CHAPTER 6

FINANCIAL STATEMENT ANALYISIS

“It sounds extraordinary but it’s a fact that balance sheets can make fascinating reading.”
— Mary Archer.
After studying this chapter, students should be able:

 To understand how to read the financial statement and the advantages and limitations of ratio
analysis.
 To explain why ratio analysis is usually the first step in the analysis of a company’s financial
statements.
 To list the five groups of ratios, specify which ratios belong in each group, and explain what
information each group gives us about the firm’s financial position.
 To describe how the Du Pont equation is used, and how it may be modified to include the
effect of financial leverage.
 To identify some of the problems with ROE that can arise when firms use it as a sole
measure of performance.
To be an effective as a financial manager, there is a certain body of knowledge and skills that
you must master. Otherwise, you will be at a distinct disadvantage in operating the business
especially the finance department. Understanding the informational content of financial
statements is one such area. Financial statements present the results of operations and the
financial position of the company. There are three major types of financial statement that is very
important to a financial manager. These three are income statement, statement of cash flow and
balance sheet. Very important information can be extracted from these statements and various
stakeholders are keen to look at it. These set of financial statement is a structured representation
of the financial performance and financial position of a business and how its financial position
changed over time. It is the ultimate output of an accounting information system.
1) Income Statement: The income statement is a historical record of the trading of a business
over a specific period (normally one year). It shows the profit or loss made by the business –
which is the difference between the firm’s total income and its total costs.
The income statement serves several important purposes:
 Allows shareholders/owners to see how the business has performed and whether it has made
an acceptable profit (return).
 Helps identify whether the profit earned by the business is sustainable (“profit quality”).
 Enables comparison with other similar businesses (e.g. competitors) and the industry as a
whole.
 Allows providers of finance to see whether the business is able to generate sufficient profits
to remain viable (in conjunction with the cash flow statement).
 Allows the directors of a company to satisfy their legal requirements to report on the
financial record of the business.

A sample of a typical Income Statement is shown below:

 Vertex Corporation
Income Statement
For the month ended December 31, 2012.

Sales Tk. 85,600 (In thousands)

Less: Expenses:  
Wages Expense Tk. 38,200  
Supplies Expense 18,480  
Rent Expense 12,000  
Miscellaneous Expense 3,470  
Electricity Expense 2,470  
Telephone Expense 1,494  
Depreciation Expense 1,100  
Interest Expense 150  
Total Expenses −77,364
Net Income Tk. 8,236

2) Statement of Cash flow: A financial statement that provides an overview of the cash inflows
and outflows of the business during a certain period of time. The purpose of the statement of
cash flows is to highlight the major activities that directly and indirectly impact cash flows and
hence affect the overall cash balance. Managers focus on cash for a very good reason―without
sufficient cash balance at the right time, a company may miss golden opportunities or may even
fall into bankruptcy.
Preparing the cash flow statement from the given data involves three major steps:
Step 1: Determine the change in cash:
This procedure is straight forward because the difference between the beginning and the ending
cash balance can be easily computed from an examination of the comparative balance sheet.
Step 2: Determine the net cash flow from operating activities:
This procedure is complex. It involves analyzing not only the current year's income statement but
also comparative balance sheets and selected transitions data.
Step 3: Determine net cash flows from investing and financing activities:
All other changes in the balance sheet accounts must be analyzed to determine their effects on
cash.

The aim of a cash flow statement should be to assist users:

 to assess the company's ability to generate positive cash flows in the future.
 to assess its ability to meet its obligations to service loans, pay dividends etc
differences between reported and related cash flows.
 to assess the effect on its finances of major transactions in the year.
 to assess the reasons for differences if any between reported and related cash flow.
A sample of a typical statement of Cash Flow is shown below:
Vertex Corporation
Statement of Cash Flow
For the month ended December 31, 2012.
(Amount in thousands)
Cash Flows from Operating Activities:

Operating Income (EBIT) Tk.489,000

Depreciation Expense 112,400
Loss on Sale of Equipment 7,300
Gain on Sale of Land −51,000
Increase in Accounts Receivable −84,664
Decrease in Prepaid Expenses 8,000
Decrease in Accounts Payable −97,370
Decrease in Accrued Expenses −113,860
Net Cash Flow from Operating
Tk. 269,806
Activities
 
Cash Flows from Investing Activities:
Sale of Equipment 89,000
Sale of Land 247,000
Purchase of Equipment −100,000
Net Cash Flow from Investing Activities Tk.136,000
 
Cash Flows from Financing Activities:
Payment of Dividends − 90,000
Payment of Bond Payable −200,000
Net Cash Flow from Financing Activities - −290,000
Net Change in Cash Tk. 115,806
Beginning Cash Balance 319,730
Ending Cash Balance Tk.435,536

3) Balance Sheet: A balance sheet shows what resoources are owned by a business (“assets”)
and what it owes to other parties (“liabilities”) and what is the net worth of that business at a
particular point in time. The balance sheet is divided into two parts that, based on the following
equation, must equal each other, or balance each other out. The fundamental accounting formula
behind balance sheets is:

Assets = Liabilities + Owners' Equity.

As the balance sheet is a snapshot at a single point in time of the company’s accounts - the
balance sheet, along with the income and cash flow statements, is an important tool for investors
to gain insight into a company and its operations.

Assets = It is anything of value owned by a business. A business could have both short term
assets like inventory, accounts receivables, cash deposits in a bank and long term assets like
buildings and factories, capital machineries etc.

Liability = It is claim against a firm’s assets by a creditor, i.e. a bank. A business could have
both short term liabilities like accounts payable, accrual payable and long term liabilities like
long term bonds payments, loan payments etc.

Here short term and long term typically means less than one year is short term and more than one
year is long term.

Owner’s Equity = It is the net assets of a business. Owner’s equity is the difference between
assets and liability. Normally a business should have positive equity but when a business has
more total liabilities than total assets then it has negative owner’s equity.

A sample of a typical Balance Sheet is shown below:

Vertex Corporation
Balance Sheet Statement
For the month ended December 31, 2013.
(Amount in thousands BDT)

ASSETS LIABILITIES AND EQUITY

Current Assets: Liabilities:
Cash Tk.20,430 Accounts Payable Tk.5,200
Accounts Receivable 5,900 Utilities Payable 3,964
Office Supplies 4,320 Unearned Revenue 1,000
Prepaid Rent 24,000 Interest Payable 150
Total Current Assets Tk.54,650 Notes Payable 20,000
Non-Current Assets: Total Liabilities Tk.30,314
Equipment 80,000 Common Stock 100,000
Accumulated Depreciation − 1,100 Retained Earnings 3,236
Net Non-Current Assets 78,900    
Total Assets Tk.133,550 Total Liabilities and Equity Tk.133,550

Advantages of Financial Statement Analysis:

There are various advantages of financial statements analysis. The major benefit is that the
investors get enough idea to decide about the investments of their funds in the specific company.
Secondly, regulatory authorities like Bangladesh Security Exchange Commission (BSEC) and
Bangladesh Bank can ensure whether the company is following accounting standards or not.
Thirdly, financial statements analysis can help the government agencies like National Board of
Revenue (NBR) to analyze the taxation due to the company. Moreover, company can analyze its
own performance over the period of time through financial statements analysis. The banker can
decide whether to loan the money to the business or even the supplier can decide where it should
supply materials to that business.

Main users of financial statement:

1) The owners of the business (its shareholders);
2) Management;
3) Employees;
4) Suppliers;
5) Customers;
6) Lenders like banks and investors;
7) Government regulatory authorities i.e. NBR (National Board of Revenue), BSEC
(Bangladesh Security Exchange Commision).

Organization that influences the reporting of financial statement in Bangladesh:

 The companies act 1994 by SEC (Security Exchange Commission)

 NBR (National Board of Revenue)
 ICAB (Institute of Chartered Accountants of Bangladesh)
 ICMAB (Institute of Cost and Management of Bangladesh)
 IFRS (International Financial Reporting Standard)

Annual Report

An annual report is a comprehensive report on a company's activities throughout the preceding

year. Annual reports are intended to give shareholders and other interested people information
about the company's activities and financial performance.

Typical annual reports will include:

 Income Statement;
 Accounting policies;
 Balance sheet;
 Cash flow statement;
 Contents: non-audited information;
 Profit and loss account;
 Notes to the financial statements;
 Chairpersons statement;
 Director's Report;
 Operating and financial review;
 Other features;
 Auditors report.
Ratio Analysis
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values
taken from an enterprise's financial statements. Financial ratios may be used by managers within
a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors.
Financial ratios are useful indicators of a firm's performance and financial situation. Ratios are
calculated from current year numbers and are then compared to previous years, other companies,
the industry, or even the economy to judge the performance of the company.
Objectives of Ratio Analysis
The objectives of ratio analysis are given below.

1) Short term and long term planning.

2) Measurement and evaluation of financial performance.
3) Study of financial trends.
4) Decision making for investment and operations.
5) Diagnosis of financial wrongdoings.
6) Providing valuable insight into firm’s financial position or picture.

Financial Ratio Comparisons

Financial ratios are financial analysis comparison in which certain financial statement items are
divided by one another to reveal their logical interrelationships.
Financial ratios are designed to help one evaluate a firm’s financial statements. Financial ratio
analysis is a fundamental task of investors, accountants and corporate managers. Financial ratios
fall into three main buckets: efficiency ratios (which tells how effectively a company utilizes its
assets); liquidity ratios (which measure the financial health of the company); and leverage ratios
(which tells how much debt the company has relative to its total capital). Financial ratios give a
snapshot of a company's financial health and help to make informed investment and management
decisions.
Financial ratios allow for comparisons:
 Between company to company
 Between different time periods for one company (Year by Year)
Between company to company
Financial ratios are often used to compare a company against an industry average or other
companies or compare financial performance of same industries. By comparing the financial
statement between company to company it will be summarized that which company sales has
increased, which company revenue has increased, which company share price has increased,
which one is the leading company, which company future position is more secure. This kind of
comparison can help the inventors to invest their money in profitable firm.
Between different time periods for one company (Year by Year)
Financial ratios are often used to compare one company for different time period basically year
by year. Ratios are calculated from current year numbers and are then compared to previous
years, to judge the performance of the company and find out the strength and weakness. It can
help a company to recover the weakness on the next year.
Advantages of Ratio Analysis

Financial ratio analysis is a useful tool for users for financial statements. It has following
advantages.

1. Financial ratios are designed to help one evaluate a firm’s financial statements.
2. It helps in comparing companies of different size with each other. Financial analysts use
financial ratios to compare the strengths and weaknesses in various companies.
3. Financial ratios can be used to analyze trends and to compare the firm's financials to those of
other firms or between different time periods for one firm.
4. It highlights important information in simple form quickly. A user can judge a company by
just looking at few numbers instead of reading the whole financial statements.

Limitations of Ratio Analysis

Despite usefulness, financial ratio analysis has some disadvantages. Some key demerits of
financial ratio analysis are:

1. Different companies operate in different industries each having different environmental

conditions such as regulation, market structure, etc. Such factors are so significant that a
comparison of two companies from different industries might be misleading.
2. Financial accounting information is affected by estimates and assumptions. Accounting
standards allow different accounting policies, which impairs comparability and hence ratio
analysis is less useful in such situations.
3. Ratio analysis explains relationships between past information while users are more
concerned about current and future information.

