FINANCIAL STATEMENT ANALYSIS

PROF. VIVEK BHATIA

MFC, FCMA, CFA(ICFAI), CMA(AUST.), LIFA(UK),,CFA-US, FRM-L1(US)
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FINANCIAL STATEMENTS

Financial statements are compilation of financial data arranged and

organised in a systematic manner according to the accounting principle
with objective of

 Assessing the Financial Position of an enterprise &

 Assessing the profitability, operational efficiency, long and short term

solvency and growth potential of the firm.
FINANCIAL STATEMENTS includes :

 Income statements (Revenues and Expenditures for the period)

 Statement of Assets & Liabilities (as on date)

 Cash flow Statements (changes in financial position during the period

 Notes to accounts (explanation to above)

PROCESS OF FINANCIAL STATEMENT ANALYSIS
 Objective of analysis
 Decide the extent of analysis
 Scope of analysis
 Going through the financial
statements
 Pooling the relevant data
 Rearrangement of financial data
 Understanding and classification of
relevant data
 Analysis
 Interpretation and conclusion
 Report
ATTRIBUTES OF GOOD FINANCIAL STATEMENT ANALYSIS
 Objectivity: Results of financial statement analysis should be analyzed
objectively to reduce the possibility of any behavioral bias to minimum.

 Precision and Brevity: Financial statement analysis should done with precision
and should provide relevant information in concise form.

 Understandability: Information provided by financial statement analysis should

be presented in such a way that the analysis fosters understandability.

 Relevance: Analysis of financial statement should be relevant to the purpose of

the analysis. Financial statements used in analysis should be timely and should
have a predictive value.

 Reliability: The information derived from the analysis of financial statement

must be free of material error and bias and should provide full and fair
disclosure of the financial performance and other relevant information.
FINANCIAL STATEMENT ANANLYSIS

 Involves a systematic and critical

examination of information.

 With objective of providing effective and

more meaningful information to its
different users.

 Postmortem of the transactional activity.

 To judge the operational ability,

profitability, solvency, managerial
efficiency and overall performance of the
entity.
Overview of Financial Statement Analysis

Overview of Financial
Statement Analysis

FINANCIAL STATEMENTS FINANCIAL STATEMENT

BUSINESS ANALYSIS
– BASIS OF ANALYSIS ANALYSIS – PREVIEW
 Business Analysis
Financial statement Analysis is an integral part of Business Analysis.
Business Analysis is a process of evaluating a company’s prospects and risks.
1) Credit Analysis – in pure credit financing, creditor bears the risk of default.
This asymmetric relation of creditor's risk and return has a major impact on
creditor’s perspective .
2) Equity Analysis – Unlike credit analysis, equity analysis is symmetric in that it
must assess both downside risk and upside potential.
Equity investors are affected by all aspects of a company’s financial condition
and performance.
Components Of Business Analysis

• Business Environment and Strategy Analysis

• Accounting Analysis
• Financial Analysis and
• Valuation.
Financial Statements – Basis of Analysis

Business Activities - consist of

• Planning Activities
• Financing Activities
• Investing Activities and
• Operating Activities.

 A thorough financial statement analysis involves examining Income

statement, Balance sheet and Cash flow statement along with

 Information such as Management’s Discussion & Analysis,

Management Report, Auditor Report, Explanatory Notes etc.
Analytical tools

Profitability
Analysis

Cash flow Growth

Analysis Analysis

Analytical
Comparative
Financial
Statements
Tools Common Size
Financial
Statement
Analysis Analysis

Trend
Ratio Analysis
Analysis
Comparative Financial Statement Analysis

 It is a form of horizontal analysis

 Financial statements of two or more years (in case of Inter-
period Analysis)
 Or of two or more different companies (in case of Inter-firm
Analysis)
 Or of a company and its industry are compared, analysed and
interpreted.
Comparative Financial Statement Analysis

 In case of Inter-period Analysis, uniformity in Accounting Concepts and

Conventions should be maintained during all the years for comparison.

