Professional Documents
Culture Documents
Financial
Statements
Study of relationships between the
variables of the same statement or
different financial statements and the
trend of these elements.
Analysis of
Financial
Analysis can be external or internal;
Statements
horizontal or vertical; and
intra-firm or inter-firm.
Horizontal analysis
Tools of
Analysis Vertical analysis (common size
financial statements)
Ratio analysis
Figures of two or more periods are
Horizontal Analysis
placed side by side.
Ratios
Lack of adequate profitability
adversely affects the liquidity of the
company, its ability to raise external
financing and its growth prospects.
Widely used measures of profitability
include
1. Gross profit margins,
2. Operating profit margins
Profitability 3. Net profit margins
Ratios 4. Earnings per share (EPS),
5. Return on capital employed
(ROCE),
6. Return on assets (ROA) and
7. Return on equity (ROE).
Profit margins are used to analyze the
profit made per unit of sales.
Three kinds of profit margins are
Profitability Ratios generally used: gross profit margin,
operating profit margin and net profit
margin.
Gross profit
Gross profit ratio= 100
Profit Margin Sales
Net profit
Net profit ratio= 100
Sales
Example
Last year, XYZ Corporation had net
sales of $8,000,000 and its cost of
goods sold was $6,000,000.
1. Gross Profit
Margin Gross margin = gross profit / net
sales
Example
Assume that XYZ is a regular corporation which
had $8,000,000 of net sales Its expenses were:
cost of goods sold of $6,000,000; SG&A
3. Net profit expenses of $1,250,000; interest expense of
margin $30,000; and income tax expense of $160,000.
Profitability
ratio
Profitability Ratios
Return = Profit after Tax/Shareholder’s
funds * 100
Return on Shareholder’s funds = Equity Capital +
Shareholder’s Res. & Surplus + Pref. Share Capital –
Funds Fictitious Assets
The return on equity relates profits to
owners’ equity. Equity stands for owners’
funds.
Profitability Ratios
This ratio may be used for declaration of
dividend and building up of reserves.
Return on
It also indicates the efficiency with which
Equity (ROE)
funds are deployed in the business
Ratios
Such ratios should be calculated separately
for each type of asset.
Average inventory
Number of days' inventory= 365
Cost of goods sold or Sales
The debtors’ turnover ratio shows
the relation between sales and
Efficiency ratios outstanding amount due from the
debtors to whom goods were sold
on credit.
10. Debtors’
/ARs’ Turnover A high debtors’ turnover ratio shows
Ratio prompt collection of bills.
Ratio = Net Credit Sales/Closing
Debtors
Example
365
Average collection period=
Debtors' turnover ratio
The creditors’ turnover ratio shows the
relation between purchases and
outstanding amount due to the creditors
from whom goods were purchased on
Efficiency ratios credit.
13. Average
Payment Period
365
Average payment period=
Creditor's turnover ratio
Efficiency ratios Average Holding Period + Average
Collection Period – Average Payment
Period
Length of Cash
Cycle
Tests of short-term solvency focus on
the liquidity position of the company
15. Current
This ratio establishes the ability of the
Ratio business to meet its short-term
obligations. and is therefore of particular
significance to short-term creditors
Current assets
Current ratio=
Current liabilities
Example
ABC is a large manufacturing
corporation with $4,200,000 of
current assets and $4,000,000 of
15. Current current liabilities. Therefore, ABC's
Ratio current ratio is:
Beta Company is an internet
Example business with significant daily sales
to customers who must pay with a
credit card when ordering.
Solvency Ratio
These ratios are commonly called
“Solvency Ratios”.
The main ratios in this category are
17. debt–equity ratio and
18. interest coverage ratio
Solvency Ratio 19. Net Debt
The debt–equity ratio relates debt to equity or
owners’ funds.
Solvency Ratio
It indicates the number of times interest
obligation is covered by the profits for
the period.
18. Interest
Coverage Ratio It is always desirable to have profits more
than the interest payable; otherwise the
position of the lenders is unsafe.
obligations
(EBITDA)/{Interest+Loan
Repayment/(1-Tax Rate)}
Net debt is a financial liquidity metric that
measures a company’s ability to pay all its
debts if they were due today.
Solvency Ratio
In other words, net debt compares a
company’s total debt with its liquid assets.
Ratios Involving
Share Ratio that capture the relationship among
Information dividend, earnings and market price of
share are of particular interest to existing
and potential investors in a company’s
shares.
Ratios such as
Ratios Involving
Share 20. Dividend Payout,
Ratios As Comments
ROE=NPM×Asset Turnover×Equity Multiplier
where:
NPM=Net profit margin, the measure of operating efficiency
Du Pont Asset Turnover=Measure of asset use efficiency
Control Chart
Equity Multiplier=Measure of financial leverage
To understand the factors affecting a
firm’s ROE, particularly its trend
over time and its performance
relative to competitors, analysts
often “decompose” ROE into the
product of a series of ratios.
Decomposition Each component ratio is in itself
of ROE meaningful, and the process serves
to focus the analyst’s attention on
separate factors influencing
performance.
Share Capital : Equity (Rs.10) Rs. 4,00,000 Current Liabilities Rs. 1,00,000
12% Preference Rs. 1,00,000 Fixed Assets Rs. 9,50,000
General Reserve Rs. 1,84,000 Current Assets Rs. 2,34,000
10% Debentures Rs. 4,00,000
Also calculate Return on Shareholders’ Funds, EPS, Book value per share and P/E ratio if
the market price of the share is Rs. 34 and the net profit after tax was Rs. 1,50,000, and the
tax had amounted to Rs. 50,000.
Following information is given by a company from its books of accounts as on
March 31, 2015:
Particulars Rs.
Inventory 1,00,000
Total Current Assets 1,60,000
Shareholders’ funds 4,00,000
13% Debentures 3,00,000
Current liabilities 1,00,000
Net Profit Before Tax 3,51,000
Cost of revenue from operations 5,00,000
Calculate:
i) Current Ratio
ii) Liquid Ratio
iii) Debt Equity Ratio
iv) Interest Coverage Ratio
v) Inventory Turnover Ratio
71
72
73
74
75
76
77