FINANCIAL STATEMENT ANALYSIS

Income statement :is tabulated and expressed in two formats as discussed below
Single step income statement: Lists and groups all types of revenues together & deducts all
expenses from revenue total. It does not have any intermediate terms and their totals as
shown in multiple step income statement.
Multiple step income statement: It contains one or more subtotals it is computed separately and
each step or subtotal shows significant relationship.
gross profit/gross margin which is the excess of sales revenue over the cost of inventory that
was sold (sales revenue cost of goods sold). Then followed by the operating expenses, which is
a group of expenses that pertain to the firms routine, ongoing operations(regular). Examples
of such expenses are wages, rent, depreciation, telephone heating & lighting, advertising etc.
when these expenses are from the gross profit it is called operating income (gross profit
operating expense). The next grouping in the multiple-step income statement contains revenues
and expenses which are not directly related to the mainstream of a firms operations (nonoperating revenues and expenses). I ncome before income tax = (operating income non-operating
expenses). Most companies follow the practice of showing income tax as a separate item that is
deducted to arrive at net income. Net income = income before income tax tax.

Balance Sheet formats

The account format is where assets are shown on the right side and liabilities and stockholders
equity is shown on the right side of the balance sheet. The report format is where assets are
shown at the top followed by liabilities and shareholders equity .Financial Statement analysis is
one of the important aspect of assessing the companys performance it is also considered as
the basic decision tool utilized to identify the financial health of the organization Primary focus
is on the investor. Trend Analysis is the technique of comparison of financial trends and
changes from one year to the other and identifies the patterns that have occurred in the past
years. Financial ratio is a cornerstone of the financial statement analysis, No single ratio by
itself is ideal to assess the performance. Typically the financial ratios are categorized under 4
categories: Short term liquidity, Long term solvency, Profitability and Market price
dividend ratios.
Liquidity It is a class of financial metrics that is used to determine a company's ability to pay off
its short-terms debts .Short term liquidity: refers to how much cash a company has in
hand to meet current payments and they become due (creditors).
Current ratio/working capital ratio = Current Assets/Current Liabilities: The ratio is mainly
used to give an idea of the company's ability to pay back its short-term liabilities
(debt and payables) with its short-term assets (cash, inventory, receivables). The higher the
current ratio, the more capable the company is of paying its obligations. A ratio under 1

suggests that the company would be unable to pay off its obligations if they came due at that
point. While this shows the company is not in good financial health, it does not necessarily
mean that it will go bankrupt - as there are many ways to access financing - but it is definitely
not a good sign. The current ratio can give a sense of the efficiency of a company's operating
cycle or its ability to turn its product into cash. A ratio equal to or near 2: 1 is considered as a
standard or normal or satisfactory.
Bankruptcy analysts and mortgage originators frequently use the liquidity ratios to
determine whether a company will be able to continue as a going concern. Companies that
have trouble getting paid on their receivables or have long inventory turnover can run into
liquidity problems because they are unable to alleviate their obligations. Because business
operations differ in each industry, it is always more useful to compare companies within the
same industry. Current assets and current liabilities make up the current ratio. The current ratio
is calculated from balance sheet data as Current.
Quick ratio/Acid-test ratio = Current Assets - Inventory/Current Liabilities: The
quick ratio, sometimes called the acid-test, is a more stringent test of liquidity than
the current ratio. This is because it removes inventory from the equation. Inventory is
the least liquid of all the current assets. Companies with ratios of less than 1 cannot
pay their current liabilities and should be looked at with extreme caution.
Furthermore, if the acid-test ratio is much lower than the working capital ratio, it
means current assets are highly dependent on inventory. Retail stores are examples
of this type of business. The term comes from the way gold miners would
test whether their findings were real gold nuggets. Unlike other metals, gold does not
corrode in acid; if the nugget didn't dissolve when submerged in acid, it was said to
have passed the acid test. If a company's financial statements pass the figurative
acid test, this indicates its financial integrity. Long term solvency refers companys
ability to generate cash to repay the long term debts as they mature.
Total debt to Total assets = Total liabilities / Total assets measure of company's
financial situation by determining how much of the company's assets have been
financed by debt.The ratio over 1 indicates that the value of the company's debt
exceeds that of its assets while a ratio below 1 indicates the opposite. Generally
speaking, a low total debt to total assets ratio is ideal .
Total Debt to Total Equity = Total Liabilities / Total Stockhoders equity is a
measure companys financial measures the degree to which the assets of the
business are financed by the debts and the shareholders' equity of a business.
Lower values of debt-to-equity ratio are favorable indicating less risk. Higher debt-toequity ratio is unfavorable because it means that the business relies more on
external lenders thus it is at higher risk, especially at higher interest rates. A debt-to-

