1. Financial statements provide information to owners and creditors about a firm's financial performance and position. The three main statements are the balance sheet, income statement, and statement of cash flows.
2. The balance sheet outlines a firm's assets, liabilities, and equity. The income statement shows revenues, expenses, and profits over a period of time. The statement of cash flows displays all cash inflows and outflows.
3. Financial analysts use ratio analysis to evaluate a firm's performance in areas like profitability, liquidity, efficiency, and financial leverage by calculating ratios from the information in the financial statements.
It is the system in which both the aspects i.e. debit as well as credit are recorded in the books of accounts .It records transactions relating to all the accounts i.e. personal, real and nominal.
This document outlines what constitutes Financial Analysis to study a company's Balance Sheet, Profit and Loss accounts, Cash Flow Statements. It also provides guidance to do Ratio Analysis.
It is the system in which both the aspects i.e. debit as well as credit are recorded in the books of accounts .It records transactions relating to all the accounts i.e. personal, real and nominal.
This document outlines what constitutes Financial Analysis to study a company's Balance Sheet, Profit and Loss accounts, Cash Flow Statements. It also provides guidance to do Ratio Analysis.
It is a type of financial ratio used to measure the efficiency of business in generating profit by utilizing assets
The larger the turnover ratio, the better as it shows that the company is optimally utilizing its assets as resources to earn revenue
Turnover ratios are calculated by dividing the revenues from average asset balance
It is also termed as efficiency ratio because it shows the company’s efficiency in conversion of assets into sales which in turn reflects the ROI
Inventory Turnover ratio measures how efficiently the stocks are being converted into finished goods to generate sales
It is calculated as –
Inventory Turnover Ratio = (Cost of Goods Sold)/(Average Inventory)
Debtors Turnover Ratio signifies the efficiency of business in converting its debtors or credit sales into cash
It is calculated as –
Debtors Turnover Ratio = (Net Credit Sales or Revenue)/(Average Trade Receivables)
Fixed assets turnover ratio measures how efficiently a company uses its fixed assets to generate revenue
Fixed Assets Turnover Ratio = (Revenue from sales)/(Average Fixed Assets)
Total assets turnover ratio takes into account both fixed as well as current asset to measure the overall efficiency in generation of revenue with assets utilization
It is calculated as –
Total Assets Turnover Ratio = (Revenue from sales)/(Average Total Assets)
Working capital ratio measures the company’s efficiency in using its working capital to generate revenue for the business
It also indicates the relation between liquidity and profitability of the business
It is calculated as –
Working Capital Turnover Ratio = (Revenue from sales)/(Average Working Capital)
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A profit and loss statement is a financial statement that reports on revenue, operating costs and expenses incurred by an entity within a nominated period of time.
International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.
IFRS were issued by the Board of the International Accounting Standards Committee (IASC), known as International Accounting Standard Board(IASB).
Techniques of Financial Statement Analysis: Introduction, Objectives of financial statement analysis, various techniques of analysis viz Common Size Statements, Comparative Statements, Trend Analysis, Ratio Analysis, Funds Flow Statement & Cash Flow Statement
