Financial Statement Analysis
Perspectives
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1.
2.
3.
4.
5.
Liquidity – the ability of the firm to pay its way
Investment/shareholders –information to enable decisions to be made
on the extent of the risk and the earning potential of a business
investment
Gearing – information on the relationship between the exposure of the
business to loans as opposed to share capital
Profitability – how effective the firm is at generating profits given sales
and/or its capital
Financial – the rate at which the company sells its stock and the
efficiency with which it uses its assets
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Liquidity
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Current Ratio
• Looks at the ratio between Current Assets and Current Liabilities
• Current Ratio = Current Assets : Current Liabilities
• A ratio of 5 : 1 would imply the firm has Rs 5 of assets to cover every
Re 1 in liabilities
• A ratio of 0.75 : 1 would suggest the firm has only 75p in assets
available to cover every Re1 it owes
• Too high – Might suggest that too much of its assets are tied up in
unproductive activities – too much stock, for example?
• Too low - risk of not being able to pay your way
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•
Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished Goods,
Debtors, Bills Receivables, Cash.
•
Current Liabilities : Sundry Creditors, Short term loan, Accounts Payable, etc. and
other liabilities payable within one year.
•
Net Working Capital : This is the difference of Current Assets and Current Liabilities.
NWC = Current Assets – Current Liabilities
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 Current Ratio measures short term liquidity of the
concern.
 It shows the ability to meet current obligations in
time.
Higher ratio may be good from the point of view of
creditors.
In the long run very high current ratio may affect
profitability (e.g. high inventory carrying cost)
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Shows the liquidity at a particular point of
time. The position can change immediately
after that date. So trend of the current ratio
over the years to be analyzed.
 Current Ratio is to be studied with the
changes of NWC. It is also necessary to look at
this ratio along with the Debt-Equity ratio.
Acid Test ratio
• Also referred to as the ‘Quick ratio’
• (Current assets – Stock & Prepaid expenses) : Current
liabilities
• The omission of stock gives an indication of the cash the
firm has in relation to its liabilities
• A ratio of 3:1 therefore would suggest the firm has 3 times
as much cash as it owes – very healthy!
• A ratio of 0.5:1 would suggest the firm has twice as many
liabilities as it has cash to pay for those liabilities. This
might put the firm under pressure but is not in itself the
end of the world!
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Example :
Cash
50,000
Debtors
1,00,000
Inventories
1,50,000
Total Current Assets 3,00,000
Current Ratio = >
Quick Ratio
=>
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Current Liabilities 1,00,000
3,00,000/1,00,000
1,50,000/1,00,000
= 3:1
= 1.5 : 1
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Investment/Shareholders
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Investment/Shareholders
Earnings per share (eps)
EPS indicates the amount of net profit of the year that
would be available for dividend for each share held by the
equity share holders.
Net profit after Taxes and Preference Dividend
No. of Equity Shares
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•
Price Earnings ratio (P/E ratio) =
Market Price Per Equity Share
Earnings Per Share
•
PE Ratio indicates the number of times the Earning Per
Share is covered by its market price.
•
The higher the better generally.
•
Comparison with other firms helps to identify value
placed on the market of the business.
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Dividend yield :
(Equity share dividend / market price) x 100
 Relates the return on the investment to the
share price.
 Higher the better.
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Dividend payout
• This ratio indicates what portion of equity
earnings is paid out as dividends to equity
shareholders.
• Dividend payout = DPS
EPS
• The compliment of this ratio is the proportion
of retained earnings.
• (RETAINED EARNINGS/SHARE)+DPS = EPS
Leverage/Gearing
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• Gearing Ratio = (Long term loans / Capital
employed) x 100
• The higher the ratio the more the business is
exposed to interest rate fluctuations and has
to pay back interest and loans before being
able to re-invest earnings
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DEBT EQUITY RATIO : It is the relationship between
borrower’s fund (Debt) and Owner’s Capital (Equity).
Long Term Outside Liabilities / Tangible Net Worth
Liabilities of Long Term Nature
(Total of Capital and Reserves & Surplus) Less Intangible Assets
For instance, if the Firm is having the following :
Capital
= Rs. 200 Lakhs
Free Reserves & Surplus
= Rs. 300 Lakhs
Long Term Loans/Liabilities = Rs. 800 Lakhs
Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1
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Profitability
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Profitability
• Profitability measures look at how much profit the
firm generates from sales or from its capital assets
• Different measures of profit – gross and net
– Gross profit – effectively total revenue (turnover/sales) –
variable costs (cost of sales)
– Net Profit – effectively total revenue (turnover) – variable
costs and fixed costs (overheads)
– Operating profit- effectively net profit – non operating
income ( like dividends received) + non operating expenses
(like interest paid on debentures)
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Profitability-Gross Profit Ratio
• Gross Profit Ratio =
(Gross profit / Turnover ) x 100
• By comparing Gross Profit percentage to Net Sales we can
arrive at the Gross Profit Ratio which indicates the
manufacturing efficiency as well as the pricing policy of the
concern.
