Financial Statement Analysis

Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06 Mar ' 05
Sources of funds
Owner's fund
Equity share capital 514.05 385.54 385.41 382.87 361.79
Share application
money
- - - - -
Preference share
capital
- - - - -
Reserves & surplus 11,855.15 7,428.45 6,458.39 5,127.81 3,749.60
Loan funds
Secured loans 5,251.65 2,461.99 2,022.04 822.76 489.81
Unsecured loans 7,913.91 3,818.53 1,987.10 2,114.08 2,005.61
Total 25,534.76 14,094.51 10,852.94 8,447.52 6,606.81
Balance sheet of Tata motors ltd
Uses of funds
Fixed assets
Gross block 13,905.17 10,830.83 8,775.80 7,971.55 6,611.95
Less : revaluation
reserve
25.07 25.51 25.95 26.39 -
Less : accumulated
depreciation
6,259.90 5,443.52 4,894.54 4,401.51 3,454.28
Net block 7,620.20 5,361.80 3,855.31 3,543.65 3,157.67
Capital work-in-
progress
6,954.04 5,064.96 2,513.32 951.19 538.84
Investments 12,968.13 4,910.27 2,477.00 2,015.15 2,912.06
Net current assets
Current assets, loans &
advances
10,836.58 10,781.23 10,318.42 9,812.06 7,248.88
Less : current liabilities
& provisions
12,846.21 12,029.80 8,321.20 7,888.65 7,268.80
Total net current assets -2,009.63 -1,248.57 1,997.22 1,923.41 -19.92
Miscellaneous expenses
not written
2.02 6.05 10.09 14.12 18.16
Total 25,534.76 14,094.51 10,852.94 8,447.52 6,606.81
Financial Statement Analysis:

Financial analysis is the process of identifying the
financial strengths and weaknesses of the firm by
property establishing relationships between the items of
the balance sheet and the profit and loss account.
Time series analysis

Inter-firm analysis

Industry analysis

Proforma financial statement analysis
Standard of Comparison
A ratio is a simple arithmetical expression of the
relationship of one number to another.

A financial ratio is a relationship between two
accounting numbers. Ratios help to make a
qualitative judgments about the firms financial
performance

Ratio Analysis can be defined as the study and
interpretation of relationships between various financial
variables, by investors or lenders. It is a quantitative
investment technique used for comparing a company's
financial performance to the market in general. A change
in these ratios helps to bring about a change in the way a
company works. It helps to identify areas where the
management needs to change.

Limitation of Financial
Statement Analysis
1. Past financial performance, good or bad, is not necessarily an accurate
predictor of future performance.
2. Financial statements do not tell you about changes in senior management.
3. Financial statements do not tell you about the loss of major customers.
4. Financial statements do not tell you about the competitive environment in
which the company operates.
5. Financial statements do not disclose the companys future prospects, or the
results of its expenditures on Research and Development, or new product
introductions, or new marketing campaigns, or new pricing strategies, or the
customers recent decision to enter or exit a particular market segment.
6. The more out-of-date a customers financial statements are, the less reliable
they are as a risk management tool.
7. Without reading the Notes to the financial statements, credit managers
cannot get a clear idea of the risk they are evaluating.
8. Unaudited statements may or may not follow Generally Accepted
Accounting Principles, and if they do not follow GAAP relying on them
could be a serious mistake.
9. Financial statements can be altered legally by adjusting certain types of
reserves.
10. Financial results can be improved by reducing or eliminating discretionary
expenditures - even if this cost cutting is at the expense of long term growth and
profits.
11. Foreign financial statements do not follow GAAP. In some cases, local
accounting rules are so different from GAAP accounting rules that it is easy to
make the wrong decision after reviewing the foreign financial data.
12. Unaudited statements may be inaccurate, misleading, or even deliberately
fraudulent - and if they seem too good be true, they may be just that.
13. To see the big picture, it is necessary to have at least two consecutive periods of
financial statements for comparison. Trends will only become apparent this way.
The corollary is that it is not enough to know a customers financial weaknesses.
It is also important to know whether the customers financial performance is weak
but improving or weak and deteriorating.
14. Audited statements do not guarantee accuracy.
15. Even audited financial statements are subject to a degree of manipulation.Off
16. balance sheet financing is lawful, but can have a devastating effect on a customers
financial health.
17. The fact that a company is publicly traded and its financial statements are readily
available does not guarantee that the company in question is financially stable
and creditworthy.
A. Common Size Financial Statement Analysis

