Analysing Financial Performance

11 Key excerpts on "Analysing Financial Performance"

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  eBook - PDF

  Strategic Managerial Accounting

  Hospitality, Tourism & Events Applications

  • Tracy Jones, Helen Atkinson, Angela Lorenz, Peter Harris(Authors)
  • 2012(Publication Date)
  • Goodfellow Publishers

    (Publisher)

  11 Financial Analysis of Performance 11.1 Introduction and objectives It is important for managers to understand how to analyse and evaluate financial information and to be able to utilise a range of techniques to understand financial performance of organisations. Managers use financial information in their daily work, but rarely see the whole picture of the performance of the firm, this chapter provides a comprehensive set of tools to analyse the performance of a business, providing a comprehensive guide for managers of both generic approaches and industry specific measures. Financial information can be complex and detailed so it is very useful for managers to be able to confidently and systematically analyse that information to support their decision making. This chapter will build on early chap-ters, which explained financial statements and the principles underpinning them (Chapter 2) and will provide a foundation for the understanding of later chapters, such as ‘Working capital management’ (Chapter 12), ‘Performance measurement’ (Chapter 15) and ‘Critical success factors and management information needs’ (Chapter 17). After studying this chapter you should be able to: „ Understand the main techniques for analysing financial information „ Use common-sized and comparative data „ Calculate a range of ratios and understand their limitations „ Evaluate ratios relating to profitability, liquidity, assets and debt „ Interpret operational ratios from a range of sectors. 163 11 Financial Analysis of Performance 11.2 Methods of analysis There are several different ways to approach the analysis of financial statements, these include scanning, trend and time series analysis, common-sized statements and ratio analysis, these are summarised in Table 11.1.

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  Accounting

  Business Reporting for Decision Making

  • Jacqueline Birt, Keryn Chalmers, Suzanne Maloney, Albie Brooks, David Bond, Judy Oliver(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  Financial analysis involves expressing the reported numbers in relative terms rather than relying on the absolute numbers, and can highlight the strengths and weaknesses of entities. It is an important decision-making tool for evaluating the historical health of an entity and predicting the entity’s future financial wellbeing. When undertaking a financial analysis, data visualisation tools are a very effective way to present the analysis as they make financial information comparisons, trends and interrelationships very clear when compared with dense tables of data. VALUE TO BUSINESS • Financial statements are employed by a range of users making a variety of decisions. The purpose of financial statements is to provide the information useful for decision making concerning the allocation of scarce resources. • Financial analysis is an analytical tool that involves expressing the reported financial numbers in relative terms. • Financial analysis helps statement users to evaluate an entity’s past decisions and form an opinion as to the entity’s future financial health. 8.2 Nature and purpose of financial analysis LEARNING OBJECTIVE 8.2 Describe the nature and purpose of financial analysis. We have identified that financial analysis involves expressing reported numbers in financial statements in relative terms. Relying on the absolute values contained in the financial statements is not meaningful when trying to evaluate an entity’s past decisions and predict future rewards and risks. For example, if you are examining an entity’s statement of profit or loss and note that the profit figure has increased from $200 000 in the previous year to $300 000 in the current year, does this mean that the entity has become more profitable? Similarly, if the entity’s interest-bearing liabilities have increased from $1 million to $2 million, does this mean that the entity has become more reliant on external funding? The answer to both of these questions is ‘not necessarily’.

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  eBook - ePub

  Managing Finance

  • D. Crowther(Author)
  • 2007(Publication Date)
  • Routledge

    (Publisher)

  The principal technique used for evaluating the performance and financial status of a firm is known as ratio analysis. Ratio analysis is the computation of indicators of financial performance; it involves taking financial information from the financial statements and making calculations which are likely to indicate business performance.

  Note that accountants are not too strict about their use of the term ratios and many financial ratios are stated as percentages (i.e., the ratios are actually multiplied by 100). Financial ratios typically include profitability percentages, operational efficiency, liquidity ratios, debt and working capital ratios.

  Analysing Financial Performance

  The modern financial manager is likely to be required to provide information for management decision-making covering a vast array of activities which have financial implications, including decisions on sources of finance, project appraisal, dividend policy, working capital requirements and potential acquisitions and mergers. The financial manager is thus both concerned with providing information to aid management in its decision-making in the long term (for example, on debt and fixed assets) and in the short term (for example, on the availability of cash). However, when interpreting cost of sales and gross profit, especially for comparative analysis, we must be aware that there may be distortions arising from differential accounting methods (for example, in the application of alternative methods for valuing stocks and the fixed assets).

