Financial accounting

for students of MSc in Finance (7AFIAC)

Financial accounting – specific topics –

Analysis with ratios

Mireille Durr
Analysing the performance of a company
▪ Annual reports include
▪ Introduction and explanations from the management on the
company, its competitors, its environment, specific events
occurred during the exercise
▪ Its strategy / targets and key indicators
▪ Financial statements, with accounting methods used
▪ Independent auditors’ opinion
👉 Have a look at the notes on sensitive items (receivables, inventory,
LT assets, cash... impacting the net result and ratios)
Analysing the performance of a company

▪ Analysis of the company’s figures

▪ Horizontal
▪ Evolution over the years
▪ Figures as shown or retreated as a percentage of the base-period
amount
▪ Vertical
▪ Shows the relationship of financial statement item to its base (Net
Sales usually for P&L ; Total assets for BS items)
▪ Useful when benchmarking with competitors

👉 Analyse trends within the company (over 3 years) and with industry
comparable
Analysing the efficiency of means allocated
Analysing the efficiency of means allocated
Ratios – working capital
▪ Working capital = current assets – current liabilities
▪ Ability to pay current liabilities with current assets

▪ Liquidity
▪ Current ratio = current assets / current liabilities
▪ Quick (Acid-test) ratio = (current assets – inventories) /
current liabilities
▪ Rotation
▪ Account receivable turnover = Net credit Sales /
Average net account receivable
▪ Inventory turnover = Cost of Goods Sold /
Average inventory
▪ Accounts payable turnover = Cost of Goods Sold /
Average accounts payable
Ratios – working capital
▪ Cash conversion cycle = DSO + DIO - DPO
▪ Days’ Sales Outstanding (DSO = time to collect receivables)
= 365 / Account Receivable Turnover
= (Account Receivable / Total Credit Sales) x 365
▪ Days’ Inventory Outstanding (DIO = time inventories are on
the shelves)
= 365 / Inventory turnover
= (Average inventory / CoGS) x 365
▪ Days’ Payable Outstanding (DPO = time to pay its providers)
= (Accounts Payable / CoGS) x 365
Ratios - debt
▪ Debt ratio
= Total liabilities (without Shareholders’ equity)
/ Total assets

▪ Times-interest-earned ratio
= Operational income / interest expense
Ratios - Profitability
▪ Gross (Profit) Margin Percentage
= Gross margin / Net sales
▪ Operating Income (Profit) Percentage
= Operating income / Net sales
▪ Asset Turnover
= Net sales / Average total assets
Ratios - Profitability
▪ Rate of Return on Assets (ROA)
= Rate of return on Sales x Asset turnover ratio
= (Net income / Net sales) x (Net sales / average Total assets)
▪ Leverage Ratio
= Average total assets / Average common stockholders’ equity
▪ Rate of Return on Common Stockholders’ Equity (ROE)
= (Net income – Preferred dividends)
/ Aver. common stockholders’ equity
Ratios – DuPont Analysis

▪ Analysis to understand how the ROE is generated

▪ Through Operating efficiency (Net profit margin ratio)
▪ Thanks to Asset use efficiency (Asset turnover ratio)
▪ With Financial leverage (Leverage ratio)
Ratios – for Share investors
▪ Earnings per Share of common stock (EPS)
= (Net income – Preferred dividend)
/ Average number of shares of common stock outstanding

▪ Price-Earnings ratio (P/E)

= Market price per share of common stock
/ Earnings per share

▪ Dividend yield
= Dividend per share of common stock
/ Market price per share of common stock