Common Size Statement involves representing the income statement figures as
a percentage of sales and representing the balance sheet figures as a percentage
of total assets. Financial statements represent absolute figures and a
comparison of absolute figures can be misleading. For example, the cost of
goods sold might have increased but as a percentage of sales it might have
decreased. So, to have a perfect understanding about these increases and
decreases, the figures reported are converted into percentages to some
common base. In Income Statement, Sales figure is assumed to be 100% and
all other figures are expressed as a percentage of sales. In Balance Sheet, the
total of assets is taken as 100% and all other figures are expressed as a
percentage of total assets. This type of Statement so prepared is called as the
Common Size Statement and the analysis performed on the Common Size
Statement is called as the Common Size Financial Statement Analysis or
otherwise called as Vertical Analysis.
2008 2009
Sales 100.00% 100.00%
Less: Cost of goods sold 71.43% 71.11%
Gross profit 28.57% 28.89%
Less: Operating expenses
General & administrative expenses 2.86% 3.33%
Selling & distribution expenses 5.71% 5.56%
Other operating expenses 1.43% 1.67%
Operating profit 18.57% 18.33%
Less: Interest expenses 4.29% 4.44%
Net income before taxes 14.29% 13.89%
Less: Taxes at 30% 4.29% 4.17%
Net Income after taxes 10.00% 9.72%
Common Size Income Statements for the years ended 31st Dec 2008 & 31st Dec 2009


2008 2009
Current Assets:
Cash 6.25% 5.17%
Accounts Receivables 25.00% 25.86%
Inventory 18.75% 21.55%
Total Current Assets 50.00% 52.59%
Fixed Assets:
Buildings 37.50% 34.48%
Furnitures & office equipments 12.50% 12.93%
Total Fixed Assets 50.00% 47.41%
Total Assets 100.00% 100.00%
Liabilities:
Current Liabilities:
Accounts Payable 12.50% 10.34%
Notes Payable 6.25% 4.31%
Interest Payable 1.25% 1.03%
Total Current Liabilities 20.00% 15.69%
Shareholder's Equity:
Common Stock 62.50% 64.66%
Retained earnings 17.50% 19.66%
Total Stockholder's equity 80.00% 84.31%
Total Liabilities &
Stockholder's equity
100.00% 100.00%

Common Size Balance Sheets as on 31st Dec 2008 & 31st Dec 2009


B. Comparative Financial Statement Analysis

Comparative Financial Statement analysis provides information to
assess the direction of change in the business. Financial
statements are presented as on a particular date for a particular
period. The financial statement Balance Sheet indicates the
financial position as at the end of an accounting period and the
financial statement Income Statement shows the operating and
non-operating results for a period. But financial managers and top
management are also interested in knowing whether the business
is moving in a favorable or an unfavourable direction. For this
purpose, figures of current year have to be compared with those of
the previous years. In analyzing this way, comparative financial
statements are prepared.
Comparative Financial Statement Analysis is also called as Horizontal
analysis. The Comparative Financial Statement provides information about
two or more years' figures as well as any increase or decrease from the
previous year's figure and it's percentage of increase or decrease. This kind
of analysis helps in identifying the major improvements and weaknesses.
For example, if net income of a particular year has decreased from its
previous year, despite an increase in sales during the year, is a matter of
serious concern. Comparative financial statement analysis in such situations
helps to find out where costs have increased which has resulted in lower net
income than the previous year.
31st Dec
2008
31st Dec
2009
Increase/
(Decrease)
% of
increase /
(decrease)
Sales $7,000 $9,000 $2,000 28.57%
Less: Cost of goods sold $5,000 $6,400 $1,400 28.00%
Gross profit $2,000 $2,600 $600 30.00%
Less: Operating expenses
General & administrative
expenses
$200 $300 $100 50.00%
Selling & distribution expenses $400 $500 $100 25.00%
Other operating expenses $100 $150 $50 50.00%
Operating profit $1,300 $1,650 $350 26.92%
Less: Interest expenses $300 $400 $100 33.33%
Net income before taxes $1,000 $1,250 $250 25.00%
Less: Taxes at 30% $300 $375 $75 25.00%
Net Income after taxes $700 $875 $175 25.00%
Comparative Income Statement for the years ended 31st Dec 2008 & 31st Dec 2009



C. Trend Analysis

Trend analysis involves the usage of past figures for comparison.
Trend percentages are calculated for some important items like
sales revenue, net income etc. Under this kind of analysis,
information for a number of years is taken up and one year, which is
usually the first year, is taken as the base year. Each item of the
base year is taken as 100 and on that base, the percentage for
other years are computed. This analysis will help in finding out the
percentage of increase or decrease in each item with respect to the
base year.
Year Sales
Trend
Percentage
Net Income
Trend
Percentage
2000 $100,000 100 $10,000 100
2001 $120,000 120 $12,500 125
2002 $160,000 160 $20,000 200
2003 $90,000 90 $8,000 80
2004 $150,000 150 $18,000 180
Solution:


Workings:

If the trend percentage 100 represents $100,000 sales, then $120,000
worth of sales would have a trend percentage of => 100/$100,000 x
$120,000 => 120.

