- Brijesh Pitroda. The analysis of a Business' Health starts with Financial Statement Analysis.

Financial StatementAnalysis of

- Brijesh Pitroda

The analysis of a Business' Health starts with Financial Statement Analysis.

• Financial Statement Analysis involves careful selection of data from

financial statements for the primary purpose of forecasting the financial health of the company. This is accomplished by examining trends in key financial data, comparing financial data across companies, and analyzing key financial ratios.

Who analyzes financial statements?

–Internal users• Management• Owner• Employees

–External users• Investors• creditors• regulatory agencies• stock market analysts• AUDITORS

Focus on Planning, evaluating and

controlling company operations.

Focus on Liqudity, long term cashflow, profitability

and long term health(i.e. Solvency) of the firm.

1.Horizontal Analysis

2.Vertical Analysis

3.Ratio Analysis

Methods ofFinancial Statement Analysis

Trend/ Index Analysis

Common-Size Statements

Horizontal Analysis

Uses comparative financial statements to calculate amount or percentage changes in a financial statement item from one period to the next

Increase (Decrease)2012 2011 Amount %

Assets

Non-current asstes:

Land 40,000 40,000

Buildings and equipment, net 120,000 85,000

Total Non-current assets 160,000 125,000

Current assets:

Inventory 80,000 100,000

Accounts receivable, net 60,000 40,000

Prepaid expenses 3,000 1,200

Cash 12,000 23,500

Total current assets 155,000 164,700

315000 289700

Comparative Balance SheetsDecember 31, 2011 and 2012

SAYAJIRAO CORPORATION

Horizontal Analysis Example

Since we are measuring the amount of the change between 2011 and 2012, the amounts for 2011 become the “base” year figures.

AmountChange

Current YearFigure

Base YearFigure=

Calculating Change in Amounts


_

PercentageChange

Amount Change Base Year Figure

100= ×

Calculating Change in Percentage



AssetsNon-current asstes: Land 40,000 40,000 - 0.0 Buildings and equipment, net 120,000 85,000 35,000 41.2 Total Non-current assets 160,000 125,000 35,000 28.0Current assets: Inventory 80,000 100,000 (20,000) (20.0) Accounts receivable, net 60,000 40,000 20,000 50.0 Prepaid expenses 3,000 1,200 1,800 150.0 Cash 12,000 23,500 (11,500) (48.9) Total current assets 155,000 164,700 (9,700) (5.9)

315,000 289,700 25,300 8.7

SAYAJIRAO CORPORATIONComparative Balance SheetsDecember 31, 2011 and 2012


12,000 – 23,500 = (11,500)

(11,500 ÷ 23,500) × 100% = 48.9%

SAYAJIRAO CORPORATION Comparative Balance Sheets December 31, 2011 and 2012


Equity and liabilities

Stockholders' funds: Share Capital 90,000 90,000 - 0.0 Reserves and surplus 80,000 69,700 10,300 14.8

170,000 159,700 10,300 6.4Non-Current liabilities: Bonds payable, 8% 75,000 80,000 (5,000) (6.3)Current liabilities: Accounts payable 67000 44000 23000 52.3 Notes payable 3,000 6,000 (3,000) (50.0)Total current liabilities 70,000 50,000 20,000 40.0

145,000 130,000 15,000 11.5 Total liabilities 315000 289700 25300 8.7


SAYAJIRAO CORPORATIONComparative Income Statements

For the Years Ended December 31, 2011 and 2012Increase (Decrease)

2012 2011 Amount %Net sales 520000 480000 40000 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17500 22400 -4900 (21.9)

Sales increased by 8.3% while net income decreased by 21.9%.

Horizontal Analysis ExampleThere were also increases in both cost of goods sold (14.3%) and operating expenses (2.1%). These increased costs more than offset the increase in sales, yielding an overall decrease in net income.

