Financial Analysis

Arnab Karmakar
Department of Chemical Engineering
BIT Mesra, Ranchi
Financial Status
Beginning of fiscal period

How much profit did the company make during the fiscal period? Income Statement

What did the company decide to use their profit for? Statement of Retained Earnings

How much cash did the company generate and spend during the period? Statement of Cash Flows

What is the company’s financial position at the end of fiscal period? Balance Sheet

End of fiscal period

Factors affecting stock prices
External Strategic policy Role of engineers
constraints decisions by • Evaluation of capital expenditure related to projects
• Environmental management • Selection of production methods used
regulations • Operating decisions • Selection of types of products or services produced
• Antitrust laws • Investment decisions • Assessment of engineering safety and
• Product and • Financing decisions environmental
workplace
safety rules
Accounting information
• The balance sheet
statement
• The income statement
• The cash flow statement

Expected financial
performance Farms market
• Expected profitability value
• Timing of cash flows Stock Price
• Degree of financial risk
Financial terms
Asset is the resource with economic value owned or controlled by an economic entity or
business.
1. Current asset or liquid asset is the short-term asset that a company can convert
to cash or sell within one fiscal year or operating cycle.
• Current Assets = Cash + Cash Equivalents + Marketable Securities + Accounts Receivable +
Inventory + Supplies + Prepaid Expenses + Other Liquid Assets
• Cash and cash equivalents: The Cash is the amount of money at the bank to provide for
the funds needed to conduct day-to-day business. The cash equivalents can easily be
converted into cash, like short-term savings bonds, short-term investments, and foreign
currency.
• Marketable Securities: These are investments that can be readily converted into cash and
traded on public exchanges with cryptocurrency, short-term investments, etc.
• Accounts receivable: It is the amount of money that is owed the firm, but that has not yet
been received. Like unpaid bill for an order received by a company which immediately falls
into the accounts receivable category. After the bill is paid the it is placed into the cash
category. A typical firm will have a 30- to 45-day accounts receivable.
• Inventory: The amount of money invested in raw materials, work in process, and finished
goods available for sale. It can be current and non-current asset.
• Supplies: If a company has a stock of unused supplies, list them under current assets on
your balance sheet.
• Prepaid expenses: Prepaid expenses include anything a company paid for but expect to
benefit from over time, like year-long lease, extended insurance policy, etc. It is reported
in company’s income statement over the period the payment covers.
• Other assets: investments made in other companies, assets associated with the goodwill,
copyrights, franchises, promissory notes or tax refunds, etc. Goodwill corresponds the
additional amount paid for the business above the fair market value (the price that a
buyer is willing to pay) of the business. The intangible asset includes patent, brand,
trademark, or copyright, etc.
2. Fixed assets: These are relatively permanent and take time to convert into cash.
Investment in the business, such as land, buildings, factory machinery, office
equipment, and automobiles.
• Current liabilities are those debts which must be paid in the near future (normally, within
one year). The major current liabilities include accounts and notes payable within a year.
Wages, salaries, interest, rent, taxes, etc., owed, but not yet due for payment), and
advance payments and deposits from customers.
• Other liabilities include long-term liabilities, such as bonds, mortgages, and long-term
notes, that are due and payable more than one year in the future.
• Stockholders’ equity represents the amount that is available to the owners after all other
debts have been paid. Generally, stockholders’ equity consists of preferred and common
stock, treasury stock, capital surplus, and retained earnings. Preferred stock is a hybrid
between common stock and debt. In case the company goes bankrupt, it must pay its
preferred stockholders after its debtors, but before its common stockholders. Preferred
dividend is fixed, so preferred stockholders do not benefit if the company’s earnings grow.
In fact, many firms do not use preferred stock.
• Assets ‒ Liabilities ‒ Preferred stock = Common stockholders’ equity
• $11,471 ‒ $6,163 ‒ $0 = $5,308.
Balance Sheet
• It is the statement of financial position of a company, which reports the following three
items – assets, liabilities, and stockholders’ equity.
• Assets are arranged in order of liquidity in descending order from the top of the page.
• Accounting equation:
Assets (current +long-term)= Liabilities (current +long-term) + Owners’
Equity
• Inventory: The amount of money invested in raw materials, work in process, and finished
goods available for sale. It can be current and non-current asset.
• Supplies: If a company has a stock of unused supplies, list them under current assets on
your balance sheet.
• Prepaid expenses: Prepaid expenses include anything a company paid for but expect to
benefit from over time, like year-long lease, extended insurance policy, etc. It is reported
in company’s income statement over the period the payment covers.
• Other assets: investments made in other companies, assets associated with the goodwill,
copyrights, franchises, promissory notes or tax refunds, etc. Goodwill corresponds the
additional amount paid for the business above the fair market value (the price that a
buyer is willing to pay) of the business. The intangible asset includes patent, brand,
trademark, or copyright, etc.
2. Fixed assets: These are relatively permanent and take time to convert into cash.
Investment in the business, such as land, buildings, factory machinery, office
equipment, and automobiles.
Picture (Table): Park, C. S. (2007). Contemporary Engineering
economics. United States: Pearson Prentice Hall.

