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dr A. Kocia 1
Agata Kocia, Ph.D.,MBAWarsaw UniversityDepartment of Economic Sciences email: [email protected]
Financial Statement Analysis
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Contact information
Office hours Department of Economic Sciences (Długa
Street 44/50, room 301) Tuesday at 10.00 Email: [email protected] or
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Materials
Presentation and other materials distributed by the lecturer
Additional reading 1: Dariusz Wędzki, “Analiza wskaźnikowa sprawozdania finansowego”, Wolters Kluwers, Kraków 2006
Additional reading 2: “Rachunkowość finansowa w teorii i praktyce” autorstwa E. Kalwasińska, D. Maciejowska, Warszawa, 2008 - część I: Podstawy Rachunkowości
Financial statements of companies
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Part I
Basic information on
financial statement analysis
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Factors shaping the financial situation: External (1) Macro environment
government policy phase of the economic cycle financial system inflationary policy pursued by the national
bank tax system accounting rules legal system
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Factors shaping the financial situation: External (2) Micro environment
phase of sector’s economic cycle market / bargain power of sellers market / bargain power of buyers barriers to entry and exit from the market competition and its strong points
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Factors shaping the financial situation: Internal (1) Qualitative
strategic management capabilities experience and competence of managers attitude of owners and lenders level of supervision by the owners information systems technical and technological advancement level culture of the organization market position
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Factors shaping the financial situation: Internal (2) Quantitative
value of revenues and expenses structure of revenues and expenses (variable /
fixed) level and structure of assets nature and structure of funding
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Factors shaping the financial situation – in summary Most important are:
company size market share performance productive assets investment level of debt
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Factors having impact on the value for owners (1) Sales factors
market size company’s market share sales structure seasonality of demand brand of products and level of customer loyalty distribution channels marketing
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Factors having impact on the value for owners (2) Factors related to profitability of sales
pricing policy level of employment and earnings of labor prices of materials, goods and services level for outsourcing
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Factors having impact on the value for owners (3) Factors related to effective tax rates
tax code shaping tax rates transfer prices on international sales amount of tax shield
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Factors having impact on the value for owners (4) Factors related to fixed assets
technical and technological level financing of investments economies of scale effects
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Factors having impact on the value for owners (5) Factors related to short-term assets
use of inventory management system ability to manage receivables risk management policy of investing surplus cash
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Factors having impact on the value for owners (6) Factors related to cost of capital
interest rate structure of capital markets use of financial leverage
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Part II
Basic information on
financial statements
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Who prepares financial statements
According to the Accounting Act of 29 September 1994, it applies to entities established or managed in Poland: commercial and civil partnerships individuals, civil partnerships of individuals,
partnerships of natural persons, if their net revenues for the previous financial year amounted to at least equivalent of EUR 1 200 000 in Polish zloty
entities operating under the Banking Law, regardless of the amount of net revenues
foreign natural and legal persons
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Reporting periods
quarter, half-year, year Fiscal year
calendar year or other period covering 12 consecutive full calendar months
period longer or shorter than 12 months in the year in which company opens for business
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Financial statements (1)
They are prepared in Polish and in Polish currency data can be rounded to the thousand
Balance sheet: is a statement of mutually balanced parts – assets and its sources of financing
Profit and loss account (Income statement): shows the result of the company's activities during the period
Cash flow statement: a statement of sources of cash receipts and disbursements
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Financial statements (2)
Statement of changes in equity: a summary of operations increasing and decreasing owners’ capital
Notes to financial statements: a clarification of the items included in the reports
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Announcement of reports (1)
Occurs in the Polish Administrative Journal (Dziennik Urzędowy Monitor Polski B – incomplete), includes: Introduction to the financial statements Balance sheet Profit and loss account Cash flow statement Statement of changes in equity Auditor's opinion Owners’ resolution accepting the report
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Announcement of reports (2)
Executive director is required to submit to the appropriate court register within 15 days from the date of approval of the annual financial statements: annual financial report containing an introduction