There are some inherent problems and limitations to ratio analysis that necessitate care and
judgment. Ratio analysis conducted in a mechanical, unthinking manner is dangerous, but used
intelligently and with good judgment, it can provide useful insights into a firm’s operations.

Financial ratios are used by three main groups:

 Managers, who employ ratios to help analyze, control, and thus improve their firm’s
operations.
 Credit analysts, such as bank loan officers or bond rating analysts, who analyze ratios to help
ascertain a company’s ability to pay its debts.
 Stock analysts, who are interested in a company’s efficiency, risk, and growth prospects.
 Other than that a supplier may be interested whether the firm is capable of paying if it
sells something on credit.

In learning about ratios, you could simply study the different types or categories of ratios, or you
may use ratios to answer some important questions about a firm's operations. You may prefer
the latter approach, and choose the following four questions as a map in using financial ratios:

1. How liquid is the firm?

2. Is management generating adequate operating profits on the firm's assets?
3. How is the firm financed?
4. Are the common stockholders receiving sufficient return on their investment?

Few things to remember about ratio analysis:

 Ratios are often not useful for analyzing the operations of large firms that operate in many
different industries because comparative ratios are not meaningful.
 The use of industry averages may not provide a very challenging target for high-level
performance.
 Inflation affects depreciation charges, inventory costs, and therefore, the value of both
balance sheet items and net income. For this reason, the analysis of a firm over time, or a
comparative analysis of firms of different ages, can be misleading.
 Ratios may be distorted by seasonal factors, or manipulated by management to give the
impression of a sound financial condition (window dressing techniques).
 Different operating policies and accounting practices, such as the decision to lease rather than
to buy equipment, can distort comparisons.
 Many ratios can be interpreted in different ways, and whether a particular ratio is good or bad
should be based upon a complete financial analysis rather than the level of a single ratio at a
single point in time.

While it is important to understand and interpret financial statements, sound financial

analysis involves more than just calculating and interpreting numbers.
Good analysts recognize that certain qualitative factors must be considered when evaluating a
company. Some of these factors are:
 The extent to which the company’s revenues are tied to one key customer.
 The extent to which the company’s revenues are tied to one key product.
 The extent to which the company relies on a single supplier.
 The percentage of the company’s business generated overseas.
 Competition.
 Future prospects.
 Legal and regulatory environment.
Financial ratios can be classified according to the information they provide. The following types
of ratio frequently are used:
1. Liquidity ratios
2. Asset management ratios
3. Debt management ratios
4. Profitability ratios
5. Market value ratios.
These are concerned with the return on investment for shareholders, and with the relationship
between return and the value of an investment in company’s shares. Ratios generally are not
useful unless they are benchmarked against something else, like past performance or another
company.

Here in this textbook the financial statements of Square Pharmaceuticals are attached and the
following ratio analysis is based on from that report.

LIQUIDITY RATIOS
Liquidity ratios measure the availability of cash to pay debt. These ratios actually show the
relationship of a firm’s cash and other current assets to its current liabilities. It is the ability of a
business to pay its current liabilities using its current assets.
A liquid asset is an asset that can be easily converted to cash without significant loss of its
original value. Liquidity or Short Term Solvency ratios are used to determine a company's ability
to pay off its short-terms debts obligations. The higher the value of the ratios, the larger will be
the margin of safety that the company possesses to cover short-term debts.
Different types of liquidity ratios are discussed below:
1. Current ratio
2. Quick/ Acid Test ratio.
Current ratio:
One of the most commonly used liquidity ratios is the current ratio.
1. Current Ratio is a relevant and useful measure of liquidity and short term (within the year)
debt paying of company.
2. The ratio is computed by dividing current assets by current liabilities.
3. The current ratio indicates the ability of a company to pay its current liabilities from current
assets that shows the strength of the company’s working capital position.
This ratio indicates the extent to which current liabilities are covered by those assets expected to
be converted to cash in the near future. Current assets normally include cash, marketable
securities, accounts receivables, and inventories. Current liabilities consist of accounts payable,
short-term notes payable, current maturities of long-term debt, accrued taxes, and other accrued
expenses (balance sheet).
The ratio is mainly used to give an idea of the company’s ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
1. Current ratio below 1 shows critical liquidity problems because it means that total current
liabilities exceed total current assets and suggests that the company would be unable to pay
off its obligations if they came due at that point necessarily mean that it may go bankrupt.
2. General rule is that higher the current ratio better and more capable the company is of paying
its obligations, but there is a limit to this. A current ratio higher than 2.5 might indicate
existence of idle or underutilized resources in the company.

The ratio is calculated as follows:

Current Ratio = Current Assets / Current Liabilities.

Table 6.1: Current ratios of Square Pharmaceuticals in different years.

Year Current Assets Current Ratio

Liabilities
2010 4,774,311,194 2,216,744,401 2.153749
2011 7,022,213,840 4,668,189,426 1.504269
2012 6,745,507,008 4,252,934,845 1.586083
2013 5,996,697,544 3,792,438,255 1.581225

2010; 2.1537

2012; 1.5861 2013; 1.5812

2011; 1.5043

Figure 6.1: Graph shows the change of Current ratio.

Current ratio analysis of Square Pharmaceuticals:

The above graph shows that, in 2010 the current ratio of Square pharmaceuticals limited was
2.1537; it means Square pharmaceuticals limited has 2.1537 taka of current assets against 1 taka
of current liabilities. It indicates Square pharmaceuticals limited had the ability to pay off its
current liabilities with its current assets. In 2011 the current ratio was 1.5043 which means
Square pharmaceuticals limited investment in current assets was lower than in 2010. In 2012 the
current ratio was 1.5861 which was a little better than 2011 which means in 2012 square
pharmaceuticals limited invested more in short term assets.
In this graphical representation it is quite apparent that their current ratio was capable of paying
its obligations. The company was in good financial health and it was definitely a good sign. The
company had used its current assets or its short-term financing facilities with efficiently.

Quick/ Acid Test ratio

The Quick ratio or acid-test is an indicator of a company's short term liquidity. Quick ratio
measures the liquidity of a business by matching its cash and near cash current assets with its
total liabilities. The quick ratio measure a company’s ability to meet its short term obligations or
a business would be able to pay off all its debts by using its most liquid assets.
Inventories typically are the least liquid of a firm’s current assets – they are the assets on which
require more time to be sold and losses are most likely to occur in the event of liquidation.
Therefore, it is important to measure the firm’s ability to pay off short term obligations without
having to rely on the sale of inventories. The higher value of quick ratio tells us the better short
term financial position of the company.
1. A quick ratio of 1.00 means that the most liquid assets of a business are equal to its total
debts and the business will just manage to repay all its debts by using its cash, marketable
securities and accounts receivable.
2. A quick ratio of more than 1 indicates that the most liquid assets of a business exceed its total
debts.
3. On the opposite side, a quick ratio of less than 1 indicates that a business may not be able to
repay all its debts by using its most liquid assets.
4. However a quick ratio which is quite high, say 3.00 is not favorable to a business as whole
because this means that the business has idle current assets which could have been used to
create additional projects thus increasing profits. In other words, very high value of quick
ratio may indicate inefficiency.

Current Assets−Inventories
Quick ratio=
Current Liabilities

Table 6.2: Quick/ acid test ratios of Square Pharmaceuticals in different years
Year Current Assets - Current Liabilities Ratio
Inventories
2010 2,567,233,112 2,216,744,401 1.15811
2011 4,480,525,511 4,668,189,426 0.95980
2012 4,057,688,536 4,252,934,845 0.95409
2013 3,493,014,304 3,792,438,255 0.92105
 2010;
1.1581
2011; 2012; 2013;
0.9598 0.9541 0.9210

Figure 6.2: Graph shows the change of Quick/ acid test ratio.
 Quick ratio analysis of Square Pharmaceuticals:

From the above graph you can see a gradual decline of quick ratio but still it is above 0.90. The
reason behind falling below 1 is the inventory which is constantly decreasing and also it has
some seasonality effect. This is not a bad news for Square pharmaceuticals limited because
company will get benefit in future in this inflationary economy. The value of quick ratio less
than 1 indicates a business may not be able to repay all its debts by using its most liquid assets
but here not much to worry for Square pharmaceuticals since it is around this number.
Generally, a higher quick ratio is preferable because it means greater liquidity. Quick ratio more
than 1 indicates that the company has more liquid assets which exceed its current debt. If a firm
having a high liquidity ratio may not have a satisfactory liquidity position if it has slow-paying
debtors.

While both ratios suggest that the firm is more liquid, the current ratio appears to suggest more
liquidity than the acid-test ratio, which means that the inventory is a larger component of the
current ratio than for other firms.

ASSET MANAGEMENT RATIO:

Asset management ratio is a set of ratios that measure how effectively a firm manages its assets
compared to its sales. These ratios are designed to find out whether the total amount of each type
of asset as reported on the balance sheet appear reasonable, too high, or too low considering
current and projected sales levels.

Four types of asset management ratios are discussed below:

1. Inventory turnover ratio;

2. Fixed asset turnover ratio;
3. Total asset turnover ratio;
4. The Day’s sales outstanding (DSO).

Inventory Turnover Ratio

Inventory Turnover Ratio tells how often a business's inventory turns over during the course of
the year. Inventories are the least liquid form of asset and a high inventory turnover ratio is
generally positive. On the other hand, an unusually high ratio compared to the average for the
industry could mean that the business is losing sales because of inadequate stock on hand. It is
often necessary to use average inventories rather than year-end inventories, especially if a firm’s
business is highly seasonal, or if there has been a strong upward or downward sales trend during
the year.
A ratio showing how many times a company's inventory is sold and replaced over a period. The
days in the period can then be divided by the inventory turnover formula to calculate the days it
takes to sell the inventory on hand or '' inventory turnover days''.

Since the inventory (the denominator) is at cost, you may want to measure sales (the numerator)
also on a cost basis.
The Inventory turnover ratio is calculated as follows:

Cost of goods sold

Inventory turnover =
Inventory
Table 6.3: The Inventory Turnover ratio of Square Pharmaceuticals in different years.

Year Cost of goods Sold Inventory Ratio

2010 6,561,288,485 2,207,078,082 2.972839
2011 7,703,661,010 2,541,688,329 3.030923
2012 9,167,253,620 2,687,818,472 3.410667
2013 10,223,478,073 2,503,683,240 4.083375

2013; 4.0834

2012; 3.4107
2010; 2.9728 2011; 3.0309

Figure 6.3: Graph shows the change of Inventory Turnover ratio.

