Chapter 14
Financial Statement Analysis
Who and Why?
To understand the economics of a firm and
 To help forecast its future profitability and risk





Managers
 Responsible for day to day operations and long-run performance
 Responsible and accountable for efficiency, effective deployment of
capital, human resource and other resource management
Owners
 Interested in current and long-term returns on their investments
 Expect growing earnings, dividends
 Affected by how earnings are distributed and how their shares are
valued in the market
Lenders and creditors
 Concerned about liquidity and cash flow of the company
 Interested in the degree of financial leverage employed
Others: employees, government, society
Financial Statement Analysis

Should start with an understanding of




Global and local macro economic condition
Industry (past performance, future expectations,
competition etc…)
Should involve time series analysis,
Should compare performance with peers,
competitors, industry averages
Tools

Analytical Analysis



Vertical Analysis
Horizontal Analysis
Ratio Analysis
Analytical Analysis

Vertical Analysis
 Express
the items in the financial statements as a
percentage of total assets or sales
Income Statement- Vertical Analysis
Incom e Statem ent
01.01.200631.12.2006
Sales Revenue
679.109.952 100%
533.179.059 100%
484.217.501 100%
Cost of Sales
(494.829.354) -73%
(384.957.208) -72%
(334.949.677) -69%
Gross Profit
184.280.598 27%
01.01.200531.12.2005
148.221.851
01.01.200431.12.2004
28%
149.267.824 31%
Operating expenses
(109.625.499) -16%
Operating incom e
74.655.099 11%
84.157.596
16%
90.118.115 19%
42.965.316 6%
21.707.341
4%
29.896.364 6%
Other expense
(69.646.923) -10%
(33.921.481)
-6%
(23.463.677) -5%
Financial expenses, net
(19.455.362) -3%
(7.271.009)
-1%
(10.447.308) -2%
64.672.447
12%
86.103.494 18%
0 0%
0
0%
(5.603.281) -1%
Minority Interest
(1.978.179) 0%
894.625
0%
(2.388.309) 0%
Incom e before taxes
26.539.951 4%
65.567.072
12%
78.111.904 16%
Tax expense
10.485.947 2%
(12.359.914)
-2%
(17.031.347) -4%
Net Incom e
37.025.898 5%
53.207.158
10%
61.080.557 13%
Other income
Incom e before m onetary loss and
28.518.130
taxes 4%
Loss on monetary position
Earnings per share
0,2445
(64.064.255) -12%
0,3514
(59.149.709) -12%
0,4034
Balance Sheet Vertical Analysis
Balance Sheet
Assets
Current Assets
Cash and cash equivalents
Trading securities, net
Trade receivables, net
Due from related parties, net
Other receivables, net
Inventories, net
Other current assets
Long-term assets
Trade receivables, net
Due from related parties, net
Financial assets, net
Goodw ill
Property plant & equipment, net
Intangible assets, net
Deferred Tax Assets
Total assets
12.31.2006
323.005.585
68.780.065
52.842
74.261.814
19.179.748
36.018.789
124.425.343
286.984
905.421.795
11.734
118.236.407
13.181.689
760.036.354
816.222
13.139.389
1.228.427.380
2006
31.12.2005
2005
31.12.2004
26%
6%
0%
6%
2%
3%
10%
0%
74%
0%
270.115.547
74.834.352
100.156
53.030.694
43.892.285
23.747.722
74.411.768
98.570
777.097.920
61.484
26%
7%
0%
5%
4%
2%
7%
0%
74%
0%
0%
10%
2%
62%
0%
1%
100%
212.197.885
49.026.423
25.755
40.472.344
50.714.258
18.484.620
52.128.304
1.346.181
587.857.590
21.288
10.250
68.170.577
4.196.133
515.019.808
439.534
27%
6%
0%
5%
6%
2%
7%
0%
73%
0%
0%
9%
1%
64%
0%
800.055.475
100%
10%
1%
62%
0%
1%
100%
101.513.970
16.249.281
653.345.452
378.815
5.548.918
1.047.213.467
2004
Liabilities
Current liabilities
273.773.294
Financial liabilities
111.909.791
Current portion of long-term debt
66.179.457
Other financial liabilities, net
9.974.767
Trade payables
31.376.464
Due to related parties
46.244.139
Advances received
1.022.139
Accrued expenses
674.264
Other liabilities
6.392.273
Long-term liabilities
254.733.661
Financial liabilities
204.283.035
Provisions
19.748.369
Deferred tax laibilitity
30.702.257
Other liabilities
0
Minority Interest
66.778.345
Shareholders' Equity
633.142.080
Share Capital
151.431.691
Capital reserves
344.775.869
Additional paid in capital
35
Financial asset reserve
47.011.512
Inflation adjsutment
297.764.322
Profit reserves
63.858.215
Legal reserves
13.541.041
Special reserves
1.259.266
Extraordinary reserves
45.017.611
Foreign currency translation reserve
4.040.297
Net Incom e for the year
37.025.898
Retained Earnings (accum ulated loss) 36.050.407
Total equity and liabilities
1.228.427.380
22%
9%
5%
1%
3%
4%
0%
0%
1%
21%
17%
2%
2%
0%
5%
52%
12%
28%
0%
4%
24%
5%
1%
0%
4%
0%
3%
3%
100%
189.106.987
59.274.699
27.725.877
9.661.133
45.300.618
44.590.564
852.778
163.255
1.538.063
213.920.436
152.063.743
19.032.720
42.782.723
41.250
40.198.563
603.987.481
151.431.691
327.475.774
35
29.711.417
297.764.322
60.696.208
9.581.837
549.568
44.278.183
6.286.620
53.207.158
11.176.650
1.047.213.467
18%
6%
3%
1%
4%
4%
0%
0%
0%
20%
15%
2%
4%
0%
4%
58%
14%
31%
0%
3%
28%
6%
1%
0%
4%
1%
5%
1%
100%
104.017.119
13%
39.619.889
5%
13.899.645
2%
7.131.426
1%
13.294.594
2%
23.351.021
3%
1.459.347
0%
288.234
0%
4.972.963
1%
125.084.120
16%
71.323.248
9%
16.458.811
2%
37.052.488
5%
249.573
0%
39.237.953
5%
531.716.283
66%
151.431.691
19%
304.246.330
38%
35
0%
6.481.973
1%
297.764.322
37%
52.177.043
7%
6.823.524
1%
25.125
0%
44.001.350
5%
1.327.044
0%
61.080.557
8%
(37.219.338)
-5%
800.055.475 100%
Analytical Analysis