1.Distinguish between the direct and indirect labor cost
2. Understand the various facets of labor cost control
3. Understand the concepts like labor turnover, time keeping, time booking and idle and overtime
4. Know the various methods of remuneration including incentive plans
5. Understand the pay roll accounting and disbursement of wages.
Profitability Ratio
A profitability ratio is a measure of financial ratio defining the profit percent and return percent from the business using data from financial statements at a specific point of time
It assess business’s ability to generate gross profit, operating profit and net profit from the sales using data from profit& loss statement
It even takes into consideration various return generating ability of business in terms of return on assets, return on capital employed, return on equity, return on investment using data from balance sheet
Types of profitability ratio
Gross Profit Ratio, Net Profit Ratio, Operating Profit Ratio, Return on Assets, Return on Equity, Return on Investment, Return on Capital Employed
Gross Profit Ratio
Gross Profit Ratio(GPR) is a profitability ratio that shows the relationship between gross profit and the revenue from net sales
GPR = (퐆퐫퐨퐬퐬 퐏퐫퐨퐟퐢퐭)/(퐍퐞퐭 퐒퐚퐥퐞퐬)
Net Profit Ratio
The net profit ratio is equal to how much net profit is generated as a ratio of revenue earned through sales
Net Profit Ratio = (퐍퐞퐭 푷풓풐풇풊풕)/(퐍퐞퐭 푺풂풍풆풔)
Operating Profit Margin is a profitability ratio used to calculate the percentage of operating profit a company produces from its operations, prior to deduction of taxes and interest charges
Operating Profit Ratio
Operating Profit Ratio = (퐎퐩퐞퐫퐚퐭퐢퐧퐠 퐏퐫퐨퐟퐢퐭)/(퐍퐞퐭 퐒퐚퐥퐞퐬)
Return on assets (ROA) is a kind of profitability measure used to determine returns on assets relevant when compared across the companies or previous performance of the company
Return On Asset = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐀퐯퐠.퐓퐨퐭퐚퐥 퐀퐬퐬퐞퐭퐬)
Return on equity (ROE) is a measure of financial performance calculated by dividing net profit by average shareholders' equity
ROE = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐀퐯퐠.퐓퐨퐭퐚퐥 퐄퐪퐮퐢퐭퐲)
Return on capital employed is a profitability ratio used in valuation of company’s financial position depicting the return out of capital employed
ROCE = 퐄퐁퐈퐓/(퐂퐚퐩퐢퐭퐚퐥 퐄퐦퐩퐥퐨퐲퐞퐝)
Return on investment is a profitability measure used by businesses to identify the efficiency of business in generating return out of an investment
ROI = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐂퐨퐬퐭 퐨퐟 퐈퐧퐯퐞퐬퐭퐦퐞퐧퐭)
Ratio analysis refers to the analysis and interpretation of the data collected from the financial statements (i.e., Profit and Loss Statement, Balance Sheet and Fund/Cash Flow statement etc.)
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It is a type of financial ratio used to measure the efficiency of business in generating profit by utilizing assets
The larger the turnover ratio, the better as it shows that the company is optimally utilizing its assets as resources to earn revenue
Turnover ratios are calculated by dividing the revenues from average asset balance
It is also termed as efficiency ratio because it shows the company’s efficiency in conversion of assets into sales which in turn reflects the ROI
Inventory Turnover ratio measures how efficiently the stocks are being converted into finished goods to generate sales
It is calculated as –
Inventory Turnover Ratio = (Cost of Goods Sold)/(Average Inventory)
Debtors Turnover Ratio signifies the efficiency of business in converting its debtors or credit sales into cash
It is calculated as –
Debtors Turnover Ratio = (Net Credit Sales or Revenue)/(Average Trade Receivables)
Fixed assets turnover ratio measures how efficiently a company uses its fixed assets to generate revenue
Fixed Assets Turnover Ratio = (Revenue from sales)/(Average Fixed Assets)
Total assets turnover ratio takes into account both fixed as well as current asset to measure the overall efficiency in generation of revenue with assets utilization
It is calculated as –
Total Assets Turnover Ratio = (Revenue from sales)/(Average Total Assets)
Working capital ratio measures the company’s efficiency in using its working capital to generate revenue for the business
It also indicates the relation between liquidity and profitability of the business
It is calculated as –
Working Capital Turnover Ratio = (Revenue from sales)/(Average Working Capital)
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A profit and loss statement is a financial statement that reports on revenue, operating costs and expenses incurred by an entity within a nominated period of time.
International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.
IFRS were issued by the Board of the International Accounting Standards Committee (IASC), known as International Accounting Standard Board(IASB).