to the financial statements, balance sheet, profit and loss account, statement of changes in equity, cash flow statement
auditor's opinion copy of the resolution approving the annual
financial statements and the distribution of profit or covering of loss
activity report (if required for this unit)
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Approval of reports (1)
After preparing the annual financial statements, but prior to its approval, an entity may receive information having a material impact on the financial statements; if yes, then it should: change the financial statements by making
appropriate entries in the accounts of the financial year, which applies to financial statements
notify the auditor to check the statements include the clarification in the notes to financial
statements After approval of annual financial statements,
the effect of information having a significant impact on them is recognized in the accounts of the financial year in which the information is received
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Approval of reports (2)
If, before approving the financial statements, the entity noticed an error in the previous financial year, it must show the amount of correction in the category of “profit (loss) from previous years”
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Relations between entities (1)
Parent Company: a commercial company or a state enterprise, exercising control over another entity
Control over another entity: an entity’s ability to manage the financial and operating policies of another entity so as to obtain benefits from its activities
Joint control of another entity: the ability of an interdependent joint control of an entity with other partners
Subsidiary: a commercial company or other entity created and operated in accordance with the provisions of the foreign trade law, controlled by a parent company
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Relations between entities (2)
Interdependent entity: entity jointly controlled by the shareholders on the basis of an agreement, the articles of association or statutes between them
Associate entity: a commercial company or an entity created and operated in accordance with the provisions of the foreign trade law over which a significant investor has a significant influence of
Subordinate enitity: a subsidiary, an interdependent entity or an associate entity
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Relations between entities (3)
Entities associated with the entity: parent company, a major investor, its subsidiaries and affiliates and interdependent units located along with a unit under common control and a jointly controlled entities
Significant investor: a commercial company or state enterprise, which has in another entity – a non-subsidiary or interdependent – not less than 20% of the votes in the governing body of the unit and exerting a significant impact on the unit
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Relations between entities (4)
Significant impact on an entity: not having signs of exercising control or joint control over the entity while it gives an ability to influence financial and operating policies of another
Capital Group: the parent company and its subsidiaries
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IAS and IFRS
International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) are applied to companies which: which issue securities allowed for trading
or applying for trading in Poland or in one of the regulated markets in the EU
where a subsidiary or affiliated company is a part of a group in which the parent company prepares consolidated financial statements according to IAS / IFRS
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Consolidation of financial statements
Introduces special and new items into financial statements
It is necessary to correct some values from individual financial reports
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Part III
Balance sheet
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Balance sheet: Basic information (1)
Is a set of mutually balancing assets and sources of financing
A “photography" of a company – reflects the situation of the company on a given day
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Balance sheet: Basic information (2)
Assets are ordered by increasing liquidity Liabilities are ordered by increasing maturity Balance sheet equation:
ASSETS = LIABILITIES
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Balance sheet preparation
Gross method – separately shows the results of all balance sheet accounts
Net method – (used in Poland) shows the value of individual groups of assets based on their adjusted book value: fixed assets net of previously taken
depreciation tangible current assets net of write downs receivables net of amortisation
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Balance sheet: Assets
Fixed assets: assets not classified as current assets
Current assets: are consumed or used in the normal operating
cycle will expire within 12 months are in the form of monetary assets
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Balance sheet: Fixed assets (1)
Fixed assets include: intangible assets
for example: copyrights, licenses, concessions, patents, know-how, acquired positive value of acompany
tangible assets fixed assets
tangible assets of the expected economic useful life longer than one year, complete, usable and intended for the use by the entity
for example: real estate (land, the right to perpetual usufruct of land, cooperative ownership right to the home premises), machinery, equipment, transportation,
improvements in foreign fixed assets, livestock fixed assets under construction
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Balance sheet: Fixed assets (2)
Fixed assets also include: long-term receivables
a group of receivables which are due later than 12 months from the balance sheet date, with the exception of trade receivables and services
