Analysis of Financial

Statement
Basic caveats
 Focus of analysis depends upon the
purpose in hand
 Analysis depends upon data availability
 Analysis for an entity for a period may
not be adequate
 Inter-period comparison
 Inter-firm comparison
 Flexible
 No fixed formats / formula
Tools for Analysis
 Common Size Statements
 Indexed Statements
 Ratios
Common Size Statements
 Expressing various components of the
financial statements as a % of a
common denominator
 Balance Sheet – % of total of the Balance
Sheet
 Profit & Loss A/c - % of Sales
 Helps is understanding the relative
importance of different components
 Change in weight over a period of time
Indexed Financial Statements
 Expressing various components of the
Balance Sheet and Profit & Loss A/c
as a % of the base year
 Helps is understanding the growth/
trend of different items in the
financial statements over a period of
time
Ratio Analysis
 Expressing one item of financial
statement in relation to another
 Profit and Loss A/c Ratios: Relating
different numbers of Profit & Loss A/c
 Balance Sheet A/c Ratios: Relating
different numbers of Balance Sheet
 Cross Ratios: Relating a number of Profit
& Loss A/c with a number of Balance
Sheet
Type of Ratios
 Depending upon focus of analysis
 Profitability Ratio
 Growth
 Dividend Policy
 Assets Utilization / Efficiency
 Liquidity
 Capital Structure
 Return
 Market Related
Profitability Ratios
Ratios Expressed Comments
As

Gross Margin Ratio % Higher the margin better it is.

Gross Profit / Sales Compare with the industry average and trend over a
period of time
Cash Operating Margin % Higher the margin better it is.
EBITDA / Total Income Compare with the industry average and trend over a
Operating Margin period of time
EBIT/ Total Income

Net Margin % Higher the margin better it is.

PAT/ Total Income Compare with the industry average and trend over a
period of time
Earnings Per Share ` Higher the EPS better it is.
PAT / Number of Shares Compare the trend over a period of time
Growth Ratio
 Compound Annual Growth Rate (CAGR)
 Find the value of g using the following
expression
 A = P (1+g)^n
 Where A is current year’s number, P is
base year’s number and n is number
of years.
 CAGR can be calculated for various
parameters
Growth Ratio
 Year-on-Year Growth
 (Current Year – Previous Year) /
Previous Year
 Can be calculated for sales, income,
different measures of profit
 Express as a %
Dividend Policy
Ratio Expressed Comments
as

Dividend Payout Ratio % As dividend attracts dividend distribution tax

(Dividend + Dividend Tax) / the same is also considered a part of the pay
PAT out
What % of profits after tax is being
distributed; Growing companies have a
lower payout
Rétention Ratio % What % of profits after tax is being retained;
1 – D/P Ratio Growing companies have a higher retention

Dividend Yield % Return to the shareholder by way of dividend

Dividend Per Share/ Current on the current market price
Market Price
Liquidity Ratios
Ratio Expressed Comments
as
Current Ratio Times Short term investments should also be
Current Assets / Current included in the current assets
Liabilities & Provisions 2:1 considered adequate; higher ratio indicates
blockage of funds in unproductive assets
whereas low ratio indicated inability of
company’s current assets to cover its current
liabilities

Quick Ratio Times Inventories are less liquid ;

(Current Ratio – Inventories) / Also called Liquid Ratio or Acid Test Ratio
Current Liabilities & 1 : 1 considered adequate; higher ratio
Provisions indicates blockage of funds in unproductive
assets.
Capital Structure Ratios
Ratios Expressed Comments
as
Debt Equity Ratio Times Only long tern debts to be considered
Borrowed Funds / Shareholders’ 2: 1 considered adequate; Higher ratio implies higher
Funds financial leverage; inability of the firm to meet its
long term commitments attached with debt. Lower
ratio means that the company is not taking advantage
of financial leverage.
Financial Leverage Ratio Times Higher ratio implies higher financial leverage
Total Assets / Shareholders’ Funds
Interest Coverage Ratio Times Ability of the firm’s operating profits to cover its
EBIT / Interest & Finance Charges interest obligation.
Higher the ratio better it is. Compare with the
industry average and trend over a period of time
Cash Flow Coverage Ratio Times Often used by the Banks and Financial Institution to
(EBIT + Depreciation) / {Interest + ascertain the adequacy of the firm’s cash flows to
Loan Repayment/ (1-Tax Rate) } cover its debt obligation – interest as well as
principal.
Assets Utilization Ratio
Ratios Expressed Comments
as
Total Assets Turnover Ratio Times May use average assets in the denominators i.e.
Total Income / Total Assets (Opening + Closing)/2
Indicator of efficiency in utilization of assets, higher
turnover means higher ability to generate revenue for
the same set of assets

