Content Standard 10.1

Financial Statement Analysis and Comparison

Analisis Penyata Kewangan dan Perbandingan

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Explanation

Analysis of financial statements is the process of evaluating information in the Income Statement and the Statement of Financial Position so that raw figures become useful information for decision making. Its main purposes are to assess profitability (is the business earning enough profit), to assess liquidity (can the business pay its short-term debts) and to assess how efficiently assets are managed. The main tool is the financial ratio, which compares two figures from the financial statements and expresses the result as a percentage, a number of times, or a number of days. Users of this information include owners, investors, suppliers and banks, and each looks at different ratios according to their interest.

Profitability ratios measure the ability of a business to generate profit. Percentage of Gross Profit on Cost (Markup) = Gross Profit / Cost of Sales × 100; this shows the percentage added on top of the cost of goods. Gross Profit Margin = Gross Profit / Sales × 100; it shows the gross profit earned on every RM100 of sales. Net Profit Margin = Net Profit / Sales × 100; because it takes all operating expenses into account, it gives a truer picture of profitability. Return on Capital = Net Profit / Capital × 100; it shows the return earned by the owner on the capital invested. The higher these ratios, the better the profitability performance, but they must always be compared against a prior period or another business.

Liquidity ratios measure the ability of a business to settle its current liabilities (short-term debts) using current assets. Current Ratio = Current Assets : Current Liabilities. The ideal value is generally around 2:1, meaning every RM1 of short-term debt is backed by RM2 of current assets. Acid Test Ratio (Quick Ratio) = (Current Assets − Inventory) : Current Liabilities; inventory is deducted because it is the hardest current asset to convert into cash quickly. The ideal acid test value is generally 1:1. A liquidity ratio that is too low signals a risk of cash flow problems, while one that is too high may mean too many funds are tied up in unproductive assets.

Efficiency ratios measure how effectively the business manages its assets and credit. Rate of Stock Turnover = Cost of Sales / Average Stock, where Average Stock = (Opening Stock + Closing Stock) / 2; the answer is stated in times, showing how many times stock is sold and replaced during the accounting period. Debtors Collection Period = (Debtors / Credit Sales) × 365 days; it shows the average number of days taken to collect debts from debtors. Creditors Payment Period = (Creditors / Credit Purchases) × 365 days; it shows the average number of days the business takes to pay its creditors. A high stock turnover and a short collection period are considered favourable.

The final step is to interpret and compare performance. A single ratio means little until it is compared, either vertically (this year against last year for the same business) or horizontally (the business against a competitor or the industry average). For example, if the net profit margin falls from 15% to 10%, the student must suggest a reason (operating expenses rose or sales dropped) and recommend action (control expenses, raise the selling price). Good analysis goes beyond calculation: it links each ratio to a sensible business decision.

Worked examples

Example 1: Profitability Ratios (Maju Jaya Enterprise)

Given for the year ended 31 December: Sales RM200,000; Cost of Sales RM120,000; Gross Profit RM80,000; Net Profit RM30,000; Capital RM150,000.

Percentage of Gross Profit on Cost (Markup) = 80,000 / 120,000 × 100 = 66.67%.

Gross Profit Margin = 80,000 / 200,000 × 100 = 40%. This means every RM100 of sales yields RM40 of gross profit.

Net Profit Margin = 30,000 / 200,000 × 100 = 15%. After all operating expenses, RM15 of net profit is earned for every RM100 of sales.

Return on Capital = 30,000 / 150,000 × 100 = 20%. The owner earns a 20% return on the capital invested.

Example 2: Liquidity Ratios (Sinar Murni Enterprise)

Given: Current Assets RM60,000 (including Inventory RM20,000, Debtors RM25,000, Bank RM15,000); Current Liabilities RM30,000.

Current Ratio = 60,000 : 30,000 = 2 : 1. The business has RM2 of current assets for every RM1 of current liabilities, a healthy position.

Acid Test Ratio = (60,000 − 20,000) : 30,000 = 40,000 : 30,000 = 1.33 : 1. Even without selling inventory, the business can still cover its current liabilities because the ratio exceeds 1:1.

Example 3: Efficiency Ratios (Tekun Trading)

Given: Cost of Sales RM144,000; Opening Stock RM16,000; Closing Stock RM20,000; Debtors RM24,000; Credit Sales RM180,000; Creditors RM15,000; Credit Purchases RM120,000.

Average Stock = (16,000 + 20,000) / 2 = RM18,000. Rate of Stock Turnover = 144,000 / 18,000 = 8 times a year. Stock is sold and replaced 8 times in the period.

Debtors Collection Period = (24,000 / 180,000) × 365 = 48.7 days (≈49 days). It takes on average 49 days to collect debts.

Creditors Payment Period = (15,000 / 120,000) × 365 = 45.6 days (≈46 days). The business pays its creditors in about 46 days, closely matching its collection period.

Practice

Cahaya Timur Enterprise has Sales RM300,000, Cost of Sales RM210,000 and Net Profit RM45,000. Calculate the Gross Profit Margin and Net Profit Margin.

Answer: Gross Profit = Sales − Cost of Sales = 300,000 − 210,000 = RM90,000. Gross Profit Margin = 90,000 / 300,000 × 100 = 30%. Net Profit Margin = 45,000 / 300,000 × 100 = 15%. Interpretation: every RM100 of sales yields RM30 gross profit and RM15 net profit; the 15% difference represents operating expenses.

Delima Enterprise's Current Assets are RM48,000 (including Inventory RM18,000) and Current Liabilities RM24,000. Calculate the Current Ratio and Acid Test Ratio, and comment.

Answer: Current Ratio = 48,000 : 24,000 = 2 : 1. Acid Test Ratio = (48,000 − 18,000) : 24,000 = 30,000 : 24,000 = 1.25 : 1. Comment: both ratios meet or exceed the ideal values (2:1 and 1:1), so the business has good liquidity and can settle its short-term debts without having to sell inventory immediately.

Given Cost of Sales RM240,000, Opening Stock RM22,000 and Closing Stock RM18,000, calculate the Rate of Stock Turnover and explain its meaning.

Answer: Average Stock = (22,000 + 18,000) / 2 = RM20,000. Rate of Stock Turnover = 240,000 / 20,000 = 12 times a year. Meaning: stock is sold and replaced 12 times in the period, roughly once a month, indicating efficient stock management.

Restu Enterprise's Debtors are RM30,000 with Credit Sales RM219,000. Calculate the Debtors Collection Period. If the credit period allowed is 30 days, is the performance satisfactory?

Answer: Debtors Collection Period = (30,000 / 219,000) × 365 = 50 days. The performance is not satisfactory because the average of 50 days exceeds the 30-day credit period allowed. Recommendation: tighten the credit policy, send debt reminders, or offer a cash discount to encourage early payment.

Exam tips

Key terms

Financial Ratio: A comparison of two figures from the financial statements, expressed as a percentage, times or days, to assess performance.
Gross Profit Margin: Gross Profit divided by Sales, times 100; shows the gross profit earned on every RM100 of sales.
Acid Test Ratio: (Current Assets − Inventory) : Current Liabilities; measures liquidity without relying on inventory.
Rate of Stock Turnover: Cost of Sales divided by Average Stock; shows how many times stock is sold and replaced in a period.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 5

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