FINANCIAL STATEMENT

ANALYSIS
V
 • Financial Statement Analysis is
use of Information in company's
Financial Statements and other
relevant information to make
economic decisions
WHAT IS • Examples of Such Decisions
FINANCIAL • Whether to invest in
company’s security
STATEMENT • Recommend the company's
ANALYSIS (FS A) security to investors
• Extending trade credit or bank
credit to an entity
• Form an opinion about
company's past performance
and ability to generate future
profits
 FINANCIAL STATEMENTS

Statement of Statement of
Balance Statement of
Profit and changes in
Sheet Cash flow
Loss Equity
• Assets • Revenue • Operating • Amounts
• Liabilities • Expenses Cash Flows and Sources
• Owner's • Other • Investing of changes
Total Comprehensive
CashIncome
Flows= Profit &inLoss + Other
Equity of
Equity Income
Comprehensive
• Financing IncomeFirm
Cash Flows

Notes to Accounts, Director Report (MD&A) and Independent Auditor

Report
 BAL ANCE SHEET
Assets = Liabilities + Owners' Equity
• Property, Plant &
Non- Equipment
Curren • Intangible Assets
t • Investment in
Associates
Assets • Deferred Tax Asset
Assets are
firm's
economic
resources
• Inventory
Curren • Accounts
Receivable
t • Cash & Cash
Assets Equivalent
• Financial Asset
 BAL ANCE SHEET

Non- • Long Team Debt

Current such as bonds
Liabiliti • Deferred Tax
Liabilities
es Liabilities
are
creditor's
claim on • Accounts Payable
company • Income tax
resources payable
Current • Unearned
Liabilities
Revenue
• Short Term
 BAL ANCE SHEET
Capital
Par value
of
common
stock

Other
Addition
Compreh Owners’
al Paid in
ensive Equity
capital
Income

Retained
Earnings
 STATEMENT OF PROFIT AND LOSS
Other
Revenue Expenses
Income
• Sales - • COGS • Gains.
Revenue • Selling & Increases
from the Distributio in assets
firm’s day n incidental
to day • Depreciati to day to
activities on day
• Tax activities
• Interest • Investmen
t Income
 CASH FLOW STATEMENT

Cash Flow Cash Flow Cash Flow

from from from
operations Investing Financing
• Cash • Cash • Cash
inflows and inflows and inflows and
outflows outflows outflows
affecting resulting affecting
‘Net from firm’s
Income’ of acquisition capital
the or disposal structure
company of asset
STEPS OF FINANCIAL ANALYSIS
Objective

Update
Gather Data
Analysis

Report
Conclusion & Process the
recommendat Data
ion

Analyze and
Interpret Data
 ANALYSIS

Vertical Horizontal
Ratio Analysis Common Size common-Size Others
Analysis Analysis
• Express • A vertical • Horizontal • Graphical
Relationships common-size common-size Analysis
using Data balance sheet balance sheet • Stacked Bar
• Can be used as % total or income Graph
for Internal assets statement, • Line Graph
comparison • A vertical divisor is first • Regression
and common size year values Analysis
comparison income • Relationship
across firms statements as between
% total sales different
variables,
this used for
forecasting
 RATIO ANALYSIS
Ratio
Analysis

Activity Liquidity Solvency Profitabilit Valuation

Others
Ratios Ratios Ratios y Ratios Ratios

Operating
Receivable Current Earning Du-Pont
Debt Ratio Profit
Turnover Ratio Per share Model
Margin
Price to
Inventory Quick Debt to Return on Altman’s Z
Earning
Turnover Ratio Equity Asset Score
(P/E)
Return on Price to
Payable Debt to
Cash Ratio total Book
Turnover Asset
capital value (P/B)

Asset Defensive Interest Return on

Turnover Interval Coverage Equity
 ACTIVITY RATIOS – RECEIVABLES
TURNOVER

Details of ratio :
• Average Accounts Receivables or debtors is calculated as average of opening and
closing receivable balance
• The ratio can also be expressed in terms of ‘Receivables (Debtors) Days’, Days are
calculated by dividing 365 days by Receivable Turnover Ratio