• The higher the better
• Also enables the firm to assess the impact of its sales and how
much it costs to generate (produce) those sales
• A gross profit margin of 45% means that for every Re1 of
sales, the firm makes 45p in gross profit
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Profitability-Net Profit Ratio
• Net Profit ratio = (Net Profit / Turnover )x 100
• It measures overall profitability.
• Net profit takes into account the fixed costs involved in production –
the overheads
• Keeping control over fixed costs is important – could be easy to
overlook for example the amount of waste - paper, stationery,
lighting, heating, water, etc.
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Profitability- ROCE
RETRUN ON AVERAGE CAPITAL EMPLOYED
( Net Profit before Interest & Tax / Average Capital Employed) x 100
Net Profit before interest includes interest on both long term as well as short term
loans
Average Capital Employed is the average of the equity share capital and
long term funds provided by the owners and the creditors of the firm at the
beginning and end of the accounting period.
ROCE can also be calculated on gross capital employed
(Net Fixed Assets + Current assets )
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Profitability- ROCE
The higher the better
Shows how effective the firm is in using its
capital to generate profit
ROCE of 25% means that it uses every Re1 of
capital to generate 25p in profit
Partly a measure of efficiency in organisation
and use of capital
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Financial
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Asset Turnover Ratio
Asset Turnover ratio = Net Sales /Tangible assets
Using assets to generate profit
Asset turnover x net profit margin = ROCE
 FIXED ASSET TURNOVER RATIO :
Net Sales /Fixed Assets
 CURRENT ASSET TURNOVER RATIO :
Net Sales / Current Assets
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STOCK/INVENTORY TURNOVER RATIO
= (COGS/Average Inventory) x 365 for days
= (COGS/Average Inventory) x 52 for weeks
= (COGS/Average Inventory) x 12 for months
Average Inventory or Stock = (Opening Stock + Closing Stock)
----------------------------------------2
This ratio indicates the number of times the inventory is
rotated during the relevant accounting period
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Stock Turnover Ratio
• A high stock turnover might mean increased
efficiency
– But: dependent on the type of business –
supermarkets might have high stock turnover
ratios whereas a shop selling high value
musical instruments might have low stock
turnover ratio
– Low stock turnover could mean poor customer
satisfaction if people are not buying the goods.
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DEBTORS TURNOVER RATIO
• Debtor Days or DEBTORS TURNOVER RATIO : This is also
called Debtors Velocity or Average Collection Period or Period
of Credit given .
= (Average Debtors/Sales ) x
365/ 52 / 12 (for days/weeks /months)
• Shorter the better
• Gives a measure of how long it takes the business to recover
debts
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CREDITORS TURNOVER RATIO
This is also called Creditors Velocity Ratio, which
determines the creditor payment period.
=(Average Creditors/Credit Purchases) x
365 /52/12 (for days/ weeks/ months)
Format of balance sheet for ratio analysis
LIABILITIES
ASSETS
NET WORTH/EQUITY/OWNED FUNDS
Share Capital/Partner’s Capital/Paid up Capital/ Owners
Funds
Reserves (General, Capital, Revaluation & Other
Reserves)
Credit Balance in P&L A/c
FIXED ASSETS :
LAND & BUILDING, PLANT & MACHINERIES
Original Value Less Depreciation
Net Value or Book Value or Written down value
LONG TERM LIABILITIES/BORROWED FUNDS
Term
Loans (Banks & Institutions)
Debentures/Bonds, Unsecured Loans, Fixed Deposits,
Other Long Term Liabilities
NON CURRENT ASSETS
Investments in quoted shares & securities
Old stocks or old/disputed book debts
Long Term Security Deposits
Other Misc. assets which are not current or fixed in
nature
CURRENT LIABILTIES
Bank Working Capital Limits such as CC/OD/Bills/Export
Credit
Sundry /Trade Creditors/Creditors/Bills Payable, Short
duration loans or deposits
Expenses payable & provisions against various items
CURRENT ASSETS : Cash & Bank Balance,
Marketable/quoted Govt. or other securities, Book
Debts/Sundry Debtors, Bills Receivables, Stocks &
inventory (RM,SIP,FG) Stores & Spares, Advance
Payment of Taxes, Prepaid expenses, Loans and
Advances recoverable within 12 months
INTANGIBLE ASSETS
Patent, Goodwill, Debit balance in P&L A/c, Preliminary
or Preoperative expenses
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EXERCISE 1
calculate the following from the balance sheet data
LIABILITES
ASSETS
Capital
180 Net Fixed Assets
400
Reserves
20 Closing stock
150
Long Term Loan
300 Cash
50
Bank Cash credit
200 Accounts Receivables
150
Trade Creditors
50 Goodwill
50
Provision for tax
50
800
a.
b.
c.
d.
e.
f.
