3 Financial Analysis

[May, 2022]

JICA PROJECT TEAM

1.Financial Statement
2.Cash Flow Management (CFM)
for SME manager
3.Financial Analysis
4.Management Accounting
5.Business Plan & Company Road Map
6.FM Tools to Business Improvement
7.Operating Profit Analysis
8.Management Accounting (Advanced)
9.Cost Accounting (Basic)
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Financial Analysis
(1) What is Financial Analysis

(2) Financial Analysis Tool

(3) Break Even Analysis

(4) How/where to check Financial Statement

3
(1)What is Financial analysis
Business Evaluation System
Three key points of reviewing a SME (small
and medium-sized enterprise )

1. Financial numbers evaluation

2. Business evaluation
3. Organization evaluation

① Pick up critical issues

② Establish action plan
③ Build a team and system to implement the action plan
④ Action
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What is Financial Analysis?
Financial analysis tells us the real status of a
company by using financial numbers.
• Profitability analysis
• Stability analysis
• Productivity analysis
• Growth analysis
• Cash flow analysis

6
Important aspect from different viewpoints
Financial Management Investors
who institutions,
Creditors
what
Main purpose Ability to pay Profitability, Growth
debt Productivity, potential
Growth
potential
Main focus of Historical Present Financial
the analysis analysis analysis, forecasts
Mid-term plan
Main method Financial Cash Flow, Growth,
of the analysis stability, Profitability, Future
Cash Flow Productivity, profitability,
Break even Company
7
point analysis value
Tips for Financial Analysis
To review in a structured manner
• Do not be a critic
• Dig out the number
• In line with the expected results
To assume the real status of the company
• Repeat “making hypothesis & test”
• Have a sense of ownership

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(2)Financial Analysis Tool
Ratios and Formulas in Financial Analysis １ /3

Financial analysis is a judgmental process.

• The primary objectives are:
to identify major changes in trends, and
to investigate the reasons underlying
those changes.
• The judgment process can be improved by
experience and the use of analytical tools.

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 Ratios and Formulas in Financial Analysis
2/3
• Probably the most widely used financial analysis
technique is ratio analysis
• Ratio analysis is the analysis of the relationship between
two or more line items in the financial statement.
 Gross profit to sales ratio
• Financial ratios are usually expressed in percentage or
times.
• Generally, financial ratios are calculated for the purpose
of evaluating aspects of a company's operations.
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 Ratios and Formulas in Financial Analysis 3/3
Examples of Ratio Analysis:
• Profitability ratios measure management's ability to generate
profit
• Liquidity ratios measure a firm's ability to pay its short-term
debt obligations.
• Leverage ratios measure the degree to which a company's
operations are funded by long-term debt (the degree of
protection of creditors) and can also aid in judging a firm's
ability to raise additional debt and its capacity to pay on time.
• Efficiency, activity or turnover ratios provide information about
management's ability to control expenses and to earn a return
on the resources committed to the business.
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1 Long-term Trend Analysis

By using graphics, you can visualize it.

• 10-year trend or more is ideal.
• Share with the management.
• One-off abnormal figure is identified.
• Good year and bad year can be found. 13
2 Profitability Analysis
 Profitability analysis is an analysis to measure a
company's ability to generate profits.
 One of the most important analysis.
 Return on Asset (ROA) is a ratio showing how efficiently
a company uses its assets to generate profit

Return Operating Profit Asset turnover

on Asset to sales ratio ratio

Operating Profit Operating profit Sales .

Total asset Sales Total asset
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 2 Profitability Analysis
Indicators used in the OSC:

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3 Stability Analysis
(1)Short-term stability analysis
Current Ratio, Quick Ratio

(2) Long-term stability analysis

Fixed Assets to Net Worth Ratio

(3) Financing Structure analysis

Capital adequacy ratio

(4) Other Stability Analysis Key Points : why why why 16

 Current Ratio The bigger the better
• Provides an indication of the liquidity of the business
by comparing the amount of current assets to
current liabilities.
Current Ratio = Current Assets / Current Liabilities Excellent >200%
• In general, businesses prefer to maintain at least Good >150%

110% current ratio. However, the normal current OK >110

Problem <100%
ratio fluctuates from industry to industry.
• A current ratio significantly higher than the industry
average could indicate the existence of redundant
assets. Conversely, a current ratio significantly lower
than the industry average could indicate a lack of
liquidity. 17
 Quick Ratio The bigger the better
• A measurement of the liquidity position of the business.
• The quick ratio compares the cash plus cash equivalents and
accounts receivable to the current liabilities.
Quick Ratio
= (Cash & cash equivalents + account receivables) / Current Liabilities
• The primary difference between the current Excellent >200%
ratio and the quick ratio is the quick ratio does Good >150%
not include inventory and prepaid expenses. OK >110

