Lesson - 02 Contents:

• Statements of Financial Information

Financial Analysis
• Analysis of Financial Statements

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Financial information Financial Statements

 Financial information is the basis for • Income Statements
Financial Analysis, Planning, and decision • Statement of Financial Position
making • Statement of Changes in financial position
 These are needed to predict, compare, and or Fund Flow Statement or Cash Flow
evaluate firm’s Financial Performance Statement
(Profitability and Financial position)
 These are required to aid in investing and
financing decision making

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Income Statement
• It reports the results of operation for a period of • Operating costs = Administrative costs +
time (Profit or Loss) selling and Distribution
• Profit / Loss = Revenue – Costs costs + Finance Costs +
• Revenue = value of sales other costs
• Costs = Cost of sales + other operating costs
• Net Profit After Tax = Net Profit – Tax
• Cost of Sales = Opening stock + Purchases –
Closing stock • Retained Profit = NPAT – Dividends
• Gross Profit = Sales – Cost of Sales
• Net Profit = Gross Profit + other operating
income – operating costs
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Statement of Financial Position
• It shows the Financial Position of a firm at a point
of time • Net worth = Market value of Equity
• Financial position is represented by Assets and • Assets = Non Current Assets + Current
Liabilities
Assets
• Liabilities = Equity + External Liabilities
• Equity = Ordinary Share Capital + Reserves
• Working Capital = Current Assets – Current
Liabilities
• External Liabilities = Long Term Liabilities
+ Current Liabilities • Capital Employed = Equity or Equity + LTL
• LTL = Preference Share Capital + Debenture +
Mortgage Loans
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Financial Statement Analysis Techniques for FSA

It is a process of identifying the financial • Financial Ratio Analysis

strengths and weaknesses of the firm by • Horizontal Analysis
properly establishing relationships between the • Vertical Analysis
items of the income statements and balance
sheet • Cash Flow Analysis

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Financial Ratio Analysis Ratio Format

Numerator (N)

• Ratio is the indicated quotient of two • Ratio = --------------------- =N:D

Denominator (D)
mathematical expressions or relationship
Numerator
between two / more things ---------------- X 100
• Ratio (in Percentage) = = x%
• It helps to summarize large quantities of Denominator
financial data Numerator (N)

• It helps to make qualitative judgment about • Ratio (in times) = ---------------------

= x times
Denominator (D)
the firm’s financial performance
• Ratio (in Rupees) = N/ D = Rs.x
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 Types of Ratios Profitability Ratios

Classified Based on functions to be evaluated • These measures overall performance and

• Profitability Ratios effectiveness of the firm
• Activity Ratios • Major categories:
• Liquidity Ratios • Profitability in relation to sales
• Leverage Ratios • Profitability in relation to investment
• Growth Ratios or Market Ratios

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Profitability Ratios in relation to sales 2. Net Profit Margin (NPM)

Gross Profit
Net Profit After Tax
1. Gross Profit Margin (GPM) = ---------------- X 100 NPM = -------------------------- x 100
Sales
Sales
• It measures the efficiency with which management produces each of • It measures the overall efficiency of production,
product administration, selling, financing, pricing, and tax
• High ratio implies that firm is able to produce at relatively lower cost management
• Factors which determine the ratio are:
• Variation in sales prices • The gross and net profit margin ratios provide a valuable
• Variation in cost of sales understanding of the cost and profit structure of the firm and
• Variation in both enable the analyst to identify the sources of business
• Variation in sales Volume efficiency or inefficiency
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Profitability Ratios in relation to investment

2. Return on Equity (ROE)

1. Return On Capital Employed (ROCE) Net Profit After Tax and Preference dividend
ROE = ------------------------------------------------------------ x 100
Net Profit Before Interest & After Tax Equity
= ------------------------------------------------- x 100
Capital Employed

Capital Employed = Equity + LTD It indicates how well the firm has used the
owner’s equity funds to earn profits
It indicates how well the firm has used the
capital funds to earn profits
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 3. Return on Assets (ROA) 4. Return on Investment (ROI)

Net Profit After Tax Net Profit After Tax

ROA = --------------------------- x 100 ROI = ---------------------------- x 100
Total Assets Net Assets

It indicates how well the firm has used the total It indicates how well the firm has used the
capital employed in total assets to earn profits total investment in net assets to earn
profits

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Activity Ratios Stock Turn Over Ratio

Activity ratios / Turn over ratios are used to evaluate the efficiency with Cost of Sales
which the firm manages and utilizes its assets STO = -------------------
1. Stock or Inventory Turn Over Average Stock
2. Days of Inventory Holding Opening Stock + Closing Stock
3. Debtor Turnover Average Stock = ------------------------------------------
4. Debtor Collection Period 2
5. Creditor Turn Over • It indicates the efficiency of the firm in producing and selling its
6. Creditor Payment Period product and how rapidly the inventory is turning into receivable
through sales
7. Total Asset Turn Over • Higher the ratio, the more efficient the management of
8. Fixed Asset Turn Over inventories and vice versa
9. Current Asset Turn Over • But a high ratio may be caused by a low level of stock which
10. Net Asset Turn Over may result in frequent stock outs and loss of sales and
customer goodwill
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Days of Inventory Holding Debtor Turn Over