Inventory turnover ratio analysis of Square Pharmaceuticals:

It is an activity / efficiency ratio and it measures how many times per period, a business sells and
replaces its inventory again. Inventory turnover ratio is used to measure the inventory
management efficiency of a business. Inventory turnover ratio of Square Pharmaceuticals for
2010 is 2.97 means Tk. 2.97 in sales (at cost) for every Tk. 1 of inventory. Here inventory
turnover is increasing from 2010 to 2013. In general, a higher value indicates better performance
and lower value means inefficiency in controlling inventory levels. A lower inventory turnover
ratio may be an indication of overstocking which may pose risk of obsolescence and increased
inventory holding costs. However, a very high turnover may result in loss of sales due to
inventory shortage.
1. Declining inventory turnover commonly indicates that the company is not being able to
glow its inventory very well as it was doing in the previous years. In order to improve Inventory
Turnover ratio, at first an end-to-end view in addressing inventory needs to be looked at. Supply
chains need to be optimized, production processes need to be efficient as well, so that the
suppliers become able to produce and deliver materials in a timely, low cost fashion that allows
the company to minimize their inventory and cost of materials. Collaborative relationships with
customers can allow them to make their demand for products more predictable thereby allowing
to minimize finished product inventory without failing to meet their needs for volume and
timeliness.
2. Supplier-financed inventory may reduce inventories and show improved inventory
turnover by forcing suppliers to carry the inventory for the company. The suppliers assume the
cost of maintaining inventory and passes that cost on. Alternatively, the company may reduce
inventory by the use of express shipment or other costly means of delivery to ensure the
availability of materials and supplies when needed. Solutions of maintaining inventory that
simply shift cost to suppliers return the cost in added mark-ups to the materials and supplies
purchased. This results in a rise in unit product unit cost.

Fixed Asset Turnover Ratio

Fixed assets turnover ratio measures how effectively the firm uses its plant and equipment to
help generate sales. So, fixed Asset Turnover ratio measures the amount of sales generated for
every taka worth of fixed assets. The fixed asset turnover ratio is calculated by dividing sale by
total fixed assets. It is an efficiency ratio which tells how successfully the company is using its
assets to generate revenue.

The ratio is calculated as follows

Sales
¿ AssetsTurnover ratio=
¿ Assets

Table 6.4: The FATO ratios of Square Pharmaceuticals in different years

Year Sales Fixed Asset Ratio
2010 11,462,578,410 10,643,410,336 1.076965
2011 13,471,424,469 12,422,195,814 1.084464
2012 16,054,425,243 14,708,277,754 1.091523
2013 17,959,489,496 17,450,947,962 1.029141
 2012;
2011; 1.0915
2010; 1.0845
1.0770

2013;
1.0291

Figure 6.4: Graph shows the change of FATO ratio.

Fixed Asset Turnover Ratio analysis of Square Pharmaceuticals:

The above graph shows upward trend of fixed asset turnover ratio for Square from 2010 to 2012
but a downward in 2013. The lower turnover in 2013 occurred because sales did not keep pace
with the increase of company’s fixed assets. This lower fixed-asset turnover ratio shows that
Square Pharmaceuticals limited had less effectiveness in using the investment in fixed assets to
generate its revenues.
The turnover was increasing until 2013 only because no significant investments were made
during that period and the capital work-in-progress was lowest amongst the three years.
Therefore, enough evidence is not available from this ratio analysis whether the company is
really performing inefficiently or it is the investments that pulled down the turnover. Also the
company was not being able to utilize its assets efficiently.
Total Asset Turnover Ratio
Total Asset turnover is a function of how efficiently management is using the firm's assets to
generate sales. It evaluates the efficiency of managing all of the company's assets. Total Asset
Turnover ratio measures the amount of sales generated for every unit of taka's worth of total
assets. It is similar to fixed asset turnover since both measures a company's effectiveness in
generating sales revenue from investments back in to the company. The higher total asset
turnover is due to a higher fixed asset turnover, which makes up for the less efficient
management of accounts receivables and inventories (low turnovers). The total asset turnover
ratio is calculated by dividing sale by total assets.
The ratio is calculated as follows:
Sales
Total Assets Turnover=
Total Assets

Table 6.5: The TATO ratios of Square Pharmaceuticals in different years.

Year Sales Total Assets Ratio
2010 11,462,578,410 15,029,500,278 0.762672
 2011 13,471,424,469 19,444,409,654 0.692817
2012 16,054,425,243 21,453,784,762 0.748326
2013 17,959,489,496 23,447,645,506 0.76594

2010; 2013;
0.7627 0.7659
2012;
0.7483

2011;
0.6928

Figure 6.5: Graph shows the change of TATO ratio.

Total Asset Turnover analysis of Square Pharmaceuticals:

The above graph shows that, total asset turnover of Square Pharmaceuticals limited has improved
after 2011 to 2013. The asset turnover ratio is increasing which indicate that Square
Pharmaceuticals limited was generating a sufficient volume of revenue given to its total asset
investment. But from 2010 to 2011 ratio is little lower than other three years. It may be an
indicator of company’s pricing strategy as company with high profit margins tends to have low
asset turnover. To increase this ratio Square Pharmaceuticals limited had to utilize its sources of
fund on those assets which have brought more revenue to the Company.

The Day’s Sales outstanding (DSO)

DSO is called the average collection period, is used to evaluate the firm’s ability to collect its
credit sales in a timely manner. It is calculated by dividing accounts receivable by average sales
per day which indicates the average length of time it takes the firm to collect its credit sales.
Days sales outstanding (DSO), also called the “average collection period” (ACP), is used to
appraise accounts receivable.
1. The DSO represents the average length of time that the firm must wait after making a sale
before receiving cash.

2. The DSO can also be evaluated by comparison with the terms on which the firm sells its
goods.
It measures the numbers of days it takes an average to collect accounts receivable. The accounts
receivable collection period uses accounts receivables and annual credit sales.

DSO is calculated as follows:

 Trade Debtors x 365
Days Sales Outstanding ( DSO )=
Sales

Table 6.6: The DSO Ratio (Days) of Square Pharmaceuticals in different years.

Year Trade Debtors × Sales Ratio (Days)

365
2010 185,510,948,510 11,462,578,410 16.18405
2011 281,933,790,925 13,471,424,469 20.92828
2012 295,033,775,610 16,054,425,243 18.3771
2013 292,355,842,880 17,959,489,496 16.27863

 
2011;
20.9283
2012;
2010; 18.3771 2013;
16.1841 16.2786

Figure 6.6: Graph shows the change of DSO ratio.

Days Sales Outstanding analysis of Square Pharmaceuticals:
The above graph shows that, DSO ratio of Square Pharmaceuticals limited has increased from
2010 to 2011 but then decreased consistently afterwards until 2013; it means Square
Pharmaceuticals limited is doing excellent which reflects better credit policy of the company and
the customers were taking shorter times to pay their bills, which is a good sign that customers
were very satisfied with the company's product or service, or that salespeople were making sales
to customers who were credit-worthy, or that salespeople have to offer shorter payment terms in
order to seal the deal. So the DSO ratio decreasing means that a business is locking up less of its
funds in accounts receivable, and so can use the funds for other purposes.
DEBT MANAGEMENT RATIOS
Debt management ratios measure the extent to which a firm is using debt financing, or financial
leverage, and the degree of safety afforded to creditors. Debt Management ratios help to evaluate
a company's long-term solvency measuring the extent to which the company is using long-term
debt. This ratio reflects how effectively a firm is managing its debts. It helps the analyst to
determine the extent to which borrowed funds have been used to finance assets and review how
well operating profits can cover fixed charges such as interest payment.
1. Firms with relatively high debt ratios have higher expected returns when the economy is
normal, but they are exposed to risk of loss when the economy goes into recession.
2. Firms with low debt ratios are less risky, but also forgo the opportunity to leverage up their
return on equity.
3. Decisions about the use of debt require firms to balance higher expected returns against
increased risk.
Debt management ratios quantify the firm's ability to repay long-term debt. Debt management
ratios measure financial leverage.
Different types of Debt Management ratio are discussed below:
1. Debt ratio;
2. Total Debt to Equity Ratio;
3. Equity Multiplier;
4. Times interest earned (TIE).
Debt ratio
The ratio of total debt to total assets, generally called the debt ratio, measures the percentage of
funds provided by the creditors. Debt ratio is the ratio of total liabilities of a business to its total
assets. It is a solvency ratio and it measures the portion of the assets of a business which are
financed through debt.
Total debt includes both current liabilities and long-term debt.
1. The lower the ratio, the greater the protection afforded creditors in the event of liquidation.
2. Stockholders, on the other hand, may want more leverage because it magnifies expected
earnings.
3. A debt ratio that exceeds the industry average raises a red flag and may make it costly for a
firm to borrow additional funds without first raising more equity capital.
Total debt includes both current liabilities and long term liabilities. Creditors prefer low debt
ratios, because the lower the ratio, the greater the cushion against creditor’s losses in the event of
liquidation. The owners on the other hand can benefit from leverage because it magnifies
earnings, and thus the return to stockholder. But, too much debt often leads to financial
difficulty, which eventually may cause bankruptcy.
Debt Ratio calculated as follows
Total Debt
Total Debt to Asset Ratio/Debt Ratio =
Total Assets
Table 6.7: The Debt ratios of Square Pharmaceuticals in different years

Year Total Debt Total Assets Ratio

2010 3,475,120,453 15,029,500,278 0.23122
2011 5,626,700,664 19,444,409,654 0.289374
2012 5,186,900,507 21,453,784,762 0.241771
2013 4,602,899,322 23,447,645,506 0.196305
 2011;
0.2894
2010; 2012;
0.2312 0.2418
2013;
0.1963

Figure 6.7: Graph shows the change of Debt ratio.

Debt ratio analysis of Square Pharmaceuticals:

The above graph shows that from the year 2011 to 2013 the ratios were 0.289374, 0.241771, and
0.196305 which have decreased year after year considerably which is a good sign for the
company, because the lower debt ratio may decrease the financial risk of Square
Pharmaceuticals. Debt ratio of 0.5 means that half of the company's assets are financed through
debts. As a rule of thumb, normally firms are structured as 40% ratios which means if there is
100 taka asset then 40 taka is debt and 60 taka is equity. Sometimes if the business environment
favors leveraging a firm may go debt ratio of 60% but banks could have as high as 92% debt
ratio.
Total Debt to Equity Ratio
Debt-to-Equity ratio is the ratio of total liabilities of a business to its shareholders' equity. It is a
leverage ratio and it measures the degree to which the assets of the business are financed by the
debts and the shareholders' equity of a business.
Debt to Equity Ratio calculated as follows:

Total Debt
Total debt ¿ equity Ratio=
Total Equity

Table 6.8: The Debt to Equity Ratio of Square Pharmaceuticals in different years.

Year Total Debt Total Shareholder’s Ratio

Equity
2010 3,475,120,453 11,721,331,851 0.296478
2011 5,626,700,664 13,817,708,990 0.407209
2012 5,186,900,507 16,266,884,255 0.318863
2013 4,602,899,322 18,844,746,184 0.244254
 2011; 0.4072

2012; 0.3189
2010; 0.2965

2013; 0.2443

Figure 6.8: Graph shows the change of Debt to Equity ratio.

