Download 5. Financial Statement Forecasts

‫بسم هللا الرحمن الرحيم‬
Islamic University – Gaza
Faculty of Commerce
Department of Accounting
‫الجامعة اإلسالمية – غزة‬
‫كلية التجارة‬
‫قسم المحاسبة‬
Importance of financial ratios
(Applied Study on PALTEL Company)
prepared By :
Ali Own Moheisen
Khaled Kamel Dawoud
120092647
120092173
Supervisor's name :
Dr. Salah Shubair .
August, 2012
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‫بسم هللا الرحمن الرحيم‬
‫"ي ْرفعِ هللاه الَّ ِذين آمنهوا ِمن هك ْم والَّ ِذين‬
‫أ هوتهوا ْال ِع ْلم درجات"‬
‫صدق هللا العظيم‬
‫} سورة المجادلة‪{ 11،‬‬
‫‪2‬‬
Dedication:
For Our Palestine…
For Our University…
For Our Teachers…
For Our Family…
We Present This Research…
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Acknowledgment:
- First of all, we thank Allah for helping us to complete
our Research.
- Our ability to accomplish this research is due to the
good effort provided by our great university IUG.
- We thank very much our parents, who were granted
every thing in their life for us, and also we thank
them for push us to success.
- We would like to thank Mr. Salah Shubair for his
advice and continuous supports.
- For all our teachers at IUG and for the IUG library
staff.
- We would like to express our personal gratitude to
Jawwal Company.
- Also we would like to thanks our friends for their
help.
- Finally, thanks for every one who contributes in any
way to support us.
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List of content:
Averse of Quran…………………………………………………………2
Dedication…………………………………………………….………3
Acknowledgment……………………………………………….……4\
List of Content……………………………………….………………….5
List of Tables...………. …………………………………….………...5
Table of Figures…………………………………..……………5
CHAPTER 1: RESEARCH PROPOSAL
Introduction ……………………………………………9
Statement of the problem…………………………………11
Objectives ……………………………………………………11
Main objective …………………………………………………11
Specific objectives ………………………………………………12
Significance of the project (work) …………………………………..14
Scope and limitations of the project (work) ………………………..15
Methodology………………………………………………………15
Current state of the art………………………………………….17
Related work…………………………………………………18
CHAPTER 2: INTODOCURY DEFENITIONS
Introduction…………………………………………………….21
Managerial (Business) Finance……………………………………21
Finance in the organizational structure of the firm……………………22
Financial Manager's Responsibilities……………………………………23
Methods Of Analyzing Financial Statements……………………….…25
Ways to Analyze Financial Statements……………………………….26
Component of The Financial Statement…………….……………27
Users of Financial statement…………………………………27
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CHAPTER 3: financial ratios
Introduction ……………………………………………….…31
What Does Financial Ratio Mean…………………………….31
Standards Of Comparison………………………………….…31
Financial Ratio Classification…………………………………32
Efficiency Ratios…………………………………………..…33
Investment Ratios………………………………………….…38
profitability Ratios……………………………………………40
Short Summary…………………………………………….…43
How to Use Financial Ratios to Make Managerial Decisions? ……44
Advantages and Uses of Ratio Analysis……………………………45
Limitations of Ratio Analysis………………………………….……47
Summary……………………………………………………..…….48
CHAPTER 4: APPLIED STUDY
Introduction…………………………………………………50
Key Steps in Financial Ratio Analysis…………………..…50
Palestinian Telecommunications Company…………………51
Corporate Information…………………………………….51
PalTel Group……………………………………………..52
The Mission………………………………………………52
The Promise………………………………………………52
The Vision…………………………………………….…52
The Methodology……………………………………..…52
What Can PalTel Group Do For You? ……………………..52
Financial Ratios Analysis……………………………………53
Profitability Ratios………………………………………..…53
Efficiency Ratios……………………………………………55
Liquidity Ratios………………………………………………58
Investment Ratios……………………………………………59
CHAPTER 5: conclusion and recommendation
CONCLUSION……………………………………………64
RECCOMMENDATIONS…………………………………65
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Chapter -1-
7
Research
prposal
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1.1 Introduction:
The basic financial statements containing (income statement, balance
sheet, the statement of stockholders` equity and the statement of cash
flow) of quantitative and qualitative information can be used in the
analysis of financial and economic decision-making appropriate.
Income Statement - provide a financial summary of the firm’s operating
results during a specified time period.
Balance Sheet –present a summary of the assets owned by the firm, the
liabilities owed by the firm, and the net financial position of the owners
as of a given point in time.
Statement of Retained Earnings
- This statement reconciles the net
income earned during the year, and any cash dividends paid, with the
change in retained earnings during the year.
Statement of Cash Flows - This statement provides a summary of the
cash inflows and the cash outflows experienced by the firm during the
period of concern.(1) (Gitman ، 2009 ، P44-51).
The financial statements contain a great deal of accounting data for the
previous financial periods and the current financial period, so it is not
enough to prepare the inventory, but must be analyzed using the methods
and tools appropriate to convert such data into useful information on
company performance in the past as well as to predict its future, and then
interpret the results of the analysis to serve all the parties used for
accounting data.
The analysis using financial ratios are the oldest tools of financial
analysis and most important, financial ratios were defined by many
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authors, such as: "The financial ratios are studying the relationship
between variables, one representing the numerator and the other
represents a primarily" (Gitman, 2009 , P53); or that the financial ratios
"is a relationship between two or more items of the financial statements
are expressed as a percentage or number of times."
It features financial analysis using ratios, ease of calculating the ratio of
Finance and the possibility of their use in the comparison from year to
year or between the facility and the other, and the disclosure of
information that do not directly Disclose the Final Financial Statements
(Gitman ، 2009 ، P54).
Financial ratios can be convenience into five basic categories: liquidity,
activity, debt, profitability, and market ratio (Gitman ، 2009 ، P57-69).
1. Liquidity ratios:
The liquidity of a firm is measured by its ability to satisfy its short-term
obligations as they come due.
2. Activity ratios:
Measure the speed with which various accounts are converted into sales
or cash –inflows or outflows.
3. debt ratios:
The debt position of a firm indicates the amount of other people's money
being used to generate profit. Debt ratios measure both the degree of
indebtedness and the ability to service debt.
4. Profitability ratios:
Measure the firm's ability to generate profits from money invested .
5. Market ratios:
Relate a firm's market value, as measured by its current share price, to
certain accounting values.
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1.2 The Problems Of The Study :
Our research's problem will answer these questions :
1. Why do financial analysts engage in the analysis of a firm's
statements?
2. What are common size financial statements and how are they
constructed?
3. What is the financial ratio intended to measure?
4. How the financial statement influence on making decision?
1.3 Objectives
1.3.1 Main Objective
To study the financial ratios, and knowing how it might influence on the
decision making, profitability and liquidity of the corporation.
1.3.2 Specific Objectives
The specific objectives of the project are:
1. To identify the meaning of each ratio.
2. To determine how each ratio can be computed.
3. To interpret the financial ratios and their significance.
4. To identify what might a high or low value be telling us.
5. To evaluate the firm's financial performance in light of its
competitor's performance.
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1.4 Significance Of The Project
1. Holding Of Share
Shareholders are the owners of the company. Time and again, they
may have to take decisions whether they have to continue with the
holdings of the company's share or sell them out. The financial
statement analysis is important as it provides meaningful information
to the shareholders in taking such decisions.
2. Decisions And Plan
The management of the company is responsible for taking decisions
and formulating plans and policies for the future. They, therefore,
always need to evaluate its performance and effectiveness of their
action to realize the company's goal in the past. For that purpose,
financial statement analysis is important to the company's
management.
3. Extension Of Credit
The creditors are the providers of loan capital to the company.
