financial statement analysis (fsa)

8/14/2019 Financial Statement Analysis (Fsa)

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FINANCIAL STATEMENT

ANALYSIS (FSA)

FSA is the collective name for the tools &

techniques that are intended to provide

relevant information to decision-makers

(Investors, management, owners,

creditors, government).

Evaluation of past performance & financial

position (trend of past sales, earnings,cash flows, profit margin & ROI).


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STANDARDS OF COMPARISONS

Rule of Thumb Indicators (benchmark

financial ratios); Past performance of the company (over a

period of time) trend analysis;

Industry standards.


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SOURCES OF INFORMATION

Company Reports: (i) Directors Report,(ii) Financial Statements, (iii) Schedules &Notes to Financial Statements, (iv)

Auditors Report. Stock Exchanges: BSE Official Directory &

BSE Library for Annual Reports.

Business Periodicals. Information Services: CMIE, CRISIL,

ICRA, CARE.


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QUALITY OF EARNINGS

Refers to probability of earnings trendscontinuing and the extent to which

earnings could represent distributable

cash.


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May be affected by:

Choice of Accounting Methods & Estimates:

GAAP provides flexibility in determining accountingmethods:

(a) Depreciation: SLM, WDVM, SOYDM.

(b) Inventories: LIFO, FIFO, Weighted Average Cost.

(c) Doubtful Debts: % of Receivables Method, % ofSales Method.

(d) Goodwill: Full Write-off Method, Amortization

Method, Not Write-off Method. Revenue Recognition in Long-Term Contracts: %

Completion Method, Completed Contract Method.


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May be affected by:.contd.

2. Extra-Ordinary Items:

Incomes/Expenses arise from events that are distinctfrom ordinary activities of the business (Not expected torecur regularly).

Decision to treat an item as extra-ordinary affectsoperating earnings:

Write down of inventories to net realizable value;

Write down of fixed assets to recoverable amount;

Restructuring activities if an enterprise; Dispose of Long-term investments;

Litigation Settlement.


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May be affected by: .contd.

3. Prior Period Items:

Incomes/Expenses that arise in thecurrent period as a result of errors or

omissions in the preparation of FinancialStatements of one or more prior periods:

Errors in totaling Inventory Sheets;

Mistakes in computing depreciationamount arising from use of incorrect assetlives or failure to consider residual value.


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4. Discontinued Operations:

It is the result of the sale or abandonment of a

separate, major and identifiable line of business. For predicting earnings from regular, on-going

activities, the results of continuing operationsneed to be separated from those of the

discontinued operations.


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5. Change in Accounting Policies:

GAAP do not permit an enterprise to change its

accounting policies unless there is adequate

justification for the change. Adequate justification refers that the change is

required by law or any accounting standard or by

an accounting enterprise.

When a change is executed, the fact and effect

of the change on net profit should be disclosed.


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TECHNIQUES OF FINANCIAL

STATEMENT ANALYSIS

1. HORIZONTAL ANALYSIS:

It is the calculation of amount changes &% changes from the previous year to the

current year.3. TREND ANALYSIS:

Involves the calculation of % changes in

financial statement items for a number ofsuccessive years. It is en extension ofHorizontal Analysis to several years.


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STATEMENT ANALYSIS.contd.

3. VERTICAL ANALYSIS:

It is the proportional expression of each item on

a financial statement to the statement total.

The results of Vertical Analysis are presented in

the form of Common-Size Statements in which

all elements in each statement are expressed inpercentages of some common number & always

add up to 100 percent.


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COMPARATIVE COMMON SIZE

STATEMENTS (VERTICAL ANALYSIS)

Part A: BALANCE SHEET:Particulars 20x1 20x2 20x3 20x4Capital 26 22 32 30Res.& surplus 17 23 19 22

Secured Loans 33 30 28 27Unsec. Loans 6 6 5 5Current Liab. 18 19 16 16Fixed Assets 64 63 64 65Investments 3 2 2 2

Debtors 16 15 16 16Inventories 15 18 17 16Misc. Expenses 2 2 1 1TOTAL 100 100 100 100


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COMPARATIVE COMMON SIZE

STATEMENTS (VERTICAL ANALYSIS)

Part B: INCOME STATEMENTParticulars 20x1 20x2 20x3 20x4Net Sales 100 100 100 100COGS 74 70 73 76

Gross Margin 26 30 27 24Operating Exp. 7 8 7 8Non-Op. Exp/Inc - - 1 1EBIT 19 22 21 17Interest 4 4 4 4PBT 15 18 17 13

Tax 6 8 7 7PAT 9 10 10 6Dividends 4 4 4 4Retained Earnings 5 6 6 2


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STATEMENT ANALYSIS.contd.

4. RATIO ANALYSIS:

Establishes relevant financial relationship

between the components of financial

statements;

These ratios are used to evaluate

profitability, liquidity, activity, solvency

aspects of the business along with its

capital market strength.


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RATIO ANALYSIS

(Liquidity Ratios) LIQUIDITY RATIOS: Refer to the ability of the

firm to meet its obligations in the short-run,usually one year.

Current Ratio: Current Assets Current Liabilities

(C.A. includes cash, marketable securities,debtors, inventories, loans & advances, &

prepaid expenses. C.L. includes loans &advances taken, trade creditors, accruedexpenses & provisions)


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RATIO ANALYSIS

(Liquidity Ratios) .contd.

