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Analysis and interpretation of financial statements is the re-classification and re-grouping of the data found in the financial statements into comparable factors (i.e. figures), establishment and study of the relationship between comparable factors and explanation of the relationship between comparable factors. In short, it is the re-arrangement of the figures found in the financial statements in such a manner as to provide the necessary information about the profitability and financial position of the concern.

Analysis and interpretation of financial statements involves three steps: 1. Analysis Re-grouping into desired comparable factor 2. Comparison - Process of ascertaining the relative magnitudes of the comparable factors. 3. Interpretation - the relationship between the comparable factors must be interpreted i.e., conclusions drawn.

FINANCIAL STATEMENTS Generally includes Income statement (Profit and Loss Account) Balance sheet (Statement of Assets and Liabilities) Business may also prepare Statement of retained earnings Cash flow or Fund flow statement

STANDARDS OF COMPARISON Rule of thumb indicators Benchmark financial ratio Eg, current ratio 2:1 Past performance of the company Compare performance of the company for a period of time say 5 years or ten years Industry standards Comparison with other companies in the same industry


1. Horizontal analysis

2. Trend analysis
3. Vertical analysis 4. Ratio analysis

Horizontal analysis
It is a approach to calculate percentage change and amount Change from the previous year to the current year.
HLL - COMPARITIVE PROFIT AND LOSS ACCOUNT Increase(Decrease) Year 2 Sales Other income Total revenue Expenses other than interest expense 23313 475 23696 19848 Year 1 19686 745 20732 17603 Amount 3627 (270) 3324 % 18.42% (36.24)% 16.12%

Interest expenses Profit before tax Tax Profit after tax

2 3615 829 2800

1 2898 588 2306

494 21.42%

Trend analysis
It involves calculation of % changes in financial statement items for a number of successive years. It is carried out by first assigning a value of 100 to the financial statement items in a past financial year used as base year.
HLL Selected data 2012 Sales 23313 2011 19686 2010 17935 2009 20769

Sales PBT

112 118

Trend analysis 94 95

86 91

100 100

Vertical analysis
Expression of each item on a financial statement to the statement total. All the elements within each statement are expressed in percentage. Items in profit and loss account are expressed as a % of sales while balance sheet item is expressed as a % of total assets.
HLL - PROFIT AND LOSS ACCOUNT 2012 Sales Expenses Profit before tax Tax Profit after tax 100 85 15 3 12 2011 100 86 14 3 11

Using Financial Ratios

Ratio analysis involves methods of calculating and

interpreting financial ratios to assess a firms financial

condition and performance.

It is of interest to shareholders, creditors, and the firms

own management.

How a Ratio is expressed?

As Percentage - such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales is Rs.1,00,000/then the net profit can be said to be 25% of the sales. As Proportion - The above figures may be expressed in terms of the relationship between net profit to sales as 1 : 4. As Pure Number /Times - The same can also be expressed in an alternatively way such as the sale is 4 times of the net profit or profit is 1/4th of the sales.

Liquidity Ratios
1. Current Ratio:
Current Assets Current Liabilities
Ideal Current ratio is 2. Indicator of the capacity of the firm to meet its short term Liabilities

2. Acid Test Ratio/Quick ratio/Liquid ratio:

Current Assets (Stock and Prepaid expenses) Current Liabilities
Ideal liquid ratio is 1. Indicator of short term solvency

Turnover (Activity) Ratios

1. Inventory Turnover Ratio:
Cost of goods sold Average Inventory (Op+Cl)/2

Inventory Holding Period:

360 days or 12 months Inventory Turnover Ratio

Turnover Ratios
2. Debtors Turnover Ratio:
Net Credit Sales Average Debtors

Debtors Collection Period:

360 days or 12 months Debtors Turnover Ratio

Turnover Ratios
3. Creditors Turnover Ratio:
Net Credit Purchases Average Creditors

Creditors Payment Period:

360 days or 12 months Creditors Turnover Ratio

Turnover Ratios
4. Fixed Assets Turnover Ratio:
Net Sales Net fixed assets

Total Assets Turnover Ratio:

Net Sales Total assets

Solvency Ratios
3.Debt-equity Ratio:
Debt (Total long term debt)
Equity (Shareholders Fund)

Ratio of 1 is considered to be quite satisfactory. Ratio indicates the proportion of owners stake in the business. Also determines the soundness of the long term financial policies of the company.

Solvency Ratios
4.Liabilities to equity Ratio:
All liabilities
Equity (Shareholders Fund)

Variant of Debt to equity ratio.

Solvency Ratios
5. Interest Coverage (Fixed charges cover) Ratio:

Profit before interest & taxes

Debt Interest

Profit before interest & taxes + Depreciation Debt Interest

Ratio important from the lenders point of view. Indicates whether business would earn sufficient profits to pay periodically the interest charges.

Solvency Ratios
6. Debt Service Coverage Ratio:
Profit after Tax + Depreciation + Interest on term loan Interest on term loan + Repayment of term loan
Indicates the ability of the firm to repay its debt on time

Profitability Ratios
1. Return on equity shareholders fund
Profit after interest, tax and preference dividend

Equity shareholders fund

2. Return on Shareholders Funds:

Net profit after interest and tax Shareholders fund

Profitability Ratios
3. Return on total assets
Net Profit after tax

Total assets

4. Return on capital employed

Net Profit after tax Capital employed

Profitability Ratios
5. Earnings per share :
Equity earnings No. of equity shares issued

Profitability Ratios
6. Gross Profit Margin Ratio:
Gross Profit Net Sales

7. Net Profit Margin Ratio:

Net Profit Net Sales

Market related Ratios

1. Price-earnings Ratio:
Market price per equity share Earnings per share

2. Payout ratio:
Dividend per equity share Earnings per equity share

Market related Ratios

3. Dividend Yield Ratio :
Dividend per equity share Market price per equity share