Financial statement analysis uses ratios to turn figures from the trading and profit and loss accounts and the statement of financial position into answers about a business. This topic has four skills: profitability, liquidity, efficiency and fair comparison.
It builds on the financial statements of a sole trader.
How do the four skills connect?
Profitability asks whether the business earns enough from its sales. Liquidity asks whether it can pay what it owes soon. Efficiency asks how fast stock and money move. Comparison asks whether these figures are fair to judge against another business or another year.
The first three give you numbers. The fourth teaches you what those numbers can and cannot say.
One example to orient you
An original pair: two shops each make a net profit of RM10 000.
| Shop A | Shop B | |
|---|---|---|
| Sales (RM) | 50 000 | 200 000 |
| Net profit (RM) | 10 000 | 10 000 |
| Net profit margin | 20% | 5% |
The profit is the same, but shop A keeps 20 sen of each ringgit of sales and shop B keeps 5 sen. A larger shop may be fine with a thin margin if it sells a high volume. The ratio starts the question and does not finish it.
Who should start where?
- Formulas feel slippery: begin with calculating profitability ratios.
- Cash problems in the question: go to calculating liquidity ratios.
- Stock, debtors and creditors: read interpreting efficiency ratios.
- Comment questions: read comparing businesses without ignoring context.
Then test yourself on the financial statement analysis practice set. For a teacher who practises comments with you, see online one-to-one Accounting tuition.