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Analysis of Financial Statements - Lecture 4

This document provides an overview of financial statement analysis. It discusses determining a business's financing needs by analyzing business risk, funding requirements, and financial condition and profitability using financial ratios. The document outlines different types of financial ratio analyses including liquidity, debt, profitability, DuPont, coverage, and activity ratios. Specific ratios are defined such as current ratio, quick ratio, and receivables turnover. The purpose, calculation, and interpretation of various ratios are presented.

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Zahid Shahid Sheikha
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98 views15 pages

Analysis of Financial Statements - Lecture 4

This document provides an overview of financial statement analysis. It discusses determining a business's financing needs by analyzing business risk, funding requirements, and financial condition and profitability using financial ratios. The document outlines different types of financial ratio analyses including liquidity, debt, profitability, DuPont, coverage, and activity ratios. Specific ratios are defined such as current ratio, quick ratio, and receivables turnover. The purpose, calculation, and interpretation of various ratios are presented.

Uploaded by

Zahid Shahid Sheikha
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Analysis of Financial Statement

M. Ali Baig, CPA, CFE, CIA


Visiting Faculty – Iqra University
Email: [email protected]
Cell: (342) 888-9111

1
Financial Statements Analysis

Determining the Financing Needs of a Business:

 Analyzing Business Risk – Considers “Inherent” Risks


of a Business

 Analyzing Fund Requirements –Helps in Identifying the


“Funding” Requirements for a business. The tools
primarily used for this Analysis are Statement of Cash
Flows & Cash Budgets

 Analyzing Financial Condition & Profitability –


Performed with the Help of “Calculating” & “Interpreting”
Financial Ratios

2
Financial Statements Analysis

Financial Ratios:

 The Need for Financial Ratios

 Uses of Financial Ratios

 Internal Comparison – i.e., Trend Analysis

 External Comparison – i.e., Benchmarking

3
Financial Statements Analysis

Types of Financial Ratio Analyses:

 Financial Condition Analysis – Ratios Based Purely on


Balance Sheet Information
 Liquidity Ratios, Debt (Leverage) Ratios, etc.

 Profitability Analysis – Ratios Based on Income


Statement Information Only
 Common-Sized Statements, Profit Margin Analyses, etc.

 Performance Analysis – Ratios Based on Correlation


between Information Reported on Balance Sheet and
Income Statement
 Performance Ratios, Activity Ratios, Coverage ratios, etc.
4
Financial Statements Analysis

Financial Condition Analysis:

 Liquidity Ratios

 Current Ratio: Current Assets divided by Current Liabilities

 Quick Ratio: (Current Assets – Inventories) divided by Current


Liabilities

5
Financial Statements Analysis

Financial Condition Analysis (Cont’d.):

 Financial Leverage (Debt) Ratios

 Debt-to-Equity Ratio: Total Debts divided by Owners’ Equity

 Debt-to-Total Assets Ratio: Total Debts divided by Total


Assets

 Debt-to-Total Capitalization Ratio: Long-term Debts divided by


the Sum of Long-term Debts & Owners’ Equity

6
Financial Statements Analysis

Profitability Analysis:

 Based on Income Statement Information


 Primarily used by Shareholders/owners, Potential Investors, etc.

 Gross Profit Margin –


 (Net Sales – Cost of Goods Sold) / Net Sales

 Net Profit Margin –


 Net Profit After Taxes / Net Sales

 Expenses to Profit Ratios


7
Financial Statements Analysis

Performance Analysis – DuPont Ratios:


 Return on Investment (ROI)
 Earnings Power (ROI) = Sales Profitability x Asset Efficiency
i.e., ROI = Net Profit Margin x Total Asset Turnover; OR
 Net Profit After Taxes / Total Assets

 Return On Equity (ROE)


 ROE = (Net Profit After Taxes – Preferred Stock Dividends)
Shareholders’ Equity
 ROE = ROI x Equity Multiplier (i.e., Total Assets / S. Equity)
 ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier

8
Financial Statements Analysis

Performance Analysis – Coverage Ratios:


 Relate Financial Charges of a Business to its Ability
to Service and/or Cover them
 Times Interest Earned = Earnings Before Interest & Taxes (EBIT)
Interest Expense

 Variations may also include Correlation of EBIT to


Other Principal Payments, such as “Debt
Obligations”, “Preferred Stock Dividends”, “Lease
Payments”, etc.

9
Financial Statements Analysis

Performance Analysis – Activity Ratios:

 Also Known As “Efficiency” OR “Turnover” Ratios


 Receivables
 Inventory
 Payables
 Total Assets

10
Financial Statements Analysis

Receivables Activity:
 Receivable Turnover (RT) = Annual Credit Sales .

Avg. A/Receivables

 Receivable Turnover in Days (RTD) – aka Average


Collection Period:
 RTD = Days in the Year / Receivable Turnover

 Alternatively,
 RTD = Avg. A/Receivables x Days in the Year
Annual Credit Sales
 Accounts Receivable Aging Analysis
11
Financial Statements Analysis

Inventory Activity:

 Inventory Turnover (IT) = Cost of Goods Sold


Avg. Inventory

 Inventory Turnover in Days (ITD) = Days in the


Year
Inventory Turnover
 Alternatively,
 ITD = Avg. Inventory x Days in the Year
Cost of Goods Sold

12
Financial Statements Analysis

Payables Activity:

 Payable Turnover (PT) = Annual Credit Purchases


Avg. A/Payables

 Payable Turnover in Days (PTD) – aka Average


Payable Period:
 PTD = Days in the Year / Payable Turnover

 Alternatively,
 PTD = Avg. A/Payables x Days in the Year
Annual Credit Purchases

13
Financial Statements Analysis

Total Asset (Or Capital) Turnover:


 Total Asset Turnover (RT) = Net Sales .

Total Assets

14
Thank You
&
Good Luck.
15

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