equity ratio of 1.00 means that half of the assets of a business are financed by debts
and half by shareholders' equity.
.Profitability Evaluation Ratios
Gross Profit Percentage/Gross margin percentage =Gross Profit/Net Sales The
gross profit margin looks at cost of goods sold as a percentage of sales. Gross profit
ratio may indicate to what extent the selling prices of goods per unit may be reduced
without incurring losses on operations. It reflects efficiency with which a firm
produces its products. As the gross profit is found by deducting cost of goods sold
from net sales, higher the gross profit better it is. There is no standard GP ratio for
evaluation. It varies from business to business. However, the gross profit earned
should be sufficient to recover all operating expenses and to build up reserves after
paying all fixed interest charges and dividends. This ratio looks at how well a
company controls the cost of its inventory, manufacturing of its products and
subsequently pass on the costs to its customers. The larger the gross profit margin,
the better for the company. Both terms of the equation come from the company's
income statement.
Return on Sales/Net Profit margin = Net Income/Net Sales: is a simple
profitability ratio analysis, net profit margin is the most often margin ratio used. The
net profit margin shows how much of each sales dollar shows up as net income after
all expenses are paid. The net profit margin measures profitability after consideration
of all expenses including taxes, interest, and depreciation. Both terms of the
equation come from the income statement.

Return on Equity = Net Income/Stockholder's Equity: The Return on Equity ratio

is perhaps the most important of all the financial ratios to investors in the company. It
measures the return on the money the investors have put into the company. This is
the ratio potential investors look at when deciding whether or not to invest in the
company. Net income comes from the income statement and stockholder's equity
comes from the balance sheet. In general, the higher the percentage, the better, as it
shows that the company is doing a good job using the investors' money. As the
primary objective of business is to maximize its earnings, this ratio indicates the
extent to which this primary objective of businesses being achieved. This ratio is of
great importance to the present and prospective shareholders as well as the
management of the company.

Return on Assets = Net Income/Total Assets: measures the efficiency with which
the company is managing its investment in assets and using them to generate profit.

It measures the amount of profit earned relative to the firm's level of investment in
total assets. The return on assets ratio is related to the asset management category
of financial ratios. Net Income is taken from the income statement and total assets
are taken from the balance sheet. The higher the percentage the better, because
that means the company is doing a good job using its assets to generate sales.

Financial Ratios ( Market price and dividend ratios)

Earnings per share: The earnings per share is a good measure of profitability and
when compared with EPS of similar companies, it gives a view of the comparative
earnings or earnings power of the firm. EPS ratio calculated for a number of years
indicates whether or not the earning power of the company has increased. It is the
portion of a company's profit allocated to each outstanding share of common
stock. It is an indicator of a company's profitability.

Price Earnings Ratio: The ratio is calculated to make an estimate of appreciation in

the value of a share of a company and is widely used by investors to decide whether
or not to buy shares in a particular company. If the P/E ratio falls, the management
should look into the causes that have resulted into the fall of this ratio. From the
investors viewpoint, investing in stocks of companies which are trading at low P/E
ratio and have strong fundamentals and balance sheet, along with good past history
will be profitable.

Dividend Yield Ratio: the relationship between dividends per share and the market
value of the shares. Share holders are real owners of a company and they are
interested in real sense in the earnings distributed and paid to them as dividend.
This ratio helps as intending investor knows the effective return he is going to get on
the proposed investment.

Dividend payout ratio: calculated to find the extent to which earnings per share
have been used for paying dividend and to know what portion of earnings has been
retained in the business. It is an important ratio because ploughing back of profits
enables a company to grow and pay more dividends in future. A complementary of
this ratio is retained earnings ratio. The payout ratio and the retained earnings ratio
are the indicators of the amount of earnings that have been ploughed back in the
business. The lower the payout ratio, the higher will be the amount of earnings
ploughed back in the business and vice versa. A lower payout ratio or higher
retained earnings ratio means a stronger financial position of the company.

Q) PC Deport LLC stocks were sold for about 73.5 per share. The company had earned net
income of $4,566 million for the fiscal year ending March 31,2015 and had an average of 3502
sharesmillion shares outstanding during the year and paid dividends of $1.65 per share.
Calculate and interpret the following
Earnings per Share = net income / average outstanding shares
Price earnings ratio = Price of the share / Earnings per share
Dividend yield ratio = dividends per share / market value of the shares
Dividend payout ratio = dividend per share /Earnings per share