Financial
Management
Analysis of Financial Statements
Using Financial Ratios
• Ratio analysis involves methods of calculating and
interpreting financial ratios to assess a firm’s financial
condition and performance.
• It is of interest to shareholders, creditors, and the firm’s own
management.
Using Financial Ratios
Types of Ratio Comparisons
Trend or time-series analysis
Used to evaluate a firm’s performance
over time
Using Financial Ratios
Types of Ratio Comparisons
• Trend or time-series analysis
• Cross-sectional analysis
Used to compare different firms at the
same point in time
Using Financial Ratios
Types of Ratio Comparisons
• Trend or time-series analysis
• cross-sectional analysis
– industry comparative analysis
One specific type of cross sectional analysis.
Used to compare one firm’s financial performance
to the industry’s average performance
Using Financial Ratios
Types of Ratio Comparisons
• Trend or time-series analysis
• cross-sectional analysis
– industry comparative analysis
• Combined Analysis
Combined analysis simply uses a combination of
both time series analysis and cross-sectional
analysis
Using Financial Ratios
• Ratios must be considered together; a single ratio by itself
means relatively little.
• Financial statements that are being compared should be
dated at the same point in time.
• Use audited financial statements when possible.
• The financial data being compared should have been
developed in the same way.
• Be wary of inflation distortions.
Ratio Analysis Example
Bartlett Company
Ratio Analysis
Liquidity Ratios
• Current Ratio
Current ratio
=
total current assets
total current liabilities
Current ratio
=
$1,233,000 = 1.97
$620,000
Ratio Analysis
• Liquidity Ratios
– Current Ratio
– Quick Ratio
Quick ratio
= Total Current Assets - Inventory
total current liabilities
Quick ratio
= $1,233,000 - $289,000 = 1.51
$620,000
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
– Inventory Turnover
Inventory Turnover = Cost of Goods Sold
Inventory
Inventory Turnover = $2,088,000 = 7.2
$289,000
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
– Average Collection Period
ACP = Accounts Receivable
Net Sales/360
ACP =
$503,000
$3,074,000/360
= 58.9 days
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
– Average Payment Period
APP =
Accounts Payable
Annual Purchases/360
APP =
$382,000
= 94.1 days
(.70 x $2,088,000)/360
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
– Total Asset Turnover
Total Asset Turnover
=
Net Sales
Total Assets
Total Asset Turnover
= $3,074,000 = .85
$3,579,000
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Financial Leverage Ratios
– Debt Ratio
Debt Ratio = Total Liabilities/Total Assets
Debt Ratio = $1,643,000/$3,597,000 = 45.7%
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
– Times Interest Earned Ratio
Times Interest Earned = EBIT/Interest
Times Interest Earned = $418,000/$93,000 = 4.5
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Gross Profit Margin
GPM = Gross Profit/Net Sales
GPM = $986,000/$3,074,000 = 32.1%
Ratio Analysis
•
•
•
•
Liquidity Ratios
Activity Ratios
Leverage Ratios
Profitability Ratios
– Operating Profit Margin
OPM = EBIT/Net Sales
OPM = $418,000/$3,074,000 = 13.6%
Ratio Analysis
•
•
•
•
Liquidity Ratios
Activity Ratios
Leverage Ratios
Profitability Ratios
– Net Profit Margin
NPM = Net Profits After Taxes/Net Sales
NPM = $231,000/$3,074,000 = 7.5%
Ratio Analysis
•
•
•
•
Liquidity Ratios
Activity Ratios
Leverage Ratios
Profitability Ratios
– Return on Total Assets (ROA)
ROA = Net Profits After Taxes/Total Assets
ROA = $231,000/$3,597,000 = 6.4%
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Return on Equity (ROE)
ROE = Net Profits After Taxes/Stockholders Equity
ROE = $231,000/$1,954,000 = 11.8%
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Earnings Per Share (EPS)
EPS = Earnings Available to Common Stockholders
Number of Shares Outstanding
EPS = $221,000/76,262 = $2.90
Ratio Analysis
• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Price Earnings (P/E) Ratio
P/E = Market Price Per Share of Common Stock
Earnings Per Share
P/E = $32.25/$2.90 = 11.1
Summarizing All Ratios
Summarizing All Ratios
IAS 7 Cash Flows
Users of an entity’s financial statements are interested in how
the entity generates and uses cash and cash equivalents
Provide information about the historical changes in cash and
cash equivalents of an entity by means of a statement of cash
flows
Classification of cash flows during the period as operating,
investing and investing activities
Presentation as an integral part of financial statements
32
IAS 7 Cash Flows Operating Activities
Cash flows from operating activities are primarily derived from
the principal revenue-producing activities of the entity.
