Financial

Analysis and
Working Capital
MBA (Tech) Sem VII MPSTME

Course Facilitator:
Dr. Nupur Gupta
Module 1

Weeks 1-5

ANALYSIS OF FINANCIAL

STATEMENTS

2
 OUTLINE

● Financial Ratios

● Du Pont Analysis

● Standardised Financial Statements

● Applications of Financial Analysis

● Using Financial Statements

● Going Beyond the Numbers

3
Why do we need
ratios?
Poll 1

Go to menti.com
Your access code is: 379292
5
6
Important Financial Ratios

7
 Horizon Limited: Assets side of the Balance Sheet as on
31st March 20X1
( in
million)
20X1 20X0
ASSETS
Non- current Assets 600 550
❑ Property, plant, and equipment 500 450
❑ Investments 50 40
❑ Long- term loans and advances 50 60
Current Assets 400 350
❑ Inventories 20 20
❑ Investments 160 140
❑ Trade receivables 140 120
❑ Cash and cash equivalents 60 50
❑ Loans 20 20
1000 900
8
Horizon Limited: Liabilities side of the Balance Sheet as on
31st March 20X1
( in million) 20X1 20X0
EQUITY AND LIABILITIES
Equity 500 450
Equity share capital (Par value 10) 100 100
Other equity 400 350
Non- current Liabilities 300 270
Borrowings 200 180
Provisions 50 45
Deferred tax liabilities (net) 50 45
Current Liabilities 200 180
Borrowings 40 30
Trade payables 120 110
Other current liabilities 30 30
Short- term provisions 10 10
1000 900
9
 Statement of Profit and Loss for Horizon Limited for the Year Ending March 31, 20X1
Current Period Previous Period
❑ Revenues from operations 1290 1172
❑ Other Income 10 8
❑ Total Income 1300 1180
❑ Expenses
❑Material expenses 600 560
❑Employee benefit expenses 200 180
❑Finance costs 30 25
❑Depreciation and amortization expenses 50 45
❑Other expenses 240 210
❑ Total Expenses 1120 1020
❑ Profit Before Exceptional and Extraordinary
Items and Tax 180 160
❑ Exceptional Items - -
❑ Profit Before Extraordinary Items and Tax 180 160
❑ Extraordinary Items - -
❑ Profit Before Tax 180 160
❑ Tax Expense 50 40
❑ Profit (Loss) for the Period 130 120
❑ Dividend 80
❑ Earning Per Equity Share (in rupees)
❑Basic 13
❑Diluted 13 10
 LIQUIDITY RATIOS FOR 20X1

Current assets 400

Current Ratio : = = 2.0
Current liabilities 200
Quick assets (400 – 20)
Acid – test Ratio : = = 1.9
Current liabilities 200
Cash and bank balance +Current investment (60+160)
Cash Ratio : = =1.1
Current liabilities 200

11
Which ratio is the
most stringent
measure of
liquidity?
Poll 2

Go to menti.com
Your access code is:
600127
What is the relationship between current ratio
and assets turnover ratio?
•A company’s current ratio is 2.0. If the company uses
cash to pay a trade creditor, would this transaction
increase or decrease the current ratio and asset
turnover ratio?
Current ratio Asset
turnover ratio
•(a) Increase Increase

•(b) Increase Decrease

•(c) Decrease Increase

•(d) Decrease Decrease

•(e) None of the above

13
Brain Gym on Liquidity Ratios
Ques
• Determine the current liabilities
of a firm given the following
information:
• Sales = 68,400
• Quick ratio = 0.8
• Current assets = 31,210
• Inventory turnover ratio = 8
Ans
• Inventory = Sales/Inventory
turnover ratio
• = 68,400/8 = 8,550
• Current assets – inventories = CL
x Acid-test ratio
• 31,210 – 8,550 = CL x 0.8
• CL = 22,660/0.8 = 28,325
14
How much can a
firm borrow from a
bank ,given a
current ratio
Poll 3

Go to menti.com
Your access code is:444375
 LEVERAGE RATIOS FOR 20X1

Total liabilities ( Debt) (300+ 200)

Debt – equity Ratios: = = 1.0
Shareholder’s funds (Equity) 500

Debt 500
Debt – asset Ratio : = = 0.5
Assets 1000
PBIT 210
Interest Coverage Ratio : = = 7.0
Interest 30

16
 LEVERAGE RATIOS FOR 20X1

PBIT + Depreciation and amortization

Fixed Charges Coverage Ratio :
Interest + Repayment of loan /
(1 – Tax rate)

