FINANCIAL STATEMENT ANALYSIS

A.Users of the information :

1. Internal :

(i) Employees – who have a direct interest in the financial affairs of the
business for which they work.
(ii) Manager - need to compare performance of the business by looking at
the analysis for decision making, control and planning.

2. External :
(i) Banks - need to know whether the business is capable of repaying
loan or is in a sound financial position if loans are being
requested.
(ii) Potential investors – use the accounting information to decide whether or
not to invest money in the business
(iii) Government – to ensure tax is paid on profits and that there is compliance
with relevant Acts of Parliament
(iv) Customers and suppliers – both actual and potential who may wish to
ensure that a business is solvent prior to
entering a trading relationship
(v) Local community – concerned about the effects of redundancies, factory
closure, etc.
(vi) Business competitors – who can measure their own performance against
that of their rivals.
(vii) Economic Analyst – can attempt to establish trends by an analysis of the
results of particular businesses.
(viii) Members of the general public – who may require information relating to
environmental, ecological or other
 attitudes revealed in company annual
reports.

B. Advantages of ratio analysis :

1. Easily understood
2. Useful for comparison :
 Change in ratio from one year to another year – indicate business performance
 Comparison with business in the same industry – show performance of own
business
 Comparison with business in other industry – help investors in their decision in
the use of their funds
3. Focus the attention of management and investors
4. Remedial action could be taken on weaknesses through ratio analysis.

C. Disadvantages of ratio analysis:

1. Non-financial information not revealed – skills and efficiency of employees

2. Information based on past performance – backward looking
3. Tendency to increase complexity – users do not understand
4. Changing in the purchasing power of money not taken into account.
5. Comparison with other business is not meaningful – different policies adopted
Current ratio
= CA / CL

Quick ratio / Acid Test ratio

= (CA - Inventories) / CL

Average collection period / Debtors’ Days

= Receivables / Credit sales x 365

Gross profit margin

= Gross profit / Net sales x 100

Inventory turnover ratio

= COGS / Average inventory
James Bond, is a sole trader who prepares his account annually to 31 August 2023. His
summarized accounts are shown below. All sales and purchases are on credit.
RM
Sales 120 000
Stock 1 September 2022 10 400
Stock at 31 August 2023 - CA 9 600
Purchases 90 000
Gross Profit 29 200
Net Profit 12 000
Capital employed 96 000
Bank - CA 2 900
Accounts Receivables - CA 16 000
Accounts payables - CL 22 000
Cash - CA 100

The following information at 31 August 2022 is also available.

Current ratio 1.3 : 1 1.5:1

Acid test ratio / Quick Ratio 0.86 :1 1:1
The percentage of gross profit to sales ratio 25 %
The percentage of net profit to sales ratio 10%
Return on capital employed ratio 11%
Rate of stock turnover 10 times
The debtors collection period 40 days
The creditors payment period 75 days

Required to calculate :
(a) Calculate at 31 August 2023 :
(i) the current ratio
= CA / CL

= (9,600 + 2,900 + 16,000 +100) / 22,000

= 1.3 : 1

(ii) the acid test ratio / quick ratio

= (CA – Inventory ) / CL

= (2,900 + 16,000 +100) / 22,000

= 0.86 : 1

(b) Make use of your answers to (a) (i) and (ii) to explain briefly and comment
on the solvency (liquidity) position of the business.
 Current Ratio
 Performance of 2022 is better with excess of 0.5 than 2023 with excess of 0.3
fund to repay its current liabilities.
 Both year has sufficient current asset to pay off its current obligation.

Quick Ratio

 Performance of 2022 is better than 2023 without the inventory.

 2023 do not have sufficient current asset to pay off current obligation without
inventories.

(c) Calculate at 31 August 2023 :

(i) the percentage of gross profit to sales ratio / gross profit margin
= 29 200 / 120 000

= 0.2433

= 24.33%

(iii) the percentage of net profit to sales ratio / net profit margin

= 12 000 / 120 000

= 0.1

= 10%

(iv) the net profit to capital employed ratio

= 12 000 / 96 000

= 0.125

= 12.5%

(d) Make use of your answer to (c) (i) , (ii) and (iii) to explain briefly and comment
on the profitability position of the business.
 Overall performance of James Bond for 2023 are decreasing a bit for gross
profit margin and net profit margin but improving for the net profit to capital
employed.

 In order to improve the profitabilitry James Bond should find bettter priced
supplier so that James Bond will have better gross profit margin or reduce its
ongoing expenses or diversified into diferrent industry in order to increase
their revenue.