Introduction to Financial Statement Analysis

End result of accounting

By Prof Arun Kumar Agarwal, ACA, ACS

IBS, Gurgaon
 What is Financial Statements Analysis?

Analysis
Financial Statements
i. Critical in-depth study of FS
i. Balance Sheet
ii. Interpreting the business’
ii. Statement of Profit & Loss
performance in key parameters
iii. Notes to Accounts
from such study.
iv. Cash Flow Statements
iii. Converting such interpretations
into meaningful conclusions on
the performance of the
enterprise and identifying key
areas of concern.
iv. Defining action points and
solutions for addressing the key
areas of concern(backbone of
your future action)
Key Elements of Financial Statement Analysis
What are What is Why How are Drawing
financial the source financial financial conclusion
Statements of financial statements statements Analyzing s from the
• Statemen statements need to be analyzed? the analysis of
t of Profit • Accounting analyzed? • Co analysis Financial Financial
& Loss records • Serve the – trend Statements Statements
• Balance needs of • Industry through • User driven
Sheet diverse analysis – Cases and conclusions
industry Problems for
• Cash Flow users and performanc
Statemen interested respective
e and user actions
t parties outlook

Knowledge of Accounting is the basic input for high quality “Financial Analysis”
 The Process of Financial Analysis
i. Identifying the Key Performance Indicators of a business. These are Growth,
Profitability, Liquidity (short term and long term), Wealth Creation and
Efficiency in Operations.

ii. Defining the specific ratios to study each KPI. The key point to be kept in mind
is to have the minimum number of ratios to study each KPI. Too much analysis
often leads to confusion and inability to reach meaningful conclusions. Hence,
the choice of ratios is critically important. For example, to evaluate profitability
we have GP Ratio, Ebita, PBT, PAT, ROI, ROE, EPS. The GP Ratio may be low and
yet EPS may be high. Hence, for effective and efficient analysis we may just
look at Operating Margin and ROE only. If conclusions on profitability are
reached on the basis of these two ratios we will find that the same conclusions
will be reached even if we calculate all the other ratios. [We shall do the ratios
in detail at a later stage].

iii. Based on the study of ratios as above for the last number of years we will be
able to establish a trend in performance such as is the profitability improving?
Similarly by comparing the ratios of two companies we will be able to establish
which is a better performer.(trend line)
 The Process of Financial Analysis

iv. Having established the trends in performance the next step would be to write
down conclusions in respect of performance in key business areas.

v. Analysing the conclusions reached will lead to identifying the key areas of
concern which need to be addressed to enhance performance. For example, if
the conclusion reached is that profitability has deteriorated in the current year
due to drop in Operating Margin, the key area of concern would be to
improve margins.

vi. Having identified the key area of concern as Operating Margin, the remedial
action would be to either improve sales price or reduce direct cost. This would
mean the strategic managerial decisions to either raise sale prices or reducing
material cost which is the main element of direct cost. The management will
then move on in these directions and enhance future performance.
Key Performance Indicators of a Business
 Growth-P&L(measured on basis of turnover)
 Profitability-P&L-GP, NP, ROE, ROI- OP MARGIN=
CONTRIBUTION(SALES-DIRECT COST)/Sales*100
 Solvency-B/S
 Wealth Creation-B/S

Efficiency –P&L and B/S

Raw Material Cons
Asset To Turnover
Etc
Growth contributes to profitability
All ratios are unrelated
 Hence, we may say that Financial Analysis is a
complete strategic tool for the Management to
run the business efficiently, profitably and deliver
enhanced shareholder value.

This is how the Chief Financial Officers and

Director Finance of Corporates manage their
companies in close association with the Chief
Executive Officers and the Board of Directors.
Importance & Relevance of Fin Statement Analysis
 Financial Statement Analysis for the Management
Improvements in
To Know, analyze & improve
processes,
‘Operating Efficiencies’ of the
material and
business
equipment

To know, analyze & enhance

Derive maximum
the overhead productivity of
mileage from OHs
the business

Financial
Statements Dividend to SHs

for the Determine distributable

surplus
Management
Employee Bonuses

Save on Interest
Costs
Ensuring solvency both short
term and long term for
continuity of business Fund Planning for
Expansion and
Growth
 Other Interested Parties in Financial Statements of a Co

To Know & Analyze Profits

earned in a year + future
outlook and Management Employees
Plans

Tax Authorities
To know the reliable and
Need for Financial authentic Taxable Income
Statements
Present & Future
For Others shareholders
To know the return on
investment in the enterprise
and future outlook
Bankers
Determining solvency both
short term and long term for
continuity of business
Creditors
 Importance of FSA in Portfolio Building
Investment Decisions

Long Term - Wealth Creation

Define Objectives from
Investment in Portfolio
Short Term – Trading Profits

Age
Define Risk Profile
Steps in Income Outlook
Portfolio
Building FMCG

Auto
Sectoral Distribution
Large Cap
– 45% Etc
Market Cap Size wise
Distribution Mid Cap – 35%

Stock Selection Small Cap – 20%

 Importance of FSA in Portfolio Building
Investment Decisions

 Financial Statement Analysis plays a key role in Long Term Wealth

Creating strategy in Portfolio Building.

 FSA is also referred to as Fundamental Analysis wherein the Companies

are analysed to identify high performing companies in which investment
can be made for long term wealth creation.

 On the other hand, for earning short term trading profits “Technical
Analysis” is done, which is the critical study of the market movements
and behaviour rather than studying companies.
Thank You…