financial analysis


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basics of financial analysis in referance to ratio analysis , cash flow analysis and fund flow analysis

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financial analysis

  2. 2. Financial analysis It is a process of :  Analyzing and interpreting financial statements. Analyzing means simplifying the data and interpreting means explaining the meaning and significance of data so simplified. Critically examining the accounting information given in the financial statements.  Evaluating relationships between the component parts of financial statements to obtain a better understanding of firm’s position and performance.
  3. 3. Financial Statements It is the outcome of summarising process of accounting. Means of conveying to management, owners and to interested outsiders a concise picture of profitability and financial position of the business. Its purpose is to convey an understanding of financial aspects of business firm.
  4. 4. Objectives / Importance: • To assess the earning capacity and profitability of firm • To assess the operational efficiency and managerial effectiveness. • To make inter-firm comparisons. • To make forecasts about future prospects of firm • To help in decision making and control • To guide or determine the dividend action • To identify the reason for change in profitability and financial position of the firm. • To assess the progress of firm over a period of time.
  5. 5. Potential financial statement users: • Creditors • Investors • Managers • Employees • Taxation authorities • Shareholders
  6. 6. External analysis is conducted by persons outsiders who don’t have access to the internal accounting records of business firm such as investors, creditors, govt. agencies, credit agencies and general public. Internal analysis is conducted by persons who have access to internal accounting records of a business firm, such as executives and employees of organization.
  7. 7. Horizontal analysis: It refers to the comparison of financial data of a company for several years. This type is also called ‘ dynamic analysis’ as it is based on the data from year to year rather than single year. Vertical analysis: it refers to the study of relationships of the various items in the financial statements of one accounting period. It is also called as ‘ static analysis’.
  8. 8. Steps of financial analysis: Establish objectives of the analysis. Defining extent of analysis. Reorganization and rearrangement of financial data. Relationship among financial statements with help of tools and techniques Interpretation of information Drawing a conclusion.
  9. 9. Limitations: • It is based on monetary information and monetary factors are ignored • It doesn’t consider changes in price level. • Changes in accounting procedures by a firm may often make financial analysis misleading • Analysis is only a means and not the end itself. The analyst has to make interpretation and draw his own conclusions. • Different people may interpret same analysis in different ways.
  10. 10. Tools and Techniques Comparative statements Trend- analysis Fund flow analysis Cash flow analysis Ratio analysis Common-size statements
  12. 12. Uses: • • • • Helps in decision making Helps in financial forecasting nad planning Helps in communicating strength and weakness opf a firm Helps in co-ordinating various business activities to achieve goals • Helps in making effective control of the business. Limitations : • A single ratio can’t convey much of sense. • Lack of adequate standards • Industries differ in nature and hence their ratios can’t be compared. • No consideration is made to the changes in price level.
  13. 13. Cont’d • Change in accounting procedures by a firm often make analysis misleading. • Financial statements can be easily window-dressed to provide a better picture of financial and profitable position of business firm to outsiders.(window dressing) • Ratio analysis is merely a tool of financial statements. Hence ratios become useless if separated from statements.
  14. 14. LIQUIDITY RATIOS: • Current Ratio • Current Assets/Current Liabilities • Measures ability to meet short-term cash needs • Quick or Acid Test Ratio • Current Assets-Inventory/Current Liabilities • Measure ability to meet short-term cash needs more rigorously • Absolute Liquid Ratio • Cash + short term marketable securities/Current Liabilities • Focuses on ability of the firm to generate operating cash flows as a source of liquidity
  15. 15. Leverage ratios: • Debt-to-Equity: Debt/Equity= outsider’s funds/ shareholder’s funds The debt/equity ratio, The ratio indicates what proportion of equity and debt a company uses to finance its assets. • Debt-to-Capital: funded debt/total capitalisation The ratio is used to evaluate a firm's financial structure and how it's financing operations. • Debt Ratio: Total Liabilities/Total Assets • All three measure extent of firm’s financing with debt.
  16. 16. Activity ratios: Inventory turnover ratio= cost of goods sold/inventory • Every firm has to maintain a minimum level of inventory of finished goods to meet business requirements. • Inventory turnover ratio indicates whether inventory has been efficiently used or not. • Debtors turnover ratio = net credit sales/average trade debtors. • Indicates number of times average debtors are turned over a given year. • Average collection period = no of days or months/debtor turnover ratio. • Represents average number of days for which a firm has to wait before its receivable are converted into cash.
  17. 17. • Creditor turnover ratio = credit purchases/average trade creditors • Working capital turnover ratio = net sales/working capital • Measures efficiency with which working capital is being used by the firm.
  18. 18. Profitability ratio • • • • Gross Profit ratio = Gross Profit/Net Sales Operating Profit ratio = Operating Profit/Net Sales Net Profit ratio = Net profit/Net Sales Fixed asset turnover ratio = cost of goods sold/fixed assets All measure firm’s ability to translate sales into Profits.
  19. 19. • Return on Investment (or Return on Assets)= Net Earnings/Total Assets • Return on Equity= Net Earnings/Stockholders’ Equity • Both measure overall efficiency of firm in managing investment in assets and generating return to stockholders
  20. 20. Caution!! Ratios are valuable, BUT….. They do not provide answers in an of themselves and are not predictive They should be used with other elements of financial analysis There are no “rules of thumb” that apply to interpretation of ratios
  21. 21. Fund flow analysis • It is analysis of fund flow statement. • Fund flow statement indicates various means by which the funds were obtained during a particular period and the ways in which these funds were employed • In simple words it is analysis of sources and application of funds.
  22. 22. Importance: • Gives information about amount of working capital and changes in the amount of working capital. • It analyses Balance sheet to reveal the financing & investing activities. • It analyses the Profit & Loss Account to reveal the effect of business activities of the concern on the flow of funds. • It is a tool for planning future activities of business.
  23. 23. Fund flow format:
  24. 24. Cash flow analysis: • Cash flow statement is a statement which describes the inflows(sources) and outflows(uses) of cash and cash equivalents & depicts the net change in cash position during a period. • Cash- comprises of cash in hand and bank. • Cash equivalents- short term highly liquid investments readily converted into cash. • Cash flows: inflows and outflows of cash and cash equivalents.
  25. 25. Classification: • Cash flow from operating activities- these are principal revenue producing activities. • Cash flow from investing activities- the acquisition & disposal of long term assets & other investments not included in cash equivalents. • Cash flow from financing activities- composition of the owners capital and borrowings of the enterprise.
  26. 26. Uses: • Evaluate management’s abilities to manage cash now and in the future. • Assess the company’s ability to pay dividends and to pay creditors. • The firms ability to generate future cash flow. • The financing and investment activities during a period.