Post on 04-Jun-2018
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11/3/2013 A. Elshahat 1
Financial Statement
Analysis
Financial Ratio Analysis“Reading between the lines”
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A. Elshahat 211/3/2013
Interpretation and analysis of
accounting information Stake holders main questions;
1. How is the business doing?
2. How is the business placed at present?3. What are the future prospects of the
business?
Published financial accounts are animportant source of information to enableanswering the above questions.
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A. Elshahat 311/3/2013
Area for Review
1. Review of the Business; Chairman's and
CEO's Review2. Cash flow statement
3. Calculation of significant ratios between
figures in the accounts
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A. Elshahat 411/3/2013
Common Size financial statements
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A. Elshahat 511/3/2013
Financial Ratio Analysis
A tool to handle massive data.
In isolation, a financial ratio is a uselesspiece of information.
A ratio gains utility by comparison to otherrelevant data and standards.
Financial ratio is governed by the GIGO law;
A cross industry comparison.
Using historical data independent offundamental changes
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A. Elshahat 611/3/2013
Different perspectives
Insiders Vs. Outsiders
Credit analysts: focus on the "downside" risk since they gain none
of the upside from an improvement in operations. Thus, they focus onrisk ratios (liquidity and leverage).
Equity analysts: look more to the operational and profitability
ratios, to determine the future profits that will accrue to the shareholder.
Results are not a gospel; Off-balance-sheet factors
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A. Elshahat 711/3/2013
Predictive Power of Financial
Ratios Trend Analysis
Sustainable Growth Rate (SGR)shows how
fast a company can grow using internally generated
assets without issuing additional debt or equity.
Altman Z-Score reliably predicts whether or not acompany is likely to enter into bankruptcy within one or
two years
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A. Elshahat 811/3/2013
SUSTAINABLE GROWTH RATE
provides a useful benchmark for judging a company's appropriaterate of growth. A company with a low sustainable growth rate butlots of opportunities for expansion will have to fund that growth viaoutside sources, which could lower profits and perhaps strain the
company's finances. Growth can be a major dilemma because withgrowth comes a spontaneously generated need for increasedworking capital. VentureLine calculates a Sustainable Growth Ratefrom the data entered into the Income Statement and BalanceSheet. The Sustainable Growth Rate is the rate at which the firmmay grow the Stockholder's Equity Account (Net Worth) using onlyincreases in Retained Earnings (Net Profit's contribution to retained
earnings) to fund the growth. Growth beyond this amount will forcethe firm to obtain additional financing from external sources tofinance growth.
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A. Elshahat 911/3/2013
Considerations when carrying on a trend
analysis
1. Inquire about the types of accounting policiesused
2. An appropriate allowance for any changes in
accounting policies that occurred during thesame time span is needed.
3. Determine whether ratios were calculatedbefore or after adjustments were made to the
financial statements, such as non-recurringitems and inventory or pro forma adjustments.
4. Carefully examine any departures from industrynorms
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A. Elshahat 1011/3/2013
Considerations when carrying on a
comparative analysis1. Inquire about the types of accounting policies
used by different entities being compared.
2. Allow for any material differences inaccounting policies between your companyand industry norms.
3. Make sure that you calculate the ratios by your
self or at least get all of them from the samesource.
4. Carefully examine any significant departuresfrom norms.
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A. Elshahat 1111/3/2013
Ratio Analysis Basic Frame work
Risk measurements
Shot term: Liquidity
Long term: Solvency/Leverage
Return Measurements
Short term: Profitability
Long term: Asset Utilization
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A. Elshahat 1211/3/2013
Total Operating Assets
Use “total operating assets” instead of
“total assets” (deduct long-term investments
and intangible assets from total assets). Ex. Turnover of total operating assets ratio
Note; This ratio does not measure profitability, rather it tracks over-
investment in operating assets
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A. Elshahat 1311/3/2013
Limitations
A reference point is needed.
Meaningless in isolation.
Financial Year-end values may be
manipulated.
Ratios are subject to accounting methods
limitations.