International Financial Statement Analysis

ANALYSIS OF INTERNATIONAL FINANCIAL STATEMENT:

FRAMEWORK FOR ANALYSIS - ENVIRONMENTAL FACTORS,
CULTURAL AND ACCOUNTING VALUES, ACCOUNTING VALUES,
LANGUAGE, TERMINOLOGY AND FORMAT AS WELL AS
ACCOUNTING RATIOS.

PRESENTED BY:
ALOHAN Osayamen Bright

BEING A PAPER PRESENTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS

OF INTERNATIONAL ACCOUNTING FOR THE AWARD OF MASTER OF SCIENCE
(M. Sc) DEGREE IN ACCOUNTING IN THE DEPARTMENT OF ACCOUNTING,
FACULTY OF SOCIAL AND MANAGEMENT SCIENCES, WELLSPRING
UNIVERSITY, BENIN CITY.

COURSE LECTURER:
PROF. OKOYE A. E.

MAY, 2019

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International Financial Statement Analysis

INTRODUCTION

Financial statements are a means through which the managers of entities report their
activities to stakeholders. The financial statements reveal a firm’s performance, financial
and cash positions at the end of a particular period. Through the financial statements,
shareholders, potential investors and other stakeholders are able to evaluate whether or not
the business is doing well. With efforts now made by international accounting bodies to
harmonise accounting practices globally, financial statements are expected to be useful to
stakeholders in the national and international arena. With harmonisation, it is expected that
financial statements prepared by a company in one country could be compared with the
one prepared by another company in another country. Also, with harmonisation, investors
are better motivated now than before to invest in companies that are outside their own
countries. Before an investor invests in a company, there is the need for proper analysis of
the financial statements of the company. In this paper, I shall be discussing the analysis of
international financial statement under the following framework: Environmental Factors;
Cultural Values; Accounting Values; Accounting Language, Terminology and Format.
The second part of the paper shall focus on Ratio Analysis.

MEANING OF INTERNATIONAL FINANCIAL STATEMENTS

The communication function of accounting is performed via the preparation of and

issuance of financial statements (Ejezelue 2001). Financial Statements can therefore be
viewed as formal records of the financial activities and position of a business, person or
other entity. Today, the world has become a global village. Financial statements prepared
in one country can be useful in another country. The drive towards the harmonisation of
accounting practices is to ensure that financial statements prepared by a company in a
particular country can be useful to financial information users throughout the globe.
Financial statements helps in the measurement of past and present performance of a
business and to also predict future performance.

ELEMENTS OF FINANCIAL STATEMENTS

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International Financial Statement Analysis

The International Accounting Standards Board (IASB) Framework discusses the five
elements of financial statements as follows:

Assets – a resource controlled by an entity as a result of past events from which future
economic benefits are expected to flow to the entity.

Liabilities – a present obligation of an entity arising from past events the settlement of
which will result in an outflow of resources that embody economic benefits.

Equity – the residual interest in an entity after the value of all its liabilities has been
deducted from the value of all its assets..

Income – revenue arising in the course of the ordinary activities of an entity plus gains on
the disposal of non – current assets.

Expenses – payments arising in the normal course of activities, such as the cost of sales
and other operating cost, including depreciation of non - current assets plus losses arising
from disposal of non – current assets or damage due to fire or flooding.

COMPONENTS OF FINANCIAL STATEMENT

In line with International Accounting Standard (IAS) 1, a complete set of financial

statements consist of:

1 A statement of financial position as at the end of the period;

2 A statement of profit or loss and other comprehensive income for the period
3 A statement of changes in equity for the period
4 A statement of cash flow
5 Notes to these statements

USERS OF FINANCIAL STATEMENT

Financial Statements are used by a variety of stakeholders for various reasons. Financial
Statements enable users of financial information to make key decisions which may include
management decisions, investment decisions, lending decisions, employment decisions
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International Financial Statement Analysis

etc. The users of a company’s financial statement therefore include: the shareholders,
managers, creditors, lenders, potential investors, the government, employers, banks etc.

