Grade 12 Theory Notes: Ch 4 Financial Analysis
ANALYSIS AND INTERPRETATION OF COMPANY FINANCIAL STATEMENTS AND ANNUAL REPORTS
Who uses the financial statements of a company?
Shareholders Net Profit, Dividends
Directors Net Profit, Solvency, Liquidity
Auditors Overall fair presentation
Registrar Overall presentation, Auditors Report
Financial institutions Fixed/Tangible assets, loans, net profit
Creditors Current assets and current liabilities
Employees Net Profit, salaries, and wages
SARS Net Profit
Competitors Net Profit, earnings, dividends
Important rules to remember when analysing financial statements:
1. Always compare with previous year
2. Look at formula to help with comments
3. Depending on what you are calculating decide if you are commenting in favour of:
a. the business
b. the investor
c. the lender (with regards applying for finance)
4. When commenting on profitability make sure you are using the correct Net Income figure. The NPAT is normally used when doing
calculations for the returns to the shareholders (ROE, EPS, DPS, Return on Profitability). It’s what you have left after paying everyone and
everything.
, Grade 12 Theory Notes: Ch 4 Financial Analysis
5. The effect of increased loans and capital in the business should translate into the efficient use of assets (bought with the loans and
capital) that generate higher profit
PROFITABILITY (How well it controls its expenses and how efficiently it is operating)
OPERATING EFFICIENCY (same as profitability)
Ratio Formula Purpose
Gross Profit X 100
% Gross Profit on Sales To check stock losses against poor control
Sales 1
% Gross Profit on Cost of Sales (mark- Gross Profit X 100 To check stock losses if a constant mark-up is used and then
up) Cost of Sales 1 resolve the problem
Operating Income X 100 The higher the better. The more sales the better the operating
% Operating Income on Sales
Sales 1 profit will be.
Operating Expenses X 100
% Operating Expenses on Sales The expenses should not be too high
Sales 1
If the percentage drops from last year, then decrease
Net Profit before Tax X 100
% Net Income (Profit) on Sales expenses or increase mark-up. The lower the percentage the
Sales 1
better the control is over expenses.
If the percentage drops from last year, then decrease
Net Profit after Tax X 100
% Net Income (Profit) after Tax on Sales expenses or increase mark-up. The lower the percentage the
Sales 1
better the control is over expenses.
Average OE calculated by Shareholders Equity at the
Net Profit after Tax X 100 beginning of the year + Shareholders Equity at the end of the
% Return on Equity
Average Owners Equity 1 year and divide by 2.
Compare results with other possible investments.
Net Income before Tax + Int on Loan X 100 Used to determine if the company is using the total funds
Average Capital Employed 1 available efficiently.
% Return on Total Capital Employed
Average Capital Employed = (Shareholders Favourable when ROTCE is greater than interest on loan, eg
(ROTCE)
Equity @ beginning of year + Shareholders ROTCE = 21% & Int on loan = 15%.
equity @ end of year) / 2
Net Profit after Tax X 100 The higher the percentage the better. Assets are helping
Profitability on Total Assets (%) increase the profit.
Total Assets 1
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