FINANCIAL

STATEMENT ANALYSIS

What is Financial
Ratios?
The quantitative relationship between two or
more sets of financial data derived from
Income Statement and Balance Sheet.
It facilitates Comparative Analysis of
financial statements.

Types of Financial
Ratios
Liquidity Analysis
Solvency Analysis
Profitability Analysis

Liquidity Analysis
Analysis of assets and liabilities to determine
nearness to cash.
a) Current Ratio:
Ratio of current assets to current liabilities.
Current assets (1:1)
Current liabilities

How much is better?

Rule of thumb = 2:1
Is it adequate or is impending financial
health?
Answer depends upon industry.
Apart from the ratio itself, the composition
of current assets is the major concern.

Contd..
b) Acid Test Ratio:
The stricter test of a companys ability to pay its
current debts as they are due.
Excludes inventory and prepaid assets from
current assets.
Quick Assets
= 1:1
Current Liabilities
Quick assets = cash + marketable securities +
accounts receivables

Contd..
c) Account Receivable Turnover:
- A measure of the number of times account
receivables are collected in a period.
Net credit sales = times
Account receivables

- Higher is better.
- Higher the ratio, shorter the time to remain
outstanding.

Contd..
What is an acceptable ratio?
Depends upon the nature of company,
industry and many other factors.

Contd..
d) Days sales outstanding (DSO):
- Another way to measure account
receivable.
- A measure of average age of account
receivable.
DSO =

No. of days in a period = days

A/c receivable turnover

- Shorter is better due to reinvestment

opportunity.

Contd..
e) Inventory Turnover Ratio:
- A measure of the number of times
inventory is sold during a period.
Cost of Goods sold = times
Inventory level
- Higher is better.

Contd..
f) No. of days sales in inventory:
- A measure of how long it takes to sell
inventory.
No. of days in a period = days
Inventory turnover ratio
- Higher the inventory turnover ratio,
shorter the period to sell inventory.

Solvency Analysis
Solvency refers to a companys ability to
remain in business over the long run.
It is related to liquidity but differs in time.
It concerns with the ability of the firm to stay
financially healthy over the period of time.

Contd..
a) Debt to Equity Ratio:
- The ratio of total liabilities to total shareholders
equity.
Total liabilities
= 1:1
Total shareholders equity
- The composition of debt and equity in the
capital structure that determines cost of capital.
- The degree to which the company relies on
outsiders fund.
- It has impact on profitability.

Contd..
b) Times Interest Earned Ratio:
- An income statement measure of the ability
of a company to meet its interest payment of
current year out of current years earning.
Earning before interest & tax = times
Interest expense
-

Major concern for lenders.

Greater the coverage, better is the position.

Contd..
c) Debt Service Coverage ratio:
Measures the ability of a company to meet
its interest and principal payments.
Earning before interest & tax = times
Interest + Principal

Profitability Analysis
Measures effectiveness of operation
and management of the company.
Reflects financial soundness for
creditors and operating efficiency for
owners.

Contd..
a) Net Profit Margin:
- The ratio of net income to sales.
-

Discloses firms ability to generate net

income per rupee of sales.
Net Income
Sales

=%

Contd..
b) Return on Assets (ROA):
- Percentage of net income on total assets.
-

Measures the overall effectiveness of

management in generating profit with its
available assets.
Net Income =
Total Assets

Higher the firms return on assets, the better

is its operation.

Contd..
c) Return on Equity (ROE)
- The percentage of net income on total
equity or owners investment.
-

Higher the ratio, better for the owner.

Net income
Total Equity

Contd..
e) Earning per Share (EPS)
- Profit per unit share.
-

Maximization of EPS is the primary

concern for managers.

Major concern for investors.

Net Income =
No. of shares

Rs

Contd..
e) Price Earning Ratio (PE ratio):
Amount per share that the investors are
willing to pay for each rupee of earning.
PE Ratio = Market price per share
Earning per share