Debt to equity ratio analysis of Square Pharmaceuticals:

A debt-to-equity ratio 1.00 means that half of the assets of a business are financed by debts and
half by shareholders' equity. A value higher than 1.00 means that more assets are financed by
debt that those financed by money of shareholders' and vice versa. It also means that a company
has been aggressive in financing its growth with debt. This can result in volatile earnings as a
result of the additional interest expense. Lower values of debt-to-equity ratio are favorable
indicating less risk. Higher debt-to-equity ratio is unfavorable because it means that the business
relies more on external lenders thus exposing the firm at higher risk, especially at higher interest
rates.
Equity Multiplier
Equity multiplier is a financial leverage ratio which is calculated by dividing total assets by the
total shareholders equity. It tells you about assets in taka per taka of equity. The higher ratio
indicates the lower the financial leverage and the lower the ratio the higher the financial
leverage. The equity multiplier is a way of examining how a company uses debt to finance its
assets. Equity multiplier also known as the financial leverage ratio or leverage ratio. In other
words, this ratio shows a company's total assets per taka of stockholders' equity.
Total Assets
Equity Multiplier=
Total Shareholder s' Equity

Table 6.9: The Equity Multiplier Ratio of Square Pharmaceuticals in different years

Year Total Assets Total Shareholder’s Ratio

Equity
2010 15,029,500,278 11,721,331,851 1.282235
2011 19,444,409,654 13,817,708,990 1.407209
2012 21,453,784,762 16,266,884,255 1.318863
2013 23,447,645,506 18,844,746,184 1.244254
 2011;
1.4072

2012;
1.3189
2010;
1.2822
2013;
1.2443

Figure 6.9: Graph shows the change of Equity Multiplier ratio.

Equity multipliers analysis of Square Pharmaceuticals:

The higher the equity multiplier ratio the lower the financial leverage and the lower the ratio the
higher the financial leverage. A higher equity multiplier ratio indicates the company is relying
less on debt to finance its assets. Higher equity multiplier leads to a higher return on equity. In
2011, 2012 and 2013 it falls down that indicates it has higher leverage that is not good.
Square Pharmaceuticals gradually reduced their
Times interest earned (TIE)
3. Times interest earned (TIE) ratio shows how many times the annual interest expenses are
covered by the net operating income (income before interest and tax) of the company. It is a
long-term solvency ratio that measures of a company's ability to honor its debt payments. It is
computed by dividing the income before interest and tax by interest expenses. Times interest
earned ratio is known by various names such as debt service ratio, fixed charges cover ratio and
Interest coverage ratio states the number of times a company is capable of bearing its interest
expense obligation out of the operating profits earned during a period.
4.
Importance of times interest earned ratio:
1. Interest coverage is an indication of the margin of safety for an organization before it runs the
risk of non-payment of interest cost which could potentially threaten its solvency.
2. Management may also use interest cover ratio to determine whether further debt financing
can be undertaken without taking unacceptably high financial risk.
3. Potential lenders and investors assess the interest cover ratio to determine the level of
security and risk associated with their investment or lending to the organization.
4. Interest cover ratio is also a regular feature of loan covenants requiring borrowers to maintain
a minimum level of interest cover failing which may impose the immediate settlement of
debt.
5.
Times Interest Earned ratio (TIE) is calculated as a company's earnings before interest and taxes
(EBIT) divided by the total interest payable (Interest Charges). This ratio measures the extent to
which operating income can decline before the firm is unable to meet its annual interest cost.
Times interest earned (TIE) Ratio calculated as follows
EBIT
Time-Interest-Earned Ratio =
Interest Charges
6. Table 6.10: The Time-Interest-Earned of Square Pharmaceuticals in different
years.
7.
Year EBIT Interest Charges Ratio
2010 2,825,069,243 98,632,312 28.6424
2011 3,414,752,310 108,051,810 31.6029
2012 3,978,939,088 164,275,534 24.2211
2013 4,481,047,443 52,420,522 85.4826

2013; 85.48

2011; 31.6
2010; 28.64
2012; 24.22

Figure 6.10: Graph shows the change of Time-Interest-Earned ratio.

8. Times Interest Earned analysis of Square Pharmaceuticals:
9.
10. Times Interest Earned or Interest Coverage is a great tool when measuring a company's
ability to meet its debt obligations. A lower times interest earned ratio means less earnings are
available to meet interest payments and that the business is more vulnerable to increase in
interest rates. Higher value of times interest earned ratio is favorable meaning greater ability of a
business to repay its interest and debt. Generally, companies would aim to maintain interest
coverage of at least 2 times. A very high interest cover may suggest the fact that the company is
not capitalizing on the relatively cheaper source of finance (i.e. debt) and in such instances an
increase in leveraging ratio may actually add value to the enterprise.
11.
PROFITABILITY RATIOS

Profitability ratios measure the company's use of its assets and control of its expenses to generate
an acceptable rate of return. Profitability is the net result of a number of policies and decisions.
Profitability ratios show the combined effects of liquidity, asset management and debt on
operating results. It is a group of ratios that show the combined effect of liquidity, asset
management, and debt management on operating results. It is the net result of a number of
policies and decisions. Profitability ratios show the combined effects of liquidity, asset
management, and debt on operating results.

Different types of Profitability ratios are discussed below:

1. Gross Profit Margin;

2. Net Profit Margin;
3. Return on Asset;
4. Return on Equity;
5. Operating profit margin;
6. Basic Earning Power Ratio.

Gross Profit Margin
Gross Profit Margin gives us the amount of Gross profit a firm is earning per taka of its sales.
Gross margin ratio is the ratio of gross profit of a business to its revenue. It is a profitability ratio
measuring what proportion of revenue is converted into gross profit (i.e. revenue less cost of
goods sold). Gross profit and revenue figures are obtained from the income statement of a
business.
Gross profit margin Ratio calculated as follows:

Gross Profit
Gross Profit Margin=
Sales
Table 6.12: The Gross Profit Margin of Square Pharmaceuticals in different years.
Year Gross Profit Sales Ratio
2010 4,901,289,925 11,462,578,410 0.427591
2011 5,767,763,459 13,471,424,469 0.428148
2012 6,887,171,623 16,054,425,243 0.428989
2013 7,736,011,423 17,959,489,496 0.430748
 2013;
0.4307

2012;
0.4290
2011;
0.4281
2010;
0.4276

Figure 6.12: Graph shows the change of Gross Profit Margin ratio.

Gross profit margin ratio analysis of Square pharmaceuticals:

Gross margin ratio measures profitability. The Gross Profit Margin has remained pretty much
stable throughout the whole three years. It increased very slowly each year. It indicates that
Square Pharmaceutical is managing its sales and gross profit very well. As sales were increasing
so were the gross profits.

Net Profit Margin of Square Pharmaceuticals:

Net Profit Margin tells you the net profit that the business is earning per taka of sales. Profit
Margin is the ratio measures net income per taka of sales and is calculated as net income divided
by revenues, or net profits divided by sales. It measures how much out of every taka of sales a
company actually keeps in earnings. Profit margin is very useful when comparing companies in
similar industries.
Net Profit Margin Ratio calculated as follows:

Net Income
Net Profit Margin=
Sales

Fable 12: The Net Profit Margin of Square Pharmaceuticals in different years

Year Net Income Sales Ratio

2010 2,087,871,791 11,462,578,410 0.182147
2011 2,532,054,550 13,471,424,469 0.187957
2012 2,897,710,641 16,054,425,243 0.180493
2013 3,341,424,783 17,959,489,496 0.186053
 2011; 0.1880

2013; 0.1861

2010; 0.1821
2012; 0.1805

Figure 6.11: Graph shows the change of Net Profit Margin ratio.
Net profit margin ratio analysis of Square Pharmaceuticals:
Profit margin is displayed as a percentage; 18.21% profit margin, for example, means the
company has a net income of Tk.0.1821 for Tk. 1 of sales. A higher profit margin indicates a
more profitable company that has better control over its costs compared to its competitors. The
main reason that the profit margin declined is high cost. High cost, in turn, generally occurs due
to inefficient operations. Profit margin also declined because in 2012 Square Pharmaceuticals
used a lot of long-term debt. This invariably resulted in more interest cost, which brought the Net
income down.

Return on Assets (ROA)

Return on assets is the ratio of annual net income to average total assets of a business during a
financial year. It measures efficiency of the business in using its assets to generate net income. It
is a profitability ratio. Return on Asset (ROA) is an indicator of a company which deals with
profit relative to its total assets. It gives an idea as to how efficient management is at using its
assets to generate earnings. It is calculated by dividing a company's annual earnings by its total
assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".

Gross profit margin Ratio calculated as follows:

Net Income
Returnon Asset=
Total Assets

Table 6.13: The Return on Total Assets of Square Pharmaceuticals in different years.

Year Net Income Total Assets Ratio

2010 2,087,871,791 15,029,500,278 0.138918
2011 2,532,054,550 19,444,409,654 0.13022
2012 2,897,710,641 21,453,784,762 0.135068
2013 3,341,424,783 23,447,645,506 0.142506
 2013; 0.1425

2010; 0.1389

2012; 0.1351

2011; 0.1302

Figure 6.13: Graph shows the change of Return on Total Assets ratio.

Return on total assets ratio analysis of Square Pharmaceuticals:

Return on total assets indicates the number of paisas earned on each taka of assets. Thus higher
values of return on assets show that business is more profitable. An increasing trend of ROA
indicates that the profitability of the company is improving. Conversely, a decreasing trend
means that profitability is deteriorating. This may have occurred in 2011 because it had used
more debt financing in 2011 compared to 2010 which resulted in more interest expenses and
brought the net income down.

Return on Equity (ROE)

Return on Equity (ROE) measures the rate of return on common stockholders’ equity. It
measures a company's profitability by revealing how much profit a company generates with the
money shareholders have invested. Return on Equity measures the amount of Net Income earned
by utilizing each taka of Total common equity. It is the most important of the “Bottom line”
ratio. By this, you can find out how much the shareholders are going to get for their shares.
Return on Equity (ROE) is equal to net income divided by common equity. Stockholders invest to
get a return on their money, and this ratio tells how well they are doing in an accounting sense.

Return on Equity (ROE) Ratio calculated as follows

Net Income
Return on Equity=
Shareholder s ' Equity

Table 6.14: The Return on Equity of Square Pharmaceuticals in different years.

Year Net Income Total Shareholder’s Ratio

Equity
2010 2,087,871,791 11,721,331,851 0.178126
2011 2,532,054,550 13,817,708,990 0.183247
 2012 2,897,710,641 16,266,884,255 0.178136
2013 3,341,424,783 18,844,746,184 0.177313

2011;
0.1832

2010; 2012;
0.1781 0.1781 2013;
0.1773

Figure 6.14: Graph shows the change of return on equity ratio.

Return on equity ratio analysis of Square Pharmaceuticals:

After doing the analysis from Square Pharmaceuticals limited financial statements it is shows in
the years 2010 to 2013, the return from 100 taka invested by the shareholders was respectively
17.81%, 18.32%, 17.81% and 17.73%. The higher the percentage is the better for the company as
well as for shareholders it also means that the company is efficient in generating income on new
investment. Square Pharmaceuticals limited had higher ROE in 2011, after 2011 their ROE
gradually decreased so it can be said that the rate of return from equity is almost constant at
around 18% which is quite good but investors may ask for higher return.

Operating Profit Margin

Operating margin ratio or return on sales ratio is the ratio of operating income of a business to its
revenue. It is profitability ratio showing operating income as a percentage of revenue. Operating
margin is a measurement of what proportion of company's revenue is left over after paying for
variable costs of production such as wages, raw materials, etc. A healthy operating margin is
required for a company to be able to pay for its fixed costs, such as interest on debt. Operating
income is same as earnings before interest and tax (EBIT).
Operating profit margin Ratio calculated as follows

Operting Income
Operating profit margin =
Sales

Table 6.15: The Operating profit margin of Square Pharmaceuticals in different years.