for example: public-law claims, amounts due from employees, financial receivables
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Balance sheet: Fixed assets (3)
Fixed assets also include: Long-term investments
investments are assets held in order to achieve the economic benefits arising from the increase in the value of these assets or in the form of interest income, dividends or other benefits, including in the process of a commercial transaction
for example: real estate, intangible assets, long-term financial assets and other long-term investments
Long-term prepayments used to match revenues and expenses of more than
12 months for example: long-term assets, deferred tax and other
accruals
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Balance sheet: Current assets (1)
Current assets include those: held for sale or consumption within 12 months
from the balance sheet date or within the normal operating cycle
stock / inventory materials – purchased by the entity for their own
use finished products (semi-finished products, work
in progress) – manufactured or processed products and services fit for sale
goods – tangible assets acquired by an entity for resale without further processing
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Balance sheet: Current assets (2)
Current assets also include: short-term receivables
receivables from sale of goods and services as well as from other sources not included in financial assets that are due within 12 months from the balance sheet date
short-term investments financial assets and other investments due and payable
or intended for sale within 12 months from the balance sheet date
for example: shares, other securities, loans, other short-term financial assets and investments in non-financial assets
short-term prepayments short-term deferred operating and financial prepayments
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Balance sheet: Liabilities and equity
Liabilities and equity – sources of financing of entity’s assets
Stockholders’ equity – the equivalent of the assets contributed to the unit by its owners and retained by the entity in the course of a business net assets – assets less liabilities
Liabilities – a result of past events and the obligation to pay with a reliably set value which will result in use of current or future assets of the unit foreign capital – the equivalent of an asset that has
been brought temporarily to the assets by natural or legal persons
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Balance sheet: Equity (1)
Share capital: is created by the business entities in
accordance with the principles laid down by law
is a capital entrusted by the owners is shown in the value declared, but may be
adjusted downward by due but not paid-in capital and value of its own shares
Payable share capital: a difference between the value of capital
resulting from the shares’ nominal value and the actual value paid
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Balance sheet: Equity (2)
Treasury shares / Own shares (negative value) own shares bought back by the company from
the market Paid-in / Additional capital
used for adjustement of basic capital is created in stock companies (joint stock and
limited liability companies) rules governing the creation and use of additional
capital are governed by the Commercial Companies Code (Kodeks spółek handlowych) and statutes and resolutions of the General Assembly of Owners
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Balance sheet: Equity (3)
Revaluation reserve is used to account for valuation adjustments of fixed
assets special case of the reserve capital arises from the revaluation of fixed assets,
if appropriate regulation will be issued Other reserves
gathered by the company for specific purposes is created in capital companies as a result
of agreement or statute of the entity
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Balance sheet: Equity (4)
Retained earnings amount of profit (loss) undivided / unused
in previous periods Net profit (loss) from a current financial year
income of a business unit achieved during the year
is the difference between revenues and expenditures
Deduction from net profit during the financial year (negative value) advance payment against future dividend
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Balance sheet: Liabilities (1)
Reserves / Provisions for liabilities these are specific obligations whose maturity
or amount is not certain you can not create reserves for liabilities, if the
entity has no legal or customary obligation to provide goods or services or if it can not reliably determine the likely amount of the liability
for example: provision for retirement benefits Long-term liabilities – liabilities other than trade
liabilities that become payable in a period of more than 12 months from the balance sheet date
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Balance sheet: Liabilities (2)
Current liabilities – total trade liabilities and all or part of other obligations that become due within 12 months from the balance sheet date
Deferred income – includes negative goodwill and the equivalent of already received or receivables from customers or the performance of which will be settled in subsequent reporting periods used to ensure matching of revenues and
expenses
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Valuation methods (1) Historical cost principle – used to include an asset for the first
time in the accounting books assets are recognized at the acquisition date at a value equal
to the amount paid or the fair value of transferred assets liabilities are measured at a value equal to the amount
of proceeds received in exchange for a commitment or a value equal to the amount of cash expected to be paid to settle the obligation
Current cost principle recognition of the assets at a value that would be payable
in case of an acquisition of the same or an equivalent item liabilities are valued at non discounted amount that would be
required at the moment to settle the obligation
