Non Finance Mgrs Seminar

FINANCIAL STATEMENTS ANALYSIS
PRESENTED BY
HEZEKIAH A. OYEYEMI BSc, AAT, ACA
ON WEDNESDAY AUGUST 27, 2014
AT THE HR SEMINAR ROOM, FLOUR MILLS OF NIGERIA PLC, APAPA, LAGOS
Finance for Non Finance Managers
- INTRODUCTION TO FINANCIAL
STATEMENTS ANALYSIS 1

 To expose the basic principles on which
accounting practice rest to the audience
 To educate the participants on the relevance
of financial statements reporting to the
business entity.
 For clear understanding of basic elements of
financial statements and it importance to
business decisions
 To expose the attendee to basic financial
indicators from the information provided by
the financial statements reporting.

Understanding basic accounting principles and concepts
Objectives of Financial Statements
Elements of Financial Statements
Interpretation of Financial Statements
Ratio Analysis and Key indicators

Finance for Non Finance Managers -
INTRODUCTION TO FINANCIAL

 A financial statement (or financial report) is a
formal record of the financial activities of a
business, person, or other entity.
 Relevant financial information is presented in
a structured manner and in a form easy to
understand.
 Financial statements include reports such as
Income Statement, Statement of Financial
Position (Balance Sheet), Statement of
Changes in Equity, Statement of Cash Flow
among others accompanied by
a management discussion and analysis.

Generally Accepted Accounting Principles (GAAP) - In the world of financial
accounting, there are many different rules, concepts, and guidelines that
govern how companies should account for financial transactions and
present their financial statements. These rules and concepts are called
generally accepted accounting principles (GAAP). Every private company
that issues financial statements to the public must follow the rules of
GAAP. This is useful because it maintains accounting consistency through
years and across companies. This way an investor can compare a 2013
Statement of Financial Position (SFP) of one company to the 2013 SFP of
another company.
The numbers and ratios will be meaningful because both companies used
the same methods and techniques to prepare and present their balance
sheets.
NGAAP is created by ICAN and known as Nigerian Accounting Standard
Board –NASB before it was taken over by government. NASB is now known
as FRCN – Financial Reporting council of Nigeria overseeing the setting of
accounting standard and guidelines in Nigeria.

 GAAP was mainly concerned about the end users of
financial statements to evaluate business decisions. End
users include people like investors, banks, lenders etc.
For instance, an investor will look at a company's
financial statements in order to decide whether to
invest.
 It was meant to make consistent standards that help
end users understand and use the company's financial
data.
 To make financial statements universally
understandable, comparable and usable for all users.
 For proper evaluation of financial statements by the
users, GAAP came up with the accounting qualitative
characteristics which are Relevance, Reliability,
Comparability and Consistency.

 Accounting Concepts and Principles are a set of
broad conventions that have been devised to
provide a basic framework for financial reporting.
As financial reporting involves significant
professional judgments by accountants, these
concepts and principles ensure that the users of
financial information are not mislead by the
adoption of accounting policies and practices
that go against the spirit of the accountancy
profession.
 Accountants must therefore actively consider
whether the accounting treatments adopted are
consistent with the accounting concepts and
principles.

Concepts
Economic Entity
Monetary Unit
Time Period (Periodicity)
Historical Cost
Concepts
Going Concern
Matching/Accrual
Revenue Recognition
Conventions
Consistency
Prudency/
Conservatism
Materiality
Objectivity

 Economic Entity Assumption The accountant keeps all of the business transactions of a
sole proprietorship separate from the business owner's personal transactions.
For legal purposes, a sole proprietorship and its owner are considered to be one entity,
but for accounting purposes they are considered to be two separate entities.
 Monetary Unit Assumption Economic activity is measured in a nation’s currency, and
only transactions that can be expressed in that currency are recorded. For instance,
transactions in Nigeria are recorded in Naira. Because of this basic accounting principle,
it is assumed that the naira's purchasing power has not changed over time. As a result
accountants ignore the effect of inflation on recorded amounts. For example, naira from
a 1960 transaction are combined (or shown) with naira from a 2013 transaction.
 Time Period (Periodicity) Assumption This accounting principle assumes that it is possible
to report the complex and ongoing activities of a business in relatively short, distinct
time intervals such as the five months ended May 31, 2013, or the 5 weeks ended May 1,
2013. The periodicity principle is based on the assumption that the financial statements
must be prepared to cover a particular time frame usually a year. Hence, it
is imperative that the time interval (or period of time) be shown in the heading of each
element of financial statement. For instance, Income statement for the year ended
December 31, 2013.
 Historical Cost Principle From an accountant's point of view, the term "cost" refers to the
amount spent (cash or the cash equivalent) when an item was originally obtained,
whether that purchase happened last year or thirty years ago. For this reason, the
amounts shown on financial statements are referred to as historical cost amounts.
Because of this accounting principle asset amounts are not adjusted upward for inflation.