Year Operating income Sales Ratio

2010 2,380,757,879 11,462,578,410 0.207698
2011 2,751,605,397 13,471,424,469 0.204255
 2012 3,321,146,713 16,054,425,243 0.206868
2013 3,852,810,574 17,959,489,496 0.214528

2013; 0.2145

2010; 0.2077
2012; 0.2069

2011; 0.2043

Figure 6.15: Graph shows the change of Operating profit margin ratio.

Analysis of operating profit margin ratio of Square Pharmaceuticals:

Operating margin ratio of 20.77% means that a net profit of Tk.0.2077 is made on Tk.1 of sales.
Thus a higher value of operating margin ratio is favorable which indicates that more proportion
of revenue is converted to operating income. An increase in operating margin ratio overtime
means that the profitability is improving.

Basic Earning Power Ratio

Basic earnings power (BEP) is useful for comparing firms in different tax situations and with
different degrees of financial leverage. This ratio indicates the ability of the firm's assets to
generate operating income.
This ratio is often used as a measure of the effectiveness of operations. Basic Earning Power
measures the basic profitability of Assets because it excludes consideration of interest and tax.
This ratio should be examined in conjunction with turnover ratios to help pinpoint potential
problems regarding asset management.
Using EBIT instead of operating income means that the ratio considers all income earned by the
company, not just income from operating activity. This gives a more complete picture of how the
company makes money. Earnings before interest and taxes measure of a business's profitability.
Basic Earning Power Ratio calculated as follows:
EBIT
Basic Earning Power Ratio =
Total Assets

Table 6.16: The Basic Earning Power Ratio of Square Pharmaceuticals in different years
Year EBIT Total Assets Ratio
2010 2,825,069,243 15,029,500,278 0.762672
 2011 3,414,752,310 19,444,409,654 0.692817
2012 3,978,939,088 21,453,784,762 0.748326
2013 4,481,047,443 23,447,645,506 0.76594

2013; 0.19
2010; 0.19
2012; 0.19

2011; 0.18

Figure 6.16: Graph shows the change of Basic Earning Power ratio.

Analysis of the change of basic earning power ratio:

The higher the BEP ratio, the more effective a company is at generating income from its assets.
BEP, like all profitability ratios, does not provide a complete picture of which company is better
or more attractive to investors. Investors should favor a company with a higher BEP over a
company with a lower BEP because that means it extracts more value from its assets, but they
still need to consider how things like leverage and tax rates affect the company.

MARKET VALUE RATIO

Market value ratios measure investor response to owning a company's stock and also the cost of
issuing stock. These are concerned with the return on investment for shareholders, and with the
relationship between return and the value of an investment in company’s shares. Market value
ratios relate the firm’s stock price to its earnings, cash flow, and book value per share, and thus
give management an indication of what investors think of the company’s past performance and
future prospects. If the liquidity, asset management, debt management, and profitability ratios
all look good, then the market value ratios will be high, and the stock price will probably be as
high as can be expected.
Market value ratio is a set of ratio that relates the firm’s stock price to its earnings and book
value per share. These ratios give management an indication of what investors think of the
company’s past performance and future prospect. If the firm’s liquidity, asset management, debt
management, and profitability ratios are all good then market value ratios will be high which will
lead to an increase in the stock price of the company.
Different types of Market Value ratios are discussed below
1. Price/Earnings Ratio (P/E)
2. Market/Book Ratio (M/B)
Earnings per Share (EPS)

Earnings per Share (EPS) are the portion of a company's profit allocated to each outstanding
share of common stock. It serves as an indicator of a company's profitability. It is generally
considered to be the single most important variable in determining a share's price. It is also a
major component used to calculate the price-to-earnings valuation ratio.
Earnings per Share (EPS) Ratio calculated as follows:
Net Earning
Earnings per share (EPS) =
Number of Shares
Table 6.17: The Earnings per Share (EPS) of Square Pharmaceuticals in different years.
Year Net Earning Numbers of Shares EPS (Taka)
2010 2,087,871,791 15,090,3000 13.83585
2011 2,532,054,550 19,617,3900 12.90719
2012 2,897,710,641 264,834,760 10.94158
2013 3,341,424,783 370,768,664 9.012155

2010; 13.84
2011; 12.91

2012; 10.94

2013; 9.01

Figure 6.17: Graph shows the change of Earnings per Share (EPS) ratio.

Analysis of the change of earning per share ratio:

EPS of Square Pharmaceuticals limited has been decreasing rate over the years. This is not good
news because this will not help to attract the investors and thus the company can collect more
money from stock market.
Advantage and advantages of using EPS
EPS is the profit obtained by the company after tax but before the dividend preference share
divided by the weighted average number of outstanding ordinary shares during the period and its
very useful in measuring company performance and profitability in future.
Advantages: EPS is very easy to compute its value and comparing with the previous period in
performance. EPS helps in measuring performance of the company by bringing the sign
indicators of company to continue with business. EPS is considering the time factor by taking the
current time in measuring performance in relation to the extracted data.
Disadvantages: EPS is too difficult to obtain the exact numbers of ordinary shares outstanding
during the period. EPS refers to previous information on making decision of performance of the
organization in future where it’s seems that it’s not bring realistic due to the economic factors
change. EPS can be affected by changes in a company’s accounting policy. EPS yields growth
percentages that can be misleading or meaningless when based on small base or negative
earnings from a prior period. EPS will be distorted if a company conducts a share buy-back.
(When a company repurchases its own shares it thereby reduces the number of shares in issue,
which automatically increases its EPS figure). EPS takes no account of a company’s debt
position and financial leverage, factors that a discerning investor needs to be aware of.
Given the above limitations of EPS, it’s clear that this measure should not be used in isolation.

Price/Earning (P/E) Ratio

This is the ratio of the price per share to earnings per share. It shows how much investors are
willing to pay per taka of reported profit.

Price/Earning (P/E) Ratio calculated as follows:

Market Price Per Share

P/E Ratio =
Earning per Share
Table 6.18: The Price/Earning (P/E) Ratio of Square Pharmaceuticals in different years

Year Market Price Per Share Earnings Per EPS (Taka)

(DSE) Share
2010 358.1 13.83585 25.88204
2011 327.2 12.90719 25.35021
2012 237.30 10.94158 21.68791
2013 178.60 9.012155 19.81768
 2010; 25.88 2011; 25.35

2012; 21.69
2013; 19.82

Figure 6.18: Graph shows the change of Price/Earning (P/E) ratio.

Analysis of the change of P/E ratio:

From the above graph, the price/earnings ratio of Square Pharmaceuticals is significantly
decrease over the years which are an alarming signal for the potential investors. The investors
willing to pay 25.88 taka for earning 1 taka profit from the company. This low P/E Ratio means
that Square Pharmaceuticals has a very low growth potential.

Book Value per Share

Common stockholders' equity is determined on a per-share basis. Book value per share is
calculated by subtracting liabilities and the par value of any outstanding preferred stock from
assets and dividing the remainder by the number of outstanding shares of stock.

Book Value per Share Ratio calculated as follows

Equity
Book Value per Share =
Number of Shares Outstanding

Table 6.19: The Book Value per Share of Square Pharmaceuticals in different years

Year Equity Numbers of Shares Book Value per Share

(Taka)
2010 11,721,331,851 15,090,3000 77.67461
2011 13,817,708,990 19,617,3900 70.43602
2012 16,266,884,255 264,834,760 61.42277
2013 18,844,746,184 370,768,664 50.82616
 2010; 77.67
2011; 70.44

2012; 61.42

2013; 50.83

Figure 6.19: Graph shows the change of Book Value per share ratio.

Analysis of the change of book value per share ratio:

The book value per share of Square Pharmaceuticals limited is decreasing over the years from
2010 to 2013 and decreasing trend of Square Pharmaceuticals limited in book value per share is a
bad indicator for the company. But you must keep that in mind that Square Pharmaceutical has
issued 30% stocks in 2013 and 40% stocks in 2012 which simply means if an investor has got
100 shares in 2011 then he would have 140 shares in 2012 and 182 shares in 2013. So, the book
value per share may be falling from 2010 but it is not actually falling due to the increase in
number of shares.
Market/Book (M/B) Ratio:
The Market/Book Ratio refer to the company market value per share to its book value per share.
It indicates management success in creating value for its stockholders. The ratio of a stock’s
market price to its book value gives another suggestion of how investors regard the company.
Companies with relatively high rates of return on equity generally sell at higher multiples of
book value than those with low returns.

The formula for Market/Book Value is given below:

Market Price Per Share

Market/Book (M/B) Ratio =
Book Value Per Share

Table 6.20: The Market/Book (M/B) Ratio of Square Pharmaceuticals in different years.

Year Market Price Per Share Book Value per Share M/B
(Taka)
2010 358.1 77.67461 4.610258
2011 327.2 70.43602 4.64535
2012 237.30 61.42277 3.863388
 2013 178.60 50.82616 3.513938

2010; 4.61 2011; 4.65

2012; 3.86
2013; 3.51

Figure 6.20: Graph shows the change of Market/Book value (M/B) ratio.

Analysis of the change of market to book value ratio:

The above graph shows the market to book value per share of Square pharmaceuticals limited
from 2010 to 2013. The first two years Market/Book (M/B) ratio has increased which means
Investors are willing to pay more for the book value.

The main reason behind the decline of M/B ratio is the issuance of more shares as stock
dividend. Price of the share of Square Pharmaceuticals may fall for several reasons. Failing to
meet market expectations is one of the main reasons for the market to lose interest in a share and
also the whole share market crashes in 2010 which still maintained its bear trend. Shares are
usually valued according to what investors reckon the company would do in future. Therefore,
when a business fails to meet those expectations then it is not unreasonable for investors to
reconsider their position.

Receivables Turnover and Receivable Collection Period

In addition to examining total liquid assets relative to near-term liabilities, it is useful to analyze
the quality (liquidity) of the accounts receivables. One way to do this is to calculate how often
the company’s turnover, which implies an average collection period. The faster these accounts
are paid, the sooner the company gets the funds that can be used to pay off its own current
liabilities.

Receivables turnover is computed as follows:

 Net Annual Sales
Receivable Turnover =
Average Receivables

Figure 6.21: The Receivable Turnover of Square Pharmaceuticals in different years.

Year Net Annual Sales Average Receivable RT

2010 13,279,141,757 (508,249,174+ 477,562,002)/2 26.94054
2011 15,576,487,536 (508,249,174+ 772,421,345)/2 24.32552
2012 18,592,856,236 (808,311,714 + 772,421,345)/2 23.52435
2013 20,742,746,372 (808,311,714 + 800,974,912)/2 25.77881

Given these annual receivables turnover figures, an average collection period is as follows:

365
Average Receivable Collection Period =
Receivable Turnover

Table 6.21: The Receivable Collection Period of Square Pharmaceuticals in different years

Year Receivable Collection Period RCP

2010 365/26.94054 13.54836
2011 365/24.32552 15.00482
2012 365/23.52435 15.51584
2013 365/25.77881 14.15892

Interpretation

These results indicate that square pharmaceuticals collected its accounts receivables in about 14
days on average and collection period had increased slightly over the recent years. To determine
whether these receivables collection numbers are good or bad, it is essential that they be related
to the company’s credit policy and to comparable collection figures for other companies in the
industry.

Average Annual Turnover

Other current assets that should be examined in terms of its liquidity are inventory based upon
the company’s average Annual Turnover and implied processing time. Average Annual Turnover
can be calculated relative to sales or cost of goods sold. The preferred turnover ratio is relative to
cost of goods sold because it does not include the profit implied in sales.

