FINANCIAL STATEMENT ANALYSIS:

♦ The quality of financial information determines the value of analysis.

♦ Financial information must be accurate, timely and comprehensive to be useful in
the financial management
♦ Financial statements compares the company against itself to evaluate strengths and
weakness
♦ Requires at least three years of historical financial information to identify operating
records
♦ Use industry standards as one of the measures but not the only measure of
performance
♦ Financial analysis raises the questions to be answered and the issues to be
addressed

Analyzing The Profit and Loss Statement: Four Credit Questions

♦ Is the Business Growing?

a) Quality Indicator: % of sales growth/decline
b) Are sales increasing at a growth greater than the inflation rate?

♦ Does the business control its Direct Cost?

a) Quality Indicator: COGS/Sales
b) Beware of sudden changes in relationship of COGS to Sales
♦ Does the Business Control Overhead Cost
a) Quality Indicator: Operating and Administrative Exp./Sales
b) Is the relationship of operating and administrative exp to sales stable or falling
over time?
♦ Is the Business Truly Profitable?
a) Quality indicator: i) EBT (Earnings before taxes)/Sales ii) Operating
Profit/Sales
b) Is the percentage of OP/Sales and EBT/Sales increasing with growth?

Analyzing The Balance Sheet: The Six Credit Questions

♦ Does the Business Collect its Bills?
a) Quality indicator: Account Receivables/Sales*360dys
b) Measures the average number of days it takes to collect bills
c) Compare the term a company offers to customers to day’s receivables to measure
quality
♦ Does the business control its inventory?
a) Quality Indicator: Inventory/COGS*360 days
b) Measures the average number of days worth of inventory on hand
c) Compare the company’s inventory cycle: ordering time, production time,
warehousing
♦ Does the Business Pay its Bills?
a) Quality indicator: Accounts Payables/COGS*360
b) Measures the average number of days its takes to pay suppliers
♦ Have the owners invested in the business?
 a) Reinvested profits, investment in common stock, deferred officers’ salary
♦ Has the business produced a positive net worth?
a) Positive retained earnings indicate that the company has been profitable and has
reinvested profits into operations
b) Negative retained earnings indicates the company has experienced losses

Analyzing The Balance Sheet: The Six Credit Questions

♦ Does the business match its sources and uses of funds?

a) Is there adequate short-term debt financing for short-term or seasonal working
capital needs
b) Are fixed assets financed by long- term debts?
c) What is the quality of debts?

Another Financial Ratios:

Working Capital:
 Current Assets-Current Liabilities
 Measures of liquidity: excess of current assets over current liabilities
 Lenders look for a positive and growing amount of the working capital as
a sign that a company can handle its short-term obligation
Current Ratios:

 Current Assets/Current Liabilities

 A variation on the working capital measure of liquidity
 Lenders look for a 2:1 ratio which indicates that there are twice as many
current liabilities to satisfy current short-term obligations
Debt and Equity

 Short term and Long term debt/Net worth

 Measures the percent of the company financed by lenders relative to
owner
 Fact: Most private sector lender won’t finance companies with more than
2:1 ratio: public lenders may go up to 5:1
Contact: Chris Pavlides, Executive Director, Innovation & Entrepreneurship Institute, 201 Speakman
Hall (006-00), Philadelphia PA 19122-6083. Phone: 215-204-1035 or 215-204-3080. Email:
iei@temple.edu.
Web: www.fox.temple.edu/iei.