Trend Analysis

Show changes over time in given financial statement items (can helps us in determine how the firm is likely to perform over time)

2010 2011 2012 2010 2011 2012Assets

Non-current asstes: Land 40,000 40,000 40,000 100 100 100 Buildings and equipment, net 80,000 85,000 120,000 100 106 150 Total Non-current assets 120,000 125,000 160,000 100 104 133Current assets: Inventory 120,000 100,000 80,000 100 83 67 Accounts receivable, net 35,000 40,000 60,000 100 114 171 Prepaid expenses 1,000 1,200 3,000 100 120 300 Cash 24,000 23,500 12,000 100 98 50 Total current assets 180,000 164,700 155,000 100 92 86

300,000 289,700 315,000 100 97 105

Amount Trend (%)

SAYAJIRAO CORPORATIONTrend Balance Sheets

Trend Analysis Example

2010 2011 2012 2010 2011 2012 Equity and liabilities

Stockholders' funds: Share Capital 90,000 90,000 90,000 100 100 100 Reserves and surplus 79,600 69,700 80,000 100 88 101

169,600 159,700 170,000 100 94 100 Non-Current liabilities: Bonds payable, 8% 77,700 80,000 75,000 100 103 97 Current liabilities: Accounts payable 45,700 44,000 67,000 100 96 147 Notes payable 7,000 6,000 3,000 100 86 43

Total current liabilities 52,700 50,000 70,000 100 95 133

130,400 130,000 145,000 100 100 111

Total 300,000 289,700 315,000 100 97 105

Amount Trend (%)

SAYAJIRAO CORPORATIONTrend Balance Sheets


2010 2011 2012 2010 2011 2012Net sales 450,000 480,000 520,000 100 107 116Cost of goods sold 300,000 315,000 360,000 100 105 120Gross margin 150,000 165,000 160,000 100 110 107Operating expenses 120,000 126,000 128,600 100 105 107Net operating income 30,000 39,000 31,400 100 130 105Interest expense 5,200 7,000 6,400 100 135 123Net income before taxes 24,800 32,000 25,000 100 129 101Less income taxes (30%) 6,700 9,600 7,500 100 143 112Net income 18,100 22,400 17,500 100 124 97

Amount Trend (%)

SAYAJIRAO CORPORATIONTrend Income Statements


Vertical Analysis

For a single financial statement, each item is expressed as a percentage of a significant total, e.g., all income statement items are expressed as a percentage of sales

2011 2012 2011 2012Assets

Non-current asstes: Land 40,000 40,000 14 13 Buildings and equipment, net 85,000 120,000 29 38 Current assets: Inventory 100,000 80,000 35 25 Accounts receivable, net 40,000 60,000 14 19 Prepaid expenses 1,200 3,000 0 1 Cash 23,500 12,000 8 4

289,700 315,000 100 100

Amount % of Total Assets


December 31, 2011 and 2012Balance Sheets

Vertical Analysis Example

40,000 ÷ 2,89,700 = 14% rounded40,000 ÷ 3,15,000 = 13% rounded

2011 2012 2011 2012 Equity and liabilities

Stockholders' funds: Share Capital 90,000 90,000 31 29 Reserves and surplus 69,700 80,000 24 25 Non-Current liabilities: Bonds payable, 8% 80,000 75,000 28 24 Current liabilities: Accounts payable 44,000 67,000 15 21 Notes payable 6,000 3,000 2 1

Total 289,700 315,000 100 100

Amount % of Total Liabilities


December 31, 2011 and 2012Balance Sheets

90,000 ÷ 2,89,700 = 31% rounded

Vertical Analysis Example

Common-Size Analysis

An analysis of percentage financial statements where all balance sheet items are divided by total assets or liabilities and all income statement items are divided by net sales or revenues.

2010 2011 2012 2010 2011 2012Assets

Non-current asstes: Land 40,000 40,000 40,000 13 14 13 Buildings and equipment, net 80,000 85,000 120,000 27 29 38 Total Non-current assets 120,000 125,000 160,000 40 43 51 Current assets: Inventory 120,000 100,000 80,000 40 35 25 Accounts receivable, net 35,000 40,000 60,000 12 14 19 Prepaid expenses 1,000 1,200 3,000 0 0 1 Cash 24,000 23,500 12,000 8 8 4 Total current assets 180,000 164,700 155,000 60 57 49

300,000 289,700 315,000 100 100 100

Amount Common-Size (%)

SAYAJIRAO CORPORATIONCommon-Size Balance Sheets

Common-Size Analysis Example

2010 2011 2012 2010 2011 2012 Equity and liabilities

Stockholders' funds: Share Capital 90,000 90,000 90,000 30 31 29 Reserves and surplus 79,600 69,700 80,000 27 24 25

169,600 159,700 170,000 57 55 54 Non-Current liabilities: Bonds payable, 8% 77,700 80,000 75,000 26 28 24 Current liabilities: Accounts payable 45,700 44,000 67,000 15 15 21 Notes payable 7,000 6,000 3,000 2 2 1

