This document discusses financial statement analysis and ratio analysis. It provides an overview of the rationale, process, tools and components of financial analysis. Some key ratios discussed include liquidity ratios, capital structure ratios, profitability ratios, activity ratios and ratios on investments. Examples are given of how to calculate common ratios like current ratio, debt-to-equity ratio, gross profit margin, return on assets and inventory turnover. The document stresses the importance of ratio analysis for decision making and compares firms, while noting some limitations to keep in mind.

1. Financial Statement Analysis

2. Rationale of Financial Statement
Analysis
 Financial statement – summary of
figures as of any given date
 To identify relevant information
 Draw meaningful interpretations

3. Process of Analysis
 Identification of significant
information
 Highlight significant relationships
 Interpretation

4. Tools of Financial Analysis
 Fund flow Statement
 Cash Flow Statement
 Ratio Analysis
 Common size statements

5. Balance Sheet Overview-
ASSETS
Assets
Gross Block 3978.55
Net Block 2790.57
Capital WIP 66.72
Investments 454.33
Inventory 610.81
Receivables 1546.81
Other Current Assets 3673.67
Balance Sheet Total 9142.92

6. Balance Sheet Overview-
Liabilities
Liabilities
Equity Share Capital 434.12
Reserves 5815.65
Total Debt 2096.69
Creditors and Acceptances 393.91
Other current liab/prov. 402.55
Balance Sheet Total 9142.92

7. Ratio Analysis
 Most widely used and significant tool
 Provides a basis for comparison
 Useful when benchmark ratios are
known
 Relationships between variables in
the financial statement

8. Types of ratios
 Liquidity ratios
 Capital Structure ratios
 Profitability Ratios
 Activity/Efficiency ratios
 Integrated Analysis of ratios
 Growth ratios

9. Overview of Balance Sheet
LIABILITIES
 Equity
Capital/Owners’
Funds
 Long Term
Borrowings
 Current Liabilities
ASSETS
 Fixed Assets
 Current Assets

10. Liquidity Ratios
 Measure the ability of firm to meet
short term obligations
 Reflect short term financial strength
 Why short term??- of interest to
creditors..
 Ratios- Current ratio, Liquid ratio,
Turnover ratios, cash flow from
operation ratio

11. Liquidity ratios
 Current Ratio= Current Assets/
Current Liabilities
 Liquid ratio= Liquid Assets/Current
Liabilities

12. NEED FOR LIQUIDITY
 Assume stocks are bought on credit
 Converted to inventory
 Sales=0
 Current Ratio??
 Liquid Ratio??
 Implications on liquidity-serious

13. ACTIVITY 1
 Calculate Current Ratio, Liquid ratio,
Debtors Turnover and Creditors turnover
from the following information
Average Debtors=1,00,000
Average Creditors=75,000
Cash= 5,000
Inventory=75,000
Credit Purchases=6,00,000
Credit Sales=12,00,000

14. Capital Structure ratios
 Helps to measure long term financial
strength
 Solvency of the firm
 Ability to service interest on loans
 Ability to service the principal

15. Capital Structure Ratios
 Debt Equity ratio= Long Term
Debt/Shareholders Equity
 Debt to total Capital= Total
Debt/Total Assets
 Interest Coverage Ratio= Earnings
Before Interest and Tax/Interest

16. ACTIVITY 2
 What happens when a firm is purely
funded by equity?
 What happens when a firm is purely
funded by debt?
 Which is riskier when profits are less?
 When equity is high and profits are
high, what happens to ROI?

17. Profitability ratios
 Related to Sales
 Ability of the firm to mark up on sales
 Ability of firm to convert margins to
profit
 Proportion of expense to income
 Analysis of income and expenses

18. Profitability ratios
 Gross Profit Margin= Gross
profit/Sales*100
 Operating Profit ratio= Earnings
Before Interest and taxes/Net Sales
 Net Profit Ratio= Earnings after
interest and taxes/Net Sales
 Expenses ratio- Cost of Goods sold,
Operating Ratio, Financial Expenses

19. Ratios on Investments
 Related to investment
 Ability to generate return on
investment
 Ultimate measure of profitability
 Ability of firm to generate wealth

20. Profitability on Investment
 Return on Assets= Profit after
Taxes/Average total assets*100
 Return on Capital Employed=
EBIT/Average Total Capital
Employed*100
 Return on Shareholders Equity=
Net profit after taxes/Average
shareholders’ equity*100

21. ACTIVITY 3
 Earnings Before Interest and Tax=
Rs.5,00,000
 Interest payment =Rs.75,000
 Tax rate = 50%
 Calculate Earnings after Interest and
tax

22. Profitability on investment
 Earnings per share=Net Profit
available to Equity
Shareholders/Number of ordinary
shares outstanding
 Price earning ratio= Market price of
share/EPS

23. ACTIVITY 4
Calculate Gross Profit Margin and Net
profit Margin
 Sales 2,00,000
 Cost of Goods Sold 1,00,000
 Other operating expenses 50,000

24. ACTIVITY 5
Calculate Return on Assets
 Current Assets 4,00,000
 Fixed Assets 6,00,000
 Net Profit before taxes 2,50,000
 Tax rate 50%

25. Activity Ratios
 Concerned with measuring the
efficiency
 Also the asset utilisation
 Rate at which assets are converted
into sales
 Test of relationship of sales to various
assets of the firm

26. Activity Ratios
 Turnover ratios
 Inventory turnover=Cost of Goods
Sold/Average Inventory
 Debtors turnover=Net Credit
Sales/Average Debtors
 Creditors turnover=Net Credit
Purchases/Average creditors
 Assets Turnover=Cost of Goods
sold/Average total assets

27. Activity ratios
 Turnover refers to the number of
times the asset turned over
 Does faster turnover mean efficiency?
 What does a slow turnover of
inventory mean?
 Should inventory turnover be
homogenous across industries?

28. ACTIVITY 6
 In which industries inventory
turnover is irrelevant?
 Which industries have seasonal
turnover of inventory?
 Which are the industries where
turnover is not rapid?
 When will the Debtor Turnover be
irrelevant?

29. Integrated Analysis of ratios
 To understand the interrelationship of
ratios
 Operating efficiency-combination of
various factors
 Tests the earning power of the firm

30. Integrated Analysis
 Earning Power=
EAT/Sales*Sales/Assets*Assets/Equit
y

31. Growth ratios
 Growth that can be sustained without
external funding
 Earnings that are retained and
reinvested within the firm
 The two common measures used are
Internal Growth rate-without raising
funds
 Sustainable growth rate- Without
altering Debt Equity ratio

32. ACTIVITY 7
 Which ratios will you look for when
you want to invest in a firm
 Which are the ratios a banker will
look for?
 Which ratios are relevant from the
point of view of revenue?
 Which ratios are relevant if a supplier
is contemplating to give credit to a
firm?

33. What you must remember while
calculating ratios
 Nature of Industry-Service, Seasonal,
Heavy Engineering, Infrastructure..
 Age of the firm
 Industry benchmark
 Peculiarities in the business
 Risk Factors

34. Importance of ratio Anlaysis
 Liquidity
 Solvency
 Operating efficiency
 Overall Profitability
 Interfirm Comparison
 Trend Analysis

35. Limitations of ratio Analysis
 Individual accounting variations
 Impact of inflation
 Conceptual diversity
 Only quantifiable inputs can be
evaluated