3. PROFIT MARGINS
-Indication of the percentage of revenue that shows as profit after certain deductions are
made
-Profit margins could influence profitability ratios
o Higher profit margins should increase profitability levels
Gross Profit Margin
• Portion of revenue available after cost of sales has been paid, relative to revenue
GP Margin = Gross profit x 100
Revenue 1
Gross Profit Mark-Up
• Gross profit expressed as percentage of the cost of sales
Chapter 2 – Financial Statements
Financial Statements need to be comparable
• Statements of companies may not be comparable as a result of different accounting
standards
• SA companies converted to IFRS after 2005; comparison to previous years where other
accounting standards were used may be problematic; IFRS is only a guideline, open for
interpretation
• Multinational firms: US GAAP vs. IFRS
Solution?
Standardise published financial statements
• Facilitate comparisons between companies and over time
• Simplifies the calculation of financial ratios
Statement of profit or loss
Income = expenses + retained earnings
Statement of financial position
Non-current assets + current assets = ordinary shares, reserves, preference shares, non-
controlling interest (equity) + non-current liabilities + current liabilities (debt)
Statement of cash flow
Cash at the beginning of the year + movement in cash during the year = Cash at the end of
the year
Movement in cash during the year = cash from operating/investing/financing activities
Formats of standardises financial statements:
• Need to understand the relationship between the elements that form part of each
statement and be able to identify all items included within these elements
Chapter 3 – Ratio Analysis
DuPont Analysis
Provides a breakdown of the components that contribute to a company’s ROE in order to
evaluate changes in the ratio
• Possible to identify the individual components that contribute to the overall value of the
return ratio
• Also possible to evaluate changes in the values of the ratios over time to determine
where possible problem areas exist
• Could also compare the ratios of similar firms to investigate where value is created
,Unless the tax rates are indicated in a question the following rates should be used:
Corporate tax rate = 28%
Capital gains inclusion rate = 80%
Value added tax (VAT) = 15%
1. PROFITABILITY RATIOS
-Evaluates the efficiency with which a company utilises its capital to generate revenue
o Small investment in assets generates large income: company is highly profitable
o Large investment in assets generates small income: assets are not utilised efficiently
-Possible to calculate the profitability of different capital items
-Ensure a relevant comparison between capital item and corresponding income/profit
Return on Assets (ROA)
• Measures the return earned on the total assets that are utilised to generate revenue
• Compares profit after tax with total assets
• In order to improve ROA: Improve profit figure
Reduce amount of assets
Combination
ROA = Profit after tax x 100
Total assets 1
Return on Equity (ROE)
• Indicates return generated on total equity
• Total equity includes ordinary shareholders’ equity, preference share capital and non-
controlling interest
• Profit after tax represents profit available to all equity providers
ROE = Profit after tax x 100
Equity 1
, 2. SOLVENCY RATIOS
-Solvency refers to a company’s ability to cover all its obligations when it eventually closes
down its operating activities
-Comparisons between total assets (Kt), equity (Ke) and debt (Kv) capital
o If value of assets exceeds the value of liabilities: solvency level would most probably
be sufficient
o If this is not the case: long term survival of the company might be at risk
-Kv/Kt or Kv/Ke
Financial Leverage Ratio
• The amount of total assets is compared with the amount of equity capital included in a
company’s capital structure
• The higher the value of this ratio, the weaker the solvency position
Financial Leverage Ratio = Total assets
Equity
Debt: Asset Ratio
• Relationship between debt capital and total assets
• Provides indication of the portion of the total capital requirement that is financed by
means of debt capital
• The higher the value of this ratio, the weaker the solvency position
Debt: asset ratio = Total debt
Total assets
Debt: Equity Ratio
• Compares amount of debt capital with equity capital
• The higher the value of this ratio, the weaker the solvency position
Debt: equity ratio = Total debt
Total equity
3. PROFIT MARGINS
-Indication of the percentage of revenue that shows as profit after certain deductions are
made
-Profit margins could influence profitability ratios
o Higher profit margins should increase profitability levels
Gross Profit Margin
• Portion of revenue available after cost of sales has been paid, relative to revenue
GP Margin = Gross profit x 100
Revenue 1
Gross Profit Mark-Up
• Gross profit expressed as percentage of the cost of sales