Therefore they may have to take decisions as to whether they have to
extend their loans to the company and demand for higher interest
rates. The financial statement analysis provides important information
to them for their purpose (www.ehow.com).
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4.Investment Decision
The prospective investors are those who have surplus capital to invest
in some profitable opportunities. Therefore, they often have to decide
whether to invest their capital in the company's share. The financial
statement analysis is also important to them because they can obtain
useful information for their investment decision making purpose.
Other significant of our project :
 Company can analyze its own performance over the period of
time through financial statement analysis.
 Financial ratios are an important tool of economic decisionmaking for all businesses.
 Investors get enough idea to decide about investments of their
funds in specific company.
 Regulatory authorities like International Accounting Standard
Board can ensure whether the company is following accounting
standard or not.
 Financial statements can help the government agencies to
analyze the taxation due to the company.
 Ratios are used in the financial aspects of businesses. They are
used for comparison purposes in finding out how their company
is doing compared to prior years and compared to other
businesses in the same industry.
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1.5 Limitations of the Project (Work)
The limitations of our project could be presented in the following
points:
 Making the research was very hard, and there is no enough time to
make a good research.
 Analyzing the financial ratios requires analytical skills .
 As students we still not working in any business we didn’t get
this skills yet .
 There are various types of financial ratios and also various
classifications, depending on an investor's perspective or areas that
corporate leadership wants to review.
 Not all of the Palestinian corporations declare their financial
statements for the public.
 Taking the Palestinian Telecommunications Company (PALTEL)
as a case study was
very challengeable because it is a service company and its
financial statements differ from the financial statements for the
merchandising or manufacturing companies.
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1.6 Methodology
In our research we used the analytical methodology will follow a
systematic way in which we can put the key titles for each chapter and
then beginning talking about each title separately depending on the
information that we can get it from the books in the university’s libraries
and by searching on the internet.
we realize that our research’s topic needs a Palestinian corporation
to be a case study for this research, so we will apply this research
on the Palestinian Telecommunications Company (PALTEL) ,using
its financial statements with its declarations and notes.
1.6.1 Overview of the Current State of the Art
Analysis of financial statements is the process of reviewing and
evaluating a company’s financial statements (such as the balance sheet or
profit and loss statement), thereby gaining an understanding of the
financial health of the company and enabling more effective decision
making. Financial statements record financial data; however, this
information must be evaluated through financial statement analysis to
become more useful to investors, shareholders, managers and other
interested parties.
So our topic will contain five chapters which are as follows:
The first Chapter:
In which we will take an introduction about the whole research and
introduce the significance of my research topic and its limitations.
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The second chapter :
This chapter will be as introductory chapter for almost all the definitions
that we will need it in my research, beginning talking in introduction
about the financial statement analysis, then talking about the importance
of analyzing the financial statements.
The third chapter:
In this chapter we will talk particularly about one method of many
methods of analyzing the financial statements, taking the clearest
classification for the financial ratios. we shall see financial (or
accounting) ratios can help in assessing the financial health of a business.
we shall also discuss the problems that are encountered when applying
this technique.
The fourth chapter:
In this chapter we will take Palestinian Telecommunications Company
(PALTEL) as a case
study, and then introduce its financial statements by analyzing them
according to the financial ratios. we shall also interpret each financial
ratio by comparing this ratio among two years which are 2009 and 2010.
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The fifth chapter:
In this chapter we include the conclusion from our research, also the
results and recommendations .
Sources to collect information:
1. Primary sources:
• Previous researches.
• Related websites.
2. Secondary sources:
• Related books.
• Magazines and periodicals.
Our main reference is (www.accountingformanagement.com) .
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Time table and budget:
The research has a time limit; it should be done in nine weeks. The
following chart describes the way we will spent the research time.
July
Activity
August
Table 1.1 time table
Week Number
1
2
3
4
5
6
Generate Topic
Read books and related researches
Writing research proposal
Introdocury definitions
Financial ratios
Applied study
Conclusion & recommendations
Discussion the Search
The estimated research budget could be 200 NIS. This budget will be
spent on copying, typing and other expenses related to this research.
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Chapter -2-
19
Introdocury
Definition
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2.1 Introduction
In simple terms, finance is concerned with decisions about money, or
more appropriately, cash flows. Finance decisions deal with how money
is raised and used by businesses, government, and individuals; To make
rational financial decisions .
The study of the finance consists of four interrelated areas: (1)financial
markets institutions, (2)investments, (3)financial services, (4)managerial
finance.
Managerial (Business) Finance:
Managerial finance deals with decisions that all firms make concerning
their cash flows. As a consequence, managerial finance is important in all
types of businesses, whether they are public or private, deal with financial
services, or manufacture products. The types of duties encountered in
managerial finance range from making decisions about plant expansions
to choosing what types of securities to issue to finance such as
expansions.
Managerial finance is very important area, because all areas of the
finance are interrelated, an individual who works in any once area should
have a good understanding of the other areas as well. For example, a
banker lending to a business must have a good understanding managerial
finance to judge how well the borrowing company is operated.
2.2 Finance in the organizational structure of the firm
Finance is intimately woven into any aspect of the business that involves
the payment or receipt of money in the future. For this reason it is
important that everyone in a business have a good working knowledge of
the basic principle of finance. However, within a large business
organization, the responsibility for managing the firm financial affairs
falls to the firm's chief financial officer (CFO).
Figure 2.1 shows how the finance function fits into firm's organizational
chart.
In the typical large corporation, the CFO serves under the corporation's
Chief Executive Officer (CEO) and is responsible for overseeing the
firm's finance-related activities. Typically, both a treasure and controller
serve under the CFO, although in a small firm the same person may fulfill
both roles. The treasure generally handles the firm's financing activities.
These include managing its cash and credit, exercising control over the
firm's major spending decision, raising money, developing financial plan,
and managing any foreign currency the firm receives.
The firm's controller is responsible for managing the firm's accounting
duties, which include producing financial statement, paying taxes, and
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gathering and monitoring data that the firm's executives need to oversee
its financial well-being.
Board of Directors
Chief Executive Officer
Vice PresidentMarketing
Treasure
Duties:
Cash
management
Credit management
Capital
expenditure
Raising capital
Financial
planning
Vice President-Finance
or Chief Financial
Officer(CFO) Duties
Oversee financial
planning Corporate
strategic planning Control
corporate cash flow
Vice PresidentProduction and
Operation
Controller
Duties:
Taxes
Financial
statement
Cost
accounting
Data processing
2.3 Financial Manager's Responsibilities
The financial manager's task is to make decisions concerning the
acquisition and uses of funds for the greatest benefit of the firm. Here are
some specific activities that are
involved:(www.accountingformanagment.com)
1. Forecasting and planning. The financial manager must interest
with other executives as they look ahead and lay the plans that will
shape the firm's future positions.
2. Major investment and financing decisions. A successful firm
generally has rapid growth in sales, which requires investments in
plant, equipment, and inventory. The financial manager must help
determine the optimal sales growth rate, and he or she must help
decide on the specific assets to acquire and the best way to finance
those assets.
3. Coordinating and controlling. The financial manager must
interact with other executrices to ensure that the firm is operated as
efficiently as possible. All business decisions have financial
implications, and all managers, financial and other wise need to
take it into account.
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4. Dealing with the financial markets. The financial manager must
deal with the money and capital markets. Each firm affects and is
affected by the general financial markets where funds are raised,
where the firm's securities are traded, and where its investors are
either rewarded or penalized.
From what we have already said, we can say that all the previous tasks
required the financial manager to analyze the financial statements for the
company which he works in, so what is financial analysis?
Financial statement analysis is defined as the process of identifying
financial strengths and weaknesses of the firm by properly establishing
relationship between the items of the statement of financial position and
the income statement.
