Prepared by: Sherif Yassin

Agenda
• Basic financial statements
• Liquidity ratios
• Activity ratios
• Profitability ratios
• Capital structure
• Market ratios
 Objective
To have the ability of analyzing financial
statement, through using ratio analysis.
 Basic financial statements
• Statement of financial position (balance sheet).
• Statement of income (profit & loss account).
• Statement of retained earnings.
• Statement of cash flow.

N.B. disclosure is considered an integral part of the

financials.
 Cont’d
• Basic financial statements & notes serve as
vehicles for achieving the objective of financial
reporting.
• They describe different aspects of the same
transaction, more than one statement is
necessary to provide information for specific
economic decision.
 Users of financial statements;
• Internal users;
– Management.
– Employees.
– Board of directors.

• External users;
– Creditors.
– Investors.
– Financial advisors.
– For general public use.
 Needs of users;
• Investors: decide whether to increase, decrease or obtain
an investment.
• Creditors: determine whether to extend credit & under
what terms.
• Employees: negotiate wages & fringe benefits, based on
the value they provide to a profitable firm.
• Management: assess, evaluate & plan.
• Financial advisors: help investors to take decisions.
• Stock exchange: accept listing of a stock.
• Regulatory agencies: evaluate firm’s conformity with
regulations.
 Statement of financial position
• Provide information about entity’s assets, liabilities &
equity and their relationships to each other at a moment,
it helps users to assess entity’s liquidity, financial flexibility,
profitability and risk.
 Assets structure
– Current assets.
• Cash.
• Others that is expected to be converted into cash
within one year or during normal operating cycle
whichever is longer.
– Non-current assets.
• Long term investment.
• Property, plant & equipment.
• Intangible assets.
• Others (deferred tax, long term receivables…etc.).
 Financing structure
– Current liabilities;
• Obligations expected to require use of existing current
assets or creation of other current liabilities.
– Non-current liabilities;
• long term notes & bonds payable.
• Others (pension obligations, deferred tax,…etc.).
– Equity;
• Capital.
• Retained earnings.
• Others.
 Income statement & statement of retained earnings

• Reports revenues & expenses of entity’s major

activities, gains & losses from other activities
over an interval of time.
• Discontinued operations & extraordinary items
are reported separately.
 What is ratio analysis?

• Address firm’s performance through checking,

liquidity, leverage, asset management, cost
control, profitability,…etc.
 Liquidity ratios
• Current ratio =current assets/current liabilities
• Quick ratio =current assets – inventory/current liabilities
• Cash ratio = current assets – inventory – receivables/current liabilities
• Working capital =current assets – current liabilities
• Liquidity of liability is company’s ability to raise liability.
 Activity ratios
– Receivables turnover= credit sales
average accounts receivables
– Receivables days on hand = 360/receivables turnover ratio
– Payables turnover = purchases (or COGS)
average accounts payables
– Payables days on hand =360/payables turnover ratio
– Inventory turnover= COGS
avrg. inventory
– Inventory days on hand = 360/inventory turnover ratio
N.B. if we have a ratio that contain income statement component & balance sheet component, it is preferable to have the balance sheet component as an average.
 Activity ratios
– Fixed assets turnover = sales
avrg. net fixed assets
– Total assets turnover = sales
avrg. total assets
 Profitability ratio
– Measure earning to some bases such as assets, sales,
capital…etc.
– Increased profits benefit owners through dividends &
capital gain.
– Profits provide cushion for protection of debt
coverage.
 Profitability ratios
• Earning persistence (predictability & stability of sources,
amount & trend of earning), it is important to
understand response of share price to financial
accounting information.
• Extraordinary & nonrecurring items are low persistence
ones, revenue from successful new product or lower
cost from efficiency are examples of high persistence
items.
 Profitability ratios
• Separating persistent from non-persistent
items (recasting earning).
• Trend percentage analysis & evaluation of
management’s discussion & analysis in
annual report are useful techniques for
assessing revenues’ persistence.
 Profitability ratios
• Relationship of revenue & receivables help to assess earning (if
sales growing more slowly than receivables).
• Relationship of revenue & inventory help to assess earning
(falling of raw materials & WIP with increasing F.G).
• Revenue should be recognized as it is realized or realizable &
earned.
 Profitability ratios
• Profit margin on sales (ROS)=net profit/sales
• Operating income to sale= EBIT/sales
• Return on assets (ROA)=net income/avrg. assets
• Du pont equation*;
net income = net sales X net income
avrg. assets avrg. assets sales

*Relates return on assets, assets turnover & profit margin on sales

 Cont’d
• Return on total equity (ROE) = Net profit
avrg. total equity

• Gross margin = sales – COGS

sales
 Capital structure & coverage ratios
Solvency is firm’s ability to survive in long term
by paying long term obligations, the ingredients
of solvency are;
• Capital structure (equity & debt)
• Earning power (capacity of operations to generate
cash inflow)
• Asset coverage
– Asset composition (tenor matching)
– Fixed assets/total equity
– Net tangible assets/long term debt
– Total liabilities/net tangible assets.
 Cont’d
• Times interest earned ratio = EBIT/interest expense.
• Cash flow per share =cash from operations – pref. div
common shares O/S
• Total debt ratio = total liabilities/total assets
• Financial leverage ratio = Total liability
Total equity
 Market ratios
• Basic earnings per share (BEPS)
net income available to common shareholders
avrg. outstanding shares

• Price earning ratio (P-E)*

market price per share
EPS

* Opposite to earnings yield

 Cont’d
• Dividend payout ratio
Dividends per common share
EPS

• Sustainable equity growth rate

net income – preferred div X [1 – div. per common share ]
avrg. common equity EPS

Return on common equity / 1- dividend payout rate.

 Cont’d
• Book value per share
Equity
shares outstanding

• Market to book ratio

Market price per share
Book value per share