Chapter - 19

Financial Statement Analysis

Financial Statement Analysis

Need for Financial Statement Analysis:

Comparison Purpose.
Intra company basis.
Intercompany basis.
Industry Average.

Tools of Financial Statement

Analysis
Horizontal Analysis: also known as
trend analysis.
evaluates a series of F/S data over a
period of time.
Example: Comparison of net sales of
2002, 2003 and 2005.
At first determine the Base year.

Horizontal Analysis

Net Sales:

2002

2003

$81,500
85,750
**Changes Science Base Period

2004

89,850

=(Current Year Amount-Base Year Amount)/Base

year amount
(2004)= (89,850-81500)/81,500
=10.25%
**Current Result in relation to Base Period
= Current Year Amount/Base Year Amount
=89,850/81,500
=110.25%

Vertical Analysis
Vertical Analysis: also known as
common size analysis.
evaluates a series of F/S data by
expressing each item in a financial
statement as a percentage of a base
amount.

Vertical Analysis

Example:

2004
Amount
Percent

Assets

Current Assets 102,000 55.6%

Plant Assets
80,000 43.6%
Intangible Assts
1,500 0.8%

2005
Amount Percent

Total

183,500 100.00%

94,500 59.2%
63,250 39.7%
1,750 1.1%
159,500 100.00%

Ratio Analysis
Ratio Analysis: express a relationship
among selected items of F/S data.
A ratio express the mathematical
relationship between one quantity and
other.

Liquidity Ratio.
Profitability ratio.
Solvency ratio.

Liquidity Ratio.

- measures the short term ability of the

enterprise to pay its obligations and to
meet unexpected need for cash.
Current Ratio.
Acid-test ratio.
Receivable turnover.
Inventory turnover.

Liquidity Ratio
Current Ratio.
= Current Assets / Current Liability
Purpose: Measure short term debt paying
ability.
Acid-test ratio/Quick Ratio.
= (Current Assets-Inventory) / Current Liability
Purpose: Measure short term debt paying
ability.

Liquidity Ratio

Receivable turnover.
=Net Credit Sales/Average Net Receivable

**Average Net Receivable=(Beginning A/R + Ending A/R)/2

Purpose: Measures Liquidity of receivable

Inventory turnover
= CGS/Avg Inventory

**Average Inventory =(Beginning Inventory + Ending

Inventory) /2
Purpose: Measures Liquidity of inventory

Profitability ratio.

-measures the income or operating

success of an enterprise for a given
period of time.
Gross profit margin.
Net profit margin.
Asset turnover.
Return on assets.
Return on equity

Profitability ratio

Gross profit margin.

= (Gross Profit / Net Sales) x 100
Purpose: Measures gross income generated by each
dollar of sale

Net profit margin.

=(Net Profit / Net Sales) x 100
Purpose: Measures net income generated by each
dollar of sale

Profitability ratio
Asset

turnover.

= Net Sales / Avg Assets

Purpose: Measures how efficiently assets are
used to generate sales.
Return

on assets.

= Net Income / Avg Assets

Purpose: Measures overall profitability of
Assets

Profitability ratio
Return

on equity

= Net Income / Avg Common Stock Equity

Purpose: Measures profitability of owners
investment
Earning

Per Share (EPS).

= Net Income / No. of outstanding shares

Purpose: Measures net income earned on a
per share basis.

Profitability ratio
Price-Earnings

Ratio

= Market Price per share/ EPS

Purpose: P-E ratio reflects investors
assessments of a companies future earnings.
Payout

Ratio

= Cash Dividend/ Net Income

Purpose: Measures the percentage of
earnings distributed in the form of cash
dividend.

Solvency ratio.

- measures the ability of the company to

survive over a long period of time.
Debt to total assets ratio.
Time interest earned.

Solvency ratio

Debt to total assets ratio.

= Total Debt / Total Assets
Purpose: Measures the percentage of total assets
provided by creditors.

Time interest earned

= EBIT / Interest expenses
Purpose: Measures ability to meet interest
payments as they come due.