2.4 Methods Of Analyzing Financial Statements
There are various methods or techniques that are used in analyzing
financial statements, such as comparative statements, schedule of changes
in working capital, common size percentages, funds analysis, trend
analysis, and ratios analysis (www.accountingformanagment).
1. Horizontal or Trend Analysis
Methods of financial statement analysis generally involve comparing
certain information. The horizontal analysis compares specific items
over a number of accounting periods. For example, accounts payable
may be compared over a period of months within a fiscal year, or
revenue may be compared over a period of several years. These
comparisons are performed in one of two different ways.
 Absolute Dollars
One method of performing a horizontal financial statement analysis
compares the absolute dollar amounts of certain items over a period
of time. For example, this method would compare the actual dollar
amount of operating expenses over a period of several accounting
periods. This method is valuable when trying to determine whether a
company is conservative or excessive in spending on certain items.
This method also aids in determining the effects of outside influences
on the company, such as increasing gas prices or a reduction in the
cost of materials.
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 Percentage
The other method of performing horizontal financial statement
analysis compares the percentage difference in certain items over a
period of time. The dollar amount of the change is converted to a
percentage change. For example, a change in operating expenses
from $1,000 in period one to $1,050 in period two would be reported
as a 5% increase. This method is particularly useful when comparing
small companies to large companies.
2. Vertical Analysis
The vertical analysis compares each separate figure to one specific
figure in the financial statement. The comparison is reported as a
percentage. This method compares several items to one certain item
in the same accounting period. Users often expand upon vertical
analysis by comparing the analyses of several periods to one another.
This can reveal trends that may be helpful in decision making. An
explanation of Vertical analysis of the income statement and vertical
analysis of the balance sheet follows.
 Income Statement
Performing vertical analysis of the income statement involves
comparing each income statement item to sales. Each item is then
reported as a percentage of sales. For example, if sales equals
$10,000 and operating expenses equals $1,000, then operating
expenses would be reported as 10% of sales.
 Balance Sheet
Performing vertical analysis of the balance sheet involves comparing
each balance sheet item to total assets. Each item is then reported as a
percentage of total assets. For example, if cash equals $5,000 and
total assets equals $25,000, then cash would be reported as 20% of
total assets.
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3. Ratio Analysis
Ratio analysis is a dynamic way of analyzing a financial
statement. It involves taking two or more numbers and comparing
them to calculate a result that accurately displays a business's
financial strengths and weaknesses. There are many categories of
ratios, including profitability ratios, liquidity ratios, debt ratio and
asset ratios. A business can compare ratios to industry and
competitive benchmarks in order to gauge its performance and
make decisions on how to operate in the future.
2.5 Ways to Analyze Financial Statements
Users may choose different methods to analyze financial statements
depending on the types of business insight they desire:
1. Common-size Statements
A common-size statement may be either the balance sheet or income
statement. Financial statements are restated in "comment-size" terms
by converting their numbers to percentages. This standardizes the
financial results to allow comparison between companies in the same
industry, regardless of their size. For example, the common-size
income statement reports every line item as a percentage of sales. The
common-size income statement allows companies to compare their
percentage of SG&A expenses or cost of goods sold against industry
averages or other similar companies. A common-size balance sheet
reports every item as a percentage of total assets. For example, if total
assets of the company are $1 million, and cash is $80,000, then cash
is 8 percent of total assets.
2. Comparative Statements
Comparative financial statements show different periods compared to
each other. For example, an income statement might show three years
worth of profit and loss data, and to use this to demonstrate the
growth from one year to the next for certain line items, such as sales
or specific types of expenses. Companies may use comparative
financial statements internally, to compare one month to the next and
look for trends in sales or expenses throughout the year. This
information also helps formulate the company's monthly and yearly
budgets and forecasts.
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3. Ratio Analysis
Financial ratios on their own are simply one number divided by
another. Alone, one ratio does not mean much, but several used
together can provide users with a substantial amount of information.
Financial ratios are a relatively quick method of assessing a
company's liquidity, how effectively it manages its resources, how
efficiently it turns inventory and the company's level of reliance on
debt-to-finance operations.
4. Industry Comparison
Financial statements analyzed against industry averages or other
specific companies in the same industry tell how competitive a
business is among its peers. Return Merchandise Authorization
'RMA' is a nonprofit association that publishes annual financial
statement studies, providing comparative financial data from the
financial statements of small to medium size businesses in various
industries. This information allows businesses to benchmark
themselves against the industry, using metrics, such as sales growth,
cost of goods sold as a percent of sales .
5. Financial Statement Forecasts
Forecasts are sometimes assembled based on the results of financial
statement analysis, but once the forecast period has passed, the
projected financial information can be compared to actual data to
measure the company's performance against its objectives, and spot
any potential trends that management was not previously aware of.
2.6 Component of The Financial Statement
Financial statements consist of three different statements: income
statement, balance sheet and cash flow statement. All three are necessary
to provide an accurate overview of the financial stability and viability of a
business. At the least, firms prepare annual financial statements, and most
businesses compile them monthly or quarterly as well.
1. The Income Statement
An income statement, also called a profit and loss statement, measure
the amount of profits generated by a firm over a given time of period
(usually a year or quarter). In its most basic form, the income
statement can be expressed as follow:
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Revenues (or sales) – Expenses = Profits
Revenue represent the sales for the period. Profit are the difference
between the firm's revenues and the expenses the firm incurred in
order to generate those revenues for the period.
2. The balance sheet statement
The balance sheet is a snapshot of the firm's financial position on an
a specific date. In its simplest form, the balance sheet is defined by
the following equation:
Total Assets = Total Liabilities + Total Shareholders' Equity
Total Liabilities represent the total amount of money the firm owes
its creditors (including the firm's total bank and suppliers).
Total shareholders' equity refers to the difference in the value of
the firm total assets and the firm's recorded in the firm's balance
sheet. As such, total shareholders' equity refers to the book value of
their investment in the firm, which includes both the money they
invested in the firm to purchase its share and the accumulation of
past earnings from the firm's operation. The sum of total
shareholders' equity and total liabilities is equal to the firm's total
asset, which are the resources owned by the firm.
3.The Cash Flow Statement
The cash flow is a report, like the income statement and balance
sheet, that’s firms use to explain changes in their cash balances over
a period of time by identifying all of the recourse and the uses of
cash for the period spanned by the statement. The focus of cash flow
statement is the change in the firm's cash balance for the period of
time covered by the statement.
Change in cash balance =
Ending Cash Balance – Beginning Cash Balance
2.7 Users of Financial statement
Financial statements are intended to be understandable by readers who
have "a reasonable knowledge of business and economic activities and
accounting and who are willing to study the information diligently."
There are different kinds of users of financial statements. The users of
financial statements may be inside or outside the business (Eugene,
2000).
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1. Internal users
The internal users of financial statements are individuals who have direct
bearing with the organization. They may include:
 Owners
Owners are typically the most interested user of financial statements.
Not only do owners have an interest in profits, but also in the amount
of money they retain for personal income. This information comes
from the income statement. Owners want to know how much capital
the business consumed in order to generate sales revenue.
 Employees
Employees have an interest in financial statements because they need
assurances for job retention. Employees can also have an interest in
their company's stock price, which has a close relationship to the
company's accounting information. Employee stock options may
increase or decrease precipitously based on the company's financial
health. Employees need this information to determine if they should
buy more or hold their current investment level.
2. External Users
The external users comprise of:





Institutional Investors: The external users of financial statements are
basically the investors who use the financial statements to assess the
financial strength of a company. This would help them to make logical
investment decisions.
Financial Institutions: The users of financial statements are also the
different financial institutions like banks and other lending institutions
who decide whether to help the company with working capital or to issue
debt security to it.
Government: The financial statements of different companies are also
used by the government to analyze whether the tax paid by them is
accurate and is in line with their financial strength.
Vendors: The vendors who extend credit to a business require
financial statements to assess the creditworthiness of the business.
