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ANALYSIS

Kishor Chandra Sahu

Objective of Analysis

profit or not

2. To evaluate the financial strength of the company

3. To judge the ability of the company to generate

enough cash and cash equivalents and their timing

4. To know the future growth prospects

FINANCIAL STATEMENT ANALYSIS

Multi-step Income Statement

From the reported statement , it is necessary to segregate

information and break-up of manufacturing, administrative

and selling expenses which will show the profitability and

disclose the following

a) Gross Profit—GP

b) Profit before depreciation, interest and tax—PBDIT

c) Operating Profit—OP or PBIT

d) Profit before tax—PBT

e) Net profit--PAT

FINANCIAL STATEMENT ANALYSIS

Ratio Analysis:

Ratio refers to relationship between two variables

expressed either in percentages or in multiples and

seeks to establish the cause and effect relationship.

It assists in the following cases

1. Inter-firm comparison

2. Intra-firm comparison

3. Comparison against industry benchmark

4. Analysis of performance over a long period

FINANCIAL STATEMENT ANALYSIS

Classification of Ratios

1. Liquidity ratios

2. Efficiency or Turnover ratios

3. Profitability ratios

4. Capital Structure ratios (Leverage ratios)

FINANCIAL STATEMENT ANALYSIS

Liquidity Ratio

Liquidity refers to the capacity a company to meet its

day to day expenses and discharge short-term

obligations of suppliers and other creditors

smoothly.

Following ratios are calculated under this head.

1. Current Ratio

2. Quick Ratio

FINANCIAL STATEMENT ANALYSIS

Current Ratio ( times ) / Working capital ratio

The ratio measures the ability of a company to discharge its day

to day obligations. A company should possess adequate level

of current assets over current liabilities to be able to do so. A

current ratio of more than 1 indicates that value of short-term

assets is more than short-term liabilities. A current ratio of less

than 1 indicates poor liquidity. The firm is said to be

comfortable in its liquidity position if the current ratio is 2:1

Formula:

Current Assets

------------------

Current Liabilities

FINANCIAL STATEMENT ANALYSIS

Quick Ratio ( times )

The ratio measures as to how fast the company is able to meet

its current obligations as and when they fall due. This is also

known as acid-test ratio. Inventory and working capital limits

are taken out of current assets and current liabilities

respectively. A quick ratio of 1: 1 is indicates highly solvent

position.

Formula:

Current Assets –Inventories- Prepaid Expenses

--------------------------------------------------------------------

Current Liabilities

FINANCIAL STATEMENT ANALYSIS

Suppliers’ Credit ( days )

The ratio measures the average credit period enjoyed

by the company from its suppliers. It also helps to

understand the credit policy extended to a company

by the suppliers.

Formula:

Payables*365

----------------------

Credit Purchases

FINANCIAL STATEMENT ANALYSIS

Turnover Ratios

These ratios indicate how efficiently the assets of the

company are used to generate revenue .

Following ratios are calculated under this group.

1. Inventory Turnover Ratio

2. Debtors Turnover Ratio

3. Creditors Turnover Ratio

FINANCIAL STATEMENT ANALYSIS

Inventory Turnover Ratio

The ratio measures the amount of capital tied up in

raw material, W.I.P. and finished goods

Formula:

Cost of Goods Sold

---------------------------------------

Average Inventory

FINANCIAL STATEMENT ANALYSIS

Inventory Holding Period( days )

The ratio measures the average period for which cash is

blocked in inventory. In other words the ratio explains

how fast the company is able to convert its inventory

into cash.

Formula:

Average Inventory*365

------------------------

Cost of goods sold

FINANCIAL STATEMENT ANALYSIS

Debtors Turnover Ratio ( times )

It represents the number of times average dues from

customers are realised. Higher the ratio, the better is

the position.

Formula:

Credit Sales

-------------------------------------------------

Average Debtors

Average Debtors = Opening balance + closing

balance/2

FINANCIAL STATEMENT ANALYSIS

Collection Period ( days )

The ratio measures how fast the company is able to

realise the dues from the customers on credit sales. It

helps to understand the credit policy of the company.

Formula:

365/ Debtor Turnover Ratio

FINANCIAL STATEMENT ANALYSIS

The ratio shows the average time taken to pay for goods

and services. Longer the credit period achieved the

better.

Formula:

Credit Purchase

----------------------------------------------------

Average Creditors

FINANCIAL STATEMENT ANALYSIS

Return on Investment (ROI) ratios

This ratio seeks to measure the efficiency of

performance or otherwise of the company. Higher

the ratio, greater is the financial security for

investors. Maximisation of ROI is the ultimate

objective of any company.

Under this group, the following ratios are computed

1. Return on Net Worth

2. Earnings per Share

FINANCIAL STATEMENT ANALYSIS

Return on Net Worth (RONW)

The ratio measures the net profit earned on equity

shareholders’ funds. It is the measure of overall

profitability of a company.

Formula:

(PAT-Pref.dividend)*100

-----------------------------------------------------------

Net Worth (Equity capital + Reserves & Surplus-Misc.

expenditure not written off)

FINANCIAL STATEMENT ANALYSIS

Earning per Share ( EPS)

The ratio measures the overall profitability in terms of

per equity share of capital contributed.This is the

most widely used ratio across industries.

Formula:

PAT-Pref.Dividend

-----------------------------------------------------------

Weighted average no. of equity shares O/S

FINANCIAL STATEMENT ANALYSIS

The capacity of a company to discharge its long-term

obligation indicates its financial strength and

solvency position.

