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8. Company Analysis- Financial Analysis

Introduction to financial statement analysis 

Financial statement analysis is the process of analyzing a company‘s financial statements, such as the balance sheet, income statement, and cash flow statement, in order to understand the company‘s financial performance and health. Financial statement analysis is used by investors, creditors, and internal management to evaluate a company‘s financial position and performance. Financial statement analysis involves analyzing historical financial data to identify trends, assess a company‘s financial performance, and make predictions about the company‘s future. It also involves comparing a company‘s financial performance to that of its peers and the industry in general. Financial statement analysis is an important tool for investors, creditors, and management to make informed decisions about a company.

 

Standalone financial statement and consolidated financial statement analysis

Financial statement analysis can be conducted on either a standalone or a consolidated basis. A standalone analysis examines the financial statements of a single entity, while a consolidated analysis examines the financial statements of multiple entities that are combined in a group.

In stand-alone analysis, the financial statements of the company being analyzed are examined independently. This type of analysis is typically used to assess the financial performance of a single company and identify potential areas of improvement.

In consolidated analysis, the financial statements of multiple entities are combined, and the financial performance of the entire group is analyzed. This type of analysis is used to assess the financial performance of a group of entities and identify areas of improvement across the entire group.

Balance Sheet Analysis

The format for the balance sheet is prescribed under Schedule 3 of the Companies Act 2013. In addition, IndAS 1 requires that companies should also report changes in shareholders equity, which shows the various movements in shareholders equity. Balance sheet analysis involves analyzing the assets, liabilities, and shareholders equity of a company. It is used to identify potential areas of improvement in the companys financial position and to assess the companys ability to meet its financial obligations.

Common Balance Sheet Line Items

Assets: Cash, Accounts Receivable, Inventory, Investments, Fixed Assets, Intangible

Assets Liabilities: Accounts Payable, Accrued Liabilities, Bank Loans, Longterm Debt

Shareholders Equity: Common Stock, Preferred Stock, Retained Earnings Income Statement Line Items

Revenues: Sales, Interest,

Dividends Expenses: Cost of Goods Sold, Selling, General, and Administrative Expenses, Interest Expense, Taxes

Net Income: Revenues minus Expenses

Basics of Profit and Loss Account (P/L)

A profit and Loss account is a financial statement that summarizes the revenues, expenses, and net income of a company during a specific period of time. It is also known as an income statement. The profit and loss account is used to assess a company’s financial performance and health. It typically includes line items such as sales, cost of goods sold, operating expenses, and net income.

Common profit and loss account line items

Revenues: Sales, Interest,

Dividends Expenses: Cost of Goods Sold, Selling, General, and Administrative Expenses, Interest Expense, Taxes Ne

Income: Revenues minus Expenses

Key metrics from profit and loss account

Gross Profit: Revenues minus Cost of Goods Sold

Operating Profit: Gross Profit minus Operating Expenses

Net Profit: Operating Profit minus Interest Expense and Taxes

Basics of Cash Flows

Cash flow is the movement of cash into and out of a business. The cash flow statement is a financial statement that summarizes the inflows and outflows of cash during a specific period of time. It is used to assess a companys ability to generate cash and identify potential areas of improvement.

Common cash flow statement line items

Cash from Operating Activities: Cash from sales, Cash from collections of accounts receivable, Cash paid for expenses, Cash paid for taxes

Cash from Investing Activities: Cash investments in property, plant, and equipment, Cash investments in other companies, Cash received from sale of investments

Net Cash Flow: Cash from Operating Activities plus Cash from Investing Activities plus Cash from Financing Activities

Financial statement analysis using ratios

Financial statement analysis using ratios is a method of reviewing and analyzing a company‘s financial statements in order to gain insight into its financial performance. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry average, or other benchmarks. This comparison provides information about trends and helps in predicting future performance. Ratios are used to measure liquidity, profitability, efficiency, solvency, and shareholder return. Each ratio provides a different view of the company‘s financial performance and can be used to identify areas of strength and weakness.

Commonly used ratios include:

Liquidity Ratios: These ratios measure the company‘s ability to meet its shortterm obligations such as paying bills and meeting payroll. Examples include the current ratio and quick ratio.

Current Ratio: Current Assets/Current Liabilities

Quick Ratio: (Current Assets Inventories)/Current Liabilities

Profitability Ratios: These ratios measure the company‘s ability to generate income and profits from operations. Examples include gross profit margin, operating profit margin, and return on assets.

