Financial Statement Analysis Methods and Examples

Financial Statement Analysis Martyna Miko ajek M.Sc. Management Financial Facility Institute of Economic Sciences

Office hours E-mail: martyna.mikolajek@uwr.edu.pl Room:106C Tuesday: 17:00-19:00

Recommended reading FridsonM., Alvarez F., Financial Statement Analysis: A Practitioner's Guide, John Wiley & Sons, Inc., New York, 2002. KarwowskiM., Accounting and financial reporting, Warsaw School of Economics, 2015. Lecture s presentations

Preliminary (initial index) analysis

Methods and problems of preliminary (initial index) analysis Initial index analysis is aimed at examining the problem's persistence; there may be a problem of excess information, then the analysis is to help you choose all the information necessary to solve the problem formulation of hypotheses and drawing conclusions for further investigation Identification of factors, i.e. determining which of the reports' positions affect the problem diagnosed earlier

Verticalanalysis Otherwise, structure analysis It defines what part of a certain consolidated financial amount is a given item in the financial statements Structure ratio = (the value of the i-th item entering the aggregate) / (the aggregate for the i-th item)

Verticalanalysis Two possible versions general version useful in comprehensive analysis then the interest in the analytics is focused on all aspects of the company's operations detailed version useful when a specific component of reports is analyzed a given item has little expressive interpretation in the general version

Verticalanalysis -example Item Amount Fix asset 682,4 1. Intagibleassetsa 1,1 2. Business assets 663,5 3. Long-term investments 13,8 4. Accruals 4,0 Current assets 375,3 1. Supplies 113,5 2. Receivables 147,3 3. Short-term investments 84,5 4. Short-term prepayments 30,0 Total 1057,7

Verticalanalysis -example Item Amount Structure indicator (%) Fix asset 682,4 64,50 1. Intagibleassetsa 1,1 0,10 2. Business assets 663,5 62,70 3. Long-term investments 13,8 1.30 4. Accruals 4,0 0,38 Current assets 375,3 35,55 1. Supplies 113,5 10,73 2. Receivables 147,3 13,93 3. Short-term investments 84,5 7,99 4. Short-term prepayments 30,0 2,90 Total 1057,7 100,00

Horizontal analysis Otherwise time analysis It studies the change of the i-th position in time Includes dynamics or incremental analysis for a fixed or variable base Dynamics for a fixed base The dynamics of the i-thposition according to the fixed base = (value of the i-thposition in the period w) / (value of the i-thposition from the base period) Dynamics for the base variable The dynamics of the i-thposition according to the variable base = (value of the i-thposition in the period w) / (the value of the i-thposition in the period w-1)

Horizontal analysis An increase for a fixed base The increment of the i-thposition according to the fixed base = (the value of the i-th position in the period w -the value of the i-thposition from the base period) / (the value of the i-thposition from the base period) Increment for the base variable The increment of the i-thposition according to the variable base = (the value of the i-th position in the period w -the value of the i-thposition in the period w-1) / (the value of the i-thposition in the period w-1)

Horizontal analysis The value of the dynamics indicator determines the direction of changes in the following way if it is higher than 100% (1.0) then the given value from period to period increases if it is equal to 100% (1.0) then the given quantity does not change if it is less than 100% (1.0) then the given size decreases interpetationsdepend on the examined size The value of the dynamics index expresses the strength of change (intensity) of a given item of the statement

Horizontal analysis The value of the increment index determines the direction of changes as follows if it is higher than zero, then the given value from period to period increases if it is equal to zero then the given quantity does not change if it is less than zero then the given size decreases the interpretation depends on the size being tested The value of the increment index expresses the strength of change (intensity) of a given item of the report

Horizontal analysis We use it in practice for longer periods, dynamics based on a fixed base are used for shorter periods, the dynamics are used according to the variable base or the increment according to the variable base In practice, the use of growth according to a fixed base is practically not practiced

Ratio analysis

Ratio analysis - advantages characterizes various aspects of the company's business operations Allows you to evaluate your financial condition allows you to study trends and progression over at least 3 years creates a chance of comparison with industry-average indicators can explain the decrease in profit and the potential threat

Ratio analysis - disadvantages The figures included in the reports are the result of approximations, estimates, interpretations and judgments The author of the accounting data is the company's management board, and the auditor checks the data received from the company Financial statements present the past, so the analysis is based on historical data

Ratio analysis -Classification of rates Liquidity ratios Debt indicators Performance indicators Profitability ratios Market value indicators