Debt Management
Debt ratio tells us the proportion of the company’s assets that it has financed
with debt: 𝑫𝒆𝒃𝒕 𝒓𝒂𝒕𝒊𝒐 = 𝑻𝒐𝒕𝒂𝒍 𝒅𝒆𝒃𝒕Τ𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕
= $𝟏𝟔, 𝟕𝟑𝟎Τ$𝟐𝟑, 𝟐𝟏𝟓 = 0.72 = 72%; Low debt ratio is preferred by the creditors.
For the large liabilities, the debt payments may be too much for the business to
handle.

Times-Interest-Earned Ratio measures the ability of a company’s operations to

provide protection to the long-term creditor.
𝑇𝑖𝑚𝑒𝑠 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝐸𝑎𝑟𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜
= 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥𝑒Τ𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
=($4,445 + $11.29)/$11.29 = 394.72

Liquidity
$16,897
Current Ratio =𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡ൗ𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑖𝑠 = = 1.195
$14,136
If current liabilities are rising faster than current assets, the current ratio will fall, and
that could spell trouble. The acceptable one varies from 1 to 2.
Quick (Acid-Test) Ratio=(Current assets – Inventories)/Current liabilities
=($16,897 – $459)/$14,136 = 1.1628. It tells us whether a company could pay all of
its current liabilities if they came due immediately. If we find that a firm’s ratio is
quite different from the average for its industry, we should examine the reason for the
difference.
Asset Management
The inventory turnover ratio measures how many times the company sold and replaced its inventory over a specific
$49,205
period, =𝑆𝑎𝑙𝑒𝑠 (𝑟𝑒𝑣𝑒𝑛𝑒𝑤)ൗ𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑟𝑦 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 = = 125.20
($327 + $459)/2.
The lower inventory turnover ratio means the excessive stocks of the inventory, which leads to the lower rate of return and
unproductive.
The day’s sales outstanding (DSO) is a rough measure of how many times a company’s accounts receivable have been
turned into cash during the year, = Receivables/Average sales per day=$4,414/($49,205/365)= 32.74 days
If credit term is 30 days, it can be said that on average, the customers are not paying their bills on time.
The total assets turnover ratio measures how effectively the firm uses its total assets in generating its revenues.
𝑆𝑎𝑙𝑒𝑠 $49,205
= = = 2.12
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 $23,215
The lower total assets turnover ratio implies that the company has the higher investments in inventory, plant, and
equipment compared to the size of sale.
Profitability
$3,043
Profit Margin on Sales=𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑡𝑜 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠ൗ𝑆𝑎𝑙𝑒𝑠 = = 0.0618 = 6.18%
$49,205
The low profit margin is also a result of its heavy use of debt and carrying a very high volume of inventory.
The return on total assets or simply, return on assets (ROA) measures a company’s success in using its assets to earn a
profit.
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒 $3,043 + $11.29(1 − 0.315)
= = 0.1435 = 14.35%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 ($23,215 + $19,311)/2
This high return results from (1) the company’s high basic earning power and (2) its low use of debt, both of which cause
its net income to be relatively high.
Return on Common Equity is the measure of profitability which is rate of return on common equity.
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑡𝑜 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 $3,043
= = 0.4768 = 47.68%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 ($6,485 + $6,280)/2
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡
Rate of return= = × ×
𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝑒𝑞𝑢𝑖𝑡𝑦 𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝑒𝑞𝑢𝑖𝑡𝑦
23,215
= 𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑒𝑟𝑔𝑖𝑛 × 𝐴𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 × 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒 = 6.18 × 2.12 × =47.68%
6,382.5
Market Trend
Price-to-Earnings Ratio shows how much investors are willing to pay per dollar of reported profits.
𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $41.5
Price−to−Earnings Ratio = = =34.29
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $1.21
P/E ratios are higher for firms with high growth prospects, other things held constant, but they are lower for firms with
lower expected earnings.

Book Value per Share measures the amount that would be distributed to holders of each share of common stock if all
assets were sold at their balance-sheet carrying amounts and if all creditors were paid off.

𝑇𝑜𝑡𝑎𝑙 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝑒𝑞𝑢𝑖𝑡𝑦−𝑝𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠𝑡𝑜𝑐𝑘 $6,485−$0

Book Value per Share = = = $2.58.
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 2,509
We are to compare the book value with the current market value, whether the asset is overpriced or not.
Picture (Table): Park, C. S. (2007). Contemporary
Engineering economics. United States: Pearson Prentice
Hall.

• Revenue is the income from goods sold and services

rendered during a given accounting period
• Net revenue represents gross sales, less any sales
return and allowances.
• cost of revenue (or cost of goods sold) are the
expense of making a product (such as labor, materials,
and overhead).
• Gross margin is the net revenue less the cost of
revenue.
• Operating income is the Gross margin less the
operating expenses.
• Operating expenses are expenses associated with
paying interest, leasing machinery or equipment,
selling, and administration.
• Net income/accounting income (or net profit) by
subtracting the income taxes from the taxable income
Reference
Park, C. S. (2007). Contemporary Engineering economics. 4th ed., United
States: Pearson Prentice Hall.
Thank You