Interpretation :
• Higher the better, higher receivable turnover indicates lower time required for
converting receivables into liquid cash
• Comparison is usually done with the industry to see where the company in question
stands
• Receivable days are also compared with average credit period offered by an Entity
• Higher receivable days than credit period indicates company’s inability to collect
receivable on time and leading to higher capital tied up in current assets
•
 ACTIVITY RATIOS – INVENTORY
TURNOVER

Details of ratio :
• Average Inventory is calculated as average of opening and closing inventory balance
• The ratio can also be expressed in terms of ‘Inventory Days’, Days are calculated by
dividing 365 days by Inventory Turnover Ratio

Interpretation :
• Higher the better, higher inventory turnover indicates lower time required for
converting inventory into liquid cash
• Comparison is usually done with the industry to see where the company in question
stands
• Inventory days are also compared with average Inventory days in an industry
• High inventory days than industry indicates higher processing time leading to
higher capital tied up in an inventory or holding of an obsolete inventory
• Low inventory days indicates that company is not holding enough stock or
 ACTIVITY RATIOS – PAYABLE
TURNOVER

Details of ratio :
• Average Accounts Payable is calculated as average of opening and closing inventory
balance
• The ratio can also be expressed in terms of ‘Accounts Payable (Creditor) Days’, Days
are calculated by dividing 365 days by Payables Turnover Ratio

Interpretation :
• Lower the better, lower payable turnover indicates higher credit period is allowed by
creditor for payments
• Comparison is usually done with the industry to see where the company in question
stands
• Payables days are also compared with average credit period allowed by suppliers to an
Entity
 ACTIVITY RATIOS – ASSET TURNOVER

Details of ratios :
• These ratios indicates how efficiently company using its asset base to generate
revenue
• Current Asset turnover ratio of working capital (Current Asset – Current Liabilities)
turnover ratio can also be calculated similarly

Interpretation :
• Higher the better, higher asset turnover ratios indicates efficient use of asset base,
whereas lower asset turnover ratios indicates higher capital tied up in assets or
inefficient use of asset
• Comparison is usually done with the industry to see where the company in question
 LIQUIDITY RATIOS – CURRENT RATIO

Details of ratio :
• It is best known measure of short term solvency for an Entity
• This ratio answers ‘Whether an entity has enough current assets to meet the payment
schedule of current debts with margin of safety for possible losses in current assets?’
• Current Assets = Inventories + Sundry Receivables + Cash & Bank Balances +
Accruals/Prepaid expense + Loans & Advances + Disposable Investments + Any other
current Assets
• Current Liabilities = Accounts Payables + Short term loans + Bank overdrafts + Cash
Credit + Outstanding Expenses + Provisions for taxation + Proposed dividend + Any
other current liabilities

Interpretation :
• Higher the better, generally accepted current ratio is 2:1 but it depends on nature of
business and nature of current assets held
• Current ratio less than 1 shows company is having negative working capital and it
 LIQUIDITY RATIOS – QUICK RATIO

Details of ratio :
• Also referred as ‘Acid Test Ratio’
• This ratio is conservative or stringent ratio than the current ratio, it shows whether
Entity can satisfy its current obligations if all the revenues disappear
• Quick Assets (Near Cash Assets) = Current Assets – Inventories – Prepaid Expenses
• Current Liabilities = Accounts Payables + Short term loans + Bank overdrafts + Cash
Credit + Outstanding Expenses + Provisions for taxation + Proposed dividend + Any
other current liabilities

Interpretation :
• Higher the better, generally accepted quick ratio is 1:1 unless majority of quick assets
are only in Accounts Receivables and pattern of Accounts receivable collections lags
behind the current liability payment cycle
 LIQUIDITY RATIOS – CASH RATIO

Details of ratio :
• Also referred as ‘Absolute Liquidity Ratio’
• This ratio considers absolute liquid assets available with the Entity, like cash & bank
balances and marketable securities

Interpretation :
• It tests short term liquidity in terms of cash and marketable securities/current
investments
 LIQUIDITY RATIOS – BASIC DEFENSE
INTERVAL

Details of ratio :
• Also referred as ‘Interval Measure’
• Daily Expenses are taken from indirect cash flow statement, non cash expenses e.g.
depreciation etc. is not considered

