FINANCIAL
FORECASTING AND
ANALYSIS
L E C T U R E R : M R B J I YA N E , B A P ( S A )
CHAPTER :
F IN AN CIAL
ANALY SIS -R AT IO S
OUTLINE
1. Learning outcomes
2. Introduction
3. Content
a) Concept
b) Examples
4. Activity
5. Additional Resources
LEARNING OBJECTIVES
•At the end of this study session, you should be
familiar with:
• Structure of financial statement
• Need for financial reporting and analysis
• Profitability ratios
• Liquidity ratios
• Return rations
INTRODUCTION
Importance of Financial Analysis
ü Management and investors make extensive use of financial analysis and financial ratios to monitor
and evaluate corporate performance.
ü Any analysis of a firm by management, investors, and other interested parties, should include an
examination of the company’s annual financial statements
ü At the end of every financial year, the directors of each company have to produce annual financial
statements and in terms of the Companies Act (2008), are obliged to present them to shareholders at
the annual general meeting (AGM).
ü The financial statements must, in conformity with International Financial Reporting Standards
(IFRS), fairly present the state of the affairs of the company and the results of operations for the
financial year
FINANCIAL STATEMENTS
ü The purpose of Accounting is to report on the performance of an organisation.
ü Various parties need information about the performance of an organisation for various reasons.
ü How do we report on the performance of an organisation? 🤷
ü This reporting on performance is done through the issuance of financial statements consisting of the
following major components :
1. Statement of Profit or Loss and Other Comprehensive Income / Statement of Financial
Performance / Income Statement
2. Statement of Financial Position / Balance Sheet
3. Statement of Changes in Equity
4. Statement of Cashflows
5. Notes to Financial Statements
FINANCIAL STATEMENTS
Components of Financial Statements
1. Statement of Profit or Loss and Other Comprehensive Income / Statement of Financial Performance / Income
Statement:
ü Reflects the profit made or loss incurred over a specific period of time known as the reporting period.
ü The reporting period is typically a period of 12 months known as the financial year (does not need to correspond
to calendar year). Title typically includes “…for the year ended <date>”
ü Reports two elements of financial performance: Income and Expenses.
2. Statement of Financial Position / Balance Sheet:
ü Reflects the net worth of the entity at a specific point in time (at the end of the reporting period)
ü Reports three elements of financial position: Assets, Equity And Liabilities
ü Assets: resources of the entity that are needed to operate and generate income (buildings, equipment, vehicles,
cash on hand, stock, etc.)
ü Equity: capital contributed by owners and profit from prior periods retained and reinvested into the business
ü Liabilities: loans from lenders, amounts owed to trade creditors and others.
FINANCIAL STATEMENTS
3. Statement of Changes in Equity:
ü Intended to specifically show the changes in the equity of the entity for the reporting period
ü Forms the link between the Statement of Profit and Loss and the Statement of Financial
Position (profit for the year that is retained and reinvested in the business forms part of
capital)
ü An example of a change in equity: Is the contribution of additional capital by owners
OBJECTIVES OF FINANCIAL ANALYSIS
Objectives of financial analysis and stakeholders
ü The overall objective of financial statement analysis is to examine a firm’s financial position
and returns in relation to risk, with a view to forecasting the firm’s future prospects.
ü In examining the specific objectives of users of financial statements, we need to identify
different categories of users and their information requirements.
ü Users of the integrated report and annual financial statements will include stakeholders such
as shareholders, management, employees, suppliers, customers, and credit granters and
lenders, government and society.
USERS OF FINANCIAL STATEMENTS AND ANALYSIS
1. Shareholders
ü Shareholders are the suppliers of a firm’s equity risk capital.
ü This capital is exposed to all the risks of ownership and provides a cover for the debt that has a
preferen>al claim to income and capital on liquida>on.
ü On liquida>on, ordinary shareholders have a claim to what remains only aAer the prior claims of
creditors and preferred shareholders have been met.
2. Credit grantors
ü Credit grantors provide firms with loan capital in various forms and for a variety of purposes . This
may take the form of short-term or long-term credit.
ü Trade creditors who supply goods or provide services on credit normally provide short-term credit .
ü Most trade credit ranges from 30 to 90 days with cash discounts occasionally allowed for specified
earlier payment.
USERS OF FINANCIAL STATEMENTS AND ANALYSIS
3. Management
ü Management would use financial analysis to assist them in exercising control and in viewing the firm in the way
that outsiders, such as creditors and investors see it .
ü This perspective helps management to identify actions that will maximise shareholder wealth and ensure that
the firm receives an optimal allocation of capital resources.
4. Employees
ü In order to negotiate for improve wages and benefits, employees and unions need to study the annual report of
the firm to find the relationship between profitability and the amounts paid to employees.
ü Employees may also be interested in the long-term viability of the firm since this has a bearing on future job
security.
5. Customers
Customers may wish to analyse the financial statements in order to ensure the future reliability of supplies and
the value of warranties . If the company provides warranties and spare parts, then customers will want to ensure
that the company is financially secure and has a sustainable business model in the longer term
USERS OF FINANCIAL STATEMENTS AND ANALYSIS
6. Suppliers
ü The company’s suppliers will analyse the integrated report and annual financial statements in
order to evaluate the company’s profitability and financial position so that the suppliers can
continue to sell to the company and to ensure that any trade credit provided to the company
is secure.
ü Suppliers will monitor the company’s liquidity and ability to pay its short-term debts.
7. Auditors
An auditor is called upon to express an opinion on the fairness of the presentation of financial
statements. The major purpose of the audit process is to obtain the greatest possible degree of
confidence about the absence of material errors and irregularities that, if undetected, would
affect the fairness of the presentation.
APPLICATION OF RATIO ANALYSIS
ü A ratio contains little meaningful information on its own . 😉
ü For a ratio to be effectively interpreted, it needs to be either compared with historic ratios to
identify trends, or with industry ratios, or with management’s goals and standards, and it must
be evaluated in the context of associated ratios .
ü When comparing a firm’s ratio to industry ratios, care must be taken to ensure that the firm
itself does not unduly bias the industry ratios and that the comparison of financial data is
appropriate .
ü As industry ratios are the mean ratios for a large number of firms, it is possible that the
individual ratios vary extensively . This would result in the industry ratios being less
meaningful .
ü Ratios may be categorised into six groups: Liquidity Ratios, Asset Management Ratios, Debt
Management Ratios, Profitability Ratios, Cash Flow Ratios, And Market Value Ratios .
PROFITABILITY RATIOS
PROFITABILITY
ü Measures the how efficient the company is in its normal operaSng acSviSes.
1. % Gross profit on sales
2. % Net profit on sales
3. % OperaSng expenses on sales
4. % OperaSng profit on sales
5. % Gross profit on cost of sales (mark-up)
PROFITABILITY RATIOS
LIQUIDITY
ü The ability of a company to pay off its immediate (short-term) debts.
1. Current ratio
2. Acid test ratio
3. Net current assets (net working capital)
4. Turnover rate of stock
5. Debtors’ collection period
6. Creditors’ payment period
7. Average period of stock on hand
PROFITABILITY RATIOS
RETURN
ü Are the shareholders earning a fair amount on their investment?
1. % Return on average shareholders’ equity
2. Earnings per share
3. Dividends per share
4. Net asset value
ü Solvency
ü The ability of a company to pay off all its debts
1. Solvency ratio
2. Net assets
THANK YOU
🙏👍
