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Financial Statement and Ratio

Analysis


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Financial Statement Analysis

Financial Statement Analysis is the application of analyticaltools to financial statements and related data for business

decisions. It involves transformingaccounting data into useful

information. It provides us an effective and systematic basis for

business decision. It gives an insight about the company's

operating performance and financial health both to the internal

and external users of financial information.


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Standards for Comparison

A) Intra-company: With in the company, the company can compare the financial performance of

the current year ith in that of the previous year. For example, the turnover of

!eximco "extile ltd. in #$$% can be compared ith that in #$$&.

B) Inter-Company/Competitor:

A company can compare its financial performance ith other companies in the

industry. For example, the turnover of !eximco "extile ltd. in #$$% can be

compared ith that of Suare "extile ltd. in the same year.

C) Industry Average:

Industry average can also provide standards for comparison. D) Guidelines (rules of thums):

(eneral standards of comparison can develop from past experiences. Forexample) #)*is the standards for the current ratio or *)*for the uic+ ratio.


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atio Analysis A ratio expresses a mathematical relationship beteen to uantities. It can be expressed

as a percent, rate or proportion.

Comparison done in the absolute measure does not alays give us a true picture. -oo+ at

the folloing figure)

Company Company /

0et sales 1,$$,$$$ 2,$$,$$$

0et 3rofit 1$,$$$ 11,$$$ Apparently, e tell that Company / has operating performance better than Company . !ut

it is not. "a+e a loo+ at the folloing figure)

Company Company /

0et sales 1,$$,$$$ 2,$$,$$$

0et 3rofit 1$,$$$ 11,$$$ 0et 3rofit to net sales *$4 2.514

So ratio analysis expresses the relative si6e of one amount to another. !ased on ratio

analysis, e see that Company 7s profit sounds better than Company /.


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"ypes of atiosWe classify ratios under the folloing categories)

-iuidity and 8fficiency

Solvency

3rofitability

9ar+et

Liquidity and Efficiency Ratio:

-iuidity refers to the ability to meet short term obligations and efficiency refers to

the ability of being productive in using the asset. :nder this section )

a) Current ratio:

"he current ratio measures the relationship beteen total current asset and total

current liabilities at a specific date.

Current Ratio= Current Asset / Current !iailities

A high current ratio suggest a strong liuidity position. An excessively high ratio

means the company has invested too much in current assets comparing to its

current obligations.


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Current Asset Composition Current -iabilities Composition

Cash Accounts 3ayable

Cash 8uivalent Current notes payable

Short term investment Current portion of any long term debt

Accounts eceivables Accrued 8xpenses

3repaid 8xpenses Income "ax 3ayable

9erchandise inventory

B) "uic# $atio/ Acid test $atio:

"he uic+ ratio is similar to the current ratio except that it is a mere stringent test of short term

liability.

Quick Ratio= "uic# asset/ Current !iailities Quick Asset include)

Cash

Short term investment

Accounts eceivables


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!olvency/ Leverage/ "apital !tructure Ratio : Solvency refers to a company7s long run financial viability and its ability to

meet long term obligations.

a) Det $atio:

>ebt ratio measures the portion of a company7s assets contributed by creditors.

Debt Ratio = %otal !iailities / %otal Asset

Companies are said to be highly leveraged if a large portion of their asset is

financed by debt.

) 'uity $atio:

8uity ratio measures the portion of a company7s assets contributed by its

oners.

Equity Ratio = %otal 'uity/ %otal Asset


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#rofitability Ratio: 3rofitability refers to a company7s ability to use its assets efficiently to

generate revenues ? positive cash flos@. 3rofitability also refers to

solvency. 3rofitability atio7s are)

a) rofit *argin ratio:

9easures the profitability of a company. 3rofit 9argin + (,et income / ,et &ales).

0et Income < Income after Interest and "ax

) Gross *argin ratio:

Gross Margin +( Gross *argin / ,et &ales).

(ross 9argin < Sales Cost of (oods Sold


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C) $eturn on asset ($0A) :

elates income to total asset invested.

BA< 0et income Average total asset

Average "otal Asset+( 0pening total asset1 'nding total asset) /2

d) $eturn on 'uity ($0'):

eturn on euity is a fundamental test of euity.

B8


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e) Earning per sare)

83S


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$ar%et:

"est of mar+et in vie of financial statement analysis measures the ability to

generate positive mar+et expectations. 9ar+et measures are useful hen

analy6ing companies having publicly traded stoc+. "hese mar+et measures

use stoc+ price in their computation. Stoc+ price reflects hat the mar+et

?public@ expectations are for the company. :nder this section, e have)

a@ 3rice 8arning atio.

b@ >ividend /ield atio.


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a) rice 'arning (') $atio:

"he price earning ratio measures the relationship beteen the current

mar+et price of the stoc+ and its earning per share. "he 38 ratio can be

vieed as an indicator of investors expected groth and ris+ for a

company's stoc+. A high groth rate suggest a high 38 ratio and a high

level of perceived ris+ suggest a lo 38 ratio.

38 atio< Current *ar#et price per share/ 'arning per share

) Dividend 4ield:

"he dividend yield ratio measures the relationship beteen the dividend per

share paid and the current mar+et price of the stoc+.

>ividend /ield atio

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