microsoft powerpoint - how to read financial statements

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How to Read Financial

Statements

How to Read Financial

Statements

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Presented byPresented by

M. M. HasanHasan MahmudMahmudDirectorDirector

Securities and Exchange CommissionSecurities and Exchange CommissionJibanJiban BimaBima Tower (16Tower (16thth Floor)Floor)10, 10, DilkushaDilkusha C/A, DhakaC/A, Dhaka--10001000

Tel: 7160428, 9568101Tel: 7160428, 9568101--02, Fax: 956372102, Fax: 9563721

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What is Financial Statements ?What is Financial Statements ?Financial statements :Financial statements :a structured financial representation of the financial position a structured financial representation of the financial position of of and the transactions undertaken by an enterprise. and the transactions undertaken by an enterprise. A complete set of financial statements includes: A complete set of financial statements includes:

a)a) Balance sheet Balance sheet -- (Estimates the firm’s worth on a given date; (Estimates the firm’s worth on a given date; built on the accounting equation: built on the accounting equation:

Assets = Liabilities + Owner’s Equity) ;Assets = Liabilities + Owner’s Equity) ;b)b) Income statement Income statement –– (Compares the firm’s expenses against its (Compares the firm’s expenses against its

revenue over a period of time to show its net profit (or loss):revenue over a period of time to show its net profit (or loss):Net Profit = Sales Revenue Net Profit = Sales Revenue -- Expenses);Expenses);

c)c) A statement showing changes in equity;A statement showing changes in equity;d)d) Cash flow statementCash flow statement--(Shows the change in the firm’s working (Shows the change in the firm’s working

capital over a period of time by listing the capital over a period of time by listing the sourcessources of funds of funds and the and the usesuses of these funds); andof these funds); and

e)e) Accounting policies and explanatory notes.Accounting policies and explanatory notes.

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Objectives of Financial Statements:Objectives of Financial Statements:

To provide information about the To provide information about the financial position, performance and financial position, performance and cash flows of an enterprise that is cash flows of an enterprise that is useful to a wide range of users in useful to a wide range of users in making economic decisions; making economic decisions; To show the results of management’s To show the results of management’s stewardship of the resources entrusted stewardship of the resources entrusted to it.to it.

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Reading a financial statement:Reading a financial statement:

The basic techniques to extract information from The basic techniques to extract information from financial statements are:financial statements are:Examination of comparative financial statements; Examination of comparative financial statements; and and Ratio analysis.Ratio analysis.Both techniques are based on:Both techniques are based on:Comparison of performance of period with Comparison of performance of period with another period; or another period; or Comparison of performance of one business with Comparison of performance of one business with that of similar business, in either current or past that of similar business, in either current or past period.period.

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Examination of comparative Examination of comparative financial statements:financial statements:

Comparative financial statements are sideComparative financial statements are side--byby--side side presentations of consecutive financial statements of presentations of consecutive financial statements of the same type (balance sheets, income statements, the same type (balance sheets, income statements, and so forth). and so forth).

They permit periodThey permit period--toto--period comparisons of period comparisons of important accounts and account groups. important accounts and account groups.

Thus they help statement users to identify the Thus they help statement users to identify the causes of changes in a business’ future profitability causes of changes in a business’ future profitability and financial position. and financial position.

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Ratio Analysis:Ratio Analysis:Ratio is the relationship between two or more Ratio is the relationship between two or more things. things. In financial analysis, a ratio is used as a benchmark In financial analysis, a ratio is used as a benchmark for evaluating the financial position and for evaluating the financial position and performance of a firm. performance of a firm. Ratio analysis is an examination of financial Ratio analysis is an examination of financial statements conducted by preparing and evaluating statements conducted by preparing and evaluating a series of ratios. a series of ratios. Ratios (or financial ratios), like other financial Ratios (or financial ratios), like other financial analysis data, normally provide meaningful analysis data, normally provide meaningful information only when compared with ratios for information only when compared with ratios for the same firm (using previous statements) or the same firm (using previous statements) or similar firms.similar firms.

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Ratio Analysis:Ratio Analysis:(Contd.)(Contd.)

Liquidity RatiosLiquidity Ratios -- Tell whether or not the business will be able Tell whether or not the business will be able to meet its maturing obligations as they come due.to meet its maturing obligations as they come due.

1. 1. Current RatioCurrent Ratio -- Measures solvency by showing the firm's Measures solvency by showing the firm's ability to pay current liabilities out of current assets.ability to pay current liabilities out of current assets.Calculation:Calculation:Current Ratio = Current Ratio = Current Assets Current Assets = = Tk.686,985Tk.686,985 = 1.87:1= 1.87:1

Current Liabilities Tk.367,850Current Liabilities Tk.367,850Suppose Industry Average Current ratio = 1.50:1Suppose Industry Average Current ratio = 1.50:1Interpretation: Interpretation: Although the company’s Current Ratio falls short of the rule Although the company’s Current Ratio falls short of the rule of thumb of 2:1, its current ratio is above the industry averageof thumb of 2:1, its current ratio is above the industry averageby a significant amount. The company should have no by a significant amount. The company should have no problem meeting shortproblem meeting short--term debts as they come due.term debts as they come due.