 Going Concern Principle This accounting principle assumes that a company
will continue to exist long enough to carry out its objectives and
commitments and will not liquidate in the foreseeable future. If the company's
financial situation is such that the accountant believes the company
will not be able to continue on, the accountant is required to disclose this
assessment. The going concern principle allows the company to defer some
of its prepaid expenses until future accounting periods.
 Matching/Accrual Principle This accounting principle requires companies to
use the accrual basis of accounting. The matching principle requires that
expenses be matched with revenues. For example, sales commission expense
should be reported in the period when the sales were made (and not reported
in the period when the commissions were paid). Wages to employees are
reported as an expense in the week when the employees worked and not in
the week when the employees are paid.
 Revenue Recognition Principle Under the accrual basis of accounting (as
opposed to the cash basis of accounting), revenues are recognized as soon as
a product has been sold or a service has been performed, regardless of when
the money is actually received. Under this basic accounting principle, a
company could earn and report N20,000 of revenue in its first month of
operation but receive N0 in actual cash in that month.

 Consistency: It states that accounting method used in one accounting period should be
the same as the method used for events or transactions which are materially similar in
other period (i.e. accounting practices should remain unchanged from period to period ).
This also involves treatment of transaction and valuation method. Consistency is also
advisable so that the comparison of accounting figures over time is meaningful.
Consistency also states that if a change becomes necessary, the change and its effect
should be clearly stated
 Prudency/Conservatism convention If a situation arises where there are two acceptable
alternatives for reporting an item, conservatism directs the accountant to choose the
alternative that will result in less net income and/or less asset amount. Conservatism
helps the accountant to "break a tie.“ That is, the accountant is empowered to report
envisaged loss in a transaction that the company might suffer rather than anticipating
gains thereon. Accountants are expected to be unbiased and objective.
 Materiality An item should be regarded as material if there is reason to believe that
knowledge of it would influence decision of informed investors. An item is also
considered material if its omission or misstatement could distort the financial statement
such that it influences the economic decision of users taken on the basis of financial
statement. Professional judgment is needed to decide whether an amount is insignificant
or immaterial.
 Objectivity. This convention states that the financial statement should be made on
verifiable evidence. It gives proof of a transaction in an objective manner in contrast to
subjectivity or dependence on the verifiable opinion of the accountant preparing the
financial statement. It states that information relating to the economic affairs of the
enterprise which are of material interest should be clearly disclosed to the readers.

Balance Sheet
 For a sole proprietorship owned by Mary Smith named Mary Smith Associates, the effect
of principles and practice on its balance sheet showing the snapshot of the company's
assets, liabilities, and owner's equity at a particular point in time for economic entity
assumption will only capture the assets, liabilities, and owner's equity specifically
identified with business. The personal assets of the owner, Mary Smith, are not included
on the company's balance sheet.
 The assets listed on the balance sheet have a cost that can be measured and each
amount shown is the original cost of each asset (Historical Cost). For example, assuming
that a plot of land was purchased in 1986 for N10,000, Mary Smith Associates still owns
the land, and the land is now valued at N250,000. The historical cost principle requires
that the land be shown in the asset account i.e. Land at its original cost of N10,000
rather than at the recently valued amount of N250,000. If Mary Smith Associates were to
purchase a second piece of land, the monetary unit assumption dictates that the
purchase price of the land bought today would simply be added to the purchase price of
the land bought in 1986, and the sum of the two purchase prices would be reported as
the total cost of land.
 The Stock/Inventory account shows the cost of supplies (if material in amount) that were
obtained by Mary Smith Associates but have not yet been used. As the stocks are
consumed, their cost will be moved to the Material Expense account on the income
statement. This complies with the matching principle which requires expenses to be
matched either with revenues or with the time period when they are used. The cost of the
unused stocks remains on the SFP as asset.

