FS ANALYSIS

• General approach to financial statements analysis

  1. Evaluation of the environment (industry and economy as a whole) where the company conducts business

  2. Analysis of the firm's short-term solvency

  3. Analysis of the company's capital structure and long-term solvency

  4. Evaluation of the management's efficiency in running the business

  5. Analysis of the firm's profitability
• Steps in financial statements analysis

  1. Establish the objectives of the analysis to be conducted

  2. Study the industry where the firm belongs

  3. Study the firm's background and the quality of its management

  4. Evaluate the firm's financial statements using the evaluation techniques available

  5. Summarize the results of the studies and evaluation conducted

  6. Develop conclusions relevant to the established objectives
• Techniques used in financial statements analysis

  • Horizontal analysis (trend ratios and percentages)
  • Vertical analysis (common-size statements)
  • Ratio analysis
  • Analysis of variation in gross profit and net income
  • Cash flow analysis
• Financial statements analysis


  Careful selection of data from financial statements in order to assess and evaluate the firm's past performance, its present condition, and future business potentials
• Objectives of financial statements analysis

  • Evaluate and forecast the company's financial health
  • Identify the company's financial strengths and weaknesses
  • Know about the profitability of the business firm
  • Know about the firm's ability to meet its obligations
  • Know about the safety of the investment in the business
  • Know about the effectiveness of management in running the firm
• General approach to financial statements analysis

  • Evaluation of the environment (industry and economy as a whole) where the company conducts business
  • Analysis of the firm's short-term solvency
  • Analysis of the company's capital structure and long-term solvency
  • Evaluation of the management's efficiency in running the business
  • Analysis of the firm's profitability
• Problems and limitations in financial statements analysis

  • Comparison of financial data
  • The need to look beyond ratios
• Steps in financial statements analysis

  • Establish the objectives of the analysis to be conducted
  • Study the industry where the firm belongs
  • Study the firm's background and the quality of its management
  • Evaluate the firm's financial statements using the evaluation techniques available
  • Summarize the results of the studies and evaluation conducted
  • Develop conclusions relevant to the established objectives
• Techniques used in financial statements analysis

  • Horizontal Analysis (trend ratios and percentages)
  • Vertical Analysis (common-size statements)
  • Ratio Analysis
  • Analysis of variation in gross profit and net income
  • Cash flow analysis
• Horizontal analysis


  Comparison of figures shown in the financial statements of two or more consecutive periods. The difference between the figures of the two periods is calculated, and the percentage change from one period to the next is computed using the earlier period as the base
• Vertical analysis


  The process of comparing figures in the financial statements of a single period. It involves converting of figures in the statements to common base. This is accomplished by expressing all the figures in the statements as percentages of an important item such as total assets (in the balance sheet) or total or net sales (in the income statement). These converted statements are called common-size statements or percentage composition statements.
• Ratio analysis


  • Liquidity ratios
  • Leverage ratios
  • Asset management ratios
  • Cost management ratios
  • Profitability ratios
• Liquidity ratios


  Provide information about the firm's ability to pay its current obligations and continue operations
• Liquidity ratios


  • Current ratio or working capital ratio or bankers' ratio
  • Acid test or quick ratio
  • Cash ratio
  • Cash flow ratio
  • Defensive interval
  • Investment financing
  • Liquidity index
• Leverage ratios


  Measure the company's use of debt to finance assets and operations
• Leverage ratios


  • Financial leverage ratio or equity multiplier
  • Financial leverage index
  • Interest-bearing debt ratio
  • Total debt ratio
  • Debt to equity ratio
  • Debt to tangible net worth ratio
  • Times interest-earned ratio or interest coverage ratio
  • Fixed charge coverage ratio or earnings to fixed charges ratio
  • Operating cash flow to total debt ratio
• Asset management ratios


  Measure how the firm uses its assets to generate revenue and income
• Asset management ratios


  • Finished goods or merchandise inventory turnover
  • Average age of inventories or number of days of inventory
  • Receivables turnover ratio
  • Average age of receivables or average collection period
  • Operating cycle or conversion period
  • Average age of accounts payable
  • Fixed assets turnover ratio
  • Total assets turnover ratio
  • Total capital turnover ratio
  • Investment rate
  • Plowback ratio
• Cost management ratios


  Measure how well a firm controls its costs
• Cost management ratios


  • Gross profit rate or gross profit percentage
  • Labor cost ratio
  • Employment growth rate
• Profitability ratios


  Measure earnings in relation to some base, such as assets, sales, or capital
• Profitability ratios


  • Profit margin on sales or net profit percentage
  • Net operating income to sales
  • Return on investment or return on total assets or return on invested capital
  • Net operating income to total capital
• Net Sales-Cost of Sales

  Measures how much can be spent for marketing, R&D, and administrative costs while still reaching targeted income
• Labor Cost Ratio


  Measures the percentage of labor cost to sales
• Employment Growth Rate


  Used as a measure of operational growth, compared with the investment rate to determine whether capital is being substituted for labor
• Profitability Ratios


  • Profit Margin on Sales or Net Income/Net Sales
  • Net Operating Income to Sales
  • Return on Investment or Return on Total Assets or Return on Invested Capital
  • Net Operating Income to Total Capital
  • Marginal Profitability Rate
  • Return on Common Equity
  • Marginal return on Common Equity
  • Return on Total Equity
  • Economic Value Added (EVA)
• Profit Margin on Sales or Net Income/Net Sales


  Measures the percentage of net income to sales
• Net Operating Income to Sales

  Measures the percentage of operating income to sales
• Return on Investment or Return on Total Assets or Return on Invested Capital


  Indicates whether management is using funds wisely
• Net Operating Income to Total Capital


  A variation of the Net Operating Income to Total Capital Ratio
• Marginal Profitability Rate


  A variation of the Net Operating Income to Total Capital Ratio
• Return on Common Equity

  Measures the return on the carrying amount of equity
• Marginal return on Common Equity


  A variation of the return on common equity
• Return on Total Equity


  A measure of the shareholder value creation
• Economic Value Added (EVA)


  Net Operating Profit after Taxes less Capital Charge or Total Cost of Capital Capital Charge total capital employed x Weighted Average Cost of Capital
• Growth Ratios


  • Basic Earnings per Share (BEPS)
  • Earnings Yield
  • Cash Flow per Share
  • Dividend Payout Ratio
  • Dividend Yield
  • Ratio of Operating Cash Flows to Cash Dividends
  • Internal Growth Rate
  • Sustainable Equity Growth Rate
• Basic Earnings per Share (BEPS)

  Reflects the company's earning power, i.e. its ability to generate income from normal operations
• Earnings Yield


  Shows the relationship of earnings per share to the market price per share
• Cash Flow per Share

  An indicator of short-term capacity to make capital outlays and dividend payments
• Dividend Payout Ratio


  Shows whether a firm pays out most of its earnings in dividends or reinvests the earnings internally