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- 1. Financial Statement analysis<br />Sudhir Singla<br />By:<br />
- 2. Why Financial Statement Analysis ??<br />
- 3. For taking loans: Your banker will quickly analyze the financial statement to determine your capability of paying back a loan. <br />For investment: Your investor(s) will do the analysis to determine if you have been performing according to plan, and/or whether your business is a good investment. <br />For purchasing raw material: Your suppliers will analyze your financial statements to determine your credit worthiness—and so on.<br />
- 4. How it is done<br />
- 5. Technical analysis (Trend analysis)<br />Fundamental analysis (Ratio analysis)<br />
- 6. Steps Involved in Analysis<br />
- 7. <ul><li> Calculate and graph the growth of the following entries over the past several years.
- 8. Revenues (sales)
- 9. Net income (profit, earnings)
- 10. Investors value predictability, and prefer more consistent movements to large swings.
- 11. Rising G&A expenses as a % of sales could mean lavish spending.
- 12. Also, determine whether the spending trends support the company’s strategies.
- 13. e.g., increased emphasis on new products and innovation will probably be reflected by an increased proportion of spending on R & D.
- 14. Has the company issued new shares, or bought some back?
- 15. Has the retained earnings account been growing or shrinking? Why?
- 16. Are there signals about the company's long-term strategy here?</li></ul>Step1: Acquire the company’s financial statements for several years<br />Step2 : Examine the balance sheet<br />Step3: Examine the income statement<br />Step4: Examine the shareholder's equity statement<br />Step5: Examine the cash flow statement<br />Step6: Calculate financial ratios<br />Step7: Review the dividend payout<br />Step8: Review all<br /><ul><li>Graph the payout over several years.
- 17. Determine whether the company’s dividend policies are supporting their strategies.
- 18. For example, if the company is attempting to grow, are they retaining and reinvesting their earnings rather than distributing them to investors through dividends?
- 19. Liquidity ratios
- 20. Leverage (or debt) ratios
- 21. Profitability ratios
- 22. Efficiency ratios
- 23. Value ratios</li></ul>As a minimum, get the following statements, for at least 3 to 5 years. <br /><ul><li>Balance sheets
- 24. Income statements
- 25. Shareholders equity statements
- 26. Cash flow statements</li></ul>It gives information about the cash inflows and outflows from operations, financing, and investing.<br /><ul><li>Look for large changes in the overall components of the company's assets, liabilities or equity.
- 27. For example, have fixed assets grown rapidly in one or two years, due to acquisitions or new facilities? Has the proportion of debt grown rapidly, to reflect a new financing strategy? </li></li></ul><li>Suspicious ?<br />If you find anything that looks very suspicious, research the information you have about the company to find out why.<br />
- 28. Ratio Analysis<br />
- 29. 1. Liquidity ratio<br /><ul><li>The liquidity ratios show the firm’s ability to meet its short-term obligations.
