Financial Statement Analysis:

Ratio Analysis
Financial Statements
 Financial statements provide information
about the financial activities and position of a
firm.
 Important financial statements are:
 Balance sheet
 Profit & Loss statement
 Funds flow statement
 Cash flow statement

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Balance Sheet
 Balance sheet indicates the financial
condition of a firm at a specific point of time. It
contains information about the firm’s: assets,
liabilities and equity.
 Assets are always equal to equity and
liabilities:
Assets = Equity + Liabilities

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Assets
 Assets are economic resources or properties
owned by the firm.
 There are two types of assets:
 Fixed assets
 Current assets

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Current Assets
 Current assets (liquid assets) are those which
can be converted into cash within a year in
the normal course of business. Current
assets include:
 Cash and bank balance
 Accounts receivable (debtors)
 Inventory (stocks)
 Advances to suppliers
 Prepaid expenses

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Fixed Assets
 Fixed assets are long-term assets.
 Tangible fixed assets are physical assets like
plant.
 Intangible fixed assets are the firm’s rights and
claims, such as patents, copyrights, goodwill etc.
 Gross block represent all tangible assets at
acquisition costs.
 Net block is gross block net of depreciation.

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Liabilities
 Liability is a firm’s obligation to pay cash or
provide goods or services in the future. Two
types of liabilities are:
 Current liabilities
 Long-term liabilities

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Current Liabilities
 Current liabilities are payable within a year in
the normal course of business. They include:
 Accounts payable (creditors)
 Outstanding expenses
 Advances from customers
 Provision for tax
 Provision for dividend

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Long-term Liabilities
 Long-term liabilities are payable after a year.
They include:
 Borrowings from financial institutions and banks
etc.
 Debentures/bonds:
☛ Non-convertible
☛ Fully convertible
☛ Partly convertible

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Shareholders’ Funds or Equity
 Share capital is owners’ contribution divided
into shares. A share is a certificate
acknowledging the amount of capital
contributed by the shareholder.
 Reserves and surplus or retained earnings
are undistributed profits.
 Shareholders’ funds or equity is the sum of
share capital plus reserves & surplus. It is
also called net worth.

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Balance Sheet Relationship
 Total assets (TA) equal net fixed assets
(NFA) plus current assets (CA):
TA = NFA + CA
 Net current assets (NCA) is the difference
between current assets (CA) and current
liabilities (CL):
NCA = CA – CL

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Balance Sheet Relationship
 Net assets (NA) equal net fixed assets (NFA)
plus net current assets (NCA):
NA = NFA + NCA
 Capital employed (CE) is the sum of net
worth or equity (E) and borrowing/debt (D)
and it is equivalent of net assets:
CE = Net Worth + Borrowing = E + D
Capital Employed = Net Assets

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Profit & Loss Statement
 Profit & Loss statement provides information
about a firm’s:
 revenues,
 expenses, and
 profit or loss.

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Nature of Revenues
 Revenue is the amount received or receivable
within the accounting period from the sale of
the firm’s goods or services.
 Operating revenue is the one that arises from
main operations of the firm, and the revenue
arising from other activities is called non-
operating revenue.

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Nature of Expenses
 Expense is the amount paid or payable within
the accounting period for generating revenue.

Examples: raw material consumed, salary and

wages, power and fuel, repairs and maintenance,
rent, selling and marketing expenses, administrative
expenses.

 Expenses are expired costs and capital

expenditures represent un-expired costs and
appear as assets in balance sheet.

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Depreciation
 Depreciation is a charge for the use of fixed
assets; it is an expense. It is a non-cash
expense since cash was paid at the time fixed
assets were acquired. Expenditures incurred
on acquiring assets are called capital
expenditures. Depreciation is allocation of
these expenditures over the life of assets that
have helped in generating revenue.

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Methods of Depreciation
 Depreciation may be provided on
 straight line basis or
 written down value basis (DWV). DWV basis
is allowed for taxation in India.