Techniques of Financial Statement Analysis: Introduction, Objectives of financial statement analysis, various techniques of analysis viz Common Size Statements, Comparative Statements, Trend Analysis, Ratio Analysis, Funds Flow Statement & Cash Flow Statement
1.Distinguish between the direct and indirect labor cost
2. Understand the various facets of labor cost control
3. Understand the concepts like labor turnover, time keeping, time booking and idle and overtime
4. Know the various methods of remuneration including incentive plans
5. Understand the pay roll accounting and disbursement of wages.
Profitability Ratio
A profitability ratio is a measure of financial ratio defining the profit percent and return percent from the business using data from financial statements at a specific point of time
It assess business’s ability to generate gross profit, operating profit and net profit from the sales using data from profit& loss statement
It even takes into consideration various return generating ability of business in terms of return on assets, return on capital employed, return on equity, return on investment using data from balance sheet
Types of profitability ratio
Gross Profit Ratio, Net Profit Ratio, Operating Profit Ratio, Return on Assets, Return on Equity, Return on Investment, Return on Capital Employed
Gross Profit Ratio
Gross Profit Ratio(GPR) is a profitability ratio that shows the relationship between gross profit and the revenue from net sales
GPR = (퐆퐫퐨퐬퐬 퐏퐫퐨퐟퐢퐭)/(퐍퐞퐭 퐒퐚퐥퐞퐬)
Net Profit Ratio
The net profit ratio is equal to how much net profit is generated as a ratio of revenue earned through sales
Net Profit Ratio = (퐍퐞퐭 푷풓풐풇풊풕)/(퐍퐞퐭 푺풂풍풆풔)
Operating Profit Margin is a profitability ratio used to calculate the percentage of operating profit a company produces from its operations, prior to deduction of taxes and interest charges
Operating Profit Ratio
Operating Profit Ratio = (퐎퐩퐞퐫퐚퐭퐢퐧퐠 퐏퐫퐨퐟퐢퐭)/(퐍퐞퐭 퐒퐚퐥퐞퐬)
Return on assets (ROA) is a kind of profitability measure used to determine returns on assets relevant when compared across the companies or previous performance of the company
Return On Asset = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐀퐯퐠.퐓퐨퐭퐚퐥 퐀퐬퐬퐞퐭퐬)
Return on equity (ROE) is a measure of financial performance calculated by dividing net profit by average shareholders' equity
ROE = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐀퐯퐠.퐓퐨퐭퐚퐥 퐄퐪퐮퐢퐭퐲)
Return on capital employed is a profitability ratio used in valuation of company’s financial position depicting the return out of capital employed
ROCE = 퐄퐁퐈퐓/(퐂퐚퐩퐢퐭퐚퐥 퐄퐦퐩퐥퐨퐲퐞퐝)
Return on investment is a profitability measure used by businesses to identify the efficiency of business in generating return out of an investment
ROI = (퐍퐞퐭 퐏퐫퐨퐟퐢퐭)/(퐂퐨퐬퐭 퐨퐟 퐈퐧퐯퐞퐬퐭퐦퐞퐧퐭)
Ratio analysis refers to the analysis and interpretation of the data collected from the financial statements (i.e., Profit and Loss Statement, Balance Sheet and Fund/Cash Flow statement etc.)
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2. 2
What are the functions of financial
statements?
• Provide information to owners and creditors about the
firm’s current status and past financial performance
• Provide a convenient way for owners and creditors to set
performance targets and impose restrictions on
managers
• Provide a convenient way for a firm’s financial planning
3. 3
Types of financial statements
• Balance Sheet
• Income Statement
• Statement of Cash Flows
4. 4
The Balance Sheet
• The balance sheet shows a firm’s assets (what it
owns) and liabilities (what it owes)
• The difference between a firm’s assets and
liabilities is the firm’s net worth
• For corporations, net worth is called
stockholder’s equity
5. 5
A typical balance sheet
Assets
Current Assets:
Cash & short term securities
Accounts Receivable
Inventory
Total Current Assets
Fixed (long-term) assets:
Property/plant/equipment
Investments
Other assets
Total Assets
Liabilities & Shareholder Equity
Current Liabilities:
Accounts payable
Short-term debt (due in one year)
Accrued expenses
Total Current Liabilities
Long-term Liabilities
Long-term debt
Total Liabilities
Shareholder Equity:
Common equity (paid in)
Retained earnings
Total liabilities & shareholder equity
6. 6
Do financial analysts disagree with
balance sheet information?
