Vol.

IV, Issue 5
Scientific Papers (www.scientificpapers.org)
October 2014
Journal of Knowledge Management, Economics and Information Technology

Financial Statements Analysis

Author: Tănase Alin-Eliodor, EVERET România Distribution,

[email protected]

This article focuses on analyzing of a consolidated financial statements of a

hypothetically SME. The interpretation of the financial position and
performances is based on the more than 40 financial key ratios computed by
using financial data from consolidated income statement, consolidated
financial position and cash flow. However additional data from notes to
financial statements are provided.

Keywords: Financial gearing, Sales per person, EBITDA per person,

Sales margin, DSO, DPO, Quick ratio, Cash ratio, DOH, Cash conversion
cycle, ROE, ROI, Earnings per share, Dividend payout ratio, Financial leverage
index.

JEL Classification: G32 – Financing Policy, Financial Risk and Risk

Management, Capital and Ownership Structure, H32 - Firm M41 – Accounting

Introduction

Calotă (2013, pag. 13) considers accounting as "the main source of knowledge
by the management of the real state of economic organization, the one who,
through analyzes performed and documents (reports) prepared provide a
real and legal decision support”. The analyzing of financial statements of
SME is an important issue for actual shareholders or new investors and also
for the management of SME. This is the reason I write this article which is
focused on analyze of 47 financial key ratios split in five categories. This is
the second article focused on financial key ratios. The first one is based on

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October 2014

computed methodology starting from a trail balance of a SME. This present

article is referring both on computing the key ratios - starting from financial
statements- and analyzing their evolution during four year.

Description of the analyses company

This point of article is split in 3 parts:

1. Short description and financial statements;
2. Computing the financial ratios;
3. Interpretation of key ratios and conclusions.

1. Short description and financial statements

The “ABC” company is included in the category of small and

medium sized enterprises because the values from individual financial
statements and also the values from consolidated financial statements are
falling in thresholds mentioned in Article 2 of the Annex of
Recommendation 2003/361/EC:

Enterprise Headcount: Annual Annual turnover Annual balance

OR
category Work Unit sheet total
Medium-sized 50 -249 ≤ 50.000.000 Euro ≤ 43.000.000
Euro
Small 10 – 49 ≤ 10.000.000 Euro ≤ 10.000.000
Euro
Micro ≤9 ≤ 2.000.000 Euro ≤ 2.000.000 Euro

The company has two subsidiaries and it prepares consolidated

financial statements. Additional information is also provided. The
computing of key ratios is based on the values included in consolidated
financial statements:

Consolidated Income Statement ‘000

Description 2010 2011 2012 2013

Revenue 20.681 21.889 22.890 22.919

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Cost of sales -9.981 -10.947 -11.651 -11.579

Gross profit 10.700 10.942 11.239 11.340

Other operating income 78 86 79 6
Administrative expenses -1.391 -1.344 -1.441 -1.550
Distribution expenses -5.909 -6.365 -6.513 -6.446
Other expenses -86 -92 0 -160

Profit from operations 3.393 3.226 3.365 3.190

Finance expense -1.116 -912 -920 -776
Finance income 374 217 310 248
Share of post-tax profits of associates 51 62 37 40
Profit before tax 2.702 2.593 2.792 2.702
Tax expense -649 -633 -641 -652
Profit from continuing operations 2.052 1.960 2.151 2.049
Profit attributable to:
Non-controlling interests 210 187 220 165
Shareholders in Entity ABC 1.843 1.773 1.931 1.884

Additional data related to Consolidated Income Statement

Depreciation
and
amortization 2010 2011 2012 2013

Property, plant 1.266 1.211 1.292 1.286

and equipment
Intangible assets 107 91 82 86
Interest expense 746 666 656 594
Dividend per share 30 32 33 35
(proposed)
Market price per 658 482 667 719
share
Staff costs 3.289 3.733 3.533 3.729

Consolidated Statement of Financial Position ‘000 CU

2010 2011 2012 2013

Assets

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Non-current assets
Property, plant and equipment 11.185 10.968 11.017 11.530
Intangible assets 30.226 30.663 31.413 31.646

Investments in equity-accounted
associates 1.680 1.739 2.149 812
Other receivables 647 616 760 721
Deferred tax assets 448 413 403 405

Total Non-current assets 44.186 44.400 45.742 45.115

Current assets
Inventories 1.443 1.498 1.564 1.640
Trade and other receivables 2.723 3.545 3.417 3.406
Tax receivables 59 44 21 70
Prepayments 323 299 294 539
Cash and cash equivalents 942 1.083 1.984 1.279