Vertical Analysis
 Express
the items in the financial statements as a
percentage of total assets or sales

Horizontal Analysis
A
base year is selected and the changes overtime are
expressed as percentage of the base year
 Annual percentage changes are computed
Balance Sheet
Assets
Current Assets
Cash and cash equivalents
Trading securities, net
Trade receivables, net
Due from related parties, net
Other receivables, net
Inventories, net
Other current assets
Long-term assets
Trade receivables, net
Due from related parties, net
Financial assets, net
Goodw ill
Propertt plant & equipment, net
Intangible assets, net
Deferred Tax Assets
Total assets
2006
2005
2004
2003
114%
207%
31%
186%
63%
172%
105%
#DIV/0!
106%
42%
#DIV/0!
110%
24%
109%
96%
100%
100%
100%
100%
100%
100%
100%
191%
77%
161%
178%
145%
316%
120%
243%
55%
221%
150%
#DIV/0!
141%
120%
#DIV/0!
164%
95%
138%
83%
166%
142%
108%
100%
174%
291%
63%
340%
24%
336%
250%
164%
23%
100%
100%
100%
100%
100%
100%
Ratio Analysis



Important point: to be selective-too many ratios would lead to
information overload
Understand the meaning and limitations of the ratios
Define the following elements before starting:



The viewpoint taken
The objectives of the analysis
The potential standards of comparison
Usefulness of Ratios



Help compare different firms, and
Help compare the firm against its past performance
Standards against which to compare ratios
1. The planned ratio for the period
2. The corresponding ratio from a prior period
3. The corresponding ratio for another firm in the same
industry
4. The average ratio for other firms in the same industry
Ratio Analysis Categories
Activity (operations and asset management)
 Liquidity (meeting short-term obligations)
 Solvency (meeting long-term obligations)
 Profitability (earnings and cost coverage)
 Cash Flow (quality of earnings)
 Price Multiples (stock price)

Activity Ratios

Receivable turnover
Credit sales, net
Average trade receivable s

Average collection
period
365
receivable turnover
Activity Ratios

Inventory turnover
Cost of goods sold
average inventorie s

Average days in
inventory
365
inventory turnover
Activity Ratios

Payable Turnover
COGS   in inventorie s
Average trade payables

Average payment period
365
payable turnover
Activity Ratios

Cash Cycle:
Collection period  days in inventory - payment period
Activity Ratios