ENVIRONMENTAL FACTORS AFFECTING INTERNATIONAL FINANCIAL

STATEMENT

In the accounting literature, environmental factors are considered the major reason behind
international accounting diversity. Roberts et al. (2005) conclude that accounting rules and
practices are influenced by a large number of quite different factors. Particularly important
are the political and the economic system, the legal system, the taxation system, the
corporate financing system, and the accounting profession factors in each group.

The Economic environment

The economic environment exerts an important influence on financial reporting

frameworks. The economic environment provides structures which determine the
information that needs to be reported. The major economic factors that influence the
development of frameworks are: privatization, economic openness, the stage of economic
development, and international trade.

Importance of the private sector. Privatization increases the need for publicly available
financial information. As such, Ashraf and Ghani (2005) relate the evolution of Pakistan’s
accounting practices to different economic developments including the increasing role of
the private sector. Mashayekhi and Mashayekh (2008) also mention privatization as one of
the factors that has affected accounting development in Iran. Al-Akra et al. (2009)
consider that privatization was one of the motives for adopting International Financial
Reporting Standards (IFRSs) in Jordan..

Economic openness. In an open economy, the investment environment must be attractive

to foreign investors. This implies the presence of a good financial reporting framework
that ensures the quality and the comparability of financial statements. Many developing
countries have changed their financial reporting frameworks in the hope of increasing

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International Financial Statement Analysis

foreign investment. Haniffa and Cooke (2002) argue that the demand for disclosure is
greater when a high proportion of companies’ shares are held by foreigners

Stage of economic development. Ding et al. (2007) claim that countries at different
stages of economic development are expected to have different accounting practices.
Archambault and Archambault (2003) declare that firms need to raise more capital when
the economy becomes more developed. As a result, the need for financial reporting
increases. In his early study, Nobes (1983) states that economic factors (the degree of
development of the economy and the nature of the economic system) are influential factors
on the financial reporting practices in developing countries. Nobes (1998) also observes
that the level of economic development is not the key predictor for the split between
Anglo-Saxon accounting and continental European accounting. Roudaki (2008) and
Mashayekhi and Mashayekh (2008) find evidence for the effect of economic development
on the accounting profession and standard setting in Iran. In the Arab world, several
studies emphasize the effect of economic development on financial reporting frameworks.
Al-Shammari et al. (2007) finds that economic growth has encouraged the adoption of the
IFRSs by GCC states. Along the same lines, Mosebach (2005) confirm the impact of the
stage of economic development on the development of accounting in Egypt. Naser et al.
(2006) conclude that the degree of social disclosure in Qatar is related to the stage of
economic development.

International trade. The financial reporting approaches that are used by international
trade partners affect the national financial reporting framework. Irvine (2008), for
example, argues that trade partners pushed the UAE to adopt IFRSs. The trade
relationships between the UAE and European countries put a pressure on the UAE to
adopt these standards. The influence of international trade is also confirmed by other
studies (e.g. Gray, 1988). In summary, accounting standards and practices are affected by
economic factors, such as privatization, economic openness, the stage of economic
development and international trade. These factors determine the characteristics of the
accounting information needed, and accordingly the characteristics of financial reporting
frameworks.
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International Financial Statement Analysis

Political environment

Roberts et al. (2005) make a link between the political and the economic system. They
consider the political-economic system one of the most important determinants of
financial reporting regulations and practices. The authors believe that financial reporting is
affected by the way a country organizes its economic relations. The type of political
system and accordingly the intervention of the government in economic issues impact the
financial reporting framework used. Almost all developed countries have well-established
political systems which are based on high levels of democracy, freedom, political stability
and a culture of accountability. These political characteristics are reflected in their
business systems including their financial reporting frameworks. On the other hand,
developing countries often lack some or all of these characteristics. Even if they are
present, their political systems are often exposed to change. Nobes (1998) claims that
political systems do not affect accounting in developed countries since they are probably
sufficiently homogeneous in these countries, but they may affect it in developing
countries. In the accounting literature, factors such as the political structure, political and
civil freedom, political participation, and democracy are believed to affect, mainly
indirectly, the financial reporting frameworks, especially in developing countries.