- 30. Liquid assets are those that can be converted into cash quickly. </li></li></ul><li>Liquidity ratio contd..<br />1. Current Ratio = Total Current Assets / Total Current Liabilities <br />2. Quick Ratio = (Total Current Assets - Inventories) / Total Current Liabilities<br />The Rules of Thumb for acceptable values are: Current Ratio (2:1), Quick Ratio (1:1).<br />
- 31. Liquidity ratio contd..<br />
- 32. 2. Leverage/debt Ratios<br />Debt to Equity Ratio = Total Debt / Total Equity<br />Debt to Assets Ratio = Total Debt / Total assets<br />Total debt includes short-term debt (bank advances + the current portion of long-term debt) and long-term debt (bonds, leases, notes payable)<br />
- 33. Leverage/Debt Ratios contd..<br />Debt ratios show the extent to which a firm is relying on debt to finance its investments and operations, and how well it can manage the debt obligation, i.e. repayment of principal and periodic interest. <br />
- 34. Leverage/Debt Ratios contd..<br />In general, with either of the above ratios, the lower the ratio, the more conservative (and probably safer) the company is. <br />However, if a company is not using debt, it may be foregoing investment and growth opportunities.<br />Debt to Equity ratio is used by bankers to determine if your business is credit worthy.<br />A rule of thumb for manufacturing and other non-financial industries is that companies not finance more than 50% of their capital through external debt<br />
- 35. Leverage/Debt Ratios contd..<br />Interest Coverage (or Times Interest Earned) Ratio= Earnings Before Interest and Taxes / Annual Interest Expense<br />Cash Flow Coverage = Net Cash Flow / Annual Interest Expense<br />Net cash flow = Net Income +/- non-cash items (e.g. -equity income + minority interest in earnings of subsidiary + deferred income taxes + depreciation + depletion + amortization expenses)<br />
- 36. Leverage/Debt Ratios contd..<br />Cash flow is a “critical variable” in assessing a company. If a company is showing strong profits but has poor cash flow, you should investigate further before passing a favourable opinion on the company. Analysts prefer ratio #3 to ratio #2.<br />
- 37. 3. Profitability Ratio<br />In this we see whether profits are generally on the rise; <br />whether sales stable or rising; <br />how the profits compare to the industry average; <br />whether the market share of the company is rising, stable or falling; <br />other things that indicate the likely future profitability of the firm.<br />
- 38. Profitability Ratio contd..<br />1. Net Profit Margin = Profit after taxes / Sales <br />2. Return on Assets (ROA) = Profit after taxes / Total Assets<br />3. Return on Equity (ROE) = Profit after taxes / Shareholders’ Equity (book value)<br />4. Earnings per Common share(EPS) = (Profits after taxes - Preferred Dividend) / (# of common shares outstanding)<br />5. Payout Ratio = Cash Dividends / Net Income<br />
- 39. 4. Efficiency Ratio<br />These ratios reflect how well the firm’s assets are being managed. <br />1. Inventory Turnover = Cost of Goods Sold / Average Inventory <br />This ratio shows how quickly the inventory is being turned over (or sold) to generate sales. A higher ratio implies the firm is more efficient in managing inventories by minimizing the investment in inventories. <br />2. Total Assets Turnover = Sales / Average Total Assets <br />This ratio shows how much sales the firm is generating for every dollar of investment in assets. The higher the ratio, the better the firm is performing. <br />
- 40. Efficiency Ratio contd..<br />3. Accounts Receivable Turnover = Annual Credit Sales / Average Receivables<br />4. Average Collection period = Average Accounts Receivable / (Total Sales / 365)<br />Ratios #3 and #4 show the firm’s efficiency in collecting cash from its credit sales. While a low ratio is good, it could also mean that the firm is being very strict in its credit policy, which may not attract customers.<br />5. Days in Inventory = Days in a year / Inventory turnover<br />
- 41. 5. Value Ratios<br />1. Price To Earnings Ratio (P/E) = Current Market Price Per Share / After-tax Earnings Per Share<br />2. Dividend Yield = Annual Dividends Per Share / Current Market Price Per Share<br />
- 42. Value Ratios contd..<br />When the markets are bullish (optimistic) or if investor sentiment is optimistic about a particular stock, the P/E ratio will tend to be high. <br />On the other hand, a low P/E ratio may show that the company has a poor track record. It may simply be priced too low based on its potential earnings. Further investigation is required to determine whether the company would then provide a good investment opportunity.<br />
- 43. Limitations<br />1. There is considerable subjectivityinvolved, it is hard to reach a definite conclusion when some of the ratios are favourable and some are unfavourable. <br />2. Ratios may not be strictly comparable for different firms due to a variety of factors such as different accounting practices or different fiscal year periods. <br />3. Ratios are based on financial statements that reflect the past and not the future. Unless the ratios are stable, it may be difficult to make reasonable projections about future trends.<br />4. Financial statements provide an assessment of the costs ¬ actual value. <br />5. Accounting standards and practices vary among countries, and thus hamper meaningful global comparisons.<br />
- 44. THANK YOU !!<br />

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