Total current liabilities 52,700 50,000 70,000 18 17 22

130,400 130,000 145,000 43 45 46

Total 300,000 289,700 315,000 100 100 100

Amount Common-Size(%)

SAYAJIRAO CORPORATIONCommon-Size Balance Sheets


2010 2011 2012 2010 2011 2012Net sales 450,000 480,000 520,000 100 100 100Cost of goods sold 300,000 315,000 360,000 67 66 69Gross margin 150,000 165,000 160,000 33 34 31Operating expenses 120,000 126,000 128,600 27 26 25Net operating income 30,000 39,000 31,400 7 8 6Interest expense 5,200 7,000 6,400 1 1 1Net income before taxes 24,800 32,000 25,000 6 7 5Less income taxes (30%) 6,700 9,600 7,500 1 2 1Net income 18,100 22,400 17,500 4 5 3

Amount Common-Size (%)

SAYAJIRAO CORPORATIONCommon-Size Income Statements


Ratio Analysis

Which express a logical relationships between items in a financial statement of a single period (e.g., percentage relationship between revenue and net income)

Current Ratio

Current AssetsCurrent Liabilities

For SAYAJIRAO December 31, 2012

Current Ratio

Current AssetsCurrent Liabilities


Shows a firm’s ability to cover its current

liabilities with its current assets.

Balance Sheet Ratios

Liquidity Ratios

15500070000

= 2.21

Liquidity Ratio

Sayajirao Industry

2.21 2.15

3.29 3.10

3.41 3.41

Sayajirao Industry

2.21 2.15

3.29 3.10

3.41 3.41

Year

2012

2011

2010

Current Ratio

Ratio is stronger than the industry average.

Liquidity Ratio Comparisons

Acid-Test (Quick)

Current Assets - InvCurrent Liabilities


Acid-Test (Quick)

Current Assets - InvCurrent Liabilities


Shows a firm’s ability to meet current

liabilities with its most liquid assets.


Liquidity Ratios

155000 - 80000 70000

= 1.07

Liquidity Ratio

Sayajirao Industry

1.07 1.25

1.29 1.23

1.00 1.25

Sayajirao Industry

1.07 1.25

1.29 1.23

1.00 1.25

Year

2012

2011

2010

Acid-Test Ratio

Ratio is weaker than the industry average.

Acid-Test Ratio Comparisons

• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.

• Note that this industry has a relatively high level of inventories.

• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.

• Note that this industry has a relatively high level of inventories.

Ratio Sayajirao Industry

Current 2.21 2.15

Acid-Test 1.07 1.25

Summary of the Liquidity Ratio Comparisons

Debt-to-Equity

Total DebtShareholders’ Equity


Debt-to-Equity

Total DebtShareholders’ Equity


Shows the extent to which the firm is financed by debt.


Financial LeverageRatios

75000170000

= 0.44

Financial Leverage Ratio

Sayajirao Industry

0.44 0.44

0.50 0.51

0.46 0.48

Sayajirao Industry

0.44 0.44

0.50 0.51

0.46 0.48

Year

2012

2011

2010

Debt-to-Equity Ratio

Sayajirao has average debt utilization relative to the industry average.

Financial Leverage Ratio Comparisions

Debt-to-Total-Assets

Total DebtTotal Assets


Debt-to-Total-Assets

Total DebtTotal Assets


Shows the percentage of the firm’s assets that are supported by debt

financing.



75000315000

= 0.24


Sayajirao Industry

0.24 0.26

0.28 0.27

0.26 0.27

Sayajirao Industry

0.24 0.26

0.28 0.27

0.26 0.27

Year

2012

2011

2010

Debt-to-Total Assets Ratio

Sayajirao has average debt utilization relative to the industry average.


Total Capitalization(i.e., LT-Debt + Equity)

Long term DebtTotal Capitalization


Total Capitalization(i.e., LT-Debt + Equity)

Long term DebtTotal Capitalization


Shows the relative importance of long-term

debt to the long-term financing of the firm.



75000(75000+170000) = 0.31


Sayajirao Industry

0.31 0.30

0.33 0.31

0.31 0.32

Sayajirao Industry

0.31 0.30

0.33 0.31

0.31 0.32

Year

2012

2011

2010

Total Capitalization Ratio

Sayajirao has average long-term debt utilization relative to the industry average.