If the trend percentage 100 represents $10,000 net income, then $8,000
worth of net income (in year 2003) will have a trend percentage of =>
100/$10,000 x $8,000 = 80 and so on.
Modes of Expression of Ratios

1. In Proportion
2. In Rate or times or coefficient
3. In percentage


Steps in ratio Analysis

1. Selection of relevant information
2. Comparison of calculated ratio
3. Interpretation and Reporting

Advantage of Ratio Analysis:

1.Forecasting
2.Managerial Control
3.Facilitates Communication
4.Measuring efficiency
5.Facilitating Investment decisions
6.Useful in measuring Financial Solvency


Classification of ratios by statements:
Balance Sheet ratios

1. Liquidity ratio
2. Current ratio
3. Proprietary ratio
4. Debt equity ratio
5. Fixed Assets ratio
6. Capital gearing ratio

Profit and Loss A/c ratio

1. GP Ratio
2. Operating Ratio
3. Operating Profit Ratio
4. Expenses Ratio
5. NP ratio
B/S and P&L ratios

1. ROI
2. Return on
Shareholders
funds
3. Stock turnover
4. Debtors turnover
5. Creditors turnover
6. FA turnover
7. EPS

Classification by users:
Ratios for Management

1. Operating Ratio
2. ROI
3. Stock Turnover
4. Debtors turnover
5. Debt equity
6. FA turnover
7. Creditors turnover
8. NP ratio
9. Short term liquidity
10. Long term Liquidity
11. Working capital
Ratios for creditors

1. Current Ratio
2. Solvency Ratio
3. Debt equity ratio
4. Creditors turnover
5. FA ratio
Ratios for Shareholders

1. RO shareholders
funds
2. Payout ratio
3. Capital gearing
4. Dividends cover
5. Dividend Yield

Classification of ratios by purpose/function
Profitability Ratios

1. ROI
2. NP ratio
3. GP ratio
4. Expenses ratio
5. Operating profit ratio
Turnover Ratios

1. Stock turnover
2. Debtors turnover
3. Creditors Turnover
4. Working capital Turnover
5. FA turnover
Solvency ratio
Short Term Solvency

1. Current ratio
2. Liquidity ratio
3. Cash position ratio
Long term Solvency

1. Proprietary ratio
2. Debt equity
3. Fixed assets ratio
4. Capital Gearing
Sales Revenue - Cost of Good Sold = Gross Profit

GP - Selling and Administrative expenses - Depreciation = EBIT

EBIT - interest expenses (on bank loans and bonds) + interest income = EBT

EBT - taxes (current and deferred) = EAT

EAT + Income from subsidiaries (equity income) +/- Gains/Losses from
discontinued operations +/- Gain/loss on extraordinary items

= Net Earnings

Net earnings - Preferred Stock Dividends

= Earnings available for common shareholders
1. Current ratio
2. Quick ratio
3. Cash ratio
4. Interval Measure
5. Net working Capital ratio
Liquidity Ratios

Liquidity ratios provide information about a firm's ability to meet its
short-term financial obligations. They are of particular interest to those
extending short-term credit to the firm. Two frequently-used liquidity
ratios are the current ratio (or working capital ratio) and the quick ratio.

The current ratio is the ratio of current assets to current liabilities:

CR = Current assets/ Current liabilities

CA = Debtors, Stocks, BR, bank and cash balances, prepaid expenses,
income received in advance

CL = Creditors, bank overdraft, BP, outstanding expenses, income
received in advance etc.

Ideal ratio: 2:1
Current Ratio:


Quick (Acid Test) Ratio:


48 . 1
5,192.00 $
7,681.00 $
s Liabilitie Current
sets Current As
: Ratio Current
1.40
000 , 107 , 1 $
00 . 391 $ 00 . 681 , 7 $
s Liabilitie Current
s Inventorie - sets Current As
: Ratio Test Acid

Liquidity Ratio Examples: Dell
Ratio Comparison: Current Ratio
0
0.5
1
1.5
2
2.5
C
u
r
r
e
n
t

R
a
t
i
o
Dell 2.08 1.66 1.45 1.72 1.48
Industry 1.80 1.80 1.90 1.60
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00
Cash ratio

Cash ratio is the most conservative liquidity ratio.
It excludes all current assets except the most liquid: cash and
cash equivalents. The cash ratio is defined as follows

Cash Position ratio: Cash and Bank balance + Marketable
securities

Current liabilities

Ideal Ratio: .75: 1

Quick Ratio or Liquid ratio

One drawback of the current ratio is that inventory may include many
items that are difficult to liquidate quickly and that have uncertain
liquidation values. The quick ratio is an alternative measure of
liquidity that does not include inventory in the current assets.


