Notesale: Turn your study into money

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Investors

Lenders

Employees

Analysts

Profitability

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Auditors

Managers
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Growth Potential
Return on Investment
Risk
Liquidity
Management Efficiency

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USER’S INFORMATION NEEDS
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Requirement of information from financial report vary from users
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General financial reports not always give specific information for certain users
Users
Define Users
Information Needed
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Profitability, especially futures ones
Management efficiency
Equity investors vary depending on whether it’s a small or 
Eg
...
However, in general they take on risks to do
Investors
with ownerships and they are entitled to any rewards after 
Return on their investment (within firm and compared with alternatives
other prior claims have been met
...
)
Preference shareholders differ from ordinary shareholders in
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Profitability, mainly future ones
such a way that they are entitled to fixed rate of dividend and
Preference

Net realisable value of asset
to repayments before ordinary shares
...

There are three types of lenders: short term creditors, medium Different lenders broadly have same need for information, but their emphasis on them
Lenders
term lenders and long term lenders
change depending on whether the loan is long term or short term
...

Creditors
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Profitability and future growth
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Risks (financial and commercial)
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Profitability (future cash for repayment of loan)
Medium
They are usually banks or other financial institute
...


Interest cover (how well interest is covered by profit made)
Profitability (average profits per employee for purposes of productivity bargaining)
They are interested in judging their job security and whether 
Employees
their wages are relatively fair
...
Such They have wide ranging interest in all type of information about the entity (in a similar
Analysts
organisation include superannuation funds, investment banks, way to investor/ownership groups)
stockbroking firm, etc
...

information, however, in order to carry out audits effectively,
Auditors

Variation from the norm
they will use this information to analyse accounts
...
They also require detail information on the
Managers
day to day basis
...


INFORMATION AVAILABLE FOR FINANCIAL DECISION MAKING
Information for users to help them make financial decision can come from sources like:
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Company’s website
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Financial advisors like brokers
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Finance magazines, and daily media coverage on TV, in newspaper and online
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Australian Securities Exchange (ASX) data
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A company’s annual report (As required by Corporation Act 2001 and ASX Listing Rules if it’s a public company)
Australian Securities Exchange (ASX) data
ASX provides:
 Company profile, like detail about the company, principal business activities, and dividends declared and paid, etc
...

Measures
business’s
capacity to pay its
liabilities in short
term (next month
or two) using
quickly available
asset

Reason for
Increase
LIQUIDITY RATIOS: assist in assessing the business’s ability to meet financial commitments in both the short and long term
...


Higher = More Liquid
Ideal: 𝑥 > 1: 1

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Reduced use of creditor finance
Increased sales of debtors

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Improved stock
Improved debtors turnover
Additional creditors

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𝐶𝐴𝑠𝑠𝑒𝑡 − 𝑆𝑡𝑜𝑐𝑘 − 𝑃𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝐶𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 − 𝑂𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡
= ($: $ 𝑜𝑟 %)

Increased use of trade
creditors
Slower debt collection
Increase use of short term
finance

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Related Ratio

Decrease

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Total assets
Debtors
Collection
Stock Turnover
Debt to Equity

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Debtors
Collection
Net Profit

LEVERAGE RATIOS: describe the extend which business funded its operations from borrowed funds rather than equity

Debt to
Equity

Measures how
business has
funded its asset
by comparing
total liabilities to
contributed
equity
...
wages)
Improved efficiency of NC asset
Change in credit policy
Improved economic conditions

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Higher gross profit rate
Improved sales
Improved expense control
Lower stock loss
Gain on asset sale

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Reduced external financing
Additional funds by owner
Increase in net profit

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Owner’s Equity
Total Assets
Net Profit

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Reduction in sales
Competition
Increase COS
Higher stock level
Slow selling price
Less credit availability on
sales

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Net Sales
Stock Turnover

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Net Profit
Gross Profit

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Decrease in sales
Increased in expense
Tightening up of credit
policy
Rise in costs

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Higher cost of sales
Poor expense control
Increase depreciation
Stock losses
Sales decrease
Poor economic conditions

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Gross Profit
Operating Ex
Owner Investment
Return on Asset

PRIFITABILITY

Gross
Profit

Operating
Expenses

Profit
(Margin)

What is the level
of profit on direct
costs?

