Financial Statements Analysis

A.A. Samitha Jayaweera

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Financial Statements……..few ?s.

Do F/Ss produce comparative information? Are these information enough to make

decisions? Why? - absolute figures do not produce

comparative information, less utility and practical value

What further do? convert into relative / comparative figures

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Financial Statements Analysis -what does it do? “Financial statement analysis is the process

of identifying the financial strengths and weaknesses of the firm by properly establishing relationship between the items of balance sheet and the income statement”

It enhance the utility or practical value of accounting information.

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Why Financial Statements analysis is needed?

Since, It produces comparative information It’s a tool to identify strength and

weaknesses It provides information of profitability,

liquidity, efficiency and gearing/ solvency etc.

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Is the firm in a position to meet current obligation? -Liquidity

What sources of long-term finance are employed and its relationship (debt-equity)?- Solvency

How efficiently assets utilised?- Assets turnover

Are earnings adequate?- Profitability

Further it Provides Answers to…….

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Produce Comparisons Information…

Absolute increases and decreases for an item from year to year

% increases and decreases for an item from year to year

Trend % % of single item to an aggregate total Ratios

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Compare with…….

Past years ratios Budgeted/ standards Intra company - divisional Inter company - industry

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Analytical Techniques

Horizontal analysis Vertical analysis Trend analysis Common-size analysis Ratio analysis Cash flow analysis

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Horizontal Analysis

The calculation of $ (Rs. value) changes or

% changes in the statement or total

Ex; changes in sales, total operating expenses, N.P.

It detects changes in company performance It highlights trends

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Horizontal Analysis

2010 2009 increase/ % (decrease) RevenueSales 207,500 159,500 48,000 30.1Cost of sales 145,000 114,500 30,500 26.6Gross profit 62,500 45,000 17,500 38.9Operating Expenses Selling & Distribution 19,750 13,650 6,100 44.7Administrative 24,820 16,300 8,520 52.3Total Operating Expenses 44,570 29.950 14,620 48.8Profit from operations 17,930 15,050 2,880 19.1Interest expenses 1,500 1,200 300 25.0Profit before tax 16,430 13,850 2,580 18.6Income tax 4,930 4,432 498 11.2Profit after tax 11,500 9,418 2,082 22.1

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Trend Analysis

Based on Horizontal analysis % es are calculated for several successive

years select a based year which assign a weight

of 100% Ex; base year sales is 100% current year

110% OR 95% etc;

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Trend Analysis

2006 2007 2008 2009 2010Sales 100 85 119 158 205Net profit 100 89 123 142 174

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Vertical Analysis

Items in a single financial statement are expressed as a % of a significant total.

Ex: cost of sales as % to turnover, G.P. as % to cost of sales/ turnover

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Vertical Analysis

2010 % 2009 % RevenueSales 207,500 100.0 159,500 100.0 Cost of sales 145,000 69.9 114,500 71.8 Gross profit 62,500 30.1 45,000 28.2 Operating Expenses Selling & Distribution 19,750 9.5 13,650 8.6 Administrative 24,820 12.0 16,300 10.2 Total Operating Expenses 44,570 21.5 29.950 18.8 Profit from operations 17,930 8.6 15,050 9.4 Interest expenses 1,500 0.7 1,200 0.7Profit before tax 16,430 7.9 13,850 8.7Income tax 4,930 2.4 4,432 2.8Profit after tax 11,500 5.5 9,418 5.9

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Common size Analysis

Common –size financial statements show only % value, no absolute value

In common-size balance sheet all values of assets items are presented as a % to total assets where as liability items are presented as a% to total liabilities

Income statement- all items are presented as a % to net sales

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Common-Size Analysis

2010 2009RevenueSales 100.0 100.0 Cost of sales 69.9 71.8 Gross profit 30.1 28.2 Operating Expenses Selling & Distribution 9.5 8.6 Administrative 12.0 10.2 Total Operating Expenses 21.5 18.8 Profit from operations 8.6 9.4 Interest expenses 0.7 0.7Profit before tax 7.9 8.7Income tax 2.4 2.8Profit after tax 5.5 5.9

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Ratio analysis

Items of the financial statements are presented as comparative figures as ratios

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Classifications of ratios

Liquidity ratio - ability to meet current obligation

Leverage ratio - proportion of debt equity Activity ratio - efficiency of assets

utilisation Profitability ratio - overall performance

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Liquidity ratio

Current ratio Quick ratio Working capital analysis

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Leverage / Capital stricture ratios

Debt- equity ratio (long-term debt to equity, total debt to equity, debt to total capital)

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Activity/ efficiency ratio

Inventory turnover and stock holding period Debtors turnover and collection period Fixed assets turnover Total assets turnover Capital employed turnover

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Profitability ratio

Gross profit margin, Net profit margin Return on investment (return on assets, return

on capital employed, return on shareholder’s equity)

Earning per share, Dividend per share Earning yield, Dividend yield Price earning ratio Earning power

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