210 + 50
= = 2.56
30 + 50( these are nothing but borrowings and short term provisions from current liabilities here)
(1-0.3)

17
Debt Service Coverage Ratio:
Profit after Tax + Depreciation + Other Non-Cash Charges
+ Interest on Term Loan + Lease Rentals
=
----------------------------------------------------------------------------------
Interest on Term Loan + Lease Rentals + Repayment of Term Loan/
(1 – Tax rate)

18
In DSCR interest
on term debt
appears in?
Poll 4

Menti .com
Use access code: 108773
Repayment of
term loan is not
considered in?
Poll 5

Menti.com
Use access code: 340793
You are divided
into break out
groups
Solve for :
Current Ratio
Acid Test Ratio
Debt Equity Ratio
Interest Coverage Ratio
Horizon Limited: Liabilities side of the Balance Sheet as on
31st March 20X1
( in million) 20X1 20X0
EQUITY AND LIABILITIES
Equity 500 450
Equity share capital (Par value 10) 100 100
Other equity 400 350
Non- current Liabilities 300 270
Borrowings 200 180
Provisions 50 45
Deferred tax liabilities (net) 50 45
Current Liabilities 200 180
Borrowings 40 30
Trade payables 120 110
Other current liabilities 30 30
Short- term provisions 10 10
1000 900 22
 Horizon Limited: Assets side of the Balance Sheet as on
31st March 20X1
( in
million)
20X1 20X0
ASSETS
Non- current Assets 600 550
❑ Property, plant, and equipment 500 450
❑ Investments 50 40
❑ Long- term loans and advances 50 60
Current Assets 400 350
❑ Inventories 20 20
❑ Investments 160 140
❑ Trade receivables 140 120
❑ Cash and cash equivalents 60 50
❑ Loans 20 20
1000 900
23
 Statement of Profit and Loss for Horizon Limited for the Year
Ending March 31, 20X1
Current Period Previous Period
❑ Revenues from operations 1290 1172
❑ Other Income 10 8
❑ Total Income 1300 1180
❑ Expenses
❑Material expenses 600 560
❑Employee benefit expenses 200 180
❑Finance costs 30 25
❑Depreciation and amortization expenses 50 45
❑Other expenses 240 210
❑ Total Expenses 1120 1020
❑ Profit Before Exceptional and Extraordinary
Items and Tax 180 160
❑ Exceptional Items - -
❑ Profit Before Extraordinary Items and Tax 180 160
❑ Extraordinary Items - -
❑ Profit Before Tax 180 160
❑ Tax Expense 50 40
❑ Profit (Loss) for the Period 130 120
❑ Dividend 80
❑ Earning Per Equity Share (in rupees)
24
❑Basic 13
 PROFITABILITY : MARGIN RATIOS
• Gross Profit Margin Ratio
Gross profit
= 470/1290 = 0.36 or 36 percent
Revenues from operations

• EBITDA Margin
EBITDA 260
Total revenues = 1300 = 0.16 or 16 percent
• Net Profit Margin Ratio
Profit after tax
Total revenues = 130/1300 = 0.10 or
10 percent

25
Gross Profit margin
ratio measures
efficiency of?
Poll 6
Menti.com
Use access code: 855405
 PROFITABILITY : RATE OF RETURN MEASURES
• Return on Assets (ROA)
Profit after tax
Average total assets = 130 ÷ [(1000 + 900)/2 ] = 13.7%
• Earning Power
PBIT
Average total assets = 210 ÷ [(1000 + 900)/2 ] = 22.1 %
• Return on Capital Employed (ROCE)
Profit before interest and tax (1- Tax rate)
Average total assets = 210(1-0.3)/[(1000 + 900)/2] = 15.5 %
• Return on Equity
Equity earnings
Average equity = 130 ÷ [(500 +450 )/2 ] = 27.4%

27
Refer previous
break out room
Ques.4.8 an
calculate:

28
 • Net Profit margin ratio:
=PAT/Net Sales
Solution to Brain = 51,00,000/9,50,00,000 = 5.4%
Gym
Profitability Ratios
• Earning Power :
= PBIT / Total assets
=1,51,00,000/ 7,50,00,000 = 20.1%

• Return on Equity :
=Equity Earnings/ Net worth
=51,00,000/3,25,00,000 = 15.7%
29
What is NOPLAT?
NOPLAT = Operating Income x (1
– tax rate)
NOPLAT is an important measure in
different types of financial analyses
because it makes use of only operating
income and provides a clear picture of
operating efficiency. This is crucial as net
income is reduced by interest.

