International Financial Accounting
RATIO ANALYSIS
1. Liquidity – the ability of the firm to pay its short-term liabilities
2. Financial risk –information on the relationship between the exposure of the business loans
3. Profitability – how effective the firm is at generating profits given sales and/or its capital assets
4. Assets Management or Efficiency – how effectively the company uses the assets, like employees
5. Financial or Market strength – information to enable decision making on the level of the risk and the
earning potential of an investment
LIQUIDITY RATIOS
Acid test ratio (quick ratio) = (current assets – inventory) / current liabilities 1:1
Current ratio = current assets / current liabilities 2.0 or 1.5 are good ratios
results from is in times = 1.6/1 = 1.6 times
- want to reduce current assets to increase current ratio, can do by dropping leas trough issuing more
shares so you have money to buy instead of lease
FINANCIAL RISK
Gearing ratio = debt/Capital employed* x 100 = debt to equity ratio = debt/equity x 100
*Capital employed = debt + equity
The higher the ratio the riskier the business is (ideal 40 to 50%)
Debt= interest bearing liabilities = liabilities you pay interest over under non-current liabilities
All debts are liabilities, but not all liabilities can be debt
Interest coverage ratio = PBIT (profit before interest tax) / Interest
ideal 3.0 : 1.0
The higher the ratio lower risk
The lower the ratio higher the company’s debt and greater the risk of bankruptcy of default
PROFITABILITY
Gross profit = revenue – cost of sales
Operating profit = revenue – variable and operating expenses (cost of sales – operating expenses)
Net profit = revenue – total expenses revenue (cost of sales – operating expenses – interest and taxes)
,When cost of sales are too high, could be resolved by finding another supplier, this would increase gross profit
Gross profit margin = gross profit / sales x 100
The higher the better
Operating profit margin = operating profit (EBIT) / sales x 100
The higher the better
Net profit margin = Net profit / Sales x 100
The higher the better
Return on Capital employed (ROCE) = PBIT / Capital employed x 100
the higher the better
operating profit = EBIT (earnings before interest and tax) = PBIT = profit before interest and tax
Finance cost interest = add to profit before tax and “interest”
ASSETS MANAGEMENT – PROFOTABILITY
Asset Turnover = Sales / total assets
explained how efficiently the company is using its assets to generate the revenue / profit (higher better)
if it is low could be because of underpricing.
Net turnover x Operating profit margin = ROCE
Average inventory period = COGS / average inventory (same as just dividing by 2)
COGS (cost of goods sold) =opening inventory + purchases – closing inventory
Inventory period = inventory / cost of sales x 365
shorter inventory period is better measures the average number of days’ inventory is held
inventory turnover measures how many times on average inventory is “sold” during a period
Receivable period = accounts receivable / sales x 365
shorter the better ideal is 30 days
shows how long it takes the business to recover debts
Payable period = accounts payable (AIP) / cost of sales x 365
the longer the better, because you want to pay at the latest you can
AIP = trade payable
FINANCIAL OR MARKET STRENGTH RATIOS
Earnings per share = profit after tax / number of shares
Price earnings (PE) ratio = market price / earnings per share
the higher the better
shows that future performance is going to be positive
there is a change in the future the stock will grow faster
higher PE reflects the high confidence of the market
,Look at perspective of potential investor would like to be PE to be lower because he has to pay more and the
stock is risky if PE is higher
Dividend yield = ordinary share dividend / market price x 100
- Low yield: means company retained large portion of profit to reinvest
- High yield: means risky company or slow growing better for investor because wants higher dividend
High gross profit margin means that you do not want to increase your selling price, but you have a better
position with the supplier and good margining which lead to low cost of sales
Operating profit margin operating expenses are higher and that is why the operating profit is lower than the
gross profit. However, still better than the market
Low liquidity because of High liabilities, Low assets
Main problem shortage of cash can be solved by getting more loans to have more cash and still their gearing
ratio will be below the market
,CONSOLIDATION
When one company acquire another running company net assets of that company are acquired, this is known
as take over
Normally control comes with more than 50% shares
The first company has enough voting power to appoint, reappoint, change all the directors of the second
company (50% and voting power)
It’s parent company’s responsibility to make consolidated accounts
The consolidated statement of financial position should show all assets and liabilities of the parent and
subsidiary
The intra –groups transactions are excluded for example, accounts receivables and payables
frommthird parties are shown, but what happens between parent and subsidiary will be not sown
THE MECHANICS OF CONSOLIDATION
W1 – establish the group structure (who acquired who, how much percentage (deel/geheel), what date)
W2 – net assets of subsidiary at acquisition, reporting and post-acquisition: once parent company takes over the
subsidiary company, from that date the subsidiary company can’t issue new shares, which means share capital and
share premium will stay the same, so acquisition will stay some as reporting. (this is a limitation in our course)
Details At acquisition date At reporting date Post-acquisition
Share Capital xxx xxx -
Share premium xxx xxx -
Retained earnings xxx xxx xxx
Fair value adjustment xxx xxx -
Unrealized profit (PUP) - (xxx) (xxx)
Accumulated depreciation - (xxx) (xxx)
Net Assets xxx* xxx xxx**
*Goes to working of goodwill (W3) as “fair value of net assets at acquisition” as “minus”.
