Chapter 11 Analysis of Financial Statement

CHAPTER 11

ANALYSIS OF FINANCIAL STATEMENT

What is financial analysis?

 Financial analysis is the assessment of a firm’s past, present
and anticipated future financial performance.

 The analysis is made based on the firm’s financial statements.

 It involves looking at historical performance to estimate
future performance.

 It allows comparison of the company’s performance over
time as well as its performance relative to it competitors in
the industry.

Objective of financial analysis

 To identify the firm’s strength and weakness.
 It is important for the firm to identify its strengths so that it

can capitalize on these strengths and take remedial and
correction action to improve its weaknesses.

FinanciFailnarnactiiaol sRatio

Are mathematical aids for Used to summarize the
evaluation and comparison information in a company’s
of financial performance
financial statement in
assessing its financial health

Objectives of ratio analysis:

To standardize To evaluate current To compare
financial operations of the present

information for company. performance
comparison with past
purposes.
performance.

Types of comparison

Time series analysis Cross section analysis

 Also called as internal  Also called as external
comparison. comparison.

 It compares the firm’s  The comparison of ratios
performance from time to of a firm with ratios of
time. other firms in a similar
industry.
 Firms are able to know
whether their financial  Enable the company to
performance has improved identify its strengths and
or deteriorated compare to weaknesses as compared to
previous years’ result. its competitor.

Liquidity ratio:

measure a firm’s ability to meet its short term financial obligation
that is whether the company has the resources to pay its creditors
when payments are due.

Current ratio Quick ratio

Current assets Current assets - Inventories
Current liabilities Current liabilities

Asset management ratio:
It measures how effective a firm is managing its assets (both
current and fixed) to generate revenue or sales for a period of
time.

Inventory turnover Total assets turnover

Cost of goods sold Sales
Inventory Total assets

Receivable turnover Average Collection Period
Sales
Account receivable x 365
Account Receivable Sales

Leverage ratio: measure the level of debt or borrowings in a firm. It
tell us whether the company uses more debt financing to finance its
assets and operations. The higher level of debt, the higher the
chance that the company may not be able to payback its borrowing
and the interest charge on time.

Debt ratio 100

Current liabilities + Noncurrent liabilities x
Total assets

Time Interest Earned

Operating Profit @EBIT
Interest expenses @Finance cost

Profitability ratio: measure how efficient the firm uses its
assets to generate profit. The ratio also indicate the firm’s
efficiency in controlling costs and its pricing policy

Gross Profit Margin Return on Asset
Gross Profit x 100 Sales
Net Profit x 100 Total
Operating Profit Margin Asset
Operating Profit x 100 Sales
Return on Equity
Net Profit Margin
Net Profit x 100 Net Profit x 100 Total
Sales Equity