The average annual inventory turnover ratio is computed as:

 Cost of Goods Sold
Average Annual Turnover =
Average Inventory

Table 6.22: The Average Annual Turnover of Square Pharmaceuticals in different years.

Year Cost of goods Average Inventory Ratio

Sold
2010 6,561,288,485 (2,207,078,082 + 2,098,755,231)/2 3.047627722
2011 7,703,661,010 (2,541,688,329 + 2,207,078,082)/2 3.244489344
2012 9,167,253,620 (2,687,818,472 + 2,541,688,329)/2 3.50597254
2013 10,223,478,073 (2,503,683,240 + 2,687,818,472)/2 3.938543659

Given the turnover values, compute the average processing time as follows:

365
 Average Inventory Processing Period =
Average Annual Turnover

Table 6.23: The Inventory Processing Period of Square Pharmaceuticals in different years

Year Average Inventory Processing IPP

Period
2010 365/3.047627722 119.7653
2011 365/3.244489344 112.4984
2012 365/3.50597254 104.1081
2013 365/3.938543659 92.67385

Interpretation

This seems like a good turnover figure but it is essential to examine this figure relative to an
industry norm and/or the company’s prime competition. An abnormally high Average Annual
Turnover could mean inadequate inventory that could lead to outages, backorders, and slow
delivery to customers .On the other hand, low Average Annual Turnover value and processing
time indicate that capital is being tied up in inventory and could signal obsolete inventory.

Payable Turnover Ratio:

12. Accounts payable turnover is the ratio of net credit purchases of a business to its average
accounts payable during the period. It measures short term liquidity of business since it shows
how many times during a period, an amount equal to average accounts payable is paid to
suppliers by a business. Accounts payables turnover trends can help a company assess its cash
situation.

For square pharmaceutical Ltd the Payable Turnover Ratio as follows:

 Cost of Good Sold
Payable Turnover Ratio =
Average Trade Payable

Table 6.24: The Payable Turnover Ratio of Square Pharmaceuticals in different years.

Year Cost of goods Average Trade Payable Ratio

Sold
2010 6,561,288,485 (394,715,915 + 124,222,699)/2 25.28733961
2011 7,703,661,010 (394,715,915 + 733,369,218)/2 13.65794262
2012 9,167,253,620 (733,369,218 + 875,431,555)/2 11.39638142
2013 10,223,478,073 (875,431,555 + 1,086,097,881)/2 10.42398639

Given the payable turnover values, compute the Payable Payment Period as follows:

365
Payable Payment Period =
Payable Turnover

Table 6.25: The Payable Payment Period of Square Pharmaceuticals in different years

Year Payable Payment Period PPP

2010 365/25.28733961 14.4341
2011 365/13.65794262 26.72438
2012 365/11.39638142 32.02771
2013 365/10.42398639 35.01539

Interpretation

13. A higher value indicates that the business was able to repay its suppliers quickly. Thus
higher value of accounts payable turnover is favorable. This ratio can be of great importance to
suppliers since they are interested in getting paid early for their supplies. Other things equal, a
supplier should prefer to sell to a company with higher payable turnover ratio.
14.
DUPONT ANALYSIS
A method of performance measurement that was started by the DuPont Corporation in the 1920s.
With this method, assets are measured at their gross book value rather than at net book value in
order to produce a higher return on equity (ROE). It is also known as “DuPont identity”.

DuPont analysis tells us that ROE is affected by three things:

1) Operating efficiency, which is measured by profit margin

2) Asset use efficiency, which is measured by total asset turnover
3) Financial leverage, which is measured by the equity multiplier.
ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity
Multiplier (Assets/Equity)

 Net Profit margin is a measure of the firm’s operating efficiency – how well it controls costs
 Total asset turnover is a measure of the firm’s asset use efficiency – how well it manages its
assets
 Equity multiplier is a measure of the firm’s financial leverage.

Benefits of DuPont Analysis:

The DuPont analysis is an excellent method to determine the strengths and weaknesses of a firm.
A low or declining ROE is a signal that there may be a weakness. However, using the analysis
you can better determine the source of weakness. Asset management, expense control,
production efficiency or marketing could be potential sources of weakness within the farm.
Expressing the individual components rather than interpreting ROE itself may identify these
weaknesses more readily.

15. There are basically four major reasons for an effective financial statement analysis. These
have been mentioned as follows:

 It is useful for long-run business viability so as to determine whether a firm would be able to
provide adequate business return when compared to the amount of risks taken. This is
essential for outside investors.
 It is also used by creditors so as to find out whether a potential buyer has the capability to
service the loans that are being made or not.
 Also, the analysts concerned about the internal development of a firm, require financial
statement analysis so as to monitor the outcome as a result of applying the policy decisions,
to make future predictions with regard to the performance targets, and also make an
assessment of the capital needs of a company.
 The function of DuPont analysis in this is that it is used as a tool to provide an overview of
financial statement analysis for the purposes as stated and also provide a focus for such
analysis.

RN Spinning Mills Ltd.

DuPont Analysis: Information is given below:

[ Data is collected from the financial statements of RN Spinning Mills limited from 2007-2010]

Year 2010 2009 .

Total Asset = 2544928382 7376555662
Net Income = 539284833 120189188
Total Equity = 2159976817 1620691984
Sales = 2085432500 1147456701
ROE = Net Income / Total Equity
Year 2010 2009 .
ROE = 539284833/2159976817 = 120189188/1620691984
=24.97% =7.42%
Year 2008 2007 .
ROE = 82460563/1200502796 = 8499632/681692233
= 6.87% = 1.25%
In 2007, ROE=1.25%, in 2008 ROE=6.87%,and in 2009, ROE=7.42% means, by using the
shareholder’s equity RN spin generated 1.25% profit in 2007, 6.87% in 2008, 7.42% in
2009.That means,the company gradually increases its return on equity.
But in 2010, ROE=24.97% means, by using the shareholder’s equity RN spin generated 24.97%
profit. Thatmeans, the company made 24.97Tk profit for every 100Tk of shareholder’s equity.
It indicates that the company’s performance on generating profit is significantly improved in
2010 from 2007.
ROE Disaggregation = (NI / Sales) * (Sales / Total Asset) * (Total Asset / Total Equity)
Year 2010 2009 .
ROE D = (539284833/2085432500) * = (120189188/1147456701) *
(2085432500/2544928382) * (1147456701/7376555662) *
(2544928382/2159976817) (7376555662/1620691984)
=0.2586*0.8194*1.1782 =0.1047*0.1556*4.5515
= 24.97% = 7.42%
Year 2008 2007 .
ROE D = (82460563/1040508594) * = (8499632 / 376950237) *
(1040508594/1500416351) * (376950237/1129411333*
(1500416351/1200502796) (1129411333/681692233)

= 0.07925*0.6935*1.2498 = 0.0225 * 0.3338 * 1.6568 = 6.87%

= 1.25%
From the disaggregated figure of ROE, you can see that from 2007 to 2008, the company
decreased its leverage ratio but increased the other two ratios by which it increased its ROE.

From 2008 to 2009, the company improved its ROE by significantly increasing leverage ratio in
2009; the company’s financial leverage was very high compare to other two ratios. But in 2010,
leverage ratio is decreased but other two ratios are increased.
In 2010, both net profit margin and asset turnover is increased which mainly increases the
company’s return on equity.
Increase of net profit margin indicates the company’s operating efficiency is improved and
increase of asset turnover indicates the company’s improvement in asset utilization ability.
That means the company’s significant improvement in net profit margin and asset turnover
mainly increases the company’s ability to generate profit from shareholder’s equity.
Managers and investors repeatedly find themselves in a situation of necessity to make decisions
based on economically right data. Furthermore time for decision making is sharply limited.
However, understanding financial statements is of great importance. Thus it is essential to
examine the following methods: horizontal and vertical analysis.
Horizontal (Trend) analysis of financial statements:
Horizontal analysis of financial statements involves comparison of a financial ratio, a
benchmark, or a line item over a number of accounting periods. This method of analysis is also
known as trend analysis. Horizontal analysis allows the assessment of relative changes in
different items over time. It also indicates the behavior of revenues, expenses, and other line
items of financial statements over the course of time.
Accounting periods can be two or more than two periods. Accounting period can be a month, a
quarter or a year. It will depend on the analyst’s discretion when choosing an appropriate number
of accounting periods. During the investment appraisal, the number of accounting periods for
analysis is based on the time horizon under consideration.
Horizontal analysis of financial statements can be performed on any of the item in the income
statement, balance sheet and statement of cash flows. For example, this analysis can be
performed on revenues, cost of sales, expenses, assets, cash, equity and liabilities. It can also be
performed on ratios such as earnings per share (EPS), price earnings ratio, dividend payout, and
other similar ratio.

Horizontal analysis can be performed in one of the following two different methods i.e. absolute
comparison or percentage comparison.
Absolute Comparison:
One way of performing horizontal analysis is comparing the absolute currency amounts of some
items over the period of time. For example, cash in hand at the end of an accounting period can
be compared to other accounting periods. This method is helpful in identifying the items which
are changing the most.
Percentage Comparison:
In the second method of horizontal analysis, percentage differences in certain items are
compared over a period of time. The absolute currency amounts are converted into the
percentages for the purpose of comparison. For example, a change in cash from Tk.5,000 to
Tk.5,500 will be reported as 10% increase in cash. It can also be reported as 110%, which means
that the cash is 110% of the cash at the end of previous accounting period. This method is useful
when comparing performance of two companies of different scale and size.
Vertical analysis of financial statements:
Vertical analysis of financial statements is a technique in which the relationship between items
in the same financial statement is identified by expressing all amounts as a percentage a total
amount. This method compares different items to a single item in the same accounting period.
The financial statements prepared by using this technique are known as common size financial
statements.

This analysis is performed on the income statement as well as the balance sheet.
Balance Sheet:
When applying this method on the balance sheet, all of the three major categories accounts (i.e.
assets, liabilities, and equity) are compared to the total assets. All of the balance sheet items are
presented as a proportion of the total assets. These percentages are shown along with the absolute
currency amounts. For example, suppose a company has three assets; cash worth Tk.4 million,
inventory worth Tk.7 million and fixed assets worth Tk.9 million. The vertical analysis method
will show these as:
Cash: 20%
Inventories: 35%
Fixed Assets: 45%
Income Statement:
And when applying this technique to the income statement, each of the expense is compared to
the total sales revenue. The expenses are presented as a proportion of total sales revenue along
with the absolute amounts. For example, if the sales revenue of a company is Tk.10 million and
the cost of sales is Tk.6 million, the cost of sales will be reported as 60% of the sales revenue.
The main advantage of using vertical analysis of financial statements is that income statements
and balance sheets of companies of different sizes can be compared. Comparison of absolute
amounts of companies of different sizes does not provide useful conclusions about their financial
performance and financial position.
Usually the vertical analysis is performed for a single accounting period to see the relative
proportions of different account balances. But it is also useful to perform vertical analysis over a
number of periods to identify changes in accounts over time. It can help to identify unusual
changes in the behavior of accounts. For example, if the cost of sales has been consistently 45%
in the history, then a sudden new percentage of 60% should catch the attention of analysts.
Reasons behind this change should be investigated and then measures should be taken to bring
this percentage back to its normal level. 

