ANALYSIS OF FINANCIAL

STATEMENTS
BY
RANA ASGHAR ALI

FINANCIAL STATEMENT
USER

Supplier / Trade creditor are

interested.
Bondholders are interested in long
cash flow ability to firm
i( Service to Debt, profitability )
Investors Focus on Profit and Stability
Managers use financial Analysis for
Internal control.

Primary fundamental
Analysis, Balance Sheet

The assets what the firm owns are listed

according to the degree of their liquidity
from the most liquid to the liquid.
The fixed assets are shown on the balanced
sheet at the cost or at depreciation
adjusted amounts and do not necessarily
reflect their current market or market
values.
All liabilities and net worth what is owed are
shown separately on the right hand side of
the balance sheet when not organized
vertically with assets at the top.

Liability division

The liability is divided into two

groups.
Current liabilities
Long term liabilities.

Current liabilities.

Current
liabilities
which
are
expected to be rapid within one
year are shown at the top of the
list.
Example
are
Note
Payable,
Account Payable, Salary payable,
interest payable,

LONG TERM LIABILITIES

Long term liabilities which are due

after one year are listed below
current liabilities.
Long Term Debt
Long Term Bonds

Shareholders equity.
Share holders equity consists common stock.
1.The common stock amount as per value of
one share of a common stock times the
number of shares outstanding.
2.Additional paid in capital or capital surplus is
the excess of the actual price originally paid
for the stock over its par value.
3.Retained
earnings
represent
the
accumulated and undistributed net profits
that remain after taxes are paid and
dividends are distributed.

Balance sheet equation

The fact that total assets equal

liabilities plus net worth is called
the balance sheet equation.

Income statement.
The income statement shows the
record of a firms operating
functional analysis.
1.A framework helps focus on specific
issues and questions.
2.One possible framework is
suggested for considering how to
raise external financing.

Financing needs after

analysis

A. The nature and timing of the

funds needs of the firm.
The firms financial condition and
profitability.
The firms business risk.

Analysis of financial ratio

involves

Trend comparisons compare ratios

for several periods to determine if a
firms financial condition is improving
or deteriorating over time.
Industry comparison compare ratios
of a firm with those of similar firms or
with industry rooms.

Financial Ratio

Financial ratios can be divided

into five categories
liquidity
debt or leverage
coverage
activity and
profitability ratios

Division Of Ratios

The first two categories use data

from the balance sheet and the
last three from the income
statement or both the income
statement and balance sheet.

Current and Quick Ratio

Liquidity ratios are used to assess the firms ability to meet

its short term financial obligations.
1.
Current ratio
=Current assets
Current liabilities
Although a higher current ratio indicates greater liquidity, it
may also imply lower profitability.
Since the current ratio does not take into account the
liquidity of the individual current asset accounts, its use as
the exclusive measure of liquidity can be misleading. A
more rigorous measure, the quick ratio provides additional
information.
2.
Quick (acid test) ratio =Current assets-Inventories
Current Liabilities
This ratio is a stricter measure of a firms liquidity
in that it omits inventories, the least liquid of current assets.

DEBT TO EQUITY AND

DEBT TO ASSET RATIO

Debt or leverage ratios are uses to assess the firms

dependence on debt financing
Debt-to equity ratio= Total debt
Shareholders equity
Creditors generally like this ratio to be low,
Shareholders are providing a high percentage of
financing.
For Example 1454000/179600=0.81
This ratio will vary depending on the industry and the
variability of cash flows.
Debt-to-total assets ratio
=Total debt
Total assets

Debt to Total Asset Ratio

This ratio shows what percentage

of each Rs. Invested in asset
comes from creditors.
High Debt to Total Ratio indicates
high risk.

Coverage Ratios

Measure the to meet financial

Obligation when due.
Earning before interest and taxes (EBIT)
Interest expense
The higher the ratio the more likely it is
that the company could cover its
interest payments without difficulty.
A broader analysis would assess the
ability of the company to cover all of its
fixed expenses.