General Mass and Media: The common people as well as media also
make part of the users of financial statements.
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Chapter-3-
29
Financial
Ratios
30
3.1 Introduction
Ratios are among the more widely used tools of financial analysis
because they provide symptoms of underlying condition.
A ratio can help us uncover conditions and trends difficult to detect by
inspecting individual component making up the ratio. Ratios, like other
and analysis tools, are usually future oriented; that is, they are often
adjusted for their probable future trend and magnitude, and their
usefulness depends on skillful interpretation.
Ratios are particularly important in understanding financial statement
because they permit us to compare information from one financial
statement with information from another financial statement.
For example, we might compare net income (taken from the income
statement) with total assets(taken from the balance sheet) to see how
effectively management is using available recourses to earn a profit.
For a ratio to be useful, however, the two amount being compared must
be logically related.
3.2 What Does Financial Ratio Mean
A ratio is a simple mathematical expression of the relationship of one
item to another. It can be expressed as a percent, rate, or portion.
For instance, a change in an account balance from $100 to $250 can be
expressed as (1) 150%, (2) 2.5 times, or (3) 2.5 to 1 (or 2.5:1).
A financial ratio is a comparison between one bit of financial
information and another. Consider the ratio of current assets to current
liabilities, which we refer to as the current ratio. This ratio is a
comparison between assets that can be readily turned into cash -- current
assets -- and the obligations that are due in the near future -- current
liabilities. A current ratio of 2:1 or 2 means that we have twice as much in
current assets as we need to satisfy obligations due in the near future.
3.3 Standards Of Comparison
When interpreting measures from financial statement analysis, we need to
decide whether the measures indicate good, bad, or average performance.
To make such judgment, we need standard (benchmarks) for comparison
that include the following:
Intracompany__ The company under analysis can provide standards
for comparisons based on its own prior performance and relations
between its financial items.
Competitor__ One or more direct competitors of the company being
analyzed can provide standards for comparisons.
Industry__ Industry statistic can provide standards of comparisons.
Guidelines ( rules of thumb )__ General standards of comparison can
develop from experience.
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3.4 Financial Ratio Classification
Financial ratio can be grouped into four types (liquidity, efficiency,
Investment, and profitability). No one ratio gives us sufficient
information by which to judge the financial condition and performance of
the firm. Only when we analyze a group of ratios are we able to make
reasonable judgments.
3.4.1 Liquidity Ratio
Liquidity refers to the availability of recourses to meet short-term cash
requirements. It is affected by the timing of cash inflows and cash
outflows along with prospect for future performance.
The following ratio are widely used:
 Current ratio.
 Acid test ratio (Quick ratio).
 Working capital ratio.
Current ratio
The current ratio is calculated by dividing current assets by current
liabilities:
Current ratio =
Total current assets
Total current liabilitie s
Current assets include cash, marketable securities, account receivable and
inventories. Current liabilities consist of account payable, short-term note
payable, current maturities of long-term debt, accrued income taxes, and
other accrued expenses. It measures a company's ability to pay its
expenses with money it has on hand. If the current ratio is higher than
one, the company can pay its bills. For example, if a business has
$200,000 in current assets and $100,000 in current liabilities, its current
ratio is 2. This means the company has $2 available to pay every $1 of
debt it owes. Companies with current ratios of less than one may not be
able to pay their bills, as they have fewer current assets than current
liabilities.
If the current ratio of the company is too low, it may be able to raise it by:

Paying some debts.

Increasing your current assets from loans or other borrowings with
a maturity of more than one year.

Converting non-current assets into current assets.
32


Increasing your current assets from new equity contributions.
Putting profits back into the business.
Acid Test Ratio (Quick Ratio)
The quick ratio is calculated by deducting inventories from current assets
and then dividing the reminder by current liabilities:
Acid test ratio =
Current assets (excluding stock)
Current liabilitie s
Inventories are typically the least liquid of a firm’s current assets, so they
are the assets on which losses are most likely to occur in the event of
liquidation. Therefore, a measure of the firm’s ability to pay off shortterm obligations without relying on the sale of inventories is important.
Working Capital Ratio
Working Capital is more a measure of cash flow than a ratio. The result
of this calculation must be a positive number. It is calculated as shown
below: (Williams, 2002)
Working Capital = Total Current Assets - Total Current Liabilities
Bankers look at net working capital over time to determine a company's
ability to weather financial crises.
A general observation about these three liquidity ratios is that the higher
they are the better, especially if you are relying to any significant extent
on creditor money to finance assets.
3.4.2 Efficiency Ratios
Efficiency ratios examine the ways in which various resources of the
business are managed. The following ratios consider some of the more
important aspects of resource management:
 Average stock (inventory) turnover period.
 Average settlement period for debtors (receivables).
 Average settlement period for creditors (payables).
 Sales revenue to capital employed.
 Sales revenue per employee.
33
These ratios give us an insight into how efficiently the business is
employing those resources invested in fixed assets and working capital
(Williams, 2002).
Average stock turnover period
Average stock turnover period is the ratio of cost of goods sold to
inventory. This ratio indicates how many times inventory is created and
sold during the period.
Stocks often represent a significant investment for a business. For some
types of business (for example, manufactures), stocks may account for a
substantial proportion of the total assets held. The average stock
turnover period measures the average period for which stock are being
held. The ratio is calculated as follows:
Average stock turn over period =
Average stock held
 365
Cost of sales
The average stock for the period can be calculates as a simple average of
opening and closing stock levels for the year. However, in the case of
highly seasonal business where stock levels may vary considerably over
the year, a monthly average may be more appropriate )Foster, 1986).
Average settlement period for debtors
A business will usually be concerned with how long it takes for
customers to pay the amounts owing. The speed of payment can have a
significant effect on the business's cash flow. The average settlement
period for debtors calculates how long, on average, credit customers
take to pay the amounts that they owe to the business. The ratio is as
follows
Average settlement period for debtors =
Trade deptors
 365
Credit sales revenue
A business will normally prefer a shorter average settlement period to a
longer one as, once again, funds are being tied up that may be used for
more profitable purposes. Though this ratio can be useful, it is important
to remember that it produces an average figure for the number of days for
34
which debts are outstanding. This average may be badly distorted by, for
example, a few large customers who are very slow or very fast payers.
The average time taken by customers to pay their bills varies from
industry to industry, although it is a common complaint that trade debtors
take too long to pay in nearly every market ( Foster, 1986).
Among the factors to consider when interpreting debtor days are:
 The industry average debtor days needs to be taken into account. In
some industries it is just assumed that the credit that can be taken is 45
days, or 60 days or whatever everyone else seems (or claims) to be
taking.
 A business can determine through its terms and conditions of sale how
long customers are officially allowed to take.
There are several actions a business can take to reduce debtor days,
including offering early-payment incentives or by using invoice
factoring( Block, 2005).
Average settlement period for creditors
The average settlement period for creditor measures how long, on
average, the business takes to pay its trade creditors. The ratio is
calculated as follows:
Average settlement period for creditors =
Trade creditors
 365
Credit purchases
This ratio provides an average figure, which, like the average settlement
period for debtors' ratio, can be distorted by the payment period for one or
two large suppliers.
As trade creditors provide a free source of finance for the business, it is
perhaps not surprising that some businesses attempt to increase their
average settlement period for trade creditors. However, such a policy can
be taken too far and result in a loss of goodwill of suppliers.
In general a business that wants to maximize its cash flow should take as
long as possible to pay its bills. However, there are risks associated with
taking more time than is permitted by the terms of trade with the supplier.
One is the loss of supplier goodwill; another is the potential threat of
legal action or late-payment charges ( Block, 2005).
