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M17EFA–FinancialStatementAnalysisandValuationInterpretationoffinancialstatementsusingtrendandratioanalysisM17EFA–FinancialStatementALearningobjectivesBytheendofthissessionstudentsshouldbeableto:UnderstandwhyinterpretationoffinancialstatementsisnecessaryBeawareofthedifferencebetweenhorizontalanalysis,trendanalysis,verticalanalysis,andratioanalysisExplainthelimitationsofratioanalysisLearningobjectivesBytheendInterpretationoffinancialstatementsItisnoteasytoevaluateperformancejustbylookingatanorganisationsfinancialstatementsFinancialstatementsprovideabsolutefigureswhichmakemeaningfulcomparisondifficultForexampleaprofitbeforetaxof￡100,000mightappearadequatebut:Whatdoesthisrepresentasapercentageofrevenue?Whatpercentagereturndoesitrepresenttoaninvestor?Areresourcesbeingusedefficiently?Howdoesperformancecomparewithpreviousaccountingperiods/industryaverages/competitors?InterpretationoffinancialstInterpretationWecangainabetterunderstandingofperformancebyexaminingfinancialstatementsusingarangeoftechniquesincluding:HorizontalanalysisTrendanalysisVerticalanalysisRatioanalysisInterpretationWecangainabeInterpretationThesetechniqueslookattherelationshipbetweenfiguresinanentity’sfinancialstatementsandallowustomakecomparisonswith:previousaccountingperiodssimilarbusinesses/industryaveragesThisallowsusto:EstablishtrendsHighlightsignificantdifferencesinperformanceForecastfutureperformanceInterpretationThesetechniquesHorizontalanalysisLinebylinecomparisonofanorganisation’sfinancialstatementsforeachaccountingperiodunderreviewCalculate%changefromoneperiodtothenextFocusonkeyareas:RevenueGrossprofitOperatingprofitStaffcostsClearlyindicatessignificantchangesfromoneperiodtothenextHorizontalanalysisLinebylinNextplcHorizontalanalysisofrevenueandoperatingprofit2006-2011(AnnualReport2011,page86and2010,page87)201120102009200820072006￡m￡m￡m￡m￡m￡mRevenue3,453.73,406.53,271.53,329.13,283.83,106.2%changeonpreviousyear1.394.12-1.73+1.38+5.71-Workingfor20073,283.8–3,106.23106.2Operatingprofit(￡m)574.8529.8478.3537.1507.5470.7%changeonpreviousyear8.4910.77(10.94)5.837.81-Workingfor2007507.5-470.7470.7NextplcHorizontalanalysisofHorizontalanalysis-CommentsFromtheincomestatementwecanseethatrevenuein2011is￡47.2millionhigherthanin2010(￡3,453.7-￡3,406.5)Usinghorizontalanalysiswecanexpressthisasanincreaseof1.39%Thisismoreeasilycomparablewithpreviousperiods/competitorsBetween2006and2011revenueincreasedby￡347.5milor11.2%((3,453.7-3,106.2)/3,106.2))Operatingprofitin2011is￡574.8million.Thisis8.49%higherthan2010Horizontalanalysis-CommentsTrendanalysisSimilartohorizontalanalysisUsesindicesinsteadof%changeFiguresfromfirstaccountingperiodaregivenanindexof100RelatefiguresfromsubsequentperiodstobaseindexAgainclearlyindicatessignificantchangesfromoneperiodtothenextTrendanalysisSimilartohorizNextplcTrendanalysisofrevenueandoperatingprofit2006-2011(AnnualReport2011,page86and2010page87)201120102009200820072006￡m￡m￡m￡m￡m￡mRevenue3,453.73,406.53,271.53,329.13,283.83,106.2Trendanalysis111.19109.67105.32107.18105.72100.00Workingfor20073,283.8x1003106.2Operatingprofit(￡m)574.8529.8478.3537.1507.5470.7Trendanalysis122.12112.56101.61114.11107.82100.00Workingfor2007507.5x100470.7NextplcTrendanalysisofrevTrendanalysis-CommentsFromtheincomestatementwecanseethatrevenuein2011is￡347.5millionhigherthanin2006(￡3,453.7–￡3,106.2)Fromourtrendanalysisweseethatthisrepresentsanincreaseof11.19comparedtothebaseindexAgainthisismoreeasilycomparablewithpreviousperiods/competitorsBetween2006and2011operatingprofitincreasedby22.12indexpointsTrendanalysis-CommentsFromVerticalanalysisUsefultechniquethatexpressesindividualfiguresasa%oftotalsClearlyindicatessignificantchangesfromoneperiodtothenextallowingmanagerstoinvestigatewhythesehaveoccurredVerticalanalysisUsefultechniNextplcVerticalanalysisofincomestatement2010-2011(AnnualReport2011,page43)20112010￡m%￡m%Revenue3,453.71003,406.5100Costofsales(2,445.0)70.8(2,409.6)70.7GrossProfit1,008.729.2996.929.3Distributioncosts(223.2)6.5(232.1)6.8Adminexpenses(214.7)6.2(236.6)6.9Operatingprofit574.816.6529.815.6Netfinancecosts(23.4)0.7(24.5)0.7Taxation(150.5)4.4(141.3)4.2Profitaftertax400.911.6364.010.7NextplcVerticalanalysisofiVerticalAnalysisofNextplc’sIncomestatementFromourverticalanalysisforNextplcwecanseethat:Asapercentageofrevenue,grossprofithasfallenslightlyfrom29.3%to29.2%(maybeduetoreductioninsellingprices/increasesinsuppliercosts/acombination)Thismeansthatin2011,forevery￡100ofrevenue,Nextgeneratesagrossprofitof￡29.20(10pencelessthan2010)VerticalAnalysisofNextplc’VerticalAnalysisofNextplc’sIncomestatementAsapercentageofrevenueoperatingprofithasincreasedfrom15.6%to16.6%Thismeansthatforevery￡100ofrevenue,Nextgeneratesanoperatingprofitof￡16.60(￡1morethan2010)Asa%orrevenuebothadminanddistributioncostshavedecreased,suggestingtightercontrolofoperatingexpensesVerticalAnalysisofNextplc’NextplcVerticalanalysisoftotalrevenuebygeographicallocation2010-2011(AnnualReport2011,page57)20112010￡m%￡m%UnitedKingdom3,261.294.43,228.594.8RestofEurope153.54.5143.14.2MiddleEast21.70.623.60.7AsiaandrestofWorld17.30.511.30.3TotalRevenue3,453.71003,406.5100Fromthiswecanseethatalmost99%oftotalrevenueisgeneratedintheUKandEuropeNextplcVerticalanalysisoftRatioanalysisIngeneralratiosarebrokenintofivegroupsdealingwith:ProfitabilityEfficiencyLiquidityCapitalstructure(gearing)InvestorsSomeoverlapbetweentheseareasNotethatinordertomakeuseofratioswemusthavesomethingtocomparethemagainstRatioanalysisIngeneralratioRatioanalysisDuringthenextfewsessionswewillexamineindetailsomeofthemostcommonlyusedratiosLetusstartbylookingathowthecalculationofafewratioscanenhanceourunderstandingofhowNexthasperformedduring2011RatioanalysisDuringthenextNextplcExtractsoffiguresforNextplc2010-2011(AnnualReport2011)20112010￡m￡mRevenue(page43)3,453.73,406.5Grossprofit(page43)1,008.7996.9Operatingprofit(page43)574.8529.8Staffcosts(note4page59)675.2678.2No.ofemployees(FTE)(note4page59)37,22035,619NextplcExtractsoffiguresfoGrossprofitmargin(%)

