Financial Statement Analysis

Meaning and techniques

Dr. M. Kanchan

FSA

• Process of identifying the financial strengths and weakness by establishing a strategic relationship between Balance sheet and P/L A/c items.

• Consists of: Comparative statements, trend analysis, schedule of changes in Working Capital, Funds flow and Cash flow statements, CVP analysis and Ratio Analysis

• Dr. M. Kanchan

Classification of Ratios

• 1. Traditional: B/S Ratio, P/L Ratio, Composite Ratio

• 2. Functional : Liquidity, Leverage, Activity, Profitability

• Significance : Primary, Secondary

Dr. M. Kanchan

Balance Sheet Ratios

• a. Current Ratio• b. Liquid /Acid test /Quick Ratio• c. Debt-Equity • d. Proprietary• e. Capital Gearing• f. Capital Inventory to WC Ratio• g. Current assets: Fixed assets

Dr. M. Kanchan

P/L A/c Ratios

• Gross Profit Ratio• Operating Ratio• Operating Profit Ratio• Net Profit Ratio• Expense Ratio• Interest Coverage Ratio.

Dr. M. Kanchan

Composite/Inter-statement Ratios

• Stock Turnover• Debtors Turnover• Payables Turnover• Fixed Assets Turnover• Return on Equity• Return on Shareholders’ Funds• Return on Total ResourcesDr. M. Kanchan

Functional Classification of Ratios

• Liquidity

• Long term solvency/Leverage

• Activity

• Profitability

Dr. M. Kanchan

Components of Current Ratio

• Current Assets: Current Liabilities• Cash in hand Outstanding Expenses• Cash at Bank Bills Payable• Short term marketable securities Sundry Creditors • Short term investments Short term advances• Bills Receivables Income tax payable• Sundry Debtors Dividend Payable• Stock Bank Overdraft • Work-in- progress• Prepaid expenses

Dr. M. Kanchan

Interpretation of Current Ratio

• Rule of Thumb: 2 CA : 1 CL

High Current ratio may not be favourable• There may be slow moving stock

• Debt collection may not be satisfactory

• Cash /Bank may be idle

Dr. M. Kanchan

Important factors

• Type of Business• Type of Products• Reputation of the Concern• Seasonal Influence• Type of Assets availableLimitations:• Window Dressing• Unrefined

Weighted Current Ratio

Time Adjusted Current Ratio• DF= 1/(1+r)n Where DF= Discount Factor, r= annual Earnings Rate before tax, n= time taken for each

current asset and liability to be converted into cash.

Dr. M. Kanchan

Quick/Acid Test/Liquid Ratio

• Components:• Quick Assets Current Liabilities• current Assets-(Inventories + prepaid exp)

• Cash in hand Outstanding expenses• Cash at Bank Bills Payable• Bills Receivables Sundry creditors• Sundry Debtors Short-term advances• Marketable securities Income tax payable• Temporary Investments Dividends Payable Bank overdraft

Rule of thumb: 1 : 1

Dr. M. Kanchan

Absolute Quick/Cash Ratio

• AQ Ratio= Cash in hand + at Bank +Short term securities /CL Rule of thumb: 0.5 : 1

Interval Measure =Quick assets/Average Daily Cash expADC exp= Cost of goods sold+Admn and sell & dist exp (less dep

and non-cash exp)/No. of days in a year

Dr. M. Kanchan