FINANCIAL STATEMENT ANALYSIS

BY SYED MUHAMMAD IJAZ, FCA

AUGUST 03, 2007

TYPES OF RATIOS

• Liquidity Ratios

• Capital Structure/Leverage Ratios

• Profitability Ratios

• Activity Ratios

CURRENT RATIO

LiabilitesCurrent

AssetsCurrent RatioCurrent

• Where current assets represent the assets that can be converted into cash within a short period, conventionally with one year

• Like wise the current liabilities refer to liabilities the payment of which is to be made within 1 year

• This ratio represents the amount in Rs. Available in current assets to pay off the each Rupee of Current Liabilities

• This Ratio refers to the potential of the company to cover its current liabilities payments through its current assets.

• Greater the availability of current assets to cover current liabilities better it is

• There is no thumb rule to say what would be the best. However conventionally a current ratio of 2:1 is considered satisfactory.

Acid-Test or Quick Ratio

sLiabilitieCurrent

AssetsQuick Ratiotest Acid

• Where Quick assets refers to assets that on short notice can be converted into cash. Normally this means current assets-Stocks

• This ratio is a derived from current ratio and represents and more critical analysis

• Greater the companies ability to cover its current liabilities from Quick assets better it is

• Conventionally a ratio of 1:1 is considered satisfactory

Turnover Ratio-Inventory Turnover

Inventory Average

Sold Goods OfCost RatioTernover Inventory

• This is another form to check the liquidity position of the firm

• This ratio determines how quickly certain current assets e.g. as in above inventory transfers/converts itself into cash

• Turnovers are normally calculated with reference to Inventory, Debtors, Creditors etc.

• Greater the conversion rate better it is

• Now its clear from above that inventory rotates “X” times in a year so if we want to calculate number of days we held inventory or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.

Turnover Ratio-Debtors Turnover

Debtors Aveage

SalesCredit Net RatioTurnover Debtors

• This is another form to check the liquidity position of the firm• This ratio determines how quickly debtors are converted into cash• Greater the turnover better it is• Now its clear from above that debtor rotates “X” times in a year so if we want

to calculate number of days in which we Collect debtors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.

Creditors Turnover Ratio

Creditors Average

PurchasesCredit Net RatioTurnover Creditors

• This is another form to check the liquidity position of the firm• This ratio determines how quickly creditors are paid• Lesser the turnover better it is• Now its clear from above that creditor rotates “X” times in a year so

if we want to calculate number of days in which we pay creditors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.

Defensive-Interval Ratio

tRequiremenCash Daily Projected

Assets LiquidRatio IntervalDefensive

year ain days of No.

eexpenditur operatingcash ProjectedCashDaily Projected

• This ratio represents the ability of the firm to meet its daily future cash requirement through its liquid assets

• More the ability to meet expenditure better it is

Leverages-Debt-Equity Ratio

Equity) rs'Shareholdedebt (Total

Debt TotalRatio D/E

• This ratio is meant to disclose the structure of the capital

• Normally banks and financers use this ratio as the State Bank has bench marked the maximum debt equity ratio to 80:20 (i.e. 80% Debt+20% equity) maximum allowed debt structure

• Normally external debt is considered less expensive than the equity

• This ratio can be subdivided into many other ratios like Debt to Owners equity, Owners equity to total Capital etc.

Leverages-Interest Coverage Ratio

Interest

EBITCoverageInterest

• Where EBIT represents earnings/profit before interest and tax

• This ratio represents the earnings/profit available against each rupee of interest i.e. for payment of each rupee of interest how many rupees of profit are available

• Potent the ratio better it is

Dividend Coverage Ratio

Dividend Preference

EATCoverage Dividend

• Where EAT represents earnings/profit after tax or earnings available to shareholders

• This ratio represents the earnings/profit available against each rupee of preference dividend i.e. for payment of each rupee of preference dividend how many rupees of profit are available

• Potent the ratio better it is

Total Coverage Ratio

t)-(1 / principal) of Instalment dividend e(Preferenc Payments LeaseInterest

Payment Lease EBITCoverage Total

t)-(1

dividend) (

t)-(1

repayment) (principalInterestpayment Lease

Expensescash -NononDepreciatipayments LeaseEBITcoverage flowcash Total

preference

• Former ratio represents the firms ability to pay all the fixed obligations

• Later ratio represents the ability of firm to pay all external liabilities from available cash sources

• In both cases higher the coverage better it is

Profitability Ratio

• Represented as a %age to Sales• Greater the margin/%age better it is

100 Sales

Profit GrossMarginprofit Gross x

100 Sales

ProfitNet Marginprofit Net x

Profitability-Expenses Ratio

100SlaesNet

Sold Goods ofCost Ratio Sold Goods ofCost

NetSalesExpenses SellingExpenses iveAdminisratRatio Expenses Operating

100SalesNet

Expenses SellingRatio Expenses Selling

100NetSlaes

Expenses tiveAdministraRatio Expenses tiveAdministra

Profitability-Expenses Ratio-Continued

100SalesNet

Expenses Operating Sold Goods ofCost Ratio Operating

100SlaesNet

Expenses FinancialRatio Expenses Financial

Represented as a %age to Net SalesLesser the margin/%age better it is

PROFITABILITY RATIOS RELATED TO INVESTMENTS-RETURN ON

INVESTMENTS(ROI)

Assets Total Average

TaxesAfter Profit Net (ROA) Assetson Return

RETURN ON CAPITAL EMPLOYED

Employed Capital Total Average

Taxesafter Profit Net ROCE

EARNING PER SHARE

goutstandin sharesordinary ofNumber

ersEquityhold toAvailableProfit Net EPS

SharePer ValueMarket

EPSldEarningYie

DIVIDEND YIELD

goutstandin sharesordinary ofNumber

erssharesholdordinary topaid dividend preference andinterest after profit Net DPS

shareper ValueMarket

DPSYield Dividend

DIVIDEND PAYOUT

ersequityhold tobelongingprofit net Total

dividend)(cash ersequityhold todividend TotalD/P

(EPS) shareper Earnings

share(DPS)ordinary per DividendD/P

or

ACTIVITY RATIO

• Activity ratios are concerned with measuring the efficiency in asset management. Sometimes, these ratios are also called efficiency ratios or assets utilization ratios.

• An activity ratio may, therefore, be defined as a test of relationship between sales (more appropriately with cost of sales) and the various assets of a firm.

CURRENT ASSETS TURNOVER

• Already discussed under liquidity • Other assets turnover includes;

assets totalAverage

sold goods ofCost turnoverassets Total

assets fixed Average

sold goods ofCost turnoverassets Fixed

CURRENT ASSETS TURNOVER-CONTINUED

employed capital Average

sold good ofCost turnoverCapital

assetscurrent Average

sold goods ofCost turnoverassetsCurrent

capital gNet workin

sold goods ofCost ratio turnover capital Working