FINANCIAL STATEMENT
ANALYSIS
RAJESH KEVIN SANJAY
CONTENTS
• FINANCIAL STATEMENTS
• FRAMEWORK FOR ANALYSIS
• BALANCE SHEET RATIOS
• VERTICAL AND HORIZONTAL ANALYSIS
• INCOME STATEMENT RATIOS AND TREND ANALYSIS
• COMMON-SIZE AND INDEX ANALYSIS
Users of Financial Statement Analysis
There are a large number of people that use financial statement analysis but the few
major ones are;
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•
•
•
Creditor; A person who has lent funds to a company is interested in its ability to pay
back
Investors; Current and prospective investors examine financial statements to learn
about the company’s ability to pay dividends
Management
Regulatory authorities; Financial statements are examined by the Securities and
Exchange Commission
FINANCIAL STATEMENTS
• Financial Statements represent a formal record of the financial activities of
an entity. These record/statements are;
•
•
•
•
INCOME STATEMENTS
BALANCE SHEET
CASH FLOW STATEMENT
EQUITY (Statement of Retained Earnings)
Income Statement
• It shows managers and investors whether the company was profitable
during the period being reported. Income statement is composed of
•
•
Income; the business earnings over a period (e.g. sales revenue)
Expenses; the cost incurred by the company over a period (e.g. salaries)
ADVANTAGES AND DISADVANTAGES OF
INCOME STATEMENTS
• Advantages
•
•
Revenue Information
Investor Analysis
• Disadvantages
•
•
Misrepresentation of Value
Additional Company Factors
Preparation Methods
• Single Step Method
•
It has the advantage of simplicity
•
Provides more information about the profitability of a company
• Multi-Step Method
• Formula for Income Statement
•
Revenue – Expenses = Net Income
• Graphical Comparison Between Single and Multi Step Method
Terms Used in Income Statements
• Expenses
• Gains
• Losses
• Discontinued operations
• Extraordinary gains or losses
• Net income
Example and Format in Excel
Balance Sheet
• A financial statement that summarizes a company’s assets, liabilities and
shareholders equity at a specific period.
•
•
It shows the financial Position of a company
Assets = Liabilities + Shareholders’ Equity
Purpose and Importance of Balance Sheet
• Helps users assess the financial health of an entity
• Assist in identifying underlying trends
• Helps in determining the state of the entity’s;
•
•
•
Liquidity Risk
Financial Risk
Credit Risk
Example and Format in Excel
Cash Flow Statement
• Cash Flow Statement represents the movement in cash and bank balances
over a period. It is classifies into the following segments
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•
•
Operating Activities ; From primary activities
Investing Activities ; From the purchase and sale of assets other than inventory
Financing Activities ; Cash flow generated or spent on raising or repaying share capital
and debts
Example and Format in Excel
Cash Flow Basis of Preparation
• Cash Flow Statements represents the movement in cash and cash
equivalents, which are;
•
•
•
•
Cash in hand
Cash in bank
Short term investments that are liquid
Bank overdrafts
Operating Activities
•
It is the movement in cash during an accounting period from the primary revenue
generating activities. Profits before tax in the income statements can be used as a
starting point to calculate operating activities cash flow. The following adjustments
are
•
•
•
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Elimination of non cash expenses
Removal of expenses
Elimination of non cash income
Removal of income
Working capital changes
Investing Activities
• Movement in Cash flow as a result of the purchase or sale of assets other
than the entity's inventory. It primarily consists of ;
•
•
•
Cash outflow expended on the purchase of investments or fixed assets
Cash inflow from income from investments
Cash inflow from disposal of investments or fixed assets
Financing Activities
• Movement of cash flow resulting from the following;
•
•
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Proceeds from issuance of share capitals, debentures and bank loans
Cash outflow expended on the cost of finance
Cash outflow on the repurchase of share capital and repayment of loans.
