395 33 Powerpoint Slides 2 Comparative Historical Analysis CHAPTER 2
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Transcript of 395 33 Powerpoint Slides 2 Comparative Historical Analysis CHAPTER 2
CHAPTER 2
CONTENTS
Introduction
Balance Sheet
Profit & Loss Account
Cash Flow Statement
Stakeholders
Ratios and their types:
• Liquidity ratios, Capital Structure ratios, Working Capital ratios, Profitability ratios, Valuation ratios, DU PONT analysis
COMPARATIVE AND HISTORICAL ANALYSIS
2
CHAPTER 2
CONTENTS
Common size statements
Uses of ratio analysis
Limitations of ratio analysis.
COMPARATIVE AND HISTORICAL ANALYSIS
3
CHAPTER 2
INTRODUCTION
The historical financial performance is of significant importance for the various stakeholders.
Past performance forms the basis for future expectations.
Past financial performance is reflected in financial statements.
Financial statements consist of: Balance Sheet
Profit and Loss Account
Cash Flow Statement.
COMPARATIVE AND HISTORICAL ANALYSIS
4
CHAPTER 2
BALANCE SHEET
Reflects the financial condition of the firm as on a particular date.
Consists of:
• Assets
• Liabilities
• Owners Equity
COMPARATIVE AND HISTORICAL ANALYSIS
5
CHAPTER 2
BALANCE SHEET
Assets denote uses of funds Assets are classified broadly into:
• Fixed assets
• Investments
• Current assets, loans and advances
• Miscellaneous assets and losses.
COMPARATIVE AND HISTORICAL ANALYSIS
6
CHAPTER 2
BALANCE SHEET
Liabilities are the sources of external funds.
They are also referred to as obligations (or what the business owes) to outsiders.
Liabilities are broadly classified as:
• Secured and unsecured loans
• Current liabilities and provisions
• Contingent liabilities.
COMPARATIVE AND HISTORICAL ANALYSIS
7
CHAPTER 2
BALANCE SHEET
Owners’ equity refers to the capital contributed by the shareholders (owners).
It consists of:
• Paid up capital
• Reserves and Surplus
Share capital is of two types:
• Equity share capital
• Preference share capital
COMPARATIVE AND HISTORICAL ANALYSIS
8
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PROFIT AND LOSS ACCOUNT
Shows the income earned and the expenses incurred during a period.
Reflects earning capacity and profitability for a period.
Also referred to as Income Statement.
COMPARATIVE AND HISTORICAL ANALYSIS
9
CHAPTER 2
CASH FLOW STATEMENT
Summarizes sources and uses of cash.
Provides vital information for decision making and analysis.
Shows inflows and outflows of cash under the following three activities:
• Cash flow from operating activities
• Cash flow from investing activities
• Cash flow from financing activities.
Reflects the quality of liquidity (cash) of the business.
COMPARATIVE AND HISTORICAL ANALYSIS
10
CHAPTER 2
STAKEHOLDERS
All those who have stake in the business.
Are varied and so are their interests.
Examples include:• Shareholders• Suppliers• Customers• Competitors• Lenders• Employees• Government & Society.
COMPARATIVE AND HISTORICAL ANALYSIS
11
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STAKEHOLDERS
Depending on their stake, they look for some specific set of information in the financial statements.
Though profitability remains their common focus, specific areas of financial performance are of greater interest to them.
Financial statements at regular intervals provide answers to most questions that the they may have regarding the firms’ performance.
COMPARATIVE AND HISTORICAL ANALYSIS
12
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RATIO AND TYPES
Tool for review and analysis of financial performance.
A ratio expresses the relationship between two related financial variables.
It facilitates analysis by eliminating:
• the problem of size and
• the bias that creeps in because of size.
COMPARATIVE AND HISTORICAL ANALYSIS
13
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RATIO AND TYPES
By converting absolute figures into relative values, ratio analysis makes possible comparisons across time and firms.
There are 5 prominent categories of ratios: Liquidity Ratios
Capital Structure or Leverage Ratios
Working Capital Ratios
Profitability Ratios
Valuation Ratios.
