Chapter 3 Financial

Statements Analysis
Vaibhav Kabra
Agenda
• What is Financial Analysis or Financial Statement Analysis?
• What are the views/perspectives?
• What are the tool?
• Common Size
• Comparative
• Trend analysis
• Ratio Analysis
• Analysis of Cash cash-flow
Financial Statement Analysis (FSA)
• What is FSA?
• FSA is a systematic and critical review of financial statements in order to
facilitate a business decision making
• Why analysis?
• Financial Statements are generally prepared to cater the needs of
shareholders or regulatory reporting
• Based on the objective of assessment statements are reviewed which enables
the decision making like,
• Weather to invest in particular asset/ project or not?
• Weather to extend credit to customer or not?
• Weather to lend or not?
 Perspective

perspective

Owner Lender

Good bad
Perspectives of Financial Statement analysis
• Four hats • Management
• While assessing the financial
• Investors performance
• While taking investment • CFO and her team
• Auditor
decision
• Investment funds • Regulatory
• While assessing the compliance to
• Individual investors regulations
• Brokers and advisors • Regulators like income tax Dept.,
Sales Tax and Excise Dept.
• Lender/Banker • Government agencies providing
• While taking credit decision business clearances/ license
• Government agencies funding or
• Banks and NBFCs providing some assistance
• Creditors
Tools of financial statement analysis
• Common Size
• Comparative
• Trend analysis
• Ratio Analysis
• Analysis of Cash-flows
Ratio Analysis
• Ratio is a relationship between two numbers, which is created based
on some business logic and used for taking meaningful business
decision
• For e.g. you are an investor who wants to take a decision on
investment in either of two company, where following information is
available :
Company A Company B
Sales 200 million 1000 million
Profit 20 million 20 million
Classification of ratios
1. Liquidity Ratios
2. Capital Structure Ratios or Gearing Ratios
3. Coverage Ratio
4. Activity Ratio or Efficiency Ratios
5. Profitability Ratio
6. Market Value ratio
1. Liquidity Ratios
• What is liquidity?
• Availability of funds to meet the day to day obligation of business
• Or simply does business has sufficient sources to pay its current liabilities
• The liquidity ratio will help you to understand the liquidity position of
business,
• Why liquidity is so important? (bring a case here)*
• You must appreciate that despite earning a sufficient profits a business may
not be able to meet its current liabilities which may lead to serious trouble
• So its okey to make poor profit but not compromise on liquity
1. Liquidity ratio
• Current ratio = Current Assets/Current Liabilities
• Quick ratio = Quick Assets /Current Liabilities
• Quick Assets = Current Assets – Inventory – Prepaid Expenses
• Cash ratio (Absolute liquidity ratio) = Absolute Liquid asset / CL
• So cash ratio check the business’s ability to meet its current liabilities
immediately
• Absolute liquidity asset = cash + marketable securities
2. Capital Structure Ratios
• Generally used to understand the capital structure and long term
stability of business
• Net-worth or equity Ratio = Net-worth/ Capital Employed
• It shows confidence of owner in business, Also known as NW to TA ratio, also
known as proprietary ratio
• Long Tem Debt Ratio = LT Debt / Capital Employed
• This shows the leverage position of the business and key ratio for banker or
lender
• D/E Ratio = Debt / Equity
• Most used leverage ratio, it combines the above two ratios and present a
single number about capital structure of the business, generally presented in
times i.e. D/E of 3x
• What is acceptable D/E? Some say 3:1? Is it good? Or should we go for
industry benchmark
2. Capital Structure Ratios
• Trading on Equity: Limited Stake and control over the firm
• With the help of debt, investors can magnify their returns