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Valuation methods (2)
Realizable value principle assets are valued at realizable cash from the disposal
of the asset in a normal scheduled transaction liabilities are valued at a discounted amount of cash
that needs to be paid to settle the obligation Present value principle – uses the change time value
of money concept assets are valued at discounted present value of future
net cash flows liabilities are disclosed at the discounted present value
of future anticipated cash expenses to be paid to settle the obligation
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In practice
In process of preparation of financial statements: the most common method of valuation is
historical cost principle the valuation of financial assets and liabilities
is based on the realizable or present value
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Task 1
On Balance Sheet where would we include:1. flour in:
bakery grocery store mill food warehouse
2. 100 kg of tomatoes in: store / supermarket fruit and vegetable processing company farm
3. set of living room furniture: warehouse furniture manufacturer company president's cabinet furniture store
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Part III
Profit and loss account
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Profit and loss account: Basic information Used to present the financial result of the
business in a given period Is the difference between revenues
generated and expenses incurred
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Concept of revenues
Revenues and profits are economic benefits which will probably arise over the reporting period, whose value is reliably certain and lead to increase in assets or reduction in liabilities that will cause an increase in equity capital or reduction in its deficit in a different way than addition of capital by shareholders or owners revenues arise in the course of business profit is an increase in earnings or economic
benefits arising from the valuation at the balance sheet date
often is presented at a net value after deducting the appropriate costs
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Concept of costs
Costs and losses are probable reductions in economic benefits during the reporting period with a reliably certain value which leads to a reduction in the value of assets or increase in the value of liabilities and provisions that will cause a reduction in equity value or increase the deficit by other means than the withdrawal of funds by shareholders or owners costs arise in the course of business loss is a reduction of economic benefits arising
from valuation at the balance sheet date
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Inflows and outflows These categories are related to the settlement of receivables and
liabilities or payment for goods and services, consisting of cash flow without causing a change in equity
Remember the following relations: expense, but still not an outflow: accrued but unpaid interest on
loans expense that will not be an outflow: depreciation outflow, but not yet an expense: purchase for cash of materials that
have not yet been used outflow that will not be an expense: repayment of loan installment revenue but not yet inflow: money due from customers for goods
sold income that will not be an inflow: non-monetary donation in the form
of fixed assets inflow, but not a revenue: received an advance on future deliveries
of goods inflow, which will not be income: bank loan
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Profit and loss account – revenue structure (1) Five segments Operating activities
includes revenues related to core business of the entity
are realized from the sale of materials, goods and products
amounts due or received, regardless of whether they were paid or not, adjusted for granted rebates, discounts, subsidies and the VAT
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Profit and loss account – revenue structure (2) Other operating activities
groups income from various forms of activities not directly and continuously related to operating activities
in particular income related to: social welfare activities disposal of fixed assets, fixed assets under construction,
intangible assets and assets held as investments maintainance of the property and intangible assets
included in investments termination of previously established reserves (other
than those related to financial transactions) receipt free of charge (donation) of assets
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Profit and loss account – revenue structure (3) Investment and financial activities
includes revenues related to investing and financing activities of the company
in particular income related to: receipt and accrual of interest on loans, funds from
bank accounts and foreign bonds held receipt and accrual of interest on trade sales income from disposal of investments in financial
assets dividends received termination of provisions for anticipated financial
losses
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Profit and loss account – revenue structure (4) Extraordinary gains: arising from events
which are difficult to predict, beyond the operational activities of the entity and are not connected to the general riskrelated to the conduct of business for example: loss of assets due to random
events
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Profit and loss account – a generic approach (1) Depreciation: the cost of use of fixed assets and
intangible assets Materials and energy: the cost of consumption
of basic materials and raw materials, office supplies, spare parts for machinery and equipment, packaging, electricity, gas, water, steam and energy in other forms
External services: transport, equipment, storage, repair and maintenance, telecommunications and postal services, supervision of property, renting, leasing, operating leasing, banking services
Taxes and Fees