Liquidity ratios Current liquidity indicator Current assets Current liabilities The indicator determines the company's ability to cover its expenses at all times (timely settlement of obligations) It informs how many times the current assets cover the current liabilities of the company The norm of the liquidity ratio is the range 1.2 -2.0. This means that the value of current assets should be about twice as large as current liabilities

Liquidity ratios Fast liqudity rate Current assets -inventories Current liabilities The fast liquidity ratio shows the coverage of short-term liabilities (the most liquid ones) with highly liquid assets. This ratio is more accurate than the current liquidity ratio A range from 1.0 to 1.3 is considered satisfactory

Liquidity ratios Increased liquidity ratio Current assets -inventories - receivables Current liabilities It defines the company's ability to pay its current liabilities taking into account the most liquid assets, whose ability to settle liabilities is immediate or almost instantaneous

Debt indicators Debt rate Total liabilities Total assets The ratio informs how many zlotys of current and potential liabilities fall on total assets or what percentage of liabilities is indebtedness It illustrates the financing structure of an enterprise's assets It should belong to the range of 57 to 67 percent. The higher its level, the higher the level of debt and higher financial risk

Debt indicators The debt ratio in equity Stockholders equity Total liabilities The ratio informs how many zlotys of current and potential liabilities are attributable to equity or what percentage of equity is indebtedness It illustrates the financing structure of an enterprise's assets It should belong to the range of 30 to 40 percent

Debt indicators Repayment capability Profit before tax (EBT) Interest It expresses the ability to pay interest on time It should belong to the range of 50 - 60 percent

Debt indicators Financial leverage ratio Assets Equity capital The higher the value of this indicator, the higher the degree of using external capital and the more risk is encumbered with activity

Performance indicators Receivablescycle Receivables from recipients * 365 days Net sales The indicator determines the number of days during which payment is made. It is therefore information about the extent to which the company credits its recipients and the length of the cash freeze Too long payment period is evidence of ineffective policy of debt collection Too low its level may mean too strict a credit policy towards the recipients In many industries, the value of the indicator is around two months

Performance indicators Stock rotation Stocks * 365 days Net sales It determines how many days the company renews its inventory to achieve sales at a certain level High value informs about the free circulation of stocks and is unfavorable, because it may disrupt the liquidity of production A low value of the indicator is desirable and helps increase the company's profit There are no universal standards for this indicator

Performance indicators Asset rotation Net sales Total assets The indicator assumes lower values for industries with high capital intensity, and higher for industries with low capital-intensive activities and a large share of human labor Its level informs about the total assets turnover or value of sales obtained to one zloty involved in fixed and current assets The higher the value of this indicator, the higher the asset productivity

Rotation of current assets Net sales Assets This indicator shows the turnover rate of current assets The higher the value, the production cycle is shorter or the higher the profitability of the sale of a given product The value of the indicator differs significantly from one another among the industries and it should be considered by examining the dynamics of changes or comparing to companies within the industry

Profitability ratios Net profit margin Net profit Net income from sales The high value of this indicator indicates a large possibility of generating profit by the company and, indirectly, good financial condition The value of this indicator predominantly determines whether the company can be described as profitable or not

Profitability ratios Gross profit margin Gross profit Net sales income The main feature of this indicator is taking into account the whole achieved profits and independence from the tax rate Its value is also influenced by occasional factors, such as income from financial activities or extraordinary gains and losses

Profitability ratios Return on assets Net profit Total assets The property profitability ratio describes the profitability of all company assets This indicator can be treated as an assessment of the efficiency of the management of companies, comparing them with each other: how much profit is able to generate management, with assets of a given value In the case of high profits, the low value of this indicator informs about the inefficient use of the company's assets The rate of return on assets should be higher than the rate of interest paid by the company on loans drawn

Profitability ratios Return on equity Net profit Equity capital The assessment of this indicator is not possible in isolation from other financial values of the company Its low, though positive, value may be caused by poor profitability, but also by low indebtedness of companies Thus, its values should be interpreted at least in comparison with the company's indebtedness

Market value indicators Market value indicator to the book value Share price Book value of shares This indicator gives an indication of how investors evaluate a given company The market price should be higher than the book value, because the former is based on current prices

Market value indicators Earnings per share Net profit Number of shares issued Profit (net) per share should be positive

Market value indicators Price to profit indicator Share price Net profit per share Profit (net) per share should be positive