Financial Statements Analysis

Presented by:

Abid Khan

Muhammad Hashim

Shah Zaman

The Analysis of Financial Statements

The Use Of Financial Ratios

Analyzing Liquidity Analyzing Activity Analyzing Debt Analyzing Profitability A Complete Ratio Analysis

The Analysis of Financial Statements THE USE OF FINANCIAL

RATIOS

– Financial Ratio are used as a relative measure that facilitates the evaluation of efficiency or condition of a particular aspect of a firm's operations and status

– Ratio Analysis involves methods of calculating and interpreting financial ratios in order to assess a firm's performance and status

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Example

(1) (2) (1)/(2)Year End Current Assets/Current Liab. Current Ratio

1994 $550,000 /$500,000 1.10

1995 $550,000 /$600,000 .92

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Interested Parties

Three sets of parties are interested in ratio analysis:

ShareholdersCreditorsManagement

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Types of Ratio Comparisons

There are two types of ratio comparisons that can be made:

Cross-Sectional Analysis Time-Series Analysis

– Combined Analysis uses both types of analysis to assess a firm's trends versus its competitors or the industry

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Words of Caution Regarding Ratio Analysis

A single ratio rarely tells enough to make a sound judgment.

Financial statements used in ratio analysis must be from similar points in time.

Audited financial statements are more reliable than unaudited statements.

The financial data used to compute ratios must be developed in the same manner.

Inflation can distort comparisons.

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Groups of Financial Ratios

LiquidityActivityDebtProfitability

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Analyzing Liquidity

Liquidity refers to the solvency of the firm's overall financial position, i.e. a "liquid firm" is one that can easily meet its short-term obligations as they come due.

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Three Important Liquidity Measures

Net Working Capital (NWC)

NWC = Current Assets - Current Liabilities

Current Ratio (CR) Current Assets CR = Current LiabilitiesQuick (Acid-Test) Ratio (QR)

Current Assets - InventoryQR = Current Liabilities

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Analyzing Activity

Activity is a more sophisticated analysis of a firm's liquidity, evaluating the speed with which certain accounts are converted into sales or cash; also measures a firm's efficiency

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Inventory Turnover (IT)

Average Collection Period (ACP)

Average Payment Period (APP)

Fixed Asset Turnover (FAT)

Total Asset Turnover (TAT)

Cost of Goods SoldIT =

Inventory

Accounts ReceivableACP =

Annual Sales/360

Accounts PayableAPP=

Annual Purchases/360

Sales FAT =

Net Fixed Assets

SalesTAT =

Total Assets

Five Important Activity Measures11

Analyzing Debt

Debt is a true "double-edged" sword as it allows for the generation of profits with the use of other people's (creditors) money, but creates claims on earnings with a higher priority than those of the firm's owners.

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Measures of Debt

There are Two General Types of Debt Measures

–Degree of Indebtedness

–Ability to Service Debts

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Debt Ratio

(DR)

Debt-Equity Ratio

(DER)

Times Interest Earned

Ratio (TIE)

Fixed Payment Coverage Ratio (FPC)

Total LiabilitiesDR=

Total Assets

Long-Term DebtDER=

Stockholders’ Equity

Earnings Before Interest & Taxes (EBIT)TIE=

Interest

Earnings Before Interest & Taxes + Lease Payments

FPC= Interest + Lease Payments +{(Principal Payments + Preferred Stock Dividends) X [1 / (1 -T)]}

Four Important Debt Measures14

Analyzing Profitability

– Profitability Measures assess the firm's ability to operate efficiently and are of concern to owners, creditors, and management

– A Common-Size Income Statement, which expresses each income statement item as a percentage of sales, allows for easy evaluation of the firm’s profitability relative to sales.

