Financial Statement
Analysis
Financial Analyst:
The financial analyst can be viewed as any user of
available information concerning firms who wishes to
use the information for the purpose of decision
making.
 Financial Analysis:
 It is the procedure the financial analyst uses to
interpret the information.


The art of transforming data from Financial
Statements into information that is useful for
informed decision making is called Financial
Statement Analysis.
 The firm itself and outside providers of capital
(creditors and investors) all undertake financial
statement analysis.
 The type of analysis varies according to the specific
interest of the party involved.

Trade Creditors -- Focus on the liquidity of the firm.
Their claims are short term, and the ability of the
firm to pay these claims quickly is best judged by an
analysis of the firm’s liquidity.


Bondholders -- Focus on the long-term cash flow of
the firm.
 Because the Bondholder are more interested in the
cash flow ability of the firm to service Debt over a
long period of time.
 They may evaluate this ability by analyzing the
capital structure of the firm, the major sources and
uses of funds, the firm’s profitability over time and
projection of future profitability.

Shareholders -- Focus on the profitability and longterm health of the firm.
 They would also be concerned with the firm
financial condition.

Plan -- Focus on assessing the current financial
position and evaluating potential firm opportunities in
relation to this current position.
 Control – With respect to internal control, the
financial manager is particularly concerned with the
return on investment provided by the company and
with the efficiency of assets management.

Understand –To bargain effectively for outside
funds, Financial Manager need to Focus on all aspect
of financial analysis for understanding how suppliers
of funds analyze the firm.

Balance Sheet
A summary of a firm’s financial position on a
given date that shows total assets = total
liabilities + owners’ equity.
Income Statement


A summary of a firm’s revenues and expenses over a specified
period, ending with net income or loss for the period.
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
Cash and C.E.
$ 90 Acct.
a. How the firm stands on a
Rec.c
394
specific date.
Inventories
696 b. What BW owned.
Prepaid Exp d
5 Accum c. Amounts owed by
Tax Prepay
10
customers.
Current Assetse $1,195 Fixed d. Future expense items
Assets (@Cost)f 1030 Less: Acc.
already paid.
g
Depr.
(329)
Net Fix.
e. Cash/likely convertible to
Assets $ 701 Investment, LT
cash within 1 year.
50 Other Assets, f. Original amount paid.
LT
223
Total Assets g. Acc. deductions for wear
b
$2,169
and tear.
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
Notes Payable
$ 290 a. Note, Assets = Liabilities +
Acct. Payablec
94 Accrued
Equity.
Taxes d
16 Other Accrued b. What BW owed and
Liab. d
100
ownership position.
Current Liab. e $ 500
c. Owed to suppliers for goods
Long-Term Debt f
530
and services.
Shareholders’ Equity
d. Unpaid wages, salaries, etc.
Com. Stock ($1 par) g 200 Add Pd e. Debts payable < 1 year.
in Capital g
729 Retained f. Debts payable > 1 year.
Earnings h
210 Total Equity g. Original investment.
$1,139
h. Earnings reinvested.
a,b
Total Liab/Equity $2,169
Basket Wonders Statement of Earnings (in thousands) for Year Ending December
31, 2003a
Net Sales b
$ 2,211
a. Measures profitability over a
Cost of Goods Sold
1,599
time period.
Gross Profit
$ 612
b. Received, or receivable, from
SG&A Expenses c
402
customers.
EBITd
$ 210
c. Sales comm., adv., officers’
Interest Expense
59
salaries, etc.
EBT f
$ 151
d. Operating income.
Income Taxes
60
EATg e. Cost of borrowed funds.
$
91 Cash
f. Taxable income.
Dividends
38 Increase g. Amount earned for
in RE
$
53
shareholders.
There is little to be gained by analyzing the financial
statements of a company for one year alone.
 A “benchmark” is needed by which to judge a
company’s performance.
 This “benchmark” can be obtained by comparing
companies with in the same industries with other
companies.
 This is known as a cross-sectional study.

To compare the accounts of one company with its
own previous years. Possible to see if a company is
improving in certain areas or not.
 This is known as a Time series study.

A Financial Ratio is an
index that relates two
accounting numbers and
is obtained by dividing
one number by the other.
Types of
Comparisons
Internal
Comparisons
External
Comparisons
To compare a present ratio with past and expected
future ratios for the same company is called Internal
comparisons.
 For example to compare the Kardan 2008 ratios
with Kardan 2007 and 2006 ratios that either they
have improved or not.

