Financial Statement Analysis

Useful for your practical record

Rules

Read and copy in your practical record and discuss if you have any doubts. Make sure that these four problems must be recorded under topic Financial statement analysis in your

practical record.

SOLVED PROBLEMS

1) A Firm’s current assets and current liabilities are 1600 and 1000 respectively. How much can it borrow on a short term basis without reducing the current ratio below 1.25?

Solution

Let the maximum short term borrowings be B. The current ratio with this borrowing should be 1.25.

1600+ B = 1.25

1000+ B

Solving this equation , we get B = 1400. Hence the maximum permissible short term borrowing is 1400.

2)

Determine the cost of goods sold of a firm given the following information:

Current Ratio = 1.4

Acid – Test Ratio = 1.2

Current Liabilities = 1,600

Inventory Turnover Ratio = 8

Solution

The cost of goods sold figures may be derived as follows:

Current assets = Current liabilities * Current ratio

=1,600*1.4 = 2240

Current assets-Inventories =Current liabilities * Acid test Ratio

=1,600 *1.2 =1,920

Inventories =2,240-1920= 320

Sales =Inventories*inventories turnover ratio

=320*8 = 2,560

3) The following ratios are given for Mintex Company

Net profit Margin ratio = 4%

Current ratio =1.25

Return on net worth =15.23 %

Total debt to total assets ratio =0.4

Inventory turnover ratio =25

Complete the following statements

Profit and Loss Account

Rs.

Sales ------

Cost of goods sold ------

Operating expenses 700

PBIT ------

Interest ------

PBT ------

Tax provisions(50%) ------

PAT ------

Balance Sheet

Net Worth -- Fixed AssetsLong Term Debt(10% interest) -- Current Assets

--------------------180

Short Term Debt(10.42% interest) -- Cash --Receivables --Inventory --

Solution:

The blanks in the above statements may be filled as follows:

a) Short term debt. The value of the short term debt –the only current liabilities – is derived as follows.

Current assets

Current ratio = ----------------------- = 1.25

Current liabilities

Current assets 180

Current liailities = ----------------------- = -------- = 144

1.25 1.25

So ,the short term debt is 144.

b) Long term debt. The long term debt carries 10% interest rate. Hence the long term debt is equal to

Interest -.1042(144) 45-15

-------------------------- = -------- = 300

0.10

c) Total Assets: As the ratio of the total debt to total assets is 0 .4, total assets(the total of the balance sheet) is simply:

Total Debt 144 +300

------------- = ------------ = 1110

0.4 0.4

d) Net Worth: The difference between the total assets and the total debt represents the net worth. Hence it is equal to:

1110-(444)=666

e)Fixed Assets: The difference between the total assets and the current assets represents fixed assets. So ,

Fixed Assets = 1110-180 = 930

f) Profit after tax(PAT): This is equal to:

net worth * return on net worth = 666*0.1523 =101.40

g)Tax : As the tax rate is 50 %, the tax provision is simply equal to the profit after tax ,i.e,101.4

h) Profit before tax :The sum of the profit after tax and the tax provisions is equal to the profit before tax. So ,it is equal to:

101.4 + 101.4 = 202.8

i) Profit before interest and taxes: This is equal to profit before tax plus the interest payment .Hence it is equal to:

202.8 + 45 = 247.8

j) sales : The figure of sales may be derived as follows:

Profit after tax 101.4

------------------- ----------= ---------- = 2535

Net profit margin ratio 0.04

k) Cost of goods sold : This figure of cost of goods sold may be derived from the following accounting identity:

Sales- Cost of goods sold – operating expenses = PBIT

2535- cost of goods sold – 700 = 247. 8

Hence the figure of cost of goods sold is 1587.2

l) Inventory: This is equal to:

cogs 1587.2

------------------------------- = -------------- = 63

Inventory turnover ratio 25

m) Cash : This may be obtained as follows:

Current assets – receivables-inventory = 180-60-63 = 57

4. The financial statements of Matrix limited are given below: Matrix Limited: Profit and Loss Account for the year ending 31st March 20X1

(Rs. In Million)

20X1 20X0Net sales 1065 950Cost of goods sold 805 720

Stocks 600 520

Wages and salaries 120 110Other manufacturing expenses 85 90

Gross profit 260 230Operating expenses 90 75Depreciation 50 40Selling and general administration 40 35Profit before interest and tax 170 155Interest 35 30Profit before tax 135 125Tax 50 40Profit after tax 85 80Dividends 35 30Retained earnings 50 50