35
Sales revenue to capital employed
The sales revenue to capital employed ratio (or net assets turnover ratio)
examines how effectively the assets of the business are being used to
generate sales revenue. It is calculated as follows:
Sales revenue to capital employed
=
Sales revenue
Share capital + Reserves + Long - term (non - current) loans
Generally speaking, higher sales revenue to capital employed ratio is
preferred to a lower one. A higher ratio will normally suggest that the
long-term capital invested in assets is being used more productively in the
generation of revenue.
However, a very high ratio may suggest that the business is overtrading
on its assets', that is, it has insufficient capital (net assets) to sustain the
level of sales revenue achieved.
A variation of this formula is to use the total assets less current liabilities
(which is equivalent to long-term capital employed) in the denominator
(lower part of the fraction) the identical result is obtained ( Harrington,
1993).
Sales revenue per employee
The sales revenue per employee ratio relates sales revenue generated to
a particular business resource, that is, labor. It provides a measure of the
productivity of the workforce. The ratio is: ( Harrington, 1993)
Sales revenue per employee =
Sales revenue
Number of employees
Generally, businesses would prefer to have a high value for this ratio,
implying that they are using their staff efficiently.
36
The relationship between profitability and efficiency
In our earlier discussions concerning profitability ratios, we saw that
return on capital employed is regarded as a key ratio by many businesses.
The ratio is:
ROCE =
Net profit before interest and taxation
100%
Long - term capital employed
Where long-term capital comprises share capital plus reserves plus longterm loans.
This ratio can be broken down into two elements. The first ratio is the net
profit margin ratio, and the second is the sales revenue to capital
employed (net asset turnover) ratio.
By breaking down the ROCE ratio in this manner, we highlight the fact
that the overall return on funds employed within the business will be
determined both by the profitability of sales and by efficiency in the use
of capital.
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3.4.3 Investment Ratios
There are various ratios available that are designed to help investors
assess the returns on their investment. The following are widely used:
 Dividend payout ratio.
 Dividend yield ratio.
 Earnings per share.
 Price/earnings ratio.
Dividend payout ratio
The dividend payout ratio measures the proportion of earnings that a
business pays out to shareholders in the form of dividends. The ratio is
calculated as follows: ( Brigham, 1979)
Dividend payout ratio =
Dividends announced for the year
100%
Earnings for the year available for dividends
In the case of ordinary shares, the earnings available for dividend will
normally be the net profit after taxation and after any preference
dividends announced during the period. This ratio is normally expresses
as percentage.
Dividend yield ratio
The dividend yield ratio relates the cash return form a share to its
current market value. This can help investors to assess the cash return on
their investment in the business.
Dividend yield =
{Dividend per share / (1 - t ) }
100%
Market val ue per share
Where t is the lower rate of income tax. The dividend yield ratio is also
expresses as a percentage.
Earnings per share



The earnings per share (EPS) ratio relate the earnings generated
by the business, and available to shareholders, during a period to
the number of shares in issue. For equity shareholders, the amount
38
available will be represented by the net profit after tax. The ratio for
shareholders is calculates as follows: (Harrington, 1993)
Earnings per share =
Earnings available to ordinary shareholde rs
Number of ordinary shares in issue
'Earning per share' is one of the most widely quoted statistics when there
is a discussion of a company's performance or share value.
It serves no purpose to compare the earnings per share in one company
with that in another because a company can elect to have a large number
of shares of low denomination or a smaller number of a higher
denomination. A company can also decide to increase or reduce the
number of shares on issue. This decision will automatically alter the
earnings per share.
Price/earnings (P/E) ratio
The price/earnings ratio relates the market value of a share to the
earnings per share.
This ratio can be calculated as follows:
P/E ratio =
Market val ue per share
Earnings per share
The ratio is a measure of market confidence in the future of a business.
The higher the P/E ratio, the greater the confidence in the future earning
power of the business and, consequently, the more investors are prepared
to pay in relation to the earnings stream of the business.
P/E ratio provides a useful guide to market confidence concerning the
future and they can, therefore, be helpful when comparing different
businesses. However, differences in accounting policies between
businesses can lead to different profit and earnings per share figures, and
this can distort comparison ( Harrington, 1993).
We should say that no single financial indicator will provide enough
information to determine a company’s financial health. Therefore, ratios
must be carefully interpreted. It is important to look at a group of
financial ratios over a period of time, evaluate other companies with
similar sales and functions, and compare performance with other
companies in the same geographical area.
39
3.4.4 profitability Ratios
Profitability ratios are used in determining the profitability of a company.
Profitability ratios (also referred to as profit margin ratios) compare
components of income with sales.
They give us an idea of what makes up a company's income and are
usually expressed as a portion of each dollar of sales (Foster, 1986).
The following ratios may be used to evaluate the profitability of the
business:
 Return on ordinary shareholder's funds.
 Return on capital employed.
 Net profit margin.
 Gross profit margin.
We now look at each of these in turn.
Return on ordinary shareholders' funds (ROSF)
The return on ordinary shareholders' funds compares the amount of
profit for the period available to the owners, with the owner's average
stake in the business during the same period. The ratio is as follows :
( Harrington, 1993)
ROSF =
Net profit after taxa tion and preference dividend
100%
Ordinary share capital plus reserves
The net profit after taxation and any preference dividend is used in
calculating the ratio, as this figure represents the amount of profit that is
left for the owners.
Note that, in calculating the ROSF, the average of the figures for ordinary
shareholder's funds as at the beginning and at the end of the year has been
used. It is preferable to use an average figure, as this might be more
representative. This is because the shareholder's funds did not have the
same total throughout the year, yet we want to compare it with the profit
earned during the whole period. The easiest approach to calculating the
average amount of shareholder's funds is to take a simple average based
on the opening and closing figures for the year. This is often the only
information available.
Where not even the beginning of year figure is available, it is usually
acceptable to use just the year end figure, provided that this approach is
40
adopted consistently. This is generally valid for all ratios that combine a
figure for a period (such as net profit) with one taken at a point in time
(such as shareholder's funds).
Return on capital employed (ROCE)
The return on capital employed is a fundamental measure of business
performance.
This ratio expresses the relationship between the net profit generated
during a period and the average long-term capital in the business during
that period.
The ratio is expressed in percentage terms and is as follows:
ROCE =
Net profit before interest and taxation
100%
Share capital + Reserves + Long - term loans
Note, in this case, that the profit figure used is the net profit before
interest and taxation. This is because the ratio attempts to measure the
returns to all suppliers of long-term finance before any deductions for
interest payable to lenders or payments of dividends to shareholders are
made. The figure needs to be compared with the ROCE from previous
years to see if there is a trend of ROCE rising or falling.
, with the return on capital employed, or net assets, being less than the
rate that the business has to pay for most of its borrowed funds.
To improve its ROCE a business can try to do two things:( Harrington,
1993)
Improve the top line (i.e. increase operating profit) without a
corresponding increase in capital employed, or
 Maintain operating profit but reduce the value of capital employed.
Net profit margin
The net profit margin ratio relates the net profit for the period to the
sales revenue during that period. The ratio is expressed as follows:
( Schall,1986)
Net profit margin =
Net profit before interest and taxation
100%
Sales revenue
The net profit margin before interest and taxation is used in this ratio as it
represents the profit from trading operations before the interest costs are
taken into account. This is often regarded as the most appropriate
measure of operational performance. When used as a basis of
41
comparison, because differences arising from the way in which the
business is financed will not influence the measure.
This ratio compares one output of the business (profit) with another
output (sales revenue). The ratio can vary considerably between types of
business. For example, supermarkets tend to operate on low prices and,
therefore, low profit margins in order to stimulate sales and thereby
increase the total amount of profit generated. Jewelers, on the other hand,
tend to have high net profit margins but have much lower levels of sales
volume. Factors such as the degree of competition, the type of customer,
the economic climate, and the industry characteristics (such as the level
of risk) will influence the net profit margin of a business.
