ACCT 5906 – Topic Five
Financial Statement Analysis and
Sustainability Reporting.

Topic Five Notes
ACCT 5906 1
5. Financial Statement Analysis
and Sustainability Reporting.
Introduction
In previous weeks you have obtained a good understanding of the contents
of the key financial statements and the components that impact ROE:
margins, turnover and investment strategies. After managing margins,
assets (including working capital) and making investment decisions there
will be a resulting set of financial statements which form the basis of
evaluation of the firm’s performance. This week we tie together many of
the concepts covered in earlier topics and carry out an analysis of financial
statements.
We also consider the accounting policy choices managers make and their
impact on these statements.
Learning outcomes
After studying this topic you should be able to:
• describe the objectives of financial statement analysis
• calculate the ratios in common use to analyse a firm’s performance,
activity, liquidity and financing
• explain the expanded DuPont system (e.g. Woolworths)
• explain the impact of accounting policy choices on financial statements
• discuss opportunities for manipulation by accounting policy choices
and discuss constraints on management
• calculate the after tax effects of changes in accounting policies
2 ACCT 5906
Key concepts
1. Financial statement analysis
Reading
Trotman, Humphreys, Clout and Morgan: Chapter 6.p 204-206
This introductory reading provides you with useful background for reading
the remainder of the chapter.
2. Accounting policy choices
Reading
Trotman, Humphreys, Clout and Morgan: Chapter 6. p226-227.
This section focuses on the context for Financial Statement Analysis. For
example, accounting policy choices are the decisions made by mangers
about how, when and where to record an accounting transaction. Here you
will consider the types of accounting policy choices, why they exist, how
much freedom there is, and what constitutes manipulation of the accounts.
Note that the ratios you considered earlier are only as good as the numbers
used to calculate them.
3. Financial statement ratio analysis
Reading
Trotman, Humphreys, Clout and Morgan: Chapter 6. p206-226 and
Chapter 18 p1-13.
This section is divided into four main groups as follows:
• Performance (Profitability) Ratios
• Efficiency Ratios
• Liquidity Ratios
• Financial Structure Ratios
It is important to understand the calculation and interpretation of each
group of ratios.

ACCT 5906 3
4. Sustainability and Triple Bottom Line Reporting
Reading
Trotman, Humphreys, Clout and Morgan: Chapter 9. p314-332.
This section is concerned with understanding what we mean by the word
sustainability, and how it offers an alternative method to analysing
performance by using Triple Bottom Line Reporting.
Triple Bottom Line focuses on three main areas which are:
• Economic – where the focus is measuring the total economic impact of
the company on the community
• Environmental – the impact of the company on the environment
• Social – impact of the organisation on the people and the communities
in which they operate.

Preparation for seminar
Prior to the seminar attempt the following problems.
Trotman ,Humphreys, Clout and Morgan: Chapter 6 Problem A and B
page 228.
Trotman ,Humphreys, Clout and Morgan: Chapter 9 Problem A page
333.

1. Please also attempt :

PROBLEM 14.4 CALCULATION AND INTERPRETATION OF
RATIOS

WHITE STAR LIMITED
BALANCE SHEET AS AT 30 JUNE
2009
$m
2008
$m
Current assets
Cash
Receivables
Inventories
50
540
450
330
310
260
Total current assets 1,040 900

Noncurrent assets
Property, plant and equipment 160 140
Total noncurrent assets 160 140

Total assets 1,200 1,040


4 ACCT 5906

Current liabilities
Creditors and borrowings
Provisions
630
15
510
10
Total current liabilities 645 520

Noncurrent liabilities
Creditors and borrowings
Provisions
245
10
195
15
255 210

Total Liabilities 900 730

Net assets 300 310


Shareholders’ equity

Share capital ($1 ordinary shares)
Reserves
Retained profits
80
35
185
80
35
195
Total shareholders’ equity 300 310


ADDITIONAL INFORMATION:

Net operating profit after tax is $25 million (2008: $38 million).

REQUIRED:

1. Use the information above to calculate for 2009 and 2008:
a. Working capital
b. Current ratio
c. Quick ratio
d. Debt-to-equity ratio
e. Return on equity ratio
f. Earnings per share ratio.

2. Identify four warning signals that could have negative implications
with respect to the company future performance and liquidity, by
firstly considering the balance sheet and secondly considering the
ratios calculated above. In each case, explain why the signal you have
identified could be a concern for the company.
3. At the Annual General Meeting of White Star, the Managing Director,
Ms Rose Dawson, made the following statement: ‘Recently a number
of articles in the financial press have questioned the financial position
of our company. This criticism is totally unjustified. Net profit was $25
million and total assets have increased by $160 million. These results
show that 2009 was a very successful year for White Star’. Comment
on Ms Dawson’s statement.



ACCT 5906 5



2. PROBLEM 14.5 IMPACT OF TRANSACTIONS ON
RATIOS

Analyse the effect of each of the following transactions on the current
ratio, quick ratio, debt-to-equity ratio and earnings per share. Assume that
the current ratio, quick ratio and debt-to-equity ratio are each greater than
1, and that earnings per share is positive. Determine if the ratio increases,
decreases or is unchanged. Consider each transaction independently of all
the other transactions.

1. Purchased inventory of $48,000 on credit.
2. Made repayments of $78,000 on the long-term loan.
3. Declared, but did not pay, a $31,000 cash dividend on shares.
4. Borrowed an additional $56,000 on the long-term loan.
5. Sold the short-term investments for $34,000.
6. Issued 140,000 shares at the beginning of the financial period for cash
of $168,000.
7. Received $6,000 owing in cash from a customer.
8. Repaid short-term loans payable of $51,000.


3. Problem 14.6

Consider how UNSW as an organisation would demonstrate Sustainability
through the use of Triple Bottom Line Reporting, by suggesting a suitable
measure for each of the three areas which are:

a) Economic
b) Environmental
c) Social
















6 ACCT 5906



4. PROBLEM 14.7 EFFECTS ANALYSIS OF DISPOSAL
OF INVESTMENTS

Qantas Airways has quit its shareholding in rival Air New Zealand
for about $363 million, removing the last hurdle to the looming all-
out battle between the two carriers.

The Australian airline’s directors yesterday voted to sell the 19.4
percent stake at a board meeting in Canberra.

Qantas chief executive Mr James Strong said the board accepted an
‘unsolicited offer’ from stockbroking firm ANZ Securities to buy its
112 million Air New Zealand B class shares for $NZ3.80 ($3.36) a
share. The broker sold to a number of institutions worldwide.

Qantas’ capital gain from the eight-year investment was about $99
million before tax, Mr Strong said.

‘We regard it as a very satisfactory outcome’, he said. The proceeds
of the sale will decrease net debt, reducing gearing’.

Stockbroking analysts reacted positively to the news, saying the sale
would reduce Qantas’ gearing ratio of net debt/equity to just over 100
percent by the end of the year. It was about 200 percent in 1995.

Qantas may even receive an upgraded credit rating because of its
improved gearing.

This will further impress the market after Qantas reduced costs by
$468 million in the 1996 financial year and cut an additional $237
million in the first half of 1997.

(Source: M. Sharp, Sydney Morning Herald, 20 March 1997.)

REQUIRED:
1. Explain the effect of the sale of the shareholding on gearing.
2. Why was it considered good news by share analysts?
3. Would every sale of investments be considered good news?
4. Why might the credit rating improve?
5. How would a better credit rating assist Qantas?