ANALYSIS OF FINANCIAL STATEMENTS

BY RANA ASGHAR ALI

FINANCIAL STATEMENT USER

Supplier / Trade creditor are interested. Bondholders are interested in long cash flow ability to firm i( Service to Debt, profitability ) Investors Focus on Profit and Stability Managers use financial Analysis for Internal control.

Primary fundamental Analysis, Balance Sheet

The assets what the firm owns are listed according to the degree of their liquidity from the most liquid to the liquid. The fixed assets are shown on the balanced sheet at the cost or at depreciation adjusted amounts and do not necessarily reflect their current market or market values. All liabilities and net worth what is owed are shown separately on the right hand side of the balance sheet when not organized vertically with assets at the top.

Liability division

The liability is divided into two groups. Current liabilities Long term liabilities.

Current liabilities.

Current liabilities which are expected to be rapid within one year are shown at the top of the list. Example are Note Payable, Account Payable, Salary payable, interest payable,

LONG TERM LIABILITIES

Long term liabilities which are due after one year are listed below current liabilities. Long Term Debt Long Term Bonds

Shareholders equity.
Share holders equity consists common stock. 1.The common stock amount as per value of one share of a common stock times the number of shares outstanding. 2.Additional paid in capital or capital surplus is the excess of the actual price originally paid for the stock over its par value. 3.Retained earnings represent the accumulated and undistributed net profits that remain after taxes are paid and dividends are distributed.

Balance sheet equation

The fact that total assets equal liabilities plus net worth is called the balance sheet equation.

Income statement.
The income statement shows the record of a firms operating functional analysis. 1.A framework helps focus on specific issues and questions. 2.One possible framework is suggested for considering how to raise external financing.

Financing needs after analysis

A. The nature and timing of the funds needs of the firm. The firms financial condition and profitability. The firms business risk.

Analysis of financial ratio involves

Trend comparisons compare ratios for several periods to determine if a firms financial condition is improving or deteriorating over time. Industry comparison compare ratios of a firm with those of similar firms or with industry rooms.

Financial Ratio

Financial ratios can be divided into five categories liquidity debt or leverage coverage activity and profitability ratios

Division Of Ratios

The first two categories use data from the balance sheet and the last three from the income statement or both the income statement and balance sheet.

Current and Quick Ratio

Liquidity ratios are used to assess the firms ability to meet its short term financial obligations. 1. Current ratio =Current assets Current liabilities Although a higher current ratio indicates greater liquidity, it may also imply lower profitability. Since the current ratio does not take into account the liquidity of the individual current asset accounts, its use as the exclusive measure of liquidity can be misleading. A more rigorous measure, the quick ratio provides additional information. 2. Quick (acid test) ratio =Current assets-Inventories Current Liabilities This ratio is a stricter measure of a firms liquidity in that it omits inventories, the least liquid of current assets.

DEBT TO EQUITY AND DEBT TO ASSET RATIO

Debt or leverage ratios are uses to assess the firms dependence on debt financing Debt-to equity ratio= Total debt Shareholders equity Creditors generally like this ratio to be low, Shareholders are providing a high percentage of financing. For Example 1454000/179600=0.81 This ratio will vary depending on the industry and the variability of cash flows. Debt-to-total assets ratio =Total debt Total assets

Debt to Total Asset Ratio

This ratio shows what percentage of each Rs. Invested in asset comes from creditors. High Debt to Total Ratio indicates high risk.

Coverage Ratios

Measure the to meet financial Obligation when due. Earning before interest and taxes (EBIT) Interest expense The higher the ratio the more likely it is that the company could cover its interest payments without difficulty. A broader analysis would assess the ability of the company to cover all of its fixed expenses.

Interest Coverage Ratio

Bond Rating Services Moody s Investor Services Standard and Poor Example 400,000/ 85,000= 4.71 Where median industrial is 4.00

RECIEVABLE TURNOVER RATIO

Activity ratios indicate how efficiently a firm is using its assets. These generally focus on three areas: receivables, inventories and assets in general. Receivable turnover (RT) = Annual net credit sales. Receivables

Receivable Turnover

Net annual Credit sales=3992,000 Receivable =678,000 By applying Ratio 3,992,000/678,000=5.89

RECIEVABLE TURNOVER RATIO

The higher the RT ratio, the shorter the time between the average sale and cash collection. When credit sales figures are not available, the analyst may resort to using total sales figures. When sales are seasonal, an average of monthly closing receivables balances may be more appropriate than a simple year- end receivables balance.

RECIEVABLE TURNOVER RATIO IN DAYS

Receivable turnover in days (RTD) or average collection period. Days in the year Receivable turnover 365/RT Or equivalently: Receivables x Days in the year Annual credit sales

EXPLANATION

Al though, generally a high receivables turnover in days (or average collection period) is not good, a very low RTD may indicate an overly restrictive credit policy and possible lost sales. Another method for analyzing the liquidity of accounts receivable is through the use of an aging schedule. This involves categorizing receivable outstanding at a particular point in terms of the period of time they have gone uncollected since their original sales transaction. Accounts payable can also be analyzed in the same way as accounts receivable.

INVENTORY TURNOVER
Payable turnover in days = Accounts payable x Days in the year Annual credit purchases Liquidity in inventory may be measured by the inventory turnover (IT) Cost of goods sold Inventory e.g 2680,000/1329,000=2.02 In general, the higher the inventory turnover, the more efficient the firms inventory management.

INVENTORY TURNOVER IN DAYS.

Inventory turnover in days tells us how many days on average, before inventory is turned into accounts receivable through sales Days in the year Inventory turnover The operating cycle shown the length of time from the commitment of cash for purchase until the collection of receivables. Mathematically, the operating cycle is described as Inventory turnover in days+ receivable turnover in days

TOTAL ASSET TURNOVER

Total asset turnover tells us the relative efficiency with which a firm utilizes its total assets to generate sales. It states the number of sales dollars generated per dollar of asset investment and is calculated as Net sales Total assets e.G 3,992,000/3,252,000=1.23 Industry ratio=1.66 Generate less sales

PROFITABILITY RATIO RETURN ON INVESTMENT

Profitability ratios give an indication of the firms overall effectiveness of operation and thus, to its profitability. These can be categorized into two groups based on (1) sales and (2) investments. The gross profit margin indicates the efficiency of the firms operations as well as the pricing policies of the firm. It is Net sales-Cost of goods sold Net sales The net profit margin is another common profitability ratio: Net profit after taxes Net sales

RETURN ON INVESTMENT

A widely used overall profitability measure is the return on investment (ROI) ratio (or return on assets) Net profit after taxes Total assets Another summary profitability measure is return on equity (ROE): Net profit after taxes Shareholders equity There are sample logical relationships among some of the ratios which can be seen in the DuPont approach to ratio analysisan approach that breaks down profitability measures into their basic components. ROI may be broken down into its component parts for additional analysis of a firms earning power:

DUE POINT

ROI

= Net profit margin x Total asset turnover Net profit = after taxes x Net sales Net sales Total assets Similarly , for return on shareholders equity : Net Total Equity ROE = profit x asset x multiplier Margin turnover =

Net profit after taxes Net sales

Net sales x Total assets Total assets Shareholders equity

Investor
Percentage of earning Retained Net income-all dividend/ Net income

Price earning Ratio Market price per share/Market price common share Dividend payout DPS EPS

INVESTMENT RATIOS

Dividend yield: Dividend per common share Market price common share

Book value per share: Total stock equity-preferred stock equity Number of common share outstanding