Analysis of FS

By: Sana Tauseef
 Review of basic financial statements

 How corporate taxes influence business
decisions
 Cash flow statement
 Users of financial analysis
 Common-size statements and ratio
analysis
2
Balance Sheet shows a firm’s accounting
value on a particular date
• Assets are listed in order of liquidity.

• Assets are recorded at historical or fair
market values.
3
Current
Current Liabilities
Assets
Non-current
Liabilities
Fixed Assets
1.Tangible
fixed assets
Shareholders’
2.Intangible Equity
fixed assets
Total Value of Liabilities

Total Value of Assets 4
and Shareholders’ Equity
Listed in random order below are the balance sheet figures of Qalam
Ltd as at 31 March 2016:
Trade receivables € 50,000
Trade payables € 30,000
Building € 90,000
Share capital € 100,000
Bank loan € 40,000
Inventories € 10,000
Cash and cash equivalents € 20,000
Reserves € 50,000
Intangible assets € 30,000
Treasury shares € 20,000
Equipment € 40,000
Retained earnings € 40,000
Compute current assets, current liabilities, and the owners' equity for
the firm.
5
Income Statement measures a firm’s performance
over a period of time
The figures on the Statement of Financial
Performance may differ from actual cash inflows and
outflows during a period due to:
• Revenues and costs being recorded when they are

realized, not when they are received or paid.
• The existence of non-cash items such as

depreciation.
6
Sales
Less: Cost of Good Sold
Gross Profit
Less: Selling and Adm. Expenses
EBIT/Operating Income
Less: Interest
Taxable Income
Tax (50%)
Net Profit
Less: Preferred Dividends
Income available to CSH
7
The Kane book Company sold 1,200 finance text books
to State University for $60 each in 2010. These books
cost Kane $42 each to produce. In addition Kane spent
$2,000 (selling expense) to persuade the university to
buy its books. Kane borrowed $30,000 on January 1,
2010, on which it paid a 10% interest. The company had
15,000 shares outstanding during the year. Both
interest and principal were paid on December 31,
2010. Kane’s tax rate is 30%. Depreciation expense for
the year is $4,000.
a. Did Kane make a profit in 2010?
b. If the company paid $30,000 by issuing shares for 60
each, what is the EPS for the firm on December 31,
2010.
8
Revenues/Income can be classified as:
• Taxable
 Sales revenue
• Tax-exempted
 Dividend (partially)
Expenses can be classified as:

• Tax Deductible
 Cost of goods sold
 Interest expense
 Depreciation expense
• Non-tax Deductible
 Dividend payment
9
 Taxes affect the financing decision as
interest provides tax saving to the firm
 Taxes affect the investment decision as
dividend income is partially tax
exempted or taxed at lower rates
 Non-cash expenses provide tax savings
and increase the operating cash flow for
the firm
 Operating losses can be carried back or
forward for tax purposes
10
Firm Z
Firm A (Using preferred equity,
(Using debt, paying paying dividends of Rs.
interest of Rs. 100) 100)
Operating Income 400 400

Less: Interest -100 0
Taxable Income 300 400
Less: Taxes (35%) -105 -140
Net Income 195 260
Less: Preferred Dividends 0 -100
Income for Common
Equity Holders 195 160
11
Firm A Firm Z
(gets dividend (gets interest income of
income of $100) $100)
Operating Income 400 400

Add: Taxable Dividend/Interest 30 100
Taxable Income 430 500
Less: Tax (30%) -129 150
After-tax Income 301 350
Add: Tax-exempted Dividend 70 0
Net Income 371 350
Assume 30% of dividend income is taxable and 70% is tax-exempt.
12
Firm A Firm Z
(with Depreciation (with 0
of Rs. 100) Depreciation)
Earnings Before Depreciation
and Taxes 500 500
Less: Depreciation -100 0
Earnings Before Taxes 400 500
Less: Taxes (35%) -140 -175
Net Income 260 325
Add Back: Depreciation 100 0
Net Operating Cash flow 360 325
Net Income 371 350
13
Operating losses carry good news about
taxes because can be carried back or
forward for tax purposes.
14
Statement of cash flows summarizes the sources
and uses of cash over a specified period
• Sources of cash are those activities that

bring in cash.
• Uses of cash are those activities that involve
spending cash.
15
1. Operating activities—includes net profit and
changes in operating current accounts
2. Investment activities—includes changes in

fixed assets and financial investments
3. Financing activities—includes changes in

notes payable, long-term debt and equity
accounts as well as dividends.
16
Identify whether the following transactions will be
recorded under operating, investment or financing
activities.
a. Receipt of cash from the issuance of bonds
payable.
b. Payment of cash to repurchase outstanding
capital stock.
c. Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.
e. Purchasing inventory from supplier on credit
f. Repayment of bank loan along with interest
17
 Internal:
• Performance evaluation and setting targets for
future by management
 External:
• Assessing creditworthiness of firm by creditors
• Making the investment decisions by
shareholders
• Comparing performance by competitors
18
 Common-Size Statements
• Horizontal Analysis
• Vertical Analysis
 Ratio Analysis
• Trend Analysis
• Cross-sectional Analysis
19
Common-Size Statements are Financial
statements that show only percentages and
no absolute dollar amounts.
• Horizontal Analysis includes using comparative
financial statements to calculate dollar or
percentage changes in a financial statement
items from one period to the next.
• In vertical analysis, each item is expressed as a
percentage of a significant total in a single
financial statement
20
 Ratios express the logical relationships
between items in a financial statement or
from different financial statements of a
single period
 Ratios can be expressed as a percentage
or a multiple
21
1. Liquidity Ratios
2. Asset Management Ratios
3. Debt Management Ratios
4. Profitability Ratios
5. Market Ratios
22
These ratios measure the ability of the firm
to meet its short-term financial obligations
Current Assets/Current
Current Ratio Liabilities
(Current Assets-
Quick Ratio Inventory)/Current Liabilities
23
These ratios assess how effectively the firm
is using assets to generate sales
Cost of Goods Sold/
Inventory Turnover Inventory
Receivables Turnover Sales/ Receivables
Asset Turnover Sales/ Total Assets
24
These ratios quantify the firm's ability to
repay long-term debt
Debt Ratio Total Debt/Total Assets

Operating Income/Interest
TIE Expense
25
These ratios assess if the company can
make a reasonable profit and keeps the
costs (production, selling, admin and
interest) in control
Net Margin Net Income/Sales
ROE Net Income/Total Equity
26
These ratios give an idea of what the firm's
investors think of the firm's performance
and future prospects
Market Price per share/Book

Market-to-Book Value per share
Market Price/Earnings Per
Price-to-Earnings Share
27
 Besley, S. & Brigham, E. F. (2007).
Essentials of Managerial Finance.
 Ross, S. A., Westerfield, R. W., & Jordan, B.
D. (2012). Fundamentals of Corporate
Finance. India: McGraw Hill.
28

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By: Sana Tauseef

 Review of basic financial statements

• Assets are listed in order of liquidity.

Total Value of Liabilities

• Revenues and costs being recorded when they are

• The existence of non-cash items such as

Expenses can be classified as:

Operating Income 400 400

Operating Income 400 400

• Sources of cash are those activities that

2. Investment activities—includes changes in

3. Financing activities—includes changes in

Receivables Turnover Sales/ Receivables

Asset Turnover Sales/ Total Assets

Debt Ratio Total Debt/Total Assets

Net Margin Net Income/Sales

ROE Net Income/Total Equity

Market Price per share/Book

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