Gross profit margin
The gross profit margin is the ratio of gross income or profit to sales.
This ratio indicates how much of every dollar of sales is left after costs of
goods sold.
The gross profit margin ratio relates the gross profit of the business to
the sales revenue generated for the same period. Gross profit represents
the difference between sales revenue and the cost of sales. The ratio is
therefore a measure of profitability in buying and selling goods before
any other expenses are taken into account. As cost of sales represents a
major expense for many businesses, a change in this ratio can have a
significant on the 'bottom line' (that is the net profit for the year). The
gross profit margin ratio is calculated as follows:( Schall, 1986)
Gross profit margin 
Gross profit
100%
Sales revenue
This ratio tells us something about the business's ability consistently to
control its production costs or to manage the margins its makes on
products its buys and sells. While sales value and volumes may move up
and down significantly, the gross profit margin is usually quite stable (in
percentage terms). However, a small increase (or decrease) in profit
margin, however caused can produce a substantial change in overall
profits ( Harrington, 1993).
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Short Summary
We’ve introduced to a few of the financial ratios that a financial analyst
has in his or her tool kit. Of course there are hundreds of ratios that can be
formed using available financial statement data. We’ll see in the next
chapter how to use these ratios to get an understanding of a company’s
condition and performance.
3.5 How to Use Financial Ratios to Make Managerial Decisions?
Managers have many tools at their disposal to help with decision making,
and among the key tools used are financial ratios as prepared by an
accountant or financial officer. These ratios form a measure of the health
of an organization, and can be a signal danger ahead, or smooth sailing.
Using the quick or current ratio:
 Both these ratios are a measure of current (due or liquid in one year
or less) assets to liabilities, with the key difference being that
inventory is subtracted from the quick ratio as it can be difficult to
liquidate and have uncertain liquidation value. Ideally, the current
ratio should be around 2. If it is 1 or less, this is an indication that a
company may not be able to pay its bills if they came due at this
point. The higher the current or quick ratios are, the more
comfortable a company should be taking on new debt to finance
expansion or new development efforts. If these ratios are already
low, then new debt should not be acquired.
 Compare your ratios to averages for your industry. See if any debt
can be paid off or refinanced to long-term debt if it these ratios are
too low.
 Decide whether to proceed with debt-based financing of a new
project, or to work harder to create more revenue first.
 Increase revenue by either repositioning your products, or adding
features.
Analyze your efficiency ratios:
 Review your accounts receivable ratio, which is accounts
receivable divided by sales times 365 days. If this is low, make a
decision to double your efforts to collect on outstanding debt.
43
Adding more stringent credit requirements, adding staff to the
accounts receivable department or hiring an outside collections
agency are all ways to improve collections efficiency.
 Review your sales to inventory ratio. If this is high, you may be
losing sales as there is not enough inventories. It makes sense in
this case to increase inventory on hand. If it is too low, then you
have stocked too much inventory and need to make a decision to
build less in the future.
 Review your assets to sales ratio. A high number here means that
you need to be more aggressive in creating sales. Decisions should
be made to incentive the sales team. If this number is low, the
business is generating more sales than can be covered by its assets-so assets should be increased. In this case, increasing inventories
would make sense.
Using profitability ratios:
 Review two of the most common profitability ratios: return on
assets and return on equity. Return on assets is net income/total
assets, and return on equity is net income/total stockholders’
equity.
 Create a plan to increase overall income if these ratios are too low,
as this shows that you are not achieving enough return on your
assets or your investors' money.
 Incentive your team to increase sales by increasing commission
percentages or adding other rewards.
 Find new ways to enhance your product's acceptance in the
marketplace to increase income by either repositioning the
products, adding features. You can promote your products for free
by using Twitter, Facebook or user forums.
3.6 Advantages and Uses of Ratio Analysis
There are various groups of people who are interested in analysis of
financial position of a company. They use the ratio analysis to workout a
particular financial characteristic of the company in which they are
interested. Ratio analysis helps the various groups in the following
manner:(Schall, 1986)
To workout the profitability: Accounting ratio help to measure the
profitability of the business by calculating the various profitability ratios.
It helps the management to know about the earning capacity of the
44
business concern. In this way profitability ratios show the actual
performance of the business.
 To workout the solvency: With the help of solvency ratios,
solvency of the company can be measured. These ratios show the
relationship between the liabilities and assets. In case external
liabilities are more than that of the assets of the company, it shows
the unsound position of the business. In this case the business has
to make it possible to repay its loans.
 Helpful in analysis of financial statements: Ratio analysis help
the outsiders just like creditors, shareholders, debenture-holders,
bankers to know about the profitability and ability of the company
to pay them interest and dividend etc.
 Helpful in comparative analysis of the performance: With the
help of ratio analysis a company may have comparative study of its
performance to the previous years. In this way company comes to
know about its weak point and be able to improve them.
 To simplify the accounting information: Accounting ratios are
very useful as they briefly summarize the result of detailed and
complicated computations.
 To workout the operating efficiency: Ratio analysis helps to
workout the operating efficiency of the company with the help of
various turnover ratios. All turnover ratios are worked out to
evaluate the performance of the business in utilizing the resources.
 To workout short-term financial position: Ratio analysis helps to
workout the short-term financial position of the company with the
help of liquidity ratios. In case short-term financial position is not
healthy efforts are made to improve it.
 Helpful for forecasting purposes: Accounting ratios indicate the
trend of the business. The trend is useful for estimating future.
With the help of previous years’ ratios, estimates for future can be
made. In this way these ratios provide the basis for preparing
budgets and also determine future line of action.
3.7 Limitations of Ratio Analysis
In spite of many advantages, there are certain limitations of the ratio
analysis techniques and they should be kept in mind while using them in
interpreting financial statements. If ratio analysis conducted in a
mechanical, unthinking manager it would be dangerous.
45
The following are the main limitations of accounting ratios:(Daniel,1989)
Limited Comparability: Different firms apply different accounting
policies. Therefore the ratio of one firm cannot always be compared with
the ratio of other firm. Some firms may value the closing stock on LIFO
basis while some other firms may value on FIFO basis. Similarly there
may be difference in providing depreciation of fixed assets or certain of
provision for doubtful debts etc.
 False Results: Accounting ratios are based on data drawn from
accounting records. In case that data is correct, then only the ratios
will be correct. Therefore the data must be absolutely correct.
 Effect of Price Level Changes: Price level changes often make the
comparison of figures difficult over a period of time. Changes in
price affect the cost of production, sales and also the value of
assets. Therefore, it is necessary to make proper adjustment for
price-level changes before any comparison.
 Qualitative Factors Are Ignored: Ratio analysis is a technique of
quantitative analysis and thus, ignores qualitative factors, which
may be important in decision making. For example, average
collection period may be equal to standard credit period, but some
debtors may be in the list of doubtful debts, which is not disclosed
by ratio analysis.
 Costly Technique: Ratio analysis is a costly technique and can be
used by big business houses. Small business units are not able to
afford it.
 Misleading Results: In the absence of absolute data, the result may
be misleading. For example, the gross profit of two firms is 25%.
Whereas the profit earned by one is just $ 5,000 and sales are $
20,000 and profit earned by the other one is $ 10,000 and sales is $
40,000. Even the profitability of the two firms is same but the
magnitude of their business is quite different.
 Absence of Standard Universal Accepted Terminology: There
are no standard ratios, which are universally accepted for
comparison purposes. As such, the significance of ratio analysis
technique is reduced.
46
3.8 Summary
The main points in this chapter may be summarized as follows:
Ratio analysis
 Ratios compare two related figures, usually both from the same set
of financial statements.
 Ratios are an aid to understanding what the financial statements
portray.
 Past analysis is an inexact science and so results must be
interpreted cautiously.
 Past periods. The performance of similar businesses and planned
performance are often used to provide benchmark ratios.
