financial statements analysis
DESCRIPTION
this file consists of processes to evaluate financial statementsTRANSCRIPT
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Chapter – 6 Financial statement analysis
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Analysis of Financial statements
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Analysis of financial statement means the process of reviewing and evaluating a company's financial statements through some techniques.
Following are the techniques:
1).Financial ratios analysis.
2). Common size or Vertical analysis. 3). Index or Horizontal analysis.
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1).Financial ratios analysis.Generally only ratio is meant dividing one
number by another number. A financial ratios (or accounting ratios) is a
relative magnitude of two selected numerical values taken from an Company’s financial statements.
These ratios are as under:
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These ratios are as under:1. Liquidity ratios or Short term Solvency ratios
2. Debt management or Financial Leverage ratios
3. Efficiency or Activity or turn over ratios
4. Profitability ratios
5. Market value ratios
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1. Liquidity Ratios: Liquidity ratios are the ratios that measure the
ability of a company to meet its only short term debt.
These ratios focus on current assets and current liabilities.
Following are the key ratios fall under this category Current Ratio = Current Assets Current Liabilities
Quick Ratio = Current Assets – Inventory – Prepaid Expenses
Current Liabilities
Working capital =Total Current Assets – Total Current liabilities
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2. Debt management or Financial Leverage ratios 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 as under:
o Total debt-to-Total Assets ratio = Total liabilities
Total Assets
o Total Equity-to- Total assets ratio = Total equity Total Assets
o Time Interest Earned = Earning before Interest & Taxes(EBIT)
Interest expenses
Long term debt to total capitalization ratio = Long term debt
OR Gearing ratio Total Capitalization
*Where as, Total Capitalization = Long term debt + Total Equity
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3. Efficiency or Activity Ratios:
These ratios are typically used in order to determine that how quickly certain assets are converted in cash or sales. Similarly, it also indicates that how quickly accounts payable are paid.
Following are the key ratios fall under this category: o Accounts Receivables = Net Credit Sales ‘ Turn over ratio
Accounts Receivables
o Average Collection = ‘ Days in a year . Period-in Days Accounts Receivable Turn Over
o Total Assets Turn over ratio = Net sales .
Total AssetsContinued on next page..
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o Accounts Payables = Net Credit purchases
turn over ratio
Accounts Payables ratio
o Average Payment period in days = . Days in a year . Accounts Payables Turn Over
o Inventory Turn Over ratio = Cost of goods Sold Inventory
o Average Age of Inventory in days = Days in a year .
Inventory Turn Over
Continued on next page
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Operating cycle = Average age of inventory (In says) +
average collection period ( In days)
Cash cycle = Operating cycle (In days) – Average payment period (In
Days)
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4. Profitability Ratios: Profitability ratios focus on how well a business is performing in
terms of profit. Profitability ratios describe that how effectively the firm is using its Assets & control its expenses to generate an
acceptable rate of return.Following are the key ratios fall under this category:
o Gross profit Margin = Gross profit Net Sales o Operating Profit Margin = Net Profit +interest Net Sales o Profit Margin = . Net Profit .
Net Sales Continued on next page….
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o Return on Total Assets/investments = Net Income .
Total assets
o Return on Common Equity = Net Income –Preferred stock dividend
Common Equity
o Return on total Equity = Net Income
Total Equity
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5. Market value ratios:Market value ratios evaluate the economic status of your company in
the wider marketplace. Market value ratios give management an idea of what the firm's investors think of the firm's performance and future prospects
Following are the key ratios fall under this category: o Earning per Share = Net Income – Preferred Stock dividend Common Stock outstanding (In Nos) o Price Earning ratio = Market price per Share Earning per ShareContinued on next page. . .
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o Book value /Share= Total Stockholders Equity –Preferred stock
Common Stock outstanding (In Nos)
o Dividend Yield = Dividend per Share .
Market price per Share
o Dividend payout = Dividend per common stock Share
Earning per common stock Share [EPS]
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How to draw a final conclusion from the Ratio analysis: A meaningful conclusion is needed finally from ratio analysis. For example: Is this year good or bad? It is judged by the following
procedures:Trend analysis - It means comparing all current year’s relevant ratios
of the company with its own past years' ratios. Thus trend analysis determines the firm’s current year performance with past years.
Comparing with other similar type of Industries-Market-It involves comparing the firm’s current year’s relevant ratios with other similar type of Industries in the market.
Thus it determines the firm’s performance with other competitorBenchmarking – It involves comparing the firm’s relevant ratios with
the world-class firmThus it determines the firm’s performance with the world class firms.In this way the analyst is able to detect his final conclusion
regarding the firm’s improvement or declining during the current year/period through above.
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Summary of ratios and conclusion
Description of Ratios
Favorable
Current Ratio comparative ratio
Quick Ratio comparative ratio
Working capital comparative ratio
Total debt-to-Total Assets ratio
comparative ratio
Total Equity-to- Total assets ratio comparative ratio
Continued to next page
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Summary of ratios and conclusion
Description of Ratios
Favorable
Time Interest Earned comparative ratio
Long term debt to total capitalization ratio
comparative ratio
Accounts Receivables turnover ratio
comparative ratio
Collection period ( In days)
comparative ratio
Total Assets Turnover ratio
comparative ratio
Continued to next page
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Summary of ratios and conclusion
Description of Ratios
Favorable
Accounts Payables turnover ratio
comparative ratio
Average Payment period (in days)
comparative ratio
Inventory Turn Over ratio comparative ratio
Average Age of Inventory ( In days)
comparative ratio
Operating cycle comparative ratio
Continued to next page
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Summary of ratios and conclusion
Description of Ratios
Favorable
Cash Cycle comparative ratio
Gross profit Margin comparative ratio
Operating Profit Margin comparative ratio
Profit Margin
comparative ratio
Return on Total Assets/ Invest
comparative ratio
Return on Common equity comparative ratio
Continued to next page
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Summary of ratios and conclusion
Description of Ratios
Favorable
Return on total Equity comparative ratio
Earning per Share comparative ratio
Price Earning ratio comparative ratio
Book value per Share
comparative ratio
Dividend Yield
comparative ratio
Dividend payout comparative ratio
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2. Common size or Vertical analysis.
An analysis of percentage financial statements where all balance sheet items are divided by total assets and all income statement items are divided by net sales.
3. Index or Horizontal analysis. An analysis of percentage financial statements where
all balance sheet or income statement figures for a base year equal to 100% and subsequent financial statement items are expressed as percentages of their values from the base year.
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….The End….Prepared by:S.Zulfiqar jafar