1. Financial Statement Analysis

2. Rationale of Financial Statement
Analysis
 Financial statement – summary of
figures as of any given date
 To identify relevant information
 Draw meaningful interpretations

3. Process of Analysis
 Identification of significant
information
 Highlight significant relationships
 Interpretation

4. Tools of Financial Analysis
 Fund flow Statement
 Cash Flow Statement
 Ratio Analysis
 Common size statements

5. Balance Sheet Overview-
ASSETS
Assets
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

6. Balance Sheet Overview-
Liabilities
Liabilities
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

7. 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

8. Types of ratios
 Liquidity ratios
 Capital Structure ratios
 Profitability Ratios
 Activity/Efficiency ratios
 Integrated Analysis of ratios
 Growth ratios

9. Overview of Balance Sheet
LIABILITIES
 Equity
Capital/Owners’
Funds
 Long Term
Borrowings
 Current Liabilities
ASSETS
 Fixed Assets
 Current Assets

10. 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

11. Liquidity ratios
 Current Ratio= Current Assets/
Current Liabilities
 Liquid ratio= Liquid Assets/Current
Liabilities

12. NEED FOR LIQUIDITY
 Assume stocks are bought on credit
 Converted to inventory
 Sales=0
 Current Ratio??
 Liquid Ratio??
 Implications on liquidity-serious

13. 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

14. 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

15. 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

16. 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?

17. 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

18. 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

19. Ratios on Investments
 Related to investment
 Ability to generate return on
investment
 Ultimate measure of profitability
 Ability of firm to generate wealth

20. 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

21. 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

22. 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

23. 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

24. 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%

25. 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

26. 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

27. 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?

28. 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?

29. Integrated Analysis of ratios
 To understand the interrelationship of
ratios
 Operating efficiency-combination of
various factors
 Tests the earning power of the firm

30. Integrated Analysis
 Earning Power=
EAT/Sales*Sales/Assets*Assets/Equit
y

31. 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

32. 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?

33. 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

34. Importance of ratio Anlaysis
 Liquidity
 Solvency
 Operating efficiency
 Overall Profitability
 Interfirm Comparison
 Trend Analysis

35. Limitations of ratio Analysis
 Individual accounting variations
 Impact of inflation
 Conceptual diversity
 Only quantifiable inputs can be
evaluated