Financial Statement Analysis: A Practical Guide for BSc Accounting and Finance Students, Exercises of Accounting

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BSc Accounting

and Finance

Offer Holders session Wednesday 27 April 2022

Why is accounting important?

• Or is it important at all?
• Important because

accounting

• produces a social good: ???
• What sort of information?
• Does anyone need those

information? If yes, who

needs or wants or uses those

information?

• For what purpose? 2

Individual entity factors Industry Economy-wide^ factors factors No Yes Invest?

The investment decision

A company’s strategy

Business strategy Operating decisions Transactions Financial statements

While financial statements reflect transactions, each of those

transactions is the result of a company’s operating decisions

as it implements its business strategy.

Ratio analysis

• Ratio analysis helps decision makers identify significant relationships of items reported in financial statements and make more meaningful comparisons.
• Financial statement analysis involves a lot of judgement, and there are a good number of factors that could affect the interpretation of a ratio.
• The clearer the objective of a financial statement analysis (i.e., with more clearly defined questions that one want the answers), the easier it is to choose the most appropriate ratios to compute.
• Ratio analysis gives a snapshot of key areas of an entity’s performance (e.g., profitability, operating efficiency, liquidity, market) and often a starting point for further investigation.

Profitability ratios

Profitability ratios focus on income (profit/loss) and how it compares to other amounts reported in the financial statements. Often, more than one formula is used in practice for a ratio (why?). Some examples:

• Return on equity
• Return on assets
• Earnings per share
• Net profit margin (which also assesses a business’s operating efficiency)

Return on assets (ROA)

ROA = Net income (average) total assets

• where net income is profit/loss after interest and tax (or net income attributable to equity holders of the parent company)
• (average) total assets is total non-current assets and total current assets
• This ratio compares net income to the total assets used to generate the income.
• ROA measures how well assets have been utilised by an entity/ business in generating income.

Earnings per share (EPS)

Items/terminology Definitions Net income or Profit/(loss) attributable to ordinary equity holders Profit/(loss) after tax, less any amounts accruing to preference shareholders which are accounted for as equity, excluding amounts attributable to non- controlling interests. Ordinary shares Equity instruments which are subordinate to all other classes of equity instruments and have the lowest priority of participation in profit for the accounting period. Weighted average number of ordinary shares outstanding The number of ordinary shares outstanding at the beginning of the period, adjusted by the number of ordinary shares bought back or issued during the period multiplied by a time-weighting factor. Time-weighting factor The number of days that the shares are outstanding as a proportion of the total number of days in the period; a reasonable approximation of the weighted average is adequate in many circumstances. (Basic) EPS = Profit/(loss) a2ributable to ordinary equity holders Weighted average number of ordinary shares outstanding

Let’s apply?

• Your parents have been long-term investors of AstraZeneca and GSK. They are thinking about selling their shares in one of these companies so as to fund your further study.
• Your parents have asked you to help them to decide on which of these companies that they should sell their shares.
• Let’s try some basic financial statement analysis to assess these companies’ recent financial performance?

Extracts of some accounting data for AZ and GSK Selected data from consolidated statements of income for the year ended 31 December 2021 2020 2021 2020 AstraZeneca GSK $m $m £m £m Revenue 37,417 26,617 34,114 34, Cost of sales (12,437) (5,299) (11,603) (11,704) Gross profit 24,980 21,318 22,511 22, Operating income 1,056 5,162 6,201 7, Finance income 43 87 28 44 Finance costs (1,300) (1,306) (784) (892) Profit/(loss) before tax (265) 3,916 5,442 6, Taxation 380 (772) (346) (580) Profit for the year 115 3,144 5,096 6, Attributable to: Owners of the parent 112 3,196 4,385 5, Non-controlling interests 3 (52) 711 639 115 3,144 5,096 6,

Most recent financial statements of case

• AstraZeneca plc’s financial statements for the year ended 31 December 2021
• GSK plc’s financial statements for the year ended 31 December 2021

Ratio analysis (profitability)

AstraZeneca GSK Return on Equity (%) (^) 2021 2020 2021 2020 Net income – NCI x 100 Total ordinary share capital + reserves + retained profit = Return on Assets (%) Net income – NCI x 100 Total assets = Net Profit Margin (%) Net income x 100 Revenue = Basic Earnings per share ($/£) Net income – NCI x 100 Weighted average number of ordinary shares in issue (m) =

Summary

• An overview of the role of financial accounting
• A brief overview of analysis of a company’s performance
• A small selection of ratio to analyse company’s performance
• How to obtain data to calculate selected ratios
• To consider other issues and the need to do more research
• To think ‘outside the box’