Income Statement
 Revenues are the fees that were earned during the period of time shown in
the heading. Recognizing revenues when they are earned instead of when the
cash is actually received follows the revenue recognition principle and
the matching principle. The matching principle is what steers accountants
toward using the accrual basis of accounting rather than the cash basis.
 Gains are a net amount related to transactions that are not considered part of
the company's main operations. For example, Mary Smith Associates is in the
business of designing, not in the land development business. If the company
should sell some land for N30,000 (land that is shown in the company's
accounting records at N25,000) Mary Smith Associates will report a Gain on
Sale of Land of N5,000. The N30,000 selling price will not be reported as part
of the company's revenues.
 Expenses are costs used up by the company in performing its main
operations. The matching principle requires that expenses be reported on the
income statement when the related sales are made or when the costs are used
up (rather than in the period when they are paid).

 Financial statements are reports prepared and
issued by company management to give
investors and creditors additional information
about a company's performance and financial
standings. One of the fundamental purposes
of financial accounting is to provide useful
financial information to users outside of the
company.
 A set of general-purpose financial statements is
designed to report the earnings and profitability,
assets and debt levels, uses of cash, and total
investments by company owners for a specific
time period following the periodicity assumption.

 Companies issue financial statements for a
variety of reasons at a variety of times during the
year. Public companies are required to issue
audited financial statements to the public at least
every quarter. These regulated financial
statements must meet SEC and NSE guidelines.
 Non-public or private companies generally issue
financial statements to banks and other creditors
for financing purposes. Many creditors will not
agree to loan funds unless a company can prove
that it is financially sound enough to make its
future debt payments. Both public and private
companies issue financial statements to attract
new investors and raise funds for expansions.

Other Objectives of Financial Statements are;
 Assessment Of Past Performance Past performance is a good indicator of future
performance. Investors or creditors are interested in the trend of past sales, cost of
goods sold, operating expenses, net income, cash flows and return on investment.
These trends offer a means for judging management's past performance and are
possible indicators of future performance.
 Assessment of current position Financial statement analysis shows the current position
of the firm in terms of the types of assets owned by a business firm and the different
liabilities due against the enterprise.
 Prediction of profitability and growth prospects Financial statement analysis helps in
assessing and predicting the earning prospects and growth rates in earning which are
used by investors while comparing investment alternatives and other users in judging
earning potential of business enterprise.
 Prediction of bankruptcy and failure Financial statement analysis is an important tool in
assessing and predicting bankruptcy and probability of business failure.
 Assessment of the operational efficiency Financial statements analysis helps to assess
the operational efficiency of the management of a company. The actual performance of
the firm which is revealed in the financial statements can be compared with some
standards set earlier and the deviation of any between standards and actual
performance can be used as the indicator of efficiency of the management.

•FS consists of the under listed elements
•Income Statement
•Statement of Owner's Equity
•Statement of Financial Position (Balance
Sheet)
•Statement of Cash Flows
•Notes to the FS
•Value Added Statements and
•5- Year Financial Summary
FS are reports prepared
and are issued to the
public as a set of
reports/statements as
required by law by a
business entity. This
means they are not only
published together, but
they are also designed and
intended to be read and
used together. Since each
statement only gives
information about specific
aspects of a company's
financial position, it is
important that these
reports are used together.

Income Statement
The income
statement is the
first financial
statement typically
prepared during the
accounting
cycle because the net
income or loss must
be calculated and
carried over to
the statement of
owner's equity before
other financial
statements can be
prepared. This report
shows investors and
creditors the overall
profitability of the
company as well as
how efficiently the
company is at
generating profits
from total revenues.
Statement of
Stockholders
Equity/Changes in
equity. This
statement
displays how
equity changes
from the
beginning of an
accounting period
to the end. The
statement
displays all equity
accounts that
affect the ending
equity balance
including equity
stock, net income,
paid-in capital,
and dividends.
The balance sheet/SFP
reports a company's
financial position based
on its assets, liabilities,
and equity at a single
moment in time. Unlike
the income statement,
the balance sheet does
not report activities over
a vast time frame. The
balance sheet is
essentially a picture of a
company's resources,
debts, and ownership on
a given day. Investors
and creditors generally
look at the statement of
financial position for
insight as to how
efficiently a company
can use its resources
and how effectively it
can finance them.
The Statement of Cash Flows
summarizes how changes
in balance sheet accounts
affect the cash account during
the accounting period. It also
reconciles beginning and
ending cash and cash
equivalents account balances.
The cash flow statement shows
investors and creditors what
transactions affected the cash
accounts and how effectively
and efficiently a company can
use its cash to finance its
operations and expansions.
This is particularly important
because investors want to
know the company is
financially sound while
creditors want to know the
company is liquid enough to
pay its bills as they become
due
Notes to
the FS
details
out all
other
informati
on whose
summary
had been
presente
d in the
FS.
Value
Added
Stateme
nt
detailed
out how
the
money
generate
d during
the
period
(value
added)
are
shared
among
the
stakehol
ders –
Employe
es,
owners
of
business
,
Governm
ent and
future
expansio
n of
business.
5 Year
Financi
al
Summa
ry.
Provide
s
summa
ries of
past
five
year
financi
al
summa
ry for
compa
rison
purpos
es.