This involves comparing the ratios of one firm with those of
similar firms or with industry averages.
 Or
 To compare the ratios of one firm with those of similar firms
or with industry averages at the same point in time is called
External Comparisons.
 Similarity is important as one should compare “apples to
apples.”
 Example: to compare the ratios of Kardan and Bakhtar

As Percentage - such as 25% or 50% . For example if
net profit is Rs.25,000/- and the sales is Rs.1,00,000/then the net profit can be said to be 25% of the sales.
 As Proportion
- The above figures may be
expressed in terms of the relationship between net
profit to sales as 1 : 4.
 As Pure Number /Times - The same can also be
expressed in an alternatively way such as the sale is
4 times of the net profit or profit is 1/4th of the sales.

Ratios standardize numbers and facilitate
comparisons.
 Ratios are used to highlight weaknesses and
strengths.







(i) Liquidity Ratios
(ii) Financial Leverage (Debt) Ratios
(iii) Coverage Ratios
(iv) Activity Ratios
(v) Profitability Ratios
(vi) Investment Ratios
Balance Sheet Ratios
Liquidity Ratios
Ratio’s that measure a firm’s ability to meet short
term obligations.
Or
It shows that Can we make required payments?
Liquidity ratios are used to measure a firm ability to
meet short term obligations.
 They compare short term obligations with short
term (or current) resources available to meet these
obligations.
 From these ratios, much insight can be obtained
into the present cash solvency of the firm.

Balance Sheet Ratios
Liquidity Ratios
(i)
(ii)
Current Ratio
Acid test (quick) Ratio
Balance Sheet Ratios
Current Ratio
Shows a firm’s ability to cover its current liabilities with its
current assets.
Or
It is the relationship between the current assets and current
liabilities of a firm.
Balance Sheet Ratios
Current Ratio
Liquidity Ratios
Current Assets
Current Liabilities
If
Current Assets = Rs.1,195
and
Current Liabilities = Rs.500
Rs.1,195 = 2.39
Rs.500
Looks at the ratio between Current Assets and Current Liabilities
 Ideal level? – 1.5
 A ratio of 2.39 would imply the firm has $2.39 of current assets to
cover every $1 in current liabilities
 Too high – Might suggest that too much of its assets are tied up in
unproductive activities – too much stock, for example?
 Too low - risk of not being able to pay Current liabilities.

Current Ratio
Year
2003
2002
2001
BW
2.39
2.26
1.91
Industry
2.15
2.09
2.01
Ratio is stronger than the industry average.
Balance Sheet Ratios
Acid test (quick) Ratio
Shows a firm’s ability to meet current liabilities with its most
liquid assets.
Or
It is the ratio between Quick Current Assets and Current
Liabilities.
Balance Sheet Ratios
Acid-Test (Quick)
Liquidity Ratios
Current Assets - Inv
Current Liabilities
If
Current Assets = $1,195
and
Current Liabilities = $500
Inventory
= $696
$1,195 - $696 = 1.00
$500
1 seen as ideal
 It has been argued that Inventory takes a while to convert to cash so a
more realistic ratio would ignore Inventory.
 The omission of Inventory gives an indication of the cash the firm
has in relation to its liabilities (what it owes)
 A ratio of 1 would imply that the firm has $1 of cash to cover every
$1 in current liabilities.
 Again if it is too high means that the business is very liquid – may be able
to use the cash for other activities to increase performance.
 If it is too low then the business may face problems in payment of current
liabilities.
 Some types of business need more cash than others so acid test would be
expected to be higher

Acid-Test Ratio
Year
2003
2002
2001
BW
1.00
1.04
1.11
Industry
1.25
1.23
1.25
Ratio is weaker than the industry average.
Ratio
Current
Acid-Test


BW
2.39
1.00
Industry
2.15
1.25
Strong current ratio and weak acid-test ratio
indicates a potential problem in the
inventories account.
Note that this industry has a relatively high
level of inventories.
Ratio Value
Trend Analysis of Current Ratio
2.5
2.4
2.3
2.2
2.1
2.0
1.9
1.8
1.7
1.6
1.5
2001
BW
Industry
2002
Analysis Year
2003
Trend Analysis of Acid-Test Ratio
Ratio Value
1.5
1.3
1.0
BW
Industry
0.8
0.5
2001
2002
Analysis Year
2003

The current ratio for BW has been rising at
the same time the acid-test ratio has been
declining.

