FINANCIAL ANALYSIS

Financial Analysis - Objectives

Identify the Strengths and Weaknesses of the Firm Establish Relationship between Various Components Decision Making

Purpose of Analysis
Financial statement analysis helps users make better decisions.

Internal Users Managers Officers Internal Auditors

External Users Shareholders Lenders Customers

Building Blocks of Analysis

Ability to meet short-term obligations and to efficiently generate revenues

Liquidity and Efficiency

Solvency

Ability to generate future revenues and meet long-term obligations

Ability to provide financial rewards sufficient to attract and retain financing

Market Profitability Prospects

Ability to generate positive market expectations

Financial Analysis - Procedure

Selection
Purpose of Analysis Appropriate Data Selection

Classification
Categorization Grouping

Interpretation
Comparative Statement Common Size Statement Trend Analysis Ratio Analysis Funds Flow Statement Cash Flow Statement

Comparative Statements (Horizontal Analysis)

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Assets Current assets: Cash and equivalents Accounts receivable, net Inventory Prepaid expenses Total current assets Property and equipment: Land Buildings and equipment, net Total property and equipment Total assets 2003 Dollar Change Percent Change

$ 12,000 $ 23,500 60,000 40,000 80,000 100,000 3,000 1,200 $ 155,000 $ 164,700
40,000 40,000 120,000 85,000 $ 160,000 $ 125,000 $ 315,000 $ 289,700

Comparative Statements
Calculate Change in Dollar Amount
Dollar Change

Analysis Period Amount

Base Period Amount

Since we are measuring the amount of the change between 2003 and 2004, the dollar amounts for 2003 become the base period amounts.

Comparative Statements
Calculate Change as a Percent
Percent Change Dollar Change Base Period Amount

100%

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 2003 Dollar Change Percent Change*

Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 $ (11,500) Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 1,800 $12,000 $23,500 = $(11,500) Total current assets $ 155,000 $ 164,700 Property and equipment: ($11,500 $23,500) 100% = 48.9% Land 40,000 40,000 Buildings and equipment, net 120,000 85,000 Total property and equipment $ 160,000 $ 125,000 Total assets $ 315,000 $ 289,700 * Percent rounded to first decimal point.

(48.9)

0.0

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 * Percent rounded to first decimal point. 2003 Dollar Change Percent Change*

$ 23,500 $ (11,500) 40,000 20,000 100,000 (20,000) 1,200 1,800 $ 164,700 $ (9,700) 40,000 85,000 35,000 $ 125,000 $ 35,000 $ 289,700 $ 25,300

(48.9) 50.0 (20.0) 150.0 (5.9) 0.0 41.2 28.0 8.7

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable Total current liabilities Long-term liabilities: Bonds payable, 8% Total liabilities Shareholders' equity: Preferred stock Common stock Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity Total liabilities and shareholders' equity * Percent rounded to first decimal point. 2003 Dollar Change Percent Change*

$ 67,000 $ 44,000 $ 23,000 3,000 6,000 (3,000) $ 70,000 $ 50,000 $ 20,000 75,000 $ 145,000 80,000 (5,000) $ 130,000 $ 15,000

52.3 (50.0) 40.0 (6.3) 11.5 0.0 0.0 0.0 0.0 14.8 6.4 8.7

20,000 20,000 60,000 60,000 10,000 10,000 $ 90,000 $ 90,000 80,000 69,700 10,300 $ 170,000 $ 159,700 $ 10,300 $ 315,000 $ 289,700 $ 25,300

Trend Analysis

Now, lets look at trend analysis!

Trend Analysis

Trend analysis is used to reveal patterns in data covering successive periods.

Trend Analysis Period Amount = Percent Base Period Amount

100%

Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Item Revenues Cost of sales Gross profit 2004 $ 400,000 285,000 115,000 2003 $ 355,000 250,000 105,000 2002 $ 320,000 225,000 95,000 2001 $ 290,000 198,000 92,000 2000 $ 275,000 190,000 85,000

2000 is the base period so its amounts will equal 100%.

Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Item Revenues Cost of sales Gross profit Item Revenues Cost of sales Gross profit 2004 $ 400,000 285,000 115,000 2004 2003 $ 355,000 250,000 105,000 2003 2002 $ 320,000 225,000 95,000 2002 2001 $ 290,000 198,000 92,000 2001 105% 104% 108% 2000 $ 275,000 190,000 85,000 2000 100% 100% 100%

(290,000 275,000) (198,000 190,000) (92,000 85,000)

100% = 105% 100% = 104% 100% = 108%

Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Item Revenues Cost of sales Gross profit Item Revenues Cost of sales Gross profit 2004 $ 400,000 285,000 115,000 2004 145% 150% 135% 2003 $ 355,000 250,000 105,000 2003 129% 132% 124% 2002 $ 320,000 225,000 95,000 2002 116% 118% 112% 2001 $ 290,000 198,000 92,000 2001 105% 104% 108% 2000 $ 275,000 190,000 85,000 2000 100% 100% 100%

How would this trend analysis look on a line graph?

Trend Analysis
160 150
We can use the trend percentages to construct a graph so we can see the trend over time.

Percentage

140 130 120 110 100 2000 2001 2002 Year 2003 2004 Revenues Cost of Sales Gross Profit

V e r t i c a l A n a l y s i s

Common-Size Statements
Now, lets look at some vertical analysis tools!

Common-Size Statements
Calculate Common-size Percent

Common-size Percent

Analysis Amount Base Amount

100%

Financial Statement Balance Sheet Income Statement

Base Amount Total Assets Revenues

CLOVER CORPORATION Comparative Balance Sheets December 31, Common-size Percents* 2004 2003

2004

2003

Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 3.8% Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 ($12,000 $315,000) 100% = 3.8% Total current assets $ 155,000 $ 164,700 Property and equipment: ($23,500 $289,700) 100% = 8.1% Land 40,000 40,000 12.7% Buildings and equipment, net 120,000 85,000 Total property and equipment $ 160,000 $ 125,000 Total assets $ 315,000 $ 289,700 * Percent rounded to first decimal point.

8.1%

CLOVER CORPORATION Comparative Balance Sheets December 31, Common-size Percents* 2004 2003

2004 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 * Percent rounded to first decimal point.

2003

$ 23,500 40,000 100,000 1,200 $ 164,700 40,000 85,000 $ 125,000 $ 289,700

3.8% 19.0% 25.4% 1.0% 49.2% 12.7% 38.1% 50.8% 100.0%

8.1% 13.8% 34.5% 0.4% 56.9% 13.8% 29.3% 43.1% 100.0%

CLOVER CORPORATION Comparative Balance Sheets December 31, Common-size Percents* 2004 2003

2004 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable Total current liabilities Long-term liabilities: Bonds payable, 8% Total liabilities Shareholders' equity: Preferred stock Common stock Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity Total liabilities and shareholders' equity * Percent rounded to first decimal point.

2003

$ 67,000 $ 3,000 $ 70,000 $ 75,000 $ 145,000

44,000 6,000 50,000

21.3% 1.0% 22.2% 23.8% 46.0% 6.3% 19.0% 3.2% 28.6% 25.4% 54.0% 100.0%

15.2% 2.1% 17.3% 27.6% 44.9% 6.9% 20.7% 3.5% 31.1% 24.1% 55.1% 100.0%

80,000 $ 130,000

20,000 20,000 60,000 60,000 10,000 10,000 $ 90,000 $ 90,000 80,000 69,700 $ 170,000 $ 159,700 $ 315,000 $ 289,700

CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, Common-size Percents* 2004 2003 100.0% 100.0% 69.2% 24.7% 1.2% 4.8% 1.4% 3.4% 65.6% 26.3% 1.5% 6.7% 2.0% 4.7%

Revenues Costs and expenses: Cost of sales 360,000 315,000 Selling and admin. 128,600 126,000 Interest expense 6,400 7,000 Income before taxes $ 25,000 $ 32,000 Income taxes (30%) 7,500 9,600 Net income $ 17,500 $ 22,400 Net income per share $ 0.79 $ 1.01 Avg. # common shares 22,200 22,200 * Rounded to first decimal point.