A brief overview of the financial statements can often provide insights
that may not be revealed by ratios and/or may help in the interpretation of
them.
Liquidity ratio – concerned with the ability to meet short-term
obligations
 Current ratio.
 Acid test ratio.
 Working capital ratio.
Efficiency ratio – concerned with efficiency of using assets/resources
 Average stock (inventory) turnover period.
 Average settlement period for debtors (receivables).
 Average settlement period for creditors (payables).
 Sales revenue to capital employed.
 Sales revenue per employee.
Investment ratios – concerned with returns to shareholders
 Dividend payout ratio.
 Dividend yield ratio.
 Earnings per share.
 Price/earnings ratio.
Profitability ratios – concerned with effectiveness at generating profit
 Return on ordinary shareholders' funds (ROSF).
 Return on capital employed (ROCE).
 Net profit margin.
47
 Gross profit margin.
Chapter-4-
48
Applied
Study
49
4.1 Introduction
In this chapter we will take Palestinian Communications Company as a
case study for my research, and we will use its 2009 to 2010 financial
statements in calculating the key ratios to get a deeper understanding for
our topic.
4.2 Key Steps in Financial Ratio Analysis
When undertaking ratio analysis, analysts follow a sequence of steps:
The first step involves identifying the key indicators and relationships
that require examination. In carrying out this step, the analyst must be
clear who the target users are and why they need the information. We saw
earlier that different types of users of financial information are likely to
have different information needs that will, in turn, determine the ratios
that they find useful.
The next step in the process is to calculate ratios that are considered
appropriate for the particular users and the purpose for which they require
the information.
The final step is interpretation and evaluation of the ratios. Interpretation
involves examining the ratios in conjunction with an appropriate basis for
comparison and any other information that may be relevant.
The significance of the ratios calculated can then be established.
Evaluation involves forming a judgment concerning the value of the
information uncovered in the calculation and interpretation of the ratios.
Whereas calculation is usually straightforward, and can be easily carried
out by computer, the interpretation and evaluation are more difficult and
often require high levels of skill. This skill can only really be acquired
through much practice. The three steps described are shown in Figure 4.1.
50
Now we will take a quick view for the Palestine Telecommunications
Company which is our research’s case study.
4.3 Palestinian Telecommunications Company
4.3.1 Corporate Information
Palestine Telecommunications Company P.L.C. (PALTEL) is a limited
liability public shareholding company registered and incorporated in
Nablus - Palestine on August 2, 1995. PALTEL commenced operations
on January 1, 1997. PALTEL operates under the Telecommunication Law
No. (3) of 1996 decreed by the Palestinian National Authority (PNA).
PALTEL is engaged in providing, managing, and rendering wire line and
wireless services.
The consolidated
financialstatementsofPalestineTelecommunicationsCompanyP.L.C.forthe
yearended December 31, 2009 was authorized for issuance in accordance
with a resolution of the Board of Directors on March 10, 2010.()
4.3.2 PalTel Group
The People. The Companies. The Principles.
"Goodwill begets goodwill and success will always breed success.
responsibility.
Sabih Masri, Chairman, of PalTel Group.
51
4.3.3 The Mission
Maximizing shareholder value with perpetual growth and enriching
Palestine's information communication technology sector with a
commitment to excellence and with continues commitment to major
society social issues.
4.3.4 The Promise
Perpetual Growth in Palestine.
4.3.5 The Vision
Technology is a tool for both human resource development and nation
building. The future holds opportunities that will evolve with the
convergence of Information technology and communications.
The opportunities intertwined with the convergence trend will
exponentially grow. The foremost challenge is utilizing those
opportunities with a certain, solid discipline that is based on the scientific
thinking process and good governance.
4.3.6 The Methodology
We firmly believe that good governance leads to increase in shareholder
equity. Ethics and profits are never mutually exclusive.
From our vision and Mission stems our overall methodology.
We base our methodology on six pillars following pillars:
I. Creating national partnerships in Palestine based on win/win
scenarios.
II. Our people are unique and well-trained. The career paths of our
professionals are as important as any item on our balance sheet.
III. Customers are interested in tangible, convenient and high value
products of technology (and not technology per say). It is true that
technology provides opportunities for growth. But, at each level of the
value chain, players are demanding higher levels of efficiency, better
quality and lower prices. Therefore, our teams will focus on the
continuous improvement of a seamless process that introduces high
quality products and services that are developed from technological
improvements.
IV. We Think. We develop our thoughts with creative techniques and a
culture of excellence.
52
V. Corporate Social Responsibility endeavors are not a mere obligation.
They are a cherished responsibility. Our people will contribute and
we will work side by side with the Palestinian authority institutions,
local communities to all social development aspects in Palestinian
cities, villages and communities.
VI. Fair competition is always healthy and continually beneficial on both
the micro and the macro levels. Our teams will enhance and improve
our overall levels to improve our ability to compete. Our teams
enhance our companies' competitiveness by realizing plans and ideas
that improve our economies of scale.
4.3.7 What Can PalTel Group Do For You?
PalTel Group is built on a tradition of success and a convention of
continuous improvements. We never stop developing our people, our
products and our procedures and plans. The PalTel Group people,
nationwide, are committed and dedicated to serve our customers. They
are committed to creative thinking that produces ideas that spawn, new
services, new products and new Palestinian companies.
As a shareholder and/or customer, expect clear and transparent
professional procedures when dealing with any of our teams on both the
demand side and the supply side.
We value the investment (large and small) of all our shareholders and we
are committed to offer the highest returns, every month of every year.
We value each customer and we are dedicated to serve and honor his/her
needs and demands.
We value the social life, environment, health and safety of our
communities. Moreover we are devoted to enhance and improve the state
of our nation...Palestine.
4.4 Financial Ratios Analysis
Now we will analyze the financial statements of the Palestine
Telecommunications Company (PALTEL) for the year 2010 and 2009,
using financial ratios analysis.
Figure 4.2 shows the Income Statement for this company, and Figure 4.3
shows the Balance Sheet for the same company which we will use them
in our analysis.
Figure 4.2
Palestine Telecommunications Company P.L.C
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Consolidated income statement
For the year ended December 31, 2010
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Figure 4.3
1.4.1 profitability ratios
The following ratios may be used to evaluate the profitability of the
business:
 Return on ordinary shareholder's funds.
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 Return on capital employed.
 Net profit margin.
 Gross profit margin.
We now look at each of these in turn.
Return on ordinary shareholders' funds (ROSF)
The ratio is as follows:
From the balance sheet of the company we can notice that there are three
types of reserves which are: statutory reserve, voluntary reserve, and
special reserve, so the total reserves will be the sum of these three
reserves.
Total reserves for 2009 = 32,906 + 6,756 + 7,950 = JD 47,612
Total reserves for 2010 = 32,906 + 6,756 + 7,950 = JD 47,612
The ROSF for 2009 is:
70,335
ROSF 
 100%  78.4%
(131,625  47,612) / 2
The ROSF for 2010 is:
86,336
ROSF 
 100%  96.34 %
(131,625  47,612) / 2
The total of the shareholder's funds for the year 2009 was JD 131,625. By
a year later, however, it had still the same equaled to JD 131,625,
according to the balance sheet as at 31 December 2010.
Return on capital employed (ROCE)
The ratio is expressed in percentage terms and is as follows:
ROCE for 2009 is:
ROCE for 2010 is:
ROCE =
90,491
 100%  42.15%
131,625 + 47,612 + 35,450
ROCE is considered by many to be a primary measure of profitability. It
compares inputs (capital invested) with outputs (profit). This comparison
is vital in assessing the effectiveness .