**Goes to working of “NCI” (w4) as “NCI % of post-acquisition value”
**Goes to working of “consolidated retained eastings” (w5) as “parents % of net assets post acquisition”.
Revenue = retained earning
Unrealized profit
Profit margin = profit of sale = 20/100 = 20%
Mark up = percentage of profit on top of the cost = 20/120
When subsidiary sells to parent pup in w2
When parent sells to subsidiary pup in w5
Profit cannot be counted if it is sold between parent and subsidiary
, Start with cost of investment
Fair value of NCI at acquisition
= share capital at acq x share
price at acq x NCI%
NCI% x w2 post acq
NCI% x impairment loss
% parent x w2 post acq
% parent x impairment loss
pup if parent sub
Consolidated statement of financial positions (both = parent + subsidiary)
P,p,e (both + fair value adjusted – depreciation ) Equity share capital (parent only!)
Inventory (both – pup) Group retained earnings (w5)
Receivables (both – CIT – intra company transactions) NCI (w4)
Bank (both) Payables (both – intra company transactions)
Cash in transit (CIT) Other loans
Goodwill (w3)
Total assets Total liabilities
RATIO ANALYSIS
1. Liquidity – the ability of the firm to pay its short-term liabilities
2. Financial risk –information on the relationship between the exposure of the business loans
3. Profitability – how effective the firm is at generating profits given sales and/or its capital assets
4. Assets Management or Efficiency – how effectively the company uses the assets, like employees
5. Financial or Market strength – information to enable decision making on the level of the risk and the
earning potential of an investment
LIQUIDITY RATIOS
Acid test ratio (quick ratio) = (current assets – inventory) / current liabilities 1:1
Current ratio = current assets / current liabilities 2.0 or 1.5 are good ratios
results from is in times = 1.6/1 = 1.6 times
- want to reduce current assets to increase current ratio, can do by dropping leas trough issuing more
shares so you have money to buy instead of lease
FINANCIAL RISK
Gearing ratio = debt/Capital employed* x 100 = debt to equity ratio = debt/equity x 100
*Capital employed = debt + equity
The higher the ratio the riskier the business is (ideal 40 to 50%)
Debt= interest bearing liabilities = liabilities you pay interest over under non-current liabilities
All debts are liabilities, but not all liabilities can be debt
Interest coverage ratio = PBIT (profit before interest tax) / Interest
ideal 3.0 : 1.0
The higher the ratio lower risk
The lower the ratio higher the company’s debt and greater the risk of bankruptcy of default
PROFITABILITY
Gross profit = revenue – cost of sales
Operating profit = revenue – variable and operating expenses (cost of sales – operating expenses)
Net profit = revenue – total expenses revenue (cost of sales – operating expenses – interest and taxes)
,When cost of sales are too high, could be resolved by finding another supplier, this would increase gross profit
Gross profit margin = gross profit / sales x 100
The higher the better
Operating profit margin = operating profit (EBIT) / sales x 100
The higher the better
Net profit margin = Net profit / Sales x 100
The higher the better
Return on Capital employed (ROCE) = PBIT / Capital employed x 100
the higher the better
operating profit = EBIT (earnings before interest and tax) = PBIT = profit before interest and tax
Finance cost interest = add to profit before tax and “interest”
ASSETS MANAGEMENT – PROFOTABILITY
Asset Turnover = Sales / total assets
explained how efficiently the company is using its assets to generate the revenue / profit (higher better)
if it is low could be because of underpricing.