The current ratio for the industry has been
rising slowly at the same time the acid-test
ratio has been relatively stable.
This indicates that inventories are a significant
problem for BW.

Balance Sheet Ratios
Financial Leverage Ratios
Shows the extent to which the firm is financed
by debt.
Balance Sheet Ratios
Financial Leverage Ratios
(i). Debt-to-Equity
(ii). Debt-to-Total-Assets
(iii). Total Capitalization
Balance Sheet Ratios
Debt-to-Equity
It is the relationship between borrower’s fund (Debt)
and Owner’s Capital (Equity).
The Debt to Equity ratio is computed by simply
dividing the total debt of the firm (including
current liabilities) by its share holder’s equity.
Balance Sheet Ratios
Financial Leverage
Ratios
If
Total Debt = 1030
and
Shareholder’s equity = 1139
Debt-to-Equity
Total Debt
Shareholders’ Equity
For Basket Wonders
December 31, 2003
$1,030 = .90
$1,139
The ratio 0.90 tells us that creditors are providing 90
cents of financing for each $1 being provided by
shareholder’s.
 Creditors would generally like this ratio to be low.
 The lower the ratio the higher the level of the firm’s
financing that is being provided by shareholder’s, and
the larger the creditor cushion (margin of protection)
in the event of losses.

Debt-to-Equity Ratio
Year
2003
2002
2001
BW
.90
.88
.81
Industry
.90
.90
.89
BW has average debt utilization
relative to the industry average.
Balance Sheet Ratios
Debt-to-Total-Assets
Shows the percentage of the firm’s assets that are
supported by debt financing.
or
It is the relationship between borrower’s fund (Debt)
and total Assets.
Balance Sheet Ratios
Financial Leverage
Ratios
If
Total Debt = 1030
And
Total assets = 2169
Debt-to-Total-Assets
Total Debt
Total Assets
For Basket Wonders
December 31, 2003
$1,030 = .47
$2,169
This ratio highlights the relative importance of debt
financing to the firm by showing the percentage of
the firm’s assets that is supported by debt financing.
 The 0.47 ratio shows that 47 percent of the firm
assets are financed by debt and remaining 53 percent
of the finance comes from shareholder’s equity.

Once again this ratio points out that the greater the
percentage of financing provided by shareholder’s
equity, the larger the cushion of protection offered
the firm’s creditors.
 In short the higher the Debt to total assets ratio, the
greater the financial risk; the lower the ratio, the
lower the financial risk.

Debt-to-Total-Asset Ratio
Year
2003
2002
2001
BW
.47
.47
.45
Industry
.47
.47
.47
BW has average debt utilization
relative to the industry average.
Balance Sheet Ratios
Long term Debt to Total Capitalization(i.e., LT-Debt + Equity)
Shows the relative importance of long-term debt to the
long-term financing of the firm.
Total capitalization represents all long term debt and
shareholder’s equity.
Balance Sheet Ratios
Total Capitalization
Financial Leverage
Ratios
Long Term Debt
Total Capitalization
If
Long term Debt = 530
And
LT-debt + Equity = 1669
For Basket Wonders
December 31, 2003
(i.e., LT-Debt + Equity)
$530 = .32
$1,669
This measure tells us the relative importance of long
term debt to the long term financing of the firm.
 The 0.32 ratio shows that 32 percent of the firm
total long term financing is provided by long term
debt and remaining 68 percent of the finance comes
from shareholder’s equity.

Total Capitalization Ratio
Year
2003
2002
2001
BW
.32
.34
.33
Industry
.30
.32
.31
BW has average long-term debt utilization
relative to the industry average.
In summary, debt ratios tell us the relative
proportions of capital contribution by creditors and by
owners.

Income Statement Ratios
Coverage Ratios
Ratios that relates the financial charges (interest) of a
firm to its ability to service or cover them.
Income Statement Ratios
Coverage Ratios
(i) Interest Coverage ratio
Income Statement Ratios
Interest Coverage Ratio
It Indicates a firm’s ability to cover interest charges. It is
also called times interest earned.
Income Statement
Ratios
Interest Coverage
EBIT
Interest Charges
Coverage Ratios
If
EBIT = 210
And
Interest Charges = 59
For Basket Wonders
December 31, 2003
$210 = 3.56
$59
This ratio serves as one measure of the firm’s ability
to meet its interest payments and avoid bankruptcy.
 In general the higher the ratio, the greater the
likelihood that the company could cover its interest
payments without difficulty.
 It also sheds some light on the firm capacity to take
on new debt.

