Analysis of Financial Statements

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Analysis of Financial Statements

Ing. Zuzana Čierna, PhD.Department of Finance

SPU – FEM, Nitra

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Introduction

A wide range of valuable financial information is available on the Internet. With just a couple of clicks, an investor can easily find the key financial statements for most publicly traded companies.

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• Financial statement analysis involves comparing the firm‘s performance with that of other firms in the same industry and evaluating trends in the firm‘s financial position over time.

• Financial managers evaluate a firm‘s current financial position.

• Results of FA help management identify deficiencies and than take action to improve performance.

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Ratio analysis

• Liquidity ratios• Asset management ratios• Debt management ratios• Profitability ratios

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Current ratio

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If a firm has too many assets, its cost of capital will be too high, hence its profits will be depressed. On the other hand, if assets are too low, profitable sales will be lost.

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Days sales outstanding (DSO), also called the “average collection period”

Note that in this calculation we used a 365-day year. Other analysts use a360-day year for this calculation.

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The fixed assets turnover ratio measures how effectively the firm uses its plant and equipment.

Fixed Assets Turnover Ratio The ratio of sales to net fixed assets.

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• Debt Ratio measures the percentage of funds provided by creditors.

• There are a variety of factors that determine a company’s optimal debt ratio.

• Creditors may be reluctant to lend the firm more money, and management would probably be subjecting the firm to the risk of bankruptcy if it sought to increase the debt ratio any further by borrowing additional funds.

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ABILITY TO PAY INTEREST:TIMES-INTEREST-EARNED RATIO

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Stockholders invest to get a return on their money, and this ratio tells how well they are doing in an accounting sense.

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Ratio analysis involves comparisons —

a company’s ratios are compared with those of other firms in the same industry, that is, to industry average figures.

Ratio analysis is used by three main groups:

(1) managers, who employ ratios to help analyze, control, and thus improve their firms’ operations;

(2) credit analysts, including bank loan officers and bond rating analysts, who analyze ratios to help ascertain a company’s ability to pay its debts; and

(3) stock analysts, who are interested in a company’s efficiency, risk, and growth prospects.

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Summary

set of financial ratios

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Exercise

Selected items of financial statements:

Balance Sheet 31.12.20xx (in thousands of euros) period period ASSETS current previous LIABILITIES current previous Fixed assets 780,52 774,88 Common equity 273,62 162,32

Profit or loss for the accounting period (Net income) 134,20 74,35

Current assets 476,93 337,42 Liabilities (debts) 969,53 917,61

Inventories 81,09 50,06

Receivables 344,35 268,97 Short-term liabilities (current liabilities) 520,15 392,75

Total assets 1 257,58 1 112,39 Total common equity and liabilities 1 257,58 1 112,39

Current period Previous period Sales 3 071,37 3 166,00 Interest charges 166,60 136,29 EBIT 416,98 266,84

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Calculate the following...and interpret the results...

• Current ratio

• Quick ratio

• Days sales outstanding (DSO)

• Fixed assets turnover ratio

• Debt ratio

• Times-interest-earned (TIE) ratio

• Return on total assets

• Return on common equity

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Than you for your attention!

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Results... Current period Previous period

Current ratio 0,917 0,860Current ratio is low (optimal range is 2,0-2,5), it means problems with solvency.

Quick ratio 0,761 0,732Optimal range of quick ratio is 1,0-1,5. Values of firm’s quick ratio are close to optimal values, but it is caused by high level of receivables.

Days sales outstanding (DSO) 40,922 days 31,00 daysFirm’s DSO is 41 days (31 days). It is quit long period. Annual trend is negative, too.

Fixed assets turnover ratio 3,935-times 4,086-timesFixed asset turnover ratio is 4-times per year. Annual trend is negative.

Debt ratio 77,1% 82,5%Total debts from total capital and liabilities makes 77% (82,5%). It means firm is over-indebted (nadmerne zadĺžená). Annual trend is positive. Debt ratio decreased by 7%.

Times-interest-earned (TIE) ratio 2,51-times 1,96-timesIf the TIE value is less than 3, it means low ability to pay. Firm is not able to create enough funds to pay the price for foreign capital.

Return on total assets 10,671% 6,684%For each Euro of assets account for 10,67 (6,68) cents of net income. It is acceptable value and the annual trend is positive, too.

Return on common equity 49,046% 45,805%For each Euro of common equity account for 49 (45,8) cents of net income. Values are positive and annual trend is positive, too. It is caused by low level of common equity.