Financial Analysis
The Financial Analysis domain tests whether you can convert reported statements into a defensible view of profitability, liquidity, solvency and value for an entity reporting under IFRS as adopted by SECP and listed on the Pakistan Stock Exchange.
Core rules
- Ratios are only comparable when numerator and denominator share a period convention: state whether balance-sheet inputs are closing or average, and keep that choice across years and peers.
- Four families matter: profitability (gross, operating, net margin), efficiency (asset turnover, receivable and inventory days), leverage (debt/equity, net debt/EBITDA, interest cover), liquidity (current, quick, cash ratio).
- DuPont: ROE = net margin × asset turnover × equity multiplier; it shows whether returns come from pricing, volume or gearing.
- Earnings quality: CFO/net income at or above 1, low accruals, capex tracking depreciation, and no reliance on revaluation gains.
- Pakistan context: PKR depreciation lifts imported input costs and foreign-currency finance charges; SBP policy-rate moves pass into KIBOR-linked debt quickly; related-party balances under IAS 24 need scrutiny given common group structures.
Worked example
Sales PKR 1,200m, net income PKR 60m, total assets PKR 800m, equity PKR 400m.
Net margin = 60/1,200 = 5%; asset turnover = 1,200/800 = 1.5x; equity multiplier = 800/400 = 2.0x.
ROE = 5% × 1.5 × 2.0 = 15%, which ties to 60/400 = 15%.
Now the company borrows PKR 200m at 20% (KIBOR-linked) and holds it as cash: assets 1,000m, equity 400m, multiplier 2.5x.
Pretax interest is 40m; at a 29% corporate rate net income falls to 60 − 28.4 = 31.6m.
ROE becomes 31.6/400 = 7.9%, below the 15% unlevered return, because the 14.2% after-tax cost of debt exceeds the 7.5% return on assets.
Traps
The penalties: pairing year-end debt with a full year of interest when the borrowing was drawn mid-year; counting revaluation surplus as cash earnings; comparing EBITDA margins between a firm that capitalises borrowing costs under IAS 23 and one that expenses them; treating circular-debt receivables that never age out as liquid; and labelling a charge 'non-recurring' when it appears every year.