Legal and tax environment

The legal and the tax environment have a direct effect on how accounting is regulated.
Many authors find that the legal environment has a significant influence on the
development of accounting standards and practices (e.g. Gray, 1980). The influence of the
legal environment on accounting has been addressed in the accounting literature mainly
through the distinction between ‘common law’ and ‘code law’ systems. The type of legal
system can substantially influence the orientation of accounting regulations and of the
related laws such as commercial law and company law. It thus determines the form and the
objectives of the financial statements. Financial reporting frameworks in common-law
countries are oriented towards fair presentation, transparency, and full disclosure (known
as the Anglo-Saxon model). Standard setting and enforcement are primarily private-sector

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International Financial Statement Analysis

functions. The interference of the public authorities is limited. The stock market is the
dominant source of financing for corporate entities. Therefore, financial statements are
primarily intended to satisfy shareholders and investors. The legal framework emphasizes
shareholders’ rights. By contrast, governments in code-law countries establish and enforce
national accounting standards, typically with representation from major political groups
such as labor unions, banks and business associations. Banks or governments are the main
sources of financing. Therefore, financial reporting is geared towards creditor protection
(known as the Continental model). Financial reporting is characterized by low disclosure
and an alignment of financial accounting with company law and taxation.

The tax environment also has an impact on the financial reporting framework. In some
countries, financial reports effectively reflect tax laws. Nobes (1983) claims that the
impact of tax rules on accounting measurement is an influential factor.

Professional environment

The quality of the financial reporting is affected by the degree of development of the
accounting profession. The development of the accounting profession is a broad concept.
It can be measured in several ways. Important indicators are:

· the adequacy of accounting standards,

· the presence and the importance of professional bodies,

· the adequacy of accountants’ qualifications, and

· the availability of legal and regulatory backing.

Business environment

The business environment determines to a large extent the form and the content of the
information needed and thus helps shape the financial reporting framework rules and
practices. We will consider the following factors of the business environment:

· firms’ characteristics,
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International Financial Statement Analysis

· degree of capital market development, and

· prevailing type of financing system.

Firms’ characteristics. In the accounting literature, different firm characteristics are

believed to affect the type of accounting information needed and hence the necessary
features of the financial reporting framework. The most influential characteristics are size,
industry sector, legal form, ownership concentration, and listing/cross-listing status.

Size. Many authors assert that firm size is an important determinant for the disclosure
level and the financial reporting framework in general. large firms disclose more
information because they have a wider ownership base than smaller companies. Large
firms will have a greater need for using a variety of accounting policies. Therefore, across
countries there will be a higher variability of disclosure and measurement practices for
large firms than for small firms. Industry sector. Financial reporting frameworks and
accounting harmonization are influenced by the dominant industries. Industries such as oil
and banking are influential in orienting the accounting standards and practices. In the
second half of the last century, accounting was introduced to some developing countries
following the appearance of the oil industry. The effect of this industry is still perceived in
the financial reporting frameworks of these countries.

Capital market development. Capital markets influence accounting rules and

enforcement practices. In some counties, accounting is regulated mainly by the regulations
of capital markets. Furthermore, the push for changes in accounting practices appears to
come from the capital Markets. Archambault and Archambault (2003) argue that the
nature of capital markets influences the information requirements of investors. Companies
from countries with large capital markets disclose more information than companies from
countries with small capital markets

International environment

The local financial reporting framework is not only influenced by the local environment.
The international environment may contribute heavily in shaping the characteristics of
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International Financial Statement Analysis

financial reporting frameworks, especially in developing countries. Accounting in a

particular country can be developed as a result of the country’s engagement in the
international community. International parties (countries, organizations) may encourage or
urge a country to use particular rules of accounting. Most financial reporting frameworks
used in developing countries have been directly imported from the West through western
multinational companies, colonialism in the past, aid and loan agencies from the
industrialized nations and the influence of local professional associations, usually founded
originally by western counterpart organizations (Baydoun and Willett, 1995).

