Overview to

Financial
Statement Analysis
Prashanti Kumar
 Overview
Ascertainment of financial status of
the company
Financial Statements
Purpose of making Financial
Statements
Enhances decision making
Information not adequate
Effective analysis and interpretation of
financial statements is required
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 Spectrum of Analysis
What are the future business prospects?
Are markets expected to grow?
What are competitive strengths and
weaknesses?
What strategic initiatives are taken, or
does it plan to take, in response to
business opportunities and threats?
What is the earnings potential?
What is its recent earnings performance?
How sustainable are current earnings?
 Spectrum of Analysis
What are the drivers of profitability?
What estimates can be made about earnings
growth?
What is the current financial condition?
What risks and rewards does the financing
structure portray?
Are earnings vulnerable to variability?
Does the company possess the financial strength
to overcome a period of poor profitability?
How does the company compare with its
competitors, both domestically and globally?
 Spectrum of Analysis
What the likely sources for payment of
interest and principal?
How much cushion is available in the
earnings and cash flows to pay interest and
principal?
What is the likelihood the company will be
unable to meet its financial obligations?
How volatile are the earnings and cash
flows?
Does the company have the financial
strength to pay its commitments in a period of
poor profitability?
 Framework for Financial
Analysis

What
Who
Why
How
When

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 Framework for Financial
Analysis
What
Analysis of FS with an objective of
taking economic decision
Analysis is comparing the financial
performance of a company

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 Framework for Financial
Analysis
Who analyzes financial statements?

Internal users

External users

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 Interested Parties
Lenders/Creditor
Will they get the money lent to the firm
Investors
Interested in comparing potential
investments
Employees
Compare current financial performance
of the employer with the past
Regulatory Agencies
Assess organizational or industry
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 Framework for Financial
Analysis
Who analyzes financial statements?
Internal users
Planning, evaluating and controlling
company operations
External users
Assessing past performance
Current financial position
Making predictions about the future
profitability and solvency of the company
Evaluating the effectiveness of management

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 Need for Financial Analysis
The purpose of financial statement analysis
examine past and current financial data
company's performance and financial
position can be evaluated
Future risks and potential can be estimated
yield valuable information on
trends and relationships
quality of a company's earnings
Strengths and weaknesses of its financial
position
have a means of comparative analysis across
time
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 Uses of Financial Statement
Analysis
Screening tool
Selecting investment of merger
candidates
Forecasting tool
Future conditions & consequences
Diagnostic tool
Assessing financing, investing &
operating activities
Evaluation tool
For managerial & other business
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decisions 13
 Uses of Financial Statement
Analysis
Reduces reliance on guess work
Diminishes uncertainty in decision making
Establishes an effective & systematic basis
for making business decisions

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 Evaluation of Financial
Statements
Acquainted with business practices
Understand the purpose, nature, and
limitations of accounting
Familiar with the terminology of
business and accounting
Acquainted with the tools of financial
statement analysis

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 Introduction to Financial
Statement Analysis
It involves
Use of simple mathematical techniques
Understanding of accounting
Appreciation of business strategy to gain
insights
companys history
current financial position
future prospects

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 Introduction to Financial
Statement Analysis
Application of analytical tools &
techniques to FS & other data
Make inferences useful in decision
making
It involves examination of both
Relationships among financial statement
numbers
Trends in those numbers over time

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 Tools available for FSA
Horizontal Analysis
% increase or decrease
Difference in absolute numbers
Vertical Analysis
Trend Analysis
A base to compare
Ratio Analysis

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 Features of Horizontal
Analysis
Trend
Reveals direction, speed & extent of a
trend
Changes are generally shown both in
dollars and percentage

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 CLOVER CORPORATION
Comparative Balance Sheets
March 31, 2014 and 2013

