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Financial Statement Analysis Lecture1 1

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  • 1. FINANCIAL STATEMENT ANALYSIS BY SYED MUHAMMAD IJAZ, FCA AUGUST 03, 2007
  • 2. TYPES OF RATIOS
    • Liquidity Ratios
    • Capital Structure/Leverage Ratios
    • Profitability Ratios
    • Activity Ratios
  • 3. CURRENT RATIO
    • Where current assets represent the assets that can be converted into cash within a short period, conventionally with one year
    • Like wise the current liabilities refer to liabilities the payment of which is to be made within 1 year
    • This ratio represents the amount in Rs. Available in current assets to pay off the each Rupee of Current Liabilities
    • This Ratio refers to the potential of the company to cover its current liabilities payments through its current assets.
    • Greater the availability of current assets to cover current liabilities better it is
    • There is no thumb rule to say what would be the best. However conventionally a current ratio of 2:1 is considered satisfactory.
  • 4. Acid-Test or Quick Ratio
    • Where Quick assets refers to assets that on short notice can be converted into cash. Normally this means current assets-Stocks
    • This ratio is a derived from current ratio and represents and more critical analysis
    • Greater the companies ability to cover its current liabilities from Quick assets better it is
    • Conventionally a ratio of 1:1 is considered satisfactory
  • 5. Turnover Ratio-Inventory Turnover
    • This is another form to check the liquidity position of the firm
    • This ratio determines how quickly certain current assets e.g. as in above inventory transfers/converts itself into cash
    • Turnovers are normally calculated with reference to Inventory, Debtors, Creditors etc.
    • Greater the conversion rate better it is
    • Now its clear from above that inventory rotates “X” times in a year so if we want to calculate number of days we held inventory or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
  • 6. Turnover Ratio-Debtors Turnover
    • This is another form to check the liquidity position of the firm
    • This ratio determines how quickly debtors are converted into cash
    • Greater the turnover better it is
    • Now its clear from above that debtor rotates “X” times in a year so if we want to calculate number of days in which we Collect debtors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
  • 7. Creditors Turnover Ratio
    • This is another form to check the liquidity position of the firm
    • This ratio determines how quickly creditors are paid
    • Lesser the turnover better it is
    • Now its clear from above that creditor rotates “X” times in a year so if we want to calculate number of days in which we pay creditors or no of months. What we have to do is to just divide No. of days/months by the answer of the above equation.
  • 8. Defensive-Interval Ratio
    • This ratio represents the ability of the firm to meet its daily future cash requirement through its liquid assets
    • More the ability to meet expenditure better it is
  • 9. Leverages-Debt-Equity Ratio
    • This ratio is meant to disclose the structure of the capital
    • Normally banks and financers use this ratio as the State Bank has bench marked the maximum debt equity ratio to 80:20 (i.e. 80% Debt+20% equity) maximum allowed debt structure
    • Normally external debt is considered less expensive than the equity
    • This ratio can be subdivided into many other ratios like Debt to Owners equity, Owners equity to total Capital etc.
  • 10. Leverages-Interest Coverage Ratio
    • Where EBIT represents earnings/profit before interest and tax
    • This ratio represents the earnings/profit available against each rupee of interest i.e. for payment of each rupee of interest how many rupees of profit are available
    • Potent the ratio better it is
  • 11. Dividend Coverage Ratio
    • Where EAT represents earnings/profit after tax or earnings available to shareholders
    • This ratio represents the earnings/profit available against each rupee of preference dividend i.e. for payment of each rupee of preference dividend how many rupees of profit are available
    • Potent the ratio better it is
  • 12. Total Coverage Ratio
    • Former ratio represents the firms ability to pay all the fixed obligations
    • Later ratio represents the ability of firm to pay all external liabilities from available cash sources
    • In both cases higher the coverage better it is
  • 13. Profitability Ratio
    • Represented as a %age to Sales
    • Greater the margin/%age better it is
  • 14. Profitability-Expenses Ratio
  • 15. Profitability-Expenses Ratio-Continued Represented as a %age to Net Sales Lesser the margin/%age better it is
  • 16. PROFITABILITY RATIOS RELATED TO INVESTMENTS-RETURN ON INVESTMENTS(ROI)
  • 17. RETURN ON CAPITAL EMPLOYED
  • 18. EARNING PER SHARE
  • 19. DIVIDEND YIELD
  • 20. DIVIDEND PAYOUT or
  • 21. ACTIVITY RATIO
    • Activity ratios are concerned with measuring the efficiency in asset management. Sometimes, these ratios are also called efficiency ratios or assets utilization ratios.
    • An activity ratio may, therefore, be defined as a test of relationship between sales (more appropriately with cost of sales) and the various assets of a firm.
  • 22. CURRENT ASSETS TURNOVER
    • Already discussed under liquidity
    • Other assets turnover includes;
  • 23. CURRENT ASSETS TURNOVER-CONTINUED