Sunday, August 4, 2013

Financial Management (2066Q5): What do you mean by financial statement analysis? Shed light on the ratio analysis technique with examples of at least fie major ratios.

Financial Statement Analysis

It is a process of understanding the risk and profitability of a company by analyzing reported financial information, especially annual and quarterly reports. Financial statement analysis is a study about accounting ratios among various items included in the balance sheet such as asset utilization ratios, profitability ratios, leverage ratios, liquidity ratios and valuation ratios. Financial statement analysis can also define as a quantifying method for determining the past, current and prospective performance of a company.


1. It provides ideas to investors to decide on investing their funds in a particular company or not.
2. Ensuring a company that it is following required accounting standards or not.
3. It is helpful to the government agencies in analyzing taxes on any firm.
4. To analyze a company's performance over a specific time period.


1. Difficult to compare financial data and ratios between companies.

Ratio analysis techniques:

A. Current ratio:
Current ratio = current assets / current liabilities

B. Quick ratio:
Quick ratio = (cash + marketable securities + net receivables) / current liabilities

The main difference between current ratio and quick ratio is that quick ratio includes inventories too.

C. Debt to asset ratio = total liabilities / total assets
D. Debt – equity ratio = long – term debt / shareholder's equity
E. Return on Asset = net income / total average assets
F. Return on Equity = net income / total stockholders equity

Some commonly used financial ratios:

1. Liquidity Measurement Ratios
a. Current ratio
b. Quick ratio
c. Cash ratio
d. Cash conversion cycle

2. Profitability Indicator Ratios
a. Profit margin analysis
b. Effective tax rate
c. Return on assets
d. Return on equity
e. Return on capital employed

3. Debt Ratios
a. Overview of debt
b. Debt ratio
c. Debt-equity ratio
d. Capitalization ratio
e. Interest coverage ratio
f. Cash flow to debt ratio

4. Operating Performance Ratios
a. Fixed-asset turnover
b. Sales/Revenue per employee
c. Operating cycle

5. Cash Flow Indicator Ratios
a. Operating cash flow/ sales ratio
b. Free cash flow/ operating cash ratio
        c. Cash flow coverage ratio
        d. Dividend payout ratio

6. Investment Valuation Ratios
a. Per share data
b. Price/book value ratio
c. Cash flow coverage ratio
d. Price/Earnings ratio
e. Price/Earnings to growth ratio
f. Price/Sales ratio
g. Dividend Yield
h. Enterprise value multiple

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