Financial Statement

Analysis
AMRENDRA KUMAR
UPENDRA VERMA
Financial Statements Analysis
 Financial Statements- i.e.. Balance Sheet and Profit &
Loss account, provide a wealth of information.
 If properly analyzed and interpreted, they can provide valuable
insights into a firm’s performance and position.
 People Interested in Accounting Information:
 Internal Users (Management)
 Owners, Partners
 Board of Directors.
 Officers of the Co.
 Managers
 Supervisors
Financial Statements Analysis
 External Users
 Those with Direct Financial Interest:
• Present or Potential Investors
• Present or Potential Creditors
 Those with Indirect Financial Interest:
 Tax Authority
 Income Tax
 State Tax
 Municipal Tax etc.
 Regulatory Authority
 Stock Exchange
 SEBI
 Economic Planners
 RBI
 Government Planners
 Other Groups
 Employee & Labour union
 Customers
 Public
 Financial Advisors
 Financial Statements Analysis
 Before any analysis, the analyst must clearly define:
 The viewpoint taken (e.g.. Lender investor, management)
 The objectives of the analysis
 The standards of comparison
 There are many analytical Techniques, chief among
them are:
 Ratio Analysis, Du Pont Analysis
 Fund Flow & Cash Flow Analysis
 Time Series
 Common Size Analysis
Ratio Analysis
 The actual usefulness of any ratio depends on
the specific ‘objectives’ of the analysis.
 Ratio serves best to point out changes in
financial conditions or operating performance
 Performance assessment based on financial
statements deals with the past data and
conditions, hence it may be difficult to
extrapolate future expectations.
a) Liquidity Ratios
It refers to the ability of a firm to meet its obligations in the
short run, usually one year

1. N.W.C = Current Assets- Current Liabilities

2. Current Ratio = Current Assets__ (Ideally 1.25-1.33)

Current Liabilities

Current Assets include cash, marketable securities,

debtors, inventories, loans and advances and prepaid
expenses.

Current Liabilities include loans and advances (taken),

trade creditors, accrued expenses and provisions.
a) Liquidity Ratios
3. Acid Test Ratio =Quick Assets
Current Liabilities
(Q.A=C.A –Inventories-Prepaid expenses)

4. Super Quick Ratio= Super-quick Assets

Current Liabilities
S.Q Assets= Cash+ Marketable Securities
b) Leverage Ratios
Leverage refers to the use of debt finance.
1) Structural Ratios: Indicate the proportion or use of
debt and equity in the financial structure of the company.
(i) Debt/Equity Ratio (Ideal 2:1)
Debt = Long term+ Short term debts
Equity = Paid up capital and Reserves

(ii) Debt/Assets Ratio (Ideal .5 to .75)

Assets= Net Fixed assets+ Net Current Assets
b) Leverage Ratios
2) Coverage Ratios: Indicate the relationship between the
debt servicing commitments and the sources for meeting these
burdens
(i) Interest Coverage Ratio = EBIT/Debt Interest
(Inst. Norms: 1.5-2)
(ii) Debt- Service Coverage Ratio= EBIT + Depreciation
Interest +Installment of loan repayment
(Institutional Norms: 1.3- 1.5)
 c) Turnover Ratios
These ratios measure how efficiently assets have been employed in
the firm.
(i) Inventory T.O Ratio= Cost of Goods Sold/Average Inventory

(ii) Receivables T.O Ratio=Credit Sales/(Avg. Debtors +Avg. B.R)

(iii) Average Collection Period= Months (days) in a year
Debtors turnover

(iv) Assets T.O Ratio= Cost of Goods Sold/Avg. Total Assets

(Indicates the efficiency with which firm uses all its assets to
generate sales.)
Its variants are:
Total Assets T.O Ratio, Fixed Assets T.O Ratio etc.
 d) Profitability Ratios related to Sales
Profitability reflects the final result of business operations
1. Profit Margin Ratios:

i) Gross Profit Margin Ratio= Gross Profit/Net Sales

(Shows margin left after meeting manufacturing costs)

ii) Net Profit Margin Ratio = Net Profit/Net Sales

(Shows earnings left for shareholders as a percentage of
net sales)
iii) Expenses Ratio
(Computed by dividing expenses by sales)
 d) Profitability Ratios related to
Investments
2. Rate of Return Ratios
i) Return on Investment = EBIT(1-T)/ (TA or NA)
Where, TA= Total Assets;
NA= Net Assets/Capital Employed= Net Worth + Total Debt
( It’s a measure of business performance, in generating profits
with its available assets. It is eminently suited for inter firm
comparison)
There are 3 broad categories of ROI:
a) Return on Assets= EAT+ Interest/Average Total Assets x 100
b) Return on Capital Employed= EBIT/ Average total CE x 100
c) Return on Shareholder’s Equity= EAT/ Net Worth
(It reflects the productivity of the owner’s capital employed in the
firm)
d) Profitability Ratios related to
Investments
iii) EPS= Net Profit available to equity shareholders
No. of equity shares outstanding

iv) Book value per share= Networth

No. of equity shares outstanding

v) DPS= Dividend paid to ordinary shareholders

No. of equity shares outstanding
vi) D/P Ratio= DPS/EPS
 d) Profitability Ratios related to
Investments
These ratios indicate how the equity stock of the company is
assessed in the capital market.
1. Price Earnings Ratio= Market price per share/EPS
(It reflects the growth prospects, risk characteristics, shareholder
orientation, corporate image and degree of liquidity)

2. Earnings Yield= EPS/ Mkt. Value per share x 100

3. Dividend Yield= DPS/ Mkt. Value per share x 100
(Companies with high growth prospects offer a low dividend yield and a
high capital gains yield)
4. Price to Book value ratio = Mkt. value per share
Book value per share