Interest Coverage

EBITInterest Charged


Interest Coverage

EBITInterest Charged


Indicates a firm’s ability to cover interest

charges.314006400 = 4.91

Coverage Ratio

Income StatementRatios

Coverage Ratios

Sayajirao Industry

4.91 5.20

5.57 6.56

5.76 7.20

Sayajirao Industry

4.91 5.20

5.57 6.56

5.76 7.20

Year

2012

2011

2010

Interest Coverage Ratio

Sayajirao has below average interest coverage relative to the industry average.

Coverage Ratio Comparisions

2010 2011 20123.0

4.0

5.0

6.0

7.0

8.0

Trend Analysis of Interest Coverage Ratio

SayajiraoIndustry

Analysis Year

Ra

tio

Va

lue

Coverage Ratio- Trend Analysis Comparisions

The interest coverage ratio for Sayajirao has been falling since 2010. It has been below industry averages for the past two years.

This indicates that low earnings (EBIT) may be a potential problem for Sayajirao.

Note, we know that debt levels are in line with the industry averages.

The interest coverage ratio for Sayajirao has been falling since 2010. It has been below industry averages for the past two years.

This indicates that low earnings (EBIT) may be a potential problem for Sayajirao.

Note, we know that debt levels are in line with the industry averages.

Summary of the CoverageTrend Analysis

Receivable Turnover

Annual Net Credit Sales

Receivables

• For SAYAJIRAO December 31, 2012

Receivable Turnover

Annual Net Credit Sales

Receivables


Indicates quality of receivables and how successful the firm is

in its collections.

Income Statement /Balance Sheet

Ratios

Activity Ratios

45000035000

= 8.66

(Assume all sales are credit sales.)

Actiivity Ratio

Avg. Collection Period

Days in the YearReceivable Turnover


Avg. Collection Period

Days in the YearReceivable Turnover

• For SAYAJIRAO December 31, 2012Average number of

days that receivables are outstanding.(or RT in days)


Ratios

Activity Ratios

3658.66

= 43 Days

Actiivity Ratio

Sayajirao Industry

29 29.2

31 29

43 35

Sayajirao Industry

29 29.2

31 29

43 35

Year

2012

2011

2010

Average Collection Period

Sayajirao has improved the average collection period to that of the industry average.

Activity Ratio Comparisions

Payable Turnover

Annual Credit Purchases

Accounts Payables


Payable Turnover

Annual Credit Purchases

Accounts Payables

• For SAYAJIRAO December 31, 2012Indicates the

promptness of payment to suppliers

by the firm.


Ratios

Activity Ratios

36000067000

= 5.37

Actiivity Ratio

(Assume all annual credit purchases)

PT in days

Days in the YearPayable Turnover


PT in days

Days in the YearPayable Turnover

• For SAYAJIRAO December 31, 2012Average number of

days that payables are outstanding.


Ratios

Activity Ratios

3655.37

= 68 Days

Actiivity Ratio

Sayajirao Industry

68 58

51 51

56 48

Sayajirao Industry

68 58

51 51

56 48

Year

2012

2011

2010

Payable Turnover in Days

Sayajirao has improved the PT in Days.Is this good?


Inventory Turnover

Cost of good soldInventories


Inventory Turnover

Cost of good soldInventories

• For SAYAJIRAO December 31, 2012Indicates the

effectiveness of the inventory management practices of the firm.


Ratios

Activity Ratios

36000080000

= 4.5

Actiivity Ratio

Sayajirao Industry

4.50 5.45

3.15 4.76

2.50 3.69

Sayajirao Industry

4.50 5.45

3.15 4.76

2.50 3.69

Year

2012

2011

2010

Inventory Turnover Ratio

Sayajirao has a very poor inventory turnover ratio.


Inventory Turnover Ratio --Trend Analysis Comparison

2010 2011 20122.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Trend Analysis of Inventory Turnover Ratio

Saya-jirao

Analysis Year

Ra

tio

Va

lue

Total Assets Turnover

Net SalesTotal Assets


Total Assets Turnover

Net SalesTotal Assets


Indicates the overall effectiveness of the firm in utilizing its

assets to generate sales.


Ratios

Activity Ratios

520000315000

= 1.65

Actiivity Ratio

Sayajirao Industry

1.65 1.75

1.66 1.79

1.50 1.80

Sayajirao Industry

1.65 1.75

1.66 1.79

1.50 1.80

Year

2012

2011

2010

Total Assets Turnover Ratio

Sayajirao has a weak total asset turnover ratio.