  Financial ratio analysis is the main way in which a financial manager can understand financial statements. These statements cannot be understood, however, merely by calculating appropriate financial ratios. It is only by comparing ratios that this information can be evaluated. There are two main ways of making comparisons:

  1  Comparing the analysis of the same company over time. It is in this way that any changes in the calculated ratios can be determined and this provides a basis for then considering the performance of the company and how this is changing over time.

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  What Every Engineer Should Know about Accounting and Finance

  • Norman Henteleff, Jae K. Shim, Shim(Authors)
  • 1994(Publication Date)
  • CRC Press

    (Publisher)

  ANALYZING FINANCIAL STATEMENTS This chapter covers how to analyze a company's financial statements which include the balance sheet and income statement. Financial statement analysis attempts to answer the following basic questions: 1. How well is the business doing? 2. What are its strengths? 3. What are its weaknesses? 4. How does it fare in the industry? 5. Is the business improving or deteriorating? A complete set of financial statements, as explained in the previous chapter, will include the balance sheet, income statement, and statement of cash flows. The first two are vital in financial statement analysis. We will discuss the various financial statement analysis tools that you will use in evaluating the firm's pre-sent and future financial condition. These tools include horizontal, vertical, and ratio analysis, which give relative measures of the performance and financial condition of the company. WHAT AND WHY OF FINANCIAL STATEMENT ANALYSIS The analysis of financial statements means different things to different people. It is of interest to creditors, present and prospective investors, and the firm's own management. A creditor is primarily interested in the firm's debt-paying ability. A short-term creditor, such as a vendor or supplier, is ultimately concerned with the firm's ability to pay its bills and therefore wants to be assured that the firm is 45 4 46 Chapter 4 liquid. A long-term creditor such as a bank or bondholder on the other hand, is interested in the firm's ability to repay interest and principal on borrowed funds. An investor is interested in the present and future level of return (earnings) and risk (liquidity, debt, and activity). You, as an investor, must evaluate a firm's stock based on an examination of its financial statements. This evaluation con-siders overall financial health, economic and political conditions, industry fac-tors, and future outlook of the company.

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  Financial and Managerial Accounting

  • Carl Warren, Jefferson Jones, William Tayler, , Carl Warren, Jefferson Jones, William Tayler, Ph.D., CMA, Carl Warren, Jefferson Jones, William Tayler(Authors)
  • 2019(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Profitability Investors, such as stockholders, are the owners of the company. They benefit from increases in the price of a company’s shares and are interested in evaluating the potential for the price of the company’s stock to increase. The price of a company’s stock depends on a variety of factors, including the company’s current and potential future earnings. As such, investors focus on evaluating a company’s ability to generate earnings, which is called profitability. Techniques for Analyzing Financial Statements Financial statement users rely on the following techniques to analyze and interpret a company’s financial performance and condition: ▪ Analytical methods examine changes in the amount and percentage of financial statement items within and across periods. ▪ Ratios express a financial statement item or set of financial statement items as a percentage of another financial statement item, in order to measure an important economic relationship as a single number. Both analytical methods and ratios can be used to compare a company’s financial performance over time or to another company. ▪ Comparisons Over Time: The comparison of a financial statement item or ratio with the same item or ratio from a prior period often helps the user identify trends in a company’s economic performance, financial condition, liquidity, solvency, and profitability. ▪ Comparisons Among Companies: The comparison of a financial statement item or ratio to other companies in the same industry can provide insight into a company’s economic performance and financial condition relative to its competitors. Analytical Methods Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are: ▪ Horizontal analysis ▪ Vertical analysis ▪ Common-sized statements Horizontal Analysis The analysis of increases and decreases in the amount and percentage of comparative finan- cial statement items is called horizontal analysis.