The quick ratio is defined as follows

QR = Quick Assets/ Current Liabilities

Quick Assets = CA- (stock and prepaid expenses)

Ideal ratio: 1:1

Interval ratio:

It relates to liquid assets to average daily operating cash outflows. The daily
Operating expenses will be equal to cost of goods sold plus selling, administrative
and general expenses less depreciation divided by number of days in the year.

Interval Measure = (Current Assets - Inventory)/ Average daily operating Expenses

Net Working capital Ratio:

The difference between CA and CL excluding short term bank borrowing is called
NWC

NWC = NWC/ Net assets



19X1 19X2 19X3
Current Ratio 1.24 1.25 1.20
Quick Ratio .56 .56 0.46
Cash Ratio 0.01 0.09 .02
Interval Measure 65.00 87.00 77.00
Net working Capital ratio 0.53 0.58 0.61
Hindustan Manufacturing Company Liquidity Ratios
I nventory Ratio or Activity Ratio or Performance Ratio
It highlights the operating efficiency of the business concern
Weather the investment in inventory is optimum
It refers to effective, profitable and rational use of resources available
to the concern

1. I nventory or stock turnover ratio or stock velocity ratio:

Stock turnover ratio = Cost of goods sold / Average inventory

Cost of goods sold = Sales GP

Average stock = (OS + CS)/2

Higher the ratio indicates efficient inventory Mgt and efficiency of
businesses operations.



Stock Turnover period or I nventory Turnover period or Stock velocity
Inventory Turnover period: Days or Months in the year
Inventory turnover ratio


For eg if inventory turnover is 5 times
Inventory turnover in days = 365/5 = 73 days

It conveys that on average every item of stock remains in the store
For 73 days before it is sold.

The general objective is to increase the stock velocity as much as
Possible or in effect decrease the months for which items remain in the
stock
Q. M/s Rakesh & Co. supplies you the following information for the year ending 31
st
Dec
2004: Credit Sales: Rs 150000; Cash Sales: Rs 250000; Return inwards: Rs 25000 ;
Opening Stock: Rs25000; Closing stock Rs 35000.

Find out (i) Inventory Turnover when GP ratio is 20%; (ii) Inventory Conversion Period.

1. Inventory Turnover ratio: Cost of Goods sold/ Average Stock

Cost of goods sold
Net sales: 150000 + 250000 25000 = Rs 375000
GP on sales = 375000* 20% = 75000

Cost of goods sold = Net sales GP

Rs 375000- Rs 75000
Rs 300000

Average Stock = (OS + CS)/2 = (25000 + 35000)/2 = Rs 30000

Inventory Turnover = 300000/30000 = 10 times

Inventory conversion period = 365/Inventory = 365/10 37 times
Debtors Turnover ratio or Receivables turnover Ratio or Debtors Velocity

Measures the number of times the receivables are rotated in a year in terms of sales
Indicates the efficiency of credit collection and efficiency of credit policy


Debtors Turnover = Net Credit Sales/ Average Receivables
or
Debtors Turnover = Total Sales/ Closing Debtors

Average Collection Period = Months in a year or Days in a year/ Debtors turnover

Average receivables = (OR + CR)/2


The higher the turnover ratio and shorter the average collection period, better is the
Liquidity of the debtors.

Higher ratio convey quick payment on the part of debtors.

Creditors Turnover ratio or Accounts Payable turnover Ratio or Creditiors
Velocity

Measures the number of times the payables rotate in a year.

Creditors Turnover = Net Credit Purchases/ Average accounts payable

Average Payment Period = Months in a year or Days in a year/ Creditors
turnover

Average receivables = (OP + CP)/2


The higher the turnover ratio indicates that the creditors are not paid in time.