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Profit and loss account – a generic approach (2) Salaries: wages in cash and in kind for the
work performed regardless of the character of the employment relationship
Social insurance and other benefits: the contribution of social insurance payable by the employer, contributions to the Labour Fund, Guaranteed Employee Benefits Fund, mandatory deductions to the social benefits capital fund, costs associated with health and safety, staff training
Other costs: travel expenses, representation and advertising expenses, property insurance
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Profit and loss account – a calculative approach (1) In this arrangement, the costs are divided into
direct and indirect costs Direct costs: those that are related directly to
the products (goods and services), materials or goods in particular:
direct materials consumed direct wages including fringe benefits other direct costs such as: energy costs, utilities
costs, business trips
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Indirect costs: cost items whose linkage to the products (goods and services), materials or goods is impossible, irrelevant or not profitable to determine are initially recognized at origin and then
settled on products or on income in the reporting period in which they are incurred
in particular: indirect product costs management costs selling costs
Profit and loss account – a calculative approach (2)
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Profit and loss account – a calculative approach (3) General and administrative costs: indirect costs for
the operation of the enterprise as a whole include:
administrative costs – associated with the maintenance of the administration unit
general economic costs – to maintain facilities to ensure the functioning of the whole unit
Cost of sales: the indirect costs incurred in connection with the sale of products, goods and materials formed after the release of inventory from storage
or production for example: the costs of transportation, loading,
unloading, packaging, handling post-production costs and advertising and participation in trade fairs
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Profit and loss account – a calculative approach (4) Cost of the period: immediately reduce
earnings in the reporting period in which they are incurred for example: costs as a consequence of
unused production capacity and production losses, storage costs
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Profit and loss account – cost structure (1) Other operating costs: not directly related to core
business operations Are related to:
maintenance of social activities facilities disposal of fixed assets, fixed assets under
construction, intangible assets and assets held as investments
maintenance of property and intangible assets included in investments
writing off bad debts creation of reserves (other than those related to
financial transactions) payment of damages, penalties and fines transfer free of charge (donation) of assets
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Profit and loss account – cost structure (2) Finance costs: related to financing and investment
activities of the entity Include:
costs of disposal of investments in financial assets interest and fees on loans interest charges from finance leases interest or discount on bonds issued by the entity write offs from value of investments in financial
assets reserves created for certain or probable losses
arising from financial operations
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Profit and loss account – cost structure (3) Extraordinary losses: costs arising from
events which are difficult to predict, not related to operational activities of entity and not associated with overall risk of managing the business
Income tax: impact on financial results for the reporting year includes current tax and deferred tax
current tax: is a payment to the national budget deferred tax: the difference between the reserves
and assets resulting from deferred tax at the beginning and at the end of the reporting period
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Diagram of the profit and loss account (1)
Income from operations Cost of sales
Earnings (loss) on sales
Other operational income Other operational costs
Earnings (loss) from operations
Financial income Financial costs
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Diagram of the profit and loss account (2)
Earnings from all activities
Extraordinary gains Extraordinary losses
Gross income (loss) = Earnings before taxes (EBT)
Income tax
Net income (loss)
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Task 1
In the examples below decide whether we are dealing with expense or outflow, and if an expense of what type: purchased machine purchased with deferred payment, materials
which were immediately used paid a penalty for late payment by bank transfer paid in cash the for office rent paid interest on the loan TV was stolen paid by bank transfer for previously purchased
materials
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Task 2
In the examples below decide whether we are dealing with inflow or income, and if the income of what type of activity: received a payment from the recipient
of goods company sold some goods with deferred
payment received a donation on the current account bank accrued interest on the account a transport car was sold for cash received an invoice for the rental of office
space for half a year in advance
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Part V
Cash flow statement
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Cash flow statement: Basic information (1) It serves to present a financial result of the
business in a given period BUT revenues and expenses are measured by the actual inflow and outflow of funds
Difference between all cash receipts and cash disbursements that is cash flows
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Cash flow statement: Basic information (2) Cash flows are equal to the change in
