Financial Analysis

Financial statement analysis (or financial

analysis) is the process of reviewing and
analyzing a company's financial statements to
make better economic decisions to earn
income in future. 
Financial analysis involves using financial
data to assess a company’s performance and
make recommendations about how it can
improve going forward.
 Financial Statement
A financial statement (or financial report) is a
formal record of the financial activities and
position of a business, person, or other entity.
Relevant financial information is presented in
a structured manner and in a form easy to
understand.
 4 Major Financial Statements
1. Income Statement
An income statement, also known as a
statement of comprehensive income,
statement of revenue & expense, P&L or
profit and loss report, reports on a company's
income, expenses, and profits over a period of
time.
 A profit and loss statement provides
information on the operation of the
enterprise.
These include sales and the various expenses
incurred during the stated period.
2. Balance Sheet
A balance sheet, also referred to as a
statement of financial position, reports on a
company's assets, liabilities, and owners
equity at a given point in time.
3. Statement of Owner’s Equity
A Statement of Owner’s equity, also known
as equity statement or statement of retained
earnings, reports on the changes in equity of
the company during the stated period
Owners' equity = assets − liabilities
4. Statement of Cash flow
A cash flow statement reports on a
company's cash flow activities, particularly its
operating, investing and financing activities
 Audit and legal Implications

Although laws differ from country to country,

an audit of the financial statements of a public
company is usually required for investment,
financing, and tax purposes. These are usually
performed by independent accountants or
auditing firms.
Results of the audit are summarized in an
audit report that either provide an unqualified
opinion on the financial statements or
qualifications as to its fairness and accuracy.
The audit opinion on the financial statements
is usually included in the annual report.
 Standards and regulations

Different countries have developed their own

accounting principles over time, making
international comparisons of companies
difficult. To ensure uniformity and
comparability between financial statements
prepared by different companies, a set of
guidelines and rules are used.
The set of conditions are commonly referred
to as Generally Accepted Accounting
Principles (GAAP), these set of guidelines
provide the basis in the preparation of
financial statements, although many
companies voluntarily disclose information
beyond the scope of such requirements
 International Accounting Standards Board(IASB)

The International Accounting Standards

Board (IASB) is the independent, accounting
standard setting body of the International
Financial Reporting Standards (IFRS)
foundation.
The IASB was established on April 1, 2001, as
the successor to the International Accounting
Standards Committee (IASC).
IASB is responsible for developing
International Financial Reporting Standards
(IFRS),
 Notes to financial statements

Notes to financial statements (notes) are

additional information added to the end of
financial statements that help explain specific
items in the statements as well as provide a
more comprehensive assessment of a
company's financial condition.
Notes are also used to explain the accounting
methods used to prepare the statements and
they support valuations for how particular
accounts have been computed.
 Management discussion and analysis

Management discussion and analysis, or MD&A,

is a section that can be found in the annual
report of a company. The MD&A section
provides key information regarding how a
company is performing financially.
 MD & A continued…
The MD&A provides information on a company’s
performance in its previous fiscal year, its
current financial standing, and projections by
management for future performances.
 MD & A continued…
The section assists investors with understanding
how the management thinks, how the company
performs following the management’s decision-
making processes, and the company’s core
financial fundamentals.
 MD & A continued…
This section contains a description of the year
gone by and some of the key factors that
influenced the business of the company in
that year, as well as a fair and unbiased
overview of the company's past, present, and
future.
Since a publicly-traded company falls under the
jurisdiction of the Securities and Exchange
Commission (SEC), the commission screens and
oversees the MD&A section of the annual report
to ensure that the company has presented all
noteworthy information about the company’s
liquidity status, information on the capital of the
company, and its operations.
 MD & A continued…
MD&A typically describes the corporation's:
i. Liquidity position
ii. Capital resources
iii. Results of its operations
iv. Underlying causes of material changes in financial
statement items (such as asset impairment and restructuring
charges),
v. Events of unusual or infrequent nature (such as mergers
and acquisitions or share buybacks), positive and negative
trends, effects of inflation, domestic and international market
risks, and significant uncertainties
 Use of Financial Statements
Income Statement - The purpose of the
income statement is to provide a financial
summary of the firm’s operating results during
a specified time period. It includes both the
sales for the firm and the costs incurred in
generating those sales. Other expenses, such
as taxes, are also included on this statement.
Balance Sheet – The purpose of the balance
sheet is to present a summary of the assets
owned by the firm, the liabilities owed by the
firm, and the net financial position of the
owners as of a given point in time. The assets
are often referred to as investments(use of
Funds) and the liabilities and owners equity as
financing(Sources of funds).
Statement of Retained Earnings - This
statement reconciles the net income earned
during the year, and any cash dividends paid,
with the change in retained earnings during
the year.
Financing Flows
Cash flows that result from debt and equity
financing transactions; include incurrence and
payment of debt, cash inflows from sale of
stock and cash outflows to pay cash dividends
or repurchase stock.
 Using Financial Ratios,
Types of Ratio Comparisons
Cross-Sectional Analysis Works
When conducting a cross-sectional analysis, the analyst
uses comparative metrics to identify the valuation,
debt-load, future outlook and/or operational
efficiency of a target company.
This allows the analyst to evaluate the target
company's efficiency in these areas, and to make the
best investment choice among a group of competitors
within the industry as a whole.
 
