This document discusses financial statement analysis and key metrics used to evaluate a company's liquidity, profitability, and solvency. It outlines various ratio analyses including liquidity ratios like the current and acid test ratios, profitability ratios like net profit margin and return on assets, and solvency ratios like debt to total assets. Specific formulas are provided for calculating important ratios to analyze a company's financial health and performance over time. Limitations of financial analysis are also briefly mentioned.

1. 1
Accounting Skill Session
FINANCIAL STATEMENT ANALYSIS
BASICS OF FINANCIAL STATEMENT ANALYSIS
 Analysing financial statements involves evaluating three
characteristics of a company:
1. its liquidity
2. its profitability
3. its solvency
COMPARATIVE ANALYSIS
 Three types of comparisons:
 Intracompany basis
 Intercompany basis
 Industry averages
 Three tools:
 Horizontal analysis
 Vertical analysis
 Ratio analysis
RATIO ANALYSIS
Liquidity Ratios
Measure short-term ability of the enterprise to pay its maturing
obligations and to meet unexpected needs for cash.
Revenues – Expenses = Net Income
Profitability Ratios
Measure the income or operating success of an enterprise for a given
period of time.
Solvency Ratios
Measure the ability of the enterprise to survive over a long period of
time.
LIQUIDITY RATIOS
 Current ratio
 Acid test ratio
 Cash current debt coverage ratio

2. 2
 Receivables turnover
 Collection period
 Inventory turnover
 Days sales in inventory
CURRENT RATIO
 Measures short-term debt-paying ability
Current Ratio =
Current Assets
Current Liabilities
ACID TEST RATIO
 Measures immediate short-term debt-paying ability
Acid test Ratio =
Current Assets - Stock
Current Liabilities
COLLECTED PERIOD
 Cash receivable in Days
Receivable in Days = Receivable x 365 Credit Sales
INVENTORY TURNOVER
 Measures liquidity of inventory
Inventory turnover =
Cost of goods sold
Average inventory
PROFITABILITY RATIOS
 Book value per share
 Cash flow per share
 Earnings per share (EPS)
 Price-earnings (PE) ratio
 Payout ratio

3. 3
 Dividend yield
 Profit margin
 Gross profit margin
 Cash return on sales
 Asset turnover
 Return on assets
 Return on common shareholders’ equity
NET PROFIT MARGIN
 Measures net income generated by each dollar or Rs of
sales
Profit Margin =
Net income
Net sales
GROSS PROFIT MARGIN
 Measures margin between selling price and cost of goods
sold generated by each dollar of sales
Gross Profit Margin =
Gross Profit
Net sales
CASH RETURNS ON SALES
 Measures net cash flow generated by each dollar of sales
Cash Returns on Sales =
Net Profit from operating activities
Net sales
ASSETS TURNOVER
 Measures how efficiently assets are used to generate sales
Assets Turnover =
Net Sales
Average Total Assets

4. 4
RETURN ON ASSETS
 Measures overall profitability of assets
Return on Assets =
Net Income
Average Total Assets
RETURN ON COMMON SHAREHOLDERS’ EQUITY
 Measures profitability of common shareholders’
investment
Return on common shareholders’ equity =
Net income
Average common shareholders' equity
EARNINGS PER SHARE (EPS)
 Measures net income earned on each common share
Earnings per share =
Net income
Number of common shares

5. 5
PRICE-EARNINGS (PE) RATIO
 Measures relationship between market price per share and
earnings per share
Price-earnings ratio =
Share price
Earnings per share
PAYOUT RATIO
 Measures % of earnings distributed in the form of cash
dividends
Payout ratio =
Cash dividends
Net income
DIVIDEND YIELD
 Measures rate of return earned from dividends
Dividend Yield =
Cash dividend per share
Share Price
SOLVENCY RATIOS
 Debt to total assets
 Interest coverage
 Cash interest coverage
 Cash total debt coverage
DEBT TO TOTAL ASSETS
 Measures % of total assets provided by creditors
Debt to total assets =
Total liabilities
Total assets

6. 6
INTEREST COVERAGE
 Measures ability to meet interest payments as they come
due
Interest coverage =
Income before interest expense
Interest expense
LIMITATIONS OF FINANCIAL ANALYSIS
 Estimates
 Historical cost
 Alternative accounting methods
 Atypical data
 Diversification