FINANCIAL ANALYSIS

Objectives of financial analysis

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To know the solvency of the firm To find out the strengths and weaknesses of the firm To make comparative study with other firms and intra-firm To know the capability of payment of interest and dividend To study the trend of business To know the efficiency of management To provide useful information to the management to make future decisions To find out the earning capacity or profitability

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Tools for financial analysis –
• • • • • • Comparative statements Common size statements Trend analysis Accounting ratios Cash flow statements Funds flow statements

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Comparative Statements

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• Financial statements figures for two or more years are placed side by side to facilitate comparison • Columns indicate increase or decrease in figures from one year to another or change as a percentage Utility – • To make data simpler and more understandable • To indicate the trend of • To indicate strong and weak points of business • To compare firm’s performance with average performance of the industry • To help in forecasting
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Ratio analysis

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Ratio analysis expresses the relationship between selected financial data. These relationships can be expressed as: • percentages • rates, or • proportions
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Liquidity Ratios
Current Ratio
– Current Assets/Current Liabilities
– Current Assets- e.g. Inventories, Debtors, Cash, Bank – Current Liabilities- Trade Creditors, Bills Payables, Bank overdraft

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Current Ratio

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As the current ratio measures the ability of the enterprise to meet its current obligations. The ideal current ratio is 2:1

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Liquidity Ratio
Quick Ratio – (Current Assets – Inventory- Prepaid Expenses)/Current Liabilities The Quick ratio is the more stringent measure of liquidity because inventories which are least liquid of current assets are excluded from the ratio.

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Liquidity Ratio
Net Working Capital Ratio
Net Working Capital/Net Assets NWC = Current Assets – Current Liabilities. Net Assets = Fixed assets + Current assets – Current Liabilities

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Turnover / Activity Ratios
Inventory turnover Ratio = Cost of Goods sold/Average Inventory,
Average. Inventory. = Opening +Closing Inventory/2

Average Collection Period= Average Inventory/Cost Of Goods Sold x 360,
COGS=Sales –Gross profit
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Turnover / Activity Ratios
Debtors/Account Receivables turnover Ratio = Credit Sales/Average Debtors
Average Debtors = Opening+ Closing Debtors/2

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Turnover / Activity Ratios
Average Collection Period = 360/Debtors Turnover Ratio

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Turnover / Activity Ratios
Creditors / Payable Turnover Ratio Creditors Turnover Ratio = Credit Purchases/ Average Creditors

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Turnover / Activity Ratios
Net Asset Turnover = Net Sales/Net Assets Total Asset Turnover = Net Sales/Total Assets Fixed Asset Turnover = Net Sales/Net Fixed Assets Current Assets Turnover = Net sales/Current Assets Working Capital Turnover = Net Sales/Net Working Capital

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Solvency Ratios
Debt to total funds Ratio = Total liabilities ------------------------- x 100 Total Assets Debt Equity Ratio = Long term Liabilities -------------------------x100 Net Worth
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Profitability Ratios
Gross profit Margin = (Sales-Cost Of Good Sold)/ Net Sales Net Profit Margin = Net Profit/ Net Sales Operating Ratio =Cost of Goods Sold+ Operating Expenses/Sales

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Profitability Ratios
Return On Investment= Profit before interest,tax and dividend ______________________________x100 Capital Employed
Capital Employed= (Total Debt + Net worth)

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