cash balance on balance sheet For the purposes of the cash flow
statement, cash includes cash assets payable only or due within three months of their receipt, issue, purchase or deposit, provided that they are not included in cash flows from investing activities
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Cash flow statement – Structure
Four parts Operating activities Investing activities Financing activities Reconciliation of net cash flows and the
change in cash balance on the balance sheet
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Operating activities
Primary type of business of the entity and other activities not included in investing or financing activities
It shows in particular: Inflows Outflows
from sale of products, goods and materials
for payment of goods delivered, materials, raw materials, energy and services
rendered from the conduct of operational activities
from royalties, copyright fees and other operating revenues
for remuneration and other benefits of employees
from social security and health
for social security and health benefits
stemming from contracts to sell or resell assets, if they are part of the operating activities
stemming from contracts to buy assets, if they are part of the operating activities
from return of income tax, other taxes and charges of public character
for payment of income tax, other taxes and charges of public character
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Investing activities Activities whose purpose is the purchase or sale of tangible fixed assets (fixed
assets, fixed assets under construction), intangible assets, long-term investments and short-term financial assets (excluding cash and cash equivalents) and the associated monetary costs and benefits
It shows in particular:
Inflows Outflows from sale of fixed assets, fixed assets under construction, intangible assets, investments
in real estate and intangible assets and financial assets
for the purchase, installation, commissioning of assets, fixed assets under construction, intangible assets, investments
in real estate and intangible assets and financial assets
return of short- and long-term loans for the award of short-and long-term loans to other entities
reimbursement of advances for investing activities
for advances for investing activities
from derivative financial instruments
for derivative financial instruments
from cash benefits of the above mentioned items, e.g.: interest on deposits
for cash costs related to the above mentioned items e.g.: interest on deposits
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Financing activities Activity whose purpose is to attract outside sources of funding for operational purposes or
repayment purposes and the associated monetary costs and benefits Do not change the size and the relationship of equity and liabilities in the financial
statements of the entity It shows in particular:
Inflows Outflows from the issuance of shares (stocks) and other equity instruments and additional
(pain-in) capital
for payments to owners of shares or units for their redemption and refund of
additional (pain-in) capital
from issue of long- and short-term financial debt instruments
for profit, including one from previous years
from taking out loans and advances (including unrealized exchange rate
differences)
repayment of loans (including unrealized exchange rate differences)
costs incurred for the repayment of
obligations under finance lease agreements
from cash benefits directly related to raising capital
interest paid, bank commissions and other monetary costs directly related to raising
capital
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Part VI
Statement of changes
in equity
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Statement of changes in equity: Basic information It explains and illustrates in detail the
changes in equity not shown in other reports
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Statement of changes in equity – Structure (1) Four parts Equity capital at beginning of period Statement of operations that increased and
decreased equity according to groups stated on the balance sheet
Equity capital at end of period Expected amount of equity capital after the
division of earnings among shareholders
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Statement of changes in equity – Structure (2) Increases
issuance of stock (shares) increase in the nominal value of existing
shares additions to paid-in capital transfer from capital reserve to share capital donation / grant from another state enterprise
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Statement of changes in equity – Structure (3) Decreases
reduction in the nominal value of stock (shares donation / grant to another state enterprise free transfer of state assets to another
company return iof mproperly received a grant from the
state budget
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Part VII
Notes to financial statements
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Notes to financial statements: Basic information This is a summary of financial information not
included in other parts of financial statements Two parts:
Introduction to the Financial Statements Additional information and explanations
(explanatory notes)
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Notes to financial statements– Introduction Company name, the period covered by the
report Indicate method of consolidation
(if consolidated) Discussion of accounting policies
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Notes to financial statements– Explanatory notes The detailed scope of changes in the value
of individual assets groups Way of distributing of profit or covering of loss Amounts and types of provisions Breakdown by type of long-term liabilities List of essential accruals Net revenues by type of the business and
region Changes in accounting rules and their impact
on the items contained in the reports
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Part VIII