Lower ratio indicates payment of creditors promptly

Working Capital Turnover ratio:

Effective Utilization of working capital and measure smooth
running of business

Working capital turnover Ratio: Sales/ Net Working Capital

Net Working Capital = Current assets Current liabilities

Higher ratio is the indication of lower investment of working
Capital and more profit


Fixed Assets Turnover Ratio:

Determine efficiency of utilization of fixed Assets and
profitability of a business concern

Fixed assets Turnover Ratio: Cost of Sales/ Net FA
Or
: Sales / Net FA

Net FA : Fixed Assets less Depreciation


Higher the ratio, more is the efficiency in utilization of FA
A lower ratio is the indication of under utilization of FA
Total Asset Turnover Ratio:



Inventory Turnover Ratio:

20 2
11,471.00 $
25,265.00 $
Assets Total
Sales
: Turnover Asset Total .
64.62
391.00 $
25,265.00 $
Inventory
Sales
: Turnover Inventory
Activity (Turnover) Ratio
Examples: Dell
0%
50%
100%
150%
200%
250%
300%
350%
A
s
s
e
t

T
u
r
n
o
v
e
r
Dell 2.47 2.59 2.89 2.65 2.20
Industry 2.00 2.30 1.90 2.00
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00
Ratio Comparison: Asset Turnover
Q. The following information is given about M/s S.P. ltd. for the year ending
Dec. 31,
2004

Stock turnover ratio = 6 times
Gross profit Ratio = 20% on sales
Sales for 2004 = Rs 300000
CS is Rs 10000 more than the OS
Opening creditors = Rs 20000
Closing creditors = Rs 30000
Trade debtors at the end = Rs 60000
Net working Capital = Rs 50000

Find out:
a. Average Purchases
b. Purchases
c. Creditors turnover ratio
d. Average payment period
e. Average collection period
f. Working Capital turnover ratio
Capital Turnover Ratio : Sales/ Capital Employed

Capital Employees : Shareholders funds + long term loans
Total Assets Current liabilities

Owned Capital Turnover: Sales/ Shareholders funds

Total Capital employed: Sales/ Total Capital Employed

Total Capital employed = Total Assets

Higher ratio indicates higher efficiency and lower ratio
indicates ineffective usage of capital

Leverage ratio
1. Debt Ratio
2. Debt Equity Ratio
3. Capital employed to net worth Ratio
4. Coverage ratios
Capital Employed

NFA + CA = NW + TD + CL

NFA + CA CL = NW + TD

NFA + NCA = NW + TD

NA = CE
1. Debt ratio : Total debt/ (Total debt + Net worth)

= Total debt / Capital employed

2. Debt equity Ratio: Total debts/ Net Worth

3. Capital Employed to net worth ratio: Capital employed/ net worth
Long Term Solvency ratios:

1. Fixed Assets Ratio: FA/ Long term Funds

To know the proportion of long term funds invested in Fixed Assets
The ratio should not be generally more than 1 and ideal ratio is
0.67
If Less than 1 than it is assumed that WC is financed by long term
funds.
If more than I than FA are purchased with short term funds, which is
not prudent policy

FA = FA- Depreciation

Long term funds = Share Capital + reserves and surplus + long term
loans Fictitious assets

Debt equity ratio or external internal equity ratio

Debt equity ratio : External Equities/ Internal Equities
External equities refer to total outsiders liabilities

Internal equities refers to shareholders funds or the tangible networth

Ideal ratio is 1

Debt Equity ratio: Total long term debt/ Total long term funds
or
Shareholder funds/ Total long term funds
Or
Total long term Debt/ Shareholders funds

Shareholders fund means equity, preference and Reserves
Long term debts: Debentures, bonds, mortgage, loans


Debt Ratio:
53.73%
11,471.00 $
6,163.00 $
Assets Total
s Liabilitie Total
: Ratio Debt
Leverage Ratio Examples: Dell
Ratio Comparison: Debt Ratio
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
D
e
b
t

R
a
t
i
o
Dell 54.70% 73.07% 69.70% 66.25% 53.73%
Industry 62.96% 60.00% 52.38% 62.96%
Jan-96 Jan-97 Jan-98 Jan-99 Jan-00
Proprietary ratio: Shareholders Funds/ Total Tangible Assets

It is of particular interest to the creditors of the company
A higher ratio indicates safety to the creditors and a lower ratio
shows greater risk to the creditors.

A ratio below .5 is alarming for the creditors since they have to lose
heavily in the event of Co.s liquidation as it indicates more of
creditors funds and less of shareholders funds in the total asset of
the company.
Capital gearing Ratio or Capitalization or leverage ratio

Capital Gearing ratio : Long term loans + Deb + Preference SC
Equity Shareholders Funds

If the ratio is higher, the capital gearing is said to be high and it
indicates that high Gearing is trading on thin equity and low
gearing is trading on thick equity

Highly geared capital structure is the indication for under
capitalization which means that amount of capital is
disproportionate to the needs measured by the volume of
Activities.
Debt Service Ratio:

Also know as Interest coverage ratio. It is calculated to ascertain the capacity of
the firm to pay interest on its profits before interest and tax.

