Financial statement analysis involves analyzing a company's financial statements to assess its performance and financial position. It is done by both internal managers and external parties such as investors and creditors. Key aspects of financial statement analysis include ratio analysis, trend analysis, and comparative analysis. Ratio analysis calculates and analyzes financial ratios to evaluate aspects such as liquidity, asset efficiency, debt levels, profitability, and investor returns. Trend analysis examines changes in financial metrics over several periods. Comparative analysis compares financial results to other companies or years. The overall goal is to evaluate the company's financial health and identify strengths and weaknesses.

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Analysis ofAnalysis of
FinancialFinancial
StatementsStatementsDr. Muhammad Naveed

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Financial StatementsFinancial Statements
Financial Statement.
The purpose of FS is to provide information about the
financial position, performance and changes in financial
position of an enterprise that is useful to a wide range of
users in making economic decisions.

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Financial StatementFinancial Statement
AnalysisAnalysis
Analysis of Financial Statement is necessary to understand
the financial positions during a particular period.
According to Myres, “Financial statement analysis is largely
a study of the relationship among the various financial
factors in a business as disclosed by a single set of
statements and a study of the trend of these factors as
shown in a series of statements”.
Ratio Analysis
Trend Analysis
Comparative Statement

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Who analyzes financial statements?
Internal users (i.e., management)
External users (emphasis of chapter)
Examples?
Investors, creditors, regulatory agencies & …
stock market analysts and auditors
Financial StatementFinancial Statement
AnalysisAnalysis

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What do internal users use it for?
Planning, evaluating and controlling company
operations
What do external users use it for?
Assessing past performance and current financial
position and making predictions about the future
profitability and solvency of the company as well as
evaluating the effectiveness of management .
Financial StatementFinancial Statement
AnalysisAnalysis

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Information is available from
Published annual reports
(1) Financial statements
(2) Notes to financial statements
(3) Auditor’s report (Independent accountants)
(4) Management’s discussion and analysis
Financial StatementFinancial Statement
AnalysisAnalysis

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Information is available from
Other sources
(1) Newspapers/Journals (e.g., Wall Street
Journal, Fortune)
(2) Financial information organizations such
as: Moody’s,
Standard & Poor
(3) Other business publications
Financial StatementFinancial Statement
AnalysisAnalysis

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Ratio Analysis
Trend Analysis
Comparative Analysis
Methods ofMethods of
Financial StatementFinancial Statement
AnalysisAnalysis

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Ratio AnalysisRatio Analysis
Ratio Analysis is most commonly used tool of financial
statement analysis.
Ratio is mathematical relationship between one numbers
to another number.
Ratio is used as index for evaluating the financial
performance of business concern.

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Ratios can be expressed in three different ways:
1. Ratio (e.g., current ratio of 2:1)
2. % (e.g., profit margin of 2%)
3. $ (e.g., EPS of $2.25)
CAUTION!
“Using ratios and percentages without considering
the underlying causes may lead to incorrect
conclusions.”
RatiosRatios

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Ratio AnalysisRatio Analysis
Types of Ratio Analysis
Liquidity Ratios
Activity Ratios
Solvency Ratios
Profitability Ratios
Shareholder’s Investment Ratios

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Ratio AnalysisRatio Analysis
Liquidity Ratios
It is also called the short term solvency ratio. It indicates a company’s
short-term debt-paying ability.
This ratio helps to understand the liquidity in a business which is the
potential ability to meet obligations.
S. No Ratio Formula Significant Level
1 Current Ratio
= _Current Assets___
Current Liabilities
2 : 1
2 Quick Ratio
= _Quick Assets ___
Current Liabilities
1 : 1

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Ratio AnalysisRatio Analysis
Current Ratio
A ratio in excess of 1 should be expected. Otherwise there would be
the prospect that the company might be unable to pay its debt on time.
Quick Ratio
This ratio should ideally be at least 1 for companies with slow
inventory turnover.
For companies with a fast inventory turnover, a quick ratio can be
comfortably less than 1 without suggesting that the company should
be in cash flow trouble.