 In case of Inter-firm Analysis, size of firms taken into consideration

for comparison must be more or less the same.

 The Statement exhibits absolute figures for two or more years of the
items appearing in Financial Statements.

 It exhibits the changes in absolute figures of the current year as

compared to the previous year taken as the base year.

 Percentage changes in absolute figures of the current year on the basis

of the base year are ascertained.
 Comparative Statement of Tata Motors
Tata Motors
Consolidated Profit & Loss account 
Mar 17 Mar-16 Change % change

12 mths 12 mths

INCOME

Revenue From Operations [Gross] 2,71,228.30 2,74,175.10 -2,946.80 -1.07

Less: Excise/Sevice Tax/Other Levies 4,799.61 4,614.99 184.62 4.00

Revenue From Operations [Net] 2,66,428.69 2,69,560.11 -3,131.42 -1.16
Other Operating Revenues 3,263.82 3,485.49 -221.67 -6.36
Total Operating Revenues 2,69,692.51 2,73,045.60 -3,353.09 -1.23
Other Income 754.54 885.35 -130.81 -14.77
Total Revenue 2,70,447.05 2,73,930.95 -3,483.90 -1.27
EXPENSES
Cost Of Materials Consumed 1,59,369.55 1,53,292.49 6,077.06 3.96
Purchase Of Stock-In Trade 13,924.53 12,841.52 1,083.01 8.43
Operating And Direct Expenses 3,413.57 3,468.77 -55.20 -1.59

Changes In Inventories Of FG,WIP And Stock-In Trade -7,399.92 -2,750.99 -4,648.93 168.99
Employee Benefit Expenses 28,332.89 28,880.89 -548.00 -1.90
Finance Costs 4,238.01 4,889.08 -651.07 -13.32

Depreciation And Amortisation Expenses 17,904.99 16,710.78 1,194.21 7.15

Other Expenses 59,340.16 57,300.63 2,039.53 3.56

Less: Amounts Transfer To Capital Accounts 16,876.96 16,678.34 198.62 1.19

Total Expenses 2,62,246.82 2,57,954.83 4,291.99 1.66

Profit/Loss Before Exceptional, ExtraOrdinary Items And Tax 8,200.23 15,976.12 -7,775.89 -48.67
Exceptional Items 1,114.56 -1,850.35 2,964.91 -160.24
Profit/Loss Before Tax 9,314.79 14,125.77 -4,810.98 -34.06
Tax Expenses-Continued Operations 0.00
Current Tax 3,137.66 1,862.05 1,275.61 68.51
Less: MAT Credit Entitlement 0 0 0.00
Deferred Tax 113.57 1,163.00 -1,049.43 -90.23
Total Tax Expenses 3,251.23 3,025.05 226.18 7.48

Profit/Loss After Tax And Before ExtraOrdinary Items 6,063.56 11,100.72 -5,037.16 -45.38

Profit/Loss From Continuing Operations 6,063.56 11,100.72 -5,037.16 -45.38

Profit/Loss For The Period 6,063.56 11,100.72 -5,037.16 -45.38
Common Size Financial Statement Analysis
Relative position of each item or elements of Financial Statements cannot
be known through horizontal or comparative analysis.

To study relative significance of every item in Financial Statements, vertical

analysis or common-size statement analysis is necessary.

It exhibits absolute figures of the items appearing in Financing Statements

of two or more years or two or more firms

It also exhibit percentage figure of every item in Financial Statements as a

percentage of the pre-selected base item.

