GBS 520 :FINANCIAL AND

MANAGEMENT
ACCOUNTING
BY
BRYSON MUMBA
MBA, MAcc, FCCA, FZICA, DiCG, BSc(Hons)
 Unit 5
Analysis & Interpretation of Financial
Statements
Lesson Objectives

• interpret financial statements for a wide range of organizations.

Financial Statement Analysis

• Financial Statement Analysis will help business owners

and other interested people to analyse the data in
financial statements to provide them with better
information about such key factors for decision
making and ultimate business survival.
Financial Statement Analysis
Financial statement analysis involves analysing the
information provided in the financial statements to:
• Provide information about the organisation’s:
• Past performance
• Present condition
• Future performance
• Assess the organisation’s:
• Earnings in terms of power, persistence, quality and growth
• Solvency
• Provides information on business survival
Tools of Financial Statement
Analysis:
The commonly used tools for financial
statement analysis are:
1.Horizontal analysis
2.Trend analysis
3.Comparative financial statements
analysis/Vertical analysis/Common size analysis/
Component Percentages
4.Ratio Analysis
 HORIZONTAL ANALYSIS

 Example     Change  Increase (Decrease)

  2017 2016 Amount Percent
Sales K18,284 K16,701 K1,583 9.5%
Net Income 3,141 3,205 (64) (2.0 %)

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 Trend Analysis

This is a form of horizontal analysis that examines more than two different
periods.

Trend analysis is important as it highlights changes in the nature of a business

over time.

Formula:
Trend % = Any Year $ x 100
Base Year $
 Trend Analysis

Source: Zesco Integrated Report 2017

Trend Analysis - constructed

2017 2016 2015 2014 2013
Revenue 314% 349% 272% 183% 100%
(loss)profit before taxation -104% -53% 8% 221% 100%
Current taxation(credit) 327% 767% 461% -132% 100%
Profit for the year 77% 292% 198% 72% 100%
Trend analysis
 Vertical Analysis

This analysis shows the relationship of each item on the

face of a financial statement to a specified base.

Common base:
• Turnover - For Statement of Comprehensive
Income.
• Total assets - For Statement of Financial
Position.
 Vertical Analysis

Formulae:
For Income Statement:
Vertical Analysis/Common Size % = Each Income Statement item x 100
Net Sales

For Balance Sheet:

Vertical Analysis/Common Size % = Each Balance Sheet item x 100
Total Assets
Vertical Analysis – Income Statement
Vertical Analysis – Income Statement
 Financial Ratio Analysis
A tool that is used to assess, using ratios, key financial and
operational measures in a company.

Used to establish a trend and observe whether the ratio has been
improving or deteriorating.

Used for benchmarking against:

• Equivalent competitors
• Industry averages
 Financial Ratio Categories & Purpose

Category Purpose
Profitability Ratios • Measure profitability of a business based on
Sales and investment in assets
Liquidity Ratios • Assess the extent to which the company has
enough cash on its SOFP to service its current
obligations
Leverage Ratios • Leverage ratios highlight the extent of the
company’s debt obligations relative to its asset
base
Activity/Efficiency • Measure the degree to which a company can
Ratios use its fixed and current assets to generate
revenues.
Market Ratios • Assess a company’s performance based on
/Shareholder the shares.
ratios
Financial Ratios
 Financial Ratios Formula - Examples

Profitability Formulae
Gross Profit Margin Sales – Cost of Goods sold
Sales
Operating Profit Margin Profit before taxes and interest
Sales

Leverage Formulae
Debt to Asset Ratio Total Debt
Total Assets
Debt to Equity Ratio Total Debt
Total Equity

Liquidity Formulae
Current Ratio Current Assets
Current Liabilities
Acid Test Ratio or Quick Ratio Current Assets - Inventory
Current Liabilities
Profitability Ratios
• In the long run liquidity and solvency are meaningless if the organization is
not profitable.
• Profitability is imperative for survival and prosperity.
• Profitability refers to the ability to earn more income than expenses.
• A profitable entity covers its expenses and earns extra income over and
above its expenses.
 Financial Ratios Formula - Examples

Profitability Formulae

Gross Profit Margin Sales – Cost of Goods sold

Sales

Operating Profit Margin Profit before taxes and

interest
Sales
Liquidity or Short-Term Solvency ratios

To evaluate an organization’s or project’s

ability to pay short term debts as they fall
due current assets are compared to current
liabilities in order to give the current ratio.
 Financial Ratios Formula - Examples

Liquidity Formulae
Current Ratio Current Assets
Current Liabilities
Acid Test Ratio or Quick Ratio Current Assets - Inventory
Current Liabilities
 Benchmarking

Compares a company’s performance

against some form of standards.

Standards include:
•Intra-firm comparison:
• Past Data and
• Budget Data
•Competitor
•Industry
Limitations of Financial Statement Analysis
• We must be careful with financial statement analysis.
• Strong financial statement analysis does not necessarily
mean that the organisation has a strong financial future.
• Based on historical data
• Absolute size of a ratio is meaningless unless used in relative
way – prior year/industry/trend analysis
• Intercompany comparisons limited to how similar the
companies are
• Financial statement analysis might look good but there may
be other factors that can cause an organisation to collapse
• Need to consider a holistic view rather than just ratios but
other factors such as strategy/objectives/etc.
 EXERCISE
• APPROACH:
• HORIZONTAL ANALYSIS
• RATIOS ANALYSIS
• WRITING A PROFESSIONAL REPORT

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