SUMMARY:
This chapter provides information for external users (primarily investors and creditors) to
support investment, credit, and other decisions as well as internal users like managers.
Different groups of users of financial statements are interested in different aspects of a
company's financial activities. Short-term creditors are interested primarily in the company's
ability to make cash payments in the short term; they focus their attention on operating cash
flows and current assets and liabilities. Long-term creditors, on the other hand, are more
interested in the company's long-term ability to pay interest and principal and would not limit
their analysis to the company's ability to make cash payments in the immediate future. The focus
of common stockholders can vary from one investor to another, but generally stockholders are
interested in the company's ability to pay dividends and increase the market value of the stock of
the company. Each group may focus on different information in the financial statements to meet
its unique objectives.
Financial ratio analysis helps to evaluate the performance of a firm within itself and with the
industry. Normally it is benchmarked with the past financial performance of the company and
also with the industry. One of the unique thing about financial ratios is it adjusts for size
differences but not easy to accommodate/identify a firm in a industry. Different accounting
methods and seasonality factor forbids the perfect comparison and so it should be used as a
guidelines.
SQUARE PHARMACEUTICALS LTD.
INCOME STATEMENT

2011-2012 2010-2011 2009-2010

 Taka Taka Taka
Notes
GROSS TURNOVER 22 18,592,856,236 15,576,487,536 13,279,141,757
Less: Value Added Tax 2,538,430,993 2,105,063,067 1,816,563,347
NET TURNOVER 16,054,425,243 13,471,424,469 11,462,578,410
COST OF GOODS SOLD 23 (9,167,253,620) (7,703,661,010 (6,561,288,485)
)
GROSS PROFIT 6,887,171,623 5,767,763,459 4,901,289,925
Operating Expenses: (3,566,024,910) (3,016,158,062 (2,520,532,046)
)
Selling and Distribution Expenses 27 (2,430,466,795) (2,121,163,004 (1,687,210,447)
)
Administrative Expenses 28 (701,977,079) (626,145,987) (524,460,492)
Financial Expenses 29 (433,581,036) (268,849,071) (308,861,107)
PROFIT FROM OPERATIONS 3,321,146,713 2,751,605,397 2,380,757,879
Other Income 30 856,739,329 833,884,528 585,564,826
PROFIT BEFORE WPPF 4,177,886,042 3,585,489,925 2,966,322,705
Allocation for WPPF 31 (198,946,954) (170,737,615) (141,253,462)
PROFIT BEFORE TAX 3,978,939,088 3,414,752,310 2,825,069,243
Provision for Income Tax 32 (958,906,349) (805,575,198) (688,499,602)
Provision for Deferred Income Tax 15 (122,322,098) (77,122,562) (48,697,850)
PROFIT AFTER TAX FOR THE 2,897,710,641 2,532,054,550 2,087,871,791
YEAR
Other Comprehensive Income:
Gain/(Loss) on Marketable Securities 5 139,986,324 92,483,089 71,664,526
(Unrealized)
Total Comprehensive Income for the 3,037,696,965 2,624,537,639 2,159,536,317
Year
Earnings Per Share (EPS) 33 10.94 9.56 10.643
Number of Shares used to compute 264,834,760 264,834,760 196,173,900
EPS

SQUARE PHARMACEUTICALS LTD.

STATEMENT OF CASH FLOWS

2011-2012 2010-2011 2009-2010

Taka Taka Taka
Cash Flows From Operating Activities:
RECEIPTS:
Collection from Sales 18,579,768,546 15,264,808,445 11,401,786,553
Others 502,928,943 459,857,859 448,178,202
19,082,697,489 15,724,666,304 11,849,964,755
PAYMENTS:
Purchase of Raw and Packing Materials 6,951,917,263 5,972,234,287 4,993,049,492
Manufacturing and Operating Expenses 4,385,178,403 3,593,791,950 2,942,764,932
Value Added Tax 2,538,430,993 2,105,063,067
Bank Interest 433,581,036 268,849,071 308,861,107
Income Tax 923,732,161 802,383,301 855,888,639
Workers Profit Participation Fund 204,846,890 88,284,100 82,353,560
Others 10,673,726 3,529,132
15,437,686,746 12,841,279,502 9,186,446,862
Net cash provided by operating activities 3,645,010,743 2,883,386,802 2,663,517,893
Cash Flows From Investing Activities:
Purchase of Fixed Assets (2,904,446,492) (2,228,959,849) (1,464,938,454)
Disposal of Fixed Assets 112,246,104 17,536,162 12,475,331
Investment in Square Formulations Ltd. (901,392)
Investment in Central Depository Bangladesh 28,472,150 (34,166,580)
Ltd.
Investment in Orascom Telecom Bangladesh 10,000,000 (10,000,000) (40,000,000)
Ltd.
Investment in Square Biotechs Ltd. 418,000,000
Investment in Square Knit Fabrics Ltd. 92,000,000
Investment in Square Fashions Ltd. 48,000,000
Investment in Marketable Securities (10,592,718) (49,013,434) (213,679,839)
Loan to Sister Concerns 728,511,222 (1,593,074,391) (527,579,221)
Capital Work-in-Progress (386,806,375) (253,237,104) (634,347,093)
Sale of Marketable Securities 125,126,871 15,671,905
Interest Received 252,604,901 171,776,894 69,421,514
Dividend Received 89,900,935 80,196,827 58,144,341
Net cash used in investing activities (2,081,011,665) (3,773,814,604) (2,166,831,516)
Cash Flows From Financing Activities:
Long Term Loan Received 419,919,621 114,435,352 1,091,897,800
Long Term Loan Repaid (567,845,748) (475,313,006) (342,522,688)
Short Term Bank Loan Decrease (610,932,739) 1,891,040,016 (797,901,934)
Dividend Paid (588,521,700) (528,160,500) (482,889,600)
Net cash used in financing activities (1,347,380,566) 1,002,001,862 (531,416,422)
Increase in Cash and Cash Equivalents 216,618,512 111,574,060 (34,730,045)
Cash and Cash Equivalents at the Opening 370,301,755 258,727,695 293,457,740
Cash and Cash Equivalents at the Closing 586,920,267 370,301,755 258,727,695

SQUARE PHARMACEUTICALS LTD.

BALANCE SHEET
31-03-2012 31-03-2011 31-03-2010
Taka Taka Taka
ASSETS: Note
s
Non-Current Assets: 14,708,277,75 12,422,195,81 10,643,410,336
4 4
Property, Plant and Equipment- 2 8,767,827,062 6,981,559,781 5,630,791,822
Carrying Value
Capital Work-in-Progress 3 1,274,390,572 887,584,197 634,347,093
Investment - Long Term (at Cost) 4 3,971,022,723 4,031,751,281 3,990,050,169
Investment in Marketable Securities 5 695,037,397 521,300,555 388,221,252
(Fair Value)
Current Assets: 6,745,507,008 7,022,213,840 4,553,041,968
Inventories 6 2,687,818,472 2,541,688,329 2,207,078,082
Trade Debtors 7 808,311,714 772,421,345 508,249,174
Advances, Deposits and 8 577,156,445 523,991,079 358,250,076
Prepayments
Short Term Loan 9 2,085,300,110 2,813,811,332 1,220,736,941
Cash and Cash Equivalents 10 586,920,267 370,301,755 258,727,695
TOTAL ASSETS 21,453,784,76 19,444,409,65 15,196,452,304
2 4
SHAREHOLDERS' EQUITY
AND LIABILITIES:
Shareholders' Equity: 16,266,884,25 13,817,708,99 11,721,331,851
5 0
Share Capital 11 2,648,347,600 1,961,739,000 1,509,030,000
Share Premium 12 2,035,465,000 2,035,465,000 2,035,465,000
General Reserve 105,878,200 105,878,200 105,878,200
Tax Holiday Reserve 13 1,101,935,237 1,101,935,237
Gain on Marketable Securities 5 399,421,439 259,435,115 166,952,026
(Unrealized)
Retained Earnings 11,077,772,01 8,353,256,438 6,802,071,388
6
Non-Current Liabilities: 933,965,662 958,511,238 1,258,376,052
Long Term Loans - Secured 14 508,778,060 655,645,734 1,032,633,110
Deferred Tax Liability 15 425,187,602 302,865,504 225,742,942
Current Liabilities: 4,252,934,845 4,668,189,426 2,216,744,401
Short Term Bank Loans 16 2,016,551,125 2,627,483,864 736,443,848
Long Term Loans - Current Portion 17 477,141,480 478,199,933 462,090,211
Trade Creditors 18 875,431,555 733,369,218 394,715,915
Liabilities for Expenses 19 95,361,435 79,499,584 56,463,570
Liabilities for Other Finance 20 788,449,250 749,636,827 567,030,857
TOTAL LIABILITIES 5,186,900,507 5,626,700,664 3,475,120,453
TOTAL SHAREHOLDERS' 21,453,784,76 19,444,409,65 15,196,452,304
EQUITY AND LIABILITIES 2 4

Exercises with solution:

Example 1: A company has following assets and liabilities at the year ended December 31,
2013:

Cash ৳ 34,390
Marketable Securities 12,000
Accounts Receivable 56,200
Inventory 9,000
Total Current Assets 111,590
Total Current
73,780
Liabilities
Calculate quick ratio (acid test ratio).

Solution:
Quick ratio = (34,390 + 12,000 + 56,200) / 73,780 = 102,590 / 73,780 = 1.39
Or,
Quick ratio = ( 111,590 − 9,000 ) / 73,780 = 102,590 / 73,780 = 1.39.

Example 2: Calculate quick ratio from the following information:

Cash ৳ 21,720
Treasury Bills 18,500
Accounts Receivable 15,930
Prepaid Rent 6,500
Inventory 17,240
Total Current Assets 79,890
Total Current
52,960
Liabilities
Solution:
In this example, treasury bills are marketable securities thus we will calculate quick ratio as
follows:
Quick ratio = ( 79,890 − 6,500 − 17,240 ) / 52,960 = 56,150 / 52,960 = 1.06
or
Quick ratio = ( 21,720 + 18,500 + 15,930 ) / 52,960 = 56,150 / 52,960 = 1.06

Example 3: Total liabilities of a company are ৳267,330 and total assets are ৳680,400. Calculate
debt ratio and interpret what does it mean?
Solution:
Debt ratio =৳ 267,330/৳680,400 = 0.393 or 39.3%. It means for every ৳100 asset the firm has
39.3 taka long term debt.
Example 4: Current liabilities are ৳34,600; Non-current liabilities are ৳200,000; and Total
assets are ৳504,100. Calculate debt ratio.
Solution:
Since total liabilities are equal to sum of current and non-current liabilities therefore,
Debt Ratio = (34,600 + 200,000) / 504,100 = 0.465 or 46.5%.

Example 5: Calculate debt-to-equity ratio of a business which has total liabilities of ৳3,423,000
and shareholders' equity of ৳5,493,000.
Solution:
Debt-to-Equity Ratio = 3,423,000 / 5,493,000 ≈ 0.62.