Every item appearing in such income statement is represented as a

percentage of base items (generally net sales). In case of Balance Sheet,
generally total of Balance sheet is considered.
Common size income statement of Asahi India
Asahi India Glass
Standalone Profit & Loss account  COMMON SIZE P&L in Rs. Cr.
Mar 17 Mar-16 Mar-15

INCOME
Revenue From Operations [Gross] 2,529.00 109.07 2,317.89 107.77 2,205.32 108.07
Less: Excise/Sevice Tax/Other Levies 210.41 9.07 167.17 7.77 164.75 8.07
Revenue From Operations [Net] 2,318.59 100.00 2,150.72 100.00 2,040.57 100.00
Other Operating Revenues 17.59 0.76 17.27 0.80 16.64 0.82
Total Operating Revenues 2,336.18 100.76 2,167.99 100.80 2,057.21 100.82
Other Income 29.37 1.27 6.07 0.28 17.63 0.86
Total Revenue 2,365.55 102.03 2,174.06 101.09 2,074.84 101.68
EXPENSES
Cost Of Materials Consumed 815.24 35.16 746.4 34.70 684.37 33.54
Purchase Of Stock-In Trade 45.28 1.95 31.99 1.49 27.01 1.32
Changes In Inventories Of FG,WIP And Stock-In Trade -31.86 -1.37 3.7 0.17 19.2 0.94
Employee Benefit Expenses 224.93 9.70 189.97 8.83 170.76 8.37
Finance Costs 138.85 5.99 143.4 6.67 159.33 7.81
Depreciation And Amortisation Expenses 105.12 4.53 105.32 4.90 107.18 5.25
Other Expenses 855.79 36.91 793.39 36.89 839.02 41.12
Total Expenses 2,153.35 92.87 2,014.17 93.65 2,006.87 98.35

Profit/Loss Before Exceptional, ExtraOrdinary Items

And Tax 212.2 9.15 159.89 7.43 67.97 3.33
Exceptional Items -1.58 -0.07 -2.04 -0.09 -4.29 -0.21
Profit/Loss Before Tax 210.62 9.08 157.85 7.34 63.68 3.12
Tax Expenses-Continued Operations
Current Tax 44.95 1.94 33.45 1.56 13.5 0.66
Less: MAT Credit Entitlement 44.95 1.94 33.45 1.56 13.43 0.66
Deferred Tax 72.81 3.14 54.3 2.52 13.4 0.66
Tax For Earlier Years 7.13 0.31 6.28 0.29 0 0.00
Total Tax Expenses 79.94 3.45 60.58 2.82 13.47 0.66
Profit/Loss After Tax And Before ExtraOrdinary Items 130.68 5.64 97.27 4.52 50.21 2.46
Profit/Loss From Continuing Operations 130.68 5.64 97.27 4.52 50.21 2.46
Profit/Loss For The Period 130.68 5.64 97.27 4.52 50.21 2.46
Trend Analysis

 It indicates the trend of individual item of Financial Statements over a

period of time.

 A year (generally a normal year, i.e. a year where no abnormal incident

has been occurred) is selected as the base year.

 The figures appearing in Financial Statements of that base year are

assigned as 100.

 Necessary adjustments for price level should be made in the figures of

other years compared to the base year.
Trend Analysis of Asahi India
Asahi India Glass
Standalone Profit & Loss account 
Mar-13 Mar-14 Mar-15 Mar-16 Mar 17

12 mths 12 mths 12 mths 12 mths 12 mths

INCOME
Revenue From Operations [Gross] 2,054.17 2,244.99 2,205.32 2,317.89 2,529.00
Less: Excise/Sevice Tax/Other Levies 155.46 153.70 164.75 167.17 210.41
Revenue From Operations [Net] 1,898.71 2,091.29 2,040.57 2,150.72 2,318.59
100.00 110.14 107.47 113.27 122.11
Other Operating Revenues 14.73 13.79 16.64 17.27 17.59
Total Operating Revenues 1,913.44 2,105.08 2,057.21 2,167.99 2,336.18
Other Income 10.76 5.59 17.63 6.07 29.37
Total Revenue 1,924.20 2,110.67 2,074.84 2,174.06 2,365.55
100.00 109.69 107.83 112.99 122.94
EXPENSES
Cost Of Materials Consumed 648.95 677.21 684.37 746.40 815.24
100.00 104.35 105.46 115.02 125.62
Purchase Of Stock-In Trade 11.23 5.15 27.01 31.99 45.28

