Financial Management

Lecture 4
By:
Sameh Elish, DBA, MBA

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Let us Remember

Types of financial statements

Relationship between financial statements

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Financial Statements Analysis

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Financial Analysis

Financial Analysis is studying financial

statements and published data for the company
during accounting periods to reach results to:
Evaluate past performance.
Predict future one.

Financial Analysis is exactly like the

blood analysis test

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Analysis Techniques

• Horizontal analysis
• Vertical analysis
• Financial ratios

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Horizontal Analysis

Change
2013 2012 amount %
Net Sales $360,000 $290,000 $70,000 24.1%

Cost of goods sold 224,000 176,000 48,000 27.2%

Gross profit 136,000 114,000 22,000 19.3%

Operating expenses 80,000 50,000 30,000 60.0%

Operating income 56,000 54,000 2,000 3.7%

Net income $28,000 $25,000 3,000 12.0%

Earnings per share $2.80 $2.50 0.30 12.0%

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Vertical Analysis
2013 % 2012 %
Cash $50,000 55.5% $45,000 52.9%

Current assets 25,000 27.7% 30,000 35.2%

Fixed assets 15,000 16.6% 10,000 11.7%

Total assets $90,000 100.0% $85,000 100.0%

Current liabilities 10,000 11.1% 12,000 14.1%

Long term liabilities 20,000 22.2% 15,000 17.6%

Shareholders’ equity 60,000 66.6% 58,000 68.2%
Total liabilities and Equity $90,000 100.0% $85,000 100.0%

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Financial Ratios

 Analysis of liquidity
 Analysis of profitability
 Analysis of assets efficiency

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Exercise Question

Perform financial analysis on the following companies:

Cupcakes Company Donuts Company

Cookies Company Ice Cream Company 9

Short Term Liquidity Analysis

1. Current Ratio
2. Quick Ratio
3. Networking Capital Ratio

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Current Ratio

 How did current assets compare to current

liabilities?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Current Assets
Current Ratio =
Current Liabilities

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Current Assets vs. Current Liabilities

Current Assets Current Liabilities

Cash Accounts Payable

Accounts Receivable Notes Payable

Inventory Wages payable

Short term investment Expenses payable

Prepaid expenses

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Current Ratio - Comments

 It measures short term debt paying ability.

 Higher is better.
 We have global measure which is 2:1.
 This is a balance sheet ratio reflect the liquidity
on one date.

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 Quick Ratio

 How did quick assets compare to current

liabilities?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Quick Assets*
Quick Ratio =
Current Liabilities
*Quick asset = Current assets – (Inventory + Prepaid expenses)

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Quick Ratio - Comments

 Another measure of short term debt paying

ability.
 It excludes inventory and prepaid expenses.
 Higher is better.
 We have global measure which is 1:1.
 This is a balance sheet ratio reflect the liquidity
on one date.

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Networking Capital Ratio

 What remains after subtracting current

liabilities from current assets?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Networking Capital Ratio = Current Assets – Current Liabilities

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Networking Capital Ratio - Comments

 It measures what remains to run the business.

 Higher is better.
 This ratio should be positive.

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Long Term Liquidity Analysis

 It also called Capital Structure analysis.

1. Debt to Equity Ratio
2. Total Liabilities to Total Assets Ratio
3. Total Equity to Total Assets Ratio

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Debt to Equity Ratio

 What is the company’s level of financial risk?

Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Total Liabilities
Debt to Equity Ratio =
Total Equity

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Debt to Equity Ratio - Comments

 It measures financial risk by showing the

relation between external source of fund and
internal source of fund.
 A higher ratio indicates more financial risk .
 We have global measure which is 1:1.

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Total Liabilities to Total Assets Ratio

 What is the % of total assets financed by the

liabilities ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Total Liabilities
T.L to T.A Ratio =
Total Assets

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Total Liabilities to Total Assets Ratio
- Comments
 It measures the relation between total liabilities
and total assets.
 We have global measure which is 50%.
 No trend for this ratio, because we need extra
information.