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2. 2. Quick RatioQuick Ratio -- Shows the extent to which the firm’s most Shows the extent to which the firm’s most liquid assets cover its current liabilities.liquid assets cover its current liabilities.Calculation:Calculation:Quick Ratio = Quick Ratio = Quick Assets Quick Assets = = TkTk. 231,530. 231,530 = .63:1= .63:1

Current Liabilities Tk.367,850Current Liabilities Tk.367,850Suppose Industry Average Quick Ratio = 0.50:1Suppose Industry Average Quick Ratio = 0.50:1Interpretation:Interpretation:Again, the company’s Quick Ratio is below the rule of Again, the company’s Quick Ratio is below the rule of thumb of 1:1, but the company passes this test of liquidity thumb of 1:1, but the company passes this test of liquidity when measured against industry standards. The company when measured against industry standards. The company relies on selling inventory to satisfy shortrelies on selling inventory to satisfy short--term debt . If term debt . If sales slump, the result could be liquidity problems for the sales slump, the result could be liquidity problems for the company. company.

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Leverage RatiosLeverage Ratios -- Measure the financing provided by the Measure the financing provided by the firm’s owners against that supplied by its creditors; a gauge firm’s owners against that supplied by its creditors; a gauge of the depth of the company’s debt.of the depth of the company’s debt.

1.1. Debt RatioDebt Ratio -- Measures the percentage of total assets financed Measures the percentage of total assets financed by creditors rather than owners.by creditors rather than owners.Calculation:Calculation:Debt Ratio = Debt Ratio = Total Debt Total Debt = = TkTk. 580,000. 580,000 = .68:1= .68:1

Total Assets Total Assets TkTk. 847,655. 847,655Suppose Industry Average Debt Ratio = 0.64:1Suppose Industry Average Debt Ratio = 0.64:1Interpretation:Interpretation:Creditors provide 68% of company’s total assets. Very close Creditors provide 68% of company’s total assets. Very close to the industry average of 64%. Although the company does to the industry average of 64%. Although the company does not appear to be overburdened with debt, it might have not appear to be overburdened with debt, it might have difficulty borrowing , especially from conservative lenders.difficulty borrowing , especially from conservative lenders.

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2. 2. Debt to Net Worth RatioDebt to Net Worth Ratio -- Compares what the business Compares what the business “owes” to what it “owns.”“owes” to what it “owns.”Calculation:Calculation:Debt to Net = Debt to Net = Total Debt Total Debt = = TkTk. 580,000. 580,000 = 2.20:1= 2.20:1Worth Ratio Tangible Net Worth Worth Ratio Tangible Net Worth TkTk. 264,155. 264,155Suppose Industry Average Debt to Net Worth Ratio = 1.90:1Suppose Industry Average Debt to Net Worth Ratio = 1.90:1Interpretation:Interpretation:The company owes The company owes TkTk. 2.20 to creditors for every . 2.20 to creditors for every TkTk. 1.00 . 1.00 the owner has invested in the business (compared to the owner has invested in the business (compared to TkTk. 1.90 . 1.90 to every to every TkTk. 1.00 in equity for the typical business). Many . 1.00 in equity for the typical business). Many lenders will see the Company as “borrowed up,” having lenders will see the Company as “borrowed up,” having reached its borrowing capacity. Creditor’s claims are more reached its borrowing capacity. Creditor’s claims are more than twice those of the owners.than twice those of the owners.

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3. 3. Times Interest EarnedTimes Interest Earned -- Measures the firm’s ability to make Measures the firm’s ability to make the interest payments on its debt.the interest payments on its debt.Calculation:Calculation:Times Interest = Times Interest = EBIT* EBIT* = = TkTk. 80,479. 80,479 = 4.05:1= 4.05:1EarnedEarned Total Interest ExpenseTotal Interest Expense TkTk. 19,850. 19,850*Earnings Before Interest and Taxes*Earnings Before Interest and TaxesSuppose Industry Average Suppose Industry Average Times Interest Earned Times Interest Earned = 4.0:1= 4.0:1Interpretation:Interpretation:The company’s earnings are high enough to cover the interest The company’s earnings are high enough to cover the interest payments on its debt by a factor of 4.05:1, slightly better thanpayments on its debt by a factor of 4.05:1, slightly better thanthe typical firm in the industry. The company has a cushion the typical firm in the industry. The company has a cushion (although a small one) in meeting its interest payments. (although a small one) in meeting its interest payments.