Matrix Limited: Balance sheet as at 31st March 20X1Rs. In Million

20X1 20X0

Sources of Funds1. Shareholder’s funds 505 455

(a) Share capital 125 125(b) Reserve and surplus 380 330

2. Loan funds 280 260 (a) Secured loans 180 160

(i) Due after 1 year 130 135(ii)Due within 1 year 50 255

(b)Unsecured loans 100 100(i) Due after 1 year 60 70(ii)Due within 1 year 40 30

Total 785 715

II Application of Funds1.Net Fixed Assets 550 4952.Investments 30 25 (a) Long term investments 20 20

(b) Current investments 10 53. Current assets, loans and advances 355 333

(a) Inventories 160 138(b) Sundry Debtors 120 115(c) Cash and bank balances 25 20(d) Loans and advances 50 60 Less: Current liabilities and provisions 150 13

Net current assets 205 195Total 785 715

a. Calculate the following ratios Current ratio Acid-test ratio Cash ratio Debt-equity ratio Interest coverage ratio Fixed charges coverage ratio

Inventory turnover ratio Debtors turnover ratio Average collection period Fixed assets turnover Total assets turnover Gross profit margin Net profit margin Return on assets Earning power Return on equity

b. Set up the DuPont equation

Solution

a. Current ratio = Current assets, loans and advances + current investments Current liabilities and provisions + short term debt

= 355 + 10 = 1.52 150 + 90

Interpretation: One unit of current liability is supported by 1.52 units of current assets.

Acid-test ratio = Quick assets = 365 – 160 = 0.85Current liabilities 240

Interpretation: One unit of current liability is supported by 0.85 units of quick assets. Thus huge load of inventory is indicated by significant difference between current ratio and quick ratio.

Cash ratio = Cash and bank balances + Current investment = 25 + 10 = 0.15 Current liabilities 240

Interpretation: One unit of current liability is supported by 0.15 units of cash.

Debt-equity ratio = Debt = 280 = 0.55 Equity 505

Interpretation: This is favourable as debts are less as compared to equity.

Interest coverage ratio = PBIT = 170 = 4.9 Interest 35

Thus we have 4.9 units of PBIT available for one unit of interest.

Fixed charges coverage ratio = PBIT + Depreciation = 170 +50 = 1.24 Interest + Repayment of loan 35+90

1-Tax rate 1- .37

Inventory turnover = Cost of goods sold = 805 = 5.40Average inventory (160 + 138)/2

Thus inventory are turned into outputs 5.4 times in a year. Thus average day of supply between two consecutive supply is 365/5.4= 66 days.Debtors turnover = Net credit sales = 1065 = 9.06

Average debtors (120 + 115)/2

Debtors are turning into cash approx 9times in a year.

Average collection period = 365 365 = 40.3 daysDebtors turnover = 9.06

On an average basis debtors are turning into cash after every 40 days. Thus we have effective credit policy.

Fixed assets turnover = Net sales = 1065 = 2.04 Average net fixed assets (550 + 495)/2

Total assets turnover = Net sales = 1065 = 1.42 Average Total assets (785 + 715)/2

Gross profit margin = Gross profit = 260 = 24.4% Net sales 1065

Interpretation: It is favourable as it shows efficiency of production.

Net profit margin = Net profit = 85 = 7.98%Net sales 1065

Interpretation: It is unfavourable as net profit ratio is very low and it means firm has very much indirect expenses.

Return on assets = Net profit = 85 = 11.3% Average total assets (785 + 715)/2

Interpretation: This is favourable as the assets invested in the business are giving satisfactory return.

Earning power = PBIT = 170 = 22.7%Average total assets (785 + 715)/2

Interpretation: It is favourable as earning power of the firm is satisfactory.

Return on equity = Equity earnings = 85 = 17.7% Average equity (505 + 455)/2

Interpretation: It is favourable as it is showing satisfactory return on equity.

b. DuPont equationReturn on equity = Net profit margin x Total assets turnover ratio x leverage multiplier

Net profit x Net sales x Average total assets = Net sales Average total assets Average equity

= 85 x 1065 x (785 + 715)/2 1065 (785 + 715)/2 (504 + 455)/2

= 7.98% x 1.42 x 1.5625

= 17.7%