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1、M17EFA Financial Statement Analysis and Valuation,Interpretation of financial statements using trend and ratio analysis,Learning objectives,By the end of this session students should be able to:Understand why interpretation of financial statements is necessaryBe aware of the difference between horiz
2、ontal analysis,trend analysis,vertical analysis,and ratio analysisExplain the limitations of ratio analysis,Interpretation of financial statements,It is not easy to evaluate performance just by looking at an organisations financial statementsFinancial statements provide absolute figures which make m
3、eaningful comparison difficultFor example a profit before tax of 100,000 might appear adequate but:What does this represent as a percentage of revenue?What percentage return does it represent to an investor?Are resources being used efficiently?How does performance compare with previous accounting pe
4、riods/industry averages/competitors?,Interpretation,We can gain a better understanding of performance by examining financial statements using a range of techniques including:Horizontal analysisTrend analysisVertical analysisRatio analysis,Interpretation,These techniques look at the relationship betw
5、een figures in an entitys financial statements and allow us to make comparisons with:previous accounting periodssimilar businesses/industry averagesThis allows us to:Establish trendsHighlight significant differences in performanceForecast future performance,Horizontal analysis,Line by line compariso
6、n of an organisations financial statements for each accounting period under reviewCalculate%change from one period to the nextFocus on key areas:RevenueGross profitOperating profitStaff costsClearly indicates significant changes from one period to the next,Next plc,Horizontal analysis-Comments,From
7、the income statement we can see that revenue in 2011 is 47.2 million higher than in 2010(3,453.7-3,406.5)Using horizontal analysis we can express this as an increase of 1.39%This is more easily comparable with previous periods/competitorsBetween 2006 and 2011 revenue increased by 347.5 mil or 11.2%(
8、3,453.7-3,106.2)/3,106.2)Operating profit in 2011 is 574.8 million.This is 8.49%higher than 2010,Trend analysis,Similar to horizontal analysisUses indices instead of%changeFigures from first accounting period are given an index of 100Relate figures from subsequent periods to base indexAgain clearly
9、indicates significant changes from one period to the next,Next plc,Trend analysis-Comments,From the income statement we can see that revenue in 2011 is 347.5 million higher than in 2006(3,453.7 3,106.2)From our trend analysis we see that this represents an increase of 11.19 compared to the base inde
10、xAgain this is more easily comparable with previous periods/competitorsBetween 2006 and 2011 operating profit increased by 22.12 index points,Vertical analysis,Useful technique that expresses individual figures as a%of totalsClearly indicates significant changes from one period to the next allowing
11、managers to investigate why these have occurred,Next plc,Vertical Analysis of Next plcs Income statement,From our vertical analysis for Next plc we can see that:As a percentage of revenue,gross profit has fallen slightly from 29.3%to 29.2%(may be due to reduction in selling prices/increases in suppl
12、ier costs/a combination)This means that in 2011,for every 100 of revenue,Next generates a gross profit of 29.20(10 pence less than 2010),Vertical Analysis of Next plcs Income statement,As a percentage of revenue operating profit has increased from 15.6%to 16.6%This means that for every 100 of revenu
13、e,Next generates an operating profit of 16.60(1 more than 2010)As a%or revenue both admin and distribution costs have decreased,suggesting tighter control of operating expenses,Next plc,Ratio analysis,In general ratios are broken into five groups dealing with:ProfitabilityEfficiencyLiquidityCapital
14、structure(gearing)InvestorsSome overlap between these areasNote that in order to make use of ratios we must have something to compare them against,Ratio analysis,During the next few sessions we will examine in detail some of the most commonly used ratiosLet us start by looking at how the calculation
15、 of a few ratios can enhance our understanding of how Next has performed during 2011,Next plc,Gross profit margin(%)-Formula,=Gross Profitx 100%Revenue,Gross profit margin(%)-Calculation,2011=1,008.7 x100%=29.2%3,453.72010=996.9 x100%=29.3%3,406.5,Gross profit margin(%)-Comments,Only takes into acco
16、unt cost of goods soldIn 2011,for every 100 of sales,Next plc made a gross profit of 29.20Slight decline on 2010(0.1%decrease)May be due to:Decrease in selling pricesChange in sales mixSlight increase in supplier pricesMore items that are not sold at full priceCombination of the above factors,Profit
17、 from operations(%)-Formula,=Profit from operations x100%Revenue,Profit from operations(%)-Calculation,2011=574.8 x100%=16.6%3,453.72010=529.8 x100%=15.6%3,406.5,Profit from operations(%)-Comments,Takes into account cost of sales and all other operating expensesIn 2011,for every 100 of revenue,Next
18、plc makes a profit from operations of 16.60Alternatively for every 100 of revenue,83.40 covers cost of goods sold,wages and other operating expenses,the balance is profit from operationsSignificant improvement on 2010(1%higher)Impressive given decline in gross marginBreakdown of expenses required,Co
19、ntrol of staff costs-Formula,=Staff costsx 100%Revenue,Control of staff costs-Calculation,2011=675.2x 100%=19.6%3,453.72010=678.2x 100%=19.9%3,406.5,Control of staff costs-Comments,Indicates how well the company is controlling employee costsIn 2011 for every 100 of revenue,19.60 was spent on wages a
20、nd salariesSignificant improvement on 2010,especially since no of FTE staff has increased from 35,619 to 37,220,Revenue per employee-Formula,=Revenue Number of employees,Revenue per employee-Calculations,2011=3,453.7=92,79237,2202010=3,406.5=95,63735,619,Revenue per employee Comments,In 2010 each FT
21、E employee generated on average 95,637 of revenueIncrease in the number of FTE employees in 2011 means average revenue generated by each FTE employee fallen to 92,792This indicates a decline in the efficiency of FTE employees(but this ratio is easily distorted),Ratio analysis-Summary,From our brief
22、ratio analysis for Next plc we can see that:Slight decline in the gross profit marginSignificant improvement in operating profit marginStaff costs remain at less than 20%of revenueFurther analysis of operating expenses is necessary to establish why the operating profit margin has improvedRevenue gen
23、erated by each FTE employee has fallen,but needs further investigation before we can comment further,Limitations of ratio analysis,Financial statements are historic in nature(backward rather than forward looking/out of date)Comparison of results made difficult by:Use of different accounting policies
24、One off items that distort results(eg:large bad debt,restructure,redundancy)Definition used(eg:ROCE,Gearing,capital employed)Year end balances not always representative of period as a whole(eg:high inventory levels before Xmas)Ratio analysis may indicate problems,it wont necessarily recommend solutions,Reading,Atrill and McLaney(2011)Chapters 7 and 8 McKenzieChapter 6 and 8Melville(2009)Chapter 22Next annual report 2011,