Preliminary analysis
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Vertical analysis (1)
Also known as a structure analysis Specifies what percent of an aggregated
financial position constitutes an item Structure index = (value of i item which is
a part of aggregate financial position) / (aggregate financial position)
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Vertical analysis (2)
Two possible versions generic version useful in a complex analysis
then an interest of an analyst focuses on all aspects of the entity’s business
detailed version useful if a particular component is analyzed
item’s result is difficult to interpret in generic version
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Vertical analysis – example (1)
Balance sheet Value (in millions of zloty)
Long-term assets 682.4 1. Intangible assets 1.1 2. Tangible assets 663.5 3. Long-term investments 4.0 4. Long-term prepayments 13.8 Current assets 375.3 1. Inventory 113.5 2. Receivables 147.3 3. Short-term investments 84.5 4. Short-term prepayments 30.0 Total assets 1057.7
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Vertical analysis – example (2)
Balance sheet Value (in millions of zloty)
Structure index (%)
Long-term assets 682.4 64.50 1. Intangible assets 1.1 0.10 2. Tangible assets 663.5 62.70 3. Long-term investments 13.8 1.30 4. Long-term prepayments 4.0 0.38 Current assets 375.3 35.55 1. Inventory 113.5 10.73 2. Receivables 147.3 13.93 3. Short-term investments 84.5 7.99 4. Short-term prepayments 30.0 2.90 Total assets 1057.7 100.00
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Horizontal analysis (1) Also known as time trend analysis Examines the change in i position over time Includes a dynamic analysis or a growth for fixed or variable
base Dynamic for fixed base
dynamics of the i-th position according to a fixed base =(value of i position in the w period) / (value of i position derived from the base period)
Dynamics for variable base dynamics of the i-th position according to a variable base =
(value of i position in the w period) / (value of i position in the w-1 period)
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Horizontal analysis (2)
Growth for fixed base Increase in i position according to a fixed base
= (value of i position in the period - the value of i position derived from the base period) / (value of i position derived from the base period)
Growth for variable base Increase in i position according to a variable
base = (value of i position in the period - the value of i position in the w-1 period) / (value of i position in the w-1 period)
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Horizontal analysis (3)
An index value determines the direction of the dynamic of changes in the following way if it is higher than 100% (1.0) then the value
from one period to another is growing if it is equal to 100% (1.0) then the value from
one period to another is not changing if it is less than 100% (1.0) then the value from
one period to another is decreasing interpretation depends on the item considered
The value of the index expresses the dynamic of changes (intensity) of the position
dr A. Kocia 98
Horizontal analysis (4)
An index value determines the direction of the growth of changes in the following way if it is higher than zero then the value from one
period to another is growing if it is equal to zero then the value from one
period to another is not changing if it is less than zero then the value from one
period to another is decreasing interpretation depends on the item considered
The value of the index expresses the growth of changes (intensity) of the position
dr A. Kocia 99
Horizontal analysis (5)
It does not matter whether we choose the dynamic or growth index
However, in practice we use for longer periods we use dynamic according
to a fixed base for shorter periods we use dynamic according
to a variable base or a growth according to a fixed base
in practice, we hardly encounter the use of growth according to a fixed base
dr A. Kocia 100
Horizontal analysis – example (1)
ROK 3 2 1 Inventory (in mln zl) 113.5 112.4 144.6
Short-term receivables (in mln zl)
147.3 134.2 95.6
Short-term investments (in mln zl)
30.0 6.7 39.9
dr A. Kocia 101
Horizontal analysis – example (2)
ROK 3 2 1 DYNAMIC fixed variable fixed variable 1 = 100% Inventory (in
mln zl) 78.4 100.9 77.7 77.7
Short-term receivables (in
mln zl)
154.0 109.8 140.4 140.4
Short-term investments (in
mln zl)
211.8 1264.2 16.8 16.8
Analysis of dynamic (in %) according to a fixed and variable base
dr A. Kocia 102
Horizontal analysis – example (3)
Analysis of growth (in %)
according to a fixed and variable base
ROK 3 2 1 GROWTH fixed variable fixed variable 1 = 100%
Inventory (in mln zl)
-21.6 0.9 -22.3 -22.3
Short-term receivables (in
mln zl)
54.0 9.8 40.4 40.4
Short-term investments (in
mln zl)
111.8 1164.2 -83.2 -83.2
dr A. Kocia 103
Part IX
Ratio analysis
dr A. Kocia 104
Ratio analysis – Advantages
Characterizes various aspects of business operations
Allows for the assessment of financial condition of an enterprise
It allows you to study trends over the period of at least 3 years
Creates an opportunity for comparing the results with average industry ratios
May explain the decline in earnings and the potential risk
dr A. Kocia 105
Ratio analysis – Disadvantages
Figures contained in reports are the result of approximations, estimates, interpretations and judgments
Author of the accounting data is the company's management and the auditor checks the data received from the company
Financial statements present the past, so the analysis is based on historical data
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Ratio analysis – Classification
Liquidity ratios Debt ratios Performance ratios Profitability ratios Market value ratios
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Ratio analysis – Liquidity ratios (1)
Current ratio: Current assets
Current liabilities Indicator determines the ability of companies to cover
its expenses over time (timely payment of obligations)
