MBA Education & Careers

Eco Fundas for you

Financial Statements &

Related T
erms
Terms
PROMOD JOSEPH

Earnings Per Share (EPS). EPS, which represents

MBA, VIRGINIA TECH.

the bottom-line of a company, is the net income

of a company divided by the number of common

he balance sheet is a statement that

stock outstanding.

balances the assets of a company with

The balance sheet and income statements are

the claims on assets (called liabilities).

common to all businesses and give an overall

This statement is prepared for a particular date

snapshot of the health of the business. Another

and will detail what assets the company owns and

set of statements are based on how funds flow

what the claims are on these assets. This is a

through the business. These include statements

snapshot of the financial health of a company.

such as the statement of cash flows and statement

Items in the balance sheet are listed in the order

of retained earnings.

of their liquidity (nearness of the asset to cash).

Ratio analysis

For this reason cash is always listed as the first

One way of analysing financial statements is to

item on the balance sheet. When listing the claims

use ratio analysis. Ratios are fractions of two

on liabilities, liquidity refers to how quickly the

financial statement items that may be related to

claim against the company matures.

one another and may provide a prudent user a good

Last on this account would be the common equity,

deal of information. Normally, ratios are classified

which means that legally the last claimants on a

on what information they provide, like on liquidity,

companys assets are the common stock holders.

profitability, debt, and turnover.

Balance sheets may be quite detailed depending

Liquidity ratio indicates the firms ability to meet

on the nature and complexity of the business.

its maturing short-term obligations. Turnover

Income Statement

ratio indicates how effectively the firm manages

The income statement shows a firms expenses,

resources at its disposal to generate sales.

revenues, and taxes for a given financial period.

Profitability ratio indicates the efficiency with

This statement would give an idea about the net

which resources are managed while the debt ratio

income of the company. An important concept

indicates the extent to which the firm is financed

which is derived from the income statement is the

by debt.
June-July 2009

37

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ECO FUNDAS FOR YOU: FINANCIAL STATEMENTS & REALTED TERMS

Liquidity ratio comes out of the balance sheet and
hence measures the liquidity on a particular day.
There are three liquidity ratios: current ratio, quick
ratio, and debt to equity ratio.
Current ratio represents the current assets that
are available to meet the companys current
obligations and is obtained by dividing current
assets by the total current liabilities. A current ratio
of 1.5 means, that the company has Rs.1.5 of
current assets to meet Re.1 of its current liabilities.
Quick ratio is considered to be an acid test for
liquidity and expresses the true working capital
which can be used to meet the current liabilities.
This ratio is calculated by dividing total quick
assets (assets minus inventory) by total current
liabilities.
Debt to equity ratio is calculated by dividing the
total liability and debt by its equity. This gives an
idea on how the liabilities match up with the net
worth of the company. If liabilities exceed the net
worth, then creditors have more shares in the
company than the shareholders.
Efficiency ratio is a ratio that comes off the
balance sheet and the income statement. This ratio
measures the efficiency of the company in turning
over the sales, inventory, accounts receivables, etc.
This also gives information on how well the
company can meet its liabilities. This is because,
if the company does not get paid on time, it will
not be able to pay its creditors on time.
Day Sales Outstanding (DSO) shows the
effectiveness by which the company converts its
receivables into cash. This ratio is of particular
38 June
- July 2009
June-

importance to credit and collection associates. A

DSO of 20 means that a company takes twenty
days to convert its accounts receivables into cash.
Inventory turnover ratio indicates the speed at
which a company is able to move its products and
is calculated by dividing the total sales of the
company by its total inventory.
Accounts payable to sales percentage gives an
idea of how much of the suppliers money the
company uses to fund its sales. A high ratio means
the company is using its supplier as a source of
cheap financing.
Profitability ratio shows how well the company
is able to generate returns on the investment it
has made. Return on sales or profit margin
measures the percentage profits the company
earns for every rupee of sales. This indicates
how well the company can face adverse
conditions like rising costs and falling prices as
well as withstand competition. Return on asset
shows the ability of the company in utilising its
assets while return on equity measures the
ability of the management to generate adequate
returns for the capital invested by the owners of
the company, i.e. the shareholders. M E & C

The author is Centre Director, T.I.M.E. Madurai.