Debt service ratio: NP before interest and tax/ Fixed Interest charge

Higher this ratio, the better it is for the firm as well as for the lender. A high ratio means
That the firm will be able to pay interest out of profits comfortably.
Return on proprietors fund:

This is also called as return to shareholder funds or return on shareholders investment

Proprietors fund includes equity share capital, Pref SC, all the reserves less all
Those preliminary expenses not yet written off

Return on proprietors funds = NP after interest and tax/ proprietors funds * 100


Return on equity Capital

As pref shareholder enjoy pref performance of company is judged by equity SC

Return on equity Capital = NP after tax Pref dividend/ (Paid up equity share capital)


Return on shareholders total equity

Total equity includes SC + reserves & surplus

Return on shareholders total equity = NP after tax and pref dividend/ Sh. total equity


Profitability ratio:

1. Gross profit ratio or Gross margin or Trading margin ratio

: GP/ Net Sales * 100

Higher ratio is preferable indicating higher profitability

a. Increase in selling price without change in the cost of goods sold
b. Decrease in cost of Goods sold with selling price remaining constant
c. Increase in sales mix, the proportion of products with higher gross profit
margin


2. Operating ratio: Cost of goods sold, administrative expenses and selling
and Distribution expenses/ net Sales
or

Cost of sales + operating expenses/ Sales
Cost of sales: Sales GP

Operating Expenses; Administrative expenses and other expenses

Operating ratio indicates the amount of expenditure incurred in production,
Sales and distribution of output.

It indicates operational efficiency of the firm

Lower the ratio more is the efficiency.
Operating Profit Ratio: Operating profit/ net Sales

Operating Profit = GP operating expenses

Operating profit = NP + non operating expenses non operating
incomes
1. Dividend Yield ratio:

Dividend per equity Share/ Market value per share

To know dividend per share paid and the market value of the share

2. Dividend per Share:

Dividend Paid to Shareholders/ No. of Shares


3. Dividend Pay out Ratio:

Dividend per equity share/ EPS

To know the extend to which earning per share has been retained in
the business
Q1. Compute the Pay Out Ratio and the retained earnings ratio
from the following Data:

No. of equity shares: 3000
Dividends per equity share: Rs 0.40
Net Profit: Rs 10000
Provision for tax Rs 5000
Preference Dividend Rs 2000

EPS : (10000 5000 2000)/ 3000 Re. 1.00

Pay out ratio = .40/1 *100 40%

Retained earning ratio = 100- payout ratio
= 100 40% = 60%
3. Price earning ratio or P/E ratio (Earning Yield Ratio)

Price earning ratio = Market price per equity share/ Earning per share

Generally, higher the price earning ratio, the better it is.
If the P/E ratio falls, the management should look into the causes

4. Earning Yield ratio:

Earning yield ratio: Earning per share/ MP per equity share * 100


DU PONT ANALYSIS
To Be Successful, a business must manage its:
Operating Profits
Level of Assets
Amount of Debt


FIVE KEY FINANCIAL RATIOS
Profit Margin (PM)
Total Asset Turnover (TAT)
Equity Multiplier (EM)
Return on Investment (ROI)
Return on Equity (ROE)

1. PROFIT MARGIN (PM)
Profit Margin (PM) = Net Income / Sales or TR
Positive if: Positive and Rising Over Time

2. TOTAL ASSET TURNOVER (TAT)
Total Asset Turnover (TAT) = Sales (or Total Revenue) / Total Assets
Positive if: Rising Over Time Varies by Industry (Need Industry Average) Most
Manufacturing Firms at 1X to 2X

3. EQUITY MULTIPLIER (EM)
Equity Multiplier (EM) = Total Assets / Total Equity
Positive if: Does not rise over time Is between 2X or 3X Is less than 3X

4. RETURN ON INVESTMENT (ROI)
Return on Investment (ROI) = PM x TAT OR ROI = Net Income / Total Assets

5. RETURN ON EQUITY (ROE)
Return on Equity (ROE) = PM x TAT x EM
= ROI x EM
= Net Income / Total Equity

SUMMARY OF DUPONT


FORMULA
Firm Has Strong ROE If:
Strong Operating Management (High PM)
Strong Asset Management (High TAT)
Strong Capital Structure (Appropriately low EM)



Du Pont Analysis is an expression which breaks ROE into three
parts.

ROE = (Profit Margin) * (asset Turnover) * (Equity Multiplier)
= (NP/sales) * (Sales/Assets) * (Assets/Equity)

Operating Efficiency (measured by profit margin)
Asset use efficiency (measured by asset turnover)
Financial leverage (measured by equity multiplier)

Du point ratio = Profit Margin/ Capital Employed * 100



The ROE financial ratio is a key measure of financial health. But to non-financial
managers, the ROE can be difficult to understand, for two reasons.

