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MS-12: FINANCIAL STATEMENT ANALYSIS
FS ANALYSIS

involves the evaluation of the firm’s past performance, present condition, and
business potentials by way of careful analysis of its financial statements pertaining
to matters like:


Profitability of the business firm



Ability to meet company obligations



Safety of investment in the business



Effectiveness of management in running the firm

VARIOUS MODES OF FINANCIAL STATEMENT ANALYSIS
1) Horizontal analysis

4) Gross profit variation analysis

2) Vertical analysis

5) Cash flow analysis

3) Financial ratios

HORIZONTAL ANALYSIS
Horizontal analysis (sometimes called ‘trend’ or ‘index’ analysis) involves comparison of amounts
shown in the FS of two or more consecutive periods
...
Consider the following formula:

Percentage Change (∆% ) =

Most Recent Value − Base Period Value
Base Period Value

Comparisons can be made between an actual amount compared against a budgeted amount, with the
‘budget’ serving as the basis or pattern of performance
...


VERTICAL ANALYSIS
Vertical analysis is the process of comparing figures in the FS of a single period
...
This is accomplished by expressing all figures in
the FS as percentages of an important item such as total ass ets (in the balance sheet) or net sales (in
the income statement)
...


MS-12: FINANCIAL STATEMENT ANALYSIS
Percentage composition statements are used for comparing:
1) Multiple years of data from the same firm
2) Companies that are different in size
3) Company to industry averages

FINANCIAL RATIOS
Financial ratios involve development of mathematical relationships among accounts found in the
FS
...

BASIC RULES IN COMPUTING FINANCIAL RATIOS:


When calculating a ratio using balance sheet amounts only, the numerator and denominator should
be based on amounts as of the same balance sheet date
...
Exception: Calculation of growth ratios



If an income statement amount and a balance sheet amount are used at the same time to calculate
a ratio, the balance sheet amount should be expressed as an average for the t ime period
represented by the income statement amount
...




If sales and/or purchases are given without making distinction as to whether made in cash or on
credit, assumptions are made depending on the ratio being calculated:



-

Turnover ratios: Sales and purchases are made on credit
...


As a rule, an operating year is assumed to have 360 days, unless specified otherwise
...


MS-12: FINANCIAL STATEMENT ANALYSIS
FINANCIAL RATIOS
LIQUIDITY (Liquidity refers to the company’s ability to pay its current liabilities as
they fall due
...
It is primary
test of liquidity to meet current
obligations from current assets
...
e
...


AVERAGE AGE OF
RECEIVABLES
(Average Collection
Period )
(Days’ Sales in
Receivables )

360
Receivables Turnover

It indicates the average number
of days during which the
company must wait before
receivables are collected
...
Merchandise Inventory

It measures the number of
times that the inventory is
replaced during the period
...


RAW MATERIALS
TURNOVER

Average
age

No
...


It measures the movement
Cost
of
Sales
+
Operating
Expenses
∗∗
CURRENT ASSETS
and utilization of current
Average Current Assets
TURNOVER
assets to meet operating
requirements
...

** These exclude depreciation, amortization and other expenses related to long-term
assets
...
)
These ratios involve leverage ratios
...

TIME INTEREST
EARNED

EBIT
Interest Expense

It determines the extent to
which the operations cover
interest expense
...


DEBT RATIO

Total Liabilities
Total Assets

Proportion of total assets
provided by creditors
...


RETURN ON
SALES

Income
Net Sales

Determines the portion of
sales
that
went
into
company’s earnings
...


EQUITY RATIO

PROFITABILITY

Issue: What INCOME figure should be used?
 If the intention is to measure operational performance, income is expressed as
before interest and tax, alternatively, income before ‘after-tax’ interest may be
used to exclude the effect of capital structure
...

 The practice of expressing income after interest but before tax is being
discouraged
...

 If used in the context of “DuPont” technique, income must be after interests, taxes
and preferred stock
...


Measures the amount of net
Net Income − Preferred Dividends
Wtd
...
Common Shares Outstanding income earned by each
common share
...


DIVIDEND YIELD

Dividend Per Share
Price Per Share

Measures the rate of return
in the investor’s common
stock investments
...


OTHER MEANINGFUL RATIOS ( Used to evaluate Long-Term Financial Position as
STABILITY )
FIXED ASSETS
TO TOTAL
EQUITY

Fixed Assets
Total Equity

Measures the proportion of
owner’s equity to fixed
assets
...
*

FIXED ASSETS
TO TOTAL
ASSETS

Fixed Assets (Net)
Total Assets

Indicates possible over
expansion of plant and
equipment
...


CAPITAL
INTENSITY
RATIO

Total Assets
Net Sales

Measures efficiency of the
firm to generate sales
through employment of its
resources
...

Measures
recoverable
amount
by
common
stockholders in the event
of liquidation if assets are
realized at their book
values
...


* Trading on the equity is another name for leverage
...


MS-12: FINANCIAL STATEMENT ANALYSIS
SOLVENCY ( OR Short-Term Financial Position )
WORKING
CAPITAL
TURNOVER

Net Sales
Average Working Capital

DEFENSIVE
INTERVAL
RATIO

Current Liabilities
Cash and cash Equivalents

Measures
coverage
current liabilities
...


Fixed Assets
Long term Liabilities

Reflects extent of the
utilization of resources
from
long-term
debt
...


FIXED ASSETS
TO LONG-TERM
LIABILITIES

Indicates
adequacy
of
working capital to support
operation (sales)
...


OPERATING
PROFIT MARGIN

Operating Profit
Net Sales

Measures profit generated
after
consideration
of
operating costs
...




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