COMPARATIVE AND HISTORICAL ANALYSIS
14
CHAPTER 2
LIQUIDITY RATIOS
Denotes the firm’s capacity to pay its short-term obligations on time.
Depends on the level of current assets owned by the firm.
Three prominent measures of liquidity: • Current ratio,
• Acid test ratio and
• Cash ratio.
COMPARATIVE AND HISTORICAL ANALYSIS
15
CHAPTER 2
LIQUIDITY RATIOS-CURRENT RATIO
The ratio of current assets to current liabilities.
A current ratio of more than 1 indicates that the current assets are in excess of current liabilities.
Higher the current ratio better is the firm from the lenders’ perspective.
COMPARATIVE AND HISTORICAL ANALYSIS
16
sLiabilitie CurrentAssets Current
=Ratio Current
CHAPTER 2
LIQUIDITY RATIOS – ACID TEST RATIO
Ratio of current assets, excluding inventory, to the current liabilities.
Inventories are excluded as they are least liquid of the current assets.
It is also referred to as quick ratio.
It is more stringent measure of liquidity than current ratio.
COMPARATIVE AND HISTORICAL ANALYSIS
17
sLiabilitie CurrentInventory-Assets Current
=Ratio Test Acid
CHAPTER 2
LIQUIDITY RATIO–CASH RATIO
Denotes the extent to which cash and near cash marketable securities are sufficient to meet the current liabilities.
Most stringent measure of firm’s liquidity.
COMPARATIVE AND HISTORICAL ANALYSIS
18
sLiabilitie Current es Securitile Marketab Cash
=Ratio Cash
CHAPTER 2
CAPITAL STRUCTURE RATIOS
Measure the relationship between owners’ funds and borrowed funds.
A high usage of borrowed funds:
• brings down the cost of financing
• increases returns to shareholders
• makes the firm more risky.
Can be sub-divided into:
• structural ratios
• coverage ratio.
COMPARATIVE AND HISTORICAL ANALYSIS
19
CHAPTER 2
CAPITAL STRUCTURE RATIOS
STRUCTURAL RATIOS Structural ratios denote the
composition of capital (i.e. proportion of debt vis-à-vis equity used in financing).
Most commonly used structural ratios are:
• Debt to equity ratio
• Debt to asset ratio
• Total outside liabilities to net worth.
COMPARATIVE AND HISTORICAL ANALYSIS
20
CHAPTER 2
• Debt-equity ratio
• Debt to asset ratio
• Total outside liabilities to net worth
COMPARATIVE AND HISTORICAL ANALYSIS
21
Worth Net Debt Term Long
=
Assets Net Debt Term Long
Worth Net sLiabilitie Outside Total
=
CHAPTER 2
CAPITAL STRUCTURE RATIOS
STRUCTURAL RATIOS
Denote the relationship between the borrowed funds and owners’ funds.
Generally a large value of structural ratio is disliked. It makes the firm vulnerable to business cycles.
COMPARATIVE AND HISTORICAL ANALYSIS
22
CHAPTER 2
CAPITAL STRUCTURE RATIOS
STRUCTURAL RATIOS
CAPITAL STRUCTURE RATIOS-COVERAGE RATIOS
While structural ratios depict proportion of debt compared to equity or assets, coverage ratios express ability of the firm to service its debt.
Commonly used coverage ratios are:
• Interest coverage ratio
• Debt service coverage ratio
COMPARATIVE AND HISTORICAL ANALYSIS
23
CHAPTER 2
CAPITAL STRUCTURE-COVERAGE RATIOS
CHAPTER 2COMPARATIVE AND HISTORICAL ANALYSIS
24
Rate Tax-1Instalment Loan
Obligation Interest
comeExpense/In Cash NononDepreciatiPBIT= Ratio Coverage
ServiceDebt
obligation Interest(PBIT) Taxes and Interest Before Profit
= Cover Interest
CAPITAL STRUCTURE-COVERAGE RATIOS
Higher the value of coverage ratios safer is the firm from the lenders perspective.
Interest cover indicates the extent to which profit is able to pay interest. Higher ratio means more cushion available to lenders.
Debt service coverage ratio measures the ability of the firm to meet out its total debt obligations (both interest and principal).
