FINANCIAL STATEMENT ANALYSIS

Important Questions
Managers, shareholders, creditors and other interested groups seek answers to the following important questions about a firm:
What is the financial position of the firm at a given point of time? How has the firm performed financially over a given period of time? What have been the sources and uses of cash over a period of time?

The accountant prepares the balance sheet, the profit and loss account, and the statement of cash flows to answer the above questions.

Balance Sheet
Horizontal Form Liabilities + Equity
y Share capital
y Reserves and surplus y Secured loans y Unsecured loans y Current liabilities and y

Assets
y Fixed assets y Investments y Current assets, loans and

advances Miscellaneous expenditure and losses

provisions

Balance Sheet
Vertical (or Report) Form
I. Sources of Funds
(1) Shareholders funds: (a) Capital (b) Reserves and Surplus (2) Loan funds: (a) Secured loans (b) Unsecured loans

II. Application of funds

(1) Fixed assets (2) Investments (3) Current assets, loans and advances Less: Current liabilities and provisions: Net current assets (4) Miscellaneous expenditures and losses

Liabilities
Share Capital Reserves & Surplus Secured Loans Unsecured Loans Deferred Tax Liability Current Liabilities and Provisions

Assets
Fixed Assets Investments Current Assets, Loans, & Advances Miscellaneous Expenditure & Losses

Profit & Loss Account Of Horizon Ltd, For The Year Ending On March 31, 20 X 1
(Rs. in million)
Net sales Cost of goods sold Stocks Wages and salaries Other manufacturing expenses Gross profit Operating expenses Depreciation General administration Selling Operating profit Other income (expense) Profit before interest and tax Interest Profit before tax Provision for tax Profit after tax 20 x 1 701 552 421 68 63 149 60 30 12 18 89 89 21 68 34 34 99 06 105 22 83 41 42 148 49 20 x 0 623 475

Profit And Loss Account Items

y Net Sales y Cost of Goods Sold y Gross Profit y Operating Expenses y Operating Profit y Non-operating Gains and Losses y Profit Before Interest and Taxes y Interest y Profit before Tax y Income Tax Provision y Profit After Tax y Prior Period Adjustments y Amount Available for Appropriation y Appropriations y Balance Carried Forward

Liquidity Ratios
Current Ratio Current assets Current liabilities Acid-Test Ratio Quick assets Current liabilities Cash Ratio Cash and bank Current balances + investments Current liabilities

Leverage Ratios
Debt-equity Ratio Debt Equity Debt-asset Ratio Debt Assets Interest Coverage Ratio Profit before interest and tax Interest

Turnover Ratios
Inventory Turnover Cost of goods sold Average inventory Debtors Turnover Net credit sales Average debtors Fixed Assets Turnover Net sales Average net fixed assets Total Assets Turnover Net sales Average total assets

Profitability Ratios
Gross Profit Margin Ratio Gross profit Net sales Net Profit Margin Ratio Net profit Net sales Return on Assets (ROA) Profit after tax Average total assets

Profitability Ratios Earning Power Profit before interest and tax Average total assets Return on Capital Employed Profit before interest and tax (1 Tax rate) Average total assets Return on Equity Equity earnings Average equity

Valuation Ratios
y Price-earnings Ratio Market price per share Earnings per share y Yield Dividend + Initial price Dividend yield Initial price Capital gains/losses yield Price change

Comparison With Industry Averages

Ratios
Liquidity Current assets Current ratio Current liabilities Quick assets Acid-test ratio Current liabilities Leverage Debt Debt-equity ratio Equity Debt Debt-ratio Assets PBIT Interest coverage ratio Interest Turnover Net sales Inventory turnover Average Inventory Net credit sales Accounts receivable turnover Average accounts receivable Net sales Fixed assets turnover Average net fixed assets Net sales Total assets turnover Average Total assets 1.58 1.26 2.15 2.23 7.70 7.50 6.24 6.43 4.23 4.14 0.45 0.56 0.81 1.25 0.73 0.69 1.32 1.26

Formula

Horizon Limited

Industry Average

Ratios
Profitability

Formula
Gross profit

Horizon Limited
21.0%

Industry Average
18.0% 4.0% 6.9% 17.7% 8.8% 11.9%

Gross profit margin ratio Net sales Net profit Net profit margin ratio Net sales Net profit Return on assets Average total assets PBIT Earning power Average total assets PBIT (1T) Return on capital employed Average total assets Equity earnings Return on equity Average net worth Valuation Market price per share Price-earnings ratio Earnings per share Dividend + Price change Yield Initial price Market price per share Market value to book value ratio

4.7% 7.7% 20.1% 10.1% 13.1%

9.25

9.26

14. 0%

14.1%

1.20 Book value per share

1.16

Time Series Of Certain Financial Ratios

1 Debt-equity ratio Total assets turnover ratio Net profit margin (%) Return on equity (%) Price-earnings ratio 0.91 1.51 8.8 25.4 18.6 2 0.98 1.59 11.6 30.7 15.3 3 0.65 1.58 9.8 24.5 10.3 4 0.61 1.53 6.6 16.7 7.1 5 0.81 1.58 4.9 13.1 9.3

Dupont Analysis
Basic Du Pont Analysis
Net profit = Aveage total assets ROA Net sales = NPM Net profit x Average total assets x TATR Net sales

Extended Du Pont Analysis

Net profit = Equity Sales Net profit x Average total assets Sales x Average equity Average total assets

ROE

NPM

TATR

x 1/(1 DAR)

Du Pont Chart Applied To Horizon Limited

Net Sales +/- Non operating Surplus/Deficit 701 Net Profit 34 Net Profit Margin 4.9%

Total Costs 667

z
Net Sales 701

Return on Total Assets 7.7 %

X
Net Sales 701 Total Assets Turnover 1.58

Average Fixed assets 326

z
Average Total Assets 443

+
Average Investments 15

+
Average Net Current Assets 102

Extension Of The Du Pont Chart

Return of Equity 13.1%

Return of Assets 7.7%

Average Total Assets To Average Equity Ratio 1.70

Applications Of Financial Analysis

Financial ratios may be employed to:
Assess corporate excellence Judge creditworthiness Forecast bankruptcy Value equity shares Predict bond ratings Estimate market risk

Problems In Financial Statement Analysis

Development of Benchmarks Price Level Changes Variations in Accounting Policies Interpretation of Results