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FINANCIAL ANALYSIS

Objectives of financial analysis

To know the solvency of the firm

To find out the strengths and weaknesses of the firm

To make comparative study with other firms and intra-firm

To know the capability of payment of interest and dividendTo study the trend of business

To know the efficiency of management

To provide useful information to the management to make future decisions

To find out the earning capacity or profitability

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Tools for financial analysis

Comparative statements

Common size statements

Trend analysis Accounting ratios

Cash flow statements

Funds flow statements

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Comparative Statements

Financial statements figures for two or more years areplaced side by side to facilitate comparison

Columns indicate increase or decrease in figures fromone year to another or change as a percentage

Utility

To make data simpler and more understandable

To indicate the trend of

To indicate strong and weak points of business

To compare firms performance with averageperformance of the industry

To help in forecasting

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Ratio analysis

Ratio analysis expresses the relationship

between selected financial data.

These relationships can be expressed as:

percentages

rates, or proportions

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Liquidity RatiosCurrent Ratio

Current Assets/Current Liabilities

Current Assets- e.g. Inventories, Debtors,

Cash, Bank

Current Liabilities- Trade Creditors, Bills

Payables, Bank overdraft

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Current Ratio

As the current ratio measures the ability ofthe enterprise to meet its current

obligations. The ideal current ratio is 2:1

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Liquidity RatioQuick Ratio (Current Assets Inventory- Prepaid

Expenses)/Current Liabilities

The Quick ratio is the more stringent

measure of liquidity because inventories

which are least liquid of current assets

are excluded from the ratio.

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Net Working Capital Ratio

Net Working Capital/Net AssetsNWC = Current Assets Current Liabilities.

Net Assets = Fixed assets + Current assets

Current Liabilities

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Liquidity Ratio

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Turnover / Activity Ratios

Inventory turnover Ratio = Cost of Goods

sold/Average Inventory,Average. Inventory. = Opening +Closing

Inventory/2

Average Collection Period= AverageInventory/Cost Of Goods Sold x 360,

COGS=SalesGross profit

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Turnover / Activity Ratios

Debtors/Account Receivables turnover

Ratio = Credit Sales/Average DebtorsAverage Debtors = Opening+ Closing

Debtors/2

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Turnover / Activity Ratios

Average Collection Period = 360/Debtors

Turnover Ratio

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Turnover / Activity Ratios

Creditors / Payable Turnover Ratio

Creditors Turnover Ratio = Credit

Purchases/ Average Creditors

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Turnover / Activity RatiosNet Asset Turnover = Net Sales/Net AssetsTotal Asset Turnover = Net Sales/Total

AssetsFixed Asset Turnover = Net Sales/Net Fixed

Assets

Current Assets Turnover = Net sales/CurrentAssets

Working Capital Turnover = Net Sales/Net

Working Capital 13

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Solvency Ratios

Debt to total funds Ratio =

Total liabilities

------------------------- x 100Total Assets

Debt Equity Ratio =

Long term Liabilities-------------------------- x100

Net Worth14

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Profitability Ratios

Gross profit Margin = (Sales-Cost Of Good

Sold)/ Net Sales

Net Profit Margin = Net Profit/ Net Sales

Operating Ratio =Cost of Goods Sold+

Operating Expenses/Sales

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Profitability RatiosReturn On Investment=

Profit before interest,tax and dividend

______________________________x100

Capital Employed

Capital Employed= (Total Debt + Net worth)

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