1. CHAPTER 10
FINANCIAL STATEMENT
ANALYSIS

2. LEARNING OBJECTIVES
• To describe & explain the different
financial ratios
• To calculate & interpret the main
financial ratios
• To explain the use of ratios in analyzing
the performances of the business
• To explain the significance of each
financial ratios

3. INTRODUCTION
• The real value of the financial
statements lies in the fact that they
can be used in predicting the firm’s
future earnings and dividends, as well
as the risk.
• The financial statements are analyzed
through the use of various tools, &
one of the tools widely used is
financial ratio

4. OBJECTIVE OF FINANCIAL
STATEMENT ANALYSIS
• Financial statement analysis is used in predicting
the future (investor), & to anticipate future
conditions, planning actions that influence future
events (management).
• 3 objectives of financial statement analysis:
a) To identify the weaknesses as well as
strengths of a business
b) The business can take appropriate steps to
overcome their weaknesses
c) To enable the business to improve its overall
financial situation in the future

5. THE USE OF RATIOS TO ANALYSE
THE FINANCIAL STATEMENT
• Two types of ratios are commonly used:
LIQUIDITY RATIOS PROFITABILITY RATIOS
i) CURRENT RATIO i) GROSS PROFIT MARGIN
= Current Assets / Current = (Gross profit/Sales) x 100%
Liabilities
ii) ACID TEST @ QUICK ii) NET PROFIT MARGIN
RATIO = (Net Profit/Sales) x 100%
= (Current Assets – Stock)
/ Current Liabilities
iii) STOCK TURNOVER iii) RETURN ON CAPITAL
RATIO EMPLOYED (ROCE)
= Cost of goods sold / = Net Profit / Capital Employed
Average stock

6. LIQUIDITY RATIOS
There are 3 ratios that measure the ability of a firm to meet
its current obligations when they become due:
i)
CURRENT RATIO =
Current Assets / Current Liabilities
a) Tells about the firm’s ability to repay its current
liabilities when they become due
b) If current ratio is 2:1, this means that for every
RM1 of current liabilities, the firm has RM2 of
current assets to repay that RM1 of liabilities

7. LIQUIDITY RATIOS (cont’d)
ii)
ACID TEST OR QUICK RATIO =
(Current Assets – Stock - #Prepayments)
Current Liabilities
a) A better measure of liquidity that the current ratio
because it does not take into a/c the stock of a
business which is the least liquid asset of the
current asset
b) #
The prepayments is deducted because prepayments
are considered to be liquid and generally it will not
be converted back into cash
c) The interpretation of this ratio is similar to the
current ratio

8. LIQUIDITY RATIOS (cont’d)
iii)
STOCK TURNOVER RATIO =
Cost of Goods Sold
# Average Stock
• Average stock= ½ (opening stock + closing stock)
#
– It tells how many times the stock has to be replaced
within an accounting period
– It gives an idea of how fast the goods are being sold
– The higher the stock turnover figure, the better it is for
the business
– A reduction in stock turnover means that stocks may be
piling up & not being sold. This could lead to liquidity crisis
as money may be taken out of the bank to buy stocks that
are not sold quickly enough.

9. PROFITABILITY RATIOS
There are also 3 ratios that measure the performance of a firm
during an accounting period
i) GROSS PROFIT MARGIN =
Gross Profit
Sales
X 100%
– Represents the amount of gross profit for every RM1 of
sales i.e. Gross profit margin = 20%, therefore for every
RM100 of sales RM20 gross profit was made before any
expenses were paid.
– The amount of sales increases but the gross profit margin
fallen by a relatively greater amount. The reasons are:
a) cost of goods increases whilst selling price remains
unchanged,
b) in order to increase sales, selling price was being
reduced

10. PROFITABILITY RATIOS (cont’d)
ii) NET PROFIT MARGIN =
Net Profit
Sales
X 100%
– Represents the amount of net profit for
every RM1 of sales i.e. Net profit margin =
10%, therefore for every RM100 of sales
RM10 net profit was made.
– This ratios reveal how far costs are
covered by revenue & what is available to
the owner of a business after considering
all expenses incurred for a particular
accounting period.

11. PROFITABILITY RATIOS (cont’d)
iii)
RETURN ON CAPITAL EMPLOYED =
Net Profit X 100%
#Capital Employed
•# Capital employed = ½ (opening capital + closing capital)
– Indicates the ability of the firm to make better use
of capital employed also called Return on Investment
– Capital employed is Fixed Assets + Current Assets –
Current Liabilities or Owner’s Equity + Long Term
Liability.
– This is perhaps the most important of all
profitability ratios