Therefore, NOPLAT = $100,000 x (1 – 0.30) = $70,000

Home assignment
What is Cost of goods sold?

31
COGS

32
 TURNOVER RATIOS
• Inventory Turnover
Revenues from operations 1290
Average inventory = + 20 )/2
(20 = 64.5

• Debtors’ Turnover
Net credit sales
= 1290 ÷[ (140+ 120)/2] = 9.92
Average trade receivables
• Fixed Assets Turnover
Revenues from operations
Average net fixed assets = 1290 ÷[ (500 + 450 )/2] = 2.72
• Total Assets Turnover
Total revenues
Average total assets
= 1300 ÷[ (1000 + 900 )/2] =
1.37 33
If sales are steady and no
capital expenditure is to be
incurred, fixed assets
turnover ratio of a firm
over the years will:
Poll 7

Menti .com
Use access code: 738004
Which of the following
is not a turnover ratio?

Poll 8

Menti.com
Use access code:257950
Refer previous
break out room
Ques.4.8 an
calculate:
1. Average Collection
Period
2. Inventory Turnover
Ratio

36
 • Average collection Period (ACP)
=365/ Debtor’s Collection Period
Solution to Brain Debtor’s Collection Period =
Gym Net Credit Sales/ Average Debtors

Turnover Ratios =9,50,00,000/ 1,50,00,000 = 6.33

ACP = 365/ 6.33= 57.6 days

• Inventory Turnover ratio:

=COGS/ Average Inventory
=7,20,00,000/ 2,00,00,000= 3.6
37
 COMPARISON WITH INDUSTRY AVERAGES
Ratio Formula Horizon Limited Industry
Average
Liquidity
❑ Current ratio Current assets 2.00 1.80
Current liabilities
❑ Acid – test ratio Quick assets 1.20 1.05
Current liabilities
Leverage
❑ Debt – equity ratio Total liabilities 1.00 1.10
Shareholders’ funds
❑ Interest coverage ratio PBIT 7.0 5.0
Interest
Turnover
❑ Inventory turnover Revenues from operations 8.6 8.4
Average inventory
❑ Debtors’ turnover Net credit sales 9.92 10.1
Average trade receivables
❑ Fixed assets turnover Revenues from operations 2.72 2.75
Average net fixed assets
❑ Total assets turnover Total revenues 1.37 1.40
Average total assets
38
 Ratio Formula Horizon Limited Industry
Average
Profitability
❑ Gross profit margin ratio Gross profit 36.4% 34%
Revenues from
Operations
❑ Net profit margin ratio Net profit 10.0% 8.5%
Total revenues
❑ Return on assets Profit after tax 13.7% 12.5%
Average total assets
❑ Earning power PBIT 22.1% 19.3%
Average total assets
❑ Return on capital employed PBIT (1- T) 15.5% 13.8%
Average total assets
❑ Return on equity Equity earnings 27.4% 23.2%
Average equity
Valuation
❑ Price- earnings ratio Market price per share 15.4 12.0
Earnings per share
❑ Yield Dividend + Price change 15.6% 14.1%
Initial price
❑ Market value to book value Market price per share 4.0 3.2
Book value per share

39
 TIME SERIES OF CERTAIN
FINANCIAL RATIOS

1 2 3 4 5
Debt-equity ratio 1.3 1.2 1.0 0.9 1.0
Total assets turnover ratio 1.34 1.41 1.35 1.39 1.37
Net profit margin (%) 8.0 9.0 10.2 10.5 10.0
Return on equity (%) 20.1 22.0 26.0 27.6 27.4
Price-earnings ratio 12.5 13.2 13.8 14.9 15.4

40
 DUPONT ANALYSIS
Basic Du Pont Analysis
Net profit Net profit Net sales
= x
Average total assets Net sales Average total assets
ROA = NPM x TATR

Extended Du Pont Analysis

Net profit Net profit Sales Average total assets
------------------- = ------------- x --------------------- x ------------------------
Average Equity Sales Average total asset Average equity

ROE NPM x TATR x 1/(1 – DAR)

