ES19-FINANCIAL ANALYSIS

ENGR. C. A. ASUNCION
2ND SEMESTER A.Y. 2022-20223
LA CONCEPCION COLLEGE
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Financial analysis
• Examination of financial information to reach business decisions.
• Involves an examination of both historical and projected profitability, cash flows,
and risk.
• It may result in the reallocation of resources to or from a business or a specific
internal operation.
KEY AREAS:
1. Revenues
2. Profits
3. Operational Efficiency
4. Capital Efficiency and Solvency
5. Liquidity
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1. Revenue
• Revenue growth (revenue this period - revenue last period) ÷
revenue last period. When calculating revenue growth, don't include
one-time revenues, which can distort the analysis.
• Revenue concentration (revenue from client ÷ total revenue). If a
single customer generates a high percentage of the revenues, one
could face financial difficulty if that customer stops buying. No client
should represent more than 10 percent of your total revenues.
• Revenue per employee (revenue ÷ average number of
employees). This ratio measures the business's productivity. The
higher the ratio, the better.
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2.Profit.
• Gross profit margin
(revenues – cost of goods sold) ÷ revenues.
Cost of Goods Sold- direct costs of producing the goods sold by a
company. This amount includes the cost of the materials and labor
directly used to create the good. It excludes indirect expenses, such
as distribution costs and sales force costs.
A healthy gross profit margin allows one to absorb shocks to
revenues or cost of goods sold without losing the ability to pay for
ongoing expenses.
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Business’s net sales for the year are 50,000. Cost of goods sold is 20,000.
• Gross Margin = 50,000 – 20,000= 30,000
• Business’s total gross margin is 30,000. After subtracting how much it costs to
produce products or services, 30,000 is left
• Some businesses prefer to see their gross margin as a percentage

. To convert gross margin to a percentage, use the following formula:

• Gross Margin = [(Net Sales – Cost of Goods Sold) / Net Sales] X 100
• Gross Margin = [(50,000 – 20,000) / 50,000] X 100
= 60%. This means business has 60% of its revenue left over after it
pays direct costs (cost of goods sold).
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• Gross Profit Margin
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• Operating profit margin
(revenues – cost of goods sold – operating expenses) ÷revenues
Operating expenses don't include interest or taxes. This determines the
company’s ability to make a profit regardless of how one finances
operations (debt or equity). The higher, the better.
• Net profit margin
(revenues – cost of goods sold – operating expenses – all other
expenses) ÷ revenues.
This is what remains for reinvestment into the business and for
distribution to owners in the form of dividends
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Operating Profit Margin

• Calculated by subtracting all COGS, depreciation and amortization, and all
relevant operating expenses from total revenues.
• Operating expenses include a company’s expenses beyond direct
production costs :
a. salaries and benefits,
b. rent and related overhead expenses,
c. research and development costs,
The operating profit margin calculation is the percentage of operating
profit derived from total revenue.
For example, a 15% operating profit margin is equal to 0.15 operating
profit for every Ᵽ1 of revenue.
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• Operating Profit Margin

7.82%
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• Net Profit Margin
“Profit Margin” or “Net Profit Margin Ratio”is a financial ratio used to
calculate the percentage of profit a company produces from its total
revenue.
The net profit margin is equal to net profit (also known as net income)
divided by total revenue, expressed as a percentage
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3. Operational Efficiency
Operational efficiency measures how well you're using the
company’s resources.
Accounts receivables turnover
=(net credit sales ÷ average accounts receivable).
This measures how efficiently one manages the credit extended
to customers. A higher number means the company is
managing credit well; a lower number is a warning sign one
should improve collection from customers.
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• Inventory turnover (cost of goods sold ÷ average inventory).
This measures how efficiently one manages inventory. A higher
number is a good sign; a lower number means one is either
aren't selling well or are producing too much for current level of
sales.
4. Capital Efficiency and Solvency
• Return on equity (net income ÷ shareholder’s equity). This
represents the return investors are generating from the business.
• Debt to equity (debt ÷ equity).
The definitions of debt and equity can vary, but generally this
indicates how much leverage one is using to operate
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5. Liquidity
• Liquidity analysis addresses the ability to generate sufficient cash to cover cash
expenses. No amount of revenue growth or profits can compensate for poor
liquidity.
• Current ratio (current assets ÷ current liabilities). This measures the ability to pay
off short-term obligations from cash and other current assets. A value less
than 1 means the company doesn't have sufficient liquid resources to do this. A
ratio above 2 is best.
• Interest coverage (earnings before interest and taxes ÷ interest expense). This
measures the ability to pay interest expense from the cash one generates. A value
less than 1.5 is cause for concern to lenders.
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Types of Financial Analysis
1. Horizontal Analysis
This involves the side-by-side comparison of the financial results of
an organization for a number of consecutive reporting periods. The
intent is to discern any spikes or declines in the data that could be
used as the basis for a more detailed examination of financial results.
• Consider an investor who wishes to determine Company ABC’s
performance over the past year before investing. Assume that ABC’s
net income of Ᵽ15 million in the base year, and total earnings of
Ᵽ 65 million were retained. The company reported a net income of 25
million and retained total earnings of 67 million in the current year.
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2. Vertical Analysis
• This is a proportional analysis of the various expenses on the income statement,
measured as a percentage of net sales.
Comparative Income Statement with Vertical Analysis
2018: (104,000 / 198,000) × 100
= 52.53%