-Formula

= GrossProfit x100% RevenueGrossprofitmargin(%)

-FormGrossprofitmargin(%)

-Calculation2011= 1,008.7 x 100% = 29.2% 3,453.7 2010= 996.9 x 100% = 29.3% 3,406.5Grossprofitmargin(%)

-CalcGrossprofitmargin(%)

-CommentsOnlytakesintoaccountcostofgoodssoldIn2011,forevery￡100ofsales,Nextplcmadeagrossprofitof￡29.20Slightdeclineon2010(0.1%decrease)Maybedueto:DecreaseinsellingpricesChangeinsalesmixSlightincreaseinsupplierpricesMoreitemsthatarenotsoldatfullpriceCombinationoftheabovefactorsGrossprofitmargin(%)

-CommProfitfromoperations(%)-Formula= Profitfromoperations x 100% RevenueProfitfromoperations(%)-FProfitfromoperations(%)-Calculation2011= 574.8 x 100% = 16.6% 3,453.7 2010= 529.8 x 100% = 15.6% 3,406.5 Profitfromoperations(%)-CProfitfromoperations(%)-CommentsTakesintoaccountcostofsalesandallotheroperatingexpensesIn2011,forevery￡100ofrevenue,Nextplcmakesaprofitfromoperationsof￡16.60Alternativelyforevery￡100ofrevenue,￡83.40coverscostofgoodssold,wagesandotheroperatingexpenses,thebalanceisprofitfromoperationsSignificantimprovementon2010(1%higher)ImpressivegivendeclineingrossmarginBreakdownofexpensesrequiredProfitfromoperations(%)-CControlofstaffcosts

-Formula= Staffcosts x100% RevenueControlofstaffcosts

-FormuControlofstaffcosts

-Calculation2011= 675.2 x 100% = 19.6%

3,453.7 2010= 678.2 x 100% = 19.9% 3,406.5Controlofstaffcosts

-CalcControlofstaffcosts

-CommentsIndicateshowwellthecompanyiscontrollingemployeecostsIn2011forevery￡100ofrevenue,￡19.60wasspentonwagesandsalariesSignificantimprovementon2010,especiallysincenoofFTEstaffhasincreasedfrom35,619to37,220Controlofstaffcosts

