FINANCIAL STATEMENT

ANALYSIS
By :
PGDM-FS (2015-2017)
Group - 06
Amrit Kaur (09)
Chandra Gupt Sharma (16)
Kirti Sharma (25)
Prateek Singh (34)
Rashmi Tyagi (40)
Saurabh Mutreja (42)

What is Financial
Statement?
Afinancial statement(orfinancial report) is a formal record
of the financial activities of a business, person, or other entity.
Financial Statements reflect the financial effects of business
transactions and events on the entity.

Types of Financial
Statements
Statement of Financial Position, also known as the Balance
Sheet.
Income Statement, also known as theProfit and Loss
Statement.
Cash Flow Statement, presents the movement in cash and
bank balances over a period.
Statement of Changes in Equity, also known as
theStatement of Retained Earnings.

Financial Statement Analysis

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Who analyzes financial statements?

Internal users
External users
Examples:

Investors, creditors, regulatory agencies

Stock market analysts

Auditors

Purpose of Analysis
Financial
Financial statement
statement analysis helps
users
users make
make better
better decisions.
decisions.

Managers
Officers
Internal Auditors

Shareholders
Lenders
Customers

Financial Statement Analysis

What do internal users use it for?

Planning, evaluating and controlling company operations

What do external users use it for?

Assessing past performance, current financial position
and making predictions about the future profitability and
solvency of the company as well as evaluating the
effectiveness of management.

Purpose of Analysis
F in a n c ia l m e a s u re s a re o fte n u s e d
to ra n k c o rp o ra te p e rfo rm a n c e .
E x a m p le m e a s u r e s in c lu d e :
G ro w th
in s a le s

R e tu r n to
s to c k h o ld e rs

P r o fit
m a r g in s

D e te r m in e d b y
a n a ly z in g th e
fin a n c ia l
s ta te m e n ts .

R e tu rn o n
e q u ity

Sources of Information
Published Annual Reports
Financial statements
Notes to financial statements
Letters to stockholders
Auditors report (Independent accountants)
Managements discussion and analysis
Reports filed with the government
e.g., Form 10-K, Form 10-Q and Form 8-K

Types of
Financial Statement
Analysis

Horizontal Analysis- Horizontal analysis involves the

comparison of two firms or two years with respect to the
same entries. Since horizontal analysis moves over a
number of years or across many firms, it is also referred as
dynamic analysis. Eg: Trend analysis.

Vertical
AnalysisVertical
Analysis
involves
the
comparison of two entries of the same firm and in the same
year. Therefore, it is referred as static analysis. Eg: Ratio
Analysis and Cash Flow Statements.

Vertical Analysis of
Financial Statement
Vertical analysis is the proportional analysis of a
financial statement, where each line item on a financial
statement is listed as a percentage of another item.
Vertical analysis helps in comparing the performance
and financial position of two businesses of different size.
A vertically analyzed financial statement may be visually
presented in a pie chart.

Income Statement
Income statement shows the various expense line
items as a percentage of sales.

Balance Sheet
A balance sheet typically states each line as a
percentage of total assets.

Advantages of Vertical
Analysis
It determines a company's health and stability.
The balance sheets of businesses of all sizes can
easily be compared.
It also makes it easy to see relative annual changes
within one business.

Different Techniques of
Financial Statement
Analysis

Comparative Financial Statements

Common Size Statements

Trend Analysis

Ratio Analysis

Comparative Financial
Statements

Financial statements of two or more years or two or more

different companies and its industry are compared,
analyzed and interpreted.

Also called Inter-period analysis or Inter-firm analysis.

In case of Inter-period analysis, uniformity in accounting

concepts and conventions has to be maintained.

On the other hand, in case of inter-firm analysis, size of

firms taken into consideration for comparison must be more
or less of same size.

Forms of Comparative
Financial Statements
Most commonly used forms are :

Comparative Balance Sheet

Comparative Income Statement

Comparative Balance Sheet

Presents side by side information about an entitys assets,

liabilities and shareholders equity as of multiple points of
time.

There could be two variations :

Balance sheet as of the end of each year for the past three
years.
Balance sheet at the end of each month for the past 12
months on a rolling basis.

Comparative Income Statement

Also known as profit and loss (P&L) statement, statement of

earnings and statement of operations.

The basic equation on which income statement is based:

Revenues Expenses = Net Income

Used to assess a companys performance and financial

position.

The income statement summarizes the revenues and

expenses generated by the company over the entire
reporting time.

Limitations of Comparative
Financial Analysis

Inflation
Common size comparisons
Trend comparisons
Horizontal comparisons
Different accounting practices

Common Size Analysis

The financial statements are lengthy and run into many pages & contain figures
which are complex for the comparison.
Accountants have devised COMMON SIZE METHOD to compare items in the financial
statement which are shown in odd amounts for e.g.; 25,456.81
TYPES OF COMMON SIZE STATEMENTS
Common
Size
Balance
Sheet

Common
Size Income
Statement

HOW THIS WORKS

PROFIT LOSS ACCOUNT

To compare the items in the P&L Account Sale Revenue is taken as the base and treated as 100.