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Net profit margin
The ratio is expressed as follows:
Net profit margin for 2009 is:
Net profit margin for 2010 is:
Net profit margin =
90,491
 100%  26.62%
339,929
A good performance compared with that of 2009. Whereas in 2009 for
every JD 1 of sales revenue and average of 22.3 (that is, 22.3 %) was left
as profit, after paying other expenses of operating the business, for 2010
this had increased to 26.62 for every JD 1.
Gross profit margin
The gross profit margin ratio is calculated as follows:
Gross profit margin for 2009 is:
Gross profit margin for 2010 is:
Gross profit margin 
261,071
 100%  76.8%
339,929
The increase in this ratio means that gross profit was higher relative to
sales revenue in 2010 than it had been in 2009. Bearing in mind that:
Gross profit = sales revenue – cost of sales (or cost of goods sold)
This means that cost of sales was lower relative to sales revenue in 2010,
than in 2009.
This could means that sales prices were higher and the purchase cost of
goods sold had decreased. It is possible that both sales prices and goods
sold prices had increased, but the former at a greater rate than the latter.
Similarly, they may both have increased, but with sales prices having
increased at a higher rate than costs of the goods sold.
The analyst must now carry out some investigation to discover what
caused the increases in both cost of sales and operating costs, relative to
sales revenue, from 2009 to 2010. This will involve checking on what has
happened with sales and stock prices over the two years. Similarly, it will
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involve looking at each of the individual expenses that make up operating
costs to discover which ones were responsible for the increase, relative to
sales revenue.
4.4.2 Efficiency Ratios
The following ratios are considered as efficiency ratios:
 Average settlement period for debtors (receivables).
 Sales revenue to capital employed.
Average settlement period for debtors
This ratio is as follows:
Average settlement period for debtors =
Trade debtors
 365
credit sales revenue
Average settlement period for debtors for 2009 is:
Average settlement period for debtors =
63,313
 365  73.3 days
315,092
Average settlement period for debtors for 2010 is:
Average settlement period for debtors =
69,642
 365  74.78 days
339,929
This increase in the average settlement period is not welcome. It means
that more cash was tied up in debtors for each JD 1 of sales revenues in
2010 than in 2009.
Sales revenue to capital employed
This ratio is calculated as follows:
Sales revenue to capital employed =
Sales revenue
Share capital + Reserves + Long - term (non - current) loans
Sales revenue to capital employed for 2009 is:
Sales revenue to capital employed =
315,092
 1.3 times
131,625 + 47,612 + 51,360
Sales revenue to capital employed for 2010 is:
Sales revenue to capital employed =
339,929
 1.58 times
131,625 + 47,612 + 35,450
This seems to be an improvement, since in 2010 more sales revenue was
being generated for JD 1 of capital employed (1.58) than the case in 2009
(1.3).
Generally speaking, higher sales revenue to capital employed ratio is
preferred to a lower one. A higher ratio will normally suggest that the
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long-term capital invested in assets is being used more productively in the
generation of revenue.
4.4.3 Liquidity Ratios
The following ratios are widely used:
 Current ratio.
 Acid test ratio.
 Working capital ratio.
Current ratio
The ratio is calculated as follows:
Current ratio =
Current assets
Current liabilitie s
The current ratio for 2009 is:
Current ratio =
184,110
 1.7 times
107,807
The current ratio for 2010 is:
Current ratio =
213,260
 2.15 times
98,972
Though this is an increase from 2009 to 2010, it is not necessarily a
matter of concern.
Acid test ratio
The acid test ratio is calculated as follows:
Acid test ratio =
Current assets (excluding stock)
Current liabilitie s
Acid test ratio for 2009 is:
Acid test ratio =
184,110  11271
 1.6 times
107,807
The acid test ratio for 2010 is:
Acid test ratio =
213,260  8,926
 2.06 times
98,972
Working Capital Ratio
It is calculated as shown below:
Working Capital  Total Current Assets - Total Current Liabilities
Working Capital for 2009 is:
Working Capital = 184,110 – 107,807 = 76,303
Working Capital for 2010 is:
Working Capital = 213,260 – 98,972 = 87,767
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4.4.5 Investment Ratios
There are various ratios available that are designed to help investors
assess the returns on their investment. The following are widely used:
 Dividend payout ratio.
 Earnings per share.
Dividend payout ratio
The ratio is calculated as follows:
Dividend payout ratio =
Dividends announced for the year
 100%
Earnings for the year available for dividends
The dividend payout ratio for 2009 is:
Dividend payout ratio =
32,906
 100%  36.8%
89,180
The dividend payout ratio for 2010 is:
Dividend payout ratio =
52,650
 100%  74.8%
70,335
This would normally be considered to be a very alarming decline in the
ratio. Paying a dividend of JD 52,650 in 2009 would probably be
regarded as very important.
Earnings per share
This ratio is calculated as follows:
Earnings per share =
Earnings available to ordinary shareholde rs
Number of ordinary shares in issue
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The earnings per share for the year ended 31 December 2009 is as
follows:
EPS 
70,335
 0.534
131,625
The earnings per share for the year ended 31 December 2010 is as
follows:
EPS 
86,336
 0.655
131,625
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Chapter-5-
62
Conclusion
&
Recommenda
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5.1 CONCLUSION
The financial statements are windows into a company's performance and
health. Analysis and interpretation of financial statements is an important
tool in assessing company’s performance. It reveals the strengths and
weaknesses of a firm. It helps the clients to decide in which firm the risk
is less or in which one they should invest so that maximum benefit can be
earned. It is known that investing in any company involves a lot of risk.
So before putting up money in any company one must have thorough
knowledge about its past records and performances. Based on the data
available the trend of the company can be predicted in near future.
This project mainly focuses on the financial ratios analysis as a
method of analyzing the financial statements. Often firms make their
financial data available to the public to show workers and investors how
well the company is doing. For private firms, statement analysis and
industry comparisons are done for internal use. A few simple ratio
calculations can shed light on how well a company is doing and how it is
making profits. Those same ratio calculations are done by lenders on
personal financial data when individuals apply for a mortgage or an auto
loan.
When you are analyzing a financial statement, it is best to reduce
amount comparisons to percentages or ratios so that you have an easy
way to judge those comparisons. And if you compare those ratio results
with what you know to be good, fair or bad, you have a way of
determining the health of a business.Simply put, ratio analysis is
changing amount comparisons to ratios and then comparing those ratios
to a known standard.
Everyone in the business of analyzing financial statements has a
few favorite ratios they utilize when determining the strengths or
weaknesses of a specific financial statement. The ratios that are used
could change depending upon the industry the business is in, the size of
the business, the accounting method that is used by the business and the
amount of the credit desired and how healthy the company is.
From ratio analysis of Balance Sheet and P & L Statement of
Palestine Telecommunications Company of 2009-2010 it was concluded
that liquidity position of the company is good, current ratio, quick ratio,
and working capital were found to be acceptable.
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Short term liquidity position of Palestine Telecommunications
Company was good in 2009 and 2010. However, current ratio, quick
ratio, return on ordinary shareholder's funds ratio, return on capital
employed ratio, net profit margin ratio, gross profit margin ratio, sales
revenue to capital employed ratio, and earnings per share for the year
2010 were satisfactory compared with the year 2009.
The ratios that were found to be unsatisfactory are average
settlement period ratio.
5.2 RECCOMMENDATIONS
 Palestine Telecommunications Company needs to reduce its sales
prices and goods sold prices.
 The company should increase its “profit before interest and
taxation” to get a good return on its shareholders' funds and its
capital employed.
 The company also should generate more profits before interest and
taxation to get good net profit margin ratio.
 It will be very good if the company tried to decline the average
settlement period for debtors more and more.
 The company should use its long-term capital invested in assets
more productively in the generation of revenue.
 The company should keep or even increase its liquid current assets
to cover its current liabilities all the time, and that will protect the
company from experiencing some liquidity problems.
 The company should increase its earnings per share more and
more, because this will be very good.
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