Lesson 6

Analysis of Financial Statements

October 12, 2026

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

1. Introduction to financial statement analysis

Raw statements don’t answer the questions

  • Is the firm financially healthy?
  • Is profitability adequate?
  • Is debt sustainable?
  • Are operations efficient?

Key Concept Financial statement analysis interprets accounting information to evaluate the economic and financial situation of a firm.

Case: financial analysis in aerospace

Aerospace Case Aerospace firms operate with expensive industrial assets, long production cycles, large inventories and big R&D programmes.

→ financial analysis here must combine accounting information, operational indicators, engineering considerations and strategic analysis.

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

2. Economic vs financial structure

Two structures

Economic structure

  • how resources are invested (asset side)
  • cash, inventories, aircraft, facilities, patents

Financial structure

  • how resources are financed (equity + liabilities)
  • share capital, retained earnings, loans, leases

Different industries → different structures (retail = inventory-heavy; airlines = fleet-heavy).

The relationship must be sustainable

  • large industrial assets → substantial financing
  • long-term assets should be financed with long-term capital

Example An airline financing a modern fleet almost entirely with short-term debt faces serious refinancing and liquidity risk.

Case: financial structure in commercial aviation

Aerospace Case Aircraft acquisitions require very large investments → airlines run substantial debt and leasing obligations.

Airline financial structures are strongly shaped by long-term debt, aircraft leasing, financing costs and interest-rate conditions.

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

3. Main analysis techniques

Four techniques

  • Horizontal: change of each item over time
  • Vertical: each item as a % of a base (total assets, or sales)
  • Ratio: relationships between items
  • Comparative: intracompany (over time) / intercompany (vs peers); static vs dynamic

Case: comparing airlines

Aerospace Case Analysts compare airlines on operating margin, debt ratios, fuel costs, passenger load factors and profitability measures → to judge competitive performance and operational efficiency.

Horizontal & vertical

Example Horizontal: an item grows from 20 to 24 → \((24-20)/20 \times 100 = \mathbf{20\%}\).

Vertical: express every balance-sheet item as a share of total assets, every income-statement item as a share of sales.

Vertical analysis of the balance sheet

Balance-sheet item / Total assets → easy to plot

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

4. Balance sheet analysis

Capital employed & working capital

\[\text{Capital employed} = \text{Equity} + \text{Non-current liabilities}\] \[\text{Working capital} = \text{Current assets} - \text{Current liabilities}\]

Key Concept Positive working capital → short-term assets exceed short-term obligations. But excessive working capital may signal idle cash or poor inventory management.

Working capital

Operating cycles

Liquidity ratios

\[\text{Current ratio} = \dfrac{CA}{CL} \qquad \text{Quick ratio} = \dfrac{CA - \text{Inventories}}{CL}\]

\[\text{Collection period} = \dfrac{\text{Avg. receivables}}{\text{Sales}}\times 365\]

\[\text{Payment period} = \dfrac{\text{Avg. payables}}{\text{Purchases}}\times 365\]

\(CA\) = current assets · \(CL\) = current liabilities. Airlines keep large liquidity reserves: critical during COVID-19.

Debt & capital structure ratios

\[\text{Debt ratio} = \dfrac{L}{A} \qquad \text{Solvency} = \dfrac{A}{L} \qquad \text{Debt-to-equity} = \dfrac{L}{E}\]

\(A\) = total assets · \(L\) = total liabilities · \(E\) = equity

Example Airbus 2022: \(A\) = 115,944 · \(L\) = 102,962 · \(E\) = 12,982 (M€) → solvency ≈ 1.13, debt-to-equity ≈ 7.93.

Asset management

\[\text{Asset turnover} = \dfrac{\text{Revenue}}{\text{Assets}}\]

How much revenue is generated per euro of assets: a key input to return analysis.

