Company Financial
Analysis Made Simple
Ratios, GAAP, King IV and audit opinions - explained clearly so you can walk into your test with confidence.
✋ Read this first: Every exam question on financial analysis wants the same thing - State the figures, explain what they mean, and give advice. That's it.
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Book Now →Think of a company like a person going for a medical check-up. The doctor checks different things: heart rate, blood pressure, weight, cholesterol, stress levels. Each one tells a different story about health. Ratios do exactly the same for a company - five different "health checks," each measuring something different.
| Group | What it measures | Key question it answers |
|---|---|---|
| Profitability | How much profit the company makes relative to sales | Is the company making enough money from what it sells? |
| Return | What investors and shareholders actually earn | Is it worth investing in or lending money to this company? |
| Liquidity | Can the company pay its short-term debts (within 12 months)? | Will the company run out of cash before the year is out? |
| Asset Efficiency | How fast stock moves, how fast debtors pay, how fast we pay creditors | Is working capital being managed well or is cash getting stuck? |
| Solvency & Gearing | Long-term survival - can the company survive if things go wrong? | Is the company dangerously dependent on borrowed money? |
Ratios only mean something when you compare them - to the previous year, to a benchmark, or to the industry. A current ratio of 1.8:1 means nothing on its own. Is it better or worse than last year? Is it above or below the 2:1 benchmark? That's the analysis.
Imagine a tuck shop. You sell a R10 pie. The pie cost you R6 to buy (gross profit = R4). But then you pay R2 in rent and salaries (operating profit = R2). Then R0.50 in loan interest (net profit = R1.50). Each step of the income statement peels away another layer of cost. Profitability ratios measure what is left at each layer.
Sales → Gross Profit → Operating Profit → Net Profit. Each step isolates a different problem area. Always work from the top down.
Is Gross Profit on Sales falling?
Problem is in Cost of Sales: supplier prices increased, selling prices cut to compete, stock stolen or damaged, or inventory valuation method changed.
GP stable but Operating Profit falling?
Problem is in Operating Expenses: salaries, rent, advertising, or depreciation is rising faster than revenue growth.
Operating Profit stable but Net Profit falling?
Problem is below the operating line: interest expense rising (more loans taken out) or a higher tax rate.
Key Profitability Formulas
Measures pricing strategy and cost of buying stock
Measures overhead control - if this rises, management is losing control of costs
The bottom line - what's actually left for shareholders after everything
Return Ratios - What investors care about
How much the shareholders earned on their investment. Compare to bank interest rate - if ROE is lower than what they could earn in a savings account, why invest?
How efficiently ALL the money in the business (shareholders + lenders) is being used. Capital Employed = Shareholders' Equity + Non-Current Liabilities.
Compare ROCE to the borrowing interest rate. If ROCE > borrowing rate = POSITIVE gearing (borrowing is working in your favour). If ROCE < borrowing rate = NEGATIVE gearing (the debt is costing more than it earns - dangerous).
Liquidity = can you pay your rent and groceries THIS month? Solvency = do you own more than you owe in total? You can be solvent (own a house worth R2m with a R1m bond) but illiquid (no cash to pay the monthly instalment). Companies can fail from illiquidity even if they are technically solvent.
Current Ratio
Ideal. Minimum acceptable: 1.5:1. Below 1:1 means current liabilities exceed assets - danger.
Acid-Test Ratio
Below 0.75:1 is a warning. Below 0.5:1 triggers going-concern risk.
Net Working Capital
Must be positive. Current Assets must exceed Current Liabilities.
Solvency Ratio
Total Assets should be at least double Total Liabilities. Below 1:1 means insolvent.
The formulas
Includes ALL current assets including stock. Expressed as a ratio e.g. 2.3:1
Removes stock because stock is not instantly cash. This is the stricter test.
Long-term survival. At least 2:1 - assets must be double liabilities.
Above 1:1 = highly geared (risky). Below 1:1 = low geared (safer). More debt than equity means the company is heavily dependent on lenders.
A company might delay repaying a short-term loan by one day past year-end to make the Current Ratio look better on the balance sheet date. This is called window dressing - it violates the Ethical Culture requirement of King IV and the Prudence principle of GAAP. Examiners love testing this.
Imagine you buy stock, sell it on credit, wait to get paid, then use that cash to pay your supplier. The faster each step happens, the healthier your cash flow. If your stock sits on the shelf for 90 days, customers take 60 days to pay, but your supplier wants money in 30 days - you have a serious cash problem even if the business is profitable.
The Working Capital Cycle - Know this rule
| Ratio | Formula | What it tells you |
|---|---|---|
| Stock Turnover Rate | Cost of Sales / Average Inventories | How many times stock is sold and replaced in a year. Higher = faster moving stock. |
| Days Stock on Hand | (Average Inventories / Cost of Sales) x 365 | How long stock sits before being sold. Lower = better. |
| Debtors Collection Period | (Average Debtors / Credit Sales) x 365 | How many days customers take to pay. Lower = better cash flow. |
| Creditors Payment Period | (Average Creditors / Credit Purchases) x 365 | How many days we take to pay suppliers. Should be HIGHER than debtors period. |
If the Debtors Collection Period gets longer, cash is stuck waiting to come in. This directly REDUCES the Acid-Test Ratio because there is less available cash to pay current liabilities. Always connect these two ratios when one changes - examiners give marks for making that link.
