Financial Statement

Analysis
 Financial Analysis

The goal of financial analysis is to assess the

performance of a firm in the context of it’s stated goals
and strategy. There are two principal tools of financial
analysis: ratio analysis and cash flow analysis.
Ratio analysis involves assessing how various line items
in a firm's financial statements relate to one another.
Cash flow analysis allows the analyst to examine the
firm's liquidity, and how the firm is managing its
operating, investment and financing cash flows.
The value of a firm is determined by its profitability
and growth. Firm’s growth and profitability are
influenced by its product market and financial market
strategies.
The product market strategy is implemented through
the firm’s competitive strategy, operating policies, and
investment decisions.

Financial market strategies are implemented through

financing and dividend policies.
 Significance of Financial Analysis

Financial analysis is required for many

financial management decisions such as:

How to manage the finances to achieve

the strategic goals of the institution
How to increase profitability
How to reach self-sufficiency/breakeven
point
How to increase efficiency especially
reducing the cost per client/unit.

What is the optimum level of each

different operational expense including the
cost of funds (Cost of Working Capital).

How to manage the costs of human

resources as part of overall human resource
management.
How to deal with the effect of
inflation

What is the write-off of assets and

rescheduling of payments and
expenditure policy

What price should be charged on

products / services?

How to manage liquidity

What is the best financing structure?

What should the asset structure be?

How to manage the fixed assets,

i.e., the depreciation policy, how to
finance them, are they insured, are
they safe?
What are currency risks and can they
be minimized?

How to undertake trend analysis and

to compare actual performance against
planned performance
Financial statements provide the
fundamental information that we use
to analyze and answer valuation
questions. It is important, therefore,
that we understand the principles
governing these statements by looking
at four questions:
How valuable are the assets of a
firm? The assets of a firm can come in
several forms – assets with long lives
such as land and buildings, assets with
shorter lives such inventory, and
intangible assets that still produce
revenues for the firm such as patents
and trademarks.
How did the firm raise the funds to
finance these assets? In acquiring
these assets, firms can use the funds
of the owners (equity) or borrowed
money (debt), and the mix is likely to
change as the assets age.
How profitable are these assets? A
good investment is one that makes
a return greater than the hurdle
rate. To evaluate whether the
investments that a firm has already
made are good investments, we
need to estimate what returns we
are making on these investments.
How much uncertainty (or risk) is
embedded in these assets?
Understanding Financial
Health
 ANALYSTS’ PERSPECTIVE
OF THE BALANCE SHEET

Is the asset base appropriate to support the

current level of operations? Capacity
Utilization

Is the asset base support expected growth ?

Is the asset base effectively and efficiently

managed? Magnitude of ALM
How are the acquisitions of assets
financed in the last three years ? Off
Balance Sheet Financing, Debt or Equity

What is the net working capital

position of the company ? Quality of
CA, CL because of ability to pay or
willingness to pay
What assets are pledged as collateral?
Future Borrowing Capacity

What is the level of debt and is it

appropriate? Impact on Capital
Structure, Secured vs. Unsecured –
Credit Worthiness
When is the debt due and are there
assets available to retire the debt ?
Pressure due to Cash Outflow

Is there a need for increased

ownership interest ? Leverage
Position, Business Risk Position and
Shareholders / Capital Market
Expectation
What useful information can be
highlighted by examining the changes
in each B/S account over the past two
to three years ? Funds Deployment,
Capital Structure, Retained Earning
Position, Quality of CA and CL
 ANALYSTS’ PERSPECTIVE
OF THE INCOME STATEMENT

What are the earnings for the

period? Growth in relation to
sales and industry average.
Did the earnings generate net
Operating CFs? Credit Policy
and Market Conditions.
Are the earnings from
continuing, ongoing operations
? Operating Efficiency

Are the earnings appropriate to

the asset base of the company ?
Cost of Capital and Industry
Average
Did earnings meet expectations ?
Shareholders, Industry Average and
Future Investment Opportunities

Was there any unusual activity

reported in the current period ?
Management’s Efficiency to
understand internal and external
factors
Were the current period earnings
consistent with the overall earnings trend
for the past several periods ? Consistency
and Market Response.

What is the relationship between revenue

and costs? Economies of Scale, Product
Portfolio Analysis, Market Structure
 ANALYSTS’ PERSPECTIVE
ON THE STATEMENT OF
CASH FLOW

Did cash inflow exceed cash outflow

w.r.t. Investment, Financing and
Operating (+ve or –ve)

What were the principal / primary causes

of cash outflow, particularly for investing
and financing activities ?
Did the business generate sufficient cash
flow to maintain operations or provide for
future growth opportunities ?

Was there cash available for debt

servicing, repayment of debt and for
payment of dividend ?

Is there any restriction of cash flow

caused by debt agreement ?
 Investment
Financing
Thank Operating

You