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Balance SheetBalance Sheet
Business LeadersBusiness Leaders
As on 31As on 31stst
December, 2014December, 2014

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Balance SheetBalance Sheet
Business LeadersBusiness Leaders
As on 31As on 31stst
Dec, 1998 and 1999Dec, 1998 and 1999

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Income StatementIncome Statement
Business LeadersBusiness Leaders
For the Period Ended, 31For the Period Ended, 31stst
Dec1998 and 1999Dec1998 and 1999

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Current RatioCurrent Ratio

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Quick RatioQuick Ratio

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Quick RatioQuick Ratio

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Quick RatioQuick Ratio

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Ratio AnalysisRatio Analysis
Activity Ratios/Turnover Ratios/Efficiency Ratios
Also known as operating ratios/management ratios.
Measure the efficiency with which a business uses its assets.
This ratio helps to understand the performance of business concern.
Some of the efficiency ratios are given below:
S. No Ratio Formula
1 Stock/Inventory Turnover
= Cost of Goods Sold = Times
Average Inventory
2 Account Receivable Turnover
= _Sales on Account ______ = Times
Average Accounts Receivables
3 Accounts Payable Turnover
= _Purchases on Account _____= Times
Average Accounts Payable

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Inventory TurnoverInventory Turnover

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Accounts ReceivableAccounts Receivable
TurnoverTurnover

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Accounts Receivable inAccounts Receivable in
DaysDays

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Accounts PayableAccounts Payable
TurnoverTurnover
There is no single line item that tells how much a
company purchased in a year. The cost of sales in the
income statement shows what was sold, but the company
may have purchased either more or less than it eventually
sold. The result would be either an increase, or a decrease
in inventory.
To calculate the purchases made, the cost of goods sold
is adjusted by the change in inventory:
Purchases = Cost of sales + Ending inventory – Starting
inventory

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Accounts PayableAccounts Payable
TurnoverTurnover

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Ratio AnalysisRatio Analysis
Solvency Ratios.
It is also called the leverage ratio, which measures the long term
obligation of the business concern.
This ratio helps to understand, how the long term funds are used in
the business concern. Some the solvency ratios are as follow:
S. No Ratio Formula
1 Equity Ratio
= _Shareholders’ Equity ___
Total Assets
2 Debt Ratio
= _Total Liabilities ___
Total Assets
3 Debt Equity Ratio
= _Total Liabilities _
Shareholder’s equity
4 Interest Cover Ratio
= Profit before interest and tax_ = Times
Interest charges

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Equity RatioEquity Ratio

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Debt RatioDebt Ratio

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Debt RatioDebt Ratio
There is no absolute guide to the maximum
safe debt ratio, but as a very general guide,
you might regard 50% as a safe limit to
debt.

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Debt –Equity RatioDebt –Equity Ratio

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Interest Cover RatioInterest Cover Ratio

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Interest Cover RatioInterest Cover Ratio
 The interest cover ratio shows whether a company is
earning enough profit before interest and tax to pay its
interest costs comfortably.
 It tells the safety margin that the business has in terms
of being able to meet its interest obligations.
 A high interest cover means that the business is easily
able to meet its interest obligations from profits.
 A low interest cover ratio means that the business is
potentially in danger of not being able to meet its interest
obligations.
 Interest cover of 2-3 is comfortably covered.

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Ratio AnalysisRatio Analysis
Profitability Ratios
Profitability ratio helps to measure the profitability position of the business
concern.
S. No Ratio Formula
1 Gross Profit Ratio
= Gross Profit X 100
Net Sales
2 Net Profit Ratio
= Net Profit after interest and tax X 100
Net Sales
3 Operating Profit Ratio
= Profit before interest and tax X 100
Net Sales
4 Return on Equity
= Net Profit after interest and tax X 100
Shareholders’ Equity
5 Return on Assets
= Net Profit after interest and tax X 100

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Ratio AnalysisRatio Analysis
1. Gross Profit Ratio. It expresses the relationship between gross profit
and sales.
2. Net Profit Ratio. is the ratio of net profit to net sales.
3. Operating Profit Ratio: Operating Profit means profit earned by the
concern from its business operation and not from the other sources.
All operating incomes are added and non-operating incomes are
deducted.
4. Return on equity: measures a corporation's profitability by
revealing how much profit a company generates with the money
shareholders have invested.

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Ratio AnalysisRatio Analysis
5. Return on Assets. An indicator of how profitable a company is relative
to its total assets.
ROA gives an idea as to how efficient management is at using its assets
to generate earnings.

