Financial statement
analysis
Learn to read and analyse your
financial data
Financed by
Financed by
Supported by
Supported by
Implemented in cooperation with
Implemented in cooperation with
Who does financial statement analysis
of your SME?
 Your banker - to determine your capability of paying back a
loan or getting a loan in the first place.
 Your investor(s) - to determine if you have been performing
according to plan, and/or whether your business is a good
investment.
 Your suppliers - to determine your credit worthiness etc.
 everyone who looks at your financial statements will conduct
a financial statement analysis, in one form or another.
Financed by
Supported by
Implemented in cooperation with
Types of financial statement analysis
 Vertical and horizontal analysis (analysis of absolute
indicators)
 Analysis using perfomance measures (ratios)
Financed by
Supported by
Implemented in cooperation with
Vertical and horizontal analysis
(analysis of absolute indicators)
 This method of analysis uses direct data involved in
financial statements (Balance sheet and Income (Profit
and loss) statement) – for assessing and following of
financial situation of a given firm.
Financed by
Supported by
Implemented in cooperation with
Vertical analysis
 Vertical analysis shows how do different parts of a
financial statement relate to a total figure in the
statement.
 We set the total figure at 100 percent and compute each
part’s percentage of that total.
 On the balance sheet, the figure would be total assets or
total liabilities and owner’s equity, and
 on the income statement, the figure would be total
revenues or total sales.
Financed by
Supported by
Implemented in cooperation with
 The main advantage of vertical analysis is its
independence of the possible yearly inflation, allowing
the comparability of results of analysis from various
years and even comparison of various companies.
 We can see the percentage of various items with respect
to total revenue (in P&L statement) and with respect to
total assets and liabilities.
Financed by
Supported by
Implemented in cooperation with
Horizontal (trend) analysis
 By comparing current financial statements to previous or planned
financial statements you can see which areas of your business have
changed, and by how much.
 We compare line by line how much have certain items changed (by
using index or percentage change)
 We can then ask ourselves why the change occurred, whether
positive or negative:
- Are sales going up/down ?
- Are costs going up/down (which ones aren’t)?
- Are profits going up/down?
Financed by
Supported by
Implemented in cooperation with
Short example – vertical and horizontal analysis of
Profit and loss (Income) statement
DESCRIPTION
1.TOTAL INCOME
Sales of products
Domestic market
Foreign market
Other income
2. OPERATING COSTS
Change in inventory value
Cost of goods sold
Personnel costs
Depreciation
Other operating costs
3. EARNINGS BEFORE INTEREST
AND TAX (1-2)
Financed by
1.1.-31.12.2013
(000 EUROS)
Supported by
%
1.1.-31.12.2014.
(000 EUROS)
3.981,50
3.875,45
3.512,20
363,25
106,05
2.186,42
-31,00
1.300,35
503,80
110,25
303,02
100,0
97,3
88,2
9,1
2,7
54,9
-0,8
32,7
12,7
2,8
7,6
4.592,47
4.502,72
3.800,92
701,80
89,75
2.642,25
-23,05
1.583,03
604,05
154,05
324,17
1.795,08
45,1
1.950,22
%
100,0
98,0
82,8
15,3
2,0
57,5
-0,5
34,5
13,2
3,4
7,1
INDEX 14/13
115,3
116,2
108,2
193,2
84,6
120,8
74,4
121,7
119,9
139,7
107,0
42,5
108,6
Implemented in cooperation with
Short example – vertical and horizontal analysis of
Balance sheet
ASSETS
31.12.2013.
(000 EUROS)
Long-term assets
Non-material assets
Investments
Long-term receivables
Prepayables for long-term assets
Long-term material assets
Total long-term assets
Short-term (current) assets
Inventories
Accounts receivables
Financial assets
Cash and cash equivalents
Total short-term (current) assets
TOTAL ASSETS
Financed by
Supported by
%
31.12.2014.
(000 EUROS)
%
INDEX (2014/2013)
35,02
1.583,20
90,02
0,6
29,4
1,7
45,01
1.782,30
107,80
0,7
26,6
1,6
128,5
112,6
119,8
70,03
1.901,00
3.679,27
1,3
35,3
68,3
130,10
2.210,45
4.275,66
1,9
32,9
63,7
185,8
116,3
116,2
473,20
1.002,30
90,10
143,20
8,8
18,6
1,7
2,7
584,20
1.413,10
123,50
312,10
8,7
21,1
1,8
4,7
123,5
141,0
137,1
217,9
1.708,80
5.388,07
31,7
100,0
2.432,90
6.708,56
36,3
142,4
100,0
124,5
Implemented in cooperation with
How do we read the data? – example Profit
and loss statement
 Total income (turnover) has increased in year 2014 by 15,3%,
mainly due to growth in sales of products by 16,2%. –
HORIZONTAL
 In the structure of income, 97,3% in 2013 and 98% in 2014
come from sales of products, of which sales on domestic
market is predominant (88,2% in 2013 and 82,8% in 2014) –
VERTICAL
 Operating costs have grown by 20,8% due to increase in costs
of good sold by 21,7% (which represent the highest share in
overall cost structure (32,7% in 2013 and 34,5% in 2014) –
combination of VERTICAL and HORIZONTAL analysis
 THE SAME PRINCIPLE APPLIES FOR BALANCE SHEET!
