Financial Statement Analysis

is defined as the process of identifying
financial strengths and weaknesses of
the firm by properly establishing
relationship between the items of the
balance sheet and the profit and loss
account.
Types of Analysis
1.
2.
3.
Vertical Analysis
Horizontal Analysis
Ratio Analysis
Horizontal Analysis
Horizontal analysis of financial statements
involves comparison of a financial ratio, a
benchmark, or a line item over a number of
accounting periods. This method of
analysis is also known as trend analysis.
Horizontal analysis allows the assessment
of relative changes in different items over
time. It also indicates the behavior of
revenues, expenses, and other line items
of financial statements over the course of
time.
Vertical Analysis
Vertical analysis of financial statements
is a technique in which the relationship
between items in the same financial
statement is identified by expressing all
amounts as a percentage a total
amount. This method compares different
items to a single item in the same
accounting period.
Ratio Analysis
Ratio analysis is the calculation and
comparison of ratios which are derived
from the information in a company's
financial statements. The level and
historical trends of these ratios can be
used to make inferences about a
company's financial condition, its
operations and attractiveness as an
investment.
Types of Ratios
1.
2.
3.
Profitability
Liquidity
Solvency
Profitability Ratio
- Ratios show a company's overall efficiency
and performance.
- Two Types: margins and returns.
Ratios that show margins represent the firm's
ability to translate sales dollars into profits
at various stages of measurement.
Ratios that show returns represent the firm's
ability to measure the overall efficiency of
the firm in generating returns for its
shareholders.
Liquidity Ratio
Liquidity ratios are the ratios that measure the
ability of a company to meet its short term debt
obligations. These ratios measure the ability of
a company to pay off its short-term liabilities
when they fall due.
The liquidity ratios are a result of dividing cash
and other liquid assets by the short term
borrowings and current liabilities. They show
the number of times the short term debt
obligations are covered by the cash and liquid
assets. If the value is greater than 1, it means
the short term obligations are fully covered.
Solvency Ratio
Solvency ratio are to measure a company's ability to
meet long-term obligations. The solvency ratio
measures the size of a company's after-tax
income, excluding non-cash depreciation
expenses, as compared to the firm's total debt
obligations. It provides a measurement of how
likely a company will be to continue meeting its
debt obligations.
Generally speaking, the lower a company's solvency
ratio, the greater the probability that the company
will default on its debt obligations.
Profitability Ratios (margins)
GROSS PROFIT MARGIN
=gross profit / net sales
Gross profit margin looks at cost of goods sold as a percentage of
sales. This ratio looks at how well a company controls the cost of its
inventory and the manufacturing of its products and subsequently
pass on the costs to its customers. The larger the gross profit
margin, the better for the company.
OPERATING PROFIT MARGIN
=expense before income tax / net sales
Operating profit is also known as EBIT and is found on the company's
income statement. EBIT is earnings before interest and taxes. The
operating profit margin looks at EBIT as a percentage of sales. The
operating profit margin ratio is a measure of overall operating
efficiency, incorporating all of the expenses of ordinary, daily
business activity.
Profitability Ratios (margins)
NET PROFIT MARGIN
=net income / net sales
Net profit margin shows how much of each sales dollar shows
up as net income after all expenses are paid. The net profit
margin measures profitability after consideration of all
expenses including taxes, interest, and depreciation.
CASH FLOW MARGIN
=cash flow from operating cash flow / net sales
Cash Flow Margin it expresses the relationship between cash
generated from operations and sales. It measures the ability
of a firm to translate sales into cash.
Profitability Ratios (return)
RETURN ON ASSET
=net income / total asset
The Return on Assets ratio measures the efficiency with
which the company is managing its investment in assets
and using them to generate profit. It measures the amount
of profit earned relative to the firm's level of investment in
total assets.
RETURN ON EQUITY
=net income / stockholder’s equity
It measures the return on the money the investors have put
into the company. This is the ratio potential investors look
at when deciding whether or not to invest in the company.
In general, the higher the percentage, the better, with
some exceptions, as it shows that the company is doing a
good job using the investors' money.
Profitability Ratios (return)
CASH RETURN ON ASSET
=cash flow from operating activities /
total assets
It is used as a comparison to return on
assets since it is a cash comparison to
this ratio as return on assets is stated on
an accrual basis. The higher the
percentage, the better.
Liquidity Ratios
ACID TEST RATIO (QUICK RATIO)
=(current asset – inventory) / current liabilities
The most basic definition of acid-test ratio is that, “it measures
current (short term) liquidity and position of the company”.
CASH RATIO
=cash and cash equivalents / current liabilities
Cash ratio (also called cash asset ratio) is the ratio of a
company's cash and cash equivalent assets to its total
liabilities. Cash ratio is a refinement of quick ratio and
indicates the extent to which readily available funds can
pay off current liabilities.
Liquidity Ratios
CURRENT RATIO
=current asset / current liabilities
The current ratio indicates a company's ability to meet short-term
debt obligations. The current ratio measures whether or not a firm
has enough resources to pay its debts over the next 12 months.
The current ratio can also give a sense of the efficiency of a
company's operating cycle or its ability to turn its product into
cash.
WORKING CAPITAL
=current asset – current liabilities
Working capital is the amount by which the value of a company's
current assets exceeds its current liabilities. It measures how
much in liquid assets a company has available to build its
business. Working capital is a common measure of a company's
liquidity, efficiency, and overall health.
Solvency Ratios
DEBT RATIO
=total debt / total assets
A ratio that indicates what proportion of debt a company has
relative to its assets. The measure gives an idea to the
leverage of the company along with the potential risks
the company faces in terms of its debt-load.
SOLVENCY RATIO
= (after tax net profit + depreciation) /
(long term liabilities + short term liabilities)
Solvency is a measure of the firm's ability to pay all debt,
particularly long-term debt and is a measure of the firm's
long-term survival.
Thank you.
Reference:
 www.investopedia.com
 www.readyratios.com
 www.bizfinance.about.com