Example 6: Total assets of Company ABC on July 1, 2012 and June 30, 2013 were ৳2,132,000
and ৳2,434,000 respectively. During the year ended June 30, 2013 it earned net income of
৳213,000. Calculate its return on assets ratio.
Solution:
Average Total Assets = ( 2,132,000 + 2,434,000 ) / 2 = 2,283,000
Return on Assets = 213,000 / 2,283,000 ≈ 0.09 or 9%.
Example 7: Total liabilities and total equity of Company ABC on Dec 31, 2012 were ৳942,000
and ৳1,610,000 respectively. During the year ended Dec 31, 2013 the company earned net
income of ৳315,000. What were the total assets of the company on Jan 1, 2012 given that its
ROA for the year was 0.12?
Solution:
Step 1: Average Total Assets = Net Income / ROA = 315,000 / 0.12 = 2,625,000

Step 2: Ending Total Assets = 942,000 + 1,610,000 = 2,552,000

Step 3: Beginning Total Assets = ( 2 × 2,625,000 ) − 2,552,000 = 2,698,000.

Example 8: Company X earned net income of ৳1,722,000 during the year ending march 31,
2011. The shareholders' equity on April 30, 2010 and March 31, 2011 was ৳14,587,000 and
৳16,332,000 respectively. Calculate its return on equity for the year ending March 31, 2011.
Solution:
Average Shareholders' Equity = (14,587,000 + 16,332,000 ) / 2 = 15,459,500
Return on Equity = 1,722,000 / 15,459,500 ≈ 0.11 or 11%.

Example 9: Total assets and total liabilities of Company ABC on Jan 1, 2012 were ৳2,342,000
and ৳1,383,000. During the year ended December 31, 2012 it made a net profit of ৳242,000 and
its shareholders' equity increased by ৳302,000. Calculate ROE of Company ABC.
Solution:

Step 1: Beginning Shareholders' Equity = 2,342,000 − 1,383,000 = 959,000

Step 2: Ending Shareholders' Equity = 959,000 + 302,000 = 1,261,000.

Step 3: Average Shareholders' Equity = (959,000 + 1,261,000) / 2 = 1,110,000.

Step 4: Return On Equity = 242,000 / 1,110,000 ≈ 0.22 or 22%.

Example 10: Company XYZ has total assets of ৳100 billion, beginning equity of ৳40 billion,
net income for the year of ৳10 billion and dividends paid during the year of ৳4 billion. Calculate
the equity multiplier.

Solution:
We calculate the equity multiplier as total assets divided by total equity.
Total assets are ৳100 billion
Total equity = beginning equity + net income − dividends
= ৳40 b + ৳10 b − ৳4 b = ৳46 billion.
Equity multiplier is hence ৳100 billion divided by ৳46 billion and it equals to 2.2.

Example 11: Company XYZ has debt to equity ratio of 2. Find the equity multiplier.
Debt/Equity = 2
Since debt = assets minus equity
(Assets − Equity)/Equity = 2
Assets − Equity = 2 Equity
Assets = 3 Equity
Assets/Equity = 3.

Hence, equity multiplier is 3.

Example 12: Calculate times interest earned ratio of Company ABC given that its interest
expense and earnings before interest an tax for the year ended Dec 31, 2013 were ৳239,000 and
৳3,493,000 respectively.
Solution:
Times Interest Earned = ৳3,493,000 / ৳239,000 = 14.6.

Example 13: The times interest earned ratio and earnings before interest and tax of Company
ABC were 9.34 and ৳1,324,400 during the year ended Jun 30, 2011. What was the interest
expense of the computer during the financial year?
Solution:

Interest Expense = ৳1,324,400 / 9.34 = ৳141,800.

Example 14: For the month ended March 31, 2011, Company X earned revenue of ৳744,200 by
selling goods costing ৳503,890. Calculate the gross margin ratio of the company.
Solution:

Gross margin ratio = (৳744,200 − ৳503,890) / ৳744,200 ≈ 0.32 or 32%.

Example 15: Calculate gross margin ratio of a company whose cost of goods sold and gross
profit for the period are ৳8,754,000 and ৳2,423,000 respectively.
Solution:

Since the revenue figure is not provided, we need to calculate it first:

Revenue = Gross Profit + Cost of Goods Sold
Revenue = ৳8,754,000 + ৳2,423,000
Revenue = ৳11,177,000

Gross Margin Ratio = ৳2,423,000 / ৳11,177,000 ≈ 0.22 or 22%.

State whether each of the following statements is True (T) or False (F)

1) Financial statements are an important source of information to shareholders and stakeholders.

2) Ratio Analysis is the only technique of analysis of financial statements.
3) In Common Size Statements, each item is expressed as a percentage of some common items
(total).
4) Liquidity Ratios help in analyzing the cash position of the firm.
5) In calculation of Acid Test Ratio, Inventory is included in current assets.
6) Debt-Equity Ratio is a measure of long-term solvency of a firm.
7) Return on Equity and Earnings per Share are one and the same thing.
8) DU PONT Analysis looks into the elements of profits.
9) Ratio Analysis provides the solution to the financial problems.
10) When computing return on common stockholders' equity, retained earnings should be
included as part of common stockholders' equity.
11) The gross margin percentage is computed by dividing the gross margin by total assets.
12) If a company's acid-test ratio increases, its current ratio will also increase.

MULTIPLE CHOICE QUESTIONS:

1) In the Balance sheet of a firm, the debt equity ratio is 2:1.The amount of long term sources is
Tk.12 lac. What is the amount of tangible net worth of the firm?
A) Tk.12 lac. B) Tk.8 lac C) Tk.4 lac. D) Tk.2 lac.
2) Profitability ratio measures:
A) the ability of the firm to earn an adequate return on sales, total assets, and invested capital.
B) the debt position of the firm in light of its assets and earning power.
C) the speed at which the firm is utilizing assets
D) the speed at which the firm is building inventories.
3) Asset utilization ratio measures:
A) the speed at which the firm is turning over its’ assets.
B) the ability of the firm to earn on adequate return on sales, total assets, and invested capital.
C) the ability of reducing assets to raise debt.
D) none of the above.
4) Under the Du Pont method of analysis, return on total assets is:
A) profit margin times assets turnover.
B) total assets times profit margin.
C) total assets times total equity
D) none of the above
5) Receivable turnover is
A) an asset utilization ratio.
B) a profitability ratio.
C) leverage ratio
D) none of the above.
6) __________ of the profitability of the firm over a period of time such as a year. 
A) The income statement is a summary
B) The balance sheet is a summary
C) The cash flow is a summary
D) Retain earnings is a summary
7) __________ a snapshot of the financial condition of the firm at a particular time. 
A) A balance sheet provides
B) A cash flow provides
C) An income statement provides
D) Retain earnings.
8) A firm's equity multiplier is an indication of its ________ position:
A) debt B) equity C) Asset utilization D) none.
9) Someone who is interested to invest in a company share is interested in ---------- ratio.
A) profitability B) liquidity C) asset utilization D) none.
10) To the bondholders the most important ratio is:
A) debt to total assets B) profitability C) asset utilization D) none.
11) Which of the following ratios would be least useful in determining a company's ability to pay
its expenses and liabilities?
A) current ratio.
B) acid-test ratio.
C) price-earnings ratio.
D) times interest earned ratio.
12) Most stockholders would ordinarily be least concerned with which of the following ratios:
A) earnings per share.
B) dividend yield ratio.
C) price-earnings ratio.
D) acid-test ratio.
13) ABC Company issued bonds with an interest rate of 10%. The company's return on assets is
12%. The company's return on common stockholders' equity would most likely:
A) increase B) decrease C) remain unchanged D) none
14) Deshial Company wrote off Tk.100,000 in obsolete inventory. The company's inventory
turnover ratio would:
A) increase. B) decrease. C) remain unchanged. D) none
15) XYZ Company's net income last year was Tk.60,000. The company paid preferred dividends
of Tk.10,000 and its average common stockholders' equity was Tk.480,000. The company's
return on common stockholders' equity for the year was closest to:
A) 10.4% B) 12.6% C) 8.2% D) none
16) Debt Equity Ratio is 3:1,the amount of total assets Tk.20 lac, current ratio is 1.5:1 and owned
funds Tk.3 lac. What is the amount of current asset?
A) 2:1 B) 1:1 C) 1:2 D) 3:1
17) In the balance sheet amount of total assets is Tk.10 lac, current liabilities Tk.5 lac and capital
& reserves are Tk.2 lac .What is the debt equity ratio?
A) 2:1 B) 1:1 C) 1:2 D) none.
18) If the interest rate on debt is higher than ROA, then a firm will __________ the ROE by
increasing the use of debt in the capital structure. 
A) decrease B) increase C) not change D) A & B
19) If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same as
ROA, then ROA will be ________. 
A) greater than the ROE
B) equal to the ROE
C) less than the ROE
D) none
20) Last year the current ratio was 3:1 and quick ratio was 2:1. Presently current ratio is 3:1 but
quick ratio is 1:1.This indicates comparably
A) higher liquidity B) lower liquidity C) higher stock D) lower stock

SHORT QUESTIONS:

1) What is the annual report, and what two types of information are given in it?
2) What major types of financial statements are typically included in the annual report?
3) Why is the annual report of great interest to investors?
4) What is the balance sheet, and what information does it provide?
5) What is an income statement, and what information does it provide?
6) What is the equity multiplier?
7) Does the fact that a company generates high cash flow necessarily mean that the amount of
cash reported on its balance sheet will also be high? Briefly explain.
8) Identify four factors that affect the company’s cash position as reported on the balance sheet.
9) What is the statement of cash flows, and what types of questions does it answer?
10) Identify and briefly explain the three different categories of activities shown in the statement
of cash flows.
11) Identify the key ratio that is used to analyze a firm’s liquidity position, and write out its
equation.
12) Why is the current ratio the most commonly used measure of short-term solvency?
13) Identify four ratios that are used to measure how effectively a firm is managing its assets, and
write out their equations.
14) How might rapid growth distort the inventory turnover ratio?

BROAD QUESTIONS:

1) Name three ratios that are used to measure the extent to which a firm uses financial leverage,
and write out their equations.
2) Describe three ratios that relate a firm’s stock price to its earnings, cash flow, and book value
per share, and write out their equations.
3) How do market value ratios reflect what investors think about a stock’s risk and expected
rate of return?
4) What does the P/E ratio show? If one firm’s P/E ratio is lower than that of another, what are
some factors that might explain the difference.
5) How is book value per share calculated? Explain how inflation and goodwill could cause
book values to deviate from market values?
6) Explain how the extended Du Pont equation can be used to reveal the basic determinants of
ROE?
7) How can management use the extended Du Pont equation to analyze ways of improving the
firm’s performance?
8) List three types of users of ratio analysis. Would the different users emphasize the same or
different types of ratios. Explain.
9) List several potential problems with ratio analysis.
10) If a firm takes steps to improve its ROE, does this mean that shareholders wealth will also
increase? Explain.
11) What are some qualitative factors analysts should consider when evaluating a company’s
likely future financial performance?
12) If a firm’s ROE is low and management wants to improve it, explain how using more debt
might help.
13) Why is it sometimes misleading to compare a company’s financial ratios with those of other
firms that operate in the same industry?
14) ABC inc. has a DSO of 45 days. The firm’s annual sales are 3 miilion taka. What is the level
of its accounts receivable? Assume there are 365 days in a year.
15) Vertex has an equity multiplier of 2.6.The firm’s assets are financed with some combination of ling-
term debt and common equity. What is the firm;s cost of equity.