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Financial Statement Analysis
Financial Statement Analysis
Financial Statement Analysis
BASIC FINANCIAL
STATEMENT ANALYSIS
• So, the base year here is 2017 and trend analysis could be:
• For 2018 = 20,000= 80%
• 25000
• For 2019 = 30,000= 120%
• 25,000
Vertical Analysis
Vertical analysis shows the relationship of
financial – statement items relative to a total,
which is a 100% figure.
All items on the particular financial statement
are reported as a percentage of the base.
For an income statement, total revenue(sales)
is usually the base.
How will it be calculated?
Vertical analysis using a Pie Chart
Common Size Financial Statement
Common Size financial statements
A direct numerical comparison of companies,
where one company is with huge transactions and
another entity is small, is not meaningful because
of size differences.
One of the techniques which can be used to
compare is called common – size financial
statements.
Common Size Income Statement
looks like…
Performing Financial Ratio Analysis
to make business decisions
Financial ratios are a major tool of financial analysis.
A ratio expresses the relationship of one number to another.
The financial ratios are classified as:
Efficiency ratios
Financial strength ratios
Profitability ratios
Investment ratios
Efficiency Ratios
Inventory Turnover
It measures the number of times a company sells its average level of
inventory during a year.
A fast turnover indicates ease in selling inventory, a low turnover indicates
difficulty.
Formula:
=Cost of goods sold
Average Inventory
• = COGS
• Average net Accounts payable
=500,00
200,000
= 2.5
Cash conversion cycle
• = Sales
• Average total assets
= 250,000
(500,000+250,000)/2
=53.33
Financial Strength Ratio
• They are the indicators of an entity’s abilities to meet its
financial obligations, either in the short term or the long term.
• Short term indicators are usually called liquidity ratios.
• Long term indicators are referred as solvency ratios.
• Working Capital is the term used to describe what a business
has to work with the current assets and the current liabilities.
• It can be calculated as Current assets – Current liabilities.
Current Ratio
• The most common ratio evaluating current
assets and current liabilities is the current ratio.
• This measures the ability to pay current
liabilities with current assets.
• It can be calculated as:
• = Current assets
• Current liabilities
Illustration…
• Suppose a Business Organization has $400,000 in its
current assets and $200,000 in its current liabilities.
Compute Current ratio.
• = Current assets
• Current liabilities
• = 400,000
• 200,000
• =2
Quick Ratio
• A more refined version of current ratio is known as the quick
ratio ( also known as acid test ratio).
• It informs the entity whether a business could pass the “acid
test” of paying all its current liabilities if they came due
immediately.
• Formula:
• =Cash + Short-term investments + Net current receivables
• Current liabilities
Illustration….
• Suppose an entity has:
• Cash= 10,000Short term investment = 50,000
• Current receivables = 60,000 Outstanding salary = 40,000
• Accounts payable = 10,000 Compute Quick ratio.
Suppose an entity has earned $50,000 net profit with its average
assets of $450,000. the return on total assets would be:
= 50,000
450,000
= 11.11%
Return on Equity
• This is a popular measure of profitability.
• This shows the relationship between net income and ordinary
shareholders investment in a company.
• Formula:
• =Net profit
• Average equity
• Suppose an entity’s net profit is $50,000 and its average equity is
300,000. ROE will be:
• = 50,000
• 300,000
• = 16.67%
Investment Ratios
• Earnings per Ordinary Share
• It is the amount of net income earned for each outstanding
ordinary share.
• Formula:
• = Net income – Preference dividends
• weighted average number of ordinary shares outstanding
• Suppose an entity has net income of $48,000 and the shares
outstanding is 10,000. EPS will be:
• = 48,000 – 0
• 10,000
• =$4.80
Price/Earnings Ratio
• It shows how much an investor is willing to pay for
each unit of earnings.
• Formula:
• = Market price per ordinary share
• Earnings per Share
• Suppose a entity’s MPS is $60 and EPS is $4.8, the
PE ratio will be:
• = 60/ 4.8
• = 12.5
Dividend Yield
• It is the ratio of dividends per share of stock to the share’s market
price.
• This ratio measures the percentage of a share’s market value returned
annually to the shareholders as dividends.
• Formula:
• = Dividend per ordinary share
• Market price per ordinary share*
• Suppose an entity paid $2 per ordinary share and the market price is
being $60. The dividend yield would be:
• = 2 /60
• = 3.33%
• * it may also be calculated for preference shares
Book Value per Ordinary Share
• It is simply calculated as:
• = Total shareholders Equity – Preference Equity
• Number of ordinary shares outstanding
• Suppose the total shareholders equity is $500,000 and the
preference equity is $200,000. The number of ordinary shares
outstanding is 20,000 shares. The Book value per ordinary
share would be:
• = 500,000 – 200,000
• 20,000
• = $15
Using the Statement of Cash Flows
Other information to make investment
decisions
• Economic Value Added
• Usually EVA is used to evaluate operating performance. It combines
accounting and finance to measure whether operations have increased
shareholder wealth.
• Formula:
• = Net income + Interest expense – Capital charge
a) Cash ratio
b) Current ratio
c) Quick ratio
d) Alternate ratio
Solution!
c) Quick ratio
Question!
• Timer interest earned ratio is calculated as
a) Gross Margin
b) Operating Margin
c) Net Margin
d) All of the above
Solution!
d) All of the above
End of chapter 12