FINANCIAL STATEMENT

ANALYSIS
 Hello!
I am Puan Suryani. Let’s start the lesson together!

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LEARNING OUTCOMES
AT THE END OF THIS CHAPTER, STUDENTS
SHOULD BE ABLE TO:

✔ Explain the objectives of financial statement analysis

✔ Describe and explain the different types of financial ratios
✔ Calculate and interpret the main financial ratios
✔ Explain the use of ratios in analysing the performance of a business

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 The financial statements provide a snapshot of financial
information on business performance and its financial
position for a particular reporting period. After all, the
Financial statement can be further analyse to helps the
business stakeholders to understand the overall health of the
business and to evaluate the business value.
The analysis can be done through the use of various tools and
one of the tools commonly used is the financial ratio.

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Objectives of financial statement analysis
1. To identify the weaknesses as well as the strengths of a
business.

1. To enable the business to take the appropriate steps or

actions to overcome any weaknesses.

1. To enable the business to improve its overall financial

situation in the future.

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how to do the analysis?
“Ratio analysis is the process of determining and interpreting
numerical relationship based on financial statements.”

“It is the technique of interpretation of financial statements

with the help of accounting ratios derived from the Statement
of Profit or loss and Statement of Financial statements”

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Types of FINANCIAL ratios
Ratio

Liquidity Efficiency Profitability

ratio ratio ratio

Inventory Gross profit

Current ratio
turnover ratio margin

Average
Acid test/quick Net profit
collection
ratio margin
period

Return on
Investment

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Liquidity ratios
Objective:
These ratios measure the ability of a business to meet its
short-term obligations when they become due

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 Current ratio

▪ It is called currents since it establishes relationship between total current assets and current
liabilities.

▪ It measures business’ ability to pay current or short-term liabilities with its current or
short-term assets when they become due.

▪ Ideal ratio is 2:1. This means that for every RM1 of current liabilities, the business has RM2 of
current assets to repay that RM1 of liabilities.

▪ A current ratio of less than 1 indicates that the business’ debts due in a year are greater than its
asset that expected to be converted to cash within a year. This may seem risky to the business.
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 Acid test/quick ratio
- prepayments

▪ It indicates the business’ ability to instantly use its most liquid assets (assets that can be exchanged quickly to
cash) to pay its current liabilities.

▪ Is calculated by dividing business’ most liquid assets such as cash, bank and accounts receivables by total current
liabilities. Specific current assets such as inventory and prepayments are excluded since they may not easily
convert into cash.

▪ The higher the ratio result, the better for the business liquidity and financial health. While the lower the ratio
result, the more likely the business will struggle with paying its current debts.

▪ As example, a quick ratio of 1.5 indicates that a business has RM1.50 of liquid assets available to cover each
RM1 of its current liabilities. A business that has a quick ratio of less than 1 may not be able to fully pay off its 10
current liabilities in the short term.
Efficiency ratios
Objective:
These ratios measure the efficiency of a business in managing its
assets to generate revenue

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 Inventory turnover ratio

▪ Inventory turnover is a ratio showing number of times a business sells and replace its
inventory during a given period.

▪ Inventory turnover is calculated by dividing cost of sales by average inventory. Where the
average inventory is calculating by = Opening Inventory + Closing Inventory) / 2

▪ High inventory turnover usually a sign that the sales are healthy. It indicate that business is
selling its product in a timely manner. A rate of 1 or less means business have excess inventory
and it is a sign of risk in the business cash flow.

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 Average collection period

▪ It represents the length of time a business undertakes to collect money from its
debtors/accounts receivable

▪ The shorter the period, the better it is for the business in terms of its liquidity.

▪ If debts are not collected on time, the business may not have enough cash resources to
operate.

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 Profitability ratios
Objective:
These ratios measure the performance of a business during an
accounting period

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 Gross profit

▪ It is often shown as the gross profit as a percentage of net sales. Gross profit is expressed as a
company's net sales minus the cost of goods sold.

▪ The gross profit margin shows the amount of profit a business makes after paying off its cost
of goods sold and before deducting the administrative costs, distribution costs, finance costs
and other operating expenses.

▪ A higher ratio is more favorable. For example, if the gross profit ratio is calculated to be 40%,
that means for every RM100 sales generated, RM60 would go into cost of goods sold and the
remaining RM40 is retained and could be used to pay off the operating expenses.

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 net profit margin

▪ Net profit margin measures the amount of net profit generated by business from the sales revenue. It
indicates how much of each money of revenue is retained by the business after the total expenses is paid off
and helps investors to assess the efficiency of business in controlling its operating and overhead costs.

▪ To find the net profit, subtract the cost of goods sold, operating expenses and other expenses from the net
sales. The ratio is derived by dividing the result with net sales and convert the figure to a percentage
by multiplying it by 100

▪ A positive net profit margin indicates a strong financial health. A high profit margin is often an
indicator of efficient operation management with low expenses and efficient pricing strategies. While a low
net profit margin reflects a poor pricing strategy and inefficient cost structure.

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 RETURN ON INVESTMENT

▪ Also known as return on capital employed.

▪ Return on capital employed is calculated by dividing net operating profit, or earnings before
interest and taxes (EBIT), by capital employed.

▪ Another way to calculate capital employed is by finding the difference between total assets and
current liabilities or by adding the owner’s equity and non-current liabilities.

▪ Return on investment indicates how well the business is doing in relation to the amount of money
invested or the efficiency of business in using its capital to generate profit.
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Let’s take a
BREAK!
Sample
illustration:

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Sample
illustration:

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LET’S DISCUSS ON THE
SOLUTION

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TIPS
✔ Students must be able to understand the structure of the financial
statements and how different parts of the financial statements are
connected to each other.

✔ Students must memorise the formula and able to explain the answer
behind the formula.

✔ Students must provide workings for the ratio calculations. If an answer is

wrong and there are no workings, no marks will be awarded. If the answer
is wrong but workings are provided, it is possible that examiners can
award marks for the parts of the calculation that are correct.

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Solution:

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Solution
(cont.):

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Solution
(cont.):

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Solution
(cont.):

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Thank you!
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