Fixed Assets Turnover Ratio Times May use average assets in the denominators i.e.
Total Income / Fixed Assets (Opening + Closing)/2

Working Capital Turnover Times Working Capital means Current Assets less Current
Ratio Liabilities
Total Income / Working Capital Indicator of efficiency in utilization of working
capital , higher turnover means higher ability to
generate revenue for the same set of working capital
Assets Utilization Ratio
Ratio Expresse Comments
d as
Debtors Turnover Ratio Times If credit sales figure is not separately available use
Credit Sales / Debtors the total sales figure
Indicator of efficiency in debt collection, higher
turnover means better debt collection
Inventory Turnover Ratio Times If cost of goods sold is not available use the total
Cost of Goods Sold / Inventories sales figure
Indicator of efficiency in managing inventories,
higher turnover means better inventory
management
Average Collection Period No. of days Also called Day’s Sales Outstanding, Can be
365 / Debtors Turnover Ratio calculated as Debtors / Average Daily Sales
Average Daily Sales = Total Sales / Number of
days in the accounting period
Average Holding Period No. of days Can also be calculated as Inventories / Average
365 / Inventory Turnover Ratio Daily Consumption or Average Daily Sales
Average Payment Period No. of days
365 x Creditors / Purchases
Return Ratios
Ratios Expressed Comments
as
Return on Assets % EBIT (1-Tax Rate) is also called the Net
EBIT (1-Tax Rate) / Total Assets Operating Profit After Tax (NOPAT), Can also be
calculated as PAT/ Total Assets
Ability of the firm to generate return on the total
assets. Higher the better. Compare with industry
average and past trends.
Return on Capital Employed % Can also be calculated as PAT/ Capital Employed
(ROCE) Ability of the firm to generate return on the
EBIT (1-Tax Rate) / ( Borrowed capital employed. Higher the better. Compare
Funds + Shareholders’ Funds) with industry average and past trends.
Return on Equity % Shareholders’ Funds include reserve and surplus.
PAT / Shareholders’ Funds Any accumulated losses and fictitious assets
should be deducted
Ability of the firm to generate return on the
shareholders’ funds. Higher the better. Compare
with industry average and past trends.
Dupont Analysis
Ratios Expressed Comments
as
Return on Equity – % Helps in breaking down the ROE
DuPont Analysis into profitability, assets utilization
(PAT/Sales) x (Sales / and financial leverage
Assets ) x (Assets /
Shareholders’ Funds)
=
Net Margin x Assets
Turnover x Financial
Leverage
Market Ratios
Ratios Expressed Comments
as
Price Earning Multiple Times Inverse of earning yields (EPS/CMP)High
(Times) growth firms/ industries normally have a higher
Current Market Price / EPS P/E multiple
Price Earnings to Growth Ratio Time PEG ratio of 1 considered fair price
Price Earnings Ratio / Growth Rate
Book Value Per Share ` Shareholders’ Funds include reserve and surplus.
Shareholders’ Funds / Number of Any accumulated losses and fictitious assets
Shares should be deducted
Not much meaningful as based upon historical
cost of the assets and does not consider the
earning capacity of the assets
Price to Book Value Ratio Times
Current Market Price / Book Value
per Share
Market Capitalization ` Total market value of all the shares issued by the
No. of shares x Current Market firm Higher market capitalization acts as a
Price safeguard against hostile takeover
Ratio to Predict Insolvency
Ratios Expressed Comments
as
Altman’s Z Score No. 3 or more – Financially sound
Z = 1.2 X1 + 1.4 X2 + 3.3 1.81 to 2.99 – Grey area
X3 + 0.6 X4 + 1.0 X5 Less than 1.8 – Higher chances of
X1 = Working Capital/ financial embarrassment
Total Assets
X2 = Retained Earnings /
Total Assets
X3 = EBIT / Total Assets
X4 = Market Value of
Equity / Book Value of
Total Liabilities
X5 = Sales / Total Assets