Credit Sales
Average Stock DTO = ----------------------
DIH = ------------------- x 360 Average Debtors
Cost of Sales
It indicates the number of times debtors
It indicates the average inventory holding in turnover each year. Higher the value of DTO,
days the more efficient is the credit management

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 Debtor Collection Period Total Asset Turn Over
Average Debtors Sales
DCP = ---------------------- X 360 TATO = --------------------
Credit Sales Total Assets

It measures the average number of days for It indicates how efficiently the firm’s total
which debtors remain outstanding. The shorter assets are utilized to generate sales
the DCP, the better the quality of debtors

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Net Assets Turn Over Non- Current Assets Turn Over

Sales Sales
NATO = -------------------- NCATO = --------------------
Net Assets Non-Current Assets

It indicates how efficiently the firm’s net assets It indicates how efficiently the firm’s non-
are utilized to generate sales current assets are utilized to generate sales

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Creditor Turn Over Creditor Payment Period

Credit Purchases
CTO = ---------------------- Average Creditors
Average Creditors CPP = ---------------------- X 360
Credit Purchases
It indicates the number of times creditors are It measures the average number of days for
paid each year. Higher the value of CTO, the which creditors allow outstanding. The longer
more efficient is the creditor Payment the CPP, the better the terms of credit
management purchase

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 Liquidity Ratios Current Ratio
These measure the ability of the firm to meet
its current obligations. These include: Current Assets
• Current Ratio CR =----------------------
Current Liabilities
• Quick Ratio
• Cash Ratio It is a measure of firm’s short – term
solvency. It indicates the availability of
• Interval Measure current assets in rupees for every one rupee
• Net Working Capital Ratio of current liability

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Quick Ratio Cash Ratio

Current Assets - Inventories Cash + Cash Equivalent

QR = ------------------------------------ CR = ------------------------------------
Current Liabilities Current Liabilities

It measures the relationship between quick or It measures the relationship between Cash
liquid assets and current liabilities and current liabilities

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Interval Measure Net working Capital Ratio

Current Assets - Inventories Net Working Capital

IM = ------------------------------------ NWCR = ----------------------------
Average Daily operating Expenses Net Assets

It relates liquid assets to average daily It relates NWC to Net Assets

operating cash outflows

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Leverage Ratios Debt – Equity Ratio
These measure the long term financial
position of the firm. These include: Total Debt
DER = ---------------------------
• Debt – Equity Ratio Net worth or Equity
• Gearing Ratio
• Long Term Debt – Equity Ratio It measures the relationship between the
• Fixed Interest Coverage Ratio lenders’ contribution and each rupee of the
• Fixed Dividend Coverage Ratio owner’s contribution to the capital

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Gearing Ratio Fixed Interest Coverage

Long Term Debt NPBIT

GR = --------------------- FIC = --------------------------
Equity + Long Term Debt Fixed Interest (FI)

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Fixed Dividend Coverage Growth Ratios

NPAT • Earning Per Share

FDC = -------------------------- • Dividend Per Share
Fixed Dividend
• Dividend Payout Ratio
• Price Earning Ratio
• Earning Yield
• Dividend Yield

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 Earnings Per Share
Dividend Per Share
Profit After Tax and Preference Dividend
Ordinary Dividend
EPS = -----------------------------------------------------
DPS = -----------------------------------------------------
No. of Ordinary Shares outstanding
No. of Ordinary Shares outstanding

• It indicates whether or not the firm’s earnings power

• It indicates the amount of earnings of the firm
on per share basis has changed over a period
• It can show the profitability of the firm on a per-share distributed as cash dividend to ordinary
basis, it does not reflect how much is paid as shareholders on a per-share basis
dividend and how much is retained in the business • It can indicate the dividend policy of the firm
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Dividend Payout Ratio Price-Earning Ratio

Dividend Per Share Market value of an Ordinary share

DPO = -------------------------------- PE = -----------------------------------------------------
Earning Per Share Earning Per Share

• It indicates the proportion of earnings of the • It indicates investors’ judgment or expectation

firm distributed as cash dividend to ordinary about the firm’s performance
shareholders on a per-share basis • It reflects investors’ expectations about the growth
in the firm’s earnings
• It can also indicate the dividend policy of the
• A higher P/E ratio may reflect higher growth
firm potential.
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Earning Yield Dividend Yield

Earning Per Share Dividend Per Share

EY = -------------------------------------------- X 100 DY = -------------------------------------------- X 100
Market value of an Ordinary Share Market value of an Ordinary Share

• It evaluates the shareholders’ earning in • It evaluates the shareholders’ dividend in

relation to the market value of the share relation to the market value of the share

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