COMPARATIVE AND HISTORICAL ANALYSIS
25
CHAPTER 2
WORKING CAPITAL RATIOS
Denote the efficiency of firms in handling their operations.
More quickly a firm turns over the current assets into cash, more efficient it is.
Also referred to as Turnover ratios or Activity Ratios.
At an aggregate level, efficiency of internal operations is measured by current assets required to generate sales (i.e. current assets turnover ratio).
COMPARATIVE AND HISTORICAL ANALYSIS
26
CHAPTER 2
WORKING CAPITAL RATIOS
Further insight to operational efficiency is provided by analysing components of working capital.
Commonly used ratios are:
• Inventory turnover
• Debtors’ turnover
• Creditors’ turnover.
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
CURRENT ASSET TURNOVER
Defined as sales to current assets.
Indicates how many times the current assets have been turned over into sales in a given period (usually a year).
An increasing ratio is a sign of improving efficiency.
COMPARATIVE AND HISTORICAL ANALYSIS
28
Assets Current AverageSales
=
Ratio Turnover Assets Current
CHAPTER 2
CURRENT ASSET TURNOVER
Alternatively, it can also be expressed in terms of no. of days (i.e. current assets holding period)
Lesser the holding period, more efficient the operations.
COMPARATIVE AND HISTORICAL ANALYSIS
29
days X 365 Sales
Assets Current Average=
Period Holding
Assets Current
CHAPTER 2
INVENTORY TURNOVER RATIO
Expresses the relationship between cost of goods sold and inventory.
Alternatively it can also be expressed as no. of days of inventory (referred to as Inventory holding period)
COMPARATIVE AND HISTORICAL ANALYSIS
30
Inventory Average SoldGoodsof Cost
= Ratio Turnover Inventory
Days 365x SoldGoodsof Cost
Inventory Average=
Period Holding Inventory
CHAPTER 2
INVENTORY TURNOVER RATIO
Denotes efficiency in inventory management.
An increasing ratio (or a decreasing holding period) signifies better inventory management.
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
DEBTOR TURNOVER RATIO
Expresses the relationship between sales and debtors.
Alternatively, it can be expressed in no. of days (referred to as Average Collection Period)
COMPARATIVE AND HISTORICAL ANALYSIS
32
Debtors AverageSales
= Ratio Turnover Debtors
Days 365x Sales
Debtors Average=
Period Collection Average
CHAPTER 2
DEBTOR TURNOVER RATIO
It reflects the efficiency with which the firm realises its sales i.e. how fast the debtors are turned over into cash.
Improvement in the ratio (or reduction in the average collection period) indicates better receivables management.
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
CREDITORS TURNOVER RATIO
Reflects the number of times the dues to the suppliers are settled.
Alternatively, it can be expressed in terms of no. of days (referred to as average credit availed)
COMPARATIVE AND HISTORICAL ANALYSIS
34
CreditorsPurchases
= Ratio Turnover Creditors
Days 365x PurchasesCreditors
=
Availed Credit Average
CHAPTER 2
PROFITABILITY RATIOS
Reflect business's ability to generate earnings.
Higher ratios indicate better performance.
Examples of profitability ratios are:
• Profit margin
• Return on capital employed
• Return on assets
• Return on equity.
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
PROFITABILITY RATIOS -CONTRIBUTION MARGIN
Margin available, vis-à-vis sales, once the variable costs have been covered.
As this margin goes to meet the fixed costs larger margin is desirable.
COMPARATIVE AND HISTORICAL ANALYSIS
36
100 x Sales
cost Variable-Sales=
(%) MarginonContributi
CHAPTER 2
PROFITABILITY RATIOGROSS PROFIT MARGIN
Gross Profit expressed as a percentage of sales.
Reflects production efficiency.
Higher the gross profit margin more is the cushion to meet out the overheads.
COMPARATIVE AND HISTORICAL ANALYSIS
37
x100Sales
SoldGoodsof Cost -Sales
(%) MarginProfit Gross
CHAPTER 2
PROFITABILITY RATIONET PROFIT MARGIN
Net Profit Margin (or simple Net margin) is ratio of Profit After Tax (PAT) to sales.
Reflects the overall efficiency of the business.