PP&E Turnover
Net Sales
Average PP & E

Asset Turnover
Net Sales
Average assets
Activity Ratios- Summary
Receivable Turnover
Inventory Turnover
Payable Turnover
PP&E Turnover
Asset Turnover
Net Sales/Average Trade Receivables
COGS/Average Inventories
Purchases/Average Trade Payables
Net Sales/Average PP&E
Net Sales/Average total assets
Average collection period
Average days in inventory
Average payment period
365/receivable turnover
365/inverntory turnover
365/payable turnover
Cash cycle=
collection period +
days in inventory payment period
Activity Ratios
Receivable Turnover
Inventory Turnover
Payable Turnover
PPE Turnover
Asset Turnover
2007
10,62
4,84
17,75
1,13
0,71
2006
10,67
4,98
14,21
0,96
0,60
A. Cam
2005
11,40
6,08
13,90
0,91
0,58
Collection Period
Days in inventory
Payment period
34,37
75,48
20,57
34,21
73,33
25,68
32,00
59,99
26,26
23,47
55,52
14,46
Cash cycle
89,29
81,86
65,74
64,54
2004
15,55
6,57
25,24
0,98
0,63
Liquidity Ratios

Current ratio
Ability to meet short-term obligations
 [Current assets/current liabilities]


Quick ratio
Remove less liquid assets
 Keep cash, liquid investments, A/R


[(Cash+short-term investments + A/R)/current liabilities]
Liquidity Ratios
Short term liquidity
Current Ratio
Quick Ratio
2007
1,13
0,48
2006
1,18
0,52
2005
1,43
0,68
2004
2,04
0,86
Solvency Ratios

Debt to assets: Total liabilities/Total assets


Proportion of assets financed with debt
Could include interest bearing debt only
[(short term debt + noncurrent debt)/total assets]

Be aware that assets are recorded at historical
cost, which may be different from current
market value
Solvency Ratios

Debt to equity: Total liabilities/Total equity

A measure of how assets are financed
Solvency Ratios
Coverage Ratios
Adequacy of resources for meeting firm’s
contractual obligations
 Times interest earned

Can the firm cover its interest obligations?
 (EBIT/Interest expense)


Cash interest coverage

(Cash from ops + interest paid + tax paid)/Interest paid
Solvency Ratios
Debt to assets
Debt to equity
Times interest earned
Long-term Liquidity
Debt ratio
debt to equity
Times interest earned
Total liabilities/Total assets
Total liabilities/Total equity
EBIT/Interest expense
2007
0,43
0,86
5.04
2006
0,43
0,83
3,84
2005
0,38
0,67
11,57
2004
0,29
0,43
8,63
Profitability Ratios


Gross Margin: profitability of sales
Return on Sales: Net profitability of the
company
Gross Profit
Gross Margin % 
Sales, net
Net Income
Return on Sales 
Sales, net
Profitability Ratios
Retun on Assets
 Return on Equity

ROA =
Net Income/ Average Total Assets
ROE =
Net Income/Average SH's Equity
Profitability Ratios
Profitability Ratios
Gross Margin
Return on Sales
Return on Assets
Return on Equity
Profitability
Gross margin %
Net Profit Margin
ROA =
ROE =
Gross profit/Sales revenue
Net Income/Sales revenue
Net income/Average total assets
Net income/Average total equity
2007
27,36%
7,91%
5,60%
10,99%
2006
27,14%
5,45%
3,25%
5,99%
A. Cam
2005
27,80%
9,98%
5,76%
9,37%
2004
30,83%
12,61%
7,94%
11,96%
Cash Flow Ratios
Quality of earnings

Ability to pay obligations
CFO/Total liabilities
 CFO = Cash flows from operations


Profitability (cash flow relative to sales)


CFO/Sales revenue
Cash flow-earnings index

CFO/Net income
Cash Flow Ratios
Ability to Pay Obligations CFO/Total liabilities
Cash Flow relative to Sales CFO/Sales revenue
Cash flow-earnings index CFO/Net income
Cash flow
Ability to pay obligations
Cash flow relative to sales
cash flow earnings index
2007
0,32
0,20
2,52
2006
0,15
0,12
2,21
2005
0,37
0,28
2,77
2004
0,50
0,24
1,86
Price Multiple Ratios

