Chapter 3 Financial Statements Analysis: Vaibhav Kabra
Chapter 3 Financial Statements Analysis: Vaibhav Kabra
Chapter 3 Financial Statements Analysis: Vaibhav Kabra
Statements Analysis
Vaibhav Kabra
Agenda
• What is Financial Analysis or Financial Statement Analysis?
• What are the views/perspectives?
• What are the tool?
• Common Size
• Comparative
• Trend analysis
• Ratio Analysis
• Analysis of Cash cash-flow
Financial Statement Analysis (FSA)
• What is FSA?
• FSA is a systematic and critical review of financial statements in order to
facilitate a business decision making
• Why analysis?
• Financial Statements are generally prepared to cater the needs of
shareholders or regulatory reporting
• Based on the objective of assessment statements are reviewed which enables
the decision making like,
• Weather to invest in particular asset/ project or not?
• Weather to extend credit to customer or not?
• Weather to lend or not?
Perspective
perspective
Owner Lender
Good bad
Perspectives of Financial Statement analysis
• Four hats • Management
• While assessing the financial
• Investors performance
• While taking investment • CFO and her team
• Auditor
decision
• Investment funds • Regulatory
• While assessing the compliance to
• Individual investors regulations
• Brokers and advisors • Regulators like income tax Dept.,
Sales Tax and Excise Dept.
• Lender/Banker • Government agencies providing
• While taking credit decision business clearances/ license
• Government agencies funding or
• Banks and NBFCs providing some assistance
• Creditors
Tools of financial statement analysis
• Common Size
• Comparative
• Trend analysis
• Ratio Analysis
• Analysis of Cash-flows
Ratio Analysis
• Ratio is a relationship between two numbers, which is created based
on some business logic and used for taking meaningful business
decision
• For e.g. you are an investor who wants to take a decision on
investment in either of two company, where following information is
available :
Company A Company B
Sales 200 million 1000 million
Profit 20 million 20 million
Classification of ratios
1. Liquidity Ratios
2. Capital Structure Ratios or Gearing Ratios
3. Coverage Ratio
4. Activity Ratio or Efficiency Ratios
5. Profitability Ratio
6. Market Value ratio
1. Liquidity Ratios
• What is liquidity?
• Availability of funds to meet the day to day obligation of business
• Or simply does business has sufficient sources to pay its current liabilities
• The liquidity ratio will help you to understand the liquidity position of
business,
• Why liquidity is so important? (bring a case here)*
• You must appreciate that despite earning a sufficient profits a business may
not be able to meet its current liabilities which may lead to serious trouble
• So its okey to make poor profit but not compromise on liquity
1. Liquidity ratio
• Current ratio = Current Assets/Current Liabilities
• Quick ratio = Quick Assets /Current Liabilities
• Quick Assets = Current Assets – Inventory – Prepaid Expenses
• Cash ratio (Absolute liquidity ratio) = Absolute Liquid asset / CL
• So cash ratio check the business’s ability to meet its current liabilities
immediately
• Absolute liquidity asset = cash + marketable securities
2. Capital Structure Ratios
• Generally used to understand the capital structure and long term
stability of business
• Net-worth or equity Ratio = Net-worth/ Capital Employed
• It shows confidence of owner in business, Also known as NW to TA ratio, also
known as proprietary ratio
• Long Tem Debt Ratio = LT Debt / Capital Employed
• This shows the leverage position of the business and key ratio for banker or
lender
• D/E Ratio = Debt / Equity
• Most used leverage ratio, it combines the above two ratios and present a
single number about capital structure of the business, generally presented in
times i.e. D/E of 3x
• What is acceptable D/E? Some say 3:1? Is it good? Or should we go for
industry benchmark
2. Capital Structure Ratios
• Trading on Equity: Limited Stake and control over the firm
• With the help of debt, investors can magnify their returns