CULTURAL VALUES AFFECTING FINANCIAL STATEMENT

A considerable body of prior studies addresses the relationship between the financial
reporting framework and cultural environment. The most widely known studies are by
Hofstede (1980, 1983, and 1984) and Gray (1988). Hofstede (1984) identifies culture as
the collective programming of the mind which distinguishes the members of one group or
society from those of another. He highlights four dimensions of international differences
in cultural values relating to the environment of a country’s financial reporting framework.
These are:

Individualism versus collectivism is how in a society one group will prefer a much closed
family system while the other group prefer belonging to an expanded family system. This
cultural dimension looks at how society handles interdependence among individuals.

The second cultural dimension, large versus small power distance seeks to divide a
society between those few powerful groups of people who prefer power to be distributed
unequally through institutions and organizations and those who feel that power should be
distributed equally. This dimension addressed how a society handles inequalities amongst
a people when they occur.

The third cultural dimension by Hofstede, is the strong versus weak uncertainty
avoidance which is, the extent to which members of a society feel uncomfortable with
uncertainty and ambiguity .This feelings leads them to believing in promising certainty

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International Financial Statement Analysis

and to maintain institutions protecting conformity. He explained that a society with strong
uncertainty avoidance maintained rigid codes of belief and behaviour and are intolerant of
deviant people and ideas. The weak uncertainty maintain a more relaxed atmosphere in
which practice counts more than principles and deviance is more tolerated.

Masculinity and femininity, which is the last but not the least of the four cultural
dimensions, describes masculinity as the preference, in a Society for achievements,
heroism, assertiveness, and material success. Femininity on the other hand was said to
represent a society where preference for relationships, modesty, caring for the weak and
the quality of life is high. It can be argued that different forms of culture prevent unified
accounting practices globally. He defines the cultural environment as a national (or
regional) system comprising language, religion, morals, values, attitudes, law, education,
politics, social organization, technology, and material culture. He asserts that the
interaction of these cultural elements on accounting is expected to be exceedingly
complex.

It is quite obvious that cultural values have influenced the practice and reporting of
accounting and countries with similar cultural values practicing accounting similarly. With
the world becoming a global village and the fast cultural changes across the world, the
need for harmonization and convergence of accounting standards was given a serious
consideration by centrally planned countries, but a country like China, although have made
efforts to embrace international financial reporting system, is still holding on to some of its
cultural accounting practices. This is an indication that so far as cultural values remain
different, accounting practice will be affected and the only way out is the harmonization
and convergence of accounting standards.

ACCOUNTING VALUES AFFECTING FINANCIAL STATEMENT

Gray (1988) decided to explore this relationship by deriving four accounting values from
various accounting literature and relating them to Hofestede’s (1984) cultural dimensions.

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International Financial Statement Analysis

Hofestede (1984) and Gray’s (1988) correlating values provide a majority of the
foundation in culture and accounting research done today.

Professionalism versus statutory control. Gray’s (1988) first value is professionalism

versus statutory control. This is the dichotomy for the preference of professional judgment
and self-regulation versus complying with strict legal requirements and control. This
concept is very important in accounting as it is the accountant’s job to make independent
legal and ethical decisions in any practice.

Uniformity versus flexibility. His second value is uniformity versus flexibility.This is a

preference for uniform and consistent accounting practices between companiesrather than
accepting varying practices deemed necessary in certain situations (Gray, 1988). The
desire for uniformity can be seen in FASB’s conceptual framework through the accounting
principles of consistency and comparability (FASB, 2006). However, it may need to retain
some room for flexibility in order to adjust to varying cultural dimensions.

Conservatism versus Optimism. The third set of values Gray (1988) derived is
conservatism versus optimism. This suggests a preference for remaining cautious in
measurements when dealing with an uncertain future rather than being more optimistic and
risky in reasoning (Gray, 1988). A conservative perspective in accounting is easily seen as
many principles are based on this view, such as objectivity, verifiability, reliability and the
practice of lower of cost and market (Baydoun & Willett, 1995). It seems that the typical
accountant mind tends to be more conservative while others, such as entrepreneurs, tend to
be more risky. Conservatism also suggests a strong uncertainty avoidant tendency in order
to be more cautious and cope with the unknown (Gray, 1988).

