financial statement analysis

Financial Statement Analysis

Presentation by EDOW FinanceCommittee to Diocesan Treasurer

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Ratio Analysis

Now we will learn how to draw management information fromyour financial statements to evaluate your parish's strength andyour effectiveness as a manager. The concept we will use for thisis called ratio analysis. Ratio analysis is the process of identifyingcertain numbers from your financial statements, making amathematical calculation with them and then evaluating theresults. Draw management conclusions from your statements. Wewill look at ratios in the following three categories:

Liquidity RatiosProfitability RatiosEfficiency Ratios

As we work our way through several financial ratios, you will seehow they take certain numbers from the financial statements andcalculate a number that can be used as a management tool.However, calculating a ratio is not an end in itself and is of novalue to you. Here comes another axiom.

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Axiom 1

A ratio by itself is meaningless until it is comparedto a standard. The standard may be your ownprior period ratios, industry averages or your ownprojections and goals.

The benefit of ratio analysis is that it provides abenchmark to measure performance, target futuregoals and help identify patterns and problemareas. First, let's consider sources of comparativedata. The best are outside sources such as thefollowing:

Industry publications, banking and finance industrypublications, general financial reference books.

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Comparing Data

You can contact several sources to search for comparativefinancial ratios. The first is your local, state or national tradeassociation. The second is the loan officer at your bank. The thirdis a library. The larger public libraries will have reference materialsand will also have indexes of magazine articles that containfinancial information. You can also look to college and universitylibraries for similar information. You will usually be able to findinformation organized by type of business, size of business andgeographic location.

Once you find a source for comparative ratios, or if one isunavailable and you decide to use your own historical ratios, youwill need to decide on a way to organize and present yourinformation. Some small business owners make a fill-in-the-blankform they use each month to calculate their ratios and comparethem against standards or prior periods. Others plot them ongraph paper. Ratios lend themselves well to computerizedspreadsheets such as Lotus 123, Excel and many others. If youlike spreadsheets, you can enter your data and have both a reportand a series of graphs or charts printed. The choice is yours. Theimportant thing is that you regularly calculate your ratios andreview them.

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Liquidity Ratios

A liquidity ratio measures some aspect of yourparish's proportion of cash and other liquidassets and short-term liabilities. Because thisratio considers only assets and liabilities, all ofthe numbers will come from your balancesheet.

Since all cash and near cash assets will becomecash within the next 12 months, and since allof the liabilities considered are due within thenext 12 months, all of these items are furtherisolated within current assets and currentliabilities.

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Working Capital = Total CurrentAssets - Total Current Liabilities

The number that represents working capitalshould be a positive number that representsshort-term unencumbered capital. It isimportant for any business to haveunencumbered cash balances. This is the short-term capital a business uses for day-to-dayoperations, for taking advantage of purchasediscounts, for making payrolls, etc.

Look for a positive working capital difference,the larger the better. Look for consistency andgrowth over time.

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Current Ratio

This ratio represents the number of times yourcurrent assets will pay your current liabilities.Therefore, you want the ratio to be at least one.A ratio of less than one indicates more currentliabilities than current assets, which is not good.A ratio of two indicates twice as many currentassets as current liabilities. That is good.

Look for a positive result, the larger the better.Look for consistency and growth over time.

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Acid Test Ratio =Quick Ratio

This ratio carries the same logic as thecurrent ratio, but it is a more conservativeratio. With only cash and accounts receivableas the numerator, essentially fewer liquidassets are available to pay current liabilities.The resulting ratio will be lower than thecurrent ratio.

Look for a positive relationship, the largerthe better. Look for consistency and growthover time.

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Analysis Results

These ratios highlight the use of commonsense and good judgment to be sure youhave enough money to pay your bills. Byanalyzing the change in these ratios overtime you can track your progress towardfinancial stability and measure your businessagainst industry standards.

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Profitability Ratios

Profitability ratios measure various aspects ofyour parish's ability to generate good profits.They consider only income, cost and expenseaccounts; accordingly, only the incomestatement is used for these ratios.Profitability ratios will be expressed aspercentages. All these ratios will be displayed

on an income statement.

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Relation of Revenue toExpenses

The next important analysis result tounderstand is the relationship of revenues toexpenses (net assets). This represents theproportion of your incoming dollar that is leftover after the cost of your missions andprograms is deducted to pay operating

expenses and results in a remaining balance.Work to make this percentage increase overtime. A higher percentage is better.

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Axiom 2

The single most important percentage onyour income statement is the excess of yourrevenues over expenses. The battle forsuccess in your income statement is won orlost there. You should know the percentageby memory; understand why it is what it is,and what causes it to change.

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Operating ExpensePercentage

This ratio can be calculated for totaloperating expenses or for each operatingexpense individually. It is used to controloperating expenses.

Look at the percentages and work todecrease them. Work consistently to get yourexpenses to become a lower proportion ofyour revenues.

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Efficiency Ratios

Efficiency ratios measure your effectivenessin managing two of the most important areasof your parish - pledges receivable andprogram activity. Any business can tie up alot of money in receivables and programs.Unless these two areas are monitored withobjective standards such as these ratios, theamount of money invested can quickly get

out of hand.

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Viability

Viability compares expendable net assets(including unrestricted and temporarilyrestricted net assets) to long-term debt. Thisratio indicates a parish’s relative liquidity orits ability to convert assets to cash. It servesas a basic indicator of financial strength,because it measures the availability of cashand other liquid assets to meet the parish’s

financial obligations.

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Primary Reserve

This ratio addresses the question of whetherresources are sufficient and flexible enoughto support your mission without having toborrow externally. It compares expendablenet assets to total expenses. It describesyour organization’s ability to fund programs.

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Change in Net Assets

This ratio measures financial performance byanswering the question: “Did yourorganization live within its means during theyear?” The net income ratio is the extent towhich your parish’s total operations resultedin either a surplus or a deficit. It’s based onunrestricted resources.

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Operating Margin

This is an important forecasting ratio becauseit illustrates your parish’s potential surplus,which could be drawn on if needed in futureyears. It’s determined by subtractingexpenditures from revenues and dividing thatsum by your revenues.

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Program Efficiency

This ratio compares total program expensesto total expenses. Having this informationcan help you determine the administrativeoverhead you’ll need to run your programs.It will also assist in your budget planning andforecasting, as well as keeping you on targetto accomplish your goals.

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Operating Reliance

To show how much your parish is able to payfor total expenses solely from programrevenues, divide program revenues by total

expenses.

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Fundraising Efficiency

Do you know how much the parish isgenerating from fundraising activities? Thisratio indicates the amount of contributionsthat result from fundraising expenses bydividing the former by the latter.

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In Summary

As you consider the various ratios, identifywhich ones are relevant to your parish. Thenselect appropriate benchmarks anddetermine what the comparisons mightindicate. Keep in mind that, just as amanufacturing company and a gas stationchain are in different businesses withdifferent financial indicators, a specific ratiowill have different meanings to differentparishs.

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Get Ahead

Used monthly or yearly, financial ratioanalysis can help the parish get ahead in thenumbers game by providing the rector withvaluable insight into the parish’s financialfuture. By using this tool, the treasurer beable to identify strengths and weaknesses —and take appropriate action to help theparish achieve its mission.