Financial Statements Analysis Techniques

Financial Statements Analysis Dr.Shilpa Vardia

Analysis of financial statement means the process of reviewing and evaluating a company's financial statements through some techniques.

Decision Makers and the Kind of Decisions

Techniques Of Financial Statements Analysis Horizontal ( or trend )Financial Analysis Vertical or (Common Size) Analysis Ratio Analysis

Horizontal ( or trend )Financial Analysis Also known as dynamic analysis the kind of analysis under which financial statements of a number of years of the firm are analyzed against o common base. This is also suitable for intra firm comparison.

Vertical Financial Analysis Is under which financial statements of firms of different size are compared and analyzed against a common base This is also suitable for inter firm comparison.

Ratio Analysis ` We use different techniques to evaluate it, and one very regular and common technique is financial ratios analysis Financialratiosanalysis. Generallyonlyratiois meantdividingonenumberby anothernumber. A financial ratios (or accounting ratios) is arelative magnitude of two selected numerical valuestaken from an Company s financialstatements. 7

These ratios are asunder: 1.LiquidityratiosorShorttermSolvencyratios 2. Debt management or Financial Leverageratios 3. EfficiencyorActivityorturnoverratios 4. Profitabilityratios 5. Market valueratios 8

1. LiquidityRatios: Liquidity ratios are the ratios that measure the ability of acompanytomeet itsonlyshorttermdebt. These ratios focus on current assets and current liabilities. Followingarethekeyratiosfall underthiscategory o CurrentRatio = CurrentAssets CurrentLiabilities oQuick Ratio= Current Assets Inventory PrepaidExpenses CurrentLiabilities 9

2. Debt managementor Financial Leverageratios Debt management or financial leverage ratios measure the ability of a company to meet it s over all financial obligations when they fall due. These ratios are asunder: o Total debt-to-Total Assetsratio = Total liabilities TotalAssets =Total equity TotalAssets Total Equity-to-Total assetsratio o = Earning before Interest &Taxes(EBIT) InterestExpenses Time InterestEarned o Long termdebt Total Capitalizationratio Long term debt to total capitalizationratio OR Gearing ratio = . *Where as, Total Capitalization = Long term debt +Total Equity 10

3. Efficiency or ActivityRatios: Theseratiosaretypicallyused inordertodetermine thathowquicklycertain assetsareconverted incashorsales. Similarly, italsoindicatesthat howquicklyaccounts payablearepaid. Following are the key ratios fall under thiscategory: o Accounts Receivables Turn overratio = NetCredit Sales AccountsReceivables o Period-in Days Average Collection = Days inayear Accounts Receivable TurnOver . Netsales o Total Assets Turn over ratio = . TotalAssets o AccountsPayables turn overratio = Net Creditpurchases . Accounts Payablesratio Continued on next page .. 11

o Average Payment period indays Days in ayear = . Accounts Payables TurnOver = o InventoryTurn Overratio Cost of goodsSold Inventory Days in ayear o AverageAgeof Inventoryindays = . Inventory TurnOver 12

4. ProfitabilityRatios: Profitability ratios focuson howwell a business is performing in termsof profit.Profitabilityratiosdescribethat howeffectively the firm is using itsAssets & control itsexpenses togeneratean acceptable rate ofreturn. Followingare the key ratios fall underthiscategory: o Gross profitMargin = Grossprofit NetSales o Operating ProfitMargin = Net Profit+interest NetSales o ProfitMargin = Net Profit NetSales . . Continued on nextpage . 13

= o ReturnonTotal Assets/investments NetIncome . Totalassets o Returnon CommonEquity = Net Income Preferred stockdividend CommonEquity = o Return on total Equity NetIncome TotalEquity 14

5. Market valueratios: Marketvalue ratiosevaluate theeconomicstatusof yourcompany in themarketplace. Following arethekeyratiosfallunderthiscategory: o EarningperShare = Net Income Preferred Stockdividend Common Stock outstanding (InNos) o Price Earningratio = Market price perShare Earning perShare Continued on next page. .. 15

= Total Stockholders Equity Preferredstock Common Stock outstanding (InNos) o Book value/Share o Dividend Yield = Dividend perShare . Market price perShare o Dividend payout =Dividend per common stock Share Earning per common stock Share[EPS] 16

Howtodrawafinal conclusionfromtheRatioanalysis: A meaningfulconclusionis needed finallyfromratioanalysis. Forexample: Isthisyeargoodorbad? Itis judged bythefollowing procedures: Trendanalysis - Itmeanscomparingallcurrentyear srelevantratios of the company with its own past years' ratios. Thus trend analysis determinesthefirm scurrentyearperformancewithpastyears. Comparingwithothersimilartypeof Industries-Market-It involvescomparingthefirm scurrentyear srelevantratioswithother similar type of Industries in themarket. Thusitdeterminesthefirm sperformancewithothercompetitor Benchmarking Itinvolvescomparingthefirm srelevantratioswith the world-classfirm Thusitdeterminesthefirm sperformancewiththeworldclassfirms. In this way the analyst is able to detect his final conclusion regarding the firm s improvement ordeclining during the current year/period throughabove. 17

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