FINANCIAL STATEMENT ANALYSIS

FINANCIAL STATEMENTS
Financial Statements present data in a systematic form by following generally accepted accounting principles. Types of Financial Statements: 1. Balance Sheet: Indicates the financial condition of the business at a particular moment of time. 2. Profit and Loss Account: It reflects the earning capacity of the firm over a period of time.

3. Fund Flow Statement: It helps to understand the changes in the distribution of resources between two balance sheet periods. 4. Cash Flow Statement: It indicates the changes in cash position from one period to another. An estimated cash flow statement enables the management to ascertain the availability of cash to meet business obligation. Thus it is useful for short term planning by management. 5. Schedules: The statements which explain the items given in income statement and balance sheet.

Qualitative Characteristics of Financial Statements

Understandability : it is readily understandable by users who are having a reasonable knowledge of business and economic activities and accounting, and also willing to study the information with reasonable diligence. Relevance : Information has relevance with economic decisions to be taken by users. Materiality : The relevance of information is affected by its nature and materiality. Reliability : To be reliable information must represent faithfully the transactions and other events . Substance : To be reliable the information should be accounted for and presented in accordance with their substance and economic reality and not merely their legal form.

 Neutrality : To be reliable the information should be free from bias. Prudence : Overstatement of profit should be avoided while due consideration should be given for possible losses. Completeness

Objectives of Financial Statements

Providing information for economic decisions Providing information about financial position Information about economic resources controlled by the enterprise. Information about financial structure Information to predict success of the enterprise in raising further finance. Information about liquidity and solvency. Providing information about performance of enterprise. Providing information about changes in financial position.

Contents of Income Statement

Sales Cost of Goods Sold Gross Profit Profit Before Interest and Taxes (PBIT) Interest

Operating Expenses
Operating Profit Non-Operating Surplus

Tax
Profit After Tax (PAT) Dividends Retained Earnings

Generally Accepted Format of Income Statement

Profit and Loss Account of XYZ Ltd. for the Year ended March 31st 20XX
Income Sales Other Income Expenditure Material and Other Expenditure Interest Depreciation Profit Before Tax Provision for Tax Profit After Tax Prior period adjustments Profit available for appropriations Appropriations Investment Allowance Reserve Dividend General Reserve Surplus carried to Balance Sheet xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Horizontal form of Income Statement

Trading and Profit and Loss Account of XYZ Ltd for the period ended March 31st 20XX
Particulars To Opening Stock To Purchases To Direct Expenses To Gross Profit c/d To Admin. Exp To Mktg. Exp To Depreciation To Prov. For Tax To Net Profit c/d To Appropriations To Dividend Transfer to Reserves To Balance c/d to Balance Sheet Rs. xx xxx xxx xxx By Gross Profit b/d xxx xxx xxx xxx Particulars By Sales By Closing Stock Rs. xxx xxx xxx

xxx xxx xxx xxx xxx xxx xxx By Balance b/d By Net Profit xxx xxx xxx

Contents of Balance Sheet

I. Assets 1. Fixed Assets

2. Investments 3. Current Assets, Loans and Advances 4. Miscellaneous Expenditure and Losses II. Liabilities 1. Share Capital 2. Reserves and Surplus 3. Secured Loans 4. Unsecured Loans 5. Current Liabilities and Provisions

Horizontal Form of Balance Sheet

Balance Sheet of XYZ Ltd. as on March 31st,20XX Liabilities Rs. Assets Rs.

Share Capital Reserves and Surplus Unsecured Loans Current Liabilities and Provisions - Current Liabilities - Provisions

xxx Fixed Assets xxx Investments xxx Current Assets, Loans and Advances - Current Assets xx - Loans xx - Advances
xxx

xxx xxx

xx xx xx xxx

Vertical Form of Balance Sheet

Balance Sheet of XYZ Ltd. as on March 31st, 20XX
I. Sources of funds 1. Shareholders Funds a. Share Capital b. Reserves and Surplus 2. Loan Funds a. Secured Loans b. Unsecured Loans Rs xxx xxx xxx xxx

xxxx

xxxx xxxx

II. Application of Funds 1. Fixed Assets 2. Investments 3. Current Assets, Loans and Advances Less: Current Liabilities and Provisions 4. Miscellaneous Expenditures

xxx xxx

xxx
xxx xxx xxx xxxx

Users of Financial Statements

Management Employees

Shareholders
Investors

Government
Researchers Public

Creditors
Customers

NATURE OF FINANCIAL STATEMENT ANALYSIS

Process of establishing relationships between various components of the financial statements and finding their relative importance. Helps in assessing the profitability and operating efficiency of the firm. Helps in providing useful information to the interested parties: creditors, shareholders, researchers, government etc.

