# Financial Statement Analysis Lecture 4

Topics: Financial ratios, Generally Accepted Accounting Principles, Financial ratio Pages: 45 (1045 words) Published: December 6, 2014
Financial Statement Analysis
Lecture 4

Learning Objectives:
- Financial Analysis continued:
Profitability ratios

Interpreting Financial Statements…
We will continue today by looking at what we
want to get from financial statements.
We will look at a range of financial ratios and
measures for assessing performance, starting
with profitability ratios.

Two basic concerns of
financial statement analysis
1. Management performance
(i) Profitability
(ii) Asset utilisation

2. Financial strength
(iii)Solvency
(iv)Liquidity

Profitability
Multiple measures of profit:
- gross profit
- operating profit
- net profit before tax
- net profit after tax

Why use ratios?
Profit measures by themselves will be affected by the
Larger businesses are more likely to show larger
profits (or losses!) than smaller businesses
Using ratios makes the numbers comparable for

Margin ratios
• Gross Profit Margin
• Operating Margin
• Net Profit Margin

Gross profit margin
GPM = Gross profit / Sales X 100%
Gives an indication of how well management has
controlled direct costs in relation to sales

Widget Plc
2013 2012
2011
£m £m
£m
Sales 762 745 620
Cost of Sales
(267) (246)
Gross Profit
495 499
Operating Profit 127 141
Tax (69) (70) (42)
Net Profit After Tax 58 71

(217)
403
(300)
103
61

Gross profit margin
GPM = Gross profit / Sales X 100%
2011: GPM =
2012: GPM =
2013: GPM =

Operating margin
OM = Operating profit / Sales X 100%
A measure of the profitability of the core
business, excluding financing and taxation costs.
Provides an indication of management's control
over all operating costs - direct costs and indirect

Operating margin
OM = Operating profit / Sales X 100%
2011: OM =
2012: OM =
2013: OM =

Net profit margin
NPM = Net profit after tax / Sales X 100%
Also called "return on sales" and shows how
successful the business has been creating profit
from its sales (after all costs have been
deducted)

Net profit margin
NPM = Net profit after tax / Sales X 100%
2011: NPM =
2012: NPM =
2013: NPM =

Margins
In 2013, Widget PLC, had the following margins:
GPM = 65.0%
OM = 16.7%
NPM = 7.7%
We would need to compare this profile with others in
Widget’s industry to gauge comparative performance.

Return on Investment Ratios
Return on Equity
Return on Assets
Return on Capital Employed

Widget Plc
2013
2012
2011
£m
£m
£m
Non-current Assets 495
532
312
Current Assets 216.1 194
172.4
Total Assets
711.1 726
484.4
Equity
435.2 387.9 315.5
Current Liabilities 75.9
88.1
68.9
Long Term Debt
200
250
100

Return on equity
ROE = Net profit after tax / Equity
Measures how much the company has earned on the
funds invested by its shareholders - both directly invested
funds and retained profits
But, it is not the shareholders' return on their investment, and should not be used to compare investments

Return on equity
ROE = Net profit after tax / Equity
2011: ROE =
2012: ROE =
2013: ROE =

Return on assets
ROA = Profit before interest or tax / Total assets
Reflects how much the company has earned on the investment of all the financial resources committed to the company
Allows for comparison between companies with different ratios of debt/equity

Return on assets
ROA = Profit before interest or tax / Total assets

2011: ROA =
2012: ROA =
2013: ROA =

Return on capital employed
ROCE = Net profit before interest on long term debt /
(Equity + Long-term debt)
Shows how much the company has earned on invested
long-term funds (also called permanently employed
capital)

Return on capital employed
ROCE = Net profit before interest on long term debt / (Equity + Long-term debt)

2011: ROCE =
2012: ROCE =
2013: ROCE =

Return on Investment Ratios
The different ROI figures each reflect the...