Market’s valuation of a firm’s common stock
P/E = Share price/Earnings per share

Price/book ratio compares stock’s price to the
recorded value of the net assets
[Share price/(Book value of equity/Share outstanding)]
Market Ratios
Price earnings ratio
price to book value
2007
12,73
1,35
2006
46,67
1,34
2005
16,93
1,49
2004
11,16
1,28
Limitation of Ratio Analysis






Represent the average conditions and influenced by the
accounting methods used
Based on historical data and do not reflect price level effects
and real economic values
Changes in many ratios are strongly associated with each other
and interrelationships among/between the ratios should be
examined
During comparison of ratios over a period of time changes in
operating conditions should be taken into consideration
During comparison between companies differences among the
companies should be examined
Use audited financial statements to perform ratio analysis
Analysis of Anadolu Cam

The changes in total assets and total liabilities over the period
confirm the company’s investments that started in 2005.
During the period the following changes in total assets and
total sales were realized:
Change in total assets
From 2004 to 2005
From 2005 to 2006
From 2006 to 2007
Change in total sales
From 2004 to 2005
From 2005 to 2006
From 2006 to 2007
31%
17%
5%
10%
27%
31%





After the realization of investments, profitability of the company showed
a decline which caused fluctuations in net income.
The growth in total sales lagged behind the growth in total assets which is
generally expected in times of investments. The efficiency of assets
should be investigated by the help of turnover ratios in the ratio analysis.
The proportion of total current assets to current liabilities has been
changing in favor of current liabilities which require further analysis for
short term liquidity.
Long-term assets are mainly funded by shareholders’ equity and long-term
liabilities which is preferable for long-term solvency. However, the
composition of long-term funds is changing over the years in favor of the
liabilities.
The composition of total assets didn’t change a lot over the years
presented, although there are slight changes within the composition of
current assets. This requires further investigation in ratio analysis.
Activity Ratios


All activity ratios for operating items have been decreasing. Both accounts
receivable and inventory turnover ratios decreased considerably after 2005
(after the investment): This may be a result of higher working capital
requirements of the new investment, or a general trend in the industry.
Furthermore, accounts payable turnover increased in 2007 although no
improvements are observed for receivables and inventories. These are
expected to increase the need of working capital requirements of the
company. In other words, the increase in cash cycle to 89 days requires
additional funding for the company. When the increase in financial
liabilities from 2005 to 2006 is considered (90%), one can conclude that
the company financed the working capital investments by short term
financial liabilities.
The decreases in turnover rates for accounts receivable and inventories
and the increase in the accounts payable turnover is a future threat for the
short term liquidity of the company.
Activity Ratios

The performance in the PPE and total asset
turnover is as expected. After the investments
PPE turnover together with the total asset
turnover declined (for 2005 and 2006). Such
turnover rates improved in 2007 when the
investments were completed.
Short term Liquidity


Short-term liquidity ratios of the company had been decreasing since
2005. This may be a result of making investments. Both the current and
the quick ratios are below the rule of thumb ratios of 2 and 1, respectively.
There is a considerable difference between the current and the quick ratio.
This is normally an indication of inventory dependence. When one checks
the level of inventories and the increase in inventories, it seems that
inventory account has been growing. As the inventory turnover of the
company is decreasing over the years, we can conclude that short term
liquidity of the company is alarming. As of the last reporting date, it
seems that the company may not be able to pay its current liabilities with
its most quick assets. In addition, because of the decreases in inventory,
current assets may also not be sufficient to meet the current liabilities.
Long-term Solvency



Both the debt ratio and the debt to equity ratio are at the acceptable levels. Under normal
conditions debt ratio of 50% is deemed to be optimal for the financial risk of the company.
The debt ratio started to increase in 2005 after the investments. This means that the company
financed its investments by using liabilities. Since these liabilities are long-term, they
shouldn’t adversely affect the risk. Also, by using liability funding the company is expected
to enjoy financial leverage. As of the end of the last reporting period, the company doesn’t
seem to have a long-term solvency problem. It has a healthy financial structure.
Times interest earned is used by creditors to assess the ability to make interest payments
from the earnings of the company. Until 2006, interest coverage performance of the
company was very successful. However, starting with 2006, both the short term and long
term financial liabilities increased, and so the financial expenses. In addition in 2006, as will
be explained in the profitability analysis, operating income of the company declined
significantly. All the above mentioned factors caused times interest earned ratio to decline.
However, we should also note that the ratio recovered in 2007 as a result of recovery in
profitability. Although it would better to have a higher coverage ratio, we believe the current
performance of the company does not raise a red flag at the moment.
Profitability