• Main issue: Book values (The net asset value of a company, calculated by total
assets minus intangible assets (patents, goodwill) and liabilities) vs. market values
• Balance sheets omit some economically significant
assets called intangible assets, such as R&D
• Intangible assets, such as goodwill, are not reported at
market values (the excess of the purchase price of a company over its book value which
represents the value of goodwill as an intangible asset for accounting purposes)
• Some economically significant liabilities are also omitted,
e.g. pending lawsuits (In American law, a lawsuit is a civil action brought before a court in
which the party commencing the action)
7. 7
The Income Statement
• The income statement presents in a summary form the
profitability of a firm over an annual period
• The income statement presents information on
– Revenues (sales)
– Cost of goods sold
– Operating expenses
– Financing costs of doing business
– Tax expenses
8. 8
A typical income statement
Sales revenue
- Cost of goods sold
= Gross margin
- Operating expenses
= EBITDA (Earnings before interest, taxes and depreciation)
- Depreciation & Amortization
= EBIT (Operating income)
- Interest payment
= Taxable income
- Taxes
= Net Income
9. 9
How is net income allocated?
• Dividends
• Change in retained earnings
• Earnings per share:
– Basic: Net income / shares of common stock
outstanding
– Diluted: Adjusts for stock options and convertible debt
10. 10
Accounting vs. economic measures
of earnings
• Accounting definition of earnings ignores
unrealized gains or losses in market value of
assets and liabilities
• Accrual (make provision for (a charge) at the end of a financial period)
accounting recognizes revenues and expenses
in the period that they take place, which does
not necessarily match the cash flows of a firm
11. 11
The firm’s expenses
• The firm’s expenses are separated into operating,
financing and capital
– Accounting depreciation does not attempt to measure
economic depreciation (loss in an asset’s value)
– Inconsistencies in the application of this categorization
of expenses (e.g., R&D is treated as an operating
expense)
12. 12
Statement of Cash Flows
• The statement of cash flows shows all the cash that
flows in and out of a firm during a specified period of
time
• Note that income statements show revenues and
expenses
• Cash flow statements are useful because
– They show a firm’s cash position over time
– They avoid accounting judgments about revenues and expenses
found in income statements
13. 13
A typical cash flow statement
Cash flow from operations
Net income
+ Depreciation
- Increase in accounts receivable
- Increase in inventories
+ Increase in accounts payable
Total cash flow from operations
Cash flow from investing activities
- Investment in plant and equipment
Cash flow from financing activities
- Dividends paid
+ Increase in short-term debt
Change in cash and marketable securities
14. 14
Financial Ratio Analysis: Evaluating
a firm’s performance
• Financial ratio analysis is a popular way of using
information from financial statements to evaluate
a firm’s performance
• Through the analysis of financial ratios, we can
easily identify the strengths and weaknesses of
a firm
15. 15
How are financial ratios used?
