Financial Statement Analysis

Ratio Analysis
It is the % between any two logically related numbers Ratio analysis summarizes the figures in a form that is easily understood, interpreted and used. It enables to assess strengths and identify weaknesses, determine trends and forecast future performance

Margin/Profitability Ratios
Margins indicate return or earnings on sales It helps in charaterizing the cost structures of businesses The higher the margins, the higher the profitability

Ratio Gross Profit Margin = (Sales COGS)/Sales

Indicates This shows profitability or mark up on goods sold Measures efficiency of production or purchase Break-up of manufacturing cost elements: Labor, material and manufacturing expenses might be helpful It indicates profitability before the cost of financing, tax and other non-operating items It is a measure of efficiency for administration and selling expenses This is calculated to determine the rate earned on sales after the cost of financing but before tax

Operating Profit Margin = Operating Profit (EBIT)/ Sales

Pre-tax Margin = EBT/Sales

Net Profit Margin = PAT/Sales

It embraces effects of all areas, viz, manufacturing/purchase, operating expenses, non-operating items, financing costs and tax costs

Asset Management/Efficiency/Turnover Ratios

To find out how efficient a company is in managing its assets Efficiency = Output/Input = Sales/Assets Efficiency can be increased by
Increasing Sales Same level of Assets Same level of Sales Decreasing Assets Increasing Sales Decreasing Assets

The higher the turnover/efficiency, the higher the profitability

Ratio
Total Assets Turnover = Sales/Total Asset (Total Asset = Net Fixed Asset + Investments + Net Current Assets)

Indicates
The ratio is calculated to check whether a company is generating sufficient volume of business taking into consideration the size of its asset investment It shows sales generated per rupee of asset Highlights efficiency in used of long term assets Net Fixed Assets = Gross block Depn Higher is better : Caution: Higher fixed assets turnover may be due to higher

Fixed Assets Turnover = Sales/Net Fixed Asset

Current Assets Tests efficiency is Turnover= Sales/Current managing current assets Assets Higher is better; Caution: Risk of overtrading on current asset Working Capital Turnover = Sales/WC Tests efficiency is managing working capital Working capital = CACL

Higher turnover/lower collection period ( debtors means average suggests faster debtors = opening + collection; better credit closing / 2) policy. (b) Debtors Collection Period = 365/Debtors turnover=(Debtors*3 60)/Sales (a) Inventory Turnover= Higher turnover or COGS/Stock lower holding period is better; Caution: Risk of (b) Stock holding stock-out; lost Period= 365/Stock turnover=(Stock*360) production; lost sales /COGS (a) Debtors Turnover = Sales/Debtors

Overall Profitability Ratios

Overall profitability relates returns to investments It shows managements effectiveness as shown by returns generated on sales and investments Profitability = Margin * Asset Efficiency The higher the margins and assets efficiency, the higher the profitability

Return on Assets = PAT/Total Assets

Return on Equity or Net Worth = (PAT Pref Div)/Net Worth

It examines whether Margin in sales earned is reasonable Assets (efficiency) of the company are adequately used Interest payments (Financing Cost) made by the company are too high Tax planning and management is efficient It indicates the return available to equity shareholders after meeting all outside obligations and preference dividend Net Worth = Share Capital +Reserves and Surplus

Return on Investment or It indicates the return Capital Employed = available to all suppliers EBIT / CE of long-term funds (before financing and tax expenses) CE (Liability) = Net Worth + Loan funds CE (Asset) = FA + Investment + Net Current Assets (CA-CL)

Liquidity Ratios
Liquidity ratios help one to ascertain whether a company can pay its currently maturing financial obligations as well as have enough cash to meet its operational requirements.

Current Ratio = CA/CL

To check whether the company has adequate current assets to meet its current liabilities Higher the current ratio, the higher the liquidity Caution: However, the composition of current assets must be looked into. High current ratio is misleading if major portion of current asset is Slow or non moving inventory Sticky debtors From creditors perspective higher is better. From managers perspective lower is better

Quick Ratio/ Acid Test Ratio = (Cash and Cash equivalents) / CL= (CA Stock) / CL

To check whether the company has adequate cash or cash equivalents to meet its current obligations without having resorting to liquidating non- cash assets It is a stringent measure of liquidity From creditors perspective higher is better

Solvency: Leverage and Coverage

The long term solvency is affected by the extent of debt capital used Heavy debt reduces solvency of the business Leverage measures the extent assets are covered by liabilities and the extent loans and liabilities are as source of funds Leverage is a double-edged sword

Debt-Asset Ratio = Total Debt/ Total Assets

This ratio indicates the total fund provided by outsiders to the business

Debt- Equity Ratio = Total This ratio indicates the Debt/Net Worth or Long term amount invested by Debt/Net Worth outsiders per rupee invested by the owners High ratio is good if interest on debt is lower than ROI High Ratio is bad if interest on debt is higher than ROI Lower is not always better. It is difficult to establish a benchmark ratio

Coverage Ratios/ Debt Service Capacity

To assess whether a company generates enough profits to be able to pay the interest and principal repayment on loans given.

Interest Coverage = (EBIT + Dep) /Interest

Ability to meet interest burden

DSCR = (PAT + Non-cash An important ratio used by exp like Dep + Interest) / banks and financial (Interest + Loan Repayment) institution to judge the debt service capacity of the business If the ratio is low, repayment period is increased

Capital Market Strength Ratios

EPS = [PAT Pref Indicates the earnings Div]/No of Equity Shares attributable to a share
DPS = Dividend/ No of Equity Shares It indicates the earnings actually distributed per share

Dividend Payout = DPS/EPS P/E Ratio = Market Price/EPS

It shows the amount of dividend paid out of earnings It shows the price investors are willing to pay per rupee of earning P/E reflects growth prospect, corporate image and risk characteristics of a company Growth companies have high