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Operating RatiosOperating Ratios -- Evaluate the firm’s overall performance Evaluate the firm’s overall performance and show how effectively it is putting its resources to work.and show how effectively it is putting its resources to work.

1. 1. Average Inventory Turnover RatioAverage Inventory Turnover Ratio -- Tells the average number Tells the average number of times the firm’s inventory is “turned over” or sold out of times the firm’s inventory is “turned over” or sold out during the accounting period.during the accounting period.Calculation:Calculation:Average Inventory = Average Inventory = Cost of Goods Sold Cost of Goods Sold = = Tk.1,290.117Tk.1,290.117 = 2.05 times = 2.05 times Turnover Ratio Average Inventory* Turnover Ratio Average Inventory* TkTk. 630,600 a year. 630,600 a year

**Average Inventory = Average Inventory = Beginning Inventory + Ending InventoryBeginning Inventory + Ending Inventory22

Suppose Industry Average Suppose Industry Average Inventory Turnover Ratio Inventory Turnover Ratio = 4.0 = 4.0 times per yeartimes per yearInterpretation:Interpretation:Inventory is moving at a very slow pace. Inventory is moving at a very slow pace.

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2. 2. Average Collection Period RatioAverage Collection Period Ratio -- Tells the average number of Tells the average number of days required to collect accounts receivable.days required to collect accounts receivable.Calculation:Calculation:Two Steps:Two Steps:

oo Receivables Turnover = Receivables Turnover = Credit Sales Credit Sales = = TkTk. 1,309,589. 1,309,589 = 7.31 times Ratio= 7.31 times RatioAccounts Receivable Accounts Receivable TkTk. 179,225 a year. 179,225 a year

oo Average Collection = Average Collection = Days in Accounting Period Days in Accounting Period = = 365365 = 50.0 = 50.0 Period Ratio Period Ratio Receivables Turnover Ratio 7.31 daysReceivables Turnover Ratio 7.31 days

Suppose Industry Average Collection Period Ratio = 19. 30 Suppose Industry Average Collection Period Ratio = 19. 30 days days Interpretation:Interpretation:The company collects the average account receivable after 50 The company collects the average account receivable after 50 days compared to the industry average of 19 days days compared to the industry average of 19 days –– more than more than 2.5 times longer. 2.5 times longer.

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3. 3. Average Payable Period RatioAverage Payable Period Ratio -- Tells the average number of Tells the average number of days required to pay accounts payable.days required to pay accounts payable.Calculation:Calculation:Two Steps:Two Steps:

oo Payables Turnover = Payables Turnover = Purchases Purchases = = TkTk. 939,827. 939,827 = 6.16 times = 6.16 times RatioRatio Accounts Payable Accounts Payable TkTk. 152,580 a year. 152,580 a year

oo Average Payable = Average Payable = Days in Accounting Period Days in Accounting Period = = 365365 = 59.3 = 59.3 Period Ratio Period Ratio Payables Turnover Ratio 6.16 daysPayables Turnover Ratio 6.16 daysSuppose Industry Average payable period ratio = 43 daysSuppose Industry Average payable period ratio = 43 daysInterpretation:Interpretation:The company’s payables are nearly 40 percent slower than The company’s payables are nearly 40 percent slower than those of the typical firm in the industry. Stretching payables those of the typical firm in the industry. Stretching payables too far could seriously damage the company’s credit rating.too far could seriously damage the company’s credit rating.

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4. 4. Net Sales to Total Assets RatioNet Sales to Total Assets Ratio -- Measures the firm’s Measures the firm’s ability to generate sales given its asset base. ability to generate sales given its asset base. Calculation:Calculation:Net Sales to = Net Sales to = Net Sales Net Sales = = TkTk. . 1,870,8411,870,841 = 2.21:1 = 2.21:1 Total Assets Total Assets Total Assets Total Assets TkTk. 847,655. 847,655

Suppose Industry Average Net Sales to Total Assets Suppose Industry Average Net Sales to Total Assets Ratio = 2.7:1Ratio = 2.7:1Interpretation:Interpretation:The company is not generating enough sales, given The company is not generating enough sales, given the size of its asset base. the size of its asset base.

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5. 5. Net Sales to Working Capital RatioNet Sales to Working Capital Ratio -- Measures how many Measures how many Taka in sales the company generates for every Taka of Taka in sales the company generates for every Taka of working capital.working capital.Calculation:Calculation:Net Sales to = Net Sales to = Net Sales Net Sales = = TkTk. . 1,870,8411,870,841 = 5.86:1 = 5.86:1 Total Assets Working Capital* Total Assets Working Capital* TkTk. 847,655. 847,655

*Working Capital = Current Assets *Working Capital = Current Assets -- Current LiabilitiesCurrent Liabilities

Suppose Industry Average Net Sales to Working Capital Suppose Industry Average Net Sales to Working Capital Ratio = 10.8:1Ratio = 10.8:1Interpretation:Interpretation:The company generates just The company generates just TkTk. 5.86 in sales for every . 5.86 in sales for every TkTk. 1 . 1 of working capital, just over half of what the typical firm in of working capital, just over half of what the typical firm in the industry does. The message is clear: the company is not the industry does. The message is clear: the company is not producing an adequate volume of sales.producing an adequate volume of sales.