• Calculating financial ratios allows us to
– Examine the firm’s performance through time (e.g.
last five years) and identify trends
– Compare the firm’s performance with other
comparable firms (peer group) and identify the firm’s
competitive advantage
– Some financial ratios (e.g. price-earnings ratio,
market-to-book ratio) are useful in valuation analysis,
such as valuing private firms
17. 17
Profitability Ratios
• After-tax operating margin: Measures the firm’s effectiveness in
generating profits from operations
(EBIT – taxes)/Sales
• Return on assets: Measures the firm’s operating effectiveness in
generating profits from its assets
(EBIT – taxes)/Average Assets
18. 18
Profitability Ratios
• Return on equity: Measures the firm’s profitability from the
perspective of the equity investor
Net Income/Stockholder’s Equity
• Return on capital: Measures the firm’s effectiveness in generating
profits from the capital invested in the firm
(EBIT – taxes)/(BV Debt + BV Equity)
19. 19
Liquidity Ratios
• Current ratio: Compares current assets (cash, inventory, accounts
receivable) to current liabilities (obligations due within one year)
Current Assets/Current Liabilities
• Quick or Acid Test ratio: Variant of current ratio that distinguishes
current assets that can be converted quickly into cash (cash,
marketable securities) from those that cannot (inventory, accounts
receivable)
(Cash + Marketable Securities)/Current Liabilities
20. 20
Efficiency Ratios
(Asset Management Ratios)
• Asset Turnover ratio: Indicates how efficiently the firm is using its
assets to generate sales
Sales/Average Total Assets
• Accounts Receivable Turnover ratio: Indicates how rapidly the firm is
collecting its credit, measured by how many times accounts
receivable are rolled over during a year
Sales/Average Accounts Receivable
21. 21
Efficiency Ratios
• Inventory Turnover ratio: Indicates the relative liquidity of
inventories, measured by how many times the firm’s inventories are
replaced during a year
Cost of Goods Sold/Average Inventory
• Days Receivable Outstanding, Days Inventory Held:
365/Receivable Turnover
365/Inventory Turnover
22. 22
Financial Leverage Ratios
• Times Interest Earned Ratio (Interest Coverage Ratio): Measures
the firm’s capacity to meet interest payments from pre-debt, pre-tax
earnings
EBIT/Interest Expenses
• Debt Capitalization ratio: Measures how much debt a firm is using
as a proportion of its total capital (total value of debt plus equity)
Debt/(Debt + Equity)
23. 23
Financial Leverage Ratios
• Debt to Equity Ratio: Measures debt as a proportion of the firm’s
equity
Debt/Equity
• The above two ratios can also be calculated by using only long-term
debt
• Moreover, these ratios must be calculated using market instead of
book values for debt and equity. Market-based debt ratios give a
better indication of a firm’s ability to borrow
24. 24
Market Value Ratios
• Price to Earnings ratio (P/E) and Market to Book ratio: Measure the
relation between the accounting measures (value) of the firm and its
market value
Price per Share/Earnings per Share
Price per Share/Book Value per Share
25. 25
Payout Policy Ratios
• Dividend Payout ratio: It relates dividends paid to the earnings of the
firm
Dividends/Earnings
• Dividend Yield ratio: It relates the dividend paid to the price of the
stock
Annual Dividends per Share/Price per Share
26. 26
The DuPont Analysis
• A useful way to understand the sources that drive a
firm’s ROA and ROE
• We can disaggregate ROA as follows:
ROA = (Net Profit Margin) (Total Asset Turnover)
27. 27
The DuPont Analysis
• Asset turnover and net profit margin (return on sales) drive ROA
• If a firm can reduce working capital without hurting its competitiveness,
then asset turnover and ROA
• If a firm cuts back capital expenditures, then, in the short run, ROA
because asset turnover (due to total assets ) and return on sales
(the latter because future depreciation and, thus, net income )
• But, this strategy, will probably hurt the firm’s competitiveness and,
thus, ROA in the long run
28. 28
The DuPont Analysis
• Moreover, we can disaggregate ROE as follows:
ROE = (ROA) (1 – Debt Ratio)
• As we see, ROE can increase through an increase in
ROA or the Debt Ratio
29. 29
The DuPont Analysis
• Financial analysts value more a firm that increases
its ROE through higher ROA
• A firm that increases ROE by taking on more debt
also increases the probability of being in financial
distress (bankruptcy)