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Total Equity to Total Assets Ratio

 What is the % of total assets financed by the

Equity ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Total Equity
T.E to T.A Ratio =
Total Assets

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Total Equity to Total Assets Ratio -
Comments
 It measures the relation between total equity
and total assets.
 We have global measure which is 50%.
 No trend for this ratio, because we need extra
information.

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Profitability Analysis

 Sales Profitability:  Equity Profitability

1. Gross Profit Margin 1. Return on Equity
2. Net Profit Margin 2. Earning per Share

 Assets Profitability
1. Return on Assets

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 Gross Profit Margin

 What remains from sales after the company

pays out the cost of goods sold ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Gross Profit*
Gross Profit Margin =
Net Revenue
*Gross profit = Net Revenue – COGS (cost of goods sold)

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Gross Profit Margin - Comments

 The higher the ratio, the better sales

profitability.
 We can measure this ratio for each product
and sector.
 We can use this ratio to evaluate the
performance of Marketing and Production
managers.

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Net Profit Margin

 How much income does each dollar of sales

generate ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Net Income
Net Profit Margin =
Net Revenue

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Net Profit Margin - Comments

 The higher the ratio, the better sales

profitability.
 We can measure this ratio for each product
and sector.
 We can use this ratio to evaluate the
performance of general managers.

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 Return on Assets (ROA)

 How much income did each dollar of assets

generate ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Net Income
Return on Assets (ROA) =
Avg. Total Assets

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Return on Assets (ROA) - Comments

 This ratio measures the company’s overall

earning power, or profitability.
 Higher is better.

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 Return on Equity (ROE)

 How much net income does the company

make for each dollar invested by the owner ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Net Income
Return on Equity (ROE) =
Avg. Total Equity

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Return on Equity (ROE) - Comments

 This ratio measures the profitability of equity.

 Higher is better.

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 Earning per Share (EPS)

 How much net income does the company

make for each share ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Net Income
Earning per Share (EPS) =
No. of Outstanding Shares*
* Outstanding Shares = Issued Shares – Treasury Shares

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Earning per Share (EPS) -
Comments
 This ratio measures the profit per share.
 Higher is better.

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Assets Efficiency Analysis

1. Receivables Turnover
2. Average Collection Period
3. Inventory Turnover
4. Days’ Inventory on Hand
5. Assets Turnover

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Receivables Turnover

 How many times did the company collect its

accounts receivables during an accounting
period?
Net Sales
Receivables Turnover =
Avg. Accounts Receivables

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Receivables Turnover - Comments

 This ratio measures the relative size of

accounts receivable and the effectiveness of
credit polices.
 Higher is better.

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Average Collection Period

 How many days does it take to collect

accounts receivables?

365
Average Collection Period =
Receivables Turnover

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Average Collection Period -
Comments
 This ratio measures the number of days it
takes to collect receivables.
 Lower is better.
 We can compute this ratio for every group of
clients.

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Inventory Turnover

 How many times did the company sell its

inventory during an accounting period?

Cost of Goods Sold

Inventory Turnover =
Avg. Inventory

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Inventory Turnover - Comments

 This ratio measures the relation between

COGS and inventory.
 Higher is better.

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Days’ Inventory on Hand

 How many days did it take the company to sell

its inventory?

365
Days’ Inventory on hand =
Inventory Turnover

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Days’ Inventory on Hand -
Comments
 This ratio measures the number of days that it
takes to sell inventory.
 Lower is better.

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Asset Turnover

 How much revenue is generated by each

dollar of assets ?
Income Statement Balance Sheet

Net Net Total Total Total

Revenue Income Assets Liabilities Equity

Net Revenue
Asset Turnover =
Avg. Total Assets

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Asset Turnover - Comments

 This ratio measures how efficiency assets are

used to produce sales.
 Higher is better.

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THANK YOU

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