Financial management 314
Luschke Labuschagne
25100572
Accounting classification of financial statement
Components 1: THEORY
Dupont analysis (Reader 1)
Enables an analyst to understand what effect changes in the components of the ratios
have on the overall return generated by equity.
Profit after tax
ROE= x 100
Average equity
Profit after tax
ROA= x 100
Average total assets
Average total assets
Leverage=
Average equity
Profit after tax
Net profit margin= x 100
Revenue
A negative net profit margin is realized if a tax loss is realized.
Revenue
Total asset turnover=
Average total assets
Profit after tax
Tax burden=
Profit before tax
Profit before tax
Interest burden=
EBIT
EBIT
EBIT margin= x 100
Revenue
Can determine which factors influence the decline in the overall ROE.
o Can be influenced by the decrease in the net profit margin.
Requirements.
o Meaningful comparisons between items in the financial statements
o Relevant amounts must be included in the calculations.
o It needs to be comparable over time.
It is important to compare the ratios to conventional norms.
Categories:
o Profitability: evaluate the efficiency with which an entity utilizes its capital to
generate revenue.
o Liquidity: refer to an entity’s ability to cover current liabilities by means of its
current assets.
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, o Solvency: investigate the relationship between an entity’s debt capital and its
total assets.
o Cash flow: determine if sufficient cash flows are generated to cover the entity’s
obligations.
o Investment ratios: determine the benefits that the investors of the entity earned.
Financial gearing: refers to the effect that the use of debt capital has on the return on the
shareholders’ equity.
Chapter 2: Financial statements
Statements need to be comparable.
Statements of companies may not be comparable as a result of different accounting
standards.
SA companies converted to IFRS after 2005; comparison to previous years where other
accounting standards were used may be problematic; IFRS only a guideline, open to
interpretation.
Multinational firms: US GAAP vs IFRS
Solution:
Standardize published financial statements.
- Facilitates comparison between companies and over time.
- Simplifies the calculation of financial ratios.
Statement of profit and loss (income statement)
Income: what we generate by selling goods or delivering services
Income- expenses= Retained earnings
Statement of financial position (Balance sheet)
Assets: Non-current and current
Equity: ordinary shares, reserves, preference shares, non-controlling interest
Debt: non-current and current liabilities
Statement of cash flow (Cash flow statement)
Cash @ beginning of year+ Movement in cash during year= cash at the end of year
Movement in cash during year= Cash from OPERATING activities +/- cash from
INVESTING activities +/- cash from FINANCIAL activities
Formats of Standardized financial statements
Examples of all 3 on Sunlearn (!!!!!!!)
Need to understand relationship between elements that form part of each statement, and
be able to identify all items included within these elements
NB: TERMINOLOGY used in module (see sunlearn!!!!!)
Chapter 3: Ratio analysis
DuPont analysis:
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,NET PROFIT MARGIN= EBIT margin x Finance cost burden (Interest burden) x Tax burden
ROA= EBIT margin x Finance cost burden x Tax burden x Total asset turnover
ROE= EBIT margin x Finance cost burden x Tax burden x Total asset turnover x Financial
leverage factor
Provides a breakdown of the components that contribute to a company’s ROE in order to
evaluate changes in the ratio
o Possible to identify the individual components that contribute to the overall value
of the return ratio
o Also possible to evaluate changes in the values of the ratios over time to
determine where possible problem areas exist
o Could also compare the ratios of similar firms to investigate where value is
created
o
o Calculations:
Show all equations and calculations clearly (marks sometimes allocated)
Calculations should not be rounded
Only final answers should be rounded to two decimals (unless specified
otherwise)
indicate the correct unit of measurement (%, Rand, time, etc.)
average values not used in this module
o Tax calculations:
Unless the tax rates are indicated in a question, the following rates are
used:
Corporate tax rate: 28%
Capital gains inclusion rate: 80%
Value added tax (VAT): 15%
Profitability ratios
o Evaluates the efficiency with which a company utilizes its capital to generate
revenue
Small investment in assets generates large income: Company is highly
profitable
Large investment in assets generates small income: Assets are not
utilized efficiently
Copy right: Luschke Labuschagne
, o Possible to calculate the profitability of different capital items
o Ensure a relevant comparison between capital item and corresponding income/
profit
- Return of assets (ROA)
o Measures the return earned on the total assets that are utilized to generate
revenue
Compares profit after tax with assets
o In order to improve ROA:
Improve profit figure
Reduce amount of assets
Combination
- Return of equity (ROE)
o Indicates return generated on total equity
Total equity includes ordinary shareholders’ equity, preference share
capital and non-controlling interest
Profit after tax represents profit available to ALL equity providers
Solvency ratios
o Solvency refers to a company’s ability to cover all its obligations when it
eventually closes down its operating activities
o Comparisons between total assets (Kt), equity (Ke) and debt (Kv) capital
If value of assets exceeds the value of liabilities, solvency level would
most probably be sufficient
If this is not the case: long-term survival of the company may be at risk
Kv/Kt OR Kv/ Ke
- Financial leverage ratio
o The amount of total assets is compared with the amount of equity capital
included in a company’s capital structure
The higher the value of this ratio, the weaker the solvency position
Profit margins
o Indication of the percentage of revenue that shows as profit after certain
deductions are made
o Profit margins could influence profitability ratios
Higher profit margins should increase profitability levels
- Gross profit margin
o Portion of revenue available after cost of sales has been paid, relative to
revenue
o
- Gross profit mark-up
o Gross profit expressed as percentage of the cost of sales
Copy right: Luschke Labuschagne
Luschke Labuschagne
25100572
Accounting classification of financial statement
Components 1: THEORY
Dupont analysis (Reader 1)
Enables an analyst to understand what effect changes in the components of the ratios
have on the overall return generated by equity.