Secrecy versus transparency. The last of Gray’s (1988) values are secrecy versus
transparency. This would be a tendency for confidentiality and restricting information
about the business to those who are closely connected versus being more open and
accountable to the public. This is a difficult dichotomy in accounting as a business wants
to maintain their security from competitors but there is also a need, especially today, to
remain transparent and accountable to the public (Gray, 1988). Determining whether a
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company is more secret or transparent can be seen in the number of items they disclose
and how many and what is included in supplementary statements (Baydoun & Willett,
1995). A secret culture is related to high power distance by restricting information in order
to maintain unequal powers. Transparent cultures tend to be more feministic as they are
more caring and put more emphasis on being open with people (Gray, 1988).

ACCOUNTING LANGUAGE, TERMINOLOGY AND FORMAT AFFECTING

FINANCIAL STATEMENT

Accounting is the universal language of business. In the simplest sense, it is the process of
recording what happens in a business on a daily basis. Sure, we are recording the naira
involved in each transaction, but we are also recording the economic meaning of the
transaction and categorising it in a way that will give us useful information later for
decision – making and planning.

After being entered using the categories on the chart of accounts, the accounting data is
summarised into a standardized format which is broken into three different financial
statements:

Statement of Financial Position; Income Statement and Statement of Cash Flows.

Let’s look more at these three basic financial statements and analyse the story they are
telling us.

Statement of Financial Position

The statement of financial position tells the story of what your business owns (assets) and
what it owes (liabilities) as of a given moment in time (say, December 31). It is literally a
“snapshot in time”.

During the month, as transactions are recorded, the impact of each transaction on the
assets and liabilities of the business is also recorded. For example, when you make a cash
sale, you not only record income, but you also record an increase in the value of an asset –
your cash balance. When you incur an expense, you record the amount of the expense, but
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International Financial Statement Analysis

you also record the reduction in the value of your cash. (This is why it is called “double
entry” accounting).

The difference between the assets and the liabilities of the business represents the book
value of the business represents the book value of the owner’s equity in the business. In a
corporation, this is referred to as shareholder’s equity.

The balance sheet is used primarily to help us understand the financial strength of a
business changes in the balance accounts over time help us understand important trends in
the business as well.

The Income Statement

This can also be referred to as the “Statement of Activities”. This statement tells the story
of what your business actually accomplished during the time period that it covers (for
example, the month of December). It does this by summarising the economic results of all
the transactions that occurred during the time, and letting you know if you made profit or
lost money on those activities.

You can learn a lot about your business from analysing the income statement. It is not
enough to simply know if you made or lost money. You will also want to use this
statement to understand exactly where your money is going each month.

Also, by comparing different spending categories as a percentage of sales from month – to

– month and watching your sales, cost of goods sold, and spending trends, you can get a
pretty good idea of any changes that you need to make to become more profitable.
Negative trends on the income statement are important to investigate – don’t ignore them.

Statement of Cash Flow

Last, but certainly not least, is the statement of cash flows. Many businesses don’t bother
with this statement, but it is an extraordinarily story teller. This statement explains the

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change in your cash balance from the beginning to the end of the period, by breaking
down your business activity into three sections:

1 Cash Flow from operations

2 Cash Flow from investing activities (e.g, funds used to purchase assets)
3 Cash Flow from financing activities (such as loan proceeds or loan repayments).

Since good cash flow is critical to any business, it is extremely important to clearly
understand where your cash is coming from and where it is going. This statement is a little
trickier to learn to read, but it is worth the effort.

Understanding the story of your business as told through your financial statements is a
powerful tool for business success. You will be glad you took the time to learn the
language.

Accounting Terminology

As discussed in the previous section, Accounting is said to be the language of business.