Only considers highly-liquid assets. Problem <100%

• Consequently, a business's quick ratio will be

lower than its current ratio.
• It is a stringent test of liquidity. 18
Fixed (Non-current) Assets to Net Worth Ratio
Look at this table
good Bad

Net Fixed
Fixed Worth Asset Net
Asset Worth
Excellent >50%
Good >35% Intuitively understand the meaning
OK >20%
Problem <10% 19
Capital adequacy ratio
Look at this table

net worth
total assets total liability

Asset
net worth
The bigger the better?
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Other: interest coverage ratio

interest coverage operating profit

ratio interest expense

The bigger the better

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Other: Working Capital Requirement (WCR)
Formula for WCR calculation Check the trend!

WCR = Inventory + Accounts Receivable – Accounts Payable

 Account Receivable Turnover (days) = AR / Revenue x 365 (1)

(How efficiently a company is in collecting account receivables)
 Inventory Turnover (days)= Inventory / Revenue x 365 (2)
(How efficiently a company has sold and replaced inventory)
 Account Payable Turnover (days) = AP / Revenue x 365 (3)
(The rate at which a company pays off its suppliers)
 Working Capital Requirement (days)
= AR turnover (1) + Inventory turnover (2) – AP turnover (3)
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 The bigger the better
4 Productivity Analysis
Productivity ratios measure how efficiently production inputs,
such as labour, are being used to produce a given level of output.
 Productivity = Output / Input
 Output = Added Value ≒ Marginal Profit
 Marginal Profit = Revenue – Purchases from outside
 Added Value (Marginal Profit) – Fixed cost = Operating Profit

Simple calculation formula for Added Value

Added Value = Marginal Profit (or Gross Profit)
= Revenue- Variable Cost (or Revenue – COGS)
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Productivity Analysis Ratio
Net Sales Added
Net sales Value ratio
per person Tangible asset
turnover

# of Employees Added Value

Labor productivity

Labor
Tangible Fixed Assets
equipment Assets productivity
ratio

numerator

denominator 24
 Productivity Analysis
for Manufactures
It is very important to make a correct analysis for labor
productivity.

Labor productivity (Added Value/ #of employees) = ①X②X③

①Added Value Ratio (=added value/ net sales)
How is product profitability? Why low or high ?
②Labor equipment ratio (=tangible fixed assets/ employees)
How is mechanization of the company?
③Tangible asset turnover (=net sales/ tangible fixed assets)
How is turnover of machine/equipment ?
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Productivity Analysis
for Non-Manufactures
It is very important to make a correct analysis for labor productivity.
Labor productivity (Added Value/# of employee) = ①X②

① Added Value What percentage of sales is added

Net sales value?
How is product profitability ? Why low or high ?

② Net sales How much does one person sell?

#of employee
How about sales efficiency ? Why good or bad ?

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5 Growth Potential
• Net sales growth
• Profit growth
Change of target items • Added value growth
Number as of the base year • Total asset growth
• Net equity growth
• Fixed assets growth
• Number of
employees growth
Review the historical numbers to
predict future numbers
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 6 Earnings & Costs Structure Analysis

P&L BEP Analysis

(management analysis)

+Net Sales
-Variable Cost
Marginal Profit
-Fixed Cost
Operating Profit

Note: Variable costs are costs that change in proportion to the good or
service that a business produces. Fixed costs are business expenses that are
not dependent on the level of goods or services produced by the business. 28
6 Earnings & Costs Structure
Three factors which decide Earning, Costs Structure.
1. Size of Net Sales
2. Marginal Profit Ratio (Variable Cost Ratio)
3. Fixed Cost Amount
Management Focus are :
4. Increase Net Sales
5. Decrease Variable Cost Ratio
6. Decrease Fixed cost

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(3) Break Even Analysis
Break Even Point Analysis
What is Break Even Point?
A company's Break-Even Point is the point
 at which its net sales exactly cover its
expenses.
 at which the company sells enough units of its
product to cover its expenses without making
a profit or a loss.
By comparing the actual sales with the BEP
sales, you can find the company’s financial
health.
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CFM

Examples of FC and VC

Fixed costs
personnel costs, depreciation costs, interest payments,
rents, rents, and lease fees.
Variable costs
in the manufacturing industry
raw material costs, purchased parts costs, outsourced
processing costs, direct labor costs (payment amount
depending on the work amount), packing and packaging
costs, freight costs, power costs, fuel costs, etc.
In the distribution business, purchase costs, sales
commissions, rebates, and freight costs, etc.
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 BEP Analysis
Revenue
Sales
Profit

