Introduction analysis involves appraising and communication the position, performance and prospects of a business based on given and prepared statement and ratios
The abillity to review, analyse and interpret a set of financial statements is a key skill for a financial accountant. Analysis may involve any or all of the following:
01.Vertical or horizontal trend analysis
02.common size analysis
03.ratio analysis
01.Vertical or horizontal trend analysis
Trend analysis involves comparing financial statements. vertical trend analysis is comparing financial statements of one company from one year to the next horizontal analysis is comparing the financial statements of one company with those of an equivalent company in the same period.
This type of analysis involving comparison has drawback:
(a) The financial result of one year may be skewed by a significant event, making comparison with another year less meaningful. for this reason its more useful to perform vertical analysis over an extended period rather than just two years.
(b) An equivalent company ie a company of a similar size in the same industry may be difficult to find, and if one is found,its result for a particular year may ,again , be skewed by a particular event.
02 common size analysis
Common size analysis again involves comparison-either of the same company in different priods or different companies in the same period.
In the case, however, comparison is not of the "RAW" numbers presented in the financial statements.
interred, a common base figures is adopted and amounts are expressed as a percentage of this base number. These percentage are then compared A common base figure when analyzing the statement of profit or loss is revenue.
EXAMPLES
The following example shows the results of one company for two years
2020 % of 2019 % of
$"000 revenue $"000 revenue
Revenue 100,000 90,000
Cost of sales (35,000) 35% (30,000) 33%
Gross profit 65,000 60,000
Distribution costs (20,000) 20% (16,000) 18%
Administrative expenses (15,000) 15% (21,000) 23%
Operating profit 30,000 23,000
Finance costs (5,000) 5% (3,000) 3%
Profit before tax 25,000 20,000
Tax (5,000) 5% (4,000) 4%
Retained profit 20,000 16,000
As the revenue in the company has increased, it follows that costs might increase. Common size analysis helps to identify whether costs have increased proportionately. questions that might be asked as a result of performing this analysis are as follows.
( a) Why has cost of sales increased as a proportion of revenue ? have selling prices reduced while cost per unit remain the same or have costs increased?
(b) why have distribution cost increased as a proportion of revenue ? have cost such as petrol increased or are proportionately more items being distributed(this would be the case if prices have decreased)?
(c)There is a significant drop in the proportion of revenue spent on admin expenses .is there a one off item of income in2020 or a one -off expense in 2019 that has caused the change ?
(d) Finance cost as a proportion of revenue have increased: the company appears to have borrowed money in the year.this has been employed in the business and resulted in increased revenue.
03. Ratio Analysis
Ratio analysis involves manipulating amounts in the financial statements to produce a ratio. this is than compared with the same ratio for any of:
The same company in a different year
A different company in the same year
Industry averages
Ratios can be grouped in to five categories
01) Profitability
02) long-term solvency
03)short -term liquidity
04) Efficiency(turn over ratios)
05) Share holders investment ratios
For each of the categories of ratio, we will identify a number of standard measures or ratios that are normally calculated and generally accepted as meaningful indicators.
It must be stressed, however, that each individual business must be considered separately, and a ratio that is meaningful for a manufacture company may be too mechanical when working out ratios and constantly think about what you are trying to achieve.
It is also important to remember that ratio analysis on its own is not sufficient for interpreting company accounts, and that there are other items of information that should be looked at, for example
Example
(a) The content of any accompanying commentary on the accounts and other statements
(b) The age and nature of the company's assets
(c) current and future developments in the company's markets, at home and overseas, recent acquisitions or disposals of a subsidiary by the company
(d) Unusual items separately disclosed in the financial statements
(e) Any other noticeable features of the report and accounts, such as events after the end of the reporting period, contingent liabilities, a qualified auditors 'report, the company's taxation position, and so on
THANK YOU.
Next article topic- briefly explanation of illustrative financial statements and ratio analysis with examples
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