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Gross Profit Margin (GPM)

Operating Profit Margin (OPM)

Net Profit Margin (NPM)

Return on Total Assets (ROA)

Return On Equity (ROE)

Earnings Per Share (EPS)

Price/Earnings (P/E) Ratio

Gross ProfitsGPM=

Sales

Operating Profits (EBIT)OPM =

Sales

Net Profit After TaxesNPM=

Sales

Net Profit After TaxesROA=

Total AssetsNet Profit After Taxes

ROE= Stockholders’ Equity

Earnings Available for Common Stockholder’sEPS = Number of Shares of Common Stock Outstanding

Market Price Per Share of Common StockP/E =

Earnings Per Share

Seven Basic Profitability Measures16

Summarizing All Ratios An approach that

views all aspects of the firm's activities to isolate key areas of concern

Comparisons are made to industry standards (cross-sectional analysis)

Comparisons to the firm itself over time are also made (time-series analysis)

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Al-Noor Sugar MillsAn Introduction, Common Size financial Statements

By Shah Zaman

About the Mills

• Company Information

Al-Noor Sugar Mills Limited is a public company incorporated in Pakistan under the Companies Act, 1913 (now Companies Ordinance, 1984). Its shares are quoted on Karachi and Lahore Stock Exchange in Pakistan and is principally engaged in the production and sale of refined sugar and medium density fiber board.

Mission Statement

To gain strength through industry leadership in the manufacturing and marketing of sugar and Lasani Wood and to have a strong presence in these product markets while retaining the options to diversify in other profitable venture.To operate ethically while maximizing profits and satisfying customers needs and stake holder's interests.To assist in the socio economic development of Pakistan especially in the rulra areas through industrial expansion and development.

Al-Noor Sugar Mills

Common size Financial Statements

Trend analysis

Cross sectional Analysis

Balance Sheet 2006 2007 2008 2006 2007 2008

ASSETS

Cash 48,694 47,597 86,463 100% 98% 178%

Stores and Spares 131,668 144,818 188,578 100% 110% 143%

Stock in trade 230,809 393,723 1,009,052 100% 171% 437%

trade debts 43,166 28,978 11,314 100% 171% 26%

loans and advances 112,300 144,861 149,526 100% 129% 133%

trade deposits 3,638 5,254 7,164 100% 144% 197%

other receivables 11,081 23,271 417 100% 190% 4%

Total Current assts 100%

Fixed Assets 100%

property plant, Equip 1,472,955 1,527,982 2,264,422 100% 104% 154%

Long term investments 8,607 10,263 37,751 100% 119% 80%

Long term deposits 10,742 11,317 5,071 100% 105% 47%

total assets 2072660 2,338,064 3775726 100% 42%

LIABILITIES & EQUITY

short term liabilities

Trade and other payables 317,484 317,484 526,054 100% 100% 166%

Interest markup accrued 25,138 14,446 28,416 100% 57% 113%

short term borrowings 397,809 270,955 862,684 100% 68% 218%

Current portion of long term liab 105,139 118,679 123,808 100% 113% 123%

provision for income tax 7,460 2,089 0 100% 28% 0%

long term financing 67,470 325,000 237,500 100% 482% 315%

liabilities against assets subject to finance lease 77,568 70,840 28,261 100% 91% 46%

long term deposits 5,035 4,874 4,869 100% 97% 64%

deferred liabilities 344,112 346,074 492,058 100% 101% 122%

Authorized capital (20,000,000, @Rs. 10 each) 200,000 200,000 200,000 100% 100% 100%

Paid up capital 185,703 185,703 185,703 100% 100% 100%

General revenue reserve 190,000 190,000 190,000 100% 100% 100%

Inappropriate profit 111,468 154,659 366,139 100% 139% 310%

total stockholders equity 1

total equity and liabilities 2072660 2,338,04 3775726

Analysis

• In reviewing the basic financial ratios, we will examine the ratios of Al-Noor Sugar Mills for the fiscal years ended September 30, 2008 and September 30, 2007. Al-Noor Sugar Mills is a growing company.

Analysis (Al-Noor Sugar Mills)

By Muhammad Hashim Shah

Analysis

• Note that while Al-Noor Sugar Mills’s earnings rose from 2007 to 2008, the earnings generated per dollar of assets fell over the period. In 2007, Al-Noor Sugar Mills earned 10.22 cents before financing costs on every dollar of average assets; however, in 2008, Al-Noor Sugar Mills earned only 9.63 cents before financing costs on every dollar of average assets. The ratio, return on assets, allows the analyst to compare the earnings generating ability of the company relative to the invested assets.

