Financial Statement

Analysis
BY:
CA VAIBHAV JAIN
FCA, ACS, LL.B, MBF (ICAI), FAFD (ICAI),
Registered Valuer (S&FA) - IBBI
Phone: +91 9711310004
E-mail id: vaibhavjain@inmacs.com
What is a Financial statement
 “Financial Statements are financial data presented
in an orderly manner in compliance with relevant
accounting principles which help in assessing the
profitability, solvency, liquidity, growth potential
etc.”
 Components of Financial Statement are:
 Statement of financial position/ Balance Sheet
 Statement of Operations/ Income Statement
 Cash Flow Statement
 Statement of Changes in Equity
 Notes and schedules forming part of financial statement.
 Components of financial statement
 Statement of financial position/ Balance Sheet : Represents financial position of the
entity at a point in time.

 Statement of Operations/ Income Statement : Represents net financial results of the

entity over a period of time.

 Cash Flow Statement : Represents sources and applications of cash of the entity.

 Statement of Changes in Equity : Depicts movement in shareholder’s equity, net profit

or loss during the period, increase or decrease in reserves and dividend payments to
shareholders.

 Notes and schedules forming part of financial statement : Represents a summary of

accounting policies, assumptions, explanations forming integral part of accounts.
Key Focus Areas for financial
Statement analysis
Earnings
and
profitability

Industry Analysis of
and Market Composition of
Analysis Assets

PEER
Capital Structure/
Compariso
Solvency/ Liquidity
n

Cash Flow Analysis

Techniques of financial analysis
 Financial Statement Analysis refers to reading, interpreting and using financial data of
a company to understand the company and make economic decisions.
• Expresses relationship between metrics reflecting
Ratio Analysis an entity’s performance, liquidity, solvency, cash
flow position etc.

Common-size • Standardizes Income statement and balance sheet

Analysis for easier and meaningful comparison in the form
(Vertical of % of total assets or total sales for balance sheet
Analysis) or Income statement respectively.

• These statements show the profitability and

Comparative financial position for different periods of time in a
Statements comparative form to give an idea of the position of
two or more periods.

• This technique is used to study the operational

results and financial position over a series of
Trend Analysis years. Using previous year’s data, trend analysis
can be done to observe % change over time in
selected data.

Cash Flow • Analysis of actual movement of cash into and out

Analysis of an organisation
 Balance Sheet
Assets = Liabilities + Equity

Elements of
Balance
Sheet

Assets Liabilities Equity

Tangible or Obligation of the

Intangible enterprise arising Residual
resources from past events, Interest in the
controlled by an the settlement of
enterprise as a assets of an
which is expected
result of past to result in an entity after
events and from outflow from deducting all
which future resources its liabilities.
economic benefits embodying
are expected to economic
flow to the entity. benefits.
 Analysis of assets
 Assets are classified into two categories, depending on their liquidity:
 Current Assets
 Non-Current Assets

CURRENT ASSETS

Assets that can be converted into cash or can be used up within one year and indicate operating activities
of the entity.
Example:

 Cash
 Accounts Receivable
 Inventory
 Short term Investments

NON CURRENT ASSETS

Assets that cannot get converted into cash or used up within one year and provide information about the
entity’s investing activities.
Example:

 Property, Plant and Equipment

 Intangible Assets
 Long term Investments
 Analysis of liabilities
 Liabilities are classified into two categories, depending on their settlement:
 Current Liabilities
 Non-Current Liabilities

CURRENT LIABILITIES
Obligations that will be satisfied within one year or an operating cycle.
Example:

 Accounts Payable
 Provisions
 Accrued Expenses
 Short term Borrowings

NON CURRENT LIABILITIES

Obligations that are not satisfied within one year and reflect the entity’s long term financing
activities.
Example:

 Long Term Financial Liabilities

 Long term Borrowings
 Income statement
Profit = Income - Expenses

Elements of
Income
Statement

Income Expenses

Outflows from selling

Inflows from selling goods or rendering
goods or rendering services constituting
services constituting the the entity’s on going
entity’s on going or or operational
operational activities. activities.
 Performance analysis
 Purpose of Performance Analysis is as follows:
 It is an On going Process.
 It is linked to specified goals and objectives of the
entity
 It Determines the financial strengths and weaknesses
of a business.
Performance Analysis can be conducted using three
types of ratios viz,
 Margin Ratios;
 Ratios relative to Invested Funds;
 Activity Ratios.
Performance analysis using
margin ratios
Gross Profit Revenue or
Gross Profit
Margin (%) Sales

Earnings before
EBITDA Interest, Tax, Revenue or
margin (%) Depreciation Sales
(EBITDA)

EBIT/ Earning Before

Revenue or
Operating Interest and
Tax (EBIT) Sales
Margin (%)

PBT or Pre-
Profit before Revenue or
tax margin
Tax (PBT) Sales
(%)

Net Profit Revenue or

Margin Net Income Sales
Performance analysis using
Invested funds
Return on Average Total
Net Income
Assets (ROA) Assets

Net Income +
Return on interest Average Total
Assets expense(1- Assets
tax rate)

Operating
Operating
income or Average Total
return on
EBIT or Assets
assets
EBITDA

Return on Average Total

EBIT
capital equity

Return on Average Total

Equity Net Income equity
Performance analysis using Activity
ratios (few examples)
Receivables Average
Annual Sales
turnover ratio Receivables

Days of Sales 365 Receivable

Outstanding turnover ratio

Inventory Cost of goods Average

turnover ratio sold Inventory

Assets Average Total

Revenue
turnover ratio assets

Fixed Assets
Average net
Turnover Revenue fixed assets
ratio
Capital structure analysis

• Capital structure analysis is a periodic evaluation of all components of the

debt and equity financing used by a business.
• The intent of the analysis is to evaluate what combination of debt and
equity the business should have. This mix varies over time based on the
costs of debt and equity and the risks to which a business is subjected.
• Capital structure analysis is usually confined to short-term debt, leases,
long-term debt, preferred stock, and common stock.

 Objectives for analyzing Capital Structure

• To determine if the proportion of debt to equity enables an entity to create
wealth without unduly jeopardizing the firm.
Ratios for Capital structure
analysis
 Capital Structure can be analysed using following ratios:

1) Liquidity Ratios – To determine the entity’s ability to settle

its short term obligation within due date .
2) Solvency Ratios - To determine the entity’s ability to
settle its long term obligation within due date .
3) Coverage Ratios – Helps in determining the entity’s ability
to pay interest charges on borrowings.
4) Du-point Analysis - helps in analyzing Return on Equity
(ROE) by breaking down ROE into various ratios for
analysing the impact of profit margins, leverage and
turnover on returns to shareholders.
LIQUIDITY RATIOS
1) Current Ratio = Current Assets / Current Liabilities
2) Quick Ratio = (Cash + Short-term + Securities + Receivables) / Current Liabilities
3) Cash Ratio = (Cash + Short-term Securities) / Current Liabilities
4) Defensive interval ratio = (Cash + Short-term Securities + Receivables) / Average
daily expenditures