Accountants in preparing accounts use various terminologies that are eccentric to the
profession. Terms such as assets, liabilities, profit, loss etc are used more by accountants
compared to members of other professions. It has however been observed that these
accounting terminologies vary from one jurisdiction to another. Herve, Lebas & Ding
(2010) give how some of these terms are used in the US AND UK in comparison with the
recommendation by the International Accounting Standards Board (IASB).

USA UK IASB
Balance Sheet or SFP Balance Sheet Statement of Financial
Position or B/S
Long term or fixed assets Fixed Assets Non Current Assets
Real Estate Land and Buildings Land and Buildings
Inventories Stock Inventories
Receivables Debtors Receivables
Doubtful Accounts Bad Debt, Doubtful Debt Bad Debts
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International Financial Statement Analysis

Common Stock Ordinary Shares Share Capital

Loans Debt Loans
Long Term Liabilities Creditors Long Term Liabilities
Accounts Payable Trade Creditors Accounts Payable
Income Statement Profit and Loss Account Statement of
Comprehensive Income
Sales Turnover Revenue
Expense Charge Expense
Income Profit Profit

Accounting Format
Financial statements are presented by accountants in different formats. In most cases, the
format used will depend on the one that is permissible in a particular region or country.
The statement of financial position and the statement of profit or loss and other
comprehensive income can generally be presented using any of two formats which are the
‘horizontal or account or traditional’ format and the ‘vertical or report format’.
In the Horizontal format, financial statements are presented in form of a T – Account
where elements of the account appear on both sides of the account. For the statement of
financial position, assets appear on the left hand side of the account while equity and
liabilities appear on the right hand side of the account. For the income statement, expenses
are shown on the left hand side while sales and other incomes are shown on the right hand
side of the account. However, the IASB recommends the report format. Furthermore, the
way items appear in the statement of financial position also differ. In some countries,
assets are presented in increasing order of liquidity while in some other countries, assets
are presented in decreasing order of liquidity. Increasing order of liquidity means that the
most liquid assets (such as cash, receivables) are presented first before the least liquid
assets such as property, plant and equipment. The United States of America uses this form
of presentation. On the other hand, the decreasing order of liquidity means that the least
liquid assets are presented first before the most liquid ones. This is format recommended
by the IASB and it is the form of presentation that is used in Nigeria.
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International Financial Statement Analysis

RATIO ANALYSIS
Financial ratios are a valuable and easy way to interpret the numbers found in statements.
Ratio analysis provides the ability to understand the relationship between figures on
spreadsheets. It can help you to answer critical questions such as whether the business is
carrying excess debt or inventory, whether customers are paying according to terms, and
whether the operating expenses are too high.
When computing financial relationships, a good indication of the company's financial
strengths and weaknesses becomes clear. Examining these ratios over time provides some
insight as to how effectively the business is being operated.
Many industries compile average (or standard) industry ratios each year. Standard or
average industry ratios offer the small business owner a means of comparing his or her
company with others within the same industry. In this manner they provide yet another
measurement of an individual company’s strengths or weaknesses.
Following are the most critical ratios for most businesses, though there are others that may
be computed.

1. Liquidity Ratios
Measures a company’s capacity to pay its debts as they come due. There are two
ratios for evaluation liquidity.

Current Ratio - Gauges how able a business is to pay current liabilities by using
current assets only. Also called the working capital ratio. A general rule of thumb
for the current ratio is 2 to 1 (or 2:1, or 2/1). However, an industry average may be
a better standard than this rule of thumb. The actual quality and management of
assets must also be considered.

The formula is:

Total Current Assets
Total Current Liabilities
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International Financial Statement Analysis

Quick Ratio - Focuses on immediate liquidity (i.e., cash, accounts receivable, etc.)
but specifically ignores inventory. Also called the acid test ratio, it indicates the
extent to which you could pay current liabilities without relying on the sale of
inventory. Quick assets, are highly liquid--those immediately convertible to cash.
A rule of thumb states that, generally, your ratio should be 1 to 1 (or 1:1, or 1/1).