• Capital Gearing Ratio = Capital Bearing Fixed return / Capital Bearing

variable return
3. Coverage ratio
• Dividend Coverage Ratio = PAT/ Preference Dividend
• Interest Coverage ratio = EBIT/ Interest
• DSCR ratio = Profit available for servicing debt/Interest expenses and
Installments
• Profit available for servicing debt ={PAT+ Depreciation + amortization
+ Interest + lease rentals + deferred tax provision (liabilities to be
added and asset to be deducted)}
• Total Fixed Charge= {Interest + lease rentals +( Pref. Div. + Principal
Installments)/(1-t)}
3. Coverage ratio
• Fixed Charge Bearing ratio = (EBIT + Lease rental)/ Total Fixed Charge
• Fixed cost bearing funds = Preference Share +Debentures+Loans
• Total Cashflow Coverage ratio = Profit available for servicing debt /
Total Fixed Charge
• Profit available for servicing debt ={PAT+ Depreciation + amortization
+ Interest + lease rentals + deferred tax provision (liabilities to be
added and asset to be deducted)}
• Total Fixed Charge= {Interest + lease rentals +( Pref. Div. + Principal
Installments)/(1-t)}
4. Activity or Turnover ratio
• Capital Turnover = Sales / Capital Employed
• Total Asset Turnover = Sales / Total Assets
• Fixed Asset Turnover = Sales / FA
• Working Capital Turnover ratio
• Debtors Turnover = Credit Sales/ Average Debtors
• Receivable days = 365/ DTR
• Creditors Turnover = Credit Purchases/ Average Creditors
• Payable days = 365/ CTR
• Inventory Turnover = COGS / Average Inventory
• Inventory Holding Period= 365/ ITR
• Operating Cycle = Receivable Days + Inventory Days
• Cash conversion Cycle = Receivable Days + Inventory Days - Payable Days
Example-1
Net Working Capital Rs 240,000
Bank OD (No Further Borrowing) Rs 40,000
FANW 0.75
Reserves and Surplus Rs. 160,000
Current Ratio 2.5
Quick Ratio 1.5
Example 2
Gross Profit Rs 54,000
Shareholders fund Rs 600,000
GP Margin 20%
Credit sales 80%
Total Assets turnover 0.3x
Inventory Turnover 4x
Average Collection Period (360 days in a year) 20 days
CR 1.8
Long term Debt to equity 40%
Example 3
Equity Share Capital 1,00,000
Current Debt to Total Debt 0.40
Total Debt to NW 0.60
Total Assets Turnover 2x
Inventory Turnover 8x
FANW 0.60
5. Profitability Ratio
General Profitability ratio Return on Investment ratio
Gross Profit ratio Return On Assets
Operating ratio Return On Capital Employed
Operating Profit ratio Return On Equity
Expenses ratio
Net Profit ratio
Cash Profit ratio
EBITDA Margin ratio
EBIT Margin ratio
Minority Interest Exps. ratio
Profitability Ratio
• Net Sales= (Sales – Returns & Excise Duty)
• Gross Profit ratio = Gross Profit / Net Sales
• Operating ratio = Operating cost / Net Sales
• Operating Cost = COGS + Operating Expenses
• Operating Profit ratio = operating profit before tax/ Net Sales
• Operating profit before tax = EBIT –Other Income
• Expense ratio = Expense*/ Net Sales
• Net Profit ratio = PAT / Net Sales
5. Profitability Ratio
• ROCE = EBIT-other income/ Capital Employed
• Capital Employed = Net fixed Assets + Investments + Net Working Capital
• ROE or RONW = EAES / NW
• EAES = PAT – Preference Dividend
• Net Worth (NW) =Equity Share Capital Plus Reserves and Surplus
• ROA = PAT / Total Assets
• EPS = EAES/ No. of Equity Shares
• DPS= Dividend paid to equity shareholders/ No. of Equity Share
• Dividend payout Ratio = DPS/ EPS
DuPont Analysis
6. Market Value Ratio
• Earnings yield (E/P – multiple) = EPS / Market Price Per Share (MPS)
• Price Earning (P/E - Multiple) = MPS/ EPS
• Dividend yield = DPS/MPS
• Market Value to Book Value = MPS / BV per share
• BV per share = BV/ No. of equity shares
• BV = Paid up Equity + Reserves and surplus – Accumulated losses
• ROE = EAT/EBT *EBT/EBIT * EBIT/Sales * Sales/ Assets* Assets/Equity
Uses
• Help in managerial decision making
• It helps in financial budgeting
• It will help management in evaluating effectiveness of managerial
decisions
• Help us in understanding the liquidity positions
• Help us in understanding the Long term solvency positions
• We can check operating efficiency and perform interfirm or industry
comparisons
Limitations
• Business with multiple product line may not be able to compare the
performance of individual product
• Seasonal variations are not captured in ratios
• Problem of Window dressing
• Benchmark is difficult to arrive
• Not comparable if two company follows different accounting policies
and standards
 Example -1
• Financial Information is Presented for Aditya Ltd, Calculate relevant
ratio and Comment:
Liabilities Amt (Rs in Lacs) Particulars Amt (Rs in Lacs)
Equity share Capita (Rs 10 Each) 100 Sales 800
Reserves 217 Less: COGS 250
Creditors 61 GP 550
Bills Payable 150 Less: Operating Exps 135
Other CL 22 PBIT 415
Less: Interest 15
Assets Amt (Rs in Lacs)
PBT 400
Plant and Equipment's 140
Less: Tax @30% 120
Land And Building 60
PAT 280
Cash 70
Less: Dividend to Equity
112
Debtors 130 Shareholders
Stock 150 Transferred to RE 168
Example-2
• From following information complete balancesheet of company.
Particulars Ratio
Sales to NW 2.3
Curent Debt to Networth 42
Total Debt to Networth 75
Current ratio 2.9
Net Sales to Inventory 4.7
Average Collection Period 64
Fixed asset to Networth 53.2
Example-3
Particular Rs. Particular Rs.
3,50,000 (?)
To Op. stock To Purchase (?) By Sales (?)
To Purchase Return To Gross 87,000 By Closing Stock
Profit 7,18,421
14,96,710 14,96,710

Particular Rs. Particular Rs.

3,70,000 7,18,421
To Office Exp. To Int. on 30,000 (?)
By Gross Profit By
Deb. 18,421
To Tax. Provision To Net Profit 3,50,000 Commission
(?) (?)
Particular Rs. Particular Rs.

Paid Up Capital General 5,00,000 Plant & machinery 7,00,000

Reserve P & L a/c. (?) Stock (?)
10% Debenture (?) Debtors (?)
(?) Bank
Current Liabilities 6,00,000 Other Fixed Assets 62,500
(?)
(?) (?)
Example- 3
• Find out missing items with the help of other details are as under:
1. Current Ratio was 2:1.
2. Closing Stock is 25% of Sales.
3. Proposed Dividend was 40% of paid up capital.
4. Gross profit Ratio was 60%.
5. Amount transfer to General Reserve is same as proposed Dividend.
6. Balance of P & L Account is calculated 10% of proposed dividend.
7. Commission income is 1/7 of Net profit.
8. Balance of General reserve is twice the current year transfer amount