I
2014 2013
Assets
Current assets:
Cash $ 12,000 $ 23,500
Accounts receivable, net 60,000 40,000
Inventory 80,000 1,00,000
Prepaid expenses 3,000 1,200
Total current assets 1,55,000 1,64,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 1,20,000 85,000
Total property and equipment 1,60,000 1,25,000
Total assets $ 3,15,000 $ 2,89,700
 Horizontal Analysis
Example
CLOVER CORPORATION
Comparative Balance Sheets
March 31, 2014 and 2013
Increase (Decrease)
2014 2013 Amount %
Assets
Current assets:
Cash $ 12,000 $ 23,500 $ (11,500) (48.9)
Accounts receivable, net 60,000 40,000 20,000 50.0
Inventory 80,000 1,00,000 (20,000) (20.0)
Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets 1,55,000 1,64,700 (9,700) (5.9)
Property and equipment:
Land 40,000 40,000 - 0.0
Buildings and equipment, net 1,20,000 85,000 35,000 41.2
Total property and equipment 1,60,000 1,25,000 35,000 28.0
Total assets $ 3,15,000 $ 2,89,700 $ 25,300 8.7
 CLOVER CORPORATION
Comparative Balance Sheets
March 31, 2014 and 2013
Increase (Decrease)
2014 2013 Amount %
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 67,000 $ 44,000 $ 23,000 52.3
Notes payable 3,000 6,000 (3,000) (50.0)
Total current liabilities 70,000 50,000 20,000 40.0
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 (5,000) (6.3)
Total liabilities 1,45,000 1,30,000 15,000 11.5
Stockholders' equity:
Preferred stock 20,000 20,000 - 0.0
Common stock 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Total paid-in capital 90,000 90,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total stockholders' equity 1,70,000 1,59,700 10,300 6.4
Total liabilities and stockholders' equity $ 3,15,000 $ 2,89,700 $ 25,300 8.7
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended March 31, 2014 and 2013
Increase (Decrease)
2014 2013 Amount %
Net sales $ 5,20,000 $ 4,80,000 $ 40,000 8.3
Cost of goods sold 3,60,000 3,15,000 45,000 14.3
Gross margin 1,60,000 1,65,000 (5,000) (3.0)
Operating expenses 1,28,600 1,26,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
 Sales increased by 8.3% while net
income decreased by 21.9%.
There were increases in both cost of
goods sold (14.3%) and operating
expenses (2.1%).
These increased costs more than
offset the increase in sales, yielding
an overall decrease in net income.

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 Advantages of Horizontal
Analysis
Increase or decrease analysis in absolute
amounts & on percentage basis
Helps to gauge the trend if the analysis is
performed for a number of years
Reference to dollar amounts is necessary
To retain a proper perspective &
To make valid inferences on the relative
importance of changes

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 Common Size or Vertical
Analysis
Relationship between items in the
same financial statement is identified by
expressing all amounts as a percentage
This method compares different items to a
single item in the same accounting period
The financial statements prepared by using
this technique are known as common size
financial statements

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 Vertical Analysis Example
Sample Company
Balance Sheet (Assets)
At March 31, 2014 and 2013
% of Total Assets
2014 2013 2014 2013
Cash $ 82,000 $ 30,000 17% 8%
Accts. Rec. 1,20,000 1,00,000 25% 26%
Inventory 87,000 82,000 18% 21%
Land 1,01,000 90,000 21% 23%
Equipment 1,10,000 1,00,000 23% 26%
Accum. Depr. (17,000) (15,000) -4% -4%
Total $ 4,83,000 $ 3,87,000 100% 100%
 Vertical Analysis Example
Sample Company
Balance Sheet (Liabilities & Stockholders' Equity)
At March 31, 2014 and 2013
% of Total Assets
2014 2013 2014 2013
Acts. Payable $ 76,000 $ 60,000 16% 16%
Wages Payable 33,000 17,000 7% 4%
Notes Payable 50,000 50,000 10% 13%
Common Stock 1,70,000 1,60,000 35% 41%
Retained Earnings 1,54,000 1,00,000 32% 26%
Total $ 4,83,000 $ 3,87,000 100% 100%
 Common Size or Vertical
Analysis
Common size analysis reduces numbers to
percentages
It allow for much easier comparison
between companies and across time
Income statements and balance sheets of
companies of different sizes can be
compared
Comparison of absolute amounts of
companies of different sizes does not
provide useful conclusions
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 Common Size or Vertical
Analysis
Comparisons can be more easily
made both across time and across the
industry
These comparisons are best done
using benchmarks

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 Trend Analysis
It involves choosing of a base year
Base year represents a frame of
reference for all comparisons
It is meaningful if the time period
involved is longer
Every item in financial statements
need not be analyzed
It considers changes in company &
industry factors
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 Trend Percentages
Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a
trend analysis
Wheeler, Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues $ 2,405 $ 2,244 $ 2,112 $ 1,991 $ 1,820
Expenses 2,033 1,966 1,870 1,803 1,701
Net income $ 372 $ 278 $ 242 $ 188 $ 119
 Trend Percentages
Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a
trend analysis.
Wheeler, Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues $ 2,405 $ 2,244 $ 2,112 $ 1,991 $ 1,820
Expenses 2,033 1,966 1,870 1,803 1,701
Net income $ 372 $ 278 $ 242 $ 188 $ 119

$1,991 - $1,820 = $171

 Trend Percentages
Example
Using 2009 as the base year, we develop the
following percentage relationships.
Wheeler, Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues 132% 123% 116% 109% 100%
Expenses 120% 116% 110% 106% 100%
Net income 313% 234% 203% 158% 100%

$1,991 - $1,820 = $171

$171 $1,820 = 9% rounded
 Trend line
140
for Sales
130
% of 100 Base

120

110

100

90
Sales 2009 2010 2011 2012 2013

Expense Years
s
 Trend Analysis
Conveys insight into
management philosophies and policies
underlying the changes
How company deals or dealt with
adversity
How company took advantages of
opportunities

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