Welcome to the

Session on
Analysis of Financial Statements

by
Dr. Sujit Saha
Former Professor & Director
Bangladesh Institute of Bank Management
Introduction to Financial Statement Analysis (FSA)
FSA
Why FSA?
• To identify current strengths and weaknesses
• To suggest actions the firm might take to capitalize
strengths and correct weaknesses in future.

 Comparison of a firm’s Trend Analysis

performance over the years

 Comparison of a firm’s performance

with that of other firms in Cross-Section Analysis
the same line of business

 Comparison of a firm’s
performance with that of average Industry Average
performance in the same industry
Who are interested in FSA?
• Firm’s Managers  for Financing & Inv. Decisions
• Firm’s Investors  for Inv. in securities
• Firm’s Creditors for Credit Decisions

This chapter focuses on

• Evaluation of Firm’s current financial position

Data Sources for FSA

• Financial Statements and Reports
Financial Statements and Reports
[Review of Accounting]

Annual Report/Contents
• Past year
• Basic F/S
• Mgt. Opinion
• Future Prospects

 Four Basic F/S

• Income Statement (I/S)
• Balance Sheet (B/S)
• Statement of Retained Earnings (SRE)
• Statement of Cash Flows (SCF)
 I/S: Operating Statement
 BIS  Position Statement
More about BIS
•Cash vs. other Assets
•Liab. vs. Sh. Equity
(A – L = SHE)
•Pref. vs. Com. Stock
•Composition of Com. Equity
•Retained Earnings
•Inv. Valuation Methods
•Dep. Methods
•At a point of time
 SRE
 Reporting the change in firm’s RE

 Accounting Income vs. Cash Flow

 Cash Receipts and Disbursements vs. Rev. & Exp.
 Net Income ................ xxx
Add back Dep: ............... x
Net Cash Flow ................ xx
 SCF Impact of a Firm’s Operating,Investing and
Financing Activities on Cash Flows over a period.
Ratio Analysis
FSA Begins with Ratio Analysis
Ratio : Relative Measure  Interrelationship b/w two numbers.
: Helps Comparing uneven size firms
: Identify S(+), w(-) and Prospects/Failure
A. Liquidity Ratios
 Liq. Asset: Easily converted into cash without much loss of value
 Liq. Ratio: Ability to repay current obligations

 Current Ratio: CA/CL ] 1.5 : 1/ Ind. Av.

 best single Indicator of short term solvency
 Quick or Acid Test Ratio:
 CA - Inventories ] Ind. Av.
CL
 Variation of CR
 Liquidity Test without sale of Inventory
Comment on Liquidity
B. Asset Management Ratios
 How effectively the firm is managing assets.
 Asset: Too high or too low vis-à-vis sales?

• Inventory Turnover: COGS – Inventories

Av. Inventories
 Low Turnover ] Excessive/Obsolete Stocks
 Compare with Ind. Av.
• Day Sales Outstanding
 Length of time to collect Cr. Sales
Rec.
Av. Collection Period: = Av. Sales per day
 Compare with Credit Term
 Fixed Assets Turnover = Sales.
NFA
• Compare with Ind. Av.
• Careful in comparing diff. firms having old Fixed
Assets and New FA.

 Total Assets Turnover = Sales.

TA

o Comp. with Ind. Av.

o Either sales  or dispose some assets.
Comment on Asset Management
Debt Management Ratios
 Extent of Debt money used ] Fin. Leverage
– Eq. not to be diluted
– Creditors feel risky if equity is low
– Return on Equity Magnified/Leveraged
 Fin. Lev. affects the expected rate of return
– Int. is tax deductible
– Cost of debt lower than Return on Inv.

• Debt Ratio = TD.

TA
– Creditors prefer low-debt
– Owners benefit from high debt
– But heavy leads to bankruptcy
• Times Int. Earned
EBIT
Int. charges
– Ability to meet annual int. payments
– Higher the better ] Ind. Av.
• Fixed Charge Coverage Ratio
EBIT + Lease Payments
Int. + LP + [Sinking Fund Payment]
(1 – t)
– Comp. with Ind. Av.
Profitability Ratios
 Showing the effect of Liquidity, Asset Management,
and Debt Management on Operating Results
• Net Profit Margin
Net Income
Sales
• Operating Profit Margin Ind. Av.
EBIT
Sales
• Return on Total Assets
ROTA = Net Income Ind. Av.
RO
Low return due to high use of debt.
Return on Common Equity (RoE)
Comp. with Ind. Av.
Market Value Ratios
• Relates stock price to earnings and book value per share
• Indication of Investors’ attitude towards company
 Price-Earnings Ratio

EPS = Net Income to Common SH

No. of Co. SH outstanding

PER = Market price per Share

EPS

• Comp. with Ind. Av.

• Higher for growth firms
 Market/Book Ratio (MBR)
Book value per share = Common Equity Common SH
No. of Co. SH outstanding

MBR = Market price

BVS
per Share
]Ind. Av.

• High MBR for Successful Firms

Trend Analysis
 Firm’s Fin. Position over the years
• Showing deterioration or improvement
 Construct graphs showing both firm’s
ratios and Ind. Av. for past years

Summary of Ratio Analysis Tab: 3 – 6

DU PONT CHART
Chart showing the relationships among
return on investment, asset turnover, profit
margin & leverage

ROA = NPM x Total Asset Turnover

= NI  S  NI
S TA TA
Comparative Ratio Analysis
• Comparing a Firm’s ratios with those of other firms in the Same
Industry
• Cross-Section Analysis/Benchmarking

Uses and Limitations of Ratio Analysis

• Used by
o Managers of Firms
o Credit Analysts for Decision Making
o Security Analysts
• Limitation:
o Ind. Av. Figures
o Av. Performance not good
o Inflation distorts B/S
o Seasonal Factors
o Window-dressing
o Diff. Accounting Practices
o Ratio Standard
o Conclusions?
 IMP  JUDGEMENT & INTERPRETATION
Thank You All