Financial Statement Analysis


Common size analysis shows financial statement in percentage basis. There are some advantages by creating this common size analysis such as:

  1. investors could see the historical trend;
  2. we can see the margin of the company and compare it to industry;
  3. we can see the expenses structure;
  4. we can see the composisition of capital (debt and equity), etc.

source: Corporate Finance 10th Edition Ross Westerfield

COMMON SIZE OF BALANCE SHEETsource: Corporate Finance 10th Edition Ross Westerfield

Based on the balance sheet and the common size analysis, we can see that the balance sheet is getting stronger. We can see that the retained earning has increasing and in the same time long term debt is decreasing. Positive performance will result in the increase of inventory and fixed assets.

Common size used to standardized the income statement into percentage basis. The income statement tells us the cost structure or cost spent for each dollar in sales. Prufrock spent $0.582 on cost of goods sold to generate $1. Prufrock also spent $0.061 on interest expense for each $1 generated. We can compare Prufrock performance to the industry or other company similar to it.

source: Corporate Finance 10th Edition Ross Westerfield

COMMON SIZE OF INCOME STATEMENTsource: Corporate Finance 10th Edition Ross Westerfield

By analyzing the common size income statement, we can get the operating profit margin (29.9%), gross profit (100% – 58.2%) margin, and net profit margin (15.7%).

Analyst commonly used measures of earnings as presented below:
Net Income, the bottom line of income statement. It reflects the differences between firm’s capital structure, taxes, and also the difference in accounting method such as depreciation. Investors look closely in net income after tax because it will affect the dividend payout and retained earnings;
EPS, Net income divided by number of outstanding shares;
EBIT, commonly called operating income and exclude the unusual items such as discontinued operations or any extraordinary items. EBIT usually used because it ignores the firm’s capital structure (interest expense) and taxes;
EBITDA, the same as EBIT but added depreciation and amortization. It ignores the difference in accounting method for depreciation.


Liquidity Ratios:
Current ratio, it is a measure of short-term liquidity. We expect to see a current ratio of at least 1 and the number less than 1 means that net working capital (current assets less current liabilities) is negative.

Current ratio = Current assets / Current Liabilities
= $708 / $540 = 1.31x

Quick ratio, Inventory is often the least liquid current asset and the book values are least reliable as measures of market value because the quality of the inventory isn’t considered. Some of the inventory may be damaged, obsolete, or lost. Relatively large inventories are often a sign of short-term trouble. The firm may have overestimated sales and overbought or overproduced as a result. In this case, the firm may have a substantial portion of its liquidity tied up in
slow-moving inventory.

Quick ratio = (Current assets – Inventory) / Current Liabilities
= ($708 – $422) / $540 = 0.53x

Cash ratio, a very short term indicator might be the cash ratio.

Cash ratio = Cash / Current Liabilities
= $98 / $540 = 0.18x

Solvency Ratios
Solvency ratios used to measure the firm’s long-run ability to pay obligations. These ratios oftenly called financial leverage ratios or leverage ratios.

Total Debt Ratio = (Total Assets – Total Equity) / Total Assets
= ($3,588 – $2,591) / $3,588 = 0.28 times

Debt-Equity Ratio = Total Debt / Total Equity
= 0,28 / (1 – 0,28) = 0.39 times

Equity Multiplier = Total Assets / Total Equity
= $1 / $ 0.72 = 1.39 times

Equity Multiplier = 1 + Debt Equity Ratio
= 1 + 0.39 = 1.39 times

Times Interest Earned = EBIT / Interest
= $691 / $141 = 4.9 times

Cash Coverage = [EBIT + (Depreciation and Amortization)] / Interest
= ($691 + $276) / $141 = 6.9 times

Other measurement is “Interest Bearing Debt / EBITDA”. Values below 1 are considered very strong while above 5 are weak.

Turnover Ratios
Turnover ratios sometimes called asset management ratios. It reflects how efficient a firm uses its assets to generate sales.

Receivable Turnover = Sales / Accounts Receivables
Days of sales in receivables = 365 days / Receivable Turnover
or Days of sales in receivables = Accounts Receeivable / (Sales / 365 days)

Inventory Turnover = COGS / Inventory
Days of sales in inventory = 365 days / Inventory Turnover
or Days of sales in inventory = Inventory / (COGS / 365 days)

Total Asset Turnover = Sales / Total Asset
Capital Intensity = Total Asset / Sales

other turnover ratio is Account Payable Turnover = COGS / Accounts Payable

Profitability Ratios
The measurements below are widely used of all financial ratios. These ratios measure how efficiently the firm uses its assets and how efficiently the firm manages its operations.

Net Profit Margin = Net Profit After Tax / Sales
EBITDA Margin = EBITDA / Sales
Return on Assets = Net Income / Total Asset
Return on Equity = Net Income / Total Equity

Market Value Measurement

Price Earning Ratio = Price Per Share / Earning Per Share
Earning Per Share = Net Income / Number shares outstanding
Market to Book Ratio = Market Value Per Share / Book Value Per Share
Market Capitalization = Price per share x Number share outstanding
Enterprise Value = Market Capitalization + Debt – Cash
Enterprise Value Multiple = Enterprise Value / EBITDA

source: Corporate Finance 10th Edition Ross Westerfield

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