Financed by
Supported by
Implemented in cooperation with
Relative indicators
 Besides vertical/horizontal analysis, management and
other interested parties (banks, investors, suppliers etc.)
use for their analysis various financial indicators based on
items from your financial reports.
 These indicators show if firm is safe to invest in (liquid,
financialy stable and in debth) and to what extent is it
successful (profitable).
Financed by
Supported by
Implemented in cooperation with
Types of indicators
 liquidity ratios – ratios showing capability of firm to
service its current (short-term) obligations;
 leverage ratios – ratios showing the extent to which firm
is financed from other sources;
 acitivity ratios – ratios showing efficiency of firm in use of
its own resources;
 profitability ratios – ratios measuring return on capital
invested;
Financed by
Supported by
Implemented in cooperation with
Liquidity ratios
 ratios that measure the ability of a firm to pay its short
term debt obligations.
 They put in relation characteristic parts of the assets and
liabilities of the firm – Balance sheet data
 They determine the maturity structure of business
financing sources
 Main indicators: current ratio, quick ratio or acid test,
cash ratio
Financed by
Supported by
Implemented in cooperation with
Current ratio
 The current ratio indicates a firm's ability to meet short-term debt
obligations.
 It measures whether or not a firm has enough resources to pay its
debts over the next 12 months. Potential creditors use this ratio in
determining whether or not to make short-term loans.
 The current ratio = Current (Short-term) Assets / Current (Shortterm) Liabilities
 The higher the ratio, the more liquid the firm is. Commonly
acceptable current ratio is 2 (short term assets are 2x the short term
liabilities)
Financed by
Supported by
Implemented in cooperation with
Quick ratio/Acid test
 measures the ability to meet short-term obligations using its most




liquid assets
Quick assets include those current assets that can be quickly
converted to cash.
Quick ratio is viewed as a sign of a firm's financial strength or
weakness; it gives information about a firm’s short term liquidity.
Quick ratio = (Cash and cash equivalents + Accounts receivable) /
Current Liabilities
It should be minimum 1, which means that current liabilities should
not be larger than the sum of cash and receivables
Financed by
Supported by
Implemented in cooperation with
Cash ratio
 ratio of a firm's cash and cash equivalent assets to its total liabilities
 is a refinement of quick ratio - the extent to which readily available funds can pay off current
liabilities.
 Potential creditors use this ratio as a measure of a firm's liquidity and how easily it can
service debt and cover short-term liabilities.
 Most conservative of the three liquidity ratios (current, quick and cash ratio). It only looks at
the firm's most liquid short-term assets – cash and cash equivalents
 Cash ratio = Cash and cash equivalents / Current Liabilities
 It should not be less than 0.1. If it is 1 and larger, it means that the firm has enough cash to
pay its current liabilities within 15 days.
 in practice (especially in large companies ) it is never 1 since it means that firm is not utilizing
its cash in a good way. Companies should use extra cash to invest in business, and too much
cash represents possibility for hostile takover.
 Bare in mind - in the crisis, cash is king!
Financed by
Supported by
Implemented in cooperation with
Leverage ratios
 Ratios showing how much of companies activities are
covered from own assets and how much from various
debt.
 Predominantly calculated from Balance Sheet statement
 They influence SME’s credit rating - banks and investors
can easily calculate the ability of the business to pay
existing debt.
 Main indicators: Debt ratio, Debt to equity ratio, Equity
ratio
Financed by
Supported by
Implemented in cooperation with
Debt ratio




ratio that indicates proportion between firm's debt and its total assets.
It shows how much the firm relies on debt to finance assets.
Debt ratio = Total Liabilities / Total Assets
The higher the ratio, the greater the risk associated with the firm's performance –
the firm will not be able to service its debts with the financial results achieved and
will not it be able to cover interests on the debt.
 A low debt ratio indicates conservative financing with an opportunity to borrow in
the future at no significant risk.
If the ratio is less than 0.5, most of the firm's assets are financed through equity
(desirable). If the ratio is greater than 0.5, most of the firm's assets are financed
through debt.
Financed by
Supported by
Implemented in cooperation with
Debt to equity ratio
 Measuring the relative proportion of firm’s equity and debt used to finance




firm’s assets. Also called financial leverage.
key financial ratio used as a standard for judging a firm’s financial
standing and as measurement of ability to repay obligations.
If the ratio is increasing, firm is being financed by creditors rather than
from its own financial sources which may be a dangerous trend.
Lenders and investors usually prefer low debt-to-equity ratios because
their interests are better protected in the event of a business decline.
high debt-to-equity ratios - firms may not be able to attract additional
lending capital.
 Debt-to-equity ratio = Total Liabilities / Equity
Financed by
Supported by
Implemented in cooperation with
 Optimal debt-to-equity ratio is considered to be about 1, i.e.
liabilities = equity,
 ratio is very industry specific - it depends on the proportion of
current and non-current assets.