What are the cost
in operating?

Measures amount
of profit as % of
net sales
...

Relates the profit
before income tax
and interest to the
finance costs

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𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑠𝑡 (𝐸𝑥 & 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑠𝑒𝑑)
= (𝑡𝑖𝑚𝑒𝑠)

Higher = Better

Higher = Safer
Ideal: 3/4 times = Safe
𝑥 < 3 𝑜𝑟 4 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡
𝑥 > 3 𝑜𝑟 4 = 𝑐𝑎𝑛 𝑏𝑜𝑟𝑟𝑜𝑤 𝑚𝑜𝑟𝑒

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More active asset
Less idle asset
Improve expense control

Idle asset
Poor expense control
Replace/upgrade of NC
Asset
Asset Revaluation

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Net Profit

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𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥
× 100
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡
= (%)

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Increase level of debt
Increase interest rate

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Reduce level of debt
Reduce interest rates

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Price/Earnings

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Credit policy review (billing and
follow up)
Cash disc
Stricter approval
Improved economic conditions

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Change in credit terms
Lenient credit approvals
Poor collection methods
Poorer economic
conditions

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Net Profit
Current
Quick

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Write of obsolete stock
Better product mix
Improved sales
Better stock control
Improved advert
Lower stock level

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Slow moving or obsolete
stock
High stock level
Increased competition
Stock valuation
Inefficient buying
Less sales due to stock
unavailability

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Net Profit
Gross Profit
Current
Quick

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Higher profit

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Lower Profit
Share issue throughout
year

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Profit
Price/Earnings
Dividend Yield

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Market price on the rise
Profits increased
Investors believe in future growth

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Poor profit growth
Lower profit
Unfavourable market price

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Profit
Earnings Per
Ordinary Shares
Dividend Yield

EFFICIENCY RATIOS

Debtors
Collection
Period

Inventory/
Stock
Turnover

Measures
effectiveness of
business in
collecting amount
owing from
debtors
...
)

Lower = Better
Ideal: within 30 days
𝑥 < 𝑤𝑖𝑡ℎ𝑖𝑛 30
= need to make use of credit sales
𝑥 > 𝑤𝑖𝑡ℎ𝑖𝑛 30 = need to better collects

Higher = Better

MARKET RATIOS

Earnings
Per Share

Price/
Earnings

Dividend
Yield

Measures profit
available to
ordinary
shareholder
expressed as an
amount per share
...

Measures the
current return to
an investor on
buying a share on
the stock market
...


Higher = Better = More appealing to investors
(higher dividend)

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Higher profit for dividends

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Low profits = no dividends

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Profit
Earnings Per
Ordinary Share
Price Earnings

LIMITATIONS IN ASSESSING PERFORMANCE AND FINANCIAL POSITION
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Ratios are just as good as the figures provided in the financial report, therefore, if there’s error in report then ratios aren’t valid
Limitation of Ratio Financial Analysis
1
...
Need to be compared to an industry wide standard to be further evaluated, but standards aren’t always available
 Company may have improved over year or doing better than another business but may not be good enough for standard
3
...
Most media reported market ratio use data from previous year to calculate certain ratios
 Leads to incorrect interpretation of published ratios
5
...
in stock market downturn, company profit (& dividends) may increase but share price will go down with general market trend
6
...
companies run down creditors to an unrealistic level
Limitation of Ratio Financial Analysis
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Not always possible to compare ratios between companies
 Because may have different accounting policies that affect ratio calculation
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Choice of accounting method cause variation in different business statements and their difference can be regarded to such items like:
 Cash or accrual accounting
 Balance day adjustment
 Different method of inventory valuation
 Different depreciation method or rates of depreciation
 Historic or fair value accounting
 Different balance date (Aus = 30 June, other countries = different)
Lack of Disclosure

Financial statement of company give overall view of company’s result rather than specific and detailed information
 Sometimes, specific information included in in notes to financial statement
 However, some information not in report, making it difficult to calculate report

Lack of disclosure is evident when information isn’t good
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Companies like to show “good news” so if it’s not required by law of ASX they wouldn’t show “bad” information



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