FINANCIAL STATEMENT ANALYSIS

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Prof. Anuj Verma
 Identify Users and their
Information Needs

Calculate Appropriate Ratios

Interpret and Evaluate

the Results

Financial Ratio Analysis : The Key Steps

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Prof. Anuj Verma
TYPES OF RATIOS

Liquidity Ratios
Turnover Ratios
Leverage/ Gearing/ Structural Ratios
Profitability Ratios
Investment Ratios

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Prof. Anuj Verma
LIQUIDITY RATIOS

Current Ratio
Quick Ratio

“Current ratio is a quantitative index of liquidity whereas

Quick ratio is a qualitative index of liquidity”.

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Prof. Anuj Verma
TURNOVER RATIOS

Inventory turnover ratio

Debtors turnover ratio
Creditors turnover ratio
Asset turnover ratio

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Prof. Anuj Verma
GEARING RATIOS

Gearing ratio
Interest coverage ratio

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Prof. Anuj Verma
PROFITABILITY
RATIOS

Net profit margin

Gross profit margin
Return on equity
Return on capital employed

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Prof. Anuj Verma
INVESTMENT RATIOS

Dividend per share

Earnings per share
Dividend payout ratio
Dividend yield ratio
Price earnings ratio

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Prof. Anuj Verma
 Horizontal Analysis

Computing a percentage change in comparative

statements requires two steps.
• Compute the rupee change from the base period
to the later period.
• Divide the rupee change by the base period
amount.

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Prof. Anuj Verma
Horizontal Analysis
 20x4 20x5 Difference
Sales Rs 37,850 Rs 41,500 Rs 3,650
Expenses 36,900 40,000 3,100
Net income 950 1,500 550
What are the percentage increases in sales, expenses and
net income?

Sales: Rs 3,650/Rs 37,850 = .096 or 9.6%

Expenses: Rs 3,100/Rs 36,900 = .084 or 8.4%
Net income: Rs 550/Rs 950 = .579 or 57.9%

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Prof. Anuj Verma
Vertical Analysis...
–compares each item in a financial statement to a base
number set to 100%.
Every item on the financial statement is then reported as
a percentage of that base.
 Year 1 % Year 2 %
Sales 346 100 451 100
Cost of Goods 193 56 231 51
Gross profit 153 44 220 49
S & A 90 26 99 22
Income tax 20 6 38 8
Net income 43 12 83 19

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Prof. Anuj Verma
Things to consider when using
Ratios

What aspect of the firm or its operations are we

attempting to analyze?
Firm performance can be measured along “dimensions”
What goes into a particular ratio?
Historical cost? Market values? Accounting conventions?

What is the unit of measurement?

Rupees? Days? Turns?

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Prof. Anuj Verma
Limitations of Financial Analysis
Business decisions are made in a world of
uncertainty.
No single ratio or one-year figure should be relied
upon to provide an assessment of a company’s
performance.
The manager must evaluate data on all ratios in the
light of other information about the company and
about its particular line of business such as increased
competition or slowdown in the economy.

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Prof. Anuj Verma
 Limitations of Ratio Analysis
Seasonality
Window Dressing
Differences in Accounting Practices
Industry Averages are NOT a Goal
Data from Balance Sheet
Market Values versus Book Values
Older firms look better than newer firms
Does not focus on cash flow

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Prof. Anuj Verma