?%202003%20McGraw-Hill%20Australia%20Pty%20Ltd,%20PPTs%20t/a%20Applications%20for%20Financial%20Accounting%20by%20David%20Willis,

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ANALYSIS INTERPRETATION OF FINANCIAL REPORTS
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• LEARNING OUTCOME
• TO ANALYSE AND INTERPRET FINANCIAL REPORTS AND
  RELATED INFORMATION IN ORDER TO PROVIDE ADVICE TO
  MANAGEMENT

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KEY TERMS

• accounts receivable turnover ratio
• budget
• equity ratio
• gross profit ratio
• inventory turnover ratio
• net profit ratio
• quick asset ratio

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KEY TERMS

• ratios
• return on equity ratio
• return on asset ratio
• Statement of Financial Performance
• Statement of Financial Position
• variance
• working capital ratio

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CLASSIFICATION OF STATEMENT OF FINANCIAL
PERFORMANCE

• COST OF GOODS SOLD
• OPENING INVENTORIES
• PLUS PURCHASES
• OTHER TRADING EXPENSES
• LESS CLOSING INVENTORIES
• OTHER INCOME
• SELLING EXPENSES
• ADMINISTRATION EXPENSES
• FINANCE EXPENSES
• OTHER OPERATING EXPENSES

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CLASSIFICATION OF STATEMENT OF FINANCIAL POSITION

• CURRENT ASSETS
• CURRENT LIABILITIES
• WORKING CAPITAL
• NON-CURRENT ASSETS
• TANGIBLE
• INTANGIBLE
• INVESTMENTS
• NON-CURRENT LIABILITIES
• OWNERS EQUITY
• CAPITAL
• DRAWINGS
• NET PROFIT/LOSS

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BUDGETS

• A budget is a plan of expected future action
  expressed in monetary terms
• A variance is the difference between an actual
  result and a budget result
• Use review of Statements of Financial
  Performance and Position
• actual results are compared to the expected
  results
• variances are analyses
• explanations for these variances are given

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ADVANTAGES OF BUDGETING

• Compare the results of various items with
  previous years results
• Set future budgets
• Review variations from budgets and determine
  reasons
• Take remedial action for future periods
• Make decisions re future expansion
• Establish future marketing and selling practices
• Ascertain the reliability of budget forecasts

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RATIOS

• Ratios are tools that enable management to
• Measure and compare information within a business
  over several periods
• Compare similar businesses in the same industry

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Sources of information

• Information used in ratios comes from
• Statement of Financial Position
• Current ratio
• Liquid or quick asset ratio
• Debt to equity ratio
• Statement of Financial Performance
• Gross profit ratio
• Net profit ratio
• Both Statement of Financial Position and
  Performance
• Accounts receivable turnover

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TYPES OF RATIOS PROFITABILITY
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TYPES OF RATIOS PROFITABILITY
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TYPES OF RATIOS FINANCIAL STABILITY
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TYPES OF RATIOS EFFICIENCY

• Inventory efficiency ratios

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TYPES OF RATIOS EFFICIENCY

• Accounts receivable

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TYPES OF RATIOS OTHER RATIOS
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INTERPRETATION OF RATIOS

• Profitability ratios
• Financial stability ratios
• Ratios of efficiency

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INTERPRETATION OF RATIOSPROFITABILITY RATIOS

• Gross profit ratio
• Shows the return on net sales prior to adding
  revenue or deducting expenses
• Reasons gross profit ratio increases
• selling prices increase and purchase price
  remains unchanged
• opening inventory undervalued
• closing inventory overvalued
• purchase bought at lower price

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INTERPRETATION OF RATIOSPROFITABILITY RATIOS

• Gross profit ratio
• Reasons gross profit ratio decreases
• discounts given on sales products
• closing inventory undervalued
• obsolete or damaged stock written off
• purchases bought at higher price but sales values
  not adjusted

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INTERPRETATION OF RATIOSPROFITABILITY RATIOS

• Net profit ratio
• Shows the amount earned by normal activities
  after accounting for other revenue and expenses
• Measures operation efficiency
• Reasons net profit ratio increases
• expenses decrease
• operating revenue increases
• fixed costs spread over higher sales revenue

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INTERPRETATION OF RATIOSPROFITABILITY RATIOS

• Net profit ratio
• Reasons net profit ratio decreases
• expenses increase at higher rate than COGS
• other operating revenue sources decline
• To arrest declining net profit margins
• investigate business selling plans and techniques
• increase effective promotion and advertising
• encourage areas of operating revenue
• review alternative and cheaper interest rates
• review all expenses

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INTERPRETATION OF RATIOSPROFITABILITY RATIOS

• Return on equity ratio
• Shows the return on every dollar invested in the
  business
• Return on assets
• Indicates the earning capacity of the business
• Measures efficiency of business asset usage

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INTERPRETATION OF RATIOSFINANCIAL STABILITY
RATIOS

• Working capital ratio
• Test of business solvency, to see if it can meet
  short-term debts from its current assets
• Shows amount of dollars to cover every dollar of
  liabilities
• The higher the ratio, the better the position of
  the business

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INTERPRETATION OF RATIOSFINANCIAL STABILITY
RATIOS

• Working capital ratio cont...
• Acceptable ratio must be well above 11
• Unacceptable ratio must be below 0.71
• May require injection of capital
• Above 41
• Inventory investment to high
• Cash at bank may need to be invested short term
  for higher return

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INTERPRETATION OF RATIOSFINANCIAL STABILITY
RATIOS

• Quick asset ratio
• Only the liquid business items that easily
  convert to cash are used
• Inventories and prepayments are excluded from
  current assets and the bank overdraft from
  current liabilities
• Ratio well above 11 is acceptable

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INTERPRETATION OF RATIOSFINANCIAL STABILITY
RATIOS

• Equity ratio
• Shows relationship of owners equity invested in
  business to the total assets of the business
• It is the degree to which the business relies on
  owner capital
• The higher the ratio, the lower the need for
  externally borrowed funds
• High equity ratio long-term financial stability

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INTERPRETATION OF RATIOSRATIOS OF EFFICIENCY

• Inventory turnover times
• Means the number of times that inventories turn
  over per year
• Inventory turnover in days
• Low turnover rate indicates inventory levels are
  too high
• Product demand may have slowed

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INTERPRETATION OF RATIOSRATIOS OF EFFICIENCY

• Accounts receivable turnover
• Measures the efficiency of management in
  collecting the debts of the business
• The shorter the period of collection, the greater
  the cash flow of the business
• Long collection periods may lead to bad debt

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LIMITATIONS OF RATIOS

• Ratio analysis and interpretation can be
  influenced by factors such as
• poor or inadequate accounting methods
• incomplete financial reports
• changes in accounting methods
• existence of unusual items during a financial
  year e.g. losses by fire
• management changes
• changes to the economy, such as an industry
  recession