Ratio of 3.56 shows the BW ability to cover annual
interest 3.56 times with operating income (EBIT).

Interest Coverage Ratio
Year
2003
2002
2001
BW
3.56
4.35
10.30
Industry
5.19
5.02
4.66
BW has below average interest coverage
relative to the industry average.
Trend Analysis of Interest Coverage Ratio
Ratio Value
11.0
9.0
7.0
BW
Industry
5.0
3.0
2001
2002
Analysis Year
2003

The interest coverage ratio for BW has
been falling since 2001. It has been below
industry averages for the past two years.

This indicates that low earnings (EBIT) may be
a potential problem for BW.
Note, we know that debt levels are in line
with the industry averages.

EXERCISE 1
LIABILITES
Capital
Reserves
ASSETS
180 Net Fixed Assets
20 Inventories
Term Loan
300 Cash
Bank C/C
200 Receivables
Trade Creditors
50 Goodwill
Provisions
50
800
a.
b.
c.
d.
e.
f.
400
150
50
150
50
800
What is the Net Worth : Capital + Reserve = 200
Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600
Net Working Capital : C A - C L = 350 - 250 = 50
Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1
EXERCISE 2
LIABILITIES
2005-06
2006-07
2005-06
2006-07
Capital
300
350 Net Fixed Assets
730
750
Reserves
140
160 Security Electricity
30
30
Bank Term Loan
320
280 Investments
110
110
Bank CC (Hyp)
490
580 Raw Materials
150
170
Unsec. Long T L
150
170 S I P
20
30
Creditors (RM)
120
70 Finished Goods
140
170
Bills Payable
40
80 Cash
30
20
Expenses Payable
20
30 Receivables
310
240
Provisions
20
40 Loans/Advances
30
190
50
50
1600
1760
Goodwill
Total
1600
1760
1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390
2. Current Ratio for 2nd Year : (170 + 30 +170+20+ 240 + 190 ) / (580+70+80+70)
820 /800 = 1.02
3. Debt Equity Ratio for 1st Year : 320+150 / 390 = 1.21
Exercise 3.
LIABIITIES
ASSETS
Equity Capital
200 Net Fixed Assets
800
Preference Capital
100 Inventory
300
Term Loan
600 Receivables
150
Bank CC (Hyp)
400 Investment In Govt. Secu.
Sundry Creditors
100 Preliminary Expenses
Total
1400
1. Debt Equity Ratio will be : 600 / (200+100)
50
100
1400
= 2:1
2. Tangible Net Worth : Only equity Capital i.e. = 200
3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1
Exercise 4.
LIABILITIES
ASSETS
Capital + Reserves
355
P & L Credit Balance
Net Fixed Assets
7 Cash
Loan From S F C
100 Receivables
265
1
125
Bank Overdraft
38 Stocks
Creditors
26 Prepaid Expenses
1
Provision of Tax
9 Intangible Assets
30
Proposed Dividend
15
550
Q. What is the Current Ratio ?
Q What is the Quick Ratio ?
550
Ans : (1+125 +128+1) / (38+26+9+15)
: 255/88 = 2.89 : 1
Ans : (125+1)/ 88 = 1.43 : 11
Q. What is the Debt Equity Ratio ?
128
Ans : LTL / Tangible NW
= 100 / ( 362 – 30)
= 100 / 332 = 0.30 : 1
Income Statement/Balance Sheet Ratios
Activity Ratios
Ratios that measure how effectively the firm is using its
assets are called Activity Ratios.
Activity ratios, also known as Efficiency or Turnover
Ratio, measure how effectively the firm is using its
assets.
 In this section, we will focus our attention primarily
on how effectively the firm is managing two specific
asset groups receivables and inventories and its total
assets in general.

