Analysis and Interpretation of Financial Statements

 Analysis and Interpretation of Financial Statements

The purpose of Financial Statements Analysis and interpretation are as follows:

1. Check Accounts
2. Check hidden things
3. Analysis for decisions making

Tools Methods of Financial Statements Analysis:

1. Ratios Analysis
2. Common size statement analysis / Vertical Analysis
3. Comparative, Trend and Index Analysis / Horizontal Analysis
4. Ration Analysis / Financial Analysis
5. Relationship between two account which express in mathematical form
6. Relative form information Absolute form

Types Of Comparisons:

1. Internal Analysis
2. External Analysis
3. Combined Analysis

Ratio Analysis:

Debt Ratio:

Debt ratio are as follows:

1. Debt Ratio / Solvency Ratio
2. Debt-to-Equity Ratio
3. Time Interest Earned Ratio / Interest Coverage Ratio
4. Fixed payment coverage Ratio

Debt Ratio / Solvency Ratio:

The debt ratio measures the percentage of a company's total assets that is funded by its creditors.

Debt Ratio = Total Liabilities/Debt divide Total Assets

Solvency Risk increase if debt Ratio increase

Debt-to-Equity Ratio:

The debt-to-equity ratio measures the relative percentage of total liabilities to common stock equity used to finance the firm's assets.

Debt-to-equity ratio = Total Liabilities divide Common stock equity / Total Shareholders

If Debt to equity ratio < 1 than it is favorable

Solvency risk increase if debt to equity ratio increase

Time Interest Earned Ratio / Interest Coverage Ratio:

Measures the firm's ability to make contractual interest payments.

Formula:

Time interest earned ratio = Earnings before interest and taxes / Interest payment OR Total annual payment

IF Interest Coverage Ratio (ICR) > 3 then it is favorable

1. Better, indicates stronger solvency
2. Easier debt services
3. Higher ICR lets a company borrow money

Fixed payment coverage Ratio:

Measures the firm's ability to meet all fixed payment obligation such as loan interest and principal, lease payments, and preferred stock dividends.

Formula:

FPCR = Earnings before interest and taxes + Lease payments / Interest + Lease payments + {(Principal payments + preferred stock dividends) * [1 / (1-T) ]}

T= Corporate tax rate