Interest Coverage Ratio

Bond Rating Services

Moody s Investor Services
Standard and Poor
Example 400,000/ 85,000= 4.71
Where median industrial is 4.00

RECIEVABLE TURNOVER
RATIO

Activity ratios indicate how efficiently

a firm is using its assets.
These generally focus on three areas:
receivables, inventories and assets in
general.
Receivable turnover (RT) =
Annual net credit sales.
Receivables

Receivable Turnover

Net annual Credit sales=3992,000

Receivable =678,000
By applying Ratio
3,992,000/678,000=5.89

RECIEVABLE TURNOVER
RATIO

The higher the RT ratio, the shorter the

time between the average sale and
cash collection.
When credit sales figures are not
available, the analyst may resort to
using total sales figures. When sales
are seasonal, an average of monthly
closing receivables balances may be
more appropriate than a simple yearend receivables balance.

RECIEVABLE TURNOVER
RATIO IN DAYS

Receivable turnover in days (RTD) or

average collection period.
Days in the year
Receivable turnover
365/RT
Or equivalently:
Receivables x Days in the year
Annual credit sales

EXPLANATION

Al though, generally a high receivables turnover

in days (or average collection period) is not
good, a very low RTD may indicate an overly
restrictive credit policy and possible lost sales.
Another method for analyzing the liquidity of
accounts receivable is through the use of an
aging schedule. This involves categorizing
receivable outstanding at a particular point in
terms of the period of time they have gone
uncollected
since
their
original
sales
transaction.
Accounts payable can also be analyzed in the
same way as accounts receivable.

INVENTORY TURNOVER
Payable turnover in days =
Accounts payable x Days in the
year
Annual credit purchases
Liquidity in inventory may be
measured by the inventory
turnover (IT)
Cost of goods sold
Inventory
e.g 2680,000/1329,000=2.02
In general, the higher the

INVENTORY TURNOVER IN
DAYS.

Inventory turnover in days tells us how

many days on average, before inventory is
turned into accounts receivable through
sales
Days in the year
Inventory turnover
The operating cycle shown the length of
time from the commitment of cash for
purchase until the collection of receivables.
Mathematically, the operating cycle is
described as
Inventory turnover
in days+ receivable
turnover in days

TOTAL ASSET TURNOVER

Total asset turnover tells us the relative

efficiency with which a firm utilizes its total
assets to generate sales. It states the
number of sales dollars generated per dollar
of asset investment and is calculated as
Net sales
Total assets
e.G 3,992,000/3,252,000=1.23
Industry ratio=1.66
Generate less sales

PROFITABILITY RATIO
RETURN
ON
INVESTMENT
Profitability ratios give an indication of

the
firms overall effectiveness of operation and
thus, to its profitability. These can be
categorized into two groups based on (1) sales
and (2) investments.
The gross profit margin indicates the efficiency
of the firms operations as well as the pricing
policies of the firm. It is
Net sales-Cost of goods sold
Net sales
The net profit margin is another common
profitability ratio:
Net profit after taxes
Net sales

RETURN ON INVESTMENT

A widely used overall profitability measure is the

return on investment (ROI) ratio (or return on
assets)
Net profit after taxes
Total assets
Another summary profitability measure is return on
equity (ROE):
Net profit after taxes
Shareholders equity
There are sample logical relationships among some
of the ratios which can be seen in the DuPont
approach to ratio analysisan approach that
breaks down profitability measures into their basic
components.
ROI may be broken down into its component parts
for additional analysis of a firms earning power:

DUE POINT

ROI
= Net profit margin x Total asset turnover
Net profit
= after taxes x
Net sales
Net sales
Total assets
Similarly , for return on shareholders equity :
Net Total Equity
ROE = profit x
asset x multiplier
Margin
turnover
Net profit
= after taxes x
Net sales
equity

Net sales
Total assets

x Total assets
Shareholders

Investor
Percentage of earning Retained
Net income-alldividend/ Net income

Price earning Ratio

Market price per share/Market price
common share
Dividend payout
DPS
EPS

INVESTMENT RATIOS

Dividend yield:
Dividend per common share
Market price common share

Book value per share:

Total stock equity-preferred stock equity
Number of common share outstanding