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Topic 6: Analysis and Interpretation - Coggle Diagram
Topic 6: Analysis and Interpretation
Analysis
Looking at $ amount
What is the significance of this change in $ value?
Ratio Analysis
Comparison of financial items relative to eachother
Ratios calculated by different aspects of business
Liquidity
Market performance
Capital structure
Profitabilty
Effeciency
Liquidity
Short-term survival;
The ability of an entity to convert its assets into cash to pay short-term debts
Quick (acid test) Ratio:
measure a company's ability to meet its short-term obligations with with its most liquid assets and therefore excludes inventories from its current assets
Current (working capital) Ratio:
A basic measure of whether there are sufficient current assets to pay off current liabilities, with its current assets, such as cash, accounts receivable and inventories.
Higher ratio = better liquidity position
Market Performance
Assess success of investments:
Assesses performance specifically from a shareholder perspective. They are investing in an effort to increase their wealth, through dividends and capital growth.
Divided Per Share:
Represents how much the shareholders recieve as a reward for investing in the entity's shares.
Growing DPS can mean its earnings growth can be sustained
Payout Ratio:
Represents the proportion of profits paid out to shareholders as dividends.
Dividend Paid/Net Income = %
Capital Structure
Considers the mix of long-term debt along with equity. Being aware if an entity's capital structure is important to assess the riskiness of financial situation
Interest Coverage:
assesses how easily profits are able to cover interest expenses on borrowings.
High coverage ratio is better. EBIT/Interest Expense
Debt Ratio:
Shows the proportion of assets financed by debt rather than equity.
Debt ratio=1.0 (100%), more debt than assets. Less than 1.0 means more assets than debt
Equity Ratio:
Shows the proportion of assets financed by equity rather than debt.
Closer to 100%= More assets financed by equity than debt. Shareholder's equity/Total Assets
Debt to Equity Ratio:
Shows degree to which company is financing operations through debt v own funds/ability to cover debt with shareholder equity. **Company's Total Liabilities/Shareholder equity.
Efficiency
How assets are utilised to generate income and profits
Days' Inventory Ratio:
Measures the average time it takes to sell inventory (in days)
Days' Debtors:
Measures the average time it takes on average to collect amounts owing from credit customers
Asset Turnover:
measures sales or income relative to total asset value to assess efficiency **Total Sales/(Beg+End Assets/2). Indicator of the efficiency with which a company is using its assets to generate revenue
Profitability
Ability to generate profits
Return on Assets:
How effective a company is using assets to generate sales/profits.
More assets= more sales/profit. Economies of scale=lower cost, improve margins. Returns may grow at a faster rate than assets
Return on Equity:
Measures profits as a proportion of the value of equity invested.
Higher asset base=higher return, means it can increase without equity addition
Common Benchmarks
Data becomes useful with benchmarks
Previous periods
Competitors
Industry averages
Limitations of financial ratio analysis
Quality of data
Policy choices
Atypical data
Diversification of entities