2004 2003 $ 520,000 $ 480,000

Common-Size Graphics
This is a graphical analysis of Clover Corporations common-size income statement for 2004.
Interest expense 1.2%
Selling and administrative 24.7%

Income taxes 1.4%

Net income 3.4%

Cost of sales 69.2%

Ratio Analysis

What is a Ratio? Modes in which ratios can be presented:

Percentage Proportion

Rate

or Times

Nature of Ratio Analysis

Interpretation of Ratios

Single Absolute Ratios Group Ratios Historical Comparison Projected Ratios Inter Firm Comparison

Liquidity Ratios

Current Ratio
Formula:

CA/CL

Acid Test/Quick/Liquid Ratio

Formula:

Quick Assets/CL Quick Assets = CA (Prepaid Exp. + Inventory)

Absolute Liquid Ratio

Formula:

Absolute Liquid Assets/CL Absolute Liquid Assets = Cash in Hand/Bank + Marketable Securities

Efficiency Ratios

Inventory/Stock Turnover Ratio

Formula:

COGS/Average Inventory at Cost Average Inventory = (Opening Stock + Closing Stock)/2 If COGS data is not available Net Sales can be used

Inventory Conversion Period

Formula:

Days in a year/Inventory Turnover Ratio

Efficiency Ratios

Debtors/Receivables Turnover Ratio

Formula:

Net Credit Annual Sales/Average

Debtors Average Debtors = (Opening Debtors + Closing Debtors)/2 Debtors = Sundry Debtors + Bills Receivables + Accounts Receivables

Average Collection Period

Formula:

No. of Working Days/Debtors Turnover

Ratio

Efficiency Ratios

Creditors/Payables Turnover Ratio

Formula:

Net Credit Annual Purchases/Average

Creditors Average Creditors = (Opening Creditors + Closing Creditors)/2 Creditors = Sundry Creditors + Bills Payables + Accounts Payables

Average Payment Period

Formula:

No. of Working Days/Creditors Turnover

Ratio

Leverage/Capital Structure Ratios

Repayment of Principal Payment of Interest Due Debt-Equity Ratio:

Approach

1: Formula:
Debt/Shareholders Equity

Long-Term

Approach
Total

2: Formula:

Debt/Shareholders Equity

Leverage/Capital Structure Ratios

Debt to Total Capital Ratio

Approach

1: Formula:

Long-Term

Debt/Permanent Capital Current Liabilities are not included in Permanent Capital

Approach
Total

2: Formula:

Debt/Total Assets Total Debts = Long-Term Debt + Current Liabilities Total Assets = Permanent Capital + Current Liabilities

Coverage Ratios

Computed from information available in P&L Account. Interest Coverage Ratio

Formula:

EBIT/Interest EAT/Preference Dividend

Dividend Coverage Ratio

Formula:

Debt Service Coverage Ratio

Formula:

(EAT + Interest + Depreciation + Other Non Cash Expenses)/Instalment

Profitability Ratios Related to Sales

Measures Profitability of a Firm Interested Parties (Major):

Management Investors/Shareholders

Creditors
Owners

Types:
Profit

Margin Ratios Expenses Ratios

Profitability Ratios Related to Sales

Gross Profit Margin

Formula:

(Gross Profit/Net Sales) X 100

EBIT/Net Sales EBT/Net Sales EAT/Net Sales

Operating Profit Margin

Formula:

Pre-tax Profit Margin

Formula:

Net Profit Margin

Formula:

Profitability Ratios Related to Sales

Expenses Ratios
COGS

Ratio
(COGS/Net Sales) X 100

Formula:

Operating
Formula:

Expenses Ratio

(Operating Expenses/Net Sales) X 100 Operating Expenses = Administrative Expenses + Selling Expenses
Operating
Formula:

Ratio
(COGS + Operating Expenses/Net Sales) X

100

Profitability Ratios Related to Investment

Return on Investment (ROI)

Return

on Shareholders Equity (ROE) Return on Capital Employed (ROCE) Return on Assets (ROA)

Profitability Ratios Related to Investment

Return on Shareholders Investment

Formula:

(Net Profit After Tax/Shareholders Funds) X 100

Return on Equity Capital/Ordinary Shareholders Equity/Net Worth

Formula:

