Rationale of Financial StatementAnalysis Financial statement – summary offigures as of any given date To identify relevant information Draw meaningful interpretations
Process of Analysis Identification of significantinformation Highlight significant relationships Interpretation
Tools of Financial Analysis Fund flow Statement Cash Flow Statement Ratio Analysis Common size statements
Balance Sheet Overview-ASSETSAssetsGross Block 3978.55Net Block 2790.57Capital WIP 66.72Investments 454.33Inventory 610.81Receivables 1546.81Other Current Assets 3673.67Balance Sheet Total 9142.92
Balance Sheet Overview-LiabilitiesLiabilitiesEquity Share Capital 434.12Reserves 5815.65Total Debt 2096.69Creditors and Acceptances 393.91Other current liab/prov. 402.55Balance Sheet Total 9142.92
Ratio Analysis Most widely used and significant tool Provides a basis for comparison Useful when benchmark ratios areknown Relationships between variables inthe financial statement
Types of ratios Liquidity ratios Capital Structure ratios Profitability Ratios Activity/Efficiency ratios Integrated Analysis of ratios Growth ratios
Overview of Balance SheetLIABILITIES EquityCapital/Owners’Funds Long TermBorrowings Current LiabilitiesASSETS Fixed Assets Current Assets
Liquidity Ratios Measure the ability of firm to meetshort term obligations Reflect short term financial strength Why short term??- of interest tocreditors.. Ratios- Current ratio, Liquid ratio,Turnover ratios, cash flow fromoperation ratio
Liquidity ratios Current Ratio= Current Assets/Current Liabilities Liquid ratio= Liquid Assets/CurrentLiabilities
NEED FOR LIQUIDITY Assume stocks are bought on credit Converted to inventory Sales=0 Current Ratio?? Liquid Ratio?? Implications on liquidity-serious
ACTIVITY 1 Calculate Current Ratio, Liquid ratio,Debtors Turnover and Creditors turnoverfrom the following informationAverage Debtors=1,00,000Average Creditors=75,000Cash= 5,000Inventory=75,000Credit Purchases=6,00,000Credit Sales=12,00,000
Capital Structure ratios Helps to measure long term financialstrength Solvency of the firm Ability to service interest on loans Ability to service the principal
Capital Structure Ratios Debt Equity ratio= Long TermDebt/Shareholders Equity Debt to total Capital= TotalDebt/Total Assets Interest Coverage Ratio= EarningsBefore Interest and Tax/Interest
ACTIVITY 2 What happens when a firm is purelyfunded by equity? What happens when a firm is purelyfunded by debt? Which is riskier when profits are less? When equity is high and profits arehigh, what happens to ROI?
Profitability ratios Related to Sales Ability of the firm to mark up on sales Ability of firm to convert margins toprofit Proportion of expense to income Analysis of income and expenses
Profitability ratios Gross Profit Margin= Grossprofit/Sales*100 Operating Profit ratio= EarningsBefore Interest and taxes/Net Sales Net Profit Ratio= Earnings afterinterest and taxes/Net Sales Expenses ratio- Cost of Goods sold,Operating Ratio, Financial Expenses
Ratios on Investments Related to investment Ability to generate return oninvestment Ultimate measure of profitability Ability of firm to generate wealth
Profitability on Investment Return on Assets= Profit afterTaxes/Average total assets*100 Return on Capital Employed=EBIT/Average Total CapitalEmployed*100 Return on Shareholders Equity=Net profit after taxes/Averageshareholders’ equity*100
ACTIVITY 3 Earnings Before Interest and Tax=Rs.5,00,000 Interest payment =Rs.75,000 Tax rate = 50% Calculate Earnings after Interest andtax
Profitability on investment Earnings per share=Net Profitavailable to EquityShareholders/Number of ordinaryshares outstanding Price earning ratio= Market price ofshare/EPS
ACTIVITY 4Calculate Gross Profit Margin and Netprofit Margin Sales 2,00,000 Cost of Goods Sold 1,00,000 Other operating expenses 50,000
ACTIVITY 5Calculate Return on Assets Current Assets 4,00,000 Fixed Assets 6,00,000 Net Profit before taxes 2,50,000 Tax rate 50%
Activity Ratios Concerned with measuring theefficiency Also the asset utilisation Rate at which assets are convertedinto sales Test of relationship of sales to variousassets of the firm
Activity Ratios Turnover ratios Inventory turnover=Cost of GoodsSold/Average Inventory Debtors turnover=Net CreditSales/Average Debtors Creditors turnover=Net CreditPurchases/Average creditors Assets Turnover=Cost of Goodssold/Average total assets
Activity ratios Turnover refers to the number oftimes the asset turned over Does faster turnover mean efficiency? What does a slow turnover ofinventory mean? Should inventory turnover behomogenous across industries?
ACTIVITY 6 In which industries inventoryturnover is irrelevant? Which industries have seasonalturnover of inventory? Which are the industries whereturnover is not rapid? When will the Debtor Turnover beirrelevant?
Integrated Analysis of ratios To understand the interrelationship ofratios Operating efficiency-combination ofvarious factors Tests the earning power of the firm
Growth ratios Growth that can be sustained withoutexternal funding Earnings that are retained andreinvested within the firm The two common measures used areInternal Growth rate-without raisingfunds Sustainable growth rate- Withoutaltering Debt Equity ratio
ACTIVITY 7 Which ratios will you look for whenyou want to invest in a firm Which are the ratios a banker willlook for? Which ratios are relevant from thepoint of view of revenue? Which ratios are relevant if a supplieris contemplating to give credit to afirm?
What you must remember whilecalculating ratios Nature of Industry-Service, Seasonal,Heavy Engineering, Infrastructure.. Age of the firm Industry benchmark Peculiarities in the business Risk Factors
Importance of ratio Anlaysis Liquidity Solvency Operating efficiency Overall Profitability Interfirm Comparison Trend Analysis
Limitations of ratio Analysis Individual accounting variations Impact of inflation Conceptual diversity Only quantifiable inputs can beevaluated