 For most companies the maximum acceptable debt-to-equity
ratio is 1.5-2 and less. For large public companies the debt-toequity ratio may be much more than 2, but for most small and
medium companies it is not acceptable.
Financed by
Supported by
Implemented in cooperation with
Equity ratio
 Also called - net worth to total assets ratio.
 It tells us how much of the asset is financed from own capital
(equity) and how much from the creditors.
 Equity Ratio = owners equity / Total assets
 The value should be more than 0.5, meaning that for every 1
euro employed in the business, the contribution of owners is
about 50 eurocents or more. The creditors’ contribution would
then be 50 eurocents and less.
Financed by
Supported by
Implemented in cooperation with
Activity ratios
 also called turnover ratios,
 how many time during the year certain assets are “turned over” in
firm (speed of circulating the assets in business process)
 Most commonly used are turnover ratios on: total assets, shortterm (current) assets and receivables
 Average collection period – calculated from turnover ratios
 calculated using the figures from Profit and Loss Statement and
Balance Sheet
 Note: the items from the balance sheet can be used as average (beginning + end of
year)/2 or as stated at the end of the year!
Financed by
Supported by
Implemented in cooperation with
 Generaly speaking, successful companies have high
turnover ratios, i.e. the time in which the assets is held in
firm is shorter.
 How do you know you are succesful?
– compare yourself with other firms in the industry, or in
relation to previous years.
Financed by
Supported by
Implemented in cooperation with
Total assets turnover
 measure of how efficiently management is using the
assets at its disposal to boost sales. The ratio helps to
measure the productivity of a firm's assets.
 Asset turnover = total revenue (income) / total assets
Financed by
Supported by
Implemented in cooperation with
Current assets turnover
 Ratio that tells us how many time during the year we
“turn over” the current assets in order to gain as high
revenue (income from sales) as possible
 Current asset turnover = total revenue (income) / current
assets
Financed by
Supported by
Implemented in cooperation with
Receivable turnover ratio
 Receivable turnover ratio indicates how many times, on
average, account receivables are collected during a year
 It is an important indicator of a firm's financial and
operational performance, used also to determine if a firm
is having difficulties collecting sales made on credit.
 Receivable turnover ratio = income from sales / accounts
receivables
Financed by
Supported by
Implemented in cooperation with
Average collection period (Days sales
outstanding)
 It tells us, on average, how many day it takes a firm to
collect its accounts receivables, i.e. the average number of
days required to convert receivables into cash.
 Average collection period (Days sales outstanding) = 365 /
Receivables Turnover Ratio
Financed by
Supported by
Implemented in cooperation with
Profitability ratios
 Types of financial ratios showing ability of firm to
generate income in relation to cost in a given period.
 the larger the value in relation to the competitor or
previous years means that firm is doing good job.
Financed by
Supported by
Implemented in cooperation with
 Main indicators: Net profit margin, Return on sales
(ROS), Return on assets (ROA) and Return on equity
(ROE)
 They are calculated combining data from Balance sheet
and Profit and Loss statement
Financed by
Supported by
Implemented in cooperation with
Net profit margin
 Most important profitability ratio
 It shows the amount of each sales euro left over after all
expenses have been paid.
 Useful when comparing firms in similar industries.
 Higher net profit margin - firm is more efficient at
converting sales into actual profit.
 Net profit margin = (Net profit/ Total revenue) x 100
Financed by
Supported by
Implemented in cooperation with
Return on sales (ROS)
 also known as "operating profit margin“
 ROS indicates how much profit firm makes after paying
for variable costs of production such as wages, raw
materials, etc. (but before interest and tax) – operating
profit also known as EBIT (earnings before interests and
taxes)
 Return on sales (operating margin)= (EBIT / Total
revenue) X 100
Financed by
Supported by
Implemented in cooperation with
 ROS tells us how much operating profit is firm gaining for
each euro of sale/revenue. For example, if ROS is 20%, it
means that firm has EBIT of 0,2 euros for each 1 euro of
revenue.
 The higher the productivity, i.e. production of larger
amount of output with the same amount of input,
profitability will be also higher.
Financed by
Supported by
Implemented in cooperation with
Return on assets (ROA)
 shows the percentage of profit that a firm earns in relation to its
overall resources (total assets).
 It measures the amount of profit made by a firm per euro of its
assets.
 gives an indication of the capital intensity of the firm, which will
depend on the industry. Capital-intensive industries (such as
railroads and thermal power plant) - low return on assets due to
huge assets required. Software and service companies - high ROA:
their required assets are minimal.
 ROA = (Net profit / Total assets) X 100
Financed by
Supported by
Implemented in cooperation with
Return on equity (ROE)
 The “mother of all ratios”
 It shows how much profit a firm earned in comparison to
the total amount of owner equity found on the balance
sheet.
 It measures how profitable a firm is for the owner of the
investment, and how profitably a firm employs its equity.
 ROE = (Net profit / Owner's equity) X 100
Financed by
Supported by
Implemented in cooperation with