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23 Analysis of accounts
Introduction
In previous chapters you learned how information contained in income statements
Objectives and balance sheets can be used by business stakeholders. It’s essential to take care
when interpreting financial data. A simple comparison of the change in revenue,
In this chapter you will costs, profits, assets or liabilities of a business, from one year to the next, can
learn about: provide stakeholders with misleading information.
■ profitability performance Consider the following accounting data for two companies which are competitors in
ratios and liquidity ratios the clothing industry.
■ the importance of liquidity
■ why and how accounts Company X Company Y
are used.
$000 $000
Revenue 200 500
Profit 140 200
Total equity 50 300
Table 23.1 Financial data for Companies X and Y
A simple comparison of these results might conclude that Company Y has performed 283
better than Company X. This is because both the revenue and profits for Company Y
are higher than they are for Company X.
Shareholders in Company Y may expect to receive a higher dividend than
shareholders in Company X. This is based on the fact that Company Y has the
higher profit. However, its owner’s equity is six times higher. This may mean that
the profit of Company Y has to be divided between more shareholders. Therefore,
shareholders in Company Y may receive a higher dividend than the shareholders in
Company X, even though its profits are lower.
Clearly, the simple interpretation of accounting data you learned in previous
chapters needs to be used with some caution. This does not mean that this analysis
is not useful, but it does mean that you must interpret the results with care.
In this chapter you will find out how to analyse business accounting information with
the aid of accounting ratios. You will learn how to calculate and interpret accounting
ratios that measure business profitability performance and business liquidity.
How to interpret financial statements
A business must check its performance regularly as this can help to:
■ identify its strengths and weaknesses so that it can decide which, if any, of its
policies or strategies need to be changed
■ show whether the business is meeting its objectives
■ improve future business performance.