 Financial Statements interpretations is to provide enough information for the
users of FS on which to base their investment decisions vis-à-vis the
company’s operations efficiency and effectiveness.
 Investors and creditors analyze Financial Statements on which their financial
and investment decisions are based. They also look at extra financial reports
like financial statement notes and the management discussion for better
information about the business entity.
 The income statement and balance sheet accounts are compared with each
other to see how efficiently a company is using its assets to generate profits.
Company debt and equity levels can also be examined to determine whether
companies are properly funding operations and expansions.
 The financial information so provided is by themselves rarely give outside
users and decision makers enough information to judge whether or not a
company is fiscally sound, however, investors and creditors generally
compare different companies' ratios to develop an industry standard
or benchmark to judge company performance.

 Ratio analysis is the most popularly and widely used technique of financial
statement analysis.
 Accounting ratios are used as an important tool of analyzing the financial
performance of the company over the years and its comparative position among
other companies in the industry.
 Ratio analysis is the process of determining and interpreting numerical
relationship between figures of financial statements. It is also a process of
determining and presenting the quantitative relationship between two accounting
figures to evaluate the strengths and weakness of a business. It is important from
the point of view of investors, creditors and management for analysis and
interpretation of a firm's financial health.
 Financial ratios are the most common and widespread tools used to analyze a
business' financial standing. Ratios are easy to understand and simple to compute.
They can also be used to compare different companies in different industries.
Since a ratio is simply a mathematically comparison based on proportions, big and
small companies can use ratios to compare their financial information. In a sense,
financial ratios do not take into consideration the size of a company or the
industry. Ratios are just a raw computation of financial position and performance.
 Financial ratios are often divided up into the following main categories: liquidity,
solvency, efficiency, profitability, investment leverage and coverage.

•Liquidity,
•Solvency,
•Efficiency,
•Profitability,
•Investment leverage and
Coverage.
Financial
ratios are
often divided
up into the
following
main
categories:

•Quick Ratio. measures the ability of a company to
pay its current liabilities when they become due with
only quick assets. Quick assets are current assets
that can be converted to cash within a short-term.
Cash, cash equivalents, short-term investments or
marketable securities, and current accounts
receivable are considered quick assets.
•Working Capital/Current Ratio. Measures a firm's
ability to pay off its current liabilities with current
assets. Current liabilities are best paid with current
assets like cash, cash equivalents, and marketable
securities because these assets can be converted
into cash much quicker than fixed assets. The faster
the assets can be converted into cash, the more
likely the company will have the cash in time to pay
its debts.
Liquidity
Liquidity ratios analyze the
ability of a company to pay
off both its current
liabilities as they become
due as well as their long-
term liabilities as they
become current. In other
words, these ratios show
the cash levels of a
company and the ability to
turn other assets into cash
to pay off liabilities and
other current obligations.

•Debt to Equity Ratio compares a company's total debt to total equity.
It shows the percentage of company financing that comes from
creditors and investors. A higher debt to equity ratio indicates that
more creditor financing (bank loans) is used than investor financing
(shareholders).
•Equity Ratio measures the amount of assets that are financed by
owners' investments by comparing the total equity in the company to
the total assets. The equity ratio highlights two important financial
concepts of a solvent and sustainable business. The first component
shows how much of the total company assets are owned outright by
the investors and the other component shows how the company is
leverage on debt.
•Debt Ratio measures a firm's total liabilities as a percentage of its
total assets. In a sense, it shows a company's ability to pay off its
liabilities with its assets. In other words, this shows how many assets
the company must sell in order to pay off all of its liabilities.
•Times Interest Earned (Interest Cover) Ratio measures the
proportionate amount of income that can be used to cover interest
expenses in the future. In some respects the times interest ratio is
considered a solvency ratio because it measures a firm's ability to
make interest and debt service payments
Solvency/Leverage
Measure a company's
ability to sustain
operations indefinitely
by comparing debt
levels with equity,
assets, and earnings.
In other words,
solvency ratios identify
going concern issues
and a firm's ability to
pay its bills in the long
term.

