ACCOUNTING & FINANCE FOR

PROFESSIONALS

ANALYSIS OF
FINANCIAL
STATEMENTS

Dr Zubir Azhar
Universiti Sains Malaysia
 Analysis of Financial
Statements
Reference: Wild et. al. (2022)
Fundamental Accounting Principles

Dr. Zubir Azhar

School of Management
Universiti Sains Malaysia

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 Introduction to Financial Statements

Financial statements are a structured representation of the financial

position (Balance Sheet), financial performance (Income Statement)
of an entity & the inflow and outflow of cash (Cash Flow Statement).
The objective of financial statements is to provide information about:
§ the financial position
§ financial performance
§ cash flows of an entity

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 Introduction to Financial Statements
Balance Sheet Describes where the
Depicts the enterprise stands at a
revenue and Income Statement specific date.
expenses for
a designated Statement of Depicts the ways
period of Cash Flows cash has changed
time. during a
designated period
of time.

l These financial statements are windows to a company's

performance and health.
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 Balance Sheet
ASSETS LIABILITIES EQUITY
Cash A/C Payable Preference
Shares
Inventory Wages Payable
Common Shares
Land Taxes Payable
Retained
Equipment
= Notes Payable
+ Earnings
A/C Receivable Short-term Loan

Securities Long-term Loan

Assets: Liabilities:
Cash 5,000 Accounts Payable 900
Accounts Receivable 600 Loan Payable 3,500
Inventory 900
Equipment 1,000 Total Liabilities 4,400
Equity:
Total Assets 7,500 Owner’s equity 2,700
Retained earnings 400

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 Income Statement
Income Statement for August 20X4
The income statement shows information about the Income
revenues, expenses, and profit generated as a result of Sales revenue $2,000
the business's operations for that period. It measures a
company's performance over a specific time frame. Expenses
rent $ 850
The components of the Income Statement are: utilities 75
payroll 400
§ Revenue (how much the company earned) insurance 25
§ Expenses (how much the company has spent) marketing 250
Total expenses 1,600
§ Net Income (the profits of the company)
Profit/Loss $400

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 Cash Flow Statement

The statement of cash flows records a business's cash inflows and

outflows over a period of time.
It focuses on the following cash-related activities:
§ Operating cash flow: Cash generated from day-to-day business operations.
§ Cash from investing: Cash used for investing in assets, as well as the proceeds
from the sale of other businesses, equipment or long-term assets
§ Cash from financing: Cash paid or received from the issuing and borrowing of
funds

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 Purpose of Analysis
The common goal of financial statement analysis for both external and
internal users is to evaluate company performance and financial
condition and to assist in evaluating:
1. Past and current performance
2. Current financial position
3. Future performance and risk

Equity
Income Expenses Assets Liabilities
Net worth /
Proceeds Costs of What you What you
level of
from sales operation own owe
investment

Operations Financial Position

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 Analyzing Financial Statements
§ To obtain optimal management information, the numbers on the
financial statements should be compared against other numbers.
§ To know if your numbers are “good,” you must compare them to:
– Your expectations and needs (budget-to-actual)
– Your competitors and industry norms (benchmarking)
– Historical performance (trending)
– Each other (ratios)

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 Financial conditions…

Liquidity &
Solvency
efficiency

Market
Profitability prospects

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 Tools of Analysis
Horizontal Analysis
Comparing the financial condition and performance
across time

Vertical Analysis
Comparing the financial condition and performance
to a base amount

Ratio Analysis
Measurement of key relations between financial
statement items
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 Horizontal Analysis
Horizontal analysis refers to examination of
financial statement data across time.
Horizontal analysis is the review
of financial statement data
across time

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 Comparative Statements:
RM Change
Dollar Analysis period Base period
change = amount – amount

• When measuring the amount of the change in dollar

amounts, compare the analysis period to the base period.
• You can also compute in percentage.

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 Trend Analysis
Trend analysis is used to reveal patterns in data across
periods.