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  Fundamentals of Finance

  Investments, Corporate Finance, and Financial Institutions

  • Mustafa Akan, Arman Teksin Tevfik(Authors)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  9 Financial Analysis and Financial Planning 9.1 Introduction Managers within the firm as well as the firm ’ s lenders (e.g., banks, bondholders) and owners keep track of the firm ’ s performance by reviewing its financial state-ments (income statement, balance sheet, and statement of cash flows). These finan-cial statements show the trends facing the firm; the results of management ’ s decisions; and debt obligations and shareholder needs that can be met. Thus, finan-cial institutions, markets, and investors, as well as the firm ’ s managers, are inter-ested in reviewing and interpreting a firm ’ s financials. We show how to analyze financial statements. The techniques discussed here will be used both by the firm ’ s own analysts (as they study their own firm and its competitors) and by outside eval-uators such as stock and bond investors, competitors, bond rating agencies, and lenders such as banks. Financial ratio analysis examines historical data to pinpoint a firm ’ s strengths and weaknesses. Financial planning uses historical and expected financial ratios and financial statement relationships to estimate a firm ’ s future asset and financing needs, as well as future earnings levels. 9.2 Overview of Financial Statements A firm ’ s basic financial statements include the film ’ s balance sheet (statement of finan-cial position), income statement , and statement of cash flows . Financial statements are usually prepared and issued at the end of each quarter. In analyzing these statements, it is critical to include trend analysis tracking the changes from one period to another across time in order to detect changes in business conditions that are reflected in the financial statements. The comparison of a firm ’ s financial statements with those of competitors provides a vital look into the firm ’ s standing within the industry.

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  eBook - ePub

  The 30 Day MBA in Business Finance

  Your Fast Track Guide to Business Success

  • Colin Barrow(Author)
  • 2023(Publication Date)
  • Kogan Page

    (Publisher)

  03

  Analysing financial reports

  • The significance of accounting information
  • Using business ratios
  • Understanding the limitations of ratios
  • Finding competitor accounts
  • Improving business performance

  In Chapter 1 the important financial statement of profit and loss (income statement), balance sheet and cash flow statement were explained. To recap – the trading performance of a company for a period of time is measured in the profit and loss account by deducting running costs from sales income. A balance sheet sets out the financial position of the company at a particular point in time, usually the end of the accounting period. It lists the assets owned by the company at that date matched by an equal list of the sources of finance. Cash flow measures the movement of money in and out of the organization at the time such events actually occur.

  Reading company accounts, with practice, you can get some insight into a company’s affairs. Comparing the current year’s figure with the previous year’s figure can identify changes in some of the key items and give insights into likely causes and remedies. Competitors’ accounts can be studied to see their strengths and weaknesses from a financial perspective and perhaps also to give pointers as to how your own business’s performance can be improved or modified.

  However, just having the accounts of a business is not of much use if you can’t analyse and interpret them. The tools for measuring the relationship between various elements of performance to see whether we are getting better or worse are known as ratios; simply put these involve expressing one thing as a proportion of another with a view to gaining an appreciation of what has happened. For example, miles per gallon is a measure of the efficiency of a motor vehicle. If that ‘ratio’ is 40 mpg in one period and 30 mpg in another it would be a cause for concern and investigation as to what had caused the drop in performance.

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  Corporate Financial Accounting

  • Carl Warren, Jeff Jones, Carl Warren(Authors)
  • 2021(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  2. Analytical methods are used to compare items on a cur- rent financial statement with related items on earlier statements or to examine relationships within a financial statement. Horizontal analysis is the analysis of percent- age increases and decreases in related items in compara- tive financial statements. The analysis of the relationship of each component in a financial statement to a signifi- cant total within the statement is called vertical analysis. In a common-sized statement, all items are expressed as percentages with no dollar amounts shown. 3. Liquidity analysis evaluates a company’s ability to con- vert current assets into cash. Short-term creditors use liquidity analysis to evaluate a company’s ability to repay short-term debts by focusing on a company’s current po- sition, accounts receivable, and inventory. The measures and ratios used to evaluate a company’s liquidity include: (1) working capital, (2) current ratio, (3) quick ratio, (4) accounts receivable turnover, (5) days’ sales in re- ceivables, (6) inventory turnover, and (7) days’ sales in inventory. 4. Solvency analysis evaluates the ability of a company to pay its long-term debts. Long-term creditors use sol- vency analysis to evaluate a company’s ability to make its periodic interest payments and repay the face amount of bonds at maturity. Solvency is normally assessed by examining (1) the ratio of fixed assets to long-term liabili- ties, (2) the ratio of liabilities to stockholders’ equity, and (3) the times interest earned ratio. 5. Profitability analysis focuses on the relationship between operating results (income statement) and assets (balance sheet). Profitability analyses include (1) the asset turnover ratio, (2) the return on total assets, (3) the return on stock- holders’ equity, (4) the return on common stockholders’ equity, (5) earnings per share on common stock, (6) the price- earnings ratio, (7) dividends per share, and (8) dividend yield.