One reason is that slightly over-simplified, your ROE compares directly with your
growth rate in sales. If you grow faster than your ROE, you weaken your financial
structure; if you grow more slowly than your ROE, you strengthen your financial
structure.

The other reason that using ROE can be difficult is that it is a top-level ratio that is
affected by virtually every other measure of financial performance.

This report is based on the DuPont Chart, because the DuPont Corporation relied
on the underlying formula, and promoted it since 1991. The formula that this chart
relies on therefore became know as the DuPont formula.

DU PONT CHART
Return on investment
(NP/ Capital Employed *100)


Profit Asset/ Investment
Turnover
Operating
profit
Sales
/
(Sales- Operating Expenses)
Cost of Goods Sold + office & Administrative expenses
Selling+ Distributive exp
Investment
Fixed Assets + Working Capital
Current Assets - Current Liabilities
Sales
/
Q. Prepare a balance sheet with as many details as possible from the following
information

GP Ratio 20%
Debtors Turnover 6 times
Fixed Asset to net worth 0.80
Reserves to capital 0.50
Current ratio 2.50
Liquid ratio 1.50
Net working capital Rs 300000
Stock turnover ratio 6 times



Liabilities Rs Assets
Capital 10,00,000 Fixed Assets 12,00,000
Reserve and Surplus 5,00,000 Current Assets
Net Worth 2,00,000 Closing Stock 2,00,000
Debtors 2,50,000
Other Liquid Assets 50,000
17,00,000 17,00,000
1. Calculation of Current Assets and Liabilities:

CR = CA/CL = 2.5/1

CA = 2.5 CL

Working Capital = CA - CL = 2.5 - 1 = 1.5

WC = 300000 = 1.5
CA = 300000 *2.5/1.5 = Rs 500000

CL = 300000*1/1.5 = Rs 200000

2. Calculation of liquid assets and stock

Liquid ratio = Liquid assets/ current liabilities = LA/ 200000
LA = 200000* 1.5 = Rs 300000
LA = Current Assets Stock = 500000- 300000 = Rs 200000

3. Calculation of Debtors:

Stock turnover ratio = 6 times

Stock turnover ratio = Cost of goods sold/ Average Stock

6 = Cost of goods sold/ 200000
Cost of goods sold = 200000 * 6
= Rs 1200000


GP ratio given 20%
When sales = 100, GP = 20; Cost of goods sold = 80

Sales = Cost of goods sold *100/80 = Rs 15,00,000

Debtors Turnover = Credit sales/ Average receivables

6 = 15,00,000/Average Receivables

Average Receivables = Rs 250000
4. Other Liquid Assets

Liquid Assets 3,00,000
Less Debtors 2,50,000
Other liquid assets 50,000

5. Calculation of Fixed Assets and Net Worth

FA/Net Worth = .80
Net worth + current liabilities = FA + CA
X + 2,00,000 = .8X + 5,00,000
X ( Net worth) = Rs 15,00,000
Fixed Assets = 15,00,000* .8
= Rs 12,00,000

6. Calculation of capital and reserves

Reserves to capital given = .50/1

If capital is 1, reserves are .50
Therefore net worth = 1.5 = 15,00,000

Capital = 15,00,000/1.5 = Rs 10,00,000

Reserves = 15,00,000* .5/1.5 = Rs 5,00,000
Q Assume that a firm has owners, equity of Rs 1,00,000. The ratios for the firm are:

Current debt to total debt .40
Total Debt to owners equity .60
Fixed assets to owners equity .60
Total assets turnover 2 times
Inventory turnover 8 times

Complete the following b/s, given the information below:

Liabilities Assets

Current debt Cash
Long term debt Inventory
Total debt XXXX Total CA XXXX
Owners equity FA
Total Capital XXXX Total Assets XXXX

1. Total debt to owners equity = .60 = Total debt/owner equity
.60 = Total debt/ 1,00,000
Total debt = Rs 60,000

2. FA to owners equity = .60 = FA/owner equity
Fixed Assets = Rs 60000

3. Total Capital = Total debt + owners equity
Rs 60000 + Rs 1,00,000 = Rs 1,60,000

4. Assets = Liabilities + capital
Assets = Rs 1,60,000

Assets = FA + CA
1,60,000 = 60,000+ CA
Current Asset = Rs 1,00,000

5. Assets Turnover = Sales/Assets = 2
Sales = 1,60,000 * 2 = Rs 3,20,000

6. Inventory Turnover = Sales/Inventory = 8
Inventory = 320000/8 = Rs 40,000
Cash = CA Inventory
Rs 1,00,000 Rs 40,000 = Rs 60,000

