3.5.2 Analysing financial performance

What are the key financial statements?

Income Statement: Shows revenues, expenses, and profits over a period. Balance Sheet: Snapshot of assets, liabilities, and equity at a specific point in time. Cash Flow Statement: Tracks cash inflows and outflows over a period.

What are profitability ratios?

Gross Profit Margin = (Gross Profit / Revenue) × 100. Operating Profit Margin = (Operating Profit / Revenue) × 100. Net Profit Margin = (Net Profit / Revenue) × 100. Purpose: Measures how well a company converts revenue into profit at different levels.

What is Return on Capital Employed (ROCE)?

Formula: ROCE = (Operating Profit / Capital Employed) × 100. Capital Employed: Total assets – current liabilities. Purpose: Measures the efficiency of capital usage to generate profits.

What are liquidity ratios?

Current Ratio = Current Assets / Current Liabilities (Ideal: 1.5:1 to 2:1). Quick Ratio = (Current Assets – Inventory) / Current Liabilities. Purpose: Measures the ability to pay short-term liabilities without relying on inventory.

What are efficiency ratios?

Asset Turnover = Revenue / Total Assets. Inventory Turnover = Cost of Goods Sold / Average Inventory. Purpose: Measures how efficiently assets and inventory are used to generate sales.

What are gearing ratios?

Gearing Ratio = (Non-current Liabilities / Shareholders' Equity) × 100. Purpose: Measures the proportion of debt in the company’s capital structure. High gearing = higher financial risk.

What is the difference between gross profit and operating profit?

Gross Profit = Revenue – Cost of Goods Sold. Operating Profit = Gross Profit – Operating Expenses (wages, rent, etc.). Purpose: Gross profit focuses on direct costs, while operating profit considers all operational expenses.

What are financial objectives?

Profitability: Achieving sustainable profits. Liquidity: Ensuring ability to meet short-term debts. Growth: Expanding revenue and market share.

What does a high gearing ratio indicate?

High Gearing: Company relies heavily on debt for financing, which increases financial risk but can also lead to higher returns if well-managed.

Why is cash flow important in financial analysis?

Cash Flow: Indicates the company’s ability to generate cash for paying liabilities and reinvesting. Free Cash Flow = Operating Cash Flow – Capital Expenditures.

What is the relationship between profitability and liquidity?

Profitability: Reflects ability to generate earnings. Liquidity: Ability to pay short-term debts. Challenge: Profitable businesses may face liquidity problems if cash is tied up in receivables or inventory.

What are the limitations of financial ratio analysis?

Historical Data: Based on past performance, which may not reflect future trends. Comparability: Can be difficult to compare across industries or with different accounting methods. Non-financial Factors: Does not account for qualitative factors like brand or customer satisfaction.

What is the importance of benchmarking in financial analysis?

Benchmarking: Comparing a company’s performance to industry standards or competitors. Purpose: Identifies areas for improvement and ensures competitiveness.