Lecture Notes: Financial Modeling: Session 4

LECTURE NOTES
St. John Institute of Management & Research Specialization: Finance
Financial Modeling: Session 4 Doc No.: 2 Version: 1.0 04-01-2016
BUILDING HISTORICAL FINANCIAL STATEMENTS
DEFINITIONS:
1. FINANCIAL STATEMENTS: A financial statement (or financial report) is a formal record of the financial

activities and position of a business, person, or other entity. Relevant financial information is presented in
a structured manner and in a form easy to understand. They typically include basic financial statements.
2. HISTORICAL FINANCIAL STATEMENTS are Financial Statements that are documented and stored
with the intention of further analysis and conclusion, either by comparing with the available data across
the years or for comparison with data across other companies.
COMPONENTS OF A FINANCIAL STATEMENT
A Financial Statement will contain some or all of the following modules:
1. Balance sheet: also referred to as a statement of financial position, reports on a

company's assets, liabilities, and ownership equity at a given point in time. It is a snapshot of the
current situation of the company.
2. Profit & Loss Statement: A profit and loss statement provides information on the operation of the
enterprise. These include sales and the various expenses incurred during the stated period.
3. Cash flow statement: This is a report on the company's cash flow activities, particularly its
operating, investing and financing activities.
GATHERING HISTORICAL FINANCIAL STATEMENT
There are a number of ways of collecting Historical Financial Data:
1. Balance Sheet Mining:

a. Visit Company Website (the company’s whose financial data you are interested in analyzing)
b. Visit the “INVESTOR” Section
c. Download the balance sheet from the website
d. Gather information on to a spread sheet.
2. Getting data from Financial Websites:
a. Visit www.moneycontrol.com
b. Search for the company of interest in the Markets section.
c. Go to “FINANCIALS” section on the LHS
d. Copy Information on to a spread sheet
UTILITY OF HISTORICAL FINANCIAL STATEMENTS
Historical Financial Statements can be used as an effective management tool by companies, competitors,
academicians and students. They can be used in the following ways:
1. To predict future growth rates of the company
Lecture Notes by Reuben Buthello

2. To track changes in expenses and identify root cause of such changes
3. To plan and take strategic decisions for the future of the company
4. To benchmark the competition in terms of their cost structure and incomes.
EXERCISE 4:
1. Select a company of your choice

2. Download the Historical Financial Statements of the company for the last 5 years
3. Arrange the data on a spreadsheet
RATIO ANALYSIS
Ratio analysis is the process of determining and interpreting numerical relationships based on financial
statements. A ratio is a statistical yardstick that provides a measure of the relationship between two variables
or figures. This relationship can be expressed as a percent or as a quotient. Ratios are simple to calculate and
easy to understand.
CATEGORIES OF RATIO ANALYSIS
1. LIQUIDITY RATIOS:
a. QUICK RATIO: It is determined by dividing “quick assets”, i.e., cash, marketable
investments and sundry debtors, by current liabilities. This ratio is a bitterest of financial
strength than the current ratio as it gives no consideration to inventory which may be very a
low- moving.
b. CURRENT RATIO: It is computed by dividing current assets by current liabilities. This ratio is
generally an acceptable measure of short-term solvency as it indicates the extent to which
he claims of short term creditors are covered by assets that are likely to be converted into
cash in a period corresponding to the maturity of the claims.
c. TIMES INTEREST EARNED RATIO: The times interest earned ratio, sometimes called the
interest coverage ratio, is a coverage ratio that measures the proportionate amount of
income that can be used to cover interest expenses in the future.
2. EFFECIENCY RATIOS:
A. GROSS PROFIT MARGIN: It is the profit earned on your products without considering
indirect costs. Small changes in gross margin can significantly affect profitability. Is there
enough gross profit to cover your indirect costs? Is there a positive gross margin on all
products?
B. NET PROFIT MARGIN: It is the ability to recover all costs including indirect costs.
3. OPERATION RATIOS
A. ASSET TURNOVER RATIO: The asset turnover ratio is an efficiency ratio that measures a
company's ability to generate sales from its assets by comparing net sales with average total
assets. In other words, this ratio shows how efficiently a company can use its assets to
generate sales.
B. INVENTORY TURNOVER RATIO: The inventory turnover ratio is an efficiency ratio that
shows how effectively inventory is managed by comparing cost of goods sold with average

inventory for a period. This measures how many times average inventory is "turned" or sold
during a period. In other words, it measures how many times a company sold its total
C. average inventory dollar amount during the year. A company with $1,000 of average
inventory and sales of $10,000 effectively sold its 10 times over.
4. LEVERAGE RATIOS:
A. DEBT TO EQUITY RATIO: Compares capital invested by owners/funders (including grants)

and funds provided by lenders. Too much debt can put your business at risk, but too little
debt may limit your potential. Owners want to get some leverage on their investment to
boost profits. This has to be balanced with the ability to service debt.
5. EQUITY RELATED RATIOS:

A. EARNINGS PER SHARE
B. PRICE – EARNINGS RATIO
C. PAYOUT RATIO: It is the dividend per share to earnings per share ratio
EXERCISE 4:
Using your data from Exercise 3, develop the ratio analysis for the company. State your comments against each
of the ratios.

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LECTURE NOTES

St. John Institute of Management & Research Specialization: Finance

Financial Modeling: Session 4 Doc No.: 2 Version: 1.0 04-01-2016

BUILDING HISTORICAL FINANCIAL STATEMENTS

1. FINANCIAL STATEMENTS: A financial statement (or financial report) is a formal record of the financial

COMPONENTS OF A FINANCIAL STATEMENT

A Financial Statement will contain some or all of the following modules:

1. Balance sheet: also referred to as a statement of financial position, reports on a

GATHERING HISTORICAL FINANCIAL STATEMENT

There are a number of ways of collecting Historical Financial Data:

1. Balance Sheet Mining:

UTILITY OF HISTORICAL FINANCIAL STATEMENTS

1. To predict future growth rates of the company

Lecture Notes by Reuben Buthello

1. Select a company of your choice

CATEGORIES OF RATIO ANALYSIS

Lecture Notes by Reuben Buthello

A. DEBT TO EQUITY RATIO: Compares capital invested by owners/funders (including grants)

5. EQUITY RELATED RATIOS:

Lecture Notes by Reuben Buthello

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