Purpose and Importance of Cash Flow
Statements
• Provides insights about the liquidity and solvency of a company
• Allows analysts to use the information of previous cash flow to project
future cash flows
• Highlights the priorities of management
Statements of Retained Earnings
• Its details the change in owners’ equity over a period. It comprises of the
following elements ;
•
•
•
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Net profit/loss during the period attributable to shareholders
Increase/decrease in share capital reserves
Dividend payments to shareholders
Gains and losses recognized directly in equity
Effect of changes in accounting policies
Effect of correction of prior period error
Financial Statement Analysis Framework
The following steps are used as a framework for financial statements analysis;
• Identify the purpose and objectives of the analysis
• Review financial statements, notes and audits
• Determine the necessary adjustments to enhance the comparability of the
statements
• Determine if the firm’s size, capital structure and product mix are
appropriate to proceed to ration calculations
Framework Cont’d
• Conduct horizontal and vertical analysis
• Calculate liquidity ratio and profitability ratio
• Evaluate firms capital structure
• Examine firms market performance using investor ratio
• Examine any inconsistencies in the ratio results and notes
Types of Ratios
• Liquidity Ratio
• Capital Structure and Solvency Ratio
• Return on Investment
• Operating Performance
• Asset Utilization
• Market Measures
Use of Financial Ratio
• A tool used in assessing the relative strength of a firm
• It gives investors more relevant information
• Provides a standardized method to compare companies and industries
Ratio Analysis
Purpose :
Evaluate relation between two or more economically important
items
Output:
Mathematical expression of relation between two or more
items
Cautions:
 Prior Accounting analysis is important
 Interpretation is key - long vs short term & benchmarking
Balance Sheet Ratio
• Current Ratio
• Acid-test/ Quick Ratio
• Debt-to-worth Ratio
• Working capital
• Working capital per dollar of sales
Current Ratio
Current assets
Current ratio =
Current liabilities
Measures solvency: The number of dollars in current assets for every $1 in Current
Liabilities
For example: a Current Ratio of 1.76 means that for
every $1 of Current Liabilities, the company has $1.76 in current Assets with which to pay
them
Acid-Test Ratio
Acid-Test Ratio =
Cash + Account Receivable
Current Liabilities
Measures liquidity: The number of dollars in Cash and
Accounts Receivable for each $1 in Current Liabilities.
For example: a Quick Ratio of 1.14 means that for
every $1 of Current Liabilities, the company has $1.14
in Cash and Accounts Receivable with which to pay
them
Example and Format in Excel
Income Statement Ratio
• The following are the ratio analysis related to the income statements
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Gross Margin
Profit Margin
Earning Per Share
Times Interest Earned
Return on Stockholders’ Equity
Example and Format in Excel
Methods of Financial Statement Analysis
There are two methods for analysing financial statements, these are
• Horizontal Analysis; is the comparison of financial information over a series
of reporting periods. Also known as trend analysis
• Vertical Analysis; is the proportional analysis of a financial statement.
Trend Analysis
• It is the direction the business is taking
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•
Base year percentage is 100%
Trend Percentage = Analysis year dollar amount
Base year dollar amount
Trend Analysis Example
Complete a trend analysis for thousand Oaks Realty’s net revenue and
net income for the following 5-year period, using 2004 as the base year.
Round to the nearest full percent
Net revenue
Net income
2008
1318
122
2007
1187
114
2006
1106
83
Net revenue
Net income
2008
126%
144%
2007
114%
134%
2006
106%
98%
2005
1009
71
2005
97%
84%
2004
1043
85
2004
100%
100%
Common Size Income Statement
• A common size income statement presents all the income statement as a
percentage of net sales. Example is a corporation’s common size income
statement after each item from the income statement was divided by net
sales of $500,000
Ratio
How to Calculate it
Gross Margin
= Gross Profit ÷ Net Sales
= $120,000 ÷ $500,00
= 24.0%
Profit Margin
(after tax)
= Net Income after Tax ÷ Net Sales
= $23,000 ÷ $500,000
= 4.6%
Earning Per Share (EPS)
= Net Income after Tax ÷ Weighted
Average Number of Common Share
Outstanding
= $23,000 ÷ 100,000
= $0.23
Example and Format in Excel
Index Analysis
An analysis of percentage financial statements where all balance sheet or
income statement figures for a base year equal 100.0 (percent) and
subsequent financial statement items are expressed as percentages of their
values in the base year.
Index Analysis of a Balance Sheet
Regular (thousands of $)
Assets
2005
2006
2007
Indexed (%)
2005
2006
2007
Cash
AR
Inv
Other CA
148
283
322
10
100
410
616
14
90
394
696
15
100.0
100.0
100.0
100.0
67.6
144.9
191.3
140.0
60.8
139.2
216.1
150.0
Tot CA
Net FA
LT Inv
Other LT
763
349
0
111
1,140
631
50
223
1,195
701
50
223
100.0
100.0
100.0
100.0
149.4
180.8
inf.
200.9
156.6
200.9
inf.
200.9
1,223
2,044
2,169
100.0
167.1
177.4
Tot Assets
THE END