Cost
VC

BEP FC

Unit sold 33
BEP diagram
Break even point rate:
BEP sales ÷ actual sales
e
e nu
v
Re
o sts
C

Break even point rate

VC
Excellent ≦ 80%

OK 80% ~ 90%

Problem 90% ~ 100%

FC
Deficit ≧ 100%

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 BEP Analysis

Sales Revenue

Cost

BEP
Unit sold
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 BEP Analysis
- lower the BEP by raising selling price
New revenue
Sales Revenue

Cost

BEP
New BEP
Unit sold
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 BEP Analysis
- lower the BEP by reducing fixed cost
Revenue
Sales
Cost

New Cost
FC
BEP
New BEP
Unit sold
37
BEP Analysis
- lower the BEP by reducing variable cost
Revenue
Sales
Cost

New Cost

BEP
New BEP
Unit sold
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 BEP Analysis
 Management should constantly monitor the break even point in order
to lower the break even point whenever possible. Ways to do this
include:
1. Cost analysis: Continually review all fixed costs, to see if any can be
eliminated. Also review variable costs to see if they can be
eliminated. By doing so, increase margins and lower the breakeven
point. “Move the cost line”
2. Margin analysis: Pay close attention to product margins, and
concentrate sales of the highest-margin items to lower the
breakeven point. “Move the revenue line”
3. Outsourcing: If an activity involves fixed costs, consider outsourcing
it in order to turn it into a per-unit variable cost, which lowers the
breakeven point. “Move the cost line” 39
BEP Analysis
4. Pricing: Reduce or eliminate the use of coupons or other price
reductions, since it increases the breakeven point. Also, increase price
points whenever this is acceptable to customers. “ Move both the
revenue line and the cost line”

 When you go to the production site,

if you see you can assume
• A lot of new machines High FC

• The production site isn't tidy High VC

• Busy, but not profitable Low margin

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 BEP Analysis
How to calculate the breakeven point revenue :
The formula is:
Total fixed cost
Contribution margin *% (or Marginal Profit%)
(*% = ratio)
Contribution margin = Sales - all variable costs.
Contribution margin ratio = Contribution margin / Sales

A more refined approach is to subtract all non-cash expenses

(such as depreciation) from the numerator, so that the calculation
can focus on the breakeven cash flow level.
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Contribution margin

Contribution margin ratio

= (sales - all variable costs) / sales
Example Price of one noodle: 100Ksh
Variable Cost : 40Ksh

Contribution margin = Sales –VC = 100-40 =60

Contribution margin ratio = (Sales-VC)/Sales
=(100 – 40)/100 = 60/100 = 0.6 (or 60%)
Variable Cost Ratio = Variable Cost/Sales =
α （ alpha ） 42
 Contribution margin

 Formula of Contribution margin ratio

(Sales – VC)
Contribution margin ratio
Sales
Variable Cost Ratio （ α ）

Sales VC
1
Sales Sales Contribution margin %
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 Reference
BEP Analysis
Another variation of the formula is the one which focuses
more on the number of units that you must sell in order
to break even, rather than the sales level in currency.
This can be useful for setting sales targets.
This formula is:

Total fixed cost

Average contribution margin per unit

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 You are running a noodle restaurant. 5 minutes
BEP Analysis The table shows your restaurant’s monthly PL. There are three examples.
Try! Q1 Question: How much is your monthly BEP sales? How many noodles do you need
to sell to reach BEP sales for Ex2 and Ex3 (light yellow cells)?
Noodle Restaurant monthly P&L Unit ：Ksh
EX１ EX２ EX３
One Noodle Selling
200 200 220
price
Material cost per unit
100 100 100
(Variable cost)
Monthly rent fee for
80,000 80,000 80,000
the restaurant
Staff cost per month
100,000 100,000 100,000
( Fixed cost)
Owners payroll
0 100,000 100,000
( Expected profit)
Break Even Point
360,000
Sales
How many noodles
1,800
need to sell for BEP
Calculation for BEP Sales of Example 1:
Contribution Margin Ratio = 1 – Variable cost ratio = 1- (100/200) = 0.5
Monthly BEP Sales = Fixed Cost / Contribution Ratio = (80,000+100,000)/(1-(100/200))
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= 180,000/0.5 = 360,000
Break Even Point Analysis Try! A1
Noodle Restaurant monthly P&L Unit ：Ksh

EX１ EX２ EX３

One Noodle Selling price 200 200 220
Material cost per unit (Variable
100 100 100
cost)
Monthly rent fee for the
80,000 80,000 80,000
restaurant
Staff cost per month ( Fixed
100,000 100,000 100,000
cost)
Owners payroll ( Expected
0 100,000 100,000
profit)
Break Even Point Revenue 360,000 560,000 513,333
How many noodles to sell for
1,800 2,800 2,333
BEP