Total Current assets 5.490 6.469 7.278 6.934

TOTAL ASSETS 49.676 50.869 53.020 52.048

Liabilities
Current liabilities
Trade and other payables 7.652 8.138 7.930 8.198
Loans and borrowings 1.363 646 1.154 3.280
Corporation tax liability 184 181 185 183
Provisions 176 176 213 183

Total Current liabilities 9.376 9.141 9.482 11.843

Non-current liabilities 0 0 0 0
Loans and borrowings 11.222 11.834 12.641 10.567
Employee benefits 838 1.124 1.363 1.065
Provisions and other liabilities 836 779 837 906
Deferred tax liability 3.425 3.324 3.334 3.043

Total Non-current liabilities 16.322 17.061 18.175 15.582

Total Liabilities 25.698 26.202 27.657 27.426

NET ASSETS 23.978 24.667 25.363 24.622

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Issued capital and reserves

attributable to owners of the
parent
Share capital 1.051 1.051 1.051 1.051
Reserves -2.430 -3.010 -2.230 -4.737
Retained earnings 23.505 24.642 25.376 27.039
Equity, shareholders in Entity
ABC 22.125 22.683 24.196 23.352
Non-controlling interest 1.853 1.985 1.167 1.270

TOTAL EQUITY 23.978 24.667 25.363 24.622

Additional data related to Consolidated Financial Position ‘000 CU

Additional data: 2010 2011 2012 2013

Trade and other receivables, from

which 3.370 4.161 4.177 4.126

Sales of goods and services 1.742 2.450 2.451 2.499

On - trade loans 711 711 696 660
Loans, fair value of hedging
instruments and other
receivables 917 1.000 1.030 967

Trade and other payables 7.652 8.138 7.930 8.198

Trade payables 3.232 3.795 4.085 4.452

Deposits on returnable packaging 440 445 476 561
Other liabilities 3.980 3.898 3.369 3.185

Average number of employees 240 230 200 175

Depreciation and
amortization
Property, plant and equipment 8.992 9.383 10.401 10.340
Intangible assets 731 1.096 1.153 1.212
Interest-bearing debt 1.573 1.560 1.724 1.731

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Number of shares (average,

excl. treasury shares if any) 16.250 16.200 16.200 16.200

Note: All the above amounts - except dividend per share, market price, no. of employees and
number of shares – are shown in ‘000 CU.

2. Computing the financial ratios

For analyzing the data of this hypothetic company ABC the financial key
ratios computed are split into 5 categories as follow (see the table no. 1 to 5):

1) Asset Utilization ratios

2) Operating Performance ratios
3) Cash Flow ratios
4) Liquidity and Profitability ratios
5) Return on Investment ratios

Key ratios computed based on the above data are presented in the
following tables:

Table no. 1 Asset Utilization ratios

Financial key ratio 2010 2011 2012 2013

1.1 Working Capital to Sales Ratio 1.08% 1.92% 0.66% -0.93%
1.2 Sales to Fixed Assets Ratio 42% 43% 43% 44%
1.3 Sales to Administrative Expenses Ratio 14,86 16,29 15,88 14,78
1.4 Sales to Equity Ratio 86% 89% 90% 93%
1.5 Sales per Person 86.172 95.169 114.450 130.965
1.6 Personnel productivity 6,29 5,86 6,48 6,15
1.7 EBITDA per Person 19.858 19.688 23.693 26.063
Accumulated Depreciation to Fixed Assets
1.8 Ratio 18,04% 19,09% 20,17% 20,39%
1.9 Distribution Expenses to Sales Ratio 28,57% 29,08% 28,45% 28,12%
1.10 Investment Turnover 51,32% 52,46% 52,57% 57,01%
1.11 Interest Expense To Debt Ratio 5,92% 5,34% 4,76% 4,29%
1.12 Financial Gearing 52,49% 50,59% 54,39% 56,24%

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Table no. 2 Operating Performance ratios

Financial key ratio 2010 2011 2012 2013

2.1 Sales margin 23,17% 20,91% 20,65% 21,36%

2.2 Gross margin 51,74% 49,99% 49,10% 49,48%
2.3 Operating profit percentage 16,44% 14,77% 14,35% 14,59%
2.4 Net income percentage (Return on sales) 9,92% 8,96% 9,40% 8,94%
2.5 Consolidated profit for the year per person 8,552 8,523 10,753 11,711
2.6 Operating margin 16,41% 14,74% 14,70% 13,92%

Table no. 3 Cash Flow ratios

Financial key ratio 2010 2011 2012 2013

3.1 Cash flow from operating activities per share (CFPS) 225 178 209 166
3.2 Free cash flow per share (FCFPS) 110 83 125 5
3.3 Share price to cash flow ratio 2,24 1,72 2,28 2,55