You own shares in a company. Every year you want to know: how much did my share earn (EPS), how much did they pay me in cash (DPS), and what would I get if the company shut down today (NAV)? Then you compare all of this to what the share costs to buy on the JSE (market price). That comparison tells you if the share is cheap, fair, or overpriced.
The Three Core Share Metrics (all expressed in CENTS)
The profit earned per share. If EPS drops, the company is becoming less profitable per share - investors will sell, pushing the JSE share price down.
The cash actually paid to shareholders. Compare EPS to DPS: if EPS is 400c and DPS is 100c, the company pays out 25% and retains 75% to reinvest in the business.
The book value of each share if the company wound up today. It's the floor value of the share.
| Comparison | What it means | What to say in the exam |
|---|---|---|
| Market Price > NAV | Investors are paying more than book value | Investors have confidence in the company's future growth and are willing to pay a premium. Positive signal. |
| Market Price < NAV | Shares trade below book value | Major warning sign. The market believes the assets are overvalued or the company has poor prospects. Investor confidence is low. |
| EPS rising, DPS falling | Company earning more but paying less out | Company is retaining more profit to fund expansion. Not necessarily bad but shareholders receive less cash income. |
| Both EPS and DPS falling | Earnings and dividends both declining | Investor confidence will erode. Expect selling pressure and a falling JSE share price. |
When a company buys back its own shares, it needs either Board authorisation or a special shareholder resolution. Auditors verify this with a Securities Transfer Form (CM42), JSE Broker Notes, and bank statements showing the payment went out.
GAAP principles are the rules of the game - everyone must follow them when preparing financial statements. The auditor is the referee who checks if the rules were followed. King IV is a code of conduct for the directors - it says how they should behave, not just what numbers to report.
Matching (Accrual)
Income and expenses belong in the year they are earned or incurred - regardless of when cash moves.
Prudence
Be conservative. Do not overstate assets or income. Do not understate liabilities or expenses.
Consistency
Use the same accounting methods every year so results are comparable.
Going Concern
Assume the business will continue operating for the next 12 months.
Historical Cost
Record assets at what they originally cost, not current market value.
Business Entity
The company's finances must be completely separate from the owner's personal finances.
Full Disclosure
Disclose all information that could affect the decisions of people using the financial statements.
Materiality
Only disclose information significant enough to influence a reasonable user's decision.
✓ Unqualified (Clean)
Financial statements present a fair and accurate picture. Everything is in order. This is what you want.
⚠ Qualified
A specific problem was found but it is not widespread. Statements are mostly reliable EXCEPT for the stated issue (e.g. stock could not be verified).
✗ Adverse
The misstatements are so serious and widespread that the financial statements do not present a fair picture at all. Catastrophic for investor confidence.
— Disclaimer
The auditor cannot form any opinion because there is not enough evidence available to audit. Usually means records are missing or inaccessible.
When a ratio looks suspiciously good, ask which GAAP principle could have been violated to make it look that way. If Gross Profit % jumped suddenly, could stock have been overstated (Prudence)? If Operating Expenses % dropped sharply, could invoices have been delayed past year-end (Matching)? Connect the numbers to the rules.
Every financial analysis question in the exam wants the same three things: the numbers, the explanation, and the advice. Miss any one of these and you leave marks on the table. Structure every answer the same way.
State Figures & Trend
Name the ratio. Give the actual numbers for BOTH years. State clearly: improved, deteriorated, or stable.
Explain the Connections
What caused this movement? How does it link to another ratio? Compare to the benchmark (2:1, 1:1 etc). Reference GAAP or King IV if relevant.
Give Practical Advice
What should management DO about this? Link your advice to specific internal controls or governance actions.
Step 1: The Current Ratio deteriorated from 2.4:1 in 2024 to 1.6:1 in 2025, falling closer to the minimum acceptable level of 1.5:1.
Step 2: This decline was driven by a lengthening Debtors Collection Period from 38 days to 57 days, meaning cash is taking longer to come in while current liabilities remain constant. The company is failing to collect from its debtors efficiently, draining the available liquid assets.
Step 3: Management should implement stricter credit vetting before granting credit to new customers, introduce automated monthly debtor statements, and apply interest penalties and credit freezes to accounts overdue beyond 30 days.
Phrases that earn marks in analysis questions
They calculate the ratio correctly but then write "the ratio has decreased" without explaining WHY or WHAT it means. The calculation is worth 1 mark. The interpretation is worth 3-5 marks. Always explain the story behind the number.
Quick Reference
Benchmarks to Memorise
Current Ratio
2:1 ideal
Min 1.5:1
Acid-Test
1:1 ideal
Warning <0.75:1
Solvency
2:1 ideal
Below 1:1 = insolvent
Gearing
<1:1 safer
Above 1:1 = high risk
Gearing Rule
ROCE > rate
= positive gearing
Working Capital
Debtors < Creditors
Collect before paying
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