Financial Statement Analysis 111

7/31/2019 Financial Statement Analysis 111

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Financial Statement Analysis


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Financial Statement Analysis

Assessment of the firms past, present and

future financial conditions

Done to find firms financial strengths and

weaknesses

Primary Tools:

Financial Statements

Comparison of financial ratios to past,

industry, sector and all firms


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Objectives of Ratio Analysis

Standardize financial information for

comparisons

Evaluate current operations

Compare performance with past

performance

Compare performance against otherfirms or industry standards

Study the efficiency of operations

Study the risk of operations


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Uses for Ratio Analysis

Evaluate Bank Loan Applications

Evaluate Customers Creditworthiness

Assess Potential Merger Candidates

Analyze Internal Management Control

Analyze and Compare Investment

Opportunities


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Horizontal, Vertical, & Trend

Analysis

Horizontal Analysis = calculating the Rupee

change and % change in financial statement

amounts across time

Vertical Analysis (Common Size Analysis) =

changing all Rupee values for accounts to %

values. Trend Analysis = Using the first year as a

base year, calculate future year Rupee values as

a ratio.


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Types of Ratio Analysis

Time Series Analysis or Trend Analysis

Measures a firms performance over time

Cross Sectional Analysis

Compares the firms ratios with an industry

standard or with its competitors ratios.

Sources:

U.S. Department of Commerce

Dun & Bradstreet

Robert Morris Associates


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Types of Ratios

Financial Ratios: Liquidity Ratios

Assess ability to cover current obligations

Leverage Ratios

Assess ability to cover long term debt obligations

Operational Ratios:

Activity (Turnover) Ratios

Assess amount of activity relative to amount of

resources used

Profitability Ratios

Assess profits relative to amount of resources

used

Valuation Ratios: Assess market price relative to assets or earnings


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Liquidity Ratios

Current Ratio Current Assets / Current Liabilities

Current Assets include Cash, Marketable Securities, Accounts

Receivable and Inventory

Current Liabilities include Accounts Payable, Debt Due within one

year, and Other Current Liabilities

1:2.175.1555

92.1870

sLiabilitieCurrent

AssetsCurrent

RatioCurrent


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Liquidity Ratios

Quick Ratio or Acid Test Current Assets minus Inventory / Current Liabilities

A more precise measure of liquidity, especially if

inventory is not easily converted into cash.

1:46.075.1555

53.720

Inventory-

sLiabilitieCurrent

AssetsCurrentRatioQuik


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Liquidity Ratios

Cash Ratio

17.075.1555

08.26

SecuritiesMarketable

sLiabilitieCurrent

CashRatioCash


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Liquidity Ratios

Days77360/94.369,3

39.150,192.870,1

expensesoperatingDaily

InventoryAsMeasure

Average

setsCurrentInterval

Interval Measure

Calculated to asses a firms ability to meet its regular

cash outgoings


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Leverage Ratios

Leverage ratios measure the extent to which a firm hasbeen financed by debt.

Leverage ratios include:

Debt Ratio

Debt--Equity Ratio

Generally, the higher this ratio, the more risky a creditor

will perceive its exposure in your business. Thus, high

leverage ratios make it more difficult to obtain credit

(loans).


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Leverage Ratios Cont.

Leverage ratios also include the Interest-coverage Ratio, Fixed coverage Ratio etc,.

In contrast to the leverage ratios discussed onprevious slide, the higher the Interest

Coverage Ratio (Times-Interest-Earned Ratio),

the more credit worthy the firm is, and the

easier it will be to obtain credit (loans).


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Total Debt Ratio

Proportion of interest bearing debt in the

Capital structure.

In general, the lower the number, the better.

0.64687.1901

06.229,1

Assets

Net

DebtTotalRatioDebt


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Debt-Equity Ratio

The Debt-Equity Ratio indicates the percentage of total

funds provided by creditors versus by owners.

This ratio indicates the extent to which the business relieson debt financing (creditor money versus owners equity).

1.83

81.972

06.229,1

Worth

Equity

Net

DebtTotalRatioDebt


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Interest Coverage Ratio

interest coverage ratio indicates the extent to which

earnings can decline without the firm becoming unable

to meet its annual interest costs.

Also called the Times-Interest-Earned Ratio, thiscalculation shows how many times the firm could pay

back (or cover) its annual interest expenses out of

earnings before interest and taxes (EBIT).

2.446.143

61.342Coverage

Interest

EBITRatioInterest


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Interest Coverage Ratio

2.746.143

59.4161.342Coverage

Interest

EBITDARatioInterest

DA = Depreciation and Amortization expenses


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Fixed Coverage Ratio (OR)

Debt Service Coverage Ratio (DSCR)

Principal repayments are added to interest payments

RateTax-1

DividendPref.repaymentLoan

RateTax-1

repaymentLoan

rentalsLeaseCoverage

Coverage

Interest

EBITDARatioFixed

Interest

EBITDARatioFixed


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Activity Ratios

Activity ratios measure how effectively a firm is using its

resources, or how efficient a company is in its operations

and use of assets.

In general, the higher the ratio, the better.

Activity ratios include:

Inventory turnover

Accounts receivable turnover

Average collection period. Total assets turnover

Fixed assets turnover


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Inventory TurnoverRatio

The inventory turnover ratio indicates how fast a firm is

selling its inventories

This ratio indicates how well inventory is being managed,

which is important because the more times inventory can

be turned (i.e., the higher the turnover rate) in a given

operating cycle, the greater the profit.

days

Avg

CostRatioInventory

42TurnoverInventory

360HoldingInventoryofDays

8.6

2/)81.746126.244(

66.053,3

Inventory

SoldGoodsofTurnover


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Inventory TurnoverRatio Cont.