2017: (98,000 / 176,000) × 100

= 55.68%
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3.Liquidity Analysis
• The current ratio (arrived at by dividing the current assets by the
current liabilities) is treated as a traditional measure to gauge a
company’s liquidity position or its short term financial position. It
calculates the amount of cash available in the form of assets which
could be converted to cash within one year in order to pay debts that
fall due during the same year.
For example, if a company has Ᵽ10 million in current assets and Ᵽ5
million in current liabilities, the current ratio would be 2 (10/5 = 2).
A high current ratio is ALWAYS better than a lower current ratio,
because a higher number indicates that the company has sufficient
cash reserves to dip into to meet its short term obligations.
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4.Multi-Company Comparison
• This involves the calculation and comparison of the key financial ratios of
two organizations, usually within the same industry. The intent is to
determine the comparative financial strengths and weaknesses of the two
firms, based on their financial statements.
5. Industry Comparison
• This is similar to the multi-company comparison, except that the
comparison is between the results of a specific business and the average
results of an entire industry. The intent is to see if there are any unusual
results in comparison to the average method of doing business.
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6.Efficiency Analysis
• Efficiency ratios are an essential part of any robust financial analysis.
These ratios look at how well a company manages its assets and
uses them to generate revenue and cash flow.
Common efficiency ratio:

.
7.Cashflow
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Cashflow
• A contractor is considering on buying a crane for his next bridge
project.He intends to buy one and expects to receive a yearly cash inflow
of 1750 until year 8.
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8. Rates of Return
Investors, lenders, and finance professionals, in general, are focused on what type
of risk-adjusted rate of return they can earn on their money. As such, assessing
rates of return on investment (ROI) is critical in the industry.
1 example of Rate of Return is IRR-Internal Rate of Return
The cost of the small project(for discussion purposes only) is Ᵽ 1000. Duration is
5 years and the expected yearly cash inflows are:
Year 1 : 200
Year 2 : 300
Year 3 : 300
Year 4 : 400
Year 5 : 500
Determine IRR of the project. Opportunity Cost is 12%.
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Cashflow

1169.18 - 1000 = 169.18

Net Present Value is bigger
than 0

When discount rate is

changed to
17.70%,NPV=0.25
Therefore,IRR=17.70%
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• Scenario & Sensitivity Analysis
Building scenarios and performing sensitivity analysis can help determine
what the worst-case or best-case future for a company could look like.
Managers of businesses will often prepare these scenarios to help a
company prepare its budgets and forecasts.
• Variance Analysis
Process of comparing actual results to a budget or forecast. It is a very
important part of the internal planning and budgeting process at an
operating company, particularly for professionals working in the
accounting and finance department
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• Variance Analysis
Ex. A company had a budget of Ᵽ2.5 million of revenue and had actual
results of Ᵽ2.6 million. This results in a 0.1 million favorable variance,
which was due to higher than expected volumes (as opposed to higher
prices).
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• Valuation Analysis
 A process to estimate the approximate value or worth of an asset, whether
its a business, equity, fixed income security, commodity, real estate, or other
assets.
 It is calculated by multiplying the company's share price by its total number
of shares outstanding
 analytical process of determining the current (or projected) worth of an asset
or a company
Valuation is an estimate of an object's worth, while
Evaluation is an appraisal, such as an annual staff performance analysis
used to justify a pay raise or promotion, or a description of a specific event.
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