SOLVENCY RATIOS
1) Total Debt to Capital = (Long-term Debt + Short-term Debt) / Total
Capital
2) Total Debt to Equity = [Total Debt (Long-term and Short-term
Debt)] / Equity
3) Debt to Assets Ratio = [Total Debt (Long-term and Short-term
Debt)] / Total Assets
4) Financial Leverage = Average Total Assets / Average Total Equity.
Coverage Ratios
1) Interest coverage ratio = Earnings before interest and taxes / Interest payments
2) Fixed charge coverage ratio = (Earnings before interest and taxes + Lease payments) /
(Interest payments + Lease payments).
 Credit analysis
 Credit analysis is the method by which one calculates
the creditworthiness of a business or organization. In other words, It is
the evaluation of the ability of a company to honor its financial obligations.
The audited financial statements of a large company might be analyzed
when it issues or has issued bonds. Or, a bank may analyze the financial
statements of a small business before making or renewing a commercial
loan. The term refers to either case, whether the business is large or small.
 The objective of credit analysis is to look at both the borrower and the
lending facility being proposed and to assign a risk rating. The risk rating is
derived by estimating the probability of default by the borrower at a given
confidence level over the life of the facility, and by estimating the amount
of loss that the lender would suffer in the event of default.
 3 C’s of Credit Analysis
1) Character - This is the part where the general impression of the protective borrower is
analysed. The lender forms a very subjective opinion about the trust – worthiness of
the entity to repay the loan. Discrete enquires, background, experience level, market
opinion, and various other sources can be a way to collect qualitative information and
then an opinion can be formed, whereby he can take a decision about the character of
the entity.
2) Capacity - Capacity refers to the ability of the borrower to service the loan from the
profits generated by his investments. This is perhaps the most important of the five
factors. The lender will calculate exactly how the repayment is supposed to take place,
cash flow from the business, timing of repayment, probability of successful repayment
of the loan, payment history and such factors, are considered to arrive at the probable
capacity of the entity to repay the loan.
3) Collateral - Collateral are form of security that the borrower provides to the lender, to
appropriate the loan in case it is not repaid from the returns as established at the time
of availing the facility.
 Cash flow analysis
 Cash Flow Analysis means studying or analysing the Cash
Flow Statement comprising part of Financial Statements.
 It provides information about cash inflows and outflows
during an accounting period which is developed from Balance
Sheet and Income Statement Data.
 Valuation models used in financial analysis are often based on
projection of future cash flows for which the valuer needs to
have good analytical cash flow analysis.
 Cash Flow statement is divided into 3 parts viz,
 Operating Activities
 Investing Activities
 Financing Activities.
Operating Activities

Direct
DirectMethod
Method Indirect
IndirectMethod
Method
 Investing Activities
 Acquiring/disposing of securities that are not cash equivalents
 Cash flows related to the acquisition or sale of non-current assets.
 Lending money/collective on loans

Examples of Investing Activities:

 Cash received from sales of assets that are not held for the regular trading purposes such as sale
of building; marketable securities such as trading and available for sale securities, and
investments
 Cash payments to acquire property,plant, and equipment (PPE), other tangible or intangible
assets, and other long term assets.
 Cash received from sale of, and paid for purchases of derivative instruments
 Loans extended to other companies and collection of such loans.
 Financing Activities
 Borrowing from creditors/repaying the principal
 Obtaining resources from owners
 Providing owners with a return on investment
Examples of Financing Activities
 Cash received from issuing share capital
 Cash proceeds from issuing bonds, loans, notes, mortgages and other short or long-term
borrowings
 Cash payments to shareholders to redeem exisiting shares-treasury stock
 Cash repayment of loans and other borrowings;and
 Cash payment to shareholders as dividends.
 CASH FLOW PERFORMANCE RATIO
1) Cash flows to revenue = Operating cash flows / Revenue
2) Cash Return on Assets = Operating cash flows / Average total assets
3) Cash Return on Equity = Operating cash flows / Average total equity
4) Cash to Income = Operating cash flows / Operating Income
5) Cash flow per share = (Operating cash flows – Preferred dividends) /
Weighted average number of common shares.

Cash flow coverage ratio

1) Interest coverage = (Operating cash flows + taxes paid + interest paid) / Interest paid
2) Debt coverage = Operating cash flows / Total debt
3) Dividend payment ratio = Operating cash flows / Average total equity
4) Debt payment = Operating cash flows / Cash debt repayment
5) Investing and financing = Operating cash flows / Cash outflows from investing and
financing activities
THANK YOU!

CA. Vaibhav Jain, Partner

B.Com (Hons.), FCA, ACS, LL.B., MBF (ICAI),
CIDT, FAFD (ICAI), Registered Valuer (S&FA)
+91 97113 10004
vaibhavjain@mehragoelco.com