To assess the company’s performance in terms of profitability we should also use the ratios of a similar
company as we should for the activity ratios.
Over the years the company’s profitability declined until 2007. Especially in 2006 both the operating
margin and the net profit margin had declined significantly. One of the reasons of such decrease could be
the increase in fixed costs of the company after making the investment. When one analyses the income
statement and the related notes to the financial statements there are three important reasons for the
decreasing profits of 2006:





Within the operating expenses, selling expenses increased a lot, which may be due to marketing efforts after the
capacity increase. These expenses declined in the following year.
Secondly, the company had approximately YTL19.000 of losses from sale of property, plant and equipment. In 2006
after the new investment, the company might have disposed of old equipment. Losses on sales of PPE are not
continuing expenses therefore; they are not expected to adversely affect profitability in the future.
The third reason of the decrease in profitability in 2006 is the 170% increase in the financial expenses as a result of
the increase in the borrowings during the same period. Financial expenses continue to increase in 2007, however, as
total sales also increased, percent of financial expenses within sales is constant.
The company’s ROE and ROA had sharp decreases in 2006. Such a sharp decrease in that year had two
reasons: First because of the reasons explained above, net income decreased. Second is the growth in
assets and shareholders’ equity. The decrease in ROA is sharper because of the increase in the assets. Both
ratios recovered back in 2007, although they didn’t reach their previous levels.
In summary, although the company’s profitability ratios declined after the investment, improvements had
started in 2007. If the sales of the company continue to increase, profitability performance of the company
doesn’t raise any red flags.
Cash Flow Performance


The company had been generating positive operating
cash flows for the last four years, and the cash flow
index is more than 2 over the same period. Therefore
there doesn’t seem to be a earnings quality problem.
During 2006 the company had positive cash flows
from operating and financing activities. Investments
were mostly financed by liabilities. In 2007 cash
flows from financing activities was also negative.
The company started to pay back the liabilities. It
also continued to pay dividends, although not as
much as the previous year.
Market Ratios


Price earnings ratio of the company was
considerably high in 2006, which was probably due
to lower earnings at that year. It declined in 2007 for
two reasons: First the earnings increased, second
share price declined. We should check the PE ratios
and the market performance of other companies as
well to comment on the decrease of the share price.
However, the fact that the company increased its
share capital by issuing free shares from the inflation
adjustment might have caused the share price to
decrease.
Conclusion



Except for the short term liquidity, the company’s financial position and
performance is satisfactory. However before making any concluding remarks, we
should also compare the results of this analysis with industry averages and/or a
similar company.
Future success of the company is dependent on the continuing increase in the
growth of sales revenues. 2009 is a period for which growth in the economy and
in many other industries is not very promising, therefore the company may face
difficulties in increasing its sales. And if the sales do not increase as expected the
company’s future earnings may be at stake. Furthermore, the company’s short
term liquidity is currently dependent on sustainable short term bank loans. If
banks call back the loans and/or don’t give additional loans, the company may not
be able to pay back its liabilities.
One more point to be considered is the group within which the company operates.
It’s a part of Şişecam which is owned by İşbank. Its shareholders are currently
very powerful in the market. Furthermore, the company is the largest in its area.
One adverse point about the future of the company, is the fact that its second
market is Russia, where the economy is not going very well.
Recommendations



It is not advisable to provide a short term loan for the company.
However, from the perspective of a current short term creditor, calling
back the loan also doesn’t seem to be a good choice, as loans may not be
ultimately paid back if called early. For a new creditor it wouldn’t be
wise to give a new short term loan.
The company’s financial structure is sound. It generates profits and
operating cash flows. Therefore, a long-term loan may be provided.
As an investor, ignoring the current market conditions, Anadolu Cam
may be a good investment alternative. The company is profitable and
paying dividends. Furthermore, its PE ratio has declined in the previous
year. It can be expected to increase in the future. However, if the stock
market is expected to decline due to general economic conditions,
investing in a stock may not be a good idea from a short-term
perspective. If the investor has long-term investment goals, Anadolu
Cam shares may be purchased.