INTERPRETATION AND ANALYSIS OF FINANCIAL STATEMENTS

The final step in assessing financial statements is not the determination of how much profit
was made or how many liabilities the company has, it is the interpretation of the financial
statements using Accounting Ratios. The most important part is the comparison of the
answers these Accounting Ratios yield with the ones yielded in the past in order to come up
with concrete interpretations as to what is the financial situation the company is in, be able to
anticipate future situations and come up with ways to deal with the foreseeable.

7.1. ACCOUNTING RATIOS:

Ratio analysis is the most important technique of financial analysis in which quantities are
converted into ratios for meaningful comparisons. Ratio analysis determines trends and
exposes the strengths or weaknesses of an organisation (BusinessDictionary.com, 2013).

In order to make sensible interpretations based on data provided by final accounts, accounting
ratios are used to come up with sensible figures which represent various meanings regarding
how a financial year went by.

These ratios are meant to calculate a financial years Profitability, Efficiency and Liquidity,
which is all that a business should care about when looking at their final accounts. In
comparison between one year and another or others, trends can be seen and conclusions can
be drawn for the concerned business to act upon. The following is the interpretation process
done on Uchumi Supermarket Ltd. final accounts for 2014 and 2015 (Source: Assignment
Attachment)

7.1.1. Profitability Ratios

Profitability ratios are measures that indicate how well an organisation is performing in terms
of its ability to generate profit (BusinessDictionary.com, 2016).

Return On Capital Employed (ROCE):

The Return on Capital Employed is a financial ratio that measures a companys profitability
and the efficiency with which its capital is employed (Staff, 2016). The Return on Capital
Employed is calculated as:
 Profit before interest tax
Returnon Capital Employed= 100
Capital employed

2014:

675000
Return of Capital Employed= 100 =40.90
1650000

2015:
1275000
Return of Capital Employed= 100 =65.89
1935000

From the calculations above, one can notice an increase in the Return on Capital Employed
by approximately 24.99%. This shows that the rate at which the capital invested for the
financial years is paying-off and has increased by that amount. This is because more capital
was employed in 2015 than in 2014. This is a good thing for Uchumi Supermarket Ltd. since
it will attract more investments and promote the business activities once realised by
investors.

Gross Profit Margin:

The Gross Profit margin is a measure of an organisations profitability that is expressed as a

percentage of gross profit (BusinessDictionary.com, 2016). It is calculated as:

Gross profit
Gross Profit margin= 100
Sales

2014:
1150000
Gross Profit margin= 100=38.33
3000000

2015:

2100000
Gross Profit margin= 100=43.75
4800000

As per the calculations, Uchumis profitability has increased by 5.42% from 2014 to 2015.
Since its not very significant at the moment considering the economic crisis at hand, Uchumi
Supermarket Ltd should watch out for the next financial year to see how the trend goes and
make evident conclusions. At this point, all that can be suggested is the reduction of
unnecessary purchases in order to increase the amount of Sales.

Net Profit Margin:

The Net Profit margin, however, is the net profit divided by the net revenues and is often
expressed as a percentage. The Net Profit margin indicates how effective an organisation is at
cost control (Investorwords.com, 2016). It is calculated as:

Net profit After Tax

Net Profit margin= 100
Sales

2014:
397500
Net Profit margin= 100=13.25
3000000

2015:
757500
Net Profit margin= 100=15.78
4800000

From the figures obtained, there is a 2.53% increase in the percentage of Net profit over
Sales. This shows that Uchumi Supermarket Ltd. has been slightly keener on spotting and
reducing unnecessary expenses, which increased the Net profit figures in 2015. Other than
that, the sales figure has also increased in 2015, which supports the effort to reduce
unnecessary expenses.

7.1.2. Liquidity Ratios

Liquidity ratios are ratios that are used to determine an organisations ability to pay off its
short-term debts. Generally, the higher the value of the ratio, the larger the margin of safety
that the organisation possesses to cover its short-term debts (Investopedia, 2016).

Acid Test Ratio:

An acid test ratio is a ratio that determines whether an organisation has enough short-term
assets to cover its immediate liabilities without selling inventory. It is calculated as:
 Current assets InventoryPrepayments
Acid test ratio=
Current liabilities

2014:
1095000 6000000
Acid test ratio= =0.77 :1
645000

2015:
1350000 8250000
Acid test ratio= =0.46 :1
1140000

As usual, organisations with less than 1:1 ratio in Acid Tests cannot pay off their current
liabilities. This suggests that Uchumi Supermarket Ltd.is unable to pay off its short-term
debts in both 2014 and 2015 since the ratios are both below 1:1. Even worse, their ability to
pay off their debts in 2015 got lower than their ability to pay off their debts in 2014.