Marginal Profit -= 1 – Variable cost ratio = 1- (100/200)

BEP Revenue = Fixed Cost / Marginal Profit Ratio = (80000+100000)/(1-(100/200))
= 180000/0.5 = 360000
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 Answer
[Example 2]
Contribution Margin Ratio = 1 – Variable cost ratio
= 1- (100/200) = 0.5 (no change)
BEP Sales = Fixed Cost / Contribution Margin Ratio
= (80,000+100,000+100,000) / (1-(100/200))
= 280,000/0.5 = 560,000

[Example 3]
Contribution Margin Ratio = 1 – Variable cost ratio
= 1- (100/220) = 0.545454545..
BEP Sales = Fixed Cost / Contribution Margin Ratio
= (80,000+100,000+100,000) / (1-(100/220))
= 280,000/0.5454545.. = 513,333.. 47
CFM

CFM solution [Example 2]

VC Ratio = 0.5
Break Even Point
FC = 280,000
VC
VC VC = Sales x 0.5
（Sales x α）
Sales = VC+FC (BEP)
wage wage
Sales = (Sales x 0.5) +
Sales Sales
280,000
FC
FC Sales – (Sales x 0.5)
Dep Dep
(given) =280,000
other
other
Sales x 0.5 = 280,000
Profit Before Tax
Sales = 560,000
α= VC ratio
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Asante Sana!!

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C2 Financial Analysis – Quick Review Exercises (5 minutes)
Q1 What is the three key points of reviewing a SME?
A: Financial numbers evaluation , B: Business evaluation , C: Organization evaluation D: Effective Pricing evaluation
1.A&B, 2.B&C, 3.C&D, 4.A&B&C

Q2 What is the important attitude when conducting a financial analysis?

1.Be a critic
2.Not Digging out the number
3.In line with the expected results
4.Not to repeat “making hypothesis & test”

Q3 Which combination of words and explanations is correct?

A: Liquidity ratios a: information about management's ability to control expenses and to earn a return on the resources committed to the business
B:Profitability ratios b: rations of business dynamics
C:Leverage ratios c: the degree of protection of suppliers of long-term funds and can also aid in judging a firm's ability to raise additional debt and its
capacity to pay its liabilities on time.
D: Efficiency ratios d: management's ability to control expenses and to earn a return on the resources committed to the business.
E: dynamic ratios e: a firm's ability to meet its current obligations.
1. A&e, 2. B&b, 3. C&c, 4. D&a

Q4 Assume you are running a noodle shop. The variable cost ratio is 20%. What is the break-even point sales when the fixed cost is 500,000KS?
1. This information alone cannot answer
2. 625,000KS
3. 1,000,000KS
4. 500,000KS

Q5 Assume you are running noodle restaurant. The variable cost ratio is 20%, the fixed cost is 500,000KS. If you want to get payroll of 100,000, how
much sales is required to meet the pay?
1. This information alone cannot answer
2. 700,000KS
3. 800,000KS 50
4. 750.000KS
C2 Financial Analysis – Quick Review Exercises (5 minutes)
Q1 What is the three key points of reviewing a SME?
A: Financial numbers evaluation , B: Business evaluation , C: Organization evaluation D: Effective Pricing evaluation
1.A&B, 2.B&C, 3.C&D, 4.A&B&C

Q2 What is the important attitude when conducting a financial analysis?

1.Be a critic
2.Not Digging out the number
3.In line with the expected results
4.Not to repeat “making hypothesis & test”

Q3 Which combination of words and explanations is correct?

A: Liquidity ratios a: information about management's ability to control expenses and to earn a return on the resources committed to the business
B:Profitability ratios b: rations of business dynamics
C:Leverage ratios c: the degree of protection of suppliers of long-term funds and can also aid in judging a firm's ability to raise additional debt and its
capacity to pay its liabilities on time.
D: Efficiency ratios d: management's ability to control expenses and to earn a return on the resources committed to the business.
E: dynamic ratios e: a firm's ability to meet its current obligations.
1. A&e, 2. B&b, 3. C&c, 4. D&a

Q4 Assume you are running a noodle shop. The variable cost ratio is 20%. What is the break-even point sales when the fixed cost is 500,000KS?
1. This information alone cannot answer
2. 625,000KS
3. 1,000,000KS
4. 500,000KS

Q5 Assume you are running noodle restaurant. The variable cost ratio is 20%, the fixed cost is 500,000KS. If you want to get payroll of 100,000, how
much sales is required to meet the pay?
1. This information alone cannot answer
2. 700,000KS
3. 800,000KS 51
4. 750.000KS