ACC100 - Topic 5

  1. External Users
    Extract and adjust the information provided in accounting reports to facilitate their decision making.

    • - How well has the entity performed?
    • - What is its financial position?
  2. Creditors are Interested in
    The entity's ability to

    • - discharge its debts
    • - make payments to suppliers
    • - pay interest
    • - repay loans
  3. Owners are Interested in
    The financial solvency of the organisation and the extent of unpaid capital, which they could be liable to contribute in the event of liquidation.
  4. Financial Solvency
    The ability of an organisation to pay its debts into the future in a timely manner.
  5. Planned Approach to Financial Analysis
    • - Identify the user/s of the information
    • - Identify the decision/s to be made
    • - Identify questions that need to be answered to reach decisions
    • - Extract and supplement financial statement information as required
    • - Arrange information in a form suitable for analysis
    • Interpret information and interpret significance compared with a 'benchmark'
    • - Prepare a report answering questions posed and making recommendations
  6. Cross-Sectional Comparisions
    Show the relationship between one organisation and another at a particular point in time.

    May also show the relationship with a benchmark at a single point in time.
  7. Time-Series Comparisions
    Generally relate to the performance of one organisation over a period of time, often several years.
  8. Relationship Between 2 Figures
    • - Pure ratio, 3:1
    • - Certain number of units, 6c per share or 30 days
    • - Percentage, 200%
    • - Index number
  9. Benchmarks for Financial Analysis
    • - National or world practice
    • - Averages for the industry
    • - Other organisations in the same industry
    • - The one organisation over a number of years
    • - Alternative forms of investment
  10. Ratio Range
    • - Performance (or profitability)
    • - Operating efficiency
    • - Financial stability (or liquidity/solvency)
    • - Cash flow ratios
    • - Per-share ratios
  11. Return on Equity
    The profit or loss earned in utilising the investment of the owners.
  12. Gross Profit Margin
    Gross profit margin = gross profit / net sales
  13. Expense Components Ratio
    Represents the relative importance of various expenses in the earning of profit by comparing them to the sales for the period.
  14. Return on Sales Ratio (Net Profit Ratio)
    Shows the percentage of sales or service revenue that remains after taking account of all expenses.
  15. Quality of Income Ratio (Operations Index)
    Quality of income = cash flow from operations / earnings after interest and tax
  16. Asset Turnover Ratio
    Measures the relationship of sales to total assets.

    Asset turnover = net sales / total assets
  17. Cash Return on Assets
    The cash-generating ability of the assets.

    Cash return on assets = cash flow from operations (before interest and tax) / total assets
  18. Return on Assets (ROA)
    Results from the interaction of the profitability of sales with the rate at which sales occur.

    <earnings before interest and tax / average (or year end) total assets> = <earnings before interest and tax / sales> x <sales / average (or year end) total assets>
  19. Return on Equity Ratio
    The relationship between net profit after interest and tax and the total investment the shareholders have in a firm.

    Return on equity = earnings after interest and tax / ordinary shareholders' equity
  20. Cash Return on Shareholders' Equity
    Shows the return in cash available to the shareholders from their investment.

    Cash return on equity = cash flow from operations / shareholders' equity
  21. Inventory Turnover
    Measures the efficiency of inventory management.

    Days inventory is on hand = 365 / inventory turnover
  22. Inventory Turnover Ratio
    A measure of efficiency with respect to the level of inventory in relation to sales and costs of goods sold.

    Inventory turnover = cost of goods sold / average (or year end) inventory
  23. Accounts Receivable Turnover
    A measure of the efficiency of the management of 'credit' customers, usually expressed as the average number of days credit customers take to pay their debt to the firm.

    Accounts receivable turnover = gross credit sales / average (or year end) gross accounts receivable
  24. Average Collection Period
    Average collection period = 365 / accounts receivable turnover
  25. Cash Flow to Sales Ratio
    The efficiency of management in generating a net positive cash inflow from its sales.

    Cash flow to sales = cash flow from operations / sales
  26. Current Ratio (Working Capital Ratio)
    Represents the difference between current assets and current liabilities.

    Current ratio = current assets / current liabilities
  27. Quick Asset Ratio (Acid-Test Ratio)
    A more immediate measure of liquidity is obtained by excluding the less liquid current assets and the less pressing current liabilities in a ratio of quick assets to quick liabilities.

    Quick asset ratio = quick assets / quick liabilities
  28. Debt to Assets Ratio
    Measures the percentage of total funds provided by creditors.

    Debt to assets ratio = total debts / total assets
  29. Debt to Equity Ratio
    An alternative way of measuring the extent of leverage.

    Debt to equity ratio = total debt / owners' equity
  30. Times Interest Earned Ratio
    The amount of profits committed to interest payments.

    Times interest earned ratio = earnings before interest and tax / interest charges
  31. Dividend Per Share (DPS)
    A measure of the cash flow they will receive from their investment.

    DPS = ordinary dividends / number of ordinary shares
  32. Dividend Yield
    Measures the dividend component of shareholders' total returns.

    Dividend yield = DPS / share price
  33. Limitations of Ratio Analysis
    • - Timing
    • - The information base used
    • - The end use to be made of the analysis
  34. Window-Dressing
    Temporarily changing the appearance of the financial statements by engaging in activities that have an effect for only a short period around the entity's balance date.
  35. Information Base Problems
    • - Lack of disclosure generally, and lack of specific detail in published financial statements
    • - Variation in valuation methods
    • - Deliberate manipulation of data
    • - Variation in classification of information
    • - Use of historical cost accounting information
  36. End Use Problems
    • - Ratios use information from the past and so they are not necessarily good indicators of the future.
    • - No evaluation can take place until some standard for evaluation has been established.
    • - Some ratios appear 'satisfactory' and some appear 'unsatisfactory', may be difficult to reach an overall conclusion about the entity's financial performance and financial position.
Card Set
ACC100 - Topic 5
ACC100 - Topic 5 (5)