Income Statement/Balance Sheet Ratios
Activity Ratios
(i)
(ii)
(iii)
(iv)
(v)
(vi)
Receivable turnover Ratio
Average Collection Period (Receivable turnover in Days)
Payable turnover Ratio
Average Payable Period (Payable Turnover in Days)
Inventory Turnover Ratio
Total Assets turnover ratio
Income Statement/Balance Sheet Ratios
Receivable Turnover Ratio
Indicates quality of receivables and how successful the
firm is in its collections.
This is also called Debtors Velocity or Average
Collection Period or Period of Credit given .
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
Annual Net Credit Sales = 2211
And
Account Receivables = 394
Receivable Turnover
(Assume all sales are credit sales.)
Annual Net Credit Sales
Receivables
For Basket Wonders
December 31, 2003
$2,211 = 5.61
$394
This ratio tells us the number of times accounts
receivables have been turned over (turned into cash)
during year.
 The higher the turnover, the shorter the time
between the typical sales and cash collection, and vise
versa.
 For BW ratio 5.61 tells us that 5.61 times accounts
receivables have been turned over (turned into cash)
in 2003.

Income Statement/Balance Sheet Ratios
Average Collection Period
Average number of days that receivables are
outstanding.
(or Receivable Turnover in days)
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
Days in the year = 365
And
Receivable turn over = 5.61
Average Collection Period
Days in the Year
Receivable Turnover
or
Receivables * Days in the year
Annual Credit sales
For Basket Wonders December 31, 2003
365
5.61
= 65 days
It Gives a measure of how long it takes the business to
recover debts.
 65 days means that Average collection period of BW is 65
days.
 Shorter period is better as get cash more quickly.

Average Collection Period
Year
2003
2002
2001
BW
65.0
71.1
83.6
Industry
65.7
66.3
69.2
BW has improved the average collection
period to that of the industry average.
Income Statement/Balance Sheet Ratios
Payable Turnover Ratio
Indicates the promptness of payment to suppliers by
the firm.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
Annual Credit Purchases = 1551
And
Account Payable = 94
Payable Turnover (PT)
(Assume annual credit
purchases = $1,551.)
Annual Credit Purchases
Accounts Payable
For Basket Wonders
December 31, 2003
$1551
= 16.5
$94
When a firm wants to study its own promptness of
payment to suppliers or that of a potential credit
customer.
 In such cases it may desirable to analyze the payable
turnover ratio.
 For BW ratio 16.5 tells us that 16.5 times accounts
payable have been turned over (turned into cash
means paid to the suppliers) in 2003.

Income Statement/Balance Sheet Ratios
Payable Turnover in Days
Average number of days that payables are outstanding.
This is also called Creditors Velocity Ratio, which
determines the creditor payment period.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
Days in the year = 365
And
Payable turnover = 16.5
PT in Days
Days in the Year
Payable Turnover
Or
Accounts payable * Days in the year
Annual Credit Purchases
For Basket Wonders December 31, 2003
365
16.5
= 22.1 days
The average payable period is valuable information
in evaluating the probability that a credit applicant will
pay on time.
 If the average age of payables is 48 days and the
terms in industry are “net 30” we know that a portion
of the applicant’s payables is not being paid on time.
 Ratio of 22.1 means that the business paid the
Accounts Payables in 22.1 days on average.

Payable Turnover in Days
Year
2003
2002
2001
BW
22.1
25.4
43.5
Industry
46.7
51.1
48.5
BW has improved the PT in Days.
Income Statement/Balance Sheet Ratios
Inventory Turnover Ratio
Indicates the effectiveness of the inventory
management practices of the firm.
Or
The rate at which a company’s Inventory is turned over
is called Inventory turnover ratio.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
CGS = 1599
And
Inventory = 696
Inventory Turnover
Cost of Goods Sold
Inventory
For Basket Wonders
December 31, 2003
$1,599 = 2.30
$696