• Gross Profit Margin: Gross Profit/Net Sales

• Operating Profit Margin: Operating Profit/Net Sales

• Return on Assets: Net Income/Total Assets

Efficiency Ratios: These ratios measure the company‘s ability to use its assets and resources efficiently. Examples include inventory turnover, accounts receivable turnover, and asset turnover.

• Inventory Turnover: Cost of Goods Sold/Average Inventory

• Accounts Receivable Turnover: Net Sales/Average Accounts Receivable

• Asset Turnover: Net Sales/Total Assets

Solvency Ratios: These ratios measure the company‘s ability to meet its longterm obligations such as debt payments and other liabilities. Examples include the debt to equity ratio and the interest coverage ratio.

• Debt to Equity Ratio: Total Liabilities/Total Equity

• Interest Coverage Ratio: Earnings Before Interest & Taxes/Interest Expense

Shareholder Return Ratios: These ratios measure the company‘s ability to generate returns for its shareholders. Examples include the return on equity and the dividend yield.

• Return on Equity: Net Income/Shareholder Equity

• Dividend Yield: Dividends per Share/Share Price

Financial statement analysis using ratios is an important tool for investors, creditors, and other stakeholders in assessing the financial health of a company. By comparing the company‘s performance to that of its peers and the industry average, potential investors and lenders can identify potential areas of risk and opportunity.

Dupont analysis

Dupont analysis is a financial analysis tool used to analyze the return on equity of a company. It provides insight into the firms financial performance by breaking it down into three parts: (1) profit margin (2) asset turnover, and (3) financial leverage. By breaking down the return on equity into its components, investors can get a better understanding of the firms performance and can identify potential areas of improvement.

The formula for Dupont analysis is:

Return on Equity (ROE) = Profit Margin x Asset Turnover x Financial Leverage

Profit Margin: The profit margin ratio measures how much of each dollar of sales is converted into profits. It is calculated by dividing net income by net sales.

Asset Turnover: The asset turnover ratio measures how efficiently the firm is using its assets to generate sales. It is calculated by dividing net sales by total assets.

Financial Leverage: The financial leverage ratio measures how the firm is using debt to finance its operations. It is calculated by dividing total liabilities by total equity. By understanding how each of these components affects the firms return on equity, investors can gain insight into the firm

Forecasting Using Ratio Analysis

Forecasting using ratio analysis Ratio analysis is a forecasting method that involves analyzing historical and current financial data to determine the performance of a company. Ratios are used to compare different elements of the financial statements to identify trends and assess the overall financial health of the company. Ratios such as the current ratio, debttoequity, and liquidity ratios can be used to analyze a companys ability to pay its debt, generate revenue, and cover its expenses. Forecasting using ratio analysis can be a useful tool to help investors and managers make better decisions about the companys future performance.

Forecasting Using Ratio Analysis

Forecasting using ratio analysis Ratio analysis is a forecasting method that involves analyzing historical and current financial data to determine the performance of a company. Ratios are used to compare different elements of the financial statements to identify trends and assess the overall financial health of the company. Ratios such as the current ratio, debttoequity, and liquidity ratios can be used to analyze a companys ability to pay its debt, generate revenue, and cover its expenses. Forecasting using ratio analysis can be a useful tool to help investors and managers make better decisions about the companys future performance.

Peer Comparison

Another forecasting method using ratio analysis is peer comparison. This method involves analyzing financial ratios of a company in comparison to its peers in the industry. By benchmarking a companys performance to its peers, investors and managers can better assess the relative strengths and weaknesses of the company. This can help to identify the strengths and weaknesses of a company relative to the industry, which can be used to inform decisions about future performance.

Other aspects to study from financial reports

History of Equity Expansion/Reduction: Analyzing the history of equity expansion/reduction, such as through issuing stock, can provide valuable insight into the company’s financial health. This can be used to forecast the potential for future expansion or contraction.

Dividend and Earnings History: Examining the dividend and earnings history can provide insight into how the company has managed its profits and cash flow. This can be used to forecast the potential for future dividend payments and profits.

History of Corporate Actions: Examining the history of corporate actions, such as mergers and acquisitions, can provide important insight into the companys strategic direction. This can be used to forecast the potential for future corporate actions.

Ownership and Insiders’ Sales and Purchase of Stocks in The Past: Analyzing the ownership and insiders sales and purchase of stocks in the past can provide insight into how the company is managed and what the companys goals may be. This can be used to forecast the potential for future changes in ownership and insider trading.

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Chart Source– Tradingview.com

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