TOOLS FOR FINANCIAL STATEMENT ANALYSIS

Tools For Analyzing the Financial Statements: 1. Ratio Analysis: Helps in evaluating the performance of the firm by establishing relationship between two or more variables. 2. Comparative Analysis: Helps in evaluating the firms position relative to industry standards/ competitors/ firms past performance. 3. Funds Flow Analysis: Depicts the changes in assets and liabilities between two periods

Sources of Financial information

The financial data needed in the financial analysis comes from many sources. The primary source is the data provided by the firm in its annul report. The other sources of data are market prices of securities and financial press.

FINANCIAL RATIOS

LIQUIDITY RATIOS

TURNOVER RATIOS

PROFITABILITY RATIOS

OWNERSHIP RATIOS

EARNING RATIOS

DIVIDEND RATIOS

LEVERAGE RATIOS

LIQUIDITY RATIOS
They measure the firms ability to pay its debts in the short run.

CURRENT RATIO

QUICK RATIO

BANK FINANCE TO WORKING CAPITAL GAP RATIO

Current Assets Current Liabilities

Current Assets- Inventories Current Liabilities

Short-term bank borrowings Working Capital Gap

TURNOVER RATIOS
They measure the efficiency with which the firm manages its assets. They also indicate the speed with which assets are being converted into sales.

ACCOUNTS RECEIVABLES TURNOVER RATIO

INVENTORY TURNOVER RATIO

Net Credit Sales Average Accounts Receivable

Cost of Goods Sold Average Inventory

PROFITABILITY RATIOS
Types of Profitability Ratios: (a) Ratios computing profit in relation to sales: These ratios measure the ability of the firm to generate profit on each unit of sales. (b) Ratios computing profit in relation to assets: These ratios measure the extent to which the firm has earned profit on its asset base.

PROFITABILITY RATIOS
PROFIT IN RELATION TO SALES

Gross Profit Margin Ratio = Gross Profit Net Sales

Net Profit Margin Ratio = Net Profit Net Sales

PROFITABILITY RATIOS (contd)

PROFITS IN RELATION TO ASSETS

Asset Turnover Ratio = Sales Average Assets

Earning Power = EBIT Average Total Assets

Return on Equity = Net Income Average Equity

OWNERSHIP RATIOS

EARNING RATIOS

LEVERAGE RATIOS

DIVIDEND RATIOS

CAPITAL STRUCTURE RATIOS

COVERAGE RATIOS

EARNINGS RATIOS
They reflect the earnings of the firm and its affect on the market price of the stock.

EARNINGS PER SHARE

PRICE EARNINGS RATIO

CAPITALIZATION RATE

Net Income Number of outstanding shares

Market Price per Share Earnings Per Share

Earnings Per Share Market Price per Share

LEVERAGE RATIOS
They reflect the long-term solvency of the firm. There are two categories of leverage ratios: (a) Capital Structure Ratios: They indicate the mix of debt and equity in the capital structure of the firm. (b) Coverage Ratios: They help to compute the firms ability to meet interest and other fixed charges.

CAPITAL STRUCTURE RATIOS

Debt-Equity ratio = Debt Equity

Debt-Asset Ratio = Debt Total Assets

COVERAGE RATIOS Interest Coverage Ratio = EBIT Interest Expense

Fixed Charges Coverage ratio = [Earnings before depreciation, interest, Lease rentals and taxes] [Debt interest + Lease rentals+ Loan repayment installment +Pref. Dividend] (1-tax rate) (1-tax rate)

Debt Service Coverage Ratio = [PAT+ Depreciation+ Other non-cash charges+ Interest on term loan] [Interest on term-loan + Repayment of the term loan]

DIVIDEND RATIOS These ratios help in computing the percentage of total earnings distributed as dividends and in finding the investors current return on investment.

DIVIDEND YIELD

DIVIDEND PAYOUT RATIO

Dividend per Share Market Price Per Share

Dividend per Share Earnings Per Share