Essentials for Financial Statements Analysis
The analysis of financial data employs various techniques to emphasize the comparative and relative importance of the data presented and to evaluate the position of the firm. These techniques include ratio analysis, common size analysis, review of descriptive material, and comparisons of results with other types of data. The information derived from these types of analyses should be blended to determine the overall financial position. No one type of analysis supports overall findings or serves all types of users. Financial Statement Analysis Project In this project, you have to: • Select two listed companies existing in the same industry (e.g. Unilever and Proctor and Gamble in the food and personal care products, etc) • Get their financial statements for the most recent three years and • Perform the afore-mentioned analysis Theme of the Project Financial Analysis techniques such as ratio analysis and common size financial statements can provide valuable insight into a company’s operations, risk characteristics, and valuation beyond what is readily apparent by examining raw data. When data is presented analytically, differences across time periods, interrelationships of financial statement accounts and comparisons among companies, are more easily understood. An effective analysis encompasses both computations and interpretations. A well reasoned analysis differs from a mere complication of various pieces of information, computations, tables, and graphs by integrating the data collected into a cohesive whole. Analysis of the past performance, for example, should address not only what happened but also why it happened and whether it advanced company’s strategy. Some of the key questions to address include: What aspects of performance are critical for this company to successfully compete in the industry? How well did the company‘s performance meet these critical aspects? (This is established through computations and comparison with appropriate benchmarks, such as the company’s own historical performance or competitors’ performance.)
What are the key causes of this performance, and how would this performance affect the company in the future? What is the likely impact of trends in the company, industry, and economy on the future cash flows? What are your recommendations as an analyst?
Financial Analysis Techniques: The following techniques can help you in achieving the overall objective of financial statement analysis of the companies. 1. Ratio Analysis Ratio analysis is the calculation and comparison of ratios which are derived from the information in a company's financial statements. Financial ratios are usually expressed as a percent or as times per period. a) Liquidity Ratios Liquidity ratios measure a firm’s ability to meet its current obligations. These include: • Current Ratio • Acid Test Ratio • Sales to Working Capital • Working capital b) Leverage Ratios Leverage ratios measure the degree of protection of suppliers of long term funds. These include: • Time Interest Earned • Fixed Charge Coverage • Debt Ratio • Debt / Equity Ratio • Debt to Tangible Net worth Ratio • Current Worth / Net worth Ratio • Total Capitalization Ratio • Fixed Asset Ratio / Equity Ratio • Long term Assets versus Long term Debt c) Profitability Ratios Profitability ratios measure the earning ability of a firm. These include: • Net Profit Margin • Return on Assets • DuPont Return on Assets • Operating Income Margin
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Operating Assets Turnover Return on Operating Assets Sales to Fixed Assets Return on Investment (ROI) Return on Total Equity Gross Profit Margin
d) Activity Ratios Activity ratios measure a firm's ability to convert different accounts within their balance sheets into cash or sales. These include: • Accounts Receivable Turnover • Average Collection Period • Accounts Payable Turnover • Average Payment Period • Inventory Turnover • Average Age of Inventory • Operating Cycle • Total Assets Turnover • Fixed Assets Turnover e) Market Ratios Market ratios are commonly used by the investors to assess the performance of a business as an investment and also the cost of issuing stock. These include: • Dividend per share • Earning per Share • Price/Earning Ratio • Percentage of Earnings Retained • Dividend Payout • Dividend Yield • Book Value per Share f) Statements of Cash Flow Cash flow ratios indicate liquidity, borrowing capacity and profitability. These include: • Operating Cash Flow/Current Maturities of Long Term Debt and Current Notes Payable • Operating Cash Flow/Total Debt • Operating Cash Flow per Share • Operating Cash Flow/Cash Dividends
2. Horizontal Analysis Horizontal analysis is done by computing the increase or decrease in percentage terms of each item from the prior year. It highlights items that have changed unexpectedly or have unexpectedly remained unchanged. It uses one year's worth of entries as a baseline while every other year represents differences in terms of changes to that baseline. 3. Vertical Analysis It is a technique for identifying relationship between items in the same financial statement by expressing all amounts as the percentage of the total amount taken as 100. 4. Review of Descriptive Information The descriptive information found in an annual report, in trade periodicals, and in industry reviews helps in understanding the financial position of a firm. Descriptive material might discuss the role of research and development in producing future sales, present data on capital expansion and the goal related such as minority hiring or union negotiations, or help explain the dividend policy of the firm. 5. Comparisons Absolute figures or ratios appear meaningless unless compared to other figures or ratios. Several types of comparisons offer insight, e.g. a) Trend Analysis Trend analysis studies the financial history of a firm for comparison. It is the comparative analysis of a company's financial ratios over time. This helps to detect problems or observe good management. Ratios are plotted on graph to see whether the ratios are falling, rising, or remaining relatively constant. b) Industry Averages and Comparisons with Competitors The analysis of an entity’s financial statements is more meaningful if the results are compared with industry averages and with results of competitors. You are required to select 3-4 companies from the same industry and then calculate their 8 -10 ratios. You have to compare their ratios results with your companies’ ratios results. This enables financial analyst to check that where the selected companies fall in that particular industry.
Instructions: Please follow these instructions strictly: • You must provide scanned copies of all the financial statements used for financial analysis. (If you have downloaded the financial statements from internet then its source or web link should be provided. Scanned copies are not required in such case). NOTE: Your work will not be considered or accepted in case you do not provide scanned copies or source of original financial statements. • You must perform complete financial statements analysis of the selected companies for the most recent three years. • You must apply all afore-mentioned techniques when doing analysis of financial statements. • You must provide all the supporting calculations, working and interpretation of results obtained from each ratio. You are required to calculate/analyze minimum forty (40) ratios. • NOTE: Failure to provide the financial statements, supporting calculations and working of analyses in your project will affect the worth of your work and may result in failure/rejection of the project. • You must not perform the financial analyses of companies having losses. • While selecting companies for analyses, keep in mind that they are from same industry for example; you cannot select one company from textile spinning and one from textile weaving. Both companies should be either from textile spinning or weaving sector. • You can get annual reports of companies from companies’ offices, stock exchanges or from companies’ websites.