Cross-sectional analysis is a type of analysis
where an investor, analyst or portfolio
manager compares a particular company to its
industry peers. Cross-sectional analysis may
focus on a single company for head-to-head
analysis with its biggest competitors or it may
approach it from an industry-wide lens to
identify companies with a particular strength
 Focus Points
• Cross-sectional analysis focuses on many
companies over a focused time period.
• Cross-sectional analysis usually looks to find
metrics outside the typical ratios to produce
unique insights for that industry.
• Although cross-sectional analysis is seen as the
opposite of time series analysis, the two are used
together in practice.
Trend or time-series analysis
Time-series analysis evaluates performance
over time. Comparison of current to past
performance, using ratios, enables to assess
the firm’s progress. Any significant changes
may be symptomatic o a major problem.
Combined Analysis
It combines both cross-sectional and time-
series analyses. A combined view makes it
possible to assess the trend in the behavior of
the ratio in relation to the trend for the
industry.
 Cautions for Doing Ratio Analysis
1. Ratios must be considered together; a single
ratio by itself means relatively little.
2. Financial statements that are being compared
should be dated at the same point in time.
3. Use audited financial statements when possible.
4. The financial data being compared should have
been developed in the same way.
5. Be aware of inflation distortions.
 Types of Ratios
Liquidity ratios
Liquidity ratios are used to determine how
quickly a company can turn its assets into cash
if it experiences financial difficulties or
bankruptcy. It essentially is a measure of a
company's ability to remain in business.
 Liquidity Ratios Type
Current Ratio = C.A/C.L
Standard: 2.0

Quick Ratio = (C.A. –Inventory)/C.L

Standard: 1.0+
Activity ratios 
Activity ratios are meant to show how well
management is managing the company's
resources.
These ratios demonstrate how long it takes for
a company to pay off its accounts payable and
how long it takes for a company to receive
payments, respectively.
 Activity Ratios Types
Inventory Turnover Ratio = COGS/Inventory

Average Collection Period = AR/Average

sales per day

Average sales/day = Annual Sales/365

Average Payment Period = AP/Average
Purchase per day

Average purchase/Day = Annual Purchase/365

Total Asset Turnover = Sales/Total Assets

Debt Ratio or Leverage ratio
Leverage ratios depict how much a company
relies upon its debt to fund operations. A very
common leverage ratio used for financial
statement analysis is the debt-to-equity ratio.
This ratio shows the extent to which
management is willing to use debt in order to
fund operations.
 Debt Ratios
Debt Ratio= Total Liabilities/Total Assets

Time Interest Coverage Ratio = EBIT/Interest

Standard ration is 3~5 times
depending on nature of business
Profitability ratios 
Profitability ratios are ratios that demonstrate
how profitable a company is.
 Profitability Ratio:
Gross Profit Margin = Gross Profit/Sales
Operating Profit Margin
= Operating Profit(EBIT)/Sales
Net Profit Margin
= Earnings available for Common stock
holders/Sales
EPS = Earnings available for Common stock
holders/No of shares outstanding
Return on Total Assets (ROA)
= Earnings available for Common stock
holders/Total Assets
Return on Common Equity (ROE)
= Earnings available for Common stock
holders/Common Stock equity
 5. Market Ratio
P/E Ratio = Market price per share/EPS
 Market/Book (M/B) Ratio
Book Value per share of Common Stock
= Common stock equity/No of Common Stock
Outstanding
Market/book (M/B) Ratio = Market price per share
of Common stock/Book value per share of CS