Changes In Inventories Of FG,WIP And Stock-In Trade -12.27 10.88 19.20 3.70 -31.86
Employee Benefit Expenses 152.01 164.68 170.76 189.97 224.93
100.00 108.33 112.33 124.97 147.97
Finance Costs 169.15 162.50 159.33 143.40 138.85
100.00 96.07 94.19 84.78 82.09
Depreciation And Amortisation Expenses 148.57 137.07 107.18 105.32 105.12
Other Expenses 946.15 1,015.80 839.02 793.39 855.79
100.00 107.36 88.68 83.85 90.45
Total Expenses 2,063.79 2,173.29 2,006.87 2,014.17 2,153.35
100.00 105.31 97.24 97.60 104.34
Ratio Analysis

 A financial ratio is a relationship between two or more accounting

data expressed in mathematical terms.

 Accounting Ratio calculated from different accounting data for

exhibiting a meaningful and useful relationship between them.

 The process of comparative analysis and interpretation of all

these Accounting Ratios are called Ratio Analysis.

 It is a tool adopted for determining the quantitative relationship

between two or more financial data as obtained from Financial
Statement.
Ratio Analysis

 Usefulness of Ratios depends on our skilful application and

interpretation of them.

 Internal operating activities affect a company’s ratios.

 We should be aware of the effects of economic events, industry

factors, management policies and Accounting methods.
Analyzing Ratio

 Selection of relevant various Accounting data from the Financial

Statements.

 Computation of related Accounting Ratios in a very significant, logical

and useful manner.

 Computed Ratios are generally compared with some predetermined

standards.

 To obtain some conclusive financial information of the enterprise.

Cont.

Profitability
Ratios

Solvency Turnover
ratios Ratios
Accounting
Ratios

Liquidity Investment
Ratios Ratio
Liquidity Ratios

Current ratio = Current Asset/Current Liability

Liquid ratio = Quick Asset/ Current Liability

Cash to Current Asset ratio = Cash/ Current Asset

Bank Finance to working capital gap = BF/(CA-CL)

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Advance Liquidity Analysis
Analyze composition of current Assets

Analyze receivables
- as % of sales, trends of lasts three years and comparing with industry Trends,
from related parties,
- outstanding for more than 6 months,
- % of current assets and trends over a period and comparing with Industry
Trends,
- Revenue recognition policy and any change in current years.
- Collection period trends

Analyze inventory
- As % of sales, trends of last three years and comparing with industry trends,
- Analyzing of raw material and finished goods and factors affecting the supply
and demand of finished goods,
- Raw Material storage period, WIP Conversion period, Duration of Receivables.
- Critical material if any,
Advance Liquidity Analysis
Analyze cash and equivalents
- As % of sales, trends of last three years and comparing with industry trends,
- Marketable securities, quality, tradability. Valuation policy,
- Analyzes of Other non strategic investments.

Analyze the credit rating of various financial instruments if any,

Analyze trade payables and current portion of long term commitments,

Analyze the contingent liability with probability of its occurrence,

Auditors qualifications for unrecognized liability and their inability to quantify, if any.

Analyze cash flow from operation.

Analyze operating profits with cash profits.

Solvency Ratio

Debt to Total Assets Ratio = Debt (long term or total)/ Total Asset

Debt Service coverage Ratio = EBITDA/DEBT SERVICE

Interest Coverage Ratio=EBIT/INTEREST

Debt Equity ratio = Debt (long term or total)/Equity

Cash Flow to Debt Ratio = CFO/ Debt

Debt to Total Capital Ratio = Debt/ market capitalization

Contingent Liability to Net worth = Contingent liability/net worth

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Advance Analysis of Solvency

Analyze debt in detail specifying the amount out standing, schedule of

repayments, important terms and condition, rate of interest, call, put,
conversions, currencies, securities offered.

Analyze the contingency claims.