•Accounts Receivable Turnover Ratio measures how
many times a business can turn its accounts receivable
into cash during a period. In other words, it measures
how many times a business can collect its average
accounts receivable during the year. This ratio shows
how efficient a company is at collecting its credit sales
from customers.
•Asset Turnover Ratio measures a company's ability to
generate sales from its assets by comparing net sales
with average total assets. In other words, this ratio
shows how efficiently a company can use its assets to
generate sales. The ratio calculates net sales as a
percentage of assets to show how many sales are
generated from each naira of company assets.
•Inventory Turnover Ratio shows how effectively
inventory is managed by comparing cost of goods sold
with average inventory for a period. This measures how
many times average inventory is "turned" or sold
during a period. Sales have to match inventory
purchases otherwise the inventory will not turn
effectively.
Efficiency Ratio
Efficiency ratios also
called activity ratios
measure how well
companies utilize their
assets to generate
income. Efficiency ratios
often look at the time it
takes companies to collect
cash from customer or the
time it takes companies to
convert inventory into
cash—in other words,
make sales.

•Gross Margin Ratio measures how profitable a company
sells its inventory or merchandise. In other words, it is
essentially the percentage markup on merchandise
from its cost. This is the pure profit from the sale of
inventory/products that can go to paying operating
expenses.
•Net Profit Margin Ratio measures the amount of net
income earned with each naira of sales generated by
comparing the net income and net sales of a company.
It shows what percentage of sales which are left over
after all expenses are paid by the business. Creditors
and investors use this ratio to measure how effectively
a company can convert sales into net income, pay
dividend and loans.
•Return on Assets Ratio (ROA) measures the net income
produced by total assets during a period by comparing
net income to the average total assets. In other words,
ROA measures how efficiently a company can manage
its assets to produce profits during a period.
•Return on Capital Employed measures how efficiently a
company can generate profits from its capital
employed by comparing net operating profit to capital
employed. ROCE is a long-term profitability ratio
because it shows how effectively assets are performing
while taking into consideration long-term financing.
Profitability Ratio
Profitability ratios compare
income statement accounts and
categories to show a company's
ability to generate profits from
its operations. It focus on a
company's return on investment
in inventory and other assets.
These ratios basically show how
well companies can achieve
profits from their operations.
Investors and creditors can use
profitability ratios to judge a
company's return on investment
based on its relative level of
resources and assets.

•Dividend Payout Ratio shows the portion of net profits
the company decides to keep for the funding of its
operations and the portion of net profits that is given
to its shareholders. Investors are particularly interested
in the dividend payout ratio because they want to know
if companies are paying out a reasonable portion of net
income to investors.
•Dividend Yield Ratio measures the amount of cash
dividends distributed to equity shareholders relative to
the market value per share. It is used by investors to
show how their investment in stock is generating either
cash flows in the form of dividends or increases in
asset value by stock appreciation.
•Earnings Per Share measures the amount of net income
earned per share of stock outstanding. In other words,
this is the amount of money each share of stock would
receive if all of the profits were distributed to the
ordinary shareholders at the end of the year.
•Price Earnings (P/E) Ratio calculates the market value of
a stock relative to its earnings by comparing the
market price per share by the earnings per share. The
ratio shows what the market is willing to pay for a
stock based on its current earnings. Investors often use
this ratio to evaluate what a stock's fair market value
should be by predicting future earnings per share.
Investment leverage and
Coverage.
Investment leverage and
coverage ratio compares
the portion of the
company’s net profit that
is pay out as dividend to
shareholders and interest
payment to provider of
debt capital during the
financial year.

It has become imperative for a potential investor to
ensure that proper financial due diligence is
conducted on any business of interest before
venturing into such decision through adequate
financial statements analysis and interpretation.
Also, managers of business entity must ensure
periodic appraisal of financial information at their
disposal to aid them in their business decisions
making.
Regular financial data analysis and interpretation is
a panacea to business success and longevity.

THANK YOU!!!

Non Finance Mgrs Seminar

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