Table no. 4 Liquidity and solvability ratios

Financial key ratio 2010 2011 2012 2013

4.1 Accounts receivable Turnover 11,88 10,44 9,34 9,26

4.2 Days sales outstanding (DSO) (in days) 31 35 39 39
4.3 Inventory to sales ratio 14 15 15 14
4.4 Inventory turnover 6,92 7,31 7,45 7,06
4.5 Inventory to working capital 6,46 3,57 10,39 -7,67
4.7 Days payables outstanding (DPO) (in days) 118 117 123 135
4.6 Payables turnover 2,72 2,77 2,65 2,42
4.8 Current ratio (Golden financing rule) 0,59 0,71 0,77 0,59
4.9 Quick ratio 0,43 0,54 0,60 0,45
4.1
0 Cash ratio 0,10 0,12 0,21 0,11
4.11 Current assets turnover 3,77 3,66 3,33 3,23
4.1
Days of inventory on hand (DOH) (in days)
2 53 50 49 52
4.1 36,48 34,89 34,29 43,18
3 Current liability ratio (Leverage structure) % % % %

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4.1 Noncurrent Assets To Noncurrent Liabilities

4 Ratio 2,71 2,60 2,52 2,90
4.1 31,04
5 Short-Term Debt To Long-Term Debt Ratio 12,15% 5,46% 9,13% %
4.1
6 Interest cover 6,39 6,80 7,22 7,67
4.1
7 Cash conversion cycle (net operating cycle) -34 -32 -35 -44

Table no. 5 Return on Investment ratios

Financial key ratio 2010 2011 2012 2013

5.1 Book value per share 1.476 1.523 1.566 1.520

5.2 Return on total assets 4,13% 3,85% 4,06% 3,94%
5.3 Return on equity (ROE) 8,56% 7,95% 8,48% 8,32%
5.4 Return on equity (ROE) - excluding NCI 8,33% 7,82% 7,98% 8,07%
5.5 Return on investment (ROI) 4,13% 3,85% 4,06% 3,94%
5.6 Financial leverage index 2,07 2,06 2,09 2,11
5.7 Earnings per share 113,40 109,46 119,19 116,30
5.8 Dividend payout ratio 26,46% 29,24% 27,69% 30,09%
5.9 Dividend yield ratio 17,24% 22,72% 17,87% 16,18%

3. Interpretation of key ratios and conclusions

Comments based on above financial key ratios and focused specially for the
last two years. The purpose of computing and analyzing of key ratios is to
understand the past evolution of SME and to establish the future measures
for achieving the shareholders expectation. “If the performance goals were
not achieved, then the causes will be established and the required measures
will be configured, based on them a new strategy will be configured,
according to the new elements.” (Calotă, April 2014, page no. 9).
» For the first time during the analyzed period (2010-2013) the
working capital is negative caused by significant increase of trade payables
of 10 % in 2013 vs. 2012 (insignificant increase of accounts receivables and a
slight increase – less than 5 % - of inventory). The impact of trade payable’s
increase can be noticed when DPO for 2013 is computed: no. of days
increased from 123 days (2012) to 135 days (2013).

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» There are no significant changes in evolution of Sales to Fixed

Assets Ratio (1% small increase 2013 vs. 2012) this means that the 5% increase
of tangible fixed assets 2013 vs. 2012 is not a significant one related to the
revenue. Also there are no significant changes in evolution of Accumulated
Depreciation to Fixed Assets Ratio during 2010-2013.
» The negative evolution of Sales to Administrative Expenses Ratio
is clearly generated by 7% increase of administrative expense (2013 vs. 2012).
Generally, this kind of increase should be carefully checked by using
additional data. Based on the additional data it can be notice two issues as
follow:
- a significant de decrease of number of employees (200 employees in
2012 vs. 175 employees in 2013) but in the same time
- a significant increase of staff costs (‘ 000 CU) included in income
statements ( 3.533 in 2012 vs. 3.729 in 2013)
Apparently there is a contradiction but – in fact- the increase of staff
costs is generated by compensation wages granted for laid off employees.
These compensation wages are included in administrative expenses. The
significant decrease of employees positively influences the evolution of three
key ratios:
- Sales per Person (114.450 in 2012 vs. 130.965 in 2013),
- EBITDA per Person (23.693 in 2012 vs. 26.063 in 2013), and
- Consolidated profit for the year per person (10.753 in 2012 vs. 11.711 in
2013)
The lowest Profit from operations amount from the analyzed period
(2010-2013) is recorded in 2013 when is recorded the highest value of EBITDA
per Person. At first glance it may seem an unusual situation but number of
employees has decreased much faster in 2013 vs. 2012 (12 %) than Profit from
operations (5 % decreases in 2013 vs. 2012).
The significant increase of staff costs negatively influences the
evolution of Personnel productivity (6.48 in 2012 vs. 6.15 in 2013). Anyway
the lowest value of Personnel productivity has been recorded in 2011 (5.86 in
2011). It can be notice that the personnel costs is almost the same in 2011 v.
2013 but the value of revenue for 2011 is 4.5 % less than revenue for 2013.
» In the last two years there is a positive evolution - but without
significant impact - of Distribution Expenses to Sales Ratio (0.13 % revenue
increase vs. 1 % distribution expense decrease).

