FINANCIAL STATEMENT ANALYSIS

LECTURE 16 & 17

Maliha Rabeta
Lecturer
Department of Business Administration
in Finance and Banking
BUP

20 & 27 September 2022

BASICS OF FINANCIAL STATEMENT ANALYSIS

Analyzing financial statements involves:

▪ Characteristics ▪ Comparison Bases ▪ Tools of Analysis

▪ Liquidity ▪ Intracompany ▪ Horizontal

▪ Profitability ▪ Industry averages ▪ Vertical
▪ Solvency ▪ Intercompany ▪ Ratio
HORIZONTAL ANALYSIS

Horizontal analysis, also called trend analysis, is a technique for evaluating a series of financial statement data over a
period of time.

Its purpose is to determine the increase or decrease that has taken place.

Horizontal analysis is commonly applied to the balance sheet, income statement, and statement of retained earnings.

VERTICAL ANALYSIS

Vertical analysis, also called common-size analysis, is a technique that expresses each financial statement item as a
percent of a base amount.

On an income statement, we might say that selling expenses are 16% of net sales.

Vertical analysis is commonly applied to the balance sheet and the income statement.
 RATIO ANALYSIS

Ratio analysis expresses the relationship among selected items of financial statement data.

Financial Ratio Classifications

Liquidity Profitability Solvency

Measures short- Measures the Measures the

term ability of the
company to pay its
maturing
obligations and to
meet unexpected
needs for cash.
income or ability of the
operating success company to
of a company for a survive over a long
given period of period of time.
time.
RATIO ANALYSIS

A single ratio by itself is not very meaningful.

The discussion of ratios will include the following types of comparisons.

RATIO ANALYSIS

Liquidity Ratios

Measure the short-term ability of the company to pay its maturing obligations and to meet
unexpected needs for cash.
➢ Short-term creditors such as bankers and suppliers are particularly interested in
assessing liquidity.
➢ Ratios include the current ratio, the acid-test ratio, receivables turnover, and inventory
turnover.
RATIO ANALYSIS

Current Ratio

Current Assets
= Current Ratio
Current Liabilities

The ratio of reflects how much current asset a company has for every dollar of current liabilities.
RATIO ANALYSIS

Acid-Test Ratio

Cash + Short-Term Investments + Receivables (Net)

Acid-Test
=
Ratio
Current Liabilities

The acid-test ratio measures immediate liquidity.

RATIO ANALYSIS

Receivables Turnover ratio

Net Credit Sales Receivables

=
Turnover
Average Net Receivables
It measures the number of times, on average, the company collects receivables during the
period.

A variant of the receivables turnover ratio is to convert it to an average collection period in

terms of days. It is calculated by dividing 365 days by the receivables turnover.
RATIO ANALYSIS

Inventory Turnover ratio

Cost of Good Sold Inventory

=
Turnover
Average Inventory

Inventory turnover measures the number of times, on average, the inventory is sold during the period.

A variant of inventory turnover is the days in inventory. It is calculated by dividing 365 days by the
inventory turnover. Inventory turnover ratios vary considerably among industries.
RATIO ANALYSIS

Profitability Ratios

Measure the income or operating success of a company for a given period of time.
➢ Income, or the lack of it, affects the company’s ability to obtain debt and equity
financing, liquidity position, and the ability to grow.
➢ Ratios include the profit margin, asset turnover, return on assets, return on
common stockholders’ equity, earnings per share, price-earnings, and
payout ratio.
RATIO ANALYSIS

Net Profit Margin ratio

Net Income Profit

=
Margin
Net Sales

Measures the percentage of each dollar of sales that results

in net income.
RATIO ANALYSIS

Asset Turnover ratio

Net Sales
= Asset Turnover
Average Assets

Measures how efficiently a company uses its assets to generate sales.

RATIO ANALYSIS

Return on Assets

Net Income Return on

= Assets
Average Assets

An overall measure of profitability.

RATIO ANALYSIS

Return on Common Stockholders’ Equity ratio

Net Income – Preferred Dividends Return on Common

= Stockholders’ Equity
Average Common Stockholders’ Equity

Shows how many dollars of net income the company earned for each dollar invested by the owners.
RATIO ANALYSIS

Earnings Per Share ratio

Net Income
= Earnings Per Share
Weighted Average Common Shares
Outstanding

A measure of the net income earned on each share of common stock.

RATIO ANALYSIS

Price Earnings Ratio

Market Price per Share of Stock

= Price Earnings
Earnings Per Share Ratio

The price-earnings (PE) ratio reflects investors’ assessments of a company’s future earnings.
RATIO ANALYSIS

Payout Ratio

Cash Dividends
= Price Earnings
Net Income Ratio

Measures the percentage of earnings distributed in the form of cash dividends.

RATIO ANALYSIS

Solvency Ratios

Measure the ability of a company to survive over a long period of time.

➢ Debt to total assets and times interest earned are two ratios that provide information
about debt-paying ability.
RATIO ANALYSIS

Debt to Total Assets Ratio

Total Debt
Debt to Total Assets
= Ratio
Total Assets

Measures the percentage of the total assets that creditors provide.

RATIO ANALYSIS

Times Interest Earned

Income before Income Taxes and Interest

Expense
Times Interest
= Earned Ratio
Interest Expense

Provides an indication of the company’s ability to meet interest payments as they come due.