Profitability Analysis

As % of Sales
- Gross margins
- Operating profit margins
- Net profit margins

As % of investments
- Return on Assets
- Return on capital employed
- Return on Equity
 Advance Profitability Analysis

Define profit appropriately adjusting

• tax,
• interest,
• profit from discontinued operations,
• other non operating incomes ,
• Extraordinary/ exceptional incomes etc.
 Analyze revenue growth in different segments along with margins,
 Management view on future growth and margins along with risk associated.
 Analyze new orders in last quarters from other resources and their impact on future cash
flows.
 New products, new technology, investments in capacity creation etc.
Turnover/ Efficiency Ratio

Stock Turnover Ratio = COGS/ Avg. inventory

Debtors Turnover Ratio = Sales/ Avg. Debtor

Fixed Asset Turnover Ratio = Sales/ Avg. FA

Working capital turnover ratio= Sales/ Avg. WC

Capital turnover ratio=Sales/Avg. Capital Employed

Compare the ratios with last year figures and competitors comparative
ratios to analyze.
Adjust capital work in progress if any.
Investment Ratios

- Dividend Payout Ratio

- Dividend yield
- Dividend cover for ordinary share
- Earning per share
- Price – Earning
- Price to book value
- Price to sales
- Price to capacity
 Distress Analysis

 It refers to the process of analysis of financial crisis or hardship faced by

a concern.
 It analyses various causes responsible for the financial distress or
sickness of a firm.
 It provides effective tools for prediction of distress
 It advocates remedial measures to get out of financial hardship.
Causes of Corporate Distress

Internal Factors:

• Outdated production process

• High material cost
• Poor labour productivity
• Lack of efficient personnel or skilled labour
• High wastage in production process
• Excessive manpower
• High labour tunrover
• Lack of quality leadership
• Huge overheads
• Poor capacity utilization
• Poor estimation of demand
• Poor customer service etc.
Causes of Corporate Distress

External Factors:

• Shortage or non availability of Raw material

• Shortage of power and water
• Problem of transportation
• High cost of funds
• Imposition of government price control
• Unfavorable taxation policy
• Market saturation
• Change in customer preference and taste
• Technological changes
• Natural calamities, accidents etc.
 SYMPTOMS OF BANKRUPTCY

Production
- Low capacity utilization
- High operating cost
- Failure of product lines
- Accumulation of finished goods
Sales and Marketing
- Declining/Stagnant sales
- Loss of distribution network to competitors
Finance
- Increased borrowing at exorbitant rates
- increased borrowing against assets
- Failure to pay term loans
- Failure to pay current liabilities, salaries etc.
- Failure to make statutory payments
SYMPTOMS OF BANKRUPTCY

Others
- A declining trend in market price of share
- Rapid turnover of key personnel
- Persistent cash losses
- Frequent changes in accounting policies to enhance profits
- Frequent change of accounting years for undeclared reasons
 PRIDICTION OF BANKRUPTCY

A number of models are available to accurately predict sickness of a firm.these

models provide early warning signals , so that a potentially disastrous situation
can be averted .

BEAVER MODEL
• First to use financial ratios to predict failure
• Defined failure as ‘inability to pay its financial obligation as they
mature.’
• Used 30 ratios classified under 6 categories
• The ratio of cash flow to total debt was found to be the best
single predictor of firm
• The study also revealed that financial ratios are useful in
prediction of failure of at least five years prior to the event
ALTMAN’S Z SCORE MODEL

Used Multiple Discriminant Analysis to distinguish between bankrupt &

non bankrupt firm
Out of 22 ratios used initially , a final set of 5 ratios were selected as they
found to be better predictors of failure.
Weights were given to these ratios on the basis of their significance to
predict health of the model

Z= 1.2 X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Where,
Z = Discriminant score
X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = EBIT / Total Assets
X4 = Market value of Equity / Book value of Debt
X5 = Sales / Total Assets
ALTMAN’S Z SCORE MODEL

Z Score Classification
Less than 1.81 Bankrupt
Between 1.81 & 2.99 Area of Ignorance
More than 2.99 Healthy firm

In 1995 Altman modified this to

Z’ = 3.25 + 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4

For emerging markets