how to analyse a financial report and what are the key aspects of in it as well as main points.

1. Financial Statements Analysis
A.A. Samitha Jayaweera
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2. Financial Statements……..few ?s.
Do F/Ss produce comparative information?
Are these information enough to make
decisions?
Why?
- absolute figures do not produce
comparative information, less utility and
practical value
What further do? convert into relative /
comparative figures
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3. Financial Statements Analysis -what
does it do?
“Financial statement analysis is the process
of identifying the financial strengths and
weaknesses of the firm by properly
establishing relationship between the items
of balance sheet and the income statement”
It enhance the utility or practical value of
accounting information.
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4. Why Financial Statements analysis
is needed?
Since,
It produces comparative information
It’s a tool to identify strength and
weaknesses
It provides information of profitability,
liquidity, efficiency and gearing/ solvency
etc.
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5. Further it Provides Answers to…….
Is the firm in a position to meet current
obligation? -Liquidity
What sources of long-term finance are
employed and its relationship (debtequity)?- Solvency
How efficiently assets utilised?- Assets
turnover
Are earnings adequate?- Profitability
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6. Produce Comparisons Information…
Absolute increases and decreases for an
item from year to year
% increases and decreases for an item from
year to year
Trend %
% of single item to an aggregate total
Ratios
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7. Compare with…….
Past years ratios
Budgeted/ standards
Intra company - divisional
Inter company - industry
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8. Analytical Techniques
Horizontal analysis
Vertical analysis
Trend analysis
Common-size analysis
Ratio analysis
Cash flow analysis
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9. Horizontal Analysis
The calculation of $ (Rs. value) changes or
% changes in the statement or total
Ex; changes in sales, total operating
expenses, N.P.
It detects changes in company performance
It highlights trends
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10. Horizontal Analysis
2010
Revenue
Sales
207,500
Cost of sales
145,000
Gross profit
62,500
Operating Expenses
Selling & Distribution
19,750
Administrative
24,820
Total Operating Expenses 44,570
Profit from operations
17,930
Interest expenses
1,500
Profit before tax
16,430
Income tax
4,930
Profit after tax
11,500
2009
increase/
(decrease)
159,500
114,500
45,000
48,000
30,500
17,500
13,650
16,300
29.950
15,050
1,200
13,850
4,432
9,418
6,100
8,520
14,620
2,880
300
2,580
498
2,082
%
30.1
26.6
38.9
44.7
52.3
48.8
19.1
25.0
18.6
11.2
22.1
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11. Trend Analysis
Based on Horizontal analysis
% es are calculated for several successive
years
select a based year which assign a weight
of 100%
Ex; base year sales is 100% current year
110% OR 95% etc;
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12. Trend Analysis
Sales
Net profit
2006 2007 2008 2009 2010
100
85
119 158 205
100
89
123
142 174
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13. Vertical Analysis
Items in a single financial statement are
expressed as a % of a significant total.
Ex: cost of sales as % to turnover, G.P. as %
to cost of sales/ turnover
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14. Vertical Analysis
2010
%
Revenue
Sales
207,500 100.0
Cost of sales
145,000
69.9
Gross profit
62,500
30.1
Operating Expenses
Selling & Distribution
19,750
9.5
Administrative
24,820
12.0
Total Operating Expenses 44,570
21.5
Profit from operations
17,930
8.6
Interest expenses
1,500
0.7
Profit before tax
16,430
7.9
Income tax
4,930
2.4
Profit after tax
11,500
5.5
2009
%
159,500
114,500
45,000
100.0
71.8
28.2
13,650
16,300
29.950
15,050
1,200
13,850
4,432
9,418
8.6
10.2
18.8
9.4
0.7
8.7
2.8
5.9
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15. Common size Analysis
Common –size financial statements show
only % value, no absolute value
In common-size balance sheet all values of
assets items are presented as a % to total
assets where as liability items are presented
as a% to total liabilities
Income statement- all items are presented
as a % to net sales
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16. Common-Size Analysis
2010
Revenue
Sales
Cost of sales
Gross profit
Operating Expenses
Selling & Distribution
Administrative
Total Operating Expenses
Profit from operations
Interest expenses
Profit before tax
Income tax
Profit after tax
2009
100.0
69.9
30.1
100.0
71.8
28.2
9.5
12.0
21.5
8.6
0.7
7.9
2.4
5.5
8.6
10.2
18.8
9.4
0.7
8.7
2.8
5.9
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17. Ratio analysis
Items of the financial statements are
presented as comparative figures as ratios
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18. Classifications of ratios
Liquidity ratio - ability to meet current
obligation
Leverage ratio - proportion of debt equity
Activity ratio - efficiency of assets
utilisation
Profitability ratio - overall performance
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19. Liquidity ratio
Current ratio
Quick ratio
Working capital analysis
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20. Leverage / Capital stricture ratios
Debt- equity ratio (long-term debt to equity,
total debt to equity, debt to total capital)
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21. Activity/ efficiency ratio
Inventory turnover and stock holding period
Debtors turnover and collection period
Fixed assets turnover
Total assets turnover
Capital employed turnover
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22. Profitability ratio
Gross profit margin, Net profit margin
Return on investment (return on assets,
return on capital employed, return on
shareholder’s equity)
Earning per share, Dividend per share
Earning yield, Dividend yield
Price earning ratio
Earning power
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