Current Debt = .40* total debt = .40 * 60000 = Rs 24,000

Long term debt = Total debt current debt = 60000-24000 = Rs 36000


Liabilities Assets

Current debt 24,000 Cash 60000
Long term debt 36,000 Inventory 40000
Total debt 60000 Total CA 100000

Owners equity 1,00,000 Fixed Assets 60,000

Total equity 1,60,000 Total Assets 160000

Given the following information for ABC Company at the end of 2004
determine balances for the Income statement and the balance sheet: (3
marks)
Net sales Rs 1,00,000
Debtors turnover ratio based on net sales 2 times
Inventory Turnover ratio 1.25 times
Fixed assets Turnover ratio 0.8
Debt assets ratio 0.6
Net Profit Margin 5%
GP Margin 25%
Return on investment 2%

ABC Company
Income Statement (for the year ending dec31, 2004)
Sales Rs 1,00,000
Cost of Goods Sold
GP
Other expenses .
Earning before tax .
Taxes@ 50% .
Earning after tax ..
Balance sheet (as on 31st Dec. 2004)

Liabilities Assets


Equity Net Fixed assets .
Long Term debt .. Inventory
Short Term debt 50000 Debtors .
Cash

Total
1. GP = 25% = GP/1,00,000 = Rs 25000

2. Cost of Goods sold = Sales GP
= 1,00,000 25,000 = Rs 75,000

NP = Rs 1,00,000* 5% = Rs 5,000

NP before Tax = NP + Tax (50%) = Rs 5,000 + (Rs 5,000 tax)
= Rs 10,000

Expenses = Rs 25,000 Rs 10,000 = Rs 15,000

Debtors turnover = Net sales/ Debtors
2 = 1,00,000/debtors = Rs 50,000

Inventory Turnover Ratio = Cost of Goods sold/ Inventory
Inventory = 75,000/1.25 = Rs 60,000

FA turnover ratio = Sales/FA
FA = 1,00,000/.8 = Rs1,25,000

ROI = Earning after tax/Total assets
Total assets = 5000*100/2 = Rs2,50,000
Debt Assets Ratio: Total debt/ Total Assets
0.6 = Total Debt/ 2,50,000 = Rs1,50,000

Long Term Debt = Total Debt Short term debt
= Rs 1,50,000 Rs 50,000 = Rs1,00,000

Equity = Total Assets Total Debt
= Rs 2,50,000 Rs 1,50,000 = Rs1,00,000


Balance Sheet

Liabilities Assets
Equity 1,00,000 Net FA 1,25,000
Long Term Debt 1,00,000 Inventory 60,000
Short Term Debt 50,000 Debtors 50,000
Cash (Bal. Fig) 15,000

2,50,000 2,50,000


ABC Company
Income Statement (For the year ending 31
st
Dec 2004)

Sales 1,00,000
Cost of goods sold 75,000
G.P. 25,000
Expenses 15,000
Earning before tax 10,000
Tax @ 50% 5,000
Earning after Tax 5,000
Q2. From the following information of a textile company, complete the
proforma balance sheet if it sales are Rs 32,00,000
(3 marks)
Sales to networth 2.3 times
Current Debt to networth 42%
Total debt to networth 75%
Current ratio 2.9 times
Net sales to inventory 4.7 times
Average collection period 64 days
FA to networth 53.2%


Performa Balance Sheet


Net worth Fixed Assets
Long Term Debt .. Cash
Current Debt Stock debtors
Sundry Debtors
Total
.

1. Sales Rs 32,00,000
Sales to networth = 2.3 times

Net worth = 32,00,000/2.3 = Rs13,91,304

2. Current debt to net worth = 42%
Current debt = 13,91,304 *42/100
= 5, 84,348

3. Total debt to net worth = 75%
Total debt = 13,91,304 * 75/100
Rs 10,43,478

4. Long term Debt = Total debt current debt
= 10,43,478 584348
= 4,59,130

5 FA to networth = 53.2%
FA = 13,91,304*53.2/100
= Rs 7,40,174

CR = CA/CL
2.9 = Current Assets/5,84,348
= Rs 16,94,609
CA = 16,94,609

Net sales to Inventory = Net sales/Inventory

4.7 = 32,00,000/Inventory
Inventory = Rs 6, 80,851

Average collection period = Debtors/ Sales per day

64 = Debtors/32,00,000* 365

Debtors = Rs 5,61,096

Cash = Total Assets Stock = Debtors
Cash = Rs 4,52,662