Accounting Business Reporting for Decision Making

CHAPTER 8 Analysis and interpretation of financial statements 357

Price earnings ratio (PER) Market performance ratio calculated as the market price of the share

divided by earnings per share.

Profit margin Profitability ratio calculated as profit divided by sales revenue.

Profitability An entity’s performance (profit) during the reporting period measured in relative terms.

Profitability ratios Measure of the profit relative to the resources available to generate the profit.

Quick ratio (acid-test ratio) Stringent liquidity ratio calculated as the sum of cash, marketable

securities and net receivables divided by current liabilities.

Ratio analysis An examination of the relationship between two quantitative amounts with the

objective of expressing the relationship in ratio or percentage form.

Return on assets (ROA) Profitability ratio calculated as profit divided by average total assets.

Return on equity (ROE) Profitability ratio measuring profit earned for each dollar invested by the

owners, calculated as profit available to owners divided by average equity.

Stock item Item in the financial statements as at a point in time.

Trend analysis Method of examining changes, movements and patterns in data over a number of time

periods.

Vertical analysis Analysing financial statement data by expressing each item in a financial statement

as a percentage of a base amount.

Working capital Difference between current assets and current liabilities.

APPLY YOUR KNOWLEDGE 15 marks

Commentary in Decore Ltd’s yearly summary FY15 notes:

Our net profit remained the same as in FY14, the main reason being the contribution we made to our

co-worker loyalty program, Give ($100 million), as well as the growing number of co-workers taking

part in our bonus program ($49 million). However, adjusting for these expenses, our cost percentage

decreased. The gross margin decreased by 0.4% to 42.9%. This was expected and is due to larger price

reductions compared to FY14. But the negative effect on margins was partly balanced by lower purchase

prices and lower transport costs.

a. Decore’s 2015 financial year end shows Decore’s revenue at $14 646 million in 2015 and

$14 253 million in 2014. Further, its cost of sales increased from $7898 million in 2014

to $8186 million in 2015. Calculate and evaluate Decore’s 2014 and 2015 gross

profit margin. 4 marks

b. In 2015, Decore’s profit was $1665 million compared to $1659 from 2014 to 2015. 5 marks

c. Decore’s most recent balance sheet is presented below. Calculating the appropriate ratios,

evaluate Decore’s liquidity and solvency. 6 marks

Decore

Balance sheet as at 31 December

2015

$ millions

2014

$ millions

Cash and securities

Receivables

Inventory

8 443

1 274

2 464

8 000

1 097

2 129

Total current assets 12 181 11 226

Property, plant and equipment

Other fixed assets

8 661

1 492

8 518

1 267

Total non-current assets 10 153 9 785

(continued)