Financial Statement Analysis

Financial statement analysis can be described as the analysis of the balance sheet, profit and loss statements, cash flows and statements of equity of a business in order to understand the risk and profitability of the undertaking, and quantify the past, current and prospective performance of a business. It is a very valuable tool to a business for several reasons.  It helps investors and other users of information gain an understanding of what’s going on with the business and analyze its performance over a specific time period, and helps them in making important decisions. It can help identify strengths and weaknesses in a business in order to form recommendations and forecasts.

Performing financial statement analysis does not only require the use of ratios and comparing data. Other relevant factors in the operations, the industry and the economy should also be considered in making the analysis.

An in depth financial statement analysis can be horizontal analysis or vertical analysis. Horizontal analysis includes comparison of financial statement of different periods and focuses on trends in the financial statements over time, whereas vertical analysis is performed by looking into the results within the same period and making each amount a percentage of a selected relevant denominator.

Financial statement analysis involves the use of financial ratios. I’m sharing below the common ratios useful when analyzing a Company’s financial statements.

Liquidity Ratios  – These ratios analyze the ability to pay off current liabilities as they fall due.

Current Ratio = Current Assets / Current Liabilities

Quick Ratio = Quick Assets / Current Liabilities

Quick Assets = Current Assets – Inventories

Net Working Capital Ratio = Net Working capital / Total Assets

Net Working Capital = Current Assets – Current Liabilities

 

Profitability Analysis Ratios   – These ratios show a company’s overall efficiency and performance.

Return on Assets (ROA) = Net Income / Average Total Assets

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Return on Equity (ROE) = Net Income / Average Stockholders’ Equity

Average Stockholders’ Equity  = (Beginning Stockholders’ Equity + Ending                                                                                                Stockholders’ Equity) / 2

Return on Common Equity (ROCE) = Net Income / Average common Stockholders’ Equity

Average Common Stockholders’ Equity = (Beginning Common Stockholders’                                                                       Equity + Ending Common Stockholders’ Equity) / 2

Profit Margin = Net Income / Sales

Earnings Per Share (EPS) = Net Income / Number of Common Shares Outstanding

 

Activity Analysis Ratios   – These ratios gauge the efficiency of the business practices and measures ability to convert assets into cash.

Assets Turnover Ratio = Sales / Average Total Assets

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Accounts Receivable Turnover Ratio = Sales/ Average Accounts Receivable

Average Accounts Receivable = (Beginning Accounts Receivable + Ending                                                                              Accounts Receivable) / 2

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventories

Average Inventories = (Beginning Inventories + Ending Inventories) / 2

 

Capital Structure Analysis Ratios  

Debt to Equity Ratio = Total Liabilities / Total Stockholders’ Equity

Interest Coverage Ratio = Income Before Interest and Income Tax Expenses/ Interest                                                                                      Expense

Income Before Interest and Income Tax Expenses  = Income Before Income Taxes +                                                                                                                       Interest Expense

 

Capital Market Analysis Ratios  

Price Earnings (PE) Ratio =  Market Price of Common Stock Per Share / Earnings Per Share

Market to Book Ratio = Market Price of Common Stock Per Share / Book Value of Equity                                                               Per Common Share

Book Value of Equity Per Common Share = Book Value of Equity for Common Stock /                                                                                                   Number of Common Shares

Dividend Yield = Annual Dividends Per Common Share / Market Price of Common Stock                                               Per Share

Book Value of Equity Per Common Share = Book Value of Equity for Common Stock /                                                                                               Number of Common Shares

Dividend Payout Ratio = Cash Dividends/ Net Income