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  Accounting

  • Carl Warren, James Reeve, Jonathan Duchac(Authors)
  • 2017(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  In selecting companies in which to invest, you can use financial anal- ysis to gain insight into a company’s past performance and future prospects. This chapter describes and illustrates common financial data that can be analyzed to assist you in making investment decisions such as whether or not to invest in Nike’s stock. Source: http://news.nike.com Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 Analyzing and Interpreting Financial Statements The objective of accounting is to provide relevant and timely information to support the decision-making needs of financial statement users. Bankers, creditors, and in- vestors all rely on financial statements to provide insight into a company’s financial condition and performance. This chapter discusses the value of financial statement information, techniques used to evaluate financial statements, and how this informa- tion can be used in decision making. The Value of Financial Statement Information General-purpose financial statements are distributed to a wide range of potential users, providing each group with valuable information about a company’s economic performance and financial condition. Users typically evaluate this information along three dimensions: liquidity, solvency, and profitability. Liquidity Short-term creditors such as banks and financial institutions are concerned primarily with whether a company will be able to repay short-term borrowings such as loans and notes. As such, they are most interested in evaluating a company’s ability to convert assets into cash, which is called liquidity. Describe the techniques and tools used to analyze financial statement information. Obj. 1 Chapter 6 Accounting for Merchandising Businesses 825 Learning Objectives After studying this chapter, you should be able to: Example Exercises (EE) are shown in green.

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  Entrepreneurial Finance for MSMEs

  A Managerial Approach for Developing Markets

  • Joshua Yindenaba Abor(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Even when a computerised accounting system is used, errors may arise. This could come from wrong figures being posted or postings being made to wrong accounts. Like it is usually said in the case of computerised systems ‘garbage in, garbage out’, meaning once you make mistakes in what you input into the system, the output will also be wrong. In some other cases, the errors come about as a result of accountants attempting to perpetuate a fraud. 8.4 Analysis of Financial Statements Financial statements in themselves do not tell us much unless we begin to interrogate the figures and establish relationships among the variables and fig- ures in the financial statements. An entrepreneur may be interested in reward- ing employees based on their performance but does he know how well they have really performed? How does the entrepreneur determine how well the firm has performed? How does the small business manager ascertain at what point existing capacity will be exceeded and a bigger capacity will be required? 8 Understanding and Analysing Financial Statements 181 How do lenders and creditors ascertain whether the small business will be able to settle its debt as expected? All of these questions can be addressed by analys- ing the financial statements. Analysis of financial statements or financial analysis involves gathering information about a firm, its industry and the economy and providing an evaluation of the firm’s performance as well as it future financial condition. Financial statement analysis may be useful for both internal and external purposes. Internally, it can be used to evaluate employee performance, the efficiency of the firm’s operations and the firm’s credit policies. Externally, financial analysis can be used by lenders and creditors to evaluate the potential pertaining to the credit worthiness of borrowers. Investors such as venture capitalist also use financial analysis to determine whether the firm presents a viable investment avenue.

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  Managing Financial Resources

  • Michael Broadbent, John M. Cullen(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Assessment of company performance The aims of this chapter are to: • Explain why financial ratios are appropriate for analysing company performance. • Develop financial measures which will assist in the analysis of a company's liquidity, profitability, efficiency and investment through ratio analysis. • Apply the ratios to evaluate company performance using inter-and intra-company comparisons. • Consider the ratios used by financial markets in assessing company performance. • Consider the limitations of ratio analysis in general and the particular effect individual company accounting policies may have on this analysis. Introduction The external financial statements considered in Chapter 2 were the end product of an accounting data collection and accumulation process. Information had been filtered and moulded by the set of measurement rules known as the concepts and conventions, sup-ported by the Statements of Standard Accounting Practice (SSAP) and Company Law to produce the financial statements contained in the annual report and accounts. While the balance sheet, profit and loss account and cash flow statement of a particular company may be used for its particular stakeholder groups, they provide infor-mation in isolation from other companies, and a limited comparison of performance over time (usually the current year's results and the previous year's for comparison purposes). The broad aim of this chapter is to provide tools of analysis which will aid comparison between companies (inter-firm com-parison) and within a company (intra-firm comparison) over time. The area of study for this chapter is illustrated in Figure 3.1. The figure illustrates the flow of accounting data to the stakeholders. We have already considered that this data is not specifically designed for particular user needs, but is highly general in nature. In this chapter we will attempt to develop and adapt the information to be 3

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