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CORPORATE CREDIT (III) (Objectives of Financial Statement Analysis (Steps…

- - - - Parent/subsidiaries
      - Sister companies (companies in same group)
      - Company with common shareholders/directo
      - Appear as "Amounts due from subsidiaries"
    - - Syphoning of funds to support weak related companies
      - Transfer pricing/non-arms length transaction
      - Related companies may be in risky business
  - - - Real value of these assets is ambiguous
      - Accounting treatment will amortise (write off) intangible assets against profit and loss over a period of time
    - - Copyright, Goodwill, Intangible Assets
  - - - Amounts due to subsidiaries
- - - - Increasing CR reasons: Better liquidity (CA), high level of unsaleable stock and/or overdue debtor
      - Decreasing CR reasons: Worsening liquidity, efficient use of working capital
      - Definition
        
        If CR<1: poor liquidity as there's more current liabilities than current assets
        
        If CR>1: more current assets than current liabilities
        
        Indicator of co's ST financial position/solvency
      - High CR may not be desirable as it may mean excessive stock or AR not readily converted into cash/high cash holdings incur opportunity cost
      - How to determine if CR is acceptable
        
        Nature of business - trading co buy/sell confirmed order basis will not stock hence lower CR
        
        Quality of current assets
        
        Timing of current liabilities - not all current liabilities are due immediately
        
        Volatility of working capital requirements - seasonal business
      - Current Assets/Current Liabilities
    - - (Current Assets - Inventory) / Current Liabilities
      - Definition
        
        Inventory is generally least liquid asset
        
        More stringent test of ST liquidity
        
        Reveals how easily co can meet its current obligations using funds raised from quick assets
        
        Measure of liquidity excluding inventory
      - Many co have QR >1
      - Determine reasons for increasing/declining trend
  - - - Inventory is compared to COGS not sales as sales include profit margin
      - Indicate how fast business is selling its inventory
      - The lower the AAI the better
      - Check if AAI is within industry norm
      - Reasons for increasing trend: use stock ageing to identify risk of stock obsoleteness
      - Reasons for declining trend: risk of stockout
      - (Inventory/COGS) X 365 days
    - - Measure the average period taken by borrower to make payment to its creditor
      - The higher the APP the better as it shows that borrower is able to command good credit terms from suppliers. But sudden increase in high APP may be a sign the borrower is experiencing cask flow problem and delaying payment to suppliers
      - Check if APP is within credit terms given by suppliers and if its within industry norm.
      - Reasons for increase/decrease - use credits ageing to rule out any liquidity risk
      - (AP/Purchases) x 365 days
    - - (AR/Sales) x 365 days
      - Check if ACP is within credit term given to buyer and if its within industry norm
      - Measures collection efficiency; the lower the ACP the better
      - Solution to improve ACP: use of factoring or export facility
      - Reasons for increase in ACP: Sharp decline in sales or long overdue debt (use Debtor's ageing report to identify collection issues)
      - Reasons for decreasing trend: More efficient collection procedures/effective control over bad debt/cash discounts (affects profits)/sharp increase in sales
  - - - Net Profit = Gross Profit - Expenses
      - Declining NPM; determine cause of decline: rising expenses or declining gross profit
      - Increasing NPM, determine cause: due to increasing GPM?
    - - Profit earned in comparison to total amount of shareholder equity
      - Return to shareholders
      - Ability to service interest
      - Total sales for every dollar of assets owned
    - - understate costs by capitalising expenses or stretching depreciation period
      - Overstate ending stock
      - Not recognising decline in asset value
    - - Gross Profit = Sales - Cost Of Goods Sold,
        where COGS = Opening Stock +Purchases -Ending Stock
      - Declining GPM, determine the cause of decline; whether is it because of rising COGS or declining sales
      - Increasing GPM, determine cause of increase; whether is there improvement and if its sustainable
  - - - Measure company's financial leverage - how much debt is used to finance assets relative to shareholder equity
      - Higher gearing ratio indicates more financial leverage
      - Check gearing ratio with industry norm
      - Increasing trend: could there be increasing debt or declining equity
      - Decreasing equity: could it be decreasing debt or increasing equity
      - (Total liabilities/Shareholders' Equity) x 100
    - - Measures proportion of Total Assets financed by debt
      - Higher debt ratio indicates more financial leverage
      - Check debt ratio within industry norm
      - Reasons for increasing/decreasing trend
      - (Total liabilities/Total Assets) x 100
    - - LT funds = LT liabilities + Equity
      - (Non-CA/LT funds) x 100