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Summary FIN2603 Study Unit 03
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FIN2603 Study Unit 03
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FIN2603 – Finance for Non-Financial Managers (2023)Study Unit 03: Analysis Financial Statements (PB: Chapter 3)
The purpose of financial analysis is to evaluate the financial performance and the financial position of
the company. Such an analysis can indicate whether the company is profitable and financially sound
and is achieving its goals.
1. Types of comparisons
Industry comparative analysis involves the comparison of the financial ratios of different firms
at the same point in time. This is also called a “benchmarking approach” because the firm’s
performance can be compared either to that of the industry leader or to industry averages.
Time-series analysis is conducted when a financial analyst evaluates the performance of a firm
over time. The most informative approach to ratio analysis is one that combines industry
comparative and time-series analyses.
Caution when using ratios:
1. A single ratio cannot provide sufficient information to allow you to judge the overall
performance of the firm.
2. An analyst should be sure that the dates of the financial statements being compared
correspond.
3. It is best to use audited financial statements.
4. Care should be taken not to adopt a bigger is better approach.
5. It is important to make sure that the data being compared has been developed in the
same way.
2. Basic Financial Ratios
Financial ratios can be divided into the following 5 basic groups:
1. Profitability ratios
As a group, profitability measures allow the analyst to evaluate the effectiveness and
efficiency of the firm’s management and employees in generating profit by means of sales, and
the productive use of assets and of the capital of the owners.
Typical measurements of profitability are the following:
1.1 Gross profit margin: Indicates the contribution from the firm’s core business towards
covering the firms operating expenses.
Core business - refers to the excavation of metals and minerals, the manufacturing of goods
and buying and selling. Examples of operating expenses are advertising, salaries, interest paid,
maintenance, depreciation, insurance and taxes. The gross profit must be sufficient to enable the firm
to pay its operating expenses, and hence the greater the gross profit margin, the better the firm's
ability to cover its operating expenses.
Lyana Petzer Page 1 of 14
, FIN2603 – Finance for Non-Financial Managers (2023)
Gross profit margin = Sales – cost of goods sold X 100
sales 1
EXAMPLE
Gross profit margin = 4 500 000 X 100 = 50%
9 000 000 1
Corrective action
If a firm's gross profit margin is not satisfactory, management could consider increasing income from
sales and/or decreasing expenses. More specifically, management should consider the following:
✓ Increase sales through improved marketing.
✓ Procurement and material managers could lower the levels of inventory.
✓ Attempt to produce at a lower cost (in the case of mining and manufacturing firms) or to buy at
better prices (in the case of retailing firms). The latter may include importing goods.
✓ Produce fewer quantities (in the case of mining and manufacturing firms) or buy less stock (in
the case of retailing firms) during periods of declining sales.
1.2 Net profit margin: Measures the percentage of each sales rand remaining after all
expenses, including taxes have been deducted.
Net profit margin = Net profit after tax X 100
sales 1
EXAMPLE
Net profit margin = 997 920 X 100 = 11,09%
9 000 000 1
The higher the net profit margin, the better. The net profit is a common measure of a firm’s
success with respect to earnings on sales.
Corrective action
If a firm's net profit margin is not satisfactory, management could consider increasing income from
sales and/or decreasing expenses. More specifically, management should consider the following:
✓ Increase sales through more efficient and effective marketing.
✓ Reduce expenses. This may be done by determining the percentage of sales absorbed by each
type of expense, ranking it from the greatest to the lowest, and considering reductions in each
type of expense, starting with the greatest expenses.
1.3 Return on investment (ROI), sometimes called return on assets (ROA): Measures the
effectiveness of management in generating profits with its available assets. The greater
the return on investment, the better.
ROI = Net profit after tax X 100
Total assets 1
Lyana Petzer Page 2 of 14
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