A high Inventory turnover might mean increased efficiency?
 But: dependent on the type of business – supermarkets might
have high inventory turnover ratios whereas a shop selling high
value musical instruments might have low inventory turnover
ratio.
 Low Inventory turnover could mean poor customer satisfaction if
people are not buying the goods.
 Ratio of 2.30 means that the company converts Inventory into A/R through
sales 2.30 times in one year.
Inventory Turnover Ratio
Year
2003
2002
2001
BW
2.30
2.44
2.64
Industry
3.45
3.76
3.69
BW has a very poor inventory turnover ratio.
Trend Analysis of Inventory Turnover Ratio
Ratio Value
4.0
3.5
3.0
BW
Industry
2.5
2.0
2001
2002
Analysis Year
2003
Income Statement/Balance Sheet Ratios
Total Assets Turnover Ratio
Indicates the overall effectiveness of the firm in
utilizing its assets to generate sales.
Or
The relationship of net sales to total assets is known as
total assets turnover ratio.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
If
Net Sales = 2211
And
Total Assets = 2169
Total Asset Turnover
Net Sales
Total Assets
For Basket Wonders
December 31, 2003
$2,211 = 1.02
$2,169
 It looks at a businesses sales compared to the assets used to
generate the sales.
 A ratio of 1.02 means that BW generate $1.02 sales revenue on
each $1 investment in assets.
 Businesses with a high value of assets who have few sales will
have a low asset turnover ratio
 If a business has a high sales and a low value of assets it will have
a high asset turnover ratio
 Businesses can improve this by either increasing sales performance
or getting rid of any additional assets
Total Asset Turnover Ratio
Year
2003
2002
2001
BW
1.02
1.03
1.01
Industry
1.17
1.14
1.13
BW has a weak total asset turnover ratio.
Excessive investment in receivables and inventories
increase assets and hence decrease the ratio.
 If BW could generate the same sales revenue with
fewer dollar invested in receivables and inventories,
total asset turnover ratio would improve.

Income Statement/Balance Sheet Ratios
Profitability Ratios
Ratios that relate profits to sales and investment are
called profitability ratios.
Or
Profitability ratios measures that how much profit the firm
generates.
Income Statement/Balance Sheet Ratios
Profitability Ratios
Gross Profit Margin
(ii) Net Profit Margin
(iii) Return On Investment
(iv) Return on Equity
(i)
Income Statement/Balance Sheet Ratios
Gross Profit Margin
Indicates the efficiency of operations and firm pricing
policies.
Or
It shows the relationship between Gross profit and
sales.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
If
Gross Profit = 612
And
Net Sales = 2211
Gross Profit Margin
Gross Profit
Net Sales
For Basket Wonders
December 31, 2003
$612 = .277
$2,211
The higher the better
Enables the firm to assess the impact of its sales and
how much it cost to generate (produce) those sales.
 A gross profit margin of .277 means that for every $1
of sales, the firm makes $27.7 cents in gross profit.


Gross Profit Margin
Year
2003
2002
2001
BW
27.7%
28.7
31.3
Industry
31.1%
30.8
27.6
BW has a weak Gross Profit Margin.
Trend Analysis of Gross Profit Margin
Ratio Value (%)
35.0
32.5
30.0
BW
Industry
27.5
25.0
2001
2002
Analysis Year
2003
Income Statement/Balance Sheet Ratios
Net Profit Margin
Indicates the firm’s profitability after taking account of
all expenses and income taxes.
Or
It shows the relationship between Net profit and sales.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
If
Net profit = 91
And
Net Sales = 2211
Net Profit Margin
Net Profit after Taxes
Net Sales
For Basket Wonders
December 31, 2003
$91 = .041
$2,211
Net profit margin looks at how much of the sales revenue
is left as net profit.
 A net profit margin of .041 means that for every
$1 of sales, the firm makes $4.1 cents in net profit.
 Net profit is more important than gross profit for a
business as all costs are included
 A business would like to see that this ratio has improved
over time.

Net Profit Margin
Year
2003
2002
2001
BW
4.1%
4.9
9.0
Industry
8.2%
8.1
7.6
BW has a poor Net Profit Margin.
Trend Analysis of Net Profit Margin
Ratio Value (%)
10
9
8
7
BW
6
Industry
5
4
2001
2002
Analysis Year
2003
Income Statement/Balance Sheet Ratios
Return on Investment
Indicates the profitability on the assets of the firm
(after all expenses and taxes).
Or
It shows the relationship between Net profit and total
assets.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
If
Net profit = 91
And
Total assets = 2160
Return on Investment
Net Profit after Taxes
Total Assets
For Basket Wonders
December 31, 2003
$91 = .042
$2,160
The higher the better
Shows how effective the firm is in using its assets to
generate profit.
 A return on investment of 0.042 means that it uses
every $1 of assets to generate 4.2 cents in profit.