(b) Acid Test Ratio: Quick Assets

Current Liabilities

Quick assets are current assets excluding

inventories as it is the least liquid C.A.(c) Bank finance to Working Capital Gap Ratio:

Short-term bank borrowings

Working Capital Gap

It shows the dependence on bank finance andthe working capital is equal to C.A. less C.L.other than bank borrowings.


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RATIO ANALYSIS

(Leverage Ratios)2. LEVERAGE RATIOS: Refer to the use of debt finance in

the capital structure.

(a) Debt Equity Ratio: Debt

Equity

It shows the relative contribution of creditors & owners.Numerator consists of Short & Long-term Liabilities &denominator consists of Net Worth plus PreferenceCapital)

* Net Worth = Equity Capital + Reserves &Surplus

Lower the ratio, higher the degree of protection enjoyedby creditors.


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RATIO ANALYSIS

(Leverage Ratios) .contd.

(d) Fixed Charges Coverage Ratio:

EBIT + Depreciation

Interest + (Repayment of loan/ 1-tax rate)

It measures debt servicing ability as it considersboth the interest & principal repaymentobligations In the denominator, the repayment

of loan is adjusted upwards for the tax factor asloan repayment, unlike interest, is not taxdeductible.


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RATIO ANALYSIS

(Turnover/Activity Ratios)3. TURNOVER / ACTIVITY RATIOS: Are based on the

relationship between the level of activity, representedby COGS & the level of various other assets.

(c) Inventory Turnover Ratio:COGS

Average Inventory

It measures how fast the inventory is moving through

the firm & generating sales - higher the ratio, moreefficient is the management of inventory & vice versa.


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RATIO ANALYSIS

(Turnover Ratios)..contd.

(b) Accounts Receivable Turnover Ratio:

Measures how many times the debtors turn over

during the period.

Net Credit SalesAverage Accounts Receivables*

*If the figure for net credit sales is not available,

one may consider net sales figure.The higher the A/R turnover, the greater the

efficiency of credit management.


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RATIO ANALYSIS


(c) Average collection period: Represents thenumber of days worth of credit sales that islocked in debtors.

Average Accounts Receivable X 365Average daily credit sales

If the figure for credit sales is not available, onemay consider with net sales figure. Average

collection period & the A/R are related in thefollowing way:

Average Collection Period = 365 / A.R. Turnover


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RATIO ANALYSIS


(d) Fixed assets turnover Ratio: Measures sales

per rupee of investment in fixed assets A

higher ratio indicates a high degree of efficiency

in asset utilization.Net SalesAverage Net Fixed Assets

Caution: When fixed assets of a firm are old &substantially depreciated; this ratio tends to be

high as the denominator is low.


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RATIO ANALYSIS

(Profitability Ratios)

4. PROFITABILITY RATIOS: Reflect the

final result of the business operations

(of two types) Profit margin ratios &

Rate of return ratios.

Gross Profit Margin Ratio: Shows the

margin left after meeting manufacturing

costs: Gross Profit

Net Sales


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RATIO ANALYSIS

(Profitability Ratios). Contd.

(b) Net Profit Margin Ratio: Shows the earnings leftfor share holders (both equity & preference) as% of net sales.

Net Profit

Net Sales(c) Return on Equity Ratio: Measures the

profitability of equity funds invested in the firm reflects the productivity of the ownership capital

employed in the firm.Equity Earnings

Average Net Worth


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RATIO ANALYSIS


(d) Return on Total Assets: It is a measure

of capital employment efficiency:Net Income

Average Total AssetsTo ensure internal consistency, following

variant may be employed:

Net Income + InterestAverage Total Assets


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RATIO ANALYSIS


(e) Earning Power: it is a measure ofperformance, which is not affected byinterest charges & tax payments;

it abstracts away the effect of financialstructure & tax rate and focuses onoperating performance.

EBITAverage Total Assets


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RATIO ANALYSIS

(Valuation Ratios)5. VALUATION RATIOS: Indicate how the equity stock of

the firm is assessed in the capital market.

Price-earning Ratio: Commonly referred to as price-

earning multiple is a summary measure, reflectinggrowth prospect, risk characteristics, shareholderorientation, corporate image & degree of liquidity.

Market Price per share (Av. market price)Earning per share {(PAT Preference dIvidend)/ No. ofequity shares)}


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RATIO ANALYSIS

(Valuation Ratios). Contd.

(b) Yield: Measure of the rate of return earned by

the shareholders.Dividend + Price change

Initial PriceMay be split into two parts:Dividend + Price ChangeInitial Price Initial Price

(Dividend Yield) (Capital Gains/ Losses Yield)

Firms with low growth prospects offer a high

dividend yield and a low capital gains yield.


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RATIO ANALYSIS


(c) Market Value to Book Value Ratio: reflects the

contribution of the firm to the wealth of the

society.

A ratio >1indicates that firm has created wealth.If the ratio is 2 , it indicates that firm has created

a wealth of one rupee for every rupee invested

in it.

Market Value Per Share

Book Value Per Share


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RATIO ANALYSIS


(d) Tobins q orq Ratio: Proposed by James

Tobin, the ratio identifies the ratio of market

value of a firms securities to the replacement

cost of its physical (non-financial) assets:Market value of equity & liabilities

Estimated replacement cost of the assets

Firms will have incentive to invest, when q >1and will be reluctant to invest once q becomes

equal to 1.

financial statement analysis (fsa)

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