What is the financial position of the firm at a given point of time? Financial analysis involves the use of financial statements. A financial statement is a collection of data that is organized according to logical and consistent accounting procedures. Its purpose is to convey an understanding of some financial aspects of a business firm. It may show a position of a period of time as in the case of a Balance Sheet, or may reveal a series of activities over a given period of time, as in the case of an Income Statement.
The Balance Sheet shows the financial position condition of the firm at a given point of time. It provides a snapshot that may be regarded as a static picture.
However, financial statements do not reveal all the information related to the financial operations of a firm, but they furnish some extremely useful information, which highlights two important factors profitability and financial soundness. Financial performance analysis includes analysis and interpretation of financial statements in such a way that it undertakes full diagnosis of the profitability and financial soundness of the business.
Measures the amount of liquidity available to pay for current liabilities. Quick ratio. The same as the current ratio, but does not include inventory. Liquidity index.
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Measures the amount of time required to convert assets into cash. Activity ratios. These ratios are a strong indicator of the quality of management, since they reveal how well management is utilizing company resources. Accounts payable turnover ratio. Measures the speed with which a company pays its suppliers. Accounts receivable turnover ratio. Measures a company's ability to collect accounts receivable. Fixed asset turnover ratio. Measures a company's ability to generate sales from a certain base of fixed assets. Inventory turnover ratio.tiodutfadeba.tk
Analysis of Financial Performance and Position
Measures the amount of inventory needed to support a given level of sales. Sales to working capital ratio. Shows the amount of working capital required to support a given amount of sales. Working capital turnover ratio. Measures a company's ability to generate sales from a certain base of working capital. Leverage ratios. These ratios reveal the extent to which a company is relying upon debt to fund its operations, and its ability to pay back the debt.
Debt to equity ratio.
Shows the extent to which management is willing to fund operations with debt, rather than equity. Debt service coverage ratio. Reveals the ability of a company to pay its debt obligations. Fixed charge coverage. Shows the ability of a company to pay for its fixed costs. Profitability ratios. These ratios measure how well a company performs in generating a profit. Breakeven point. Reveals the sales level at which a company breaks even. Contribution margin ratio.
Shows the profits left after variable costs are subtracted from sales. Gross profit ratio. Each item in the statement is shown as a base figure of another item in the statement, for a given time period, usually for year. Typically, this analysis means that every item on an income and loss statement is expressed as a percentage of gross sales, while every item on a balance sheet is expressed as a percentage of total assets held by the firm.
Vertical analysis is also called static analysis because it is carried out for a single time period. Vertical analysis only requires financial statements for a single reporting period. It is useful for inter-firm or inter-departmental comparisons of performance as one can see relative proportions of account balances, no matter the size of the business or department.
How to Analyze Your Business Using Financial Ratios
Because basic vertical analysis is constricted by using a single time period, it has the disadvantage of losing out on comparison across different time periods to gauge performance. This can be addressed by using it in conjunction with timeline analysis, which shows what changes have occurred in the financial accounts over time, such as a comparative analysis over a three-year period. For instance, if the cost of sales comes out to be only 30 percent of sales each year in the past, but this year the percentage comes out to be 45 percent, it would be a cause for concern.
The main types of financial statements are the balance sheet, the income statement and the statement of cash flows. These accounting reports are analyzed in order to aid economic decision-making of a firm and also to predict profitability and cash flows. The balance sheet shows the current financial position of the firm, at a given single point in time. It is also called the statement of financial position.
The two sides of the balance sheet must balance as follows:. Current assets held by the firm refer to cash and cash equivalents. These cash equivalents are assets that can be easily converted into cash within one year. Current assets include marketable securities, inventory and accounts receivable. Long-term assets are also called non-current assets and include fixed assets like plant, equipment and machinery, and property, etc.
A firm records depreciation of its fixed, long-term assets every year. It is not an actual expense of cash paid, but is only a reduction in the book value of the asset. The book value is calculated by subtracting the accumulated depreciation of prior years from the price of the assets. Current liabilities of the firm are obligations that are due in less than one year. These include accounts payable, deferred expenses and also notes payable. Long-term liabilities of the firm are financial payments or obligations due after one year.
These include loans that the firm has to repay in more than a year, and also capital leases which the firm has to pay for in exchange for using a fixed asset. It is the difference between total assets owned by a firm and total liabilities outstanding. It is different from the market value of equity stock market capitalization which is calculated as follows: number of shares outstanding multiplied by the current share price.
The balance sheet is analyzed to obtain some key ratios that help explain the health of the firm at a given point in time.
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These metrics are as follows:. The debt-equity ratio is also called a leverage ratio. It is calculated to assess the leverage, or gearing, of a firm to show how much it relies on debt to finance its activities. This ratio has pertinent implications for the financial health of the firm and the risk and return of its shares. The variations in this ratio also show any value added by the management and its growth prospects.
The enterprise value of a firm shows the underlying value of the business. The purpose of an income statement is to report the revenues and expenditures of a firm over a specific period of time. It was previously also called a profit and loss account. The general structure of the income statement with major components is as follows:. The net income on the income statement, if positive, shows that the company has made a profit.
If the net income is negative, it means the company incurred a loss. Earnings per share can be derived from knowing the total number of shares outstanding of the company:. Some useful metrics based on the information provided in the income statement and the balance sheet are as follows:. Net profit margin: This ratio calculates the amount of profit that the company has earned after taxes and all expenses have been deducted from net sales. Return on Equity: This ratio is used to calculate company profit as a percentage of total equity.
It assesses whether the stock is overvalued or undervalued. It is essentially a statement whereby the net income is adjusted for non-cash expenses and any changes to the net working capital. It also reflects changes in cash coming from, or being used by, investing and financing activities of the firm. The structure and main components of the cash flow statement are as follows:. In order to measure how much cash is available to the company for investments without outside financing or money diverting from operations, it is useful to conduct a simple cash flow statement analysis. The free cash flow, as the name suggests, allows a company to be able to pay dividends, repay its debts, buy back its stock and also make new investments to facilitate future growth.
The excess cash produced by the company, free cash flow, is calculated as follows:. In order for the company to be doing extremely well, the cash from operating activities must be consistently greater than the net income earned by the company. Apart from the key financial statements, complete financial reporting statements also include the following:.
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