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Net Worth
Tangible Net Worth
Outside Liabilities
Net Working Capital
Current Ratio
Quick Ratio
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Exercise 1
Net Worth :
Tangible Net Worth :
Outside Liabilities :
Net Working Capital :
Current Ratio :
Quick Ratio
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EXERCISE 2
LIABILITIES
2005-06
2006-07
2005-06
2006-07
Capital
300
350 Net Fixed Assets
730
750
Reserves
140
160 Security Deposit
30
30
(Electricity)
Bank Term Loan
320
280 Investments
110
110
Bank Cash credit
490
580 Raw Materials
150
170
Unsecured long
Term Liabilities
150
170 Stock in Progress
20
30
Creditors (Raw
materials)
120
70 Finished Goods
140
170
Bills Payable
40
80 Cash
30
20
Expenses Payable
20
30 Receivables
310
240
Provisions
20
40 Loans/Advances
30
190
Goodwill
50
50
1600
1760
Total
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1600
1760
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EXERCISE 2
calculate the following:
• Tangible Net Worth for 1st Year
• Current Ratio for 2nd Year
• Debt Equity Ratio for 1st Year
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Exercise 2
1. Tangible Net Worth for 1st Year :
2. Current Ratio for 2nd Year :
3. Debt Equity Ratio for 1st Year :
Raw Materials
170
Stock in Progress
Finished Goods
580
30
Bank Cash
credit
70
170
Creditors (Raw
materials)
Bills Payable
80
Expenses
Payable
30
Provisions
40
Cash
20
Receivables
240
Loans/Advances
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190
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Exercise 3.
LIABIITIES
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ASSETS
Equity Capital
200 Net Fixed
Assets
800
Preference
Capital
100 Inventory
300
Term Loan
600 Receivables
150
Bank Cash
credit
400 Investment In
Govt. Sec
50
Sundry
Creditors
100 Preliminary
Expenses
100
Total
1400
1400
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Exercise 3:
Calculate
i) Debt Equity Ratio
ii)Tangible Net Worth
iii)Current Ratio
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Exercise 3.
1. Debt Equity Ratio : LTL/ TNW =
2. Tangible Net Worth :
3. Current Ratio :
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Exercise 4.
LIABILITIES
Capital + Reserves
P & L Credit Balance
ASSETS
355
Net Fixed Assets
7 Cash
265
1
Loan From S F C
100 Receivables
125
Bank Overdraft
38 Stocks
128
Creditors
26 Prepaid Expenses
1
Provision of Tax
9 Intangible Assets
30
Proposed Dividend
15
550
550
Q 1. What is the Current Ratio ?
Q 2. What is the Quick Ratio ?
Q 3. What is the Debt Equity Ratio ?
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Q1. What is the Current Ratio ?
Q 2. What is the Quick Ratio ?
Q 3. What is the Debt Equity Ratio ?
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Exercise 4. contd…
LIABILITIES
‘000
Capital + Reserves
P & L Credit Balance
355
ASSETS
‘000
Net Fixed Assets
265
7 Cash
1
Loan From S F C
100 Receivables
125
Bank Overdraft
38 Stocks
128
Creditors
26 Prepaid Expenses
1
Provision of Tax
9 Intangible Assets
30
Proposed Dividend
15
550
550
Q 4. What is the Proprietary Ratio ?
Q 5. What is the Net Working Capital ?
Q 6. If Net Sales is Rs.15 Lac, then What would be the Stock Turnover Ratio in
Times?
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4. Proprietary Ratio
5. Net Working Capital
6. If Net Sales is Rs.15 Lac, then What would be the Stock Turnover Ratio in
Times ?
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Exercise 4. contd…
LIABILITIES
Capital + Reserves
P & L Credit Balance
ASSETS
355
Net Fixed Assets
7 Cash
265
1
Loan From S F C
100 Receivables
125
Bank Overdraft
38 Stocks
128
Creditors
26 Prepaid Expenses
1
Provision of Tax
9 Intangible Assets
30
Proposed Dividend
15
550
550
Q 7. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.
Q 8. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
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7. Debtors Velocity Ratio ,If the sales are Rs. 15 Lac.
8. Creditors Velocity Ratio, if Purchases are Rs.10.5 Lac
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Exercise 5. From the following financial statement calculate (i) Current Ratio (ii) Acid test
Ratio (iii) Inventory Turnover (iv) Average Debt Collection Period (v) Average Creditors’
payment period.
C.Assets
Sales
1500
Inventories
125
Cost of sales 1000
Debtors
250
Gross profit
500
Cash
225
C. Liabilities
Trade Creditors
200
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(i) Current Ratio :
(ii) Acid Test Ratio : Debtors + Cash /Trade creditors =
(iii) Inventory Turnover Ratio : Cost of sales / Inventories =
(iv) Average Debt collection period : (Debtors/sales) x 365 =
(v) Average Creditors’ payment period : (Trade Creditors/Cost of sales) x 365
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