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Concepts of Profit
 Gross profit = sales – cost of goods sold (CGS)
 CGS = raw material consumed + manufacturing expenses of
goods that have been sold
 PBDIT = Profit before dep., interest and tax
= sales – expenses, except dep., interest and
tax
 PBIT= Profit before interest and tax
= PBDIT – DEP
 PBT= Profit before tax = PBIT – Interest
 PAT = Profit after tax = PBT – Tax

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Functions of Income Statement
 Summary of revenues and expenses
 Measurement of profitability

Functions of Balance Sheet

Measurement of liquidity

Measurement of solvency

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Relationships: B/S and P&L A/C
 Net profit = Equity (end) – Equity (begin)
 Equity (end) = Equity (begin) + Net profit +
Equity issued – Dividend
 Net profit = [Equity (end) – Equity (begin)] –
[Equity issued – Dividend]
 Change in equity = Equity (end) – Equity
(begin) = Net profit + Equity issued – Dividend

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Economic Vs. Accounting Profit
Accounting profit is a result of the arbitrary
allocation of expenditures between expenses
(revenue expenditure) and assets (capital
expenditure).
Economic profit is the net increase in the wealth
of the firm, and it is measured in cash flow.

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Financial Analysis
Financial analysis is the process of identifying
the financial strengths and weaknesses of the
firm by property establishing relationships
between the item of the balance sheet and the
profit and loss account.

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Users of Financial Analysis
 Trade creditors
 Lenders
 Investors
 Management

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Nature of Ratio Analysis
A financial ratio is a relationship between two
accounting numbers. Ratios help to make a
qualitative judgment about the firm’s financial
performance.

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Standard of Comparison
 Time series analysis
 Inter-firm analysis
 Industry analysis
 Proforma financial statement analysis

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Types of Financial Ratios
 Liquidity ratios
 Solvency ratios
 Turnover ratios
 Profitability ratios
 Equity-related ratios

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Liquidity Ratios
 Liquidity ratios measure a firm’s ability to
meet its current obligations.
Current assets
Current ratio =
Current liabilities
Current assets – Inventories
Quick ratio =
Current liabilities
Cash + Marketable securities
Cash ratio =
Current liabilities

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Solvency Ratios
 Solvency ratios measure the dependence of
a firm on borrowed funds.
Debt
Debt-equity ratio 
Equity (Net Worth)
Debt Debt
Debt ratio  
Debt  Equity Capital employed
Earnings before interest and tax
Interest coverage 
Interest

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Turnover Ratios
 Turnover or activity ratios measure the firm’s
efficiency in utilizing its assets.
Cost of goods sold or net sales
Inventory turnober 
Average (or closing) inventory
Number of days in the year (say, 360)
Days of inventory holding 
Inventory turnover
Credit sales or net sales
Debtors turnover 
Average (or closing) debtors
Number of days in the year (say, 360)
Collection period 
Debtors turnover

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Turnover Ratios
Net sales
Current assets turnover 
Current assets
Net sales
Net current assets turnover 
Net current assets
Net sales
Fixed assets turnover 
Net fixed assets
Net sales
Net assets turnover 
Net assets or capital employed

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Profitability Ratios
 Profitability ratios measure a firm’s overall
efficiency and effectiveness in generating
profit.
Profit before interest and tax (PBIT)
Margin 
Net sales
Profit after tax (PAT)
Net margin 
Net sales
PBIT
Before tax return on investment 
Net assets
Profit after tax
Return on equity 
Equity (net worth)

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Equity-related Ratios
 Equity-related ratios measure the
shareholders’ return and value.
Profit after tax
EPS 
Number of ordinary shares
Dividends
DPS 
Number of ordinary shares
DPS Dividends
Payout ratio  
EPS Pr ofit after tax
DPS
Dividend yield 
Market value per share

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Equity-related Ratios
EPS
Earnings yield 
Market value per share
Market value per share
P / E ratio =
EPS
Net worth
Book value per share 
Number of ordinary shares
Market value per share
M B value 
Book value per share
Market value of assets
Tobin ' s q 
Economic value of assets