Net turnover x Operating profit margin = ROCE
Average inventory period = COGS / average inventory (same as just dividing by 2)
COGS (cost of goods sold) =opening inventory + purchases – closing inventory
Inventory period = inventory / cost of sales x 365
shorter inventory period is better measures the average number of days’ inventory is held
inventory turnover measures how many times on average inventory is “sold” during a period
Receivable period = accounts receivable / sales x 365
shorter the better ideal is 30 days
shows how long it takes the business to recover debts
Payable period = accounts payable (AIP) / cost of sales x 365
the longer the better, because you want to pay at the latest you can
AIP = trade payable
FINANCIAL OR MARKET STRENGTH RATIOS
Earnings per share = profit after tax / number of shares
Price earnings (PE) ratio = market price / earnings per share
the higher the better
shows that future performance is going to be positive
there is a change in the future the stock will grow faster
higher PE reflects the high confidence of the market
,Look at perspective of potential investor would like to be PE to be lower because he has to pay more and the
stock is risky if PE is higher
Dividend yield = ordinary share dividend / market price x 100
- Low yield: means company retained large portion of profit to reinvest
- High yield: means risky company or slow growing better for investor because wants higher dividend
High gross profit margin means that you do not want to increase your selling price, but you have a better
position with the supplier and good margining which lead to low cost of sales
Operating profit margin operating expenses are higher and that is why the operating profit is lower than the
gross profit. However, still better than the market
Low liquidity because of High liabilities, Low assets
Main problem shortage of cash can be solved by getting more loans to have more cash and still their gearing
ratio will be below the market
,CONSOLIDATION
When one company acquire another running company net assets of that company are acquired, this is known
as take over
Normally control comes with more than 50% shares
The first company has enough voting power to appoint, reappoint, change all the directors of the second
company (50% and voting power)
It’s parent company’s responsibility to make consolidated accounts
The consolidated statement of financial position should show all assets and liabilities of the parent and
subsidiary
The intra –groups transactions are excluded for example, accounts receivables and payables
frommthird parties are shown, but what happens between parent and subsidiary will be not sown
THE MECHANICS OF CONSOLIDATION
W1 – establish the group structure (who acquired who, how much percentage (deel/geheel), what date)
W2 – net assets of subsidiary at acquisition, reporting and post-acquisition: once parent company takes over the
subsidiary company, from that date the subsidiary company can’t issue new shares, which means share capital and
share premium will stay the same, so acquisition will stay some as reporting. (this is a limitation in our course)
Details At acquisition date At reporting date Post-acquisition
Share Capital xxx xxx -
Share premium xxx xxx -
Retained earnings xxx xxx xxx
Fair value adjustment xxx xxx -
Unrealized profit (PUP) - (xxx) (xxx)
Accumulated depreciation - (xxx) (xxx)
Net Assets xxx* xxx xxx**
*Goes to working of goodwill (W3) as “fair value of net assets at acquisition” as “minus”.
**Goes to working of “NCI” (w4) as “NCI % of post-acquisition value”
**Goes to working of “consolidated retained eastings” (w5) as “parents % of net assets post acquisition”.
Revenue = retained earning
Unrealized profit
Profit margin = profit of sale = 20/100 = 20%
Mark up = percentage of profit on top of the cost = 20/120
When subsidiary sells to parent pup in w2
When parent sells to subsidiary pup in w5
Profit cannot be counted if it is sold between parent and subsidiary
, Start with cost of investment
Fair value of NCI at acquisition
= share capital at acq x share
price at acq x NCI%
NCI% x w2 post acq
NCI% x impairment loss
% parent x w2 post acq
% parent x impairment loss
pup if parent sub
Consolidated statement of financial positions (both = parent + subsidiary)
P,p,e (both + fair value adjusted – depreciation ) Equity share capital (parent only!)
Inventory (both – pup) Group retained earnings (w5)
Receivables (both – CIT – intra company transactions) NCI (w4)
Bank (both) Payables (both – intra company transactions)
Cash in transit (CIT) Other loans
Goodwill (w3)
Total assets Total liabilities