-Comm

Revenueperemployee-Formula

= Revenue

Numberofemployees

Revenueperemployee-Formul

Revenueperemployee-Calculations

2011= ￡3,453.7 = ￡92,792 37,220

2010= ￡3,406.5 = ￡95,637 35,619

Revenueperemployee-CalcuRevenueperemployee–CommentsIn2010eachFTEemployeegeneratedonaverage￡95,637ofrevenueIncreaseinthenumberofFTEemployeesin2011meansaveragerevenuegeneratedbyeachFTEemployeefallento￡92,792ThisindicatesadeclineintheefficiencyofFTEemployees(butthisratioiseasilydistorted)Revenueperemployee–CommentRatioanalysis-SummaryFromourbriefratioanalysisforNextplcwecanseethat:SlightdeclineinthegrossprofitmarginSignificantimprovementinoperatingprofitmarginStaffcostsremainatlessthan20%ofrevenueFurtheranalysisofoperatingexpensesisnecessarytoestablishwhytheoperatingprofitmarginhasimprovedRevenuegeneratedbyeachFTEemployeehasfallen,butneedsfurtherinvestigationbeforewecancommentfurtherRatioanalysis-SummaryFromoLimitationsofratioanalysisFinancialstatementsarehistoricinnature(backwardratherthanforwardlooking/outofdate)Comparisonofresultsmadedifficultby:UseofdifferentaccountingpoliciesOneoffitemsthatdistortresults(eg:largebaddebt,restructure,redundancy)Definitionused(eg:ROCE,Gearing,capitalemployed)Yearendbalancesnotalwaysrepresentativeofperiodasawhole(eg:highinventorylevelsbeforeXmas)Ratioanalysismayindicateproblems,itwon’tnecessarilyrecommendsolutionsLimitationsofratioanalysisFReadingAtrillandMcLaney(2011)Chapters7and8McKenzieChapter6and8Melville(2009)Chapter22Nextannualreport2011ReadingAtrillandMcLaney(201M17EFA–FinancialStatementAnalysisandValuationInterpretationoffinancialstatementsusingtrendandratioanalysisM17EFA–FinancialStatementALearningobjectivesBytheendofthissessionstudentsshouldbeableto:UnderstandwhyinterpretationoffinancialstatementsisnecessaryBeawareofthedifferencebetweenhorizontalanalysis,trendanalysis,verticalanalysis,andratioanalysisExplainthelimitationsofratioanalysisLearningobjectivesBytheendInterpretationoffinancialstatementsItisnoteasytoevaluateperformancejustbylookingatanorganisationsfinancialstatementsFinancialstatementsprovideabsolutefigureswhichmakemeaningfulcomparisondifficultForexampleaprofitbeforetaxof￡100,000mightappearadequatebut:Whatdoesthisrepresentasapercentageofrevenue?Whatpercentagereturndoesitrepresenttoaninvestor?Areresourcesbeingusedefficiently?Howdoesperformancecomparewithpreviousaccountingperiods/industryaverages/competitors?InterpretationoffinancialstInterpretationWecangainabetterunderstandingofperformancebyexaminingfinancialstatementsusingarangeoftechniquesincluding:HorizontalanalysisTrendanalysisVerticalanalysisRatioanalysisInterpretationWecangainabeInterpretationThesetechniqueslookattherelationshipbetweenfiguresinanentity’sfinancialstatementsandallowustomakecomparisonswith:previousaccountingperiodssimilarbusinesses/industryaveragesThisallowsusto:EstablishtrendsHighlightsignificantdifferencesinperformanceForecastfutureperformanceInterpretationThesetechniquesHorizontalanalysisLinebylinecomparisonofanorganisation’sfinancialstatementsforeachaccountingperiodunderreviewCalculate%changefromoneperiodtothenextFocusonkeyareas:RevenueGrossprofitOperatingprofitStaffcostsClearlyindicatessignificantchangesfromoneperiodtothenextHorizontalanalysisLinebylinNextplcHorizontalanalysisofrevenueandoperatingprofit2006-2011(AnnualReport2011,page86and2010,page87)201120102009200820072006￡m￡m￡m￡m￡m￡mRevenue3,453.73,406.53,271.53,329.13,283.83,106.2%changeonpreviousyear1.394.12-1.73+1.38+5.71-Workingfor20073,283.8–3,106.23106.2Operatingprofit(￡m)574.8529.8478.3537.1507.5470.7%changeonpreviousyear8.4910.77(10.94)5.837.81-Workingfor2007507.5-470.7470.7NextplcHorizontalanalysisofHorizontalanalysis-CommentsFromtheincomestatementwecanseethatrevenuein2011is￡47.2millionhigherthanin2010(￡3,453.7-￡3,406.5)Usinghorizontalanalysiswecanexpressthisasanincreaseof1.39%Thisismoreeasilycomparablewithpreviousperiods/competitorsBetween2006and2011revenueincreasedby￡347.5milor11.2%((3,453.7-3,106.2)/3,106.2))Operatingprofitin2011is￡574.8million.Thisis8.49%higherthan2010Horizontalanalysis-CommentsTrendanalysisSimilartohorizontalanalysisUsesindicesinsteadof%changeFiguresfromfirstaccountingperiodaregivenanindexof100RelatefiguresfromsubsequentperiodstobaseindexAgainclearlyindicatessignificantchangesfromoneperiodtothenextTrendanalysisSimilartohorizNextplcTrendanalysisofrevenueandoperatingprofit2006-2011(AnnualReport2011,page86and2010page87)201120102009200820072006￡m￡m￡m￡m￡m￡mRevenue3,453.73,406.53,271.53,329.13,283.83,106.2Trendanalysis111.19109.67105.32107.18105.72100.00Workingfor20073,283.8x1003106.2Operatingprofit(￡m)574.8529.8478.3537.1507.5470.7Trendanalysis122.12112.56101.61114.11107.82100.00Workingfor2007507.5x100470.7NextplcTrendanalysisofrevTrendanalysis-CommentsFromtheincomestatementwecanseethatrevenuein2011is￡347.5millionhigherthanin2006(￡3,453.7–￡3,106.2)Fromourtrendanalysisweseethatthisrepresentsanincreaseof11.19comparedtothebaseindexAgainthisismoreeasilycomparablewithpreviousperiods/competitorsBetween2006and2011operatingprofitincreasedby22.12indexpointsTrendanalysis-CommentsFromVerticalanalysisUsefultechniquethatexpressesindividualfiguresasa%oftotalsClearlyindicatessignificantchangesfromoneperiodtothenextallowingmanagerstoinvestigatewhythesehaveoccurredVerticalanalysisUsefultechniNextplcVerticalanalysisofincomestatement2010-2011(AnnualReport2011,page43)20112010￡m%￡m%Revenue3,453.71003,406.5100Costofsales(2,445.0)70.8(2,409.6)70.7GrossProfit1,008.729.2996.929.3Distributioncosts(223.2)6.5(232.1)6.8Adminexpenses(214.7)6.2(236.6)6.9Operatingprofit574.816.6529.815.6Netfinancecosts(23.4)0.7(24.5)0.7Taxation(150.5)4.4(141.3)4.2Profitaftertax400.911.6364.010.7NextplcVerticalanalysisofiVerticalAnalysisofNextplc’sIncomestatementFromourverticalanalysisforNextplcwecanseethat:Asapercentageofrevenue,grossprofithasfallenslightlyfrom29.3%to29.2%(maybeduetoreductioninsellingprices/increasesinsuppliercosts/acombination)Thismeansthatin2011,forevery￡100ofrevenue,Nextgeneratesagrossprofitof￡29.20(10pencelessthan2010)VerticalAnalysisofNextplc’VerticalAnalysisofNextplc’sIncomestatementAsapercentageofrevenueoperatingprofithasincreasedfrom15.6%to16.6%Thismeansthatforevery￡100ofrevenue,Nextgeneratesanoperatingprofitof￡16.60(￡1morethan2010)Asa%orrevenuebothadminanddistributioncostshavedecreased,suggestingtightercontrolofoperatingexpensesVerticalAnalysisofNextplc’NextplcVerticalanalysisoftotalrevenuebygeographicallocation2010-2011(AnnualReport2011,page57)20112010￡m%￡m%UnitedKingdom3,261.294.43,228.594.8RestofEurope153.54.5143.14.2MiddleEast21.70.623.60.7AsiaandrestofWorld17.30.511.30.3TotalRevenue3,453.71003,406.5100Fromthiswecanseethatalmost99%oftotalrevenueisgeneratedintheUKandEuropeNextplcVerticalanalysisoftRatioanalysisIngeneralratiosarebrokenintofivegroupsdealingwith:ProfitabilityEfficiencyLiquidityCapitalstructure(gearing)InvestorsSomeoverlapbetweentheseareasNotethatinordertomakeuseofratioswemusthavesomethingtocomparethemagainstRatioanalysisIngeneralratioRatioanalysisDuringthenextfewsessionswewillexamineindetailsomeofthemostcommonlyusedratiosLetusstartbylookingathowthecalculationofafewratioscanenhanceourunderstandingofhowNexthasperformedduring2011RatioanalysisDuringthenextNextplcExtractsoffiguresforNextplc2010-2011(AnnualReport2011)20112010￡m￡mRevenue(page43)3,453.73,406.5Grossprofit(page43)1,008.7996.9Operatingprofit(page43)574.8529.8Staffcosts(note4page59)675.2678.2No.ofemployees(FTE)(note4page59)37,22035,619NextplcExtractsoffiguresfoGrossprofitmargin(%)

