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Financial Statement

 Analysis

Financial Ratio Analysis“Reading between the lines”  

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Interpretation and analysis of

accounting information Stake holders main questions;

1. How is the business doing?

2. How is the business placed at present?3. What are the future prospects of the

business?

Published financial accounts are animportant source of information to enableanswering the above questions.

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 Area for Review

1. Review of the Business; Chairman's and

CEO's Review2. Cash flow statement

3. Calculation of significant ratios between

figures in the accounts

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Common Size financial statements

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Financial Ratio Analysis

 A tool to handle massive data.

In isolation, a financial ratio is a uselesspiece of information.

 A ratio gains utility by comparison to otherrelevant  data and standards.

Financial ratio is governed by the GIGO law;

 A cross industry comparison.

Using historical data independent offundamental changes

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Different perspectives

Insiders Vs. Outsiders

Credit analysts: focus on the "downside" risk since they gain none

of the upside from an improvement in operations. Thus, they focus onrisk ratios (liquidity and leverage).

Equity analysts: look more to the operational and profitability

ratios, to determine the future profits that will accrue to the shareholder.

Results are not a gospel; Off-balance-sheet factors

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Predictive Power of Financial

Ratios Trend Analysis

Sustainable Growth Rate (SGR)shows how

fast a company can grow using internally generated

assets without issuing additional debt or equity. 

 Altman Z-Score reliably predicts whether or not acompany is likely to enter into bankruptcy within one or

two years

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SUSTAINABLE GROWTH RATE

provides a useful benchmark for judging a company's appropriaterate of growth. A company with a low sustainable growth rate butlots of opportunities for expansion will have to fund that growth viaoutside sources, which could lower profits and perhaps strain the

company's finances. Growth can be a major dilemma because withgrowth comes a spontaneously generated need for increasedworking capital. VentureLine calculates a Sustainable Growth Ratefrom the data entered into the Income Statement and BalanceSheet. The Sustainable Growth Rate is the rate at which the firmmay grow the Stockholder's Equity Account (Net Worth) using onlyincreases in Retained Earnings (Net Profit's contribution to retained

earnings) to fund the growth. Growth beyond this amount will forcethe firm to obtain additional financing from external sources tofinance growth.

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Considerations when carrying on a trend

analysis

1. Inquire about the types of accounting policiesused

2.  An appropriate allowance for any changes in

accounting policies that occurred during thesame time span is needed.

3. Determine whether ratios were calculatedbefore or after adjustments were made to the

financial statements, such as non-recurringitems and inventory or pro forma adjustments.

4. Carefully examine any departures from industrynorms

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Considerations when carrying on a

comparative analysis1. Inquire about the types of accounting policies

used by different entities being compared.

2.  Allow for any material differences inaccounting policies between your companyand industry norms.

3. Make sure that you calculate the ratios by your

self or at least get all of them from the samesource.

4. Carefully examine any significant departuresfrom norms.

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Ratio Analysis Basic Frame work

Risk measurements

Shot term: Liquidity

Long term: Solvency/Leverage

Return Measurements

Short term: Profitability

Long term: Asset Utilization

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Total Operating Assets

Use “total operating assets” instead of

“total assets” (deduct long-term investments

and intangible assets from total assets). Ex. Turnover of total operating assets ratio

Note; This ratio does not measure profitability, rather it tracks over-

investment in operating assets

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Limitations

 A reference point is needed.

Meaningless in isolation.

Financial Year-end values may be

manipulated.

Ratios are subject to accounting methods

limitations.