Analysis- profit margin

• Al-Noor Sugar Mills’s profit margin increased in 2008. For every Rupee in sales, Al-Noor Sugar Mills earned 3 Passas in income before financing costs in 2008 and only 2.61 cents in 2007. Thus, the fall in ROA is not due to the reduction in income before financing costs per Rupee of sales.

Profit Margin

• Al-Noor Sugar Mills’s rise in profit margin in 2008 is due to the reduction of cost of sales rather than to the reduction of selling, general and administrative expenses relative to sales.

Analysis- ROA

• It appears that Al-Noor Sugar Mills’s fall in ROA was driven by a fall in ATO, not a fall in PM. The firm had difficulty generating sales from the assets in 2008 relative to 2007. For every Rupee of average assets, Al-Noor Sugar Mills generated only Rs.3.21 in sales in 2008 while Al-Noor Sugar Mills generated Rs.3.92 in sales in 2007.

Analysis- A/R turnover

• Most of Al-Noor Sugar Mills’s transactions are for cash or credit cards; therefore, the number of days’ sales outstanding is very small, approximately 4 days.

Analysis- Inventory turnover

• It has taken Al-Noor Sugar Mills longer to sell its inventory, on average, in 2008 relative to 2007. While it took approximately 44 days on average to sell inventory in 2007, it took Al-Noor Sugar Mills approximately 50 days on average to sell inventory in 2008.

Plant Assets turnover

• Al-Noor Sugar Mills has generated fewer sales per dollar of assets in 2008 relative to 2007. While Al-Noor Sugar Mills generated Rs.14.31 in sales per dollar of average assets in 2007, the average assets generated only Rs.11.73 in sales in 2008. Therefore, part of the explanation for the reduction in asset turnover is the reduction in the productivity of the plant assets at generating sales.

Analysis

• These results suggest that while Al-Noor Sugar Mills did generate greater income and sales in 2008 versus 2007, it generated less income (before financing costs) per dollar of average assets, it took longer to sell its inventory, and it generated fewer sales from each dollar of plant assets.

Analysis-Return on Equity

• Al-Noor Sugar Mills’s ROE has fallen in 2008 but it has not fallen as much as the fall in ROA.

• Note that Al-Noor Sugar Mills’s return on equity is higher than its return on assets. This is due to the use of leverage. Financing with debt and preferred stock can increase the return to common shareholders if the return on assets is greater than the cost of debt.

Analysis- Debt-Asset Ratio

• Al-Noor Sugar Mills has relied more on debt in 2008 relative to 2007. In 2008, 11% of Al-Noor Sugar Mills’s assets are financed with debt while in 2007 only 6% of the assets were financed through debt.

Analysis-Interest Coverage Ratio

• Al-Noor Sugar Mills’s interest coverage ratio has decreased dramatically with the heavier reliance on debt in 2008 relative to 2007.

Analysis- Current Ratio

• Al-Noor Sugar Mills’s current ratio is relatively low. Analysts often suggest that the current ratio of a healthy company should be approximately 2.0. While Al-Noor Sugar Mills’s current ratio is well below 2.0, note that Al-Noor Sugar Mills’s current ratio has increased from 2007 to 2008.

How is Al-Noor Sugar Mills doing?

• If you recall, Al-Noor Sugar Mills had increasing income and increasing sales. The ratios allow us to determine the sales and income relative to the assets and book value that the firm had available to generate income and sales.

Conclusion and Synthesis

• While Al-Noor Sugar Mills did have large increases in sales and earnings in 2008, it did not have increases in profitability.

• Al-Noor Sugar Mills also had high growth in its assets and debt in 2008. Taking into account the assets that Al-Noor Sugar Mills had to use during 2008, Al-Noor Sugar Mills looks less profitable in 2008 relative to 2007 per Rupee of invested assets and book value.

• In addition, its key drivers of operations have become less productive. In particular, Al-Noor Sugar Mills had more difficulty in 2008 in selling inventory and generated fewer sales per dollar of plant assets.

• Ratio analysis leaves one with more insight into Al-Noor Sugar Mills and its changes over the year.