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DuPont Analysis
DuPont Analysis
integrates the important ratios to analyse a firm's profitability.
PBIT Sales PBIT
RONA=  
Net Assets Net Assets Sales
PAT Sales PBIT  PAT Net Assets 
ROE     
Net Worth Net Assets Sales  PBIT Net Worth 
ROE  Assets turnover × Margin × Leverage

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 ISPAT INDUSTRIES LIMITED
BALANCE SHEET
AS AT 31ST MARCH, 2001 Rs crore
2001 2000
SOURCES OF FUNDS
1. Shareholders' Funds
Share Capital 978.07 901.55
Advances against Share Capital 244.3 96.46
Reserves & Surplus 746.77 874.08
1969.14 1872.09
2. Loan Funds
Secured Loans 4989.26 3582.6
Unsecured Loans 630.09 1088.29
5619.35 4670.89
TOTAL 7588.49 6542.98
APPLICATION OF FUNDS
1. Fixed Assets
Gross Block 3470.36 1640.28
Less: Depreciation 704.01 498.14
Net Block 2766.35 1142.14
Capital Work -in-Progress 2093.31 2740.66
Pre-operative exp. etc. 1715.74 2231.85
6575.4 6114.65
2. Investments 130.87 135.79
3. Current Assets, Loans & Advances
Inventories 257.37 259.48
Sundry Debtors 389.69 250.4
Cash & Bank Balances 53.9 77.7
Loans, Advances & Deposits 1018.31 907.61
1719.27 1495.19
Less: Current Liabilities & Provisions
Liabilities 1150.7 1185.39
Provisions 18.86 18.61
1169.56 1204
Net Current Assets 549.71 291.19
4. Miscellaneous Expenditure 134.37 1.35
(To the extent not written off or adjusted)
5. Profit and Loss Account Debit balance 198.14 _
TOTAL 7588.49 6542.98

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 ISPAT INDUSTRIES LIMITED
PROFIT AND LOSS ACCOUNT
FOR THE YEAR ENDED 31ST MARCH
(Rs. crores)
2001 2000
INCOME
Sales & Job Work (Net) 2238.89 1425.48
Other Income 25.18 11.65
TOTAL (A) 2264.07 1437.13
EXPENDITURE 3.95 33.7
Decrease in stocks 3.95 33.7
Raw Materials Consumed 823.04 778.15
Purchases of Finished Goods 7.77 9.32
Payments to & Provisions for Employees 43.99 21.79
Excise Duty 269.94 118.83
Mfg., Dist., Sell. & Admin. Expenses 890.84 306.72
Interest & Finance Charges 345.96 100.13
Depreciation 206.33 79.89
Less: Transfer from Revaluation Reserve 15.32 15.32
TOTAL (B) 2576.5 1433.21
Profit/(Loss) before Taxation (A+B) 312.43 3.92
Less: Provision for Taxation 0.03 0.32
Add: Provision for Taxation written back 0.07
Profit/(Loss) after taxation 312.46 3.67
Less: Balance brought forward from Previous Year 100.52 106.59
Transfer from Debenture Redemption Reserve 8.09
Transfer from Taxation Reserve 0.73
Transfer from General Reserve 13.07 _
Profit/(Loss) available for appropriation -198.14 118.35
APPROPRIATIONS:
Transfer to Debenture Redemption Reserve _ 17.83
Balance carried to Balance Sheet -198.14 100.52
TOTAL -198.14 118.35