Under this group, the following ratios are computed.

1. Debt-Equity ratio

2. Interest coverage ratio

3. Debt-service coverage ratio

FINANCIAL STATEMENT ANALYSIS

Debt-Equity ratio ( times )

The ratio measures the proportion of debt and capital –both

equity and preference in the capital structure of a company. It

helps in knowing whether a company is relying more on debt

or capital for financing its assets. Higher the debt , more is the

financial risk.

Formula:

Long term debt

-------------------------------------------------------------------

Total net worth( Eq. shareholders’ funds+Pref. cap)

FINANCIAL STATEMENT ANALYSIS

Debt-Equity ratio ( times )

The yardstick for this ratio is 1:1. In other words, for every rupee

of debt there should be one rupee worth internal funds. A High

D/E ratio implies that the creditors stake is more as compared

to that of owners. It implies that if the project fails financially,

there is greater risk for the creditors.

FINANCIAL STATEMENT ANALYSIS

Interest Coverage Ratio ( times )

The ratio measures the ability of a company to service

the interest obligations out of its cash profits. Higher

the ratio, greater is the ability.

Formula:

Net Profit before interest and Taxes

-----------------------------------------------------------

Fixed Interest Charges

FINANCIAL STATEMENT ANALYSIS

Ratio of Proprietor's Funds To Total Assets

This establishes the relationship between proprietor’s

funds and the total assets. 0.5:1 is considered as the

minimum desirable.

Proprietor’s Funds

--------------------- X 100

Total Assets

FINANCIAL STATEMENT ANALYSIS

Profitability Ratios

The purpose of study of these ratios is to assess the

adequacy or otherwise of the profit earned by the

company. The following ratios are calculated under

this group.

1. Multi-step Profit Margin to Sales

2. Individual Cost and Expense to Sales

3. Other Income , Extraordinary Items and Prior Period

Adjustments to PBT or Sales

4. Effective Tax Rate

FINANCIAL STATEMENT ANALYSIS

Multi-step Profit Margin to Sales Ratios(%)

These ratios measure several profit margin indicators. All these

ratios are computed in relation to Sales.

1. Gross Profit Margin-GP

2. Profit Before Depreciation, Interest and Tax-PBDIT

3. Operating Profit-OP

4. Profit Before Tax and Extra-ordinary Items-PBTEOT

5. Profit Before Tax-PBT

6. Net Profit Margin-PAT

FINANCIAL STATEMENT ANALYSIS

Gross Profit Margin (%)

This reflects the efficiency with which management

produces each unit of output. It also indicates the

spread between the cost of goods sold and the sales

revenue.

Formula:

Sales-Cost of Goods Sold

------------------------------------- x 100

Sales

FINANCIAL STATEMENT ANALYSIS

Operating Profit Margin (%)

This ratio indicates profitability from operating activities.

A higher margin implies better sales realization and

effective cost control. Operating ratio of 60% means

the firm has remaining 40% of its sales revenue as

profit.

Formula:

Operating Expenses

---------------------- X 100

Sales

FINANCIAL STATEMENT ANALYSIS

Net Profit Margin( % )

The ratio is the overall measure of the firm’s ability to

earn profit per rupee of sales. It also establishes

relationship between manufacturing, administering

and selling the products. Indicates what portion of

sales is left to the owners after operating expenses.

Formula:

Profit After Tax

--------------------- x100

Sales

FINANCIAL STATEMENT ANALYSIS

Return on Investment(RoI)

The profitability is measured in terms of return on

investments.

Formula:

Profit After Tax

---------------------

Total Investment

FINANCIAL STATEMENT ANALYSIS

Return on Capital Employed(ROCE)

The profitability is measured in terms of return on investments.

Whether the funds have been properly used or not

Formula:

Adjusted net profit

---------------------

Capital Employed

Net profit adjusted for depreciation, interest on long-term

liabilities, income tax . Net capital is the total of paid up share

capital, debentures.

FINANCIAL STATEMENT ANALYSIS

Return on equity (ROE)

The net profit available to equity shareholders to the amount

invested by them.

Formula:

Net profit – Dividends to pref. shareholders

-----------------------------------------------------

Equity Share Capital

The equity share holders switch over from one company to the

other by selling the shares based on this ration.

FINANCIAL STATEMENT ANALYSIS

Capital Market Ratios

Following ratios are computed under this group.

1. EPS

2. Price Earning Ratio-P/E

3. Dividend Yield to Investors

FINANCIAL STATEMENT ANALYSIS

EPS

Relationship between the net profit and the number of

shares outstanding.

EPS = Net profit after taxes / No of shares

outstanding

Higher EPS indicates that the demand for the shares

of that company is likely to be more.

FINANCIAL STATEMENT ANALYSIS

P/E ratio – Price/Earning Ratio

Relationship between the net profit and the number of

shares outstanding.

P/E = Market price per share / Earning per share

Used to assess the expensiveness of a given share. A

high P/E ratio indicates that the stock market price

has been pushed up in anticipation of an expectation

of rapid improvements in earnings.

Selling share with P/E of 20 at a price of 100/- is

better than selling a share with P/E of 30 at 100/-

FINANCIAL STATEMENT ANALYSIS

Dividend Yield

Percentage return on the price paid for shares.

----------------------------------------------- X % dividend

Market price of share

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