Return on Investment
Year
2003
2002
2001
BW
4.2%
5.0
9.1
Industry
9.8%
9.1
10.8
BW has a poor Return on Investment.
Trend Analysis of Return on Investment
Ratio Value (%)
12
10
8
BW
Industry
6
4
2001
2002
Analysis Year
2003
Income Statement/Balance Sheet Ratios
Return on Equity
Indicates the profitability to the shareholders of the
firm (after all expenses and taxes).
Or
It shows the relationship between Net profit and
Shareholder’s Equity.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
If
Net profit = 91
And
Shareholder’s equity =1139
Return on Equity
Net Profit after Taxes
Shareholders’ Equity
For Basket Wonders
December 31, 2003
$91 = .08
$1,139
The higher the better
Shows how effective the firm is in using its
Shareholder’s equity to generate profit.
 A return on equity of 0.08 means that it uses every
$1 of shareholder’s equity to generate 8 cents in
profit.


Return on Equity
Year
2003
2002
2001
BW Industry
8.0%
17.9%
9.4
17.2
16.6
20.4
BW has a poor Return on Equity.
Trend Analysis of Return on Equity
Ratio Value (%)
21.0
17.5
14.0
BW
Industry
10.5
7.0
2001
2002
Analysis Year
2003



The profitability ratios for BW have ALL been
falling since 2001. Each has been below the
industry averages for the past three years.
This indicates that CGS and administrative costs
may both be too high and a potential problem
for BW.
Note, this result is consistent with the low
interest coverage ratio.
Investment Ratios
The ratios which measures return to investor’s investment are
called investment ratios.
Or
The ratios which shows the risk and potential earning of a
business investment are called investment ratios.
The ratios that shareholders would be interested in are called Shareholders
ratios.
These ratios are not calculated from the financial
reports only, since they may involve market data
such as share prices.
It is also known as a Valuation Ratios.
Investment Ratios
Earning per share
(ii) Dividend per share
(iii) Price earning ratio
(iv) Market price per share/Book value per share
(i)
Earning per share
It shows that how much net profit investors are
earning on each share.
Or
“profit after tax / total number of shares” is called
earning per share.
Earning per Share
Earning per share
Net Profit after Taxes
Total number of shares
Investment Ratios
If
Net profit = 91
And
Total number of shares = 200
For Basket Wonders
December 31, 2003
$91
$200
= .455
The higher the better generally.
Ratio of 0.455 means that shareholder’s earn 45.5
cents on each share.


Dividend per share
It shows that how much Dividend investors are earning
on each share.
Or
Total dividend announced / total number of shares is
called Dividend per share.
Dividend per Share
Dividend per share
Dividend announced
Total number of shares
Investment Ratios
If
Dividend Announced = 38
And
Total number of shares = 200
For Basket Wonders
December 31, 2003
$38
$200
= .19
The higher the better generally.
Ratio of 0.19 means that shareholder’s receive 19
cents dividend on each share.


Price earning ratio (P/E)
How much investors are willing to pay for $1 of
earnings.
Or
This Ratio indicates the number of times the Earning
Per Share is covered by its market price.
Price earning ratio
Price earning ratio
Market price per share
Earning per share
Investment Ratios
If
Market price per share = 6
And
Earning per share = 0.455
For Basket Wonders
December 31, 2003
$6
$.455
= 13.19
The higher the better generally.
Ratio of 13.19 shows that investors are willing to pay
$13.19 for $1 of earnings.


Market price per share / Book value per share (M/B)
How much investors are willing to pay for $1 of book
value equity.
OR
It shows the relationship between the market price per
share and book value per share.
Market price per
share/Book value
per share
Investment Ratios
If
Market price per share = 6
And
Book value per share = 4.645
M/B
Market price per share
Book value per share
For Basket Wonders
December 31, 2003
$6
= 1.29
$4.645


The higher the better generally
Ratio of 1.29 means that investors are willing to
pay $1.29 for each $1 of book value equity.




Inventories are too high.
May be paying off creditors (accounts
payable) too soon.
CGS may be too high.
Selling, general, and administrative
costs may be too high.
Comparison with industry averages is difficult for a
conglomerate firm that operates in many different
divisions.
 “Average” performance is not necessarily good,
perhaps the firm should aim higher.
 Seasonal factors can distort ratios.
 “Window dressing” techniques can make
statements and ratios look better.

Different operating and accounting practices can
distort comparisons.
 Sometimes it is hard to tell if a ratio is “good” or
“bad”.
 Difficult to tell whether a company is, on balance, in
strong or weak position.
