Accounting Skill Session

FINANCIAL STATEMENT ANALYSIS

BASICS OF FINANCIAL STATEMENT ANALYSIS

 Analysing financial statements involves evaluating three

characteristics of a company:
1. its liquidity
2. its profitability
3. its solvency
COMPARATIVE ANALYSIS
 Three types of comparisons:
 Intracompany basis
 Intercompany basis
 Industry averages
 Three tools:
 Horizontal analysis
 Vertical analysis
 Ratio analysis
RATIO ANALYSIS
Liquidity Ratios
Measure short-term ability of the enterprise to pay its maturing
obligations and to meet unexpected needs for cash.

Revenues – Expenses = Net Income

Profitability Ratios
Measure the income or operating success of an enterprise for a given
period of time.

Solvency Ratios
Measure the ability of the enterprise to survive over a long period of
time.

LIQUIDITY RATIOS
 Current ratio
 Acid test ratio

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  Cash current debt coverage ratio
 Receivables turnover
 Collection period
 Inventory turnover
 Days sales in inventory

CURRENT RATIO
 Measures short-term debt-paying ability

Current Ratio =

ACID TEST RATIO

 Measures immediate short-term debt-paying ability

Acid test Ratio =

COLLECTED PERIOD
 Cash receivable in Days

Receivable in Days = Receivable x 365 Credit Sales

INVENTORY TURNOVER
 Measures liquidity of inventory

Inventory turnover =

PROFITABILITY RATIOS

 Book value per share

 Cash flow per share
 Earnings per share (EPS)
 Price-earnings (PE) ratio
 Payout ratio
 Dividend yield

2
  Profit margin
 Gross profit margin
 Cash return on sales
 Asset turnover
 Return on assets
 Return on common shareholders’ equity

NET PROFIT MARGIN

 Measures net income generated by each dollar or Rs of
sales

Profit Margin =

GROSS PROFIT MARGIN

 Measures margin between selling price and cost of goods

sold generated by each dollar of sales

Gross Profit Margin =

CASH RETURNS ON SALES

 Measures net cash flow generated by each dollar of sales

Cash Returns on Sales =

ASSETS TURNOVER

 Measures how efficiently assets are used to generate sales

Assets Turnover =

RETURN ON ASSETS

 Measures overall profitability of assets

3
 Return on Assets =

RETURN ON COMMON SHAREHOLDERS’ EQUITY

 Measures profitability of common shareholders’

investment

Return on common shareholders’ equity =

EARNINGS PER SHARE (EPS)

 Measures net income earned on each common share

Earnings per share =

4
PRICE-EARNINGS (PE) RATIO

 Measures relationship between market price per share and

earnings per share

Price-earnings ratio =

PAYOUT RATIO

 Measures % of earnings distributed in the form of cash

dividends

Payout ratio =

DIVIDEND YIELD

 Measures rate of return earned from dividends

Dividend Yield =

SOLVENCY RATIOS

 Debt to total assets

 Interest coverage
 Cash interest coverage
 Cash total debt coverage

DEBT TO TOTAL ASSETS

 Measures % of total assets provided by creditors

Debt to total assets =

INTEREST COVERAGE

5
  Measures ability to meet interest payments as they come
due

Interest coverage =

LIMITATIONS OF FINANCIAL ANALYSIS

 Estimates
 Historical cost
 Alternative accounting methods
 Atypical data
 Diversification