Lesson 6
Analysis of financial statements
Structure
Introduction
Analysis techniques
Balance sheet analysis
Income statement analysis
Return analysis
1. Introduction
Analysis of financial statements or financial analysis
Goals:
- to assess the current profitability and operational efficiency of the
firm as a whole as well as its different departments so as to judge
the financial health of the firm.
• to ascertain the relative importance of different components of the
financial position of the firm.
• to identify the reasons for change in the profitability/financial position
of the firm.
• to judge the ability of the firm to repay its debt and assessing the
short-term as well as the long-term liquidity position of the firm.
- to assess the current profitability and operational efficiency of the
Introduccion II
It studies:
Financial structure:
Finance sources
Capacity to face debts at maturytiy
Economic structure
Investments to carry out the company operation
Non-current assets
Minimum level of current assets
Introduction III
It allows
measuring the result of the company decisions
adopting measures to improve in the future
Limitations:
Base on historic data
Usually referred at the end of the year
Sensitive to accounting manipulations
It does not consider inflation effects
Structure
Introduction
Analysis techniques
Balance sheet analysis
Income statement analysis
Return analysis
2. Analysis techniques
Horizontal analysis
Vertical analysis
Ratio analysis
Intracompany
Intercompany
Dynamic
Static
Balance analysis
Income statement analysis
Horizontal analysis
Over multiple periods of time
Percentage growth
Easy to spot trends and growth patterns
Also call trend analysis
Vertical analysis
- Relationships between numbers in a single reporting period (or one moment in time)
Ratio analysis
- Relative analysis
- Just a division but it is important to know the definition considered in both numerator and denominator
Intracompany and intercompany analysis
- Intracompany: Comparison within the company (past or forecasting)
- Intercompany: Comparison with other companies
Static and dynamic analysis
Static: for a given time
Dynamic: Throughout time comparing several years
Balance analysis
To assess:
Liquidity and solvency
Debt
Asset management
Financial balance
Income statement analysis
To determine how the company creates profits and how to improve them
It can be used with historical or previsional statements
To evaluate sales, operation margin, financial expenses, fixed expenses
To determine the break-even-point
Structure
Introduction
Analysis techniques
Balance sheet analysis
Income statement analysis
Return analysis
3. Balance analysis
Equity and Liabilities:
Capital employed: resources not required in the short term
Capital employed = Equity + Non-current liabilities
Assets = Equity + Liabilites
Assets = Capital employed + Current Liabilities
Assets:
Non-current assets
Current assets: Inventory + Receivables + Cash and cash equivalents
Working capital
Working capital:
Working capital is the difference between a company’s current assets and its current liabilities, such as accounts payable and debts
Commonly used measurement to gauge the short-term health of an organization
Working capital II
Negative working capital: current assets < current liabilities
Positive working capital: current assets > current liabilities
It indicates whether the pool of money a company has, or expects to receive, over the next year is sufficient to meet the short term obligations it also expects to meet during that time
Vertical analysis of the balance sheet
Working out the percentage of each mass in the balance
Easy to plot
Balance sheet item / Total assets
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Balance ratios
Liquidity ratios: measure a company’s ability to pay debt obligations and its margin of safety
Debt and Structure ratios: company’s leverage and company’s long-term stability and structure. Debt/Assets
Turnover ratios: sales divided by average asset amount. It shows the efficiency on assets utilization
Operation cycles
Liquidity ratios
Liquidity Ratio=Current AssetsCurrent Liabilities
Average Collection Period=Average of Trade ReceivablesSales⋅365
Average Payment Period=Average of PayablesSales⋅365
Debt and structure ratios
Capital structure is how a company funds its overall operations and growth
Debt consists of borrowed money that is due back to the lender, commonly with interest expense
Equity consists of ownership rights in the company, without the need to pay back any investment
The debt-to-equity (D/E) ratio is useful in determining the riskiness of a company’s borrowing practices
Debt Ratio=LiabilitiesEquity+Liabilities
Solvency Ratio=AssetsLiabilities
Debt to Equity Ratio=LiabilitiesEquity
Structure
Introduction
Analysis techniques
Balance sheet analysis
Income statement analysis
Return analysis
4. Income statement analysis
Vertical and horizontal
Intracompany and intercompany
Main components (relative or absolute)
Margins
Trends (horizontal: same figure across two or more time frames)
Structure
Introduction
Analysis techniques
Balance sheet analysis
Income statement analysis
Return analysis
5. Return analysis
Components from the balance sheet and income statement
Relative measure
Return on Assets ROA
Assets Turnover
Sales margin
Return on Equity ROE
- Leverage
Return On Assets
ROA=EBITAssets=EBITSales⋅SalesAssets=Sales Margin⋅Asset turnover
The return sources are:
The margin obtained for every Euro in sales
The Sales for every Euro invested
To increase returns companys:
increase margin
sell more
Also ROA = Net income / Assets
Return On Equity
Company’s net income / Shareholder’s equity
Profits / Equity
Gauge of corporation’s profitability
The higher the ROE the better a company is converting equity into profits
Usually expressed as a percentage
ROE=SalesAssets⋅EBITSales⋅AssetsEquity⋅EBTEBIT⋅Net incomeEBT
ROE=Assets turnover⋅Sales margin⋅Financial Leverage⋅Tax effect
