Financial Statement Analysis

Rationale of Financial Statement Analysis Financial statement – summary of

figures as of any given date To identify relevant information Draw meaningful interpretations

Process of Analysis

Identification of significant information

Highlight significant relationships Interpretation

Tools of Financial Analysis

Fund flow Statement Cash Flow Statement Ratio Analysis Common size statements

Balance Sheet Overview-ASSETSAssets

Gross Block 3978.55

Net Block 2790.57

Capital WIP 66.72

Investments 454.33

Inventory 610.81

Receivables 1546.81

Other Current Assets 3673.67

Balance Sheet Total 9142.92

Balance Sheet Overview-LiabilitiesLiabilities

Equity Share Capital 434.12

Reserves 5815.65

Total Debt 2096.69

Creditors and Acceptances 393.91

Other current liab/prov. 402.55

Balance Sheet Total 9142.92

Ratio Analysis

Most widely used and significant tool Provides a basis for comparison Useful when benchmark ratios are

known Relationships between variables in

the financial statement

Types of ratios

Liquidity ratios Capital Structure ratios Profitability Ratios Activity/Efficiency ratios Integrated Analysis of ratios Growth ratios

Overview of Balance Sheet

LIABILITIES Equity

Capital/Owners’ Funds

Long Term Borrowings

Current Liabilities

ASSETS Fixed Assets Current Assets

Liquidity Ratios

Measure the ability of firm to meet short term obligations

Reflect short term financial strength Why short term??- of interest to

creditors.. Ratios- Current ratio, Liquid ratio,

Turnover ratios, cash flow from operation ratio

Liquidity ratios

Current Ratio= Current Assets/ Current Liabilities

Liquid ratio= Liquid Assets/Current Liabilities

NEED FOR LIQUIDITY

Assume stocks are bought on credit Converted to inventory Sales=0 Current Ratio?? Liquid Ratio?? Implications on liquidity-serious

ACTIVITY 1 Calculate Current Ratio, Liquid ratio,

Debtors Turnover and Creditors turnover from the following information

Average Debtors=1,00,000 Average Creditors=75,000 Cash= 5,000 Inventory=75,000 Credit Purchases=6,00,000 Credit Sales=12,00,000

Capital Structure ratios

Helps to measure long term financial strength

Solvency of the firm Ability to service interest on loans Ability to service the principal

Capital Structure Ratios

Debt Equity ratio= Long Term Debt/Shareholders Equity

Debt to total Capital= Total Debt/Total Assets

Interest Coverage Ratio= Earnings Before Interest and Tax/Interest

ACTIVITY 2

What happens when a firm is purely funded by equity?

What happens when a firm is purely funded by debt?

Which is riskier when profits are less? When equity is high and profits are

high, what happens to ROI?

Profitability ratios

Related to Sales Ability of the firm to mark up on sales Ability of firm to convert margins to

profit Proportion of expense to income Analysis of income and expenses

Profitability ratios

Gross Profit Margin= Gross profit/Sales*100

Operating Profit ratio= Earnings Before Interest and taxes/Net Sales

Net Profit Ratio= Earnings after interest and taxes/Net Sales

Expenses ratio- Cost of Goods sold, Operating Ratio, Financial Expenses

Ratios on Investments

Related to investment Ability to generate return on

investment Ultimate measure of profitability Ability of firm to generate wealth

Profitability on Investment

Return on Assets= Profit after Taxes/Average total assets*100

Return on Capital Employed= EBIT/Average Total Capital Employed*100

Return on Shareholders Equity= Net profit after taxes/Average

shareholders’ equity*100

ACTIVITY 3

Earnings Before Interest and Tax= Rs.5,00,000

Interest payment =Rs.75,000 Tax rate = 50% Calculate Earnings after Interest and

tax

Profitability on investment

Earnings per share=Net Profit available to Equity Shareholders/Number of ordinary shares outstanding

Price earning ratio= Market price of share/EPS

ACTIVITY 4

Calculate Gross Profit Margin and Net profit Margin

Sales 2,00,000 Cost of Goods Sold 1,00,000 Other operating expenses 50,000

ACTIVITY 5

Calculate Return on Assets Current Assets 4,00,000 Fixed Assets 6,00,000 Net Profit before taxes 2,50,000 Tax rate 50%

Activity Ratios

Concerned with measuring the efficiency

Also the asset utilisation Rate at which assets are converted

into sales Test of relationship of sales to various

assets of the firm

Activity Ratios Turnover ratios Inventory turnover=Cost of Goods

Sold/Average Inventory Debtors turnover=Net Credit

Sales/Average Debtors Creditors turnover=Net Credit

Purchases/Average creditors Assets Turnover=Cost of Goods

sold/Average total assets

Activity ratios

Turnover refers to the number of times the asset turned over

Does faster turnover mean efficiency? What does a slow turnover of

inventory mean? Should inventory turnover be

homogenous across industries?

ACTIVITY 6

In which industries inventory turnover is irrelevant?

Which industries have seasonal turnover of inventory?

Which are the industries where turnover is not rapid?

When will the Debtor Turnover be irrelevant?

Integrated Analysis of ratios

To understand the interrelationship of ratios

Operating efficiency-combination of various factors

Tests the earning power of the firm

Integrated Analysis

Earning Power= EAT/Sales*Sales/Assets*Assets/Equity

Growth ratios Growth that can be sustained without

external funding Earnings that are retained and

reinvested within the firm The two common measures used are

Internal Growth rate-without raising funds

Sustainable growth rate- Without altering Debt Equity ratio

ACTIVITY 7 Which ratios will you look for when

you want to invest in a firm Which are the ratios a banker will look

for? Which ratios are relevant from the

point of view of revenue? Which ratios are relevant if a supplier

is contemplating to give credit to a firm?

What you must remember while calculating ratios

Nature of Industry-Service, Seasonal, Heavy Engineering, Infrastructure..

Age of the firm Industry benchmark Peculiarities in the business Risk Factors

Importance of ratio Anlaysis

Liquidity Solvency Operating efficiency Overall Profitability Interfirm Comparison Trend Analysis

Limitations of ratio Analysis

Individual accounting variations Impact of inflation Conceptual diversity Only quantifiable inputs can be

evaluated