(Net Profit After Tax Preference Dividend)/Equity Share Capital

Earnings Per Share (EPS)

Formula:

(Net Profit After Tax Preference Dividend)/No. of Outstanding Equity Shares

Profitability Ratios Related to Investment

Dividend Per Share (DPS)

Formula:

Dividend Paid to Ordinary Shareholders/No. of Ordinary Shares Outstanding

Dividend Pay-out Ratio

Formula:

(Total dividend given to equity shareholders/Total net profit belonging to equity shareholders) X 100 Formula 2: (DPS/EPS) X 100

Profitability Ratios Related to Investment

Earnings Yield
Formula:

(EPS/Market Value per Share) X 100

(DPS/Market Value per Share) X 100 Market Price per Share/EPS

Dividend Yield
Formula:

Price Earnings Ratio:

Formula:

Book Value Per Share:

Formula:

Net Worth/No. of Equity Shares Outstanding

Profitability Ratios Related to Investment

Price to Book Value Ratio

Formula: MPS/BPS

Return on Assets (ROA)

(Net Profit After Tax/Average Total Assets) X 100 Average Tangible Assets and Average Fixed Assets can also be used as a variant

Return on Capital Employed (ROCE)

Formula: EBIT/Average Capital Emloyed Capital Employed = Long term Liablilities + Owners Capital OR Net Working Capital + Net Fixed Assets

Assets/Investment Turnover Ratios

Total Assets Turnover

Formula: COGS or Sales/Average Total Assets

Formula: COGS or Sales/Average Fixed Assets Formula: COGS or Sales/Average Capital Employed Formula: COGS or Sales/Average Current Assets Formula: COGS or Sales/Net Working Capital

Fixed Assets Turnover

Capital Turnover

Current Assets Turnover

Working Capital Turnover

Cash Flow Statement Why???

Cash flow statement is additional information to user of financial statement This statement exhibits the flow of INCOMING and OUTGOING cash

This statement assesses the ability of the enterprise to GENERATE CASH

It also assesses the needs of the enterprise to UTILIZE CASH It also assesses the LIQUIDITY & SOLVENCY of the enterprise.

Statement of Changes in Financial Position Cash Flow Statement

Sources of Cash Inflows

Cash Flow From Operations Increase in Existing Liabilities or Creation of New Liabilities Sale of Assets Non-Trading Receipts

Application of Cash or Cash Outflows

Cash Lost in Operations Discharge of Liabilities Purchase of Assets Non-Trading Payments

Calculation of Cash From Operations

Net Profit Add: Non Cash and Non-Operating items which have already been debited to P/L a/c Depreciation Transfer to Reserves and Provisions Intangible Assets Written Off Loss on Sale or Disposal of Fixed Assets Increase in Creditors Increase in Outstanding Expenses Decrease in Prepaid Expenses

Calculation of Cash From Operations

Less: Non Cash and Non-Operating items which have already been credited to P/L a/c Increase in Accounts Receivables Decrease in Outstanding Expenses Increase in Prepaid Expenses

Cash From Operations

Calculation of Cash From Operations

Add: Decrease in Current Assets Add: Increase in Current Liabilities

Less: Increase in Current Assets Less: Decrease in Current Liabilities

Cash Flow Statement - Format

Vertical Horizontal AS 3 - ICAI

Statement of Changes in Financial Position

What does P&L reflects? What does Balance Sheet reflects? What is the GAP here? Statement of Changes in Financial Position:
Cash

Flow Statement Funds Flow Statement

Funds Flow Statement

What are FUNDS? What is FLOW? Funds Flow Statement:

Schedule

of Changes in Working Capital Funds from Operations Funds Flow Statement

Schedule of Changes in Working Capital

Rules: Working Capital increases when:
CA

increases CL decreases

Working Capital decreases when:

CA

decreases CL increases

Schedule of Changes in Working Capital

Lets Practice:
Shares

are issued for Cash Shares are issued for purchase of Building Debtors have made Payment Provision for Doubtful Debts is made

Creditors

are issued Bills payable Payment made to Bills payable Rent Paid Building sold on credit Money realised on sale of Machinery Inventory purchased by issuing Shares