TOPIC 7

FINANCIAL STATEMENT ANALYSIS

(RATIO)
HASLINA MUSTAFA
ACC106

Learning objectives
Explain the objectives and uses of
ratios to analyze the financial
statement
Describe and explain the different
financial ratios
Calculate and interpret the main
financial ratios

OBJECTIVES OF RATIO
ANALYSIS
To assess a business financial
position and potential growth
To assess a business performance in
relation to the performance of similar
businesses in the same industry
To assess a business performance
from one year to another
To assess the risk of providing loans
to the business by lenders

TYPES OF FINANCIAL
RATIOS
Ratios are classified into groups that reflect
the
financial performance or financial position. The
four main groups of financial ratios discussed
in
this chapter are:
Profitability ratios
Liquidity ratios
Efficiency ratios
Leverage ratios

Profitability Ratios
Measures the profitability in relation to sales
and the efficient utilization of available
business resources in earning profits. It
usually expressed as a percentage

1. Gross Profit Margin

GPM = Gross profit x 100
Net Sales
. This represent the amount of gross
profit for every RM 1 of sales.
. Eg. GP = 53%. For every RM 1 of
sales, the business is able to make
RM 0.53 gross profit.

Profitability Ratios
2. Net Profit Margin
NPR = Net profit
x 100
Net sales
This represents the amount of net profit
for every RM 1 of sales. Net profit is to
be evaluated after taking into account
all revenues and expenses.
Eg. NPM = 31%, for every RM1 of sales,
the company can make 31 sen of net
profit.

Profitability Ratios

3. Return on Assets (ROA)

ROA = Net profit
x 100
Total Assets
Provides an overall measure of
business performance.
It measure the effectiveness of
management in generating profits
from the use of available assets.

Profitability Ratios

4. Return on Equity (ROE)

ROE = Net profit
Capital Employed

x 100

Measures the efficiency of the

management utilized the funds to
make profit.
Eg. ROE = 63%. This means that the
co. has utilized 63% of its capital to
generate the co.s profit for that
accounting period.

Liquidity Ratios
Measures the ability of the business to pay
its short-term obligations or debts as they
fall due.
They are indicators of the liquidity of the
business in the short run.
Therefore, the relevant statement of
financial position items used in calculating
this set of ratios are the working capital
items.
Working Capital = Current Assets Current
Liabilities

Liquidity Ratios
1. Current Ratio
CR = Current Asset
Current Liabilities
Indicates the business ability to pay its
current liabilities when they due.
High ratio is more liquid & has sufficient
liquid assets to cover current liabilities.
Eg. CR = 2:1 (2 times), the business has
RM 2 of current assets to cover for
every RM 1 of current liability.

Liquidity Ratios
2. Quick Ratio/ Acid Test Ratio
QR = Current Assets Closing Stock Prepaid
expenses
Current Liabilities

Tests the business ability to pay its

immediate obligations.
High ratio is more liquid & has sufficient
liquid assets to cover current liabilities.
Eg. QR = 2:1 (2 times), the business has
RM 2 of current assets to cover for every
RM 1 of current liability.

Efficiency/ Activity Ratios

Measures management efficiency in
managing or utilizing the various resources
of the business to generate revenues.
1. Inventory Turnover Ratio
ITO = Cost of goods sold
Average stock
. Average stock = opening stock + closing stock
2
. If the opening stock is not available for determining
the average stock, the closing stock figure is used.
. Indicates no. of times that inventories has to be
replaced within an accounting period.
. Higher ITO, the better it is.

Efficiency/ Activity Ratios

2. A/c Receivables Collection Period
DCP = A/c Receivables
x 365 days
Credit sales
It represent the length of time a business
undertakes to collect money from its
debtors or a/c receivable.
The shorter the period, the better it is for
the business in terms of its liquidity.

Efficiency/ Activity Ratios

3. A/c Payables Collection Period
CCP = A/c Payables
x 365 days
Credit purchases
It represent the length of time a
business undertakes to pay its creditors
or a/c payables.
The shorter the period shows the
business is efficient in meeting its shortterm debts as they fall due.

Efficiency/ Activity Ratios

4. Total Assets Turnover Ratio

TATO = Sales
Total Assets
Measures how efficient a business is
in using its total assets to generate
sales revenue.
High TATO indicates more productive
use of assets in generate sales
revenue.

Leverage Ratios
Measures the ability of the business to
repay the principal installments as well as
the interest charges.
1. Debt Ratio
DR =
Total liabilities
Total Assets
. Provides overall view of how much the
businesss assets are being financed by
external funding.
. Higher ratio, more borrowings used to
generate profits.
. Eg. DR = 2:1 , there are twice as many
liabilitiesas there are assets.

Leverage Ratios
2. Time Interest Earned Ratio
TIE = Earnings(Profit) before Interest
Interest Expense
Measures whether the business has
sufficient operating profit to cover
interest expenses.
High ratio indicates business have no
problem to cover interest expense.

Limitations of Ratios
Ratios are calculated based on
historical information while decisions
have to be made about the future
Ratios only show the strengths and
weaknesses of a business
performance but not given the
causes to the condition
The comparison of ratio result will
only meaningful if the comparison
made between businesses that use
similar accounting policies.

PROCEED TO PAST YEAR

QUESTIONS!!