Trend
Analysis period amount
Percent =
Base period amount × 100
(%)

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 Line Graph of Trend Percent

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 Vertical Analysis

Common-size Analysis amount

Percent (%)
= Base amount × 100

Financial Statement Base Amount

Balance Sheet Total Assets
Income Statement Revenues

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 Ratio Analysis…

Liquidity and
Solvency
efficiency

Market
Profitability prospects

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 (i) Liquidity and Efficiency
Working Inventory
Capital Turnover
Current Days’ Sales
Ratio Uncollected

Acid-test Days’ Sales in

Ratio Inventory

Accounts
Receivable Total Asset
Turnover Turnover

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 1. Working Capital
Working capital is the amount of current
assets minus current liabilities.

More working capital suggests a strong

liquidity position and an ability to pay debts or
continue operating.

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 2. Current Ratio
• This ratio measures the short-term debt-paying
ability of the company.
• A higher current ratio suggests a strong ability
to meet current obligations.

Current assets
Current ratio =
Current liabilities

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 3. Acid-Test Ratio

This ratio is like the current ratio but excludes current assets such
as inventories and prepaid expenses that may be difficult to
quickly convert into cash.

Cash + Short-term financial assets +

Acid-test ratio = Current receivables
Current liabilities

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 4. Accounts Receivable Turnover
This ratio measures how
many times a company
converts its receivables into
cash.

Net sales
Accounts receivable =
Average accounts receivable,
turnover
net

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 5. Inventory Turnover
This ratio measures how long a
company holds inventory
before selling it.

Cost of goods sold

Inventory turnover =
Average inventory

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 6. Days’ Sales Uncollected

This ratio measures how frequently a

company collects its accounts receivable.

Day's sales = Accounts receivable, net

× 365
uncollected Net sales

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 7. Days’ Sales in Inventory

This ratio is a useful measure in evaluating

inventory liquidity.
Used to evaluate inventory liquidity.

Day's sales in = Ending inventory

× 365
Inventory Cost of goods sold

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 8. Total Asset Turnover
• This ratio measures a company’s
ability to use its assets to
generate sales.
• It is an important indication of
operating efficiency.

Net sales
Total asset turnover =
Average total assets

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 (ii) Solvency
Debt Equity
Ratio Ratio

Debt-to-Equity Times Interest

Ratio Earned

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 1. Debt Ratio & 2. Equity Ratio

• The debt ratio shows total liabilities as a

percent of total assets.
• The equity ratio shows total equity as a
percent of total assets.

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 3. Debt-to-Equity Ratio
This ratio measures what portion of a company’s assets
are contributed by creditors. A larger debt-to-equity ratio
implies less opportunity to expand through use of debt
financing.

Total liabilities
Debt-to-equity ratio =
Total equity

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 4. Times Interest Earned
This is the most common measures a company’s
ability to pay interest.

Times interest earned = Profit before interest and taxes

Interest expense

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 (iii) Profitability
Profit
Margin

Return on
Total Assets

Return on Ordinary
Shareholders’
Equity

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 1. Profit Margin

This ratio measures a company’s ability to

earn net income from each sales dollar.

Net profit
Profit margin =
Net sales

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 2. Return on Total Assets

Return on total assets measures how well

assets are utilized by the company.

Net profit
Return on total asset =
Average total assets

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 3. Return on Ordinary Shareholders’
Equity
This measure indicates how the company’s
ability to earn profit for ordinary shareholders.

Return on ordinary shareholders' Net profit − Preference dividends

equity = Average ordinary shareholders'
equity

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 (iv) Market Prospects

Price-Earnings
Ratio

Dividend
Yield

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 1. Price-Earnings Ratio

This measure measures market expectations for

future growth.

Market price per ordinary share

Price-earnings ratio =
Earnings per share

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 2. Dividend Yield
Annual cash dividends per share
Dividend yield =
Market price per share

This ratio is used to compare the dividend-paying

performance of different companies.

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#ANYQuestion?

DR ZUBIR AZHAR

zubirazhar@usm.my