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

5. Income statement analysis

Revenue analysis

  • capacity to generate sales, growth patterns, composition
  • aviation: scheduled passenger · ancillary · cargo · other

Key Concept Revenue growth alone does not guarantee profitability: analyse it with cost evolution and efficiency.

Cost structure & fuel

Aviation costs: fuel · salaries · maintenance · leasing · airport charges · depreciation · financing

Commercial aviation is fixed-cost heavy → profitability depends on utilisation and load factor.

Aerospace Case Fuel is often the largest operating expense. Price spikes cut profitability fast; hedging affects results; fuel efficiency is strategic.

Margins & operating leverage

\[\text{Operating margin} = \dfrac{\text{Operating profit}}{\text{Revenue}}\]

Key Concept High operating leverage (high fixed costs): activity ↑ → profit ↑ strongly; activity ↓ → losses quickly. More potential profit and more risk.

Aerospace Case Load factor: occupied seats / available seats. Small changes move profitability sharply because most costs are fixed.

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

6. Return analysis

ROA

\[\text{ROA} = \dfrac{\text{EBIT}}{A} = \dfrac{\text{EBIT}}{S} \times \dfrac{S}{A}\]

= sales margin × asset turnover    (\(S\) sales · \(A\) assets)

Return on the resources invested, independent of financing. (EBIT = operating profit, from Lesson 4.)

ROE

\[\text{ROE} = \dfrac{\text{Net profit}}{\text{Equity}}\]

Key Concept ROE measures profitability for shareholders. High ROE can come from strong operations or from excessive leverage → always read with debt ratios.

Financial leverage

Using debt to support activity and investment.

  • may improve shareholder returns (finance large investments)
  • increases interest expense, financial risk, refinancing risk, downturn vulnerability

Aerospace Case Airlines run high leverage (fleets need huge investment). Great in booms; dangerous when traffic falls or fuel rises.

DuPont decomposition

\[\text{ROE} = \dfrac{S}{A} \cdot \dfrac{\text{EBIT}}{S} \cdot \dfrac{A}{E} \cdot \dfrac{\text{EBT}}{\text{EBIT}} \cdot \dfrac{\text{NI}}{\text{EBT}}\]

turnover × margin × leverage × interest burden × tax effect

(\(S\) sales · \(A\) assets · \(E\) equity · NI net income)

DuPont: reading it

\[\text{ROE} = \text{ROA} \times \text{Lev.} \times \text{Int. burden} \times \text{Tax effect}\]

  • turnover × margin = ROA (return on assets)
  • then reshaped by how the firm is financed and taxed

Example An airline with modest margins can still reach acceptable ROE through high utilisation, strong load factors and substantial leverage.

Agenda

  1. Introduction to financial statement analysis
  2. Economic vs financial structure
  3. Main analysis techniques
  4. Balance sheet analysis
  5. Income statement analysis
  6. Return analysis
  7. Limitations

7. Limitations

What ratio analysis misses

  • historical information: the past, not the future
  • accounting estimates & judgement: depreciation, provisions
  • industry differences: ratios not comparable across sectors
  • accounting profit ≠ cash flow
  • non-financial factors: safety record, order backlog, technology, ESG

Case: innovation vs short-term profit

Aerospace Case Firms investing heavily in sustainable propulsion, advanced materials, digital technologies or automation may temporarily reduce short-term profitability while strengthening future technological leadership and long-term competitive position.

→ ratios alone would flag this as “worse performance”.

AI-assisted analysis

Key Concept AI-assisted analysis can miss context, use outdated data and misread industry norms: verify against the actual statements.

Summary

  • Distinguish economic (assets) and financial (equity + liabilities) structure
  • Techniques: horizontal, vertical, ratio, comparative
  • Balance sheet: working capital, liquidity, debt, asset turnover
  • Income statement: margins, operating leverage, load factor
  • Returns: ROA → ROE via DuPont; leverage amplifies both return and risk
  • Ratios are backward-looking: combine with non-financial judgement