All the other entries in P&L account are then expressed as a % of sales.

To illustrate it with an example; Assuming Sales Revenue to be 1,30,000 and Cost of goods sold is
assumed to be 97,500. This makes Cost as 75% of sales

The relationship now is evident which was not readilyy evident just by looking at the figures.
BALANCE SHEET

To compare the items the balance sheet, the amount of total assets/ total liabilities is treated as equal
to 100.

Then the individual items are expressed as a % of thee total assets and total liabilities.

NOTE: The COMMON SIZE ANALYSIS is used for both the Horizontal and Vertical Analysis.

ADVANTAGES

Comparing Two Companies:

Expressing all the parameters in terms of percentage of sales or assets, the bias can be removed.
Companies of different sizes can be compared

Comparing the Performance of a Company over a Period of Time:

One can evaluate what percentage of sales was the cost of goods sold 5 years before, as compared to
current figure.

It helps an investor to identify large or drastic changes in a firms financials. Rapid increases or decreases
can be readily observable.

Common Statement Analysis helps in doing the corporate evaluation and Ranking in the Inter Firm
comparison.

DISADVANTAGES

In the COMMON SIZE METHOD we establish the relationship between the all the items in the P&L account
with the single item of sales.

The Common Size balance sheet takes only total assets or total liabilities as the base for other items in the
balance sheet.

It ignores relationship among the different items themselves in the balance sheet.

It also doesnt establish the relationship between the items of P&L account and Balance Sheet, thus we cannot
establish the relationship between the Sales and capital employed.

It compares the figure of the first year with the second year, or the second year with the third year, so it doesnt
give an idea over the period of years regarding the performance.

Different firms may adopt different accounting practices. In that case, the common ratios may not be directly
comparable.

Adjustments will have to be made in order to compare the common ratios.

Examples

Trend Analysis

The trend analysis treats the first year as the base year and compares the figures of all
years against it.
The trend analysis for instance sales , will reveal if the sales compared to the base year
has increased or decreased in the subsequent years.

ADVANTAGES

Revenue and cost information from a company's income statements can be arranged on a trend line for
multiple reporting periods and examined for trends and inconsistencies.
The trends show the direction (Up/down) for the change.

Trends are easy to calculate and interpret.

Quick method of analysis.

It is based on the percentages, thus provide more accurate interpretation regarding sudden spike or fall.

Predict and estimate the future results on the basis of historical trends.

DISADVANTAGES
The trends may change with the selection of the different base years.
The

total no of years covered should not be very large (such as 20 years) or too small.

Figures
The

in large number show wide variations due to factors like Inflation etc.

trend will give a distorted impression if during the years taken into account, the
accountings policies will change.

Examples

As you can see in the Balance Sheet the year

2000 is taken as the base year (100%)

All the items are expressed as 100 for the base

year.

Comments on the BALANCE SHEET

The capital contribution from the partners has

increased to 113 to 133.33 during 2001 and
2002

Unsecured loans went up in 2001 128.57 but

came down again in 2002.

There is no change in the retained earnings of

the firm.

The Current assets have increased form 100 to

135.21 in 2002. This could be due to increase in
debtors.

The position of creditors has changed

drastically from 100 in 2001 to 355.56 in 2002.

Comments on the INCOME STATEMENT

Sales for the past have increased from 100 to

120 to 133.33 in 2000, 2001 & 2002
respectively.

In 2001 the net profit increased by 33% but has

remained constant thereafter.

Expenses have increased from 100 to 114.29 in

2001 and have remained constant thereafter.

Ratio Analysis

It is a process of computing and presenting the relationship

between two items in the financial statements.
Used to evaluate the financial position of the company.
Following are the types of ratios which measure liquidity of
a firm, long term financial position of a firm, efficiency of a
firm and its profitability.

Liquidity Ratios
Leverage Ratios
Coverage Ratios
Activity Ratios
Profitability Ratios

Liquidity Ratios
A financial metrics to determine a company's ability to pay off
its short-terms debts/ current requirement obligations. It is
required for understanding in preparing Cash Budgets and
cash flow statements of a company.

Important Ratios:
Current Ratio
Quick Ratio

Current Ratio : It is a measure to find out the liquidity of the

business of a company.
Current Ratio = Current Assets/Current Liabilities

Quick Ratio : It is used to depict and liquid current assets as a

ratio of current liabilities. Inventories are included in this ratio.
Quick Ratio = Current Assets - Inventories/Current Liabilities

Leverage Ratios
Leverage ratio indicates the debt paying ability of a company.
It calculates the proportion of debt in the total financing of a
company.

