Agenda
➢ An overview of financial statements
➢ Balance sheet
➢ Income statement or Profit & Loss statement
➢ Cash flow statement - Interpretations
➢ Financial Statement Analysis
➢ Common sizing or vertical analysis
➢ Horizontal analysis
Traditional Balance sheet at a
point in time
Assets Liabilities
Current
Current Assets Liabilities
Long term debt
Fixed Assets
1. Tangible FA
2. Intangible FA Shareholders’
equity
Assets = Liabilities + Shareholder’s equity
Information in a Balance sheet
Balance sheet is an accountant’s snapshot of a firm’s accounting value
on a particular date.
❑ What are the company’s existing assets?
Asset size will depend on the nature of the business and how management
chooses to conduct it.
Management makes decisions about
➢ Cash versus marketable securities
➢ Credit versus Cash sales
❑ What are the company’s existing obligations?
Management makes decisions about raising capital, retaining profits
What are the limitations of balance sheet?
Financial View of the firm
*Reference book : Applied Corporate Finance by A.Damodaran. Courtesy:A.Damodaran
Income Statement for a period
Revenues
Less Cost of goods sold
Equals Gross Profit
Less Operating expenses (excluding depreciation and
amortization expense)
Equals Earnings before interest, tax, depreciation and amortization
(EBITDA)
Less Depreciation and amortization (DA)
Equals Earnings before interest and taxes (EBIT)
Less Interest expense
Equals Earnings before taxes (EBT)
Less Taxes
Equals Net Income (NI)
Information in an Income
statement
❑ What is the top line? – Sales revenue
❑ What is the bottom line? – Net Profit
❑ What are the expenses?
❑ What is operating profit?
Cash flow Statement for a
period
Cash flow
from
Investing
Activities
Cash
Flow
Statement
Cash flow Cash flow
from from
Operating Financing
Activities Activties
Cash flow Statement for a
period
❑ Cash flow from Operating activities:
➢ Cash flow generated by business activities (incl. sales of goods
and services)
➢ Tax payments
❑ Cash flow from Investing activities :
➢ Investment gains or losses
➢ Amounts spent on investments in capital assets, such as plant
and equipment, etc.
❑ Cash flow from Financing activities:
➢ Cash flows to and from creditors and owners
Interpretation : Cash flow
statement
Interpretation : Cash flow
statement
Question 1
You are an intern with an Investment Banking firm.
You have been given the task to assess the private
company ABC Corp. You have been provided the
Balance Sheet for the last three years’ ending, Profit &
Loss statement for last three periods and Cash flow
statement. You wanted to get an idea of profit margins,
y-o-y sales growth rates ,etc.
Perform common sizing and horizontal analysis
Ratio analysis
Long - term
Short - term
solvency or
solvency or
financial
liquidity ratios
leverage ratios
Asset Profitability
management or
turnover ratios ratios
Market value
ratios
Short-term solvency or Liquidity ratios
Intended to provide information about firm’s liquidity - the firm’s
ability to pay bills over the short run without undue stress. The
companys’ ability to meet the current obligations using its cash and
current assets.
➢ Current Ratio : higher the ratio, more protection against liquidity
problems.
➢ Quick (or acid test) Ratio: ratio of near cash of liquid assets to
meet current liabilities
➢ Cash Ratio
Long-term solvency or Financial
leverage ratios
Intended to provide information about firm’s long run ability to meet
financial obligations
➢ Debt to Asset & Debt to Equity Ratio & Equity multiplier
➢ Times Interest earned or interest coverage ratio : how operating
profits cover interest payments
➢ Cash coverage ratio: EBITDA/Interest expense
Asset Management or Turnover
measures
Intended to provide information about firm’s efficiency with which
it uses its assets
➢ Inventory turnover : how fast inventory items move through a business.
365/Inventory turnover : Average length of time items spent in inventory
➢ Receivables turnover : It gives information about credit policy of the company
(an average collection period can be calculated by dividing this measure by 365)
Higher the average collection period, would indicate credit management
problems
➢ Total Assets turnover : how efficient is the investment in assets is used to
generate sales
Profitability ratios
Intended to measure how efficiently the firm manages its operations.
➢ Profit Margin: Total operating and financial ability of
management
➢ EBITDA Margin: Operating ability of management
➢ Return on Assets (or ROA): How well they have managed their
resources
➢ Return on Equity (or ROE): Measures return on ownership
capital
ROA = EBIT/Total assets
Market value ratios
Intended to measure the market values
➢ Price to Earnings ratio: The PE ratio measures the money
that investors are willing to pay for every rupee a company
earns. It is a metric used for valuing the firm’s equity as it
takes into account the residual earning available to equity
shareholders. It is an equity multiple
➢ EV/EBITDA ratio: a firm multiple.
https://economictimes.indiatimes.com/find-out-why-ev/ebitda-is-better-than-price-to-
earnings-ratio/articleshow/28998400.cms?from=mdr
DuPont analysis
Asset / Equity = (Liab + shareholder’s
equity)/shareholder’s equity =
(Liab/equity )+1
Question on DuPont analysis
Parameter ABC Ltd.
Sales revenue 5000
EBIT 550
Net Profit 250
Total Assets 6000
Shareholder’s equity 2000
Calculate the ROE (Return on equity) for ABC Ltd.
Is there a relationship between ROE and Operating efficiency, Asset
use efficiency, and Financial Leverage?
Thank you!