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Ratio AnalysisRatio Analysis
Shareholder’s Investment Ratios:
These ratios help equity shareholders and other investors to assess the value
and quality of an investment in the ordinary shares of a company. They are:
1
Earnings per
share
= Net Profit after Interest and Tax – Preferred Dividend
Average number of issued equity shares
2
Dividend per
share
= Dividends paid to equity shareholders
Average number of issued equity shares
3
Dividend
cover
= EPS = times
DPS
4 P/E ratio
= Market value per share
EPS

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Ratio AnalysisRatio Analysis
1. Earning per share. Earnings per share is generally considered to
be the single most important variable in determining a share's
price.
For example, assume that a company has a net income of $25 million. If the
company pays out $1 million in preferred dividends and has 10 million
shares for half of the year and 15 million shares for the other half, the EPS
would be $1.92 (24/12.5).
First, the $1 million is deducted from the net income to get $24 million, then a
weighted average is taken to find the number of shares outstanding (0.5 x
10M+ 0.5 x 15M = 12.5M).

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Ratio AnalysisRatio Analysis
2. Dividend per share.
It is the amount of the dividend that shareholders have (or
will) receive for each share they own.
Dividend per share does not usually need to be calculated by
investors as it is usually disclosed.
For example: ABC company paid a total of $237,000 in dividends over the last
year of which there was a preferred dividend totaling $59,250. ABC has 2
million shares outstanding so its DPS would be ($237,000-$59,250)/2,000,000
= $0.0889 per share.

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Ratio AnalysisRatio Analysis
3. Dividend cover.
It shows the proportion of profit that is available for
distribution to shareholders that has been paid (or proposed)
and what proportion will be retained in the business to
finance future growth.
A dividend cover of 2 times would indicate that the company had
paid 50% of its distributable profits as dividends, and retained
50% in the business to help finance future operations.

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Ratio AnalysisRatio Analysis
4. Price Earning Ratio.
A high P/E ratio indicates strong shareholder confidence in the company
and its future, e.g. in profit growth, and a lower P/E ratio indicates lower
confidence.
The P/E ratio of one company can be compared with the P/E ratios of:
Other companies in the same business sector
Other companies generally
For example, if a company is currently trading at $43 a share
and earnings over the last 12 months were $1.95 per share,
the P/E ratio for the stock would be 22.05 ($43/$1.95).

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Financial StatementFinancial Statement
AnalysisAnalysis
Comparative Statement
This helps to understand the comparative position of
financial and operational performance at different period of
time.
Two major types of comparative:
Comparative Balance Sheet Analysis
Comparative Income Statement Analysis

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Comparative Balance Sheet Analysis
2007 2008 2009
Assets Amounts % of total Amounts % of total Amounts % of total
Current Assets
Cash and
Receivables $70,000 5.0% $90,000 6.0% $90,000 6.0%
Non-Current Assets
454,775 31.0% 454,775 31.0% 454,775 31.0%
520,000 36.0% 520,000 35.0% 520,000 35.0%
130,000 9.0% 130,000 9.0% 130,000 9.0%
160,000 11.0% 160,000 11.0% 160,000 11.0%
122,000 8.0% 122,000 8.0% 122,000 8.0%
Total Assets $1,456,775 100.0% $1,476,775 100.0% $1,476,775 100.0%
Liabilities Amounts % of total Amounts % of total Amounts % of total
Current Liabilities
Creditors $11,250 4.0% $11,250 4.0% $12,000 4.0%
Non-Current Liabilities
Long Term Loan 10,500 3.0% 10,500 3.0% 10,500 3.0%
Mortgages 229,000 76.0% 229,000 76.0% 229,000 75.0%
Other Debts 52,500 17.0% 52,500 17.0% 52,500 17.0%
Total liabilities $303,250 100.0% $303,250 100.0% $304,000 100.0%

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Trend AnalysisTrend Analysis
Trend analysis evaluates an organization’s financial
information over a period of time.
Periods may be measured in months, quarters, or years,
depending on the circumstances.
The goal is to calculate and analyze the amount change and
percent change from one period to the next.

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Trend AnalysisTrend Analysis
For example, in fiscal years 2010 and 2009, Coca-Cola had the
operating income shown as follows.

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Trend AnalysisTrend Analysis
Percent change = (Current year amount – Base year amount)
Base year amount
2.6% = ($8,449 – $8,231) / $8,231

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