Important Ratio
Debt Equity Ratio
Total Debt Ratio

Debt Equity Ratio : It is a measure of long term financial

solvency of a company. It gives relationship between owners
capital and borrowed capital.
Debt Equity Ratio = Total Debt/Net Worth

Total Debt Ratio : It depicts the lender contribution for each

rupee of the owners contribution.
Total Debt Ratio = Total Debt/Capital Employed

Coverage Ratios
Coverage ratios test the debt servicing capacity of a company.
This ratio indicates the ability of a firm to meet its interest
obligations.
Important Ratios:
Interest Coverage Ratio

Interest Coverage Ratio : It is a measure of long term financial

solvency of a company. It gives relationship between owners capital
and borrowed capital.
Interest Coverage Ratio = EBDIT/Interest

Activity Ratios
Activity Ratios measure a firm's ability to convert different
accounts within its balance sheets into cash or sales. These are
used to measure the relative efficiency of a firm based on its use
of its assets, leverage or other such balance sheet items.

Important Ratios
Inventory Turnover Ratio
Debtors Turnover Ratio
Collection Period Ratio

Assets Turnover Ratios

Total Assets Turnover Ratio
Fixed Assets Turnover Ratio
Working Capital Turnover Ratio

Inventory Ratios

Inventory Turnover Ratio : It indicates the liquidity of inventory in a

firm. It measures the number of times on an average an inventory is
sold by the company during the period.
Inventory Turnover Ratio = Costs of good sold/Average Inventory

Inventory Turnover Ratio Reciprocal : It is used to give the number

of days of inventory holding by a firm.
Inventory Turnover Ratio Reciprocal = (Average Inventory/Cost of good
sold)*360

Debtors Turnover & Collection

Period
Ratios

Debtors Turnover Ratio : It is used to quantify a firm's effectiveness

in extending credit as well as collecting debts. A high the debtors
turnover ratio indicates efficiency of a firm in credit management.
Debtors Turnover Ratio = Credit Sales/Average Debtors

Collection Period Ratio : It is the approximate amount of time that it

takes for a business to receive payments owed, in terms of receivables,
from its customers and clients.
Collection Period Ratio = 360/Debtors Turnover

Assets Turnover Ratios

Total Assets Turnover Ratio : It is calculated to get a view of the

turnover of all the assets resources in a company.
Total Assets Turnover Ratio = Sales/Total Assets
Total Assets = (Fixed Assets-Depreciation)+(Current Assets)

Fixed Assets Turnover Ratio : It indicates turnover of sales from net

fixed assets.
Fixed Assets Turnover Ratio = Sales/Net Fixed Assets
Net Fixed Assets = (Fixed Assets-Depreciation)

Assets Turnover Ratios

(contd.)

Working Capital Turnover Ratio : It measures the turnover of sales

with working capital.
Working Capital Turnover Ratio = Sales/(Current Assets-Current
Liabilities)

Profitability Ratios
Profitability Ratios indicate the operating efficiency of a company by
measuring the revenues of the company.

Important Ratios
Net Profit Margin Ratio
Operating Profitability Ratio
Cost of Goods Sold Ratio
Return on Investments (Total Assets) Ratio
Return on Equity Ratio
Earnings per Share Ratio
Dividend per Share Ratio
Dividend Payout Ratio
Price Earning Ratio

Net Profit Margin Ratio : It measures how much out of every unit
sales a company actually keeps in earnings.
Net Profit Margin Ratio = Profit after tax/Sales

Operating Profitability Ratio : It indicates the profitability before

interest and taxes divided by the sales.
Operating Profitability Ratio = Earnings before Interest & Tax/Sales

Cost of Goods Sold Ratio : It is a relationship between cost incurred

on goods and the total sales.
Cost of Goods Sold Ratio = Cost of goods sold/Sales

Return on Investments (Total Assets ) Ratio : It indicates the

efficiency of assets in a company. Returns to shareholders can also be
calculated through investments made in a company.
Return on Investments Ratio = EBIT (1-T)/Total Assets

Return on Equity Ratio : It measures the return that the shareholders

will get from the company net worth equal to their paid up share
capital, share premium, reserves & surpluses deducting the losses.
Return on Equity Ratio = Profit after taxes/Net worth

Earnings per Share Ratio : This ratio provides an insight into the
earnings of shareholders in a company.
Earnings per Share Ratio = Profit after tax/No. of equity shares

Dividend per Share Ratio : Dividends are calculated to find out what
proportion of the earnings are given to the shareholders. This is
calculated by earnings paid to shareholders divided by the no of shares
in the company.

Dividends per Share Ratio = Earnings paid to shareholder/No. of

shares

Dividend Payout Ratio : It indicates the amount of money paid to a

shareholder out of the earnings of the company.
Dividend Payout Ratio = Dividend per Share/Earnings per Share

Price Earning Ratio : It is the reciprocal of the earnings yield. It is

used to find out the value of the performance of the firm according to
the expectation of the investors.
Price Earning Ratio = Market Value per Share/Earnings per Share

Thank You