Why is this ratio considered weak?

Gross profit Margin

Gross ProfitNet Sales


Gross profit Margin

Gross ProfitNet Sales


Indicates the efficiency of operations and firm

pricing policies.


Ratios

Profitability Ratios

160000520000

= 30.7%

Profitability Ratio

Sayajirao Industry

30.7% 35.1%

34.3% 36.8%

33.3% 36.6%

Sayajirao Industry

30.7% 35.1%

34.3% 36.8%

33.3% 36.6%

Year

2012

2011

2010

Gross Profit Margin

Sayajirao has a weak Gross Profit Margin.

Profitability Ratio Comparisions

Gross Profit Margin --Trend Analysis Comparison

2010 2011 201230.0

31.0

32.0

33.0

34.0

35.0

36.0

37.0

Trend Analysis of Gross Profit Margin

Sayajirao

Industry

Analysis Year

Ra

tio

Va

lue

(%

)

Net profit Margin

Net Profit after taxNet Sales


Net profit Margin

Net Profit after taxNet Sales


Indicates the firm’s profitability after taking

account of all expenses and income

taxes.


Ratios


17500520000

= 3.3%

Profitability Ratio

Sayajirao Industry

3.3% 5.2%

4.6% 6.1%

4.0% 6.1%

Sayajirao Industry

3.3% 5.2%

4.6% 6.1%

4.0% 6.1%

Year

2012

2011

2010

Net Profit Margin

Sayajirao has a poor Net Profit Margin.


Net Profit Margin --Trend Analysis Comparison

2010 2011 20123

4

5

6

7

Trend Analysis of Net Profit Margin

Sayajirao

Industry

Analysis Year

Ra

tio

Va

lue

(%

)

Return on Investment

Net Profit after taxTotal Assets



Net Profit after taxTotal Assets


Indicates the profitability on the

assets of the firm (after all expenses and

taxes).


Ratios


17500520000

= 5.5%

Profitability Ratio

Sayajirao Industry

5.5% 8.1%

7.7% 9.8%

6.0% 9.3%

Sayajirao Industry

5.5% 8.1%

7.7% 9.8%

6.0% 9.3%

Year

2012

2011

2010


Sayajirao has a poor Return on Investment.


Return on Investment –Trend Analysis Comparison

2010 2011 20124

6

8

10

12

Trend Analysis of Return on Investment

Sayajirao

Industry

Analysis Year

Ra

tio

Va

lue

(%

)

Return on Equity

Net Profit after taxShareholder’s Equity


Return on Equity

Net Profit after taxShareholder’s Equity


Indicates the profitability to the

shareholders of the firm (after all expenses

and taxes).


Ratios


17500520000

= 10.2%

Profitability Ratio

Sayajirao Industry

10.2% 17.9%

14.0% 17.2%

10.6% 18.4%

Sayajirao Industry

10.2% 17.9%

14.0% 17.2%

10.6% 18.4%

Year

2012

2011

2010

Return on Equity

Sayajirao has a poor Return on Equity.


Return on Equity --Trend Analysis Comparison

2010 2011 20127.0

10.5

14.0

17.5

21.0

Trend Analysis of Return on Equity

Sayajirao

Industry

Analysis Year

Ra

tio

Va

lue

(%

)

Summary of the Profitability

The profitability ratios for Sayajirao Corporation have ALL been falling since 2010. Each has been below the industry averages for the past three years.

This indicates that COGS and administrative costs may both be too high which is a potential problem for Sayajirao Corporation.

Note, this result is also consistent with the low interest coverage ratio.

The profitability ratios for Sayajirao Corporation have ALL been falling since 2010. Each has been below the industry averages for the past three years.

This indicates that COGS and administrative costs may both be too high which is a potential problem for Sayajirao Corporation.

Note, this result is also consistent with the low interest coverage ratio.

Summary of Ratio Analyses

Inventories are too high. Low Sales. COGS may be too high. Selling, general, and administrative

costs may be too high.

Inventories are too high. Low Sales. COGS may be too high. Selling, general, and administrative

costs may be too high.

THANK

YOUAny queries/suggestions are welcomed at:[email protected]

- Brijesh Pitroda. The analysis of a Business' Health starts with Financial Statement Analysis.

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Transcript of - Brijesh Pitroda. The analysis of a Business' Health starts with Financial Statement Analysis.