Financial Statement Analysis

Overview of financial statement analysis

Purpose

Relies on looking at relationships (ratios) between 2 or more financial statement accounts and seeing how those ratios change over time, and how they compare across companies or industries

4 ratio categories

Liquidity Ratios

Profitability Ratios

Activity Ratios

Solvency Ratios

Activity Ratios

Measure how efficient a company is at using its assets

Receivables Turnover

Revenue/Avg accounts receivable

Days Sales Outstanding (DSO)

Days in period/Receivables turnover

Inventory turnover

COGS/Avg inventory

A/P Turnover

COGS/Avg AP

Payables payment period (PPP)

Days in period/AP turnover

Liquidity Ratios

Short term ability to meet current obligations

Current ratio

Current assets/current liabilities

Quick ratio

Cash + AR/Current Liabilities

Current ratio rough rule of thumb

A current ratio > 1 is good, implies that there more liquid assets than short term liabilities, reflecting a healthier level of liquidity

Profitability Ratios

Profitability relative to assets

Gross Profit margin

Gross Profit/Revenue

Operating Margin

Operating profit/Revenue

Net Profit margin

Net income/Revenue

Asset turnover

Revenue/Average assets

Return on Assets (ROA)

Net Income/Average assets

Return on Equity (ROE)

Net income/Total equity

Basic EPS

Net income less preferred dividends/weighted average shares outstanding

Diluted EPS

Diluted net income/ Weighted avg diluted shares outstanding

Dividend Yield

Dividends/Net income

Leverage & Solvency Ratios

Important to investors (especially lenders) as they try to determine whether borrowers have sufficient profits to make interest payments, and sufficient equity to carry debt.

Debt to EBITDA

Debt/EBITDA

Interest coverage ratio

EBIT/Interest expense

Fixed charge coverage

(EBIT + Lease charges) / (Lease charges + Interest expense)

Debt to total assets

Total debt/Total assets

Debt to equity

Total liabilities/Total equity

Debt to EBITDA purpose

is used to determine a company’s debt capacity

Interest and fixed charge coverage ratios purpose

Analyzes how much in profit is available to satisfy interest expense

Debt to equity purpose

Understand how levered a company is. The higher the D/E, the more highly levered a firm is.