The formula is:

Cash + Accounts Receivable
(+ any other quick assets)
Current Liabilities

2. Debt Ratios
Indicates a company’s vulnerability to risk--that is, the degree of protection
provided for the business’ debt. Three ratios help you evaluate safety:

Debt to Equity - Also called debt to net worth. Quantifies the relationship between
the capital invested by owners and investors and the funds provided by creditors.
The higher the ratio, the greater the risk to a current or future creditor. A lower ratio
means your company is more financially stable and is probably in a better position
to borrow now and in the future. However, an extremely low ratio may indicate that
you are too conservative and are not letting the business realize its potential.
The formula is:
Total Liabilities (or Debt)
Net Worth (or Total Equity)
Times Interest Earned – Assesses the company’s ability to meet interest payments.
It also evaluates the capacity to take on more debt. The higher the ratio, the greater
the company’s ability to make its interest payments or perhaps take on more debt.

The formula is:

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International Financial Statement Analysis

Earnings Before Interest & Taxes

Interest Charges

Gearing Ratio – This ratio considers the relationship between an entity’s long term
debt and the capital employed in the business. A company is said to be highly
geared when the total long term debt is higher than the total capital employed..
The formula is:
Long Term Debt
Capital Employed

3. Profitability
Measures the company’s ability to generate a return on its resources. Use the
following four ratios to help you answer the question, “Is my company as profitable
as it should be?” An increase in the ratios is viewed as a positive trend.

Gross Profit Margin - Indicates how well the company can generate a return at the
gross profit level. It addresses three areas: inventory control, pricing, and
production efficiency
The formula is:
Gross Profit
Total Sales

Net Profit Margin - Shows how much net profit is derived from every dollar of total
sales. It indicates how well the business has managed its operating expenses. It
also can indicate whether the business is generating enough sales volume to cover
minimum fixed costs and still leave an acceptable profit.

The formula is:

Net Profit
Total Sales
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International Financial Statement Analysis

Return on Assets - Evaluates how effectively the company employs its assets to
generate a return. It measures efficiency.
The formula is:
Net Profit
Total Assets

4 Efficiency
Evaluates how well the company manages its assets. Besides determining the value
of the company’s assets, you should also analyze how effectively the company
employs its assets. You can use the following ratios:

Accounts Receivable Collection Period - Reveals how many days it takes to collect
all accounts receivable. As with accounts receivable turnover (above), fewer days
means the company is collecting more quickly on its accounts.

The formula is:

Trade Receivables × 365 Days
Credit Sales

Payables Payment Period - Shows how many days it takes to pay accounts payable.
This ratio is similar to accounts payable turnover (above.) The business may be
losing valuable creditor discounts by not paying promptly.
The formula is:
Trade Payables × 365 Days
Credit Purchases

Inventory Holding Period - Identifies the average length of time in days it takes the
inventory to turn over. As with inventory turnover (above), fewer days mean that
inventory is being sold more quickly. The formula is:
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International Financial Statement Analysis

Average Inventory
Cost of Sales

5 Investment Ratios. These ratios are of interest to investors in shares and bonds
and their advisers.
Some investment ratios are:

Earnings Per Share (EPS): this measures the profit earned for each equity
share of the entity.
Formular: EPS = Profit or loss attributable to ordinary shareholders
Total number of Ordinary shares in issue

Price Earnings Ratio (P/E Ratio): This measures how expensive or cheap a
share is in relation to its annual earnings.
Formular: P/E Ratio = MPPS
EPS
Dividend Per Share (DPS): This measures the dividend received per one unit of
share.

Formular: DPS = Ordinary Shares Dividend

Total number of Ordinary shares in issue

Dividend Yield (DY): This measures the dividend paid by an entity in relation
to its price.
Formular: DY = DPS
MPPS

Dividend Cover : This measures the number of times an entity’s dividends are
covered
by profits.
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International Financial Statement Analysis

Formular: Dividend Cover: EPS

DPS

Summary Table of Financial Ratios

Ratio What it measures What it tells you

Owners:

Return on Investment Return on owners’ How well is this

(ROI) capital company doing as
an investment?
When compared with
return on assets, it
measures the extent to
which financial
leverage is being used
for or against the
owner.