Current Ratio:

The current ratio, under liquidity ratios, is a measure of both an organisations efficiency and
its short-term financial health. It compares the figure of current assets to the figure of current
liabilities. It is calculated as:

Current assets
Working capital ratio=
Current liabilities

2014:
1095000
Workingcapital ratio= =1.70 : 1
645000

2015:
1350000
Workingcapital ratio= =1.18 : 1
1140000

From the figures obtained, in 2014 Uchumi Supermarket Ltd. were very close to achieving
the 2: 1 ratio which is a perfect liquidity but in 2015, Uchumi Supermarket Ltd. given further
from that and got closer to a 1:1 ratio which means that for every current asset there was 1
current liability.

This is bad because the ratio is getting closer to getting below the 1: 1 ratio which will mean
that the business is not able to meet its obligations. Uchumi Supermarket Ltd. should keep
their liabilities at a possible minimum in their 2016 financial year in order to reverse the
trend.

7.1.3. Efficiency Ratios:

The ratios are meant to measure the efficiency of the business operations in a financial year.
The following are some of the ratios used to measure this:

Rate of Stock Turnover:

Moreover, the inventory ratio can be defined as a ratio that shows how many times an
organisations inventory is sold and replaced over a period (Investopedia, 2016). It is
calculated as:

Averageinventory
Rate of Stock Turnover= 365 days
Cost of sales

2014:
(0+600000)
Rate of Stock Turnover= 365 days=133 days
1650000

2015:
( 600000+825000)
Rate of Stock Turnover= 365 days=192days
2700000

This ratio is used to measure the inventory management efficiency in a business like Uchumi
Supermarket Ltd. In general, a higher value of inventory turnover (less days of turnover)
indicates a better performance and a lower value indicates inefficiency in controlling
inventory levels. From the figures obtained, Uchumi Supermarket Ltd. had high levels of
inventory turnover in both 2014 and 2015 but higher in 2015. This implies that sales have
increased from 2014 to 2015 but are not enough to decrease the turnover of inventory.
 Account Receivables days or period:

In addition, a trade receivable turnover ratio is an accounting measure used to quantify an

organisations effectiveness in extending credit as well as collecting debts. The receivables
turnover ratio is an activity ratio, measuring how effectively an organisation uses its assets
(Investopedia, 2016). It is calculated as:

Account receivables
Trade receivable turnover= 365
Cr . Sales

2014:
375000
Trade receivable turnover= 365=46 days
3000000

2015:
525000
Trade receivable turnover= 365=40 days
4800000

From the figures obtained, it seems like the amount of time it takes for account receivables to
pay their debts to Uchumi Supermarket Ltd. has reduced in 2015 by 6 days. Although this
amount is not very significant, it is better than having it increase instead. This suggests that
Uchumi Supermarket Ltd. are more aggressive when comes to following up payments as per
2015s figure of turnover. This is good and Uchumi Supermarket Ltd. should only get better
from here.

Account Payables days or period:

Furthermore, a trade payable turnover ratio is a short-term liquidity measure that is used to
quantify the rate at which an organisation pays off its payables (Investopedia, 2016). It is
calculated as:

NB: The figure of Purchases has not been provided for any of the years. So it can be worked
out through the following formulae derived from how the Cost of goods sold (COGS) is
determined in the Income Statement:
Purchases=C .O .G . SOpening Stock+Closing Stock . Where the Opening Stock was

not provided, i.e.: 2014, it has been treated as inexistent, 0, for it cannot be determined
from this information.
 Trade creditors
Trade payable turnover = 365
Purchases

2014:
217500
Trade payableturnover = 365=35 days
(16500000+ 600000)

2015:
300000
Trade payableturnover = 365=37 days
(2700000600000+ 825000)

As per the calculations, in 2014, Uchumi Supermarket Ltd. took less days to pay off its
payables as compared to 2015. Generally, an organisation that strives to maximise its cash
inflow may take as long as possible to pay its creditors. However, Uchumi Supermarket Ltd.
may face risks if they take a longer time than permitted by its agreements with its account
payables. Uchumi Supermarket Ltd. may lose its creditors goodwill, especially due to the
implications this economic crisis at hand portrays, and may face extra charges too.

Conclusively speaking, it would be prudent of Uchumi Supermarket to take keen notice of

the interpretation given within each accounting ratio calculated. The most important part
Uchumi should consider its Liquidity status and the trends observed in its efficiency for the
two years, 2014 and 2015, especially on the Account Payables Period and the Stock Turnover.

Uchumi Supermarket should try to stimulate sales through promotion activities in order to
improve on its profitability further and its stock turnover per financial period. Furthermore,
unnecessary expenses should be avoided as much as possible and an economic style of
spending should be employed in order to support the figure of Net-Profit and total Current
Assets, i.e.: Cash at hand or bank. From here, Uchumi Supermarket should get better.