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Profitability Ratios Profitability Ratios -- Measure how efficiently the firm is Measure how efficiently the firm is operating; offer information about the firm’s “bottom line.”operating; offer information about the firm’s “bottom line.”

1. Net Profit on Sales Ratio 1. Net Profit on Sales Ratio -- Measures the firm’s profit per Measures the firm’s profit per dollar of sales revenue.dollar of sales revenue.Calculation:Calculation:Net Profit on = Net Profit on = Net IncomeNet Income = = TkTk. 60,629. 60,629 = 3.24% = 3.24% Sales Sales Net Sales Net Sales TkTk. 1,870,841. 1,870,841

Suppose Industry Average Net profit on sale ratio = 7.6%Suppose Industry Average Net profit on sale ratio = 7.6%Interpretation:Interpretation:After deducting all expenses, the company has just After deducting all expenses, the company has just TkTk. 3.24 . 3.24 of every sales of of every sales of TkTk. 100.00 left as profit . 100.00 left as profit –– less than half the less than half the industry average.industry average.

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2. 2. Net Profit to Equity RatioNet Profit to Equity Ratio -- Measures the owner’s rate of Measures the owner’s rate of return on the investment in the business.return on the investment in the business.Calculation:Calculation:Net Profit to = Net Profit to = Net Income Net Income = = TkTk. . 60,629 60,629 = 22.65% = 22.65% Equity Equity Owner’s Equity* Owner’s Equity* TkTk. 267,655. 267,655

* * Also called net worthAlso called net worth

Suppose Industry Average Net profit on equity ratio = Suppose Industry Average Net profit on equity ratio = 12.6%12.6%Interpretation:Interpretation:The company’s return on owner's investment in the The company’s return on owner's investment in the business is an impressive 22.65%, compared to an industry business is an impressive 22.65%, compared to an industry average of just 12.6%.average of just 12.6%.

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Stockholder Ratios:Stockholder Ratios:Measures the firm’s performance and stock returns relevant Measures the firm’s performance and stock returns relevant to investors.to investors.

1. Earning1. Earning--perper--Share Ratio (EPS)Share Ratio (EPS)-- Measures the income Measures the income available to common stockholders on a peravailable to common stockholders on a per--share basis. share basis. Calculation:Calculation:EPS = EPS = Net Income after preferred dividend Net Income after preferred dividend = = TkTk. . 50,00050,000 = = TkTk. 5.00 . 5.00

Average number of Common shares 10,000Average number of Common shares 10,000

Suppose Industry Average EPS = Suppose Industry Average EPS = TkTk. 10.00. 10.00Interpretation:Interpretation:The company earns The company earns TkTk. 5.00 only for each share . 5.00 only for each share –– just half just half the industry average.the industry average.

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2. 2. Dividend Yield RatioDividend Yield Ratio-- Measures the rate at which Measures the rate at which dividends provide a return to stockholders. dividends provide a return to stockholders.

Calculation:Calculation:Dividend YieldDividend Yield = = Dividend per Share Dividend per Share = = TkTk. . 10 10 = 5% = 5%

Market Price per Share Market Price per Share TkTk. 200. 200

Suppose Industry Average Dividend Yield Ratio = 10%Suppose Industry Average Dividend Yield Ratio = 10%

Interpretation:Interpretation:The company’s dividend provides 5% return to The company’s dividend provides 5% return to shareholdersshareholders–– just half the industry average.just half the industry average.

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3. Price3. Price--Earning RatioEarning Ratio-- PricePrice--Earning Ratio is the Earning Ratio is the measurement of the future income growth and risk prospects measurement of the future income growth and risk prospects relative to its current income. relative to its current income.

Calculation:Calculation:PE RatioPE Ratio = = Market Price per ShareMarket Price per Share = = TkTk. . 200200 = 20 = 20

Earning per Share Earning per Share TkTk. 10. 10

Suppose Industry Average PE Ratio = 10Suppose Industry Average PE Ratio = 10

Interpretation:Interpretation:The pay back period of the investment in the company’s The pay back period of the investment in the company’s share, in terms of dividend income, is very long share, in terms of dividend income, is very long --just double just double than the industry average, which indicates that investment in than the industry average, which indicates that investment in the share is risky.the share is risky.

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Thank YouThank You

microsoft powerpoint - how to read financial statements

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