41
DU PONT CHART APPLIED TO HORIZON LIMITED
Total
Revenues 1300

Net Profit
130
–
Net Profit
Margin
10%
÷ Total Costs
1170

Total Revenues
1300
Return on
Assets 13.7 %
X
Total Revenues
1300
Average
Non current assets
Total Assets
Turnover
÷ 575
1.37 Average
Total Assets
950
+
Average
Current Assets 375

42
 EXTENSION OF THE DU PONT CHART

Return of Equity
27.4

Return of Assets Average Total Assets

to Average Equity
13.7 Ratio 2.0

43
 COMMON SIZE STATEMENTS
Part A: Statement of Profit and Loss
Regular (in million) Common Size (%)
20X1 20X0 20X1 20X0
❑ Total income 1300 1180 100 100
❑ Total expenses other than finance 1090 995 84 84
cost
❑ PBIT 210 185 16 16
❑ Interest (Finance costs) 30 25 2 2
❑ PBIT 180 160 14 14
❑ Tax 50 40 4 4
❑ PAT 130 120 10 10

44
 Part B:Balance Sheet
Regular (in million) Common Size (%)
20X1 20X0 20X1 20X0
❑ Non- current assets 600 550 60 61
❑ Current assets 400 350 40 39
❑ Total 1000 900 100 100
❑ Equity 500 450 50 50
❑ Non –current liabilities 300 270 30 30
❑ Current liabilities 200 180 20 20
Total 1000 900 100 100

45
 COMMON-BASE YEAR FINANCIAL STATEMENTS
Part A: Statement of Profit and Loss
Regular (in million) Common Size (%)
20X1 20X0 20X1 20X0
❑ Total income 1300 1180 110 100
❑ Total expenses other than finance 1090 995 110 100
cost
❑ PBIT 210 185 114 100
❑ Interest (Finance costs) 30 25 120 100
❑ PBIT 180 160 113 100
❑ Tax 50 40 125 100
❑ PAT 130 120 108 100

46
 Part B:Balance Sheet
Regular (in million) Common Size (%)
20X1 20X0 20X1 20X0
❑ Non- current assets 600 550 109 100
❑ Current assets 400 350 114 100
❑ Total 1000 900 111 100
❑ Equity 500 450 111 100
❑ Non –current liabilities 300 270 111 100
❑ Current liabilities 200 180 111 100
Total 1000 900 111 100

47
APPLICATIONS
OF FINANCIAL
ANALYSIS Financial ratios may be employed to:

Assess corporate excellence

Judge creditworthiness

Forecast bankruptcy

Value equity shares

Predict bond ratings

Estimate market risk

48
 PROBLEMS IN FINANCIAL
STATEMENT ANALYSIS

• Heuristic and Intuitive Character

• Development of Benchmarks
• Window Dressing
• Price Level Changes
• Variations in Accounting Policies
• Interpretation of Results
• Correlation among Ratios

49
50
GUIDELINES

• USE RATIO TO
GET CLUES TO • BE SELECTIVE • EMPLOY • KNOW THE
ASK THE RIGHT IN THE CHOICE PROPER TRICKS USED BY
QUESTIONS OF RATIOS BENCHMARKS ACCOUNTANTS

• UNDERSTAND • REMEMBER …
• READ THE HOW THE FSA .. ODD
FOOT NOTES RATIOS ARE MIXTURE OF
INTERRELATED ART & SCIENCE

51
LOOKING
BEYOND THE 1. ARE THE COMPANY’S REVENUES TIED TO ONE KEY
NUMBERS CUSTOMER ?

2. TO WHAT EXTENT ARE THE COMPANY’S REVENUES

TIED TO ONE KEY PRODUCT ?

3. TO WHAT EXTENT DOES THE COMPANY RELY ON A

SINGLE SUPPLIER ?

4. WHAT PERCENTAGE OF THE COMPANY’S BUSINESS IS

GENERATED OVERSEAS ?

5. COMPETITION

6. FUTURE PROSPECTS

7. LEGAL AND REGULATORY ENVIRONMENT

52
SUMMING UP

Financial ratios may be

divided into five broad
categories:
Financial statement • Liquidity ratios
The principal tool of
analysis can provide • Leverage ratios
financial statement
valuable insights into a
analysis is financial ratio • Turnover ratios
firm’s performance and
analysis.
position. • Profitability ratios
• Valuation ratios

The Du Pont chart is a There are certain

Generally, the financial popular tool of financial
ratios of a company are analysis. It provides
compared with some insights into the
benchmark ratios. determinants of the
return on equity
problems and issues in
financial statement
analysis that call for care,
circumspection, and
judgment.

53