-Formula

= GrossProfit x100% RevenueGrossprofitmargin(%)

-FormGrossprofitmargin(%)

-Calculation2011= 1,008.7 x 100% = 29.2% 3,453.7 2010= 996.9 x 100% = 29.3% 3,406.5Grossprofitmargin(%)

-CalcGrossprofitmargin(%)

-CommentsOnlytakesintoaccountcostofgoodssoldIn2011,forevery￡100ofsales,Nextplcmadeagrossprofitof￡29.20Slightdeclineon2010(0.1%decrease)Maybedueto:DecreaseinsellingpricesChangeinsalesmixSlightincreaseinsupplierpricesMoreitemsthatarenotsoldatfullpriceCombinationoftheabovefactorsGrossprofitmargin(%)

-CommProfitfromoperations(%)-Formula= Profitfromoperations x 100% RevenueProfitfromoperations(%)-FProfitfromoperations(%)-Calculation2011= 574.8 x 100% = 16.6% 3,453.7 2010= 529.8 x 100% = 15.6% 3,406.5 Profitfromoperations(%)-CProfitfromoperations(%)-CommentsTakesintoaccountcostofsalesandallotheroperatingexpensesIn2011,forevery￡100ofrevenue,Nextplcmakesaprofitfromoperationsof￡16.60Alternativelyforevery￡100ofrevenue,￡83.40coverscostofgoodssold,wagesandotheroperatingexpenses,thebalanceisprofitfromoperationsSignificantimprovementon2010(1%higher)ImpressivegivendeclineingrossmarginBreakdownofexpensesrequiredProfitfromoperations(%)-CControlofstaffcosts

-Formula= Staffcosts x100% RevenueControlofstaffcosts

-FormuControlofstaffcosts

-Calculation2011= 675.2 x 100% = 19.6%

3,453.7 2010= 678.2 x 100% = 1

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