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» There is a positive evolution during 2010 – 2013 for Finance

expense and Interest Expense To Debt Ratio. SME has borrowed money at
lower interest rates. The total balance amount of short and long term
interest – bearing debt increased during the last 3 years. This increase has
generated the evolution of Financial Gearing. Anyway the SME has preferred
to borrow money from banks instead of borrow money from shareholders by
increasing the share capital.
» The evolution of Sales margin and Gross margin indicate that SME
has maintained its profitability. The same conclusion can be notice from
evolution of Operating profit percentage. During 2010-2013 there is a slight
decrease for all these three key ratios; the lowest value is recorded in 2012.
This decrease can be considered to be normal due to the fact that – in the
analyzed period – the revenue increased (5.84 % in 2011 vs. 2010; 4.75 % in
2012 vs. 2011) and it is possible that the SME offered better conditions (e.g.
increasing of commercial discounts) to its customers or to record higher
distribution expenses.
» The above mentioned administrative expense increase (7% in 2013
vs. 2012) has a notable negative impact regarding the evolution of Operating
margin and a slightly negative influence of Return on sales because the
negative influence is diminished by the positive evolution of financial costs (
decrease 15.6 % in 2013 vs. 2012).
“The solvency ratio expresses the degree to which the company
copes with total liabilities, the way its assets are able to deal with the
liabilities incurred. A solvent entity is able to pay its creditors.” (Calotă &
Vintilescu, October 2013, page no. 10).
» The evolution of cash flow key ratios is not good and suggests a
lack of liquidity, especially from operating activities. This lack of liquidity
can be noticed more clearly when the value of Quick ratio and Cash Ratio
are analyzed. These two ratios are less than 1. As a common rule, if these
ratios are less than 1 it indicates that SME can have significant difficulties
regarding the payments for current liabilities. Even Current ratio – also
known as Golden financial rule - is less than 1. It expresses the relationship
between current assets and current liabilities. Generally, if this ratio is:
a) 1:1 is considered to be the absolute minimum level of acceptable
liquidity;
b) Less than 1 it indicates that SME might have significant difficulties
regarding the payments for current liabilities.

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» Likewise, it can be notice that the amount of short term liabilities

increased in 2013 vs. 2012. The total of short and long term liabilities
remained constant in 2013 vs. 2012 but there is an important increase of
proportion of the total liabilities which must be paid in a period less than
one year. However this ratio doesn't indicate the ability of SME to pay its
current liabilities. In the same time can be notice that there is a significant
switch from long term category to short term category. This is clearly
indicated by evolution of Short-Term Debt to Long-Term Debt Ratio (5.46 %
in 2011, 9.13% in 2012 and 31% in 2013). Days sales outstanding is the same in
2012 and 2013 (39 days) but Days payables outstanding increase in 2013 with
11 days vs. 2012 and this may be a sign of lack of liquidity.
» The evolution of Return on Investments Key ratios indicates that
the SME has a constant evolution. There are no significant changes. It is
important to notice that Dividend payout ratio increased in 2013. The
highest value has been recorded in 2013. There is a constant dividend policy.
ABC is a stabile enterprise. The evolution for the last 4 years is good,
especially regarding the increase of revenue. The future fixed costs,
especially staff costs, will be low in the next years due to the significant
reduction of employees. It is a good sign the fact that this decreasing of
employees didn’t affect the sales increasing. The evolution of market share
price is good (the prices are constantly increasing). This is a good sign for
shareholders. However the enterprises have a poor liquidity. This part must
be carefully motorized by management. It can be noticed a constant policy
for distribution of dividends. This is also a good sign for investors.

Acknowledgement

This paper has been financially supported within the project entitled
“Horizon 2020 - Doctoral and Postdoctoral Studies: Promoting the National
Interest through Excellence, Competitiveness and Responsibility in the Field
of Romanian Fundamental and Applied Scientific Research”, contract
number POSDRU/159/1.5/S/140106. This project is co-financed by European
Social Fund through Sectoral Operational Programme for Human Resources
Development 2007-2013. Investing in people!

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October 2014

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