They arise from the transactions and other events that enter into
the determination of profit or loss.
The amount of cash flows arising from operating activities is a
key indicator of the extent to which the operations of the entity
have generated sufficient cash flows to:
repay loans, maintain the operating capability of the entity, pay
dividends
make new investments without recourse to external sources of
financing.
forecast future operating cash flows.
33
IAS 7 Cash Flows Direct Method
Direct method statement of cash
flows 20X2
Cash flows from operating
activities
30150
Cash receipts from customers
Cash paid to suppliers and
employees
Cash generated from operations
Interest Paid
Income Tax Paid
Net cash from operating activities
(27600)
2550
(270)
(900)
1380
IAS 7 Cash Flows Operating Activities
It represent the extent to which expenditures have been made
for resources intended to generate future income and cash flows.
It includes:
Payments to acquire property, plant and equipment, intangibles
and other long-term assets.
Cash advances and loans made to other parties except by FIs
Cash receipts from sales of equity or debt instruments of other
entities and interests in joint ventures
35
IAS 7 Cash Flows Direct Method
Net cash from operating activities
Cash flows from investing
activities
Acquisition of subsidiary X, net of
cash acquired
Purchase of property, plant and
equipment
Proceeds from sale of equipment
Interest Received
Dividends received
Net cash used in investing activities
1380
( 550)
(350)
20
200
200
(480)
Financing Activities
Need to disclose of cash flows arising from financing activities
arises because it is useful in predicting claims on future cash
flows by providers of capital to the entity
1. Cash proceeds from issuing shares or other equity
instruments;
2. Cash payments to owners to acquire or redeem the entity’s
shares;
3. Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short-term or long-term borrowings
37
IAS 7 Cash Flows Direct Method
Cash flows from financing activities
Proceeds from issue of share capital
250
Proceeds from long-term borrowings
250
Payment of finance lease liabilities
(90)
Dividends paid
Net cash used in financing activities
(1200)
(790)
IAS 7 Cash Flows Direct Method
Effect of exchange rate changes
( 40)
Net increase in cash and cash
equivalents
70
Cash and cash equivalents at
beginning of period
Cash and cash equivalents at end of
period
160
230
IAS 7 Cash Flows Indirect Method
Cash flows from operating
activities
Profit before taxation
Depreciation
Foreign exchange loss
Investment income
Interest expense
Increase in trade and other
receivables
Decrease in inventories
Decrease in trade payables
Cash generated from operations
3350
450
40
(500)
400
(500)
1050
(1740)
2550
IAS 7 Cash Flows Indirect Method
Cash generated from operations
2550
Interest paid
(270)
Income taxes paid
(900)
Net cash from operating activities
1,380
IAS 7 Cash Flows Indirect Method
Net cash from operating activities
Cash flows from investing activities
1380
Acquisition of subsidiary X, net of cash
acquired
Purchase of property, plant and equipment
( 550)
Proceeds from sale of equipment
Interest Received
Dividends received
Net cash used in investing activities
20
200
200
(480)
(350)
IAS 7 Cash Flows Direct Method
Cash flows from financing activities
Proceeds from issue of share capital
250
Proceeds from long-term borrowings
250
Payment of finance lease liabilities
(90)
Dividends paid
(1200)
IAS 7 Cash Flows Direct Method
Effect of exchange rate changes
( 40)
Net increase in cash and cash equivalents
70
Cash and cash equivalents at beginning of
period
160
230
Cash and cash equivalents at end of period