COMPARATIVE AND HISTORICAL ANALYSIS
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100xSalesPAT
Margin(%)Profit Net
CHAPTER 2
PROFITABILITY RATIORETURN ON CAPITAL EMPLOYED
(ROCE)
Is a measure of efficiency of capital.
Also known as Return on Investment (ROI).
COMPARATIVE AND HISTORICAL ANALYSIS
39
x100Assets Net
T)-EBIT(1=
% (ROCE) Employed Capital on Return
CHAPTER 2
PROFITABILITY RATIORETURN ON EQUITY
(ROE) Return that the firm has been able to earn
on the equity financed portion of its capital.
Increasing ROE denotes improving efficiency of the firm in handling its shareholders’ funds.
COMPARATIVE AND HISTORICAL ANALYSIS
40
x100Worth Net
(PAT) Tax After Profit= ROE%
CHAPTER 2
PROFITABILITY RATIOEPS AND DPS
Earnings per Share (EPS) is the return earned on a per share basis.
The part of EPS that the firm distributes to the shareholders is known as Dividend per share (DPS).
COMPARATIVE AND HISTORICAL ANALYSIS
41
sharesof NumberPAT
=)(Rs./Share EPS
sharesof Number Dividend
=)(Rs./Share DPS
CHAPTER 2
VALUATION RATIOS
Assess the value that stock market places on stocks.
Commonly used ratios are:
• Earnings and dividends yield
• Price earnings ratio
• Price to book ratio.
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
VALUATION RATIOEARNINGS AND
DIVIDENDS YIELD
Earnings/dividends expressed as a percentage of market price gives earnings/dividends yields respectively.
COMPARATIVE AND HISTORICAL ANALYSIS
43
Share perPrice MarketEPS
(%) Yield Earnings
Share perPrice MarketDPS
(%) Yield Dividends
CHAPTER 2
VALUATION RATIOS-PRICE EARNINGS RATIO
Shows how much the investors are willing to pay per rupee of reported profits.
Also referred to as P/E multiple.
Reflects the confidence that the market reposes in a given firm/scrip.
COMPARATIVE AND HISTORICAL ANALYSIS
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Shareper Earnings
Shareper PriceMarket (P/E) Ratio Earnings Price
CHAPTER 2
VALUATION RATIOPRICE BOOK RATIO
Ratio of market price of a stock to its book value.
Reflects the perception of investors towards a stock.
Firms with relatively higher returns on equity generally sell at higher P/B.
COMPARATIVE AND HISTORICAL ANALYSIS
45
Share perValue Book Share perPrice Market
(P/B) Ratio Book to Price
CHAPTER 2
DUPONT ANALYSIS
Introduced by DU Pont Co. of USA.
Establishes relationship of few important ratios.
Return on assets or the return on capital employed is a function of margin on sales (i.e. profitability) and the efficiency of the assets utilisation (i.e. operating efficiency).
COMPARATIVE AND HISTORICAL ANALYSIS
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CHAPTER 2
DUPONT ANALYSIS
COMPARATIVE AND HISTORICAL ANALYSIS
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Worth NetAssets
Assets
Tax After ProfitWorth Net
Tax After Profit ROE
Worth NetWorth NetLoan
AssetsTax After Profit
)(EquityDebt
1 ROA
)EquityDebt
(1 Turnover Asset Profit Net
Leverage Financial
Efficiency Operating
MarginOperating
CHAPTER 2
COMMON SIZE STATEMENTS
A financial statement that displays all items as percentages of a common base figure.
Allow easy analysis across companies and across time.
Enables to remove bias due to size.
The values are expressed as a percentages of revenue or assets.
COMPARATIVE AND HISTORICAL ANALYSIS
48
CHAPTER 2
USES OF RATIO ANALYSIS
Ratio analysis helps in:
• Diagnosis and objective analysis of financial performance.
• Financial planning and decision-making by creditors
• Setting a benchmark for performance.
COMPARATIVE AND HISTORICAL ANALYSIS
49
CHAPTER 2
LIMITATIONS OF RATIO ANALYSIS
Arbitrariness in the selection
Lack of unanimous definitions
Locational, business, and accounting differences.
COMPARATIVE AND HISTORICAL ANALYSIS
50
CHAPTER 2