Tells us how many times current assets cover current liabilities
Standard liquidity ratio should be in a range of 1.2 - 2.0. This means that the value of current assets should be about two times greater than current liabilities
dr A. Kocia 108
Ratio analysis – Liquidity ratios (2)
Quick ratio:Current assets - inventories Current liabilities
Quick ratio shows the coverage of current assets (most liquid) with current liabilities
This indicator is more accurate than the current ratio
Should range between 1.0 - 1.3
dr A. Kocia 109
Ratio analysis – Liquidity ratios (3)
Increased liquidity ratio:Current assets - inventories - receivables
Current liabilities It defines the company's ability to repay current
liabilities with the most liquid assets, whose ability to regulate liabilities is immediate or nearly immediate
dr A. Kocia 110
Ratio analysis – Debt ratio (1)
Debt ratio:Total liabilities Total assets
It indicates how much zlotych of present and potential liabilities is related to total assets or what percent of liabilities is debt
It illustrates the structure of financing of business assets
It should be between 57 to 67 percent The higher the level, the higher the debt and
so the higher financial risk
dr A. Kocia 111
Ratio analysis – Debt ratio (2)
Debt to equity:Total equity
Total liabilities It indicates how much zlotych the current and
potential liabilities attribute to equity or what percentage of equity is debt
It illustrates the structure of financing of business assets
It should be between 30 to 40 percent
dr A. Kocia 112
Ratio analysis – Debt ratio (3)
Interest coverage:
Profit before tax (EBT)Interest
It expresses the ability to timely pay interest It should be between 50 - 60 percent
dr A. Kocia 113
Ratio analysis – Debt ratio (4)
Financial leverage:Total assetsTotal equity
Higher the ratio, the greater the degree of foreign capital and the higher the risk of activities
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Ratio analysis – Performance ratio (1) Debt turnover:
Loans and advances to customers * 365 days
Net sales Determines the number of days during which the settlement
is due It is, therefore, information about the extent to which the
company credited its customers and the length of the freezing of funds
Too long time to pay its dues shows ineffective debt collection policy
Short time to pay its dues shows too strict credit policy for customers
In many industries the index value stands at about two months
dr A. Kocia 115
Ratio analysis – Performance ratio (2) Inventory turnover:
Inventory * 365 daysNet sales
Specifies in how many days the company renews its inventory to achieve a certain level of sales
High value indicates a low turover of inventory and is unfavorable, since it can disrupt production
Low value of the indicator is desirable and helps to increase company profits
There are no universal standards for this indicator
dr A. Kocia 116
Ratio analysis – Performance ratio (3) Asset turnover:
Net sales Total assets
Lower value for industries with high capital intensity and higher for industries with low capital and high proportion of human labor
Level indicates the number of turnover of total assets or the value of sales received from one zloty of total assets
Generally, the higher this ratio, the higher the productivity of assets
dr A. Kocia 117
Ratio analysis – Performance ratio (4) Current asset turnover:
Net sales Current assets
This indicator shows the current assets turnover rate
The higher the value, the production cycle is shorter or the higher profitability of sales
Index value can be significantly different among various branches and it should be interpreted by examining the dynamics of change or growth within the industry
dr A. Kocia 118
Ratio analysis – Profitability ratio (1)
Net Profit Margin: Net profitNet sales
The high value of this index indicates a high possibility of company to generate profits and indirectly of financial soundness
The value of this ratio largely determines whether the company can be defined as viable or not
dr A. Kocia 119
Ratio analysis – Profitability ratio (2)
Gross profit margin:
Gross income
Net sales The main features of this indicator is that it
takes into account all incomes and is independent of tax rate
Its value is also affected by occasional factors such as income from financial activities and extraordinary items
dr A. Kocia 120
Ratio analysis – Profitability ratio (3)
Return on assets: Net income Total assets
Describes the profitability of all business assets This indicator can be regarded as evaluating
the efficiency of the management in comparison to other companies
Shows how much profit is the management able to generate using the available assets
If the value of profits is high, a low value of this index indicates an inefficient use of company’s assets
Return on assets should be higher than the rate of interest paid by a company on loans
dr A. Kocia 121
Ratio analysis – Profitability ratio (4)
Return on equity: Net income
Total equity Assessment of this indicator is not possible in
isolation from other values of the company's financial
Its low, but positive value may be due to poor profitability but also small business debt
Thus, its value should be interpreted, at least in comparison with the value of company's debt
dr A. Kocia 122
Ratio analysis – Market value ratio (1) Market value to book value (per one stock):
Stock price
Book value This indicator gives a clue as to how investors
assess the company The market price should be higher than its
book value because the former is based on current prices
dr A. Kocia 123
Ratio analysis – Market value ratio (2) Earnings per share (EPS):
Net income
Number of stocks issued Earnings per share should be positive
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Ratio analysis – Market value ratio (3) Price to earnings:
Stock price
Earnings per share Price to earnings should be positive
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Thank you for your attention …
… and now let’s look at some case studies