Interpretation :
• This ratio helps to determine the number of days for which the company can cover its
cash expenses without the aid of additional financing
 SOLVENCY RATIOS – DEBT RATIO

Details of ratio :
• Total debt includes short term & long term borrowings from financial institutions,
debentures, bonds, bank borrowings, deferred payment arrangement for buying asset,
public deposits and any other interest bearing loan
• This ratio is used to analyze the long term solvency

Interpretation :
• A debt ratio higher than 1 indicates greater portion of company assets are funded by
debt and could be a risky scenario
 SOLVENCY RATIOS – DEBT TO EQUITY
RATIO

Details of ratio :
• Total outside liabilities include current, non current debt and present value of lease
obligations and non interest bearing current liabilities like Accounts payable
• * Not merely long term debt i.e. both current and non-current liabilities
• ** Only interest bearing, long term debt is used instead of total liabilities (exclusive of
current liabilities)
• Usually only long term debt is used in this ratio with current maturities related to long
term debt

Interpretation :
• High debt ratio indicates less protection for creditors, a low ratio indicates larger
 SOLVENCY RATIOS – DEBT TO TOTAL
ASSET

Details of ratio :
• This measures the portion of total assets financed by debt
• Total Debt = Not merely long term debt i.e. both current and non-current liabilities
• Usually Total debt is used for this ratio

Interpretation :
• Higher the ratio, indicates that assets are less backed by equity and hence higher
financial leverage
 SOLVENCY RATIOS – INTEREST
COVERAGE RATIO

Details of ratio :
• This ratio also known as ‘times interest earned ratio’ indicates firm’s ability to meet
interest obligations
• EBIT is used, as ability of payment of interest is not affected by tax payments as debt
interest is tax deductible expenditure

Interpretation :
• High interest coverage ratio means than an enterprise can easily meet its interest
obligations even if EBIT suffers considerable decline.
• Lower ratio indicates excessive use of debt or inefficient operations.
 S OLVENCY RAT I OS – D EB T S ERVI C E
C OVERAG E RAT I O

Details of ratio :
• Lenders are interested in debt service coverage to judge firm’s ability to pay off
current interest and installment
• Earning available for debt services = Net profit (Earning after taxes) + Non cash
operating expenses like depreciations & other amortization + Interest + other
adjustments like loss on sale of fixed assets
• Cash from operating activities can also be used as numerator
• Interest is taken as net off taxes
• Leases payments are sometime also considered both in numerator and denominator

Interpretation :
• Normally DSCR of 1.5 to 2 is satisfactory
P R O F I TA B I L I T Y RAT I O S – O P E RAT I N G P R O F I T
MARGIN

Details of ratio :
• Operating Profit = Sales – Cost of Good Sold (COGS) – Operating Expenses
• Operating Profit is often referred as EBIT
• EBIT might include non-operating incomes like gain from investments, analysts need
to adjust the same for this ratio
• Operating margin shows the % of sales in rupees remains with company after
payment of costs and expenses except for interest and taxes

Interpretation :
• This ratio is closely watched by analyst because it focuses on operating results
• This ratio needs to be seen in context of industry in which Entity is working
P R O F I TA B I L I T Y RAT I O S – N E T P R O F I T M A R G I N

Details of ratio :
• It measures relationship between Net Profit and Sales of business
• This ratio calculates % of sales value that remains with company after paying all the
expenses

Interpretation :
• A high net profit margin indicates positive returns from business
P R O F I TA B I L I T Y RAT I O S – R E T U R N O N A S S E T S

Details of ratio :
• This ratio provides relationship between net profit and assets employed to earn that
profit
• Interest to be added back net of taxes

Interpretation :
• A high ROA indicates efficient use of asset employed
• ROA is used for comparing efficient use of asset across industry
 P R O F I TA B I L I T Y RAT I O S – R E T U R N O N C A P I TA L
E M P LOY E D

Details of ratio :
• Capital Employed = Equity + Pref. share capital + Long term debt
• Some analyst include short term loans and lease liabilities
• Average capital employed is also used as denominator

Interpretation :
• ROCE should be always higher than the rate at which company borrows funds from
market
• Analyst should be concerned if this ratio is too low
 PROFITABILITY RATIOS – RETURN ON
EQUITY