Return on Assets How well assets have How well has

(ROA) been employed by management
management. employed company
assets? Does it pay
to borrow?
Managers:

Net Profit Margin Operating efficiency. Are profits high

The ability to create enough, given the

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International Financial Statement Analysis

sufficient profits from level of sales?

operating activities.

Asset Turnover Relative efficiency in How well are assets

using total resources being used to
to product output. generate sales
revenue?

Return on Assets Earning power on all How well has

assets; ROA ratio management
broken into its logical employed company
parts: turnover and assets?
margin
.
Average Collection Liquidity of Are receivables
Period receivables in terms of coming in too
average number of slowly?
days receivables are
outstanding.

Inventory Turnover Liquidity of Is too much cash

inventory; the number tied up in
of times it turns over inventories?
per year.

AverageAgeof Approximate length How quickly does a

Payables of time a firm takes to prospective
pay its bills for trade customer pay its
purchases. bills?
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International Financial Statement Analysis

Short-Term Creditors

Working Capital Short-term debt- Does this customer

paying ability. have sufficient cash
or other liquid
assets to cover its
short-term
obligations?

Current Ratio Short-term debt- Does this customer

paying ability without have sufficient cash
regard to the liquidity or other liquid
of current assets. assets to cover its
short-term
obligations?

Quick Ratio Short-term debt- Does this customer

paying ability without have sufficient cash
having to rely on sale or other liquid
of inventory. assets to cover its
short-term
obligations?

Long-Term Amount of assets Is the company’s

Creditors: provided by creditors debt load
for each dollar of excessive?
Debt-to-Equity Ratio
assets provided by
owner(s)

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International Financial Statement Analysis

Times Interest Earned Ability to pay fixed Are earnings and

charges for interest cash flows
from operating profits. sufficient to cover
interest payments
and some principal
repayments?

CashFlow Total debt coverage. Are earnings and

General debt-paying cash flows
to Liabilities
ability. sufficient to cover
interest payments
and some principal
repayments

Advantages of Ratio Analysis

1 Ratio analysis guides investment decisions

2 Ratio analysis provides insight into a firm’s performance
3 It helps in forecasting a firm’s future performance.
4 It helps in trend analysis
5 In facilitates the assessment of assets efficient utilisation
6 Financial Ratios helps in knowing the firm’s ability to meet its obligations.
7 It facilitates inter – firm and intra – firm comparison
8 Some ratios are useful in determining the value of a company – EPS × PE for
Market value.

Disadvantages of Ratio Analysis

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International Financial Statement Analysis

1 Use of different accounting policies to prepare financial statements make

comparison difficult.
2 There are no generally accepted formulae for calculating certain ratios.
3 Ratios can only measure quantitative phenomena.
4 Incidence of creative accounting can give misleading ratios
5 Some items in the accounts are subjective, ratios based on them will also be
subjective.
6 Ratios are computed from historical information, the predictive value of the
ratios may be hampered by unforeseen circumstances.

CONCLUSION

Financial statements can be analysed qualitatively and quantitatively. The purpose of such
analysis is to know how a business is faring at a particular point in time. Financial analysts
have come to the realisation that a lot of factors shape the way financial information is
presented. These factors are both qualitative and quantitative. Before now, emphasis was
placed on only the quantitative factors. Qualitative factors such as the business
environment, culture, religion, legal system, economic system, international relations etc
have an impact on the activities of business enterprises as well as the financial statements
produced by them. In this paper, I have examined how these factors affect the financial
statements of business enterprises locally and internationally. The second aspect of the
paper dealt with how accounting ratios can be used to analyse financial statements. Five
different categories of such ratios were considered, they include profitability ratios,
liquidity ratios, efficiency ratios, debt ratios and investment ratios. These ratios help both
local and international financial analysts to have more insight into the activities of a
business which helps them to take more informed financial decisions.

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