INTRODUCTION
(FINANCIAL STATEMENT ANALYSIS AND DECISIONS)
FACULTY OF CHEMICAL & NATURAL RESOURCES
ENGINEERING,
UNIVERSITI MALAYSIA PAHANG
CHAPTER 1

Topics
Accounting Concepts and
Conventions
Profit and Loss
Cash Flow Statements
Balance Sheet
Financial Ratios
Financial Reports

Financial Reports
Primary purpose:
To provide information and data about
company’s financial position and performance
Information and data presented in financial
reports:
Management's commentary
Statement of financial position (i.e. balance
sheet)
Statement of comprehensive income (i.e.
income statement)
Statement of changes in equity
Statement of cash flows

Classification of Business
Activities

Common Accounts
• Components:
– What elements are affected?
– What accounts are affected?
– Did accounts go up or down?
• Accounting records:
– Identify those activities requiring further action
– Assess the profitability of the operations
– Evaluate the current financial position of the company

Accounting Equations
• Assets = Liabilities + Owner’s Equity
• Owner’s equity = Contributed capital + Retained earnings
• Revenue – Expenses = Net income (loss)

Debit/Credit Accounting System

Debit/Credit Accounting System

• Refer Handout
Example 1

Balance Sheet
• The following formula summarizes what a balance
sheet shows:
ASSETS = LIABILITIES + SHAREHOLDERS‘ EQUITY
• A company's assets have to equal, or "balance," the
sum of its liabilities and shareholders' equity.

Components of Balance Sheet
• Assets:
– What company owns or control
– Tangible: property, plant, and equipment
– Intangible: Brands, patents, etc.
• Liabilities:
– What the company owes
• Equity
– Owners’ residual interest in the company's assets after
deducting its liabilities

Current vs non-current
• Assets:
– Assets held primarily for the purpose of trading or expected to be
sold, used up, or otherwise realized in cash within one year or one
operating cycle of the business, which ever is greater, after the
reporting period are classified as current assets.
– Assets not expected to be sold or used up within one year or one
operating cycle of the business are classified as non-current assets
(long term, long-lived assets)
• Liabilities:
– Criteria of current liabilities
• Expected to be settled in the entity’s normal operating cycle
• Held primarily for the purpose of being traded
• Due to be settled within one year after the balance sheet date
• Does not have unconditional right to defer settlement of liabilities for at
least one year after balance sheet date
– All other liabilities are classified as non-current liabilities (long-term
debt, financing)

Analysis of Balance Sheet
• Working capital = Current assets – Current liabilities
• Current ratio = Current assets
Current liabilities
• Acid test ratio or = . Quick asset .
Quick ratio Total current liabilities
• . = Current assets - Inventories.
Total current liabilities

• Based on balance sheet above, calculate the followings:
– Working capital
– Current ratio
– Acid test ratio
Example 2

Income Statement
• Presents information on the financial results of a company’s business
activities over a period of time
• Also referred as “statement of operations”, “statement of earnings”, or
“profit and loss statement”.
• Components:
– Revenue: Amount charged (and expected to be received) for the delivery
of goods or services in the ordinary business activities.
– Expenses: Reflect outflows, depletion of assets, and incurrences of
liabilities in the course of business activities.
– Net income:
• Income – expenses
• Revenue + other income + gains – expenses
• Revenue + other income + gains – expenses – other expenses – losses
– Gross profit or Gross margin: For multistep format reporting
– Operating profit or EBIT: Deducting operating expenses from gross profit

Analysis of Income Statement

Example 3
• Determine interest coverage and net profit ratio

Cash Flow Statement
• Provides information about a company’s cash receipts,
and cash payments during an accounting period.
• Classifications of Cash Flows and Non-Cash Activities:
– Operating activities: Cash outflows from payments of
inventory, salaries, taxes, and other operating related
expenses from paying accounts payable.
– Investing activities: Purchasing and selling long-term
assets and other investment.
– Financing activities: Obtaining or repaying capital, such as
equity and long term debt.

Cash Flow Statement Analysis

Cash Flow Statement Analysis

Ratio Equation for calculation Industry average
Liquidity
Current
Cash or quick cash
Current assets/current liabilities
Current assets – inventory/current
liabilities
1.5 – 2.0 times
1.0 – 1.5 times
Leverage
Debt-to-total assets
Times interest earned
Fixed-charge coverage
Total debt/total assets
Profit before taxes plus interest
charges/interest charges
Income available for meeting fixed
charges/fixed charges
30 – 35%
7.0 – 8.0 times
5.5 times
Activity
Inventory turnover
Average collection period
Fixed assets turnover
Total assets turnover
Sales or revenue/inventory
Receivables/sales per day
Sales/fixed assets
Sales/total assets
7.0 times
45 – 60 days
2 – 3 times
1 – 2 times
Summary of Selected Financial
Ratios

Ratio Equation for calculation Industry average
Profitability
Gross profit margin
Net operating margin
Profit margin on sales
Return on net worth
(return on equity)
Return on total assets
Net sales – cost of goods sold/sales
(revenue)
Net operating profit before
taxes/sales (revenue)
Net profit after taxes/sales (revenue)
Net profit after taxes/net worth
Net profit after taxes/total assets
Varies
Varies
5 – 8 %
15%
10%
Summary of Selected Financial
Ratios (cont’d)

Thank
You
Mohd Shaiful Zaidi Bin Mat Desa
shaiful@ump.edu.my