Details of ratio :
• It is one of the important indicator of company’s profitability and potential growth
• ROE ratio is more thoroughly analyzed by Du-Pont Model

Interpretation :
• Analyst should be concerned if this ratio is too low
 VALUATION RATIOS – EARNING PER
SHARE

Details of ratio :
• Net profit available to equity shareholders = 'Profit/ (loss) for the period from
continuing operations - After Tax Impact of Preference dividend
• Profit from discontinued business and other comprehensive Income (OCI) are excluded
• Number of equity shares outstanding = Time weighted of no. of equity shares

Interpretation :
• Its most commonly used corporate profitability measure for publicly traded firms
 VALUATION RATIOS – PRICE – EARNING
RATIO

Details of ratio :
• This ratio indicates expectations of equity investors about future earnings of the
company
• This is also most watched indicator for publicly traded entity

Interpretation :
• Higher P/E ratio could either mean that a company’s stock is over-valued or the
investors are expecting high growth rate in future
 VALUATION RATIOS – PRICE – BOOK
VALUE RATIO

Details of ratio :
• It provides evaluation of how investors view the company’s past and future
performance

Interpretation :
• Higher the ratio indicates better position to shareholders in terms of returns and
capital gains
 VALUATION RATIOS – YIELD RATIOS

Details of ratio :
• This ratios indicates return on investments, this may use average value of investment
or closing market value

Interpretation :
• Higher the better for investors
 DU-PONT MODEL FOR ROE

Details of ratio :
• Net Profit Margin = Net Profit Margin is simply the after-tax profit a company
generates for each rupee of revenue. Higher margin provides a better safety cushion
to Management.
• Asset Turnover = It measures how effectively a company converts its assets into sales
• Equity Multiplier = Total Assets divided by Equity

Interpretation :
• This Model shows how ROE is earned by company, if company has low ROE, it would
have either of this 3
• It has lower profit margin
• It is using asset inefficiently
• It is using too much of leverage
ALTMAN Z SCORE – 1968 MODEL

1.2 *
Working Details
capital/Tota • Altman Z score determines
l Assets
whether company is going
into Bankruptcy or not
• Original Altman Model was
1.4 * issued in 1968 which was
0.99 *
Turnover/To
Retained only for listed companies
Earnings/To • It uses 5 ratios to calculate Z
tal Assets
Original tal Assets
score and also assigns
Altman
various weights to those 5
model ratios
(Z)
Interpretation
• Altman classifies companies
in 3 zones
0.6 * • Safe Zone – Z score
3.3 *
Market
EBIT/Total above 2.99
Value/ Total
Assets
assets • Bankruptcy Zone – Z
score below 1.81
• Grey Zone – Z score
ALTMAN Z SCORE – 1983 MODEL

0.717 *
Working Details
capital/Tota • Altman Z score determines
l Assets
whether company is going
into Bankruptcy or not
• Revised Altman Model was
0.847 * revised in 1983 which was
0.998 *
Turnover/To
Retained for privately held companies
Earnings/To • It uses 5 ratios to calculate
tal Assets
Revised tal Assets
Z’ score and also assigns
Altman
various weights to those 5
model ratios
(Z’)
Interpretation
• Altman classifies companies
in 3 zones
0.42 * Book • Safe Zone – Z score
3.107 *
Value of
EBIT/Total above 2.90
Equity/Total
Assets
Liabilities • Bankruptcy Zone – Z
score below 1.23
• Grey Zone – Z score
ALTMAN Z SCORE – 2017 MODEL
6.56 *
Working Details
capital/Tota • Altman Z score determines
l Assets
whether company is going
into Bankruptcy or not
• Altman Model was further
revised in 2017 which was for
both manufacturing & non-
Revised manufacturing firms
1.05 * Book 3.26 * • It uses 4 ratios to calculate Z’’
Value of Altman Retained
Equity/Total model Earnings/To score and also assigns various
Liabilities tal Assets weights to those 4 ratios
(Z’’)

Interpretation
• Altman classifies companies
in 3 zones
• Safe Zone – Z score
6.72 * above 2.60
EBIT/Total • Bankruptcy Zone – Z
Assets
score below 1.10
• Grey Zone – Z score
between 1.10 to 2.60
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