In the absence of information. Instead of CGS

we can use Sales

In the case of CGS and Inventory both are

valued at cost. While the sales are valued atmarket prices

Therefore better to use CGS


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Accounts Receivable Turnover

The accounts receivable turnover ratio, indicates the

average length of time it takes a firm to collect credit sales

(in percentage terms), i.e., how well accounts receivable

are being collected.

If receivables are excessively slow in being converted to

cash, liquidity could be severely impaired.

7.718.483

23.717,3

AR

AR

TurnoverR

Avg

Sales

Avg

SalesCreditA


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Average Collection Period

The average collection period is the average length of

time (in days) it takes a firm to collect on credit sales.

days47Turnover

360CP

ARA


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Net Assets Turnover

The total assets turnover ratio, indicates how efficiently

a firm is using all its assets to generate revenues.

This ratio helps to signal whether a firm is generating asufficient volume of business for the size of its asset

investment

times1.951901.87

3,717.23Turnover

AssetsNet

SalesAssetsNet


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Profitability Ratios

Profitability ratios measure managementsoverall effectiveness as shown by returnsgenerated on sales and investment.

Profitability ratios include

Gross profit margin

Operating profit margin Net profit margin

Return on total assets (ROA)

Return on stockholders equity (ROE)


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Gross Profit Margin

The gross profit margin is the total margin available to cover

operating expenses and yield a profit. This ratio indicates

how efficiently a business is using its labor and materials in

the production process, and shows the percentage of net

sales remaining after subtracting cost of goods sold.

The higher the ratio, the better. A high gross profit margin

indicates that a firm can make a reasonable profit on sales,

as long as it keeps overhead costs under control.

17.9%or0.1793,717.23

663.57

ProfitMargin

Sales

GrossGP


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Operating Profit Margin

The Operating Profit Margin measures profitability without

concern for taxes and interest.

The higher the ratio, the better. A high operating profit

margin indicates that a firm can make a reasonable profit

on sales, as long as it does good tax planning.

9.2%or0.0923,717.23342.61Margin

SalesEBITOP


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Net Profit Margin

The net profit margin shows the after-tax profits per rupee of

sales.

The higher the ratio, the better.

3.6%or0.0363,717.23

134.86Margin

Sales

PATNP

R t I t t (ROI) OR


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Return on Investment (ROI) ORReturn on Capital Employed (ROCE)

The return on total assets ratio shows the after-taxprofits per dollar of assets; this is also called return

on investment (ROI).

The ROI is perhaps the most important ratio of all. It

is the percentage of return on money invested in thebusiness. The ROI should always be higher than the

rate of return on an alternative, risk-free investment.


18%or0.181,901.87

342.61

EmployedCapital

EBITROI


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Return on Shareholders Equity

The net profit margin shows the after-tax profits per

rupee of sales.


20%or0.20672.81

134.86

Worth

Net

PATROE


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Market Valuation Ratios

Earnings per share (EPS)

Price-earnings ratio (P/E).

Dividend Yield

Market to Book Ratio


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Earnings Per Share (EPS)

The Profitability of the common shareholders

Investment.


Adjust for the bonus issues

6.00Rs.22.50

134.86

goutstandin

on sharesNo of comm

PATEPS


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Dividends Per Share (DPS)

Earnings distributed to the shareholders as

cash dividends.


.

2.00Rs.22.50

45.00

goutstandin

rsShareholdetoPaidDividends

on sharesNo of commDPS

Dividend Payout Ratio


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Dividend Payout Ratio

&

Retention Ratio

33%or0.336

2

DPS

EPSRatioPayout

Retention Ratio = 1- Payout Ratio

Growth in Equity = Retention Ratio * ROE


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Market Valuation Measures

Dividend Yield

Dividend / Market Value per Share payout declared as a percentage of the stock

price Earnings Yield

EPS / Market Value per Share

Dividend and Earnings yield evaluate theshareholders return in relation to the marketvalue of the share


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Price-Earnings Ratio

Measure of optimism or pessimism about firms

future.

High PE Ratio indicates optimism

Low PE Ratio indicates pessimism

times4.88Rs.6

29.25

SharetheofValueMarketRatio/

EPSEP


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Market Value to Book Value Ratio

Stock price / book value per share The number of times the market values the stock over its

paid-in capital and retained earnings.


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Dupont Analysis

ROE is a closely watched number

It is a strong measure of how well themanagement of a company creates value for itsshareholders

The number can be misleading

Due to its vulnerability to measures that increaseits value while making the stock risky

Without a way of breaking down the componentsof ROE, investors could be duped into believinga company is a good investment when it is not.


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Components of ROE

ROE = (Net profit margin) * (Asset Turnover) * (Equity multiplier)

Operating Efficiency Profit margin

Asset use efficiency Total asset turnover

Financial leverage Equity multiplier


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Dupont Calculation

ROE = requityShareholdeAssets

Asset

Sales

Sales

NetIncome


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Ratio Analysis Limitations

Financial ratios are based on accounting data,and firms differ in their treatment of such items

as depreciation, inventory valuation, research

and development expenditures, pension plan

costs, mergers, and taxes. Reflects Book Value

Does not take size differences of companies into

account

Identifies problem areas, but not causes


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Limitations

Seasonal factors can influence comparative ratios.

A firms financial condition depends not only on the

functions of finance, but also on many other factors

such as

Management, marketing, production/operations,R&D, and MIS decisions

Actions by competitors, suppliers, distributors,

creditors, customers, and shareholders

Economic, social, cultural, demographics,environmental, political, governmental, legal, and

technological trends.


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Cautions in using Ratio Analysis

Company differences

Price Level

Different Definitions Changing Situations

Past Data

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Financial Statement Analysis 111

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