Profit after tax
ROE= x 100
Average equity
Profit after tax
ROA= x 100
Average total assets
Average total assets
Leverage=
Average equity
Profit after tax
Net profit margin= x 100
Revenue
A negative net profit margin is realized if a tax loss is realized.
Revenue
Total asset turnover=
Average total assets
Profit after tax
Tax burden=
Profit before tax
Profit before tax
Interest burden=
EBIT
EBIT
EBIT margin= x 100
Revenue
Can determine which factors influence the decline in the overall ROE.
o Can be influenced by the decrease in the net profit margin.
Requirements.
o Meaningful comparisons between items in the financial statements
o Relevant amounts must be included in the calculations.
o It needs to be comparable over time.
It is important to compare the ratios to conventional norms.
Categories:
o Profitability: evaluate the efficiency with which an entity utilizes its capital to
generate revenue.
o Liquidity: refer to an entity’s ability to cover current liabilities by means of its
current assets.
Copy right: Luschke Labuschagne
, o Solvency: investigate the relationship between an entity’s debt capital and its
total assets.
o Cash flow: determine if sufficient cash flows are generated to cover the entity’s
obligations.
o Investment ratios: determine the benefits that the investors of the entity earned.
Financial gearing: refers to the effect that the use of debt capital has on the return on the
shareholders’ equity.
Chapter 2: Financial statements
Statements need to be comparable.
Statements of companies may not be comparable as a result of different accounting
standards.
SA companies converted to IFRS after 2005; comparison to previous years where other
accounting standards were used may be problematic; IFRS only a guideline, open to
interpretation.
Multinational firms: US GAAP vs IFRS
Solution:
Standardize published financial statements.
- Facilitates comparison between companies and over time.
- Simplifies the calculation of financial ratios.
Statement of profit and loss (income statement)
Income: what we generate by selling goods or delivering services
Income- expenses= Retained earnings
Statement of financial position (Balance sheet)
Assets: Non-current and current
Equity: ordinary shares, reserves, preference shares, non-controlling interest
Debt: non-current and current liabilities
Statement of cash flow (Cash flow statement)
Cash @ beginning of year+ Movement in cash during year= cash at the end of year
Movement in cash during year= Cash from OPERATING activities +/- cash from
INVESTING activities +/- cash from FINANCIAL activities
Formats of Standardized financial statements
Examples of all 3 on Sunlearn (!!!!!!!)
Need to understand relationship between elements that form part of each statement, and
be able to identify all items included within these elements
NB: TERMINOLOGY used in module (see sunlearn!!!!!)
Chapter 3: Ratio analysis
DuPont analysis:
Copy right: Luschke Labuschagne
,NET PROFIT MARGIN= EBIT margin x Finance cost burden (Interest burden) x Tax burden
ROA= EBIT margin x Finance cost burden x Tax burden x Total asset turnover
ROE= EBIT margin x Finance cost burden x Tax burden x Total asset turnover x Financial
leverage factor
Provides a breakdown of the components that contribute to a company’s ROE in order to
evaluate changes in the ratio
o Possible to identify the individual components that contribute to the overall value
of the return ratio
o Also possible to evaluate changes in the values of the ratios over time to
determine where possible problem areas exist
o Could also compare the ratios of similar firms to investigate where value is
created
o
o Calculations:
Show all equations and calculations clearly (marks sometimes allocated)
Calculations should not be rounded
Only final answers should be rounded to two decimals (unless specified
otherwise)
indicate the correct unit of measurement (%, Rand, time, etc.)
average values not used in this module
o Tax calculations:
Unless the tax rates are indicated in a question, the following rates are
used:
Corporate tax rate: 28%
Capital gains inclusion rate: 80%
Value added tax (VAT): 15%
Profitability ratios
o Evaluates the efficiency with which a company utilizes its capital to generate
revenue
Small investment in assets generates large income: Company is highly
profitable
Large investment in assets generates small income: Assets are not
utilized efficiently
Copy right: Luschke Labuschagne
, o Possible to calculate the profitability of different capital items
o Ensure a relevant comparison between capital item and corresponding income/
profit
- Return of assets (ROA)
o Measures the return earned on the total assets that are utilized to generate
revenue
Compares profit after tax with assets
o In order to improve ROA:
Improve profit figure
Reduce amount of assets
Combination
- Return of equity (ROE)
o Indicates return generated on total equity
Total equity includes ordinary shareholders’ equity, preference share
capital and non-controlling interest
Profit after tax represents profit available to ALL equity providers
Solvency ratios
o Solvency refers to a company’s ability to cover all its obligations when it
eventually closes down its operating activities
o Comparisons between total assets (Kt), equity (Ke) and debt (Kv) capital
If value of assets exceeds the value of liabilities, solvency level would
most probably be sufficient
If this is not the case: long-term survival of the company may be at risk
Kv/Kt OR Kv/ Ke
- Financial leverage ratio
o The amount of total assets is compared with the amount of equity capital
included in a company’s capital structure
The higher the value of this ratio, the weaker the solvency position
Profit margins
o Indication of the percentage of revenue that shows as profit after certain
deductions are made
o Profit margins could influence profitability ratios
Higher profit margins should increase profitability levels
- Gross profit margin
o Portion of revenue available after cost of sales has been paid, relative to
revenue
o
- Gross profit mark-up
o Gross profit expressed as percentage of the cost of sales
Copy right: Luschke Labuschagne
