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FINANCIAL STATEMENT ANALYSIS
BY SYED MUHAMMAD IJAZ, FCA
AUGUST 03, 2007
TYPES OF RATIOS
• Liquidity Ratios
• Capital Structure/Leverage Ratios
• Profitability Ratios
• Activity Ratios
CURRENT RATIO
LiabilitesCurrent
AssetsCurrent RatioCurrent
• Where current assets represent the assets that can be converted into cash within a short period, conventionally with one year
• Like wise the current liabilities refer to liabilities the payment of which is to be made within 1 year
• This ratio represents the amount in Rs. Available in current assets to pay off the each Rupee of Current Liabilities
• This Ratio refers to the potential of the company to cover its current liabilities payments through its current assets.
• Greater the availability of current assets to cover current liabilities better it is
• There is no thumb rule to say what would be the best. However conventionally a current ratio of 2:1 is considered satisfactory.
Acid-Test or Quick Ratio
sLiabilitieCurrent
AssetsQuick Ratiotest Acid
• Where Quick assets refers to assets that on short notice can be converted into cash. Normally this means current assets-Stocks
• This ratio is a derived from current ratio and represents and more critical analysis
• Greater the companies ability to cover its current liabilities from Quick assets better it is
• Conventionally a ratio of 1:1 is considered satisfactory
Turnover Ratio-Inventory Turnover
Inventory Average
Sold Goods OfCost RatioTernover Inventory
• This is another form to check the liquidity position of the firm
• This ratio determines how quickly certain current assets e.g. as in above inventory transfers/converts itself into cash
• Turnovers are normally calculated with reference to Inventory, Debtors, Creditors etc.
• Greater the conversion rate better it is
• Now its clear from above that inventory rotates “X” times in a year so if we want to calculate number of days we held inventory or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
Turnover Ratio-Debtors Turnover
Debtors Aveage
SalesCredit Net RatioTurnover Debtors
• This is another form to check the liquidity position of the firm• This ratio determines how quickly debtors are converted into cash• Greater the turnover better it is• Now its clear from above that debtor rotates “X” times in a year so if we want
to calculate number of days in which we Collect debtors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
Creditors Turnover Ratio
Creditors Average
PurchasesCredit Net RatioTurnover Creditors
• This is another form to check the liquidity position of the firm• This ratio determines how quickly creditors are paid• Lesser the turnover better it is• Now its clear from above that creditor rotates “X” times in a year so
if we want to calculate number of days in which we pay creditors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
Defensive-Interval Ratio
tRequiremenCash Daily Projected
Assets LiquidRatio IntervalDefensive
year ain days of No.
eexpenditur operatingcash ProjectedCashDaily Projected
• This ratio represents the ability of the firm to meet its daily future cash requirement through its liquid assets
• More the ability to meet expenditure better it is
Leverages-Debt-Equity Ratio
Equity) rs'Shareholdedebt (Total
Debt TotalRatio D/E
• This ratio is meant to disclose the structure of the capital
• Normally banks and financers use this ratio as the State Bank has bench marked the maximum debt equity ratio to 80:20 (i.e. 80% Debt+20% equity) maximum allowed debt structure
• Normally external debt is considered less expensive than the equity
• This ratio can be subdivided into many other ratios like Debt to Owners equity, Owners equity to total Capital etc.
Leverages-Interest Coverage Ratio
Interest
EBITCoverageInterest
• Where EBIT represents earnings/profit before interest and tax
• This ratio represents the earnings/profit available against each rupee of interest i.e. for payment of each rupee of interest how many rupees of profit are available
• Potent the ratio better it is
Dividend Coverage Ratio
Dividend Preference
EATCoverage Dividend
• Where EAT represents earnings/profit after tax or earnings available to shareholders
• This ratio represents the earnings/profit available against each rupee of preference dividend i.e. for payment of each rupee of preference dividend how many rupees of profit are available
• Potent the ratio better it is
Total Coverage Ratio
t)-(1 / principal) of Instalment dividend e(Preferenc Payments LeaseInterest
Payment Lease EBITCoverage Total
t)-(1
dividend) (
t)-(1
repayment) (principalInterestpayment Lease
Expensescash -NononDepreciatipayments LeaseEBITcoverage flowcash Total
preference
• Former ratio represents the firms ability to pay all the fixed obligations
• Later ratio represents the ability of firm to pay all external liabilities from available cash sources
• In both cases higher the coverage better it is
Profitability Ratio
• Represented as a %age to Sales• Greater the margin/%age better it is
100 Sales
Profit GrossMarginprofit Gross x
100 Sales
ProfitNet Marginprofit Net x
Profitability-Expenses Ratio
100SlaesNet
Sold Goods ofCost Ratio Sold Goods ofCost
NetSalesExpenses SellingExpenses iveAdminisratRatio Expenses Operating
100SalesNet
Expenses SellingRatio Expenses Selling
100NetSlaes
Expenses tiveAdministraRatio Expenses tiveAdministra
Profitability-Expenses Ratio-Continued
100SalesNet
Expenses Operating Sold Goods ofCost Ratio Operating
100SlaesNet
Expenses FinancialRatio Expenses Financial
Represented as a %age to Net SalesLesser the margin/%age better it is
PROFITABILITY RATIOS RELATED TO INVESTMENTS-RETURN ON
INVESTMENTS(ROI)
Assets Total Average
TaxesAfter Profit Net (ROA) Assetson Return
RETURN ON CAPITAL EMPLOYED
Employed Capital Total Average
Taxesafter Profit Net ROCE
EARNING PER SHARE
goutstandin sharesordinary ofNumber
ersEquityhold toAvailableProfit Net EPS
SharePer ValueMarket
EPSldEarningYie
DIVIDEND YIELD
goutstandin sharesordinary ofNumber
erssharesholdordinary topaid dividend preference andinterest after profit Net DPS
shareper ValueMarket
DPSYield Dividend
DIVIDEND PAYOUT
ersequityhold tobelongingprofit net Total
dividend)(cash ersequityhold todividend TotalD/P
(EPS) shareper Earnings
share(DPS)ordinary per DividendD/P
or
ACTIVITY RATIO
• Activity ratios are concerned with measuring the efficiency in asset management. Sometimes, these ratios are also called efficiency ratios or assets utilization ratios.
• An activity ratio may, therefore, be defined as a test of relationship between sales (more appropriately with cost of sales) and the various assets of a firm.
CURRENT ASSETS TURNOVER
• Already discussed under liquidity • Other assets turnover includes;
assets totalAverage
sold goods ofCost turnoverassets Total
assets fixed Average
sold goods ofCost turnoverassets Fixed
CURRENT ASSETS TURNOVER-CONTINUED
employed capital Average
sold good ofCost turnoverCapital
assetscurrent Average
sold goods ofCost turnoverassetsCurrent
capital gNet workin
sold goods ofCost ratio turnover capital Working