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 ISPAT INDUSTRIES LIMITED
RATIO ANALYSIS
Liquidity ratios
Current ratio 1.47 1.24
Quick ratio 0.05 0.06
Activity ratios
Sales/TA 0.30 0.22
Sales/FA 0.81 1.25
Sales/Debtors 5.75 5.69
Sales/Inventory 8.70 5.49
Leverage ratios
Debt/Equity 2.85 2.50
Debt/TA 0.74 0.71
PBIT/Interst 1.90 1.04
Profitability ratios
PBIT/Sales 29.41% 7.30%
Net profit/Sales 13.96% 0.26%
PBIT/TA 8.68% 1.59%
Net profit/NW 15.87% 0.21%
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INFOSYS
Balance Sheeet as at March 31
in Rs.
2,001 2,000
SOURCES OF FUNDS
SHAREHOLDERS FUNDS
Share capital 330,792,085 330,755,000
Reserves and surplus 13,565,599,903 8,002,273,248
Capital Employed 13,896,391,988 8,333,028,248
APPLICATION OF FUNDS
FIXED ASSETS
Original cost 6,311,444,025 2,840,305,143
Less: Depreciation 2,441,315,982 1,336,520,594
Net book value 3,870,128,043 1,503,784,549
Add: Capital work-in-progress 1,706,504,250 569,603,505
5,576,632,293 2,073,388,054
INVESTMENTS 341,154,821 138,348,469
CURRENT ASSETS, LOANS AND ADVANCES
Sundry debtors 3,023,702,417 1,361,781,253
Cash and bank balances 3,850,610,285 4,317,935,730
Loans and advances 4,302,793,623 2,101,277,161
11,177,106,325 7,780,994,144
Less: Current liabilities 1,349,181,176 671,506,459
Provisions 1,849,320,275 988,195,960
NET CURRENT ASSETS 7,978,604,874 6,121,291,725
Net Assets 13,896,391,988 8,333,028,248

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INFOSYS
Profit and Loss Account for the year ended March 31
in Rs.
2001 2000
INCOME
Software development services and products
Overseas 18,740,266,421.00 8,696,980,931.00
Domestic 265,392,386.00 126,256,042.00
Other income 593,714,915.00 391,411,095.00
19,599,373,722.00 9,214,648,068.00
EXPENDITURE
Software development expenses 9,581,766,650.00 4,662,684,578.00
Administrative and other expenses 1,775,470,971.00 694,850,282.00
Provision for investments 152,898,608.00
Provision for contingencies 33,300,000.00
Provision for e-inventing the company 35,000,000.00
11,510,136,229.00 5,425,834,860.00
Operating profit (PBIDT) 8,089,237,493.00 3,788,813,208.00
Interest
Depreciation 1,128,945,152.00 532,327,389.00
Profit before tax and extraordinary item 6,960,292,341.00 3,256,485,819.00
Provision for tax
earlier years 14,000,000.00 2,400,000.00
current year 713,100,000.00 394,600,000.00
Profit after tax before extraordinary item 6,233,192,341.00 2,859,485,819.00
Extraordinary item -- transfer of intellectual property right (net of tax) 54,944,000.00
-- provision no longer required 75,670,846.00
Net profit after tax and extraordinary item 6,288,136,341.00 2,935,156,665.00
AMOUNT AVAILABLE FOR APPROPRIATION 6,288,136,341.00 2,935,156,665.00
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INFOSYS
Financial Ratios
2001 2000
Activity Ratios
Income/Assets 1.41 1.11
Income/Debtors 6.48 6.77

Current Ratios
CA/CL 3.49 4.69
CA/Assets 0.80 0.93
NCA/Assets 0.57 0.73

Profitability Ratios
Margin
PBDIT/Income 41.27% 41.12%
PBIT/Income 35.51% 35.34%
PAT/Income 31.80% 31.03%
Return on Investment
PBDIT/Assets 58.21% 45.47%
PBIT/Assets 50.09% 39.08%
PAT/NW 44.85% 34.32%

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Utility of Ratio Analysis
 Assessment of the firm’s financial conditions
and capabilities.
 Diagnosis of the firm’s problems, weaknesses
and strengths.
 Credit analysis
 Security analysis
 Comparative analysis
 Time series analysis

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Cautions in Using Ratio Analysis
 Standards of comparisons
 Company differences
 Price level
 Different definition
 Changing situations
 Past data

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