Evaluating a

Firm's Financial
WHAT IS FINANCIAL PERFORMANCE?

Financial performance
is a subjective measure
of how well a firm can
use assets from its
primary mode of
business and generate
revenues.
The term is also used as a
general measure of a firm's
overall financial health over a
given period.

Analysts and investors use

financial performance to
compare similar firms across
the same industry or to
compare industries or sectors
in aggregate.
FINANCIAL STATEMENT
There are three
financial statements;
the balance sheet, the
income statement
and the cash flow
statement.
WHAT IS BALANCE
SHEET?
THE TERM BALANCE SHEET
REFERS TO A FINANCIAL
STATEMENT THAT REPORTS A
COMPANY'S ASSETS,
LIABILITIES, AND
SHAREHOLDER EQUITY AT A
SPECIFIC POINT IN TIME.
Balance sheets provide the basis for
computing rates of return for investors
and evaluating a company's capital
structure.

The balance sheet is a financial

statement that provides a snapshot of
what a company owns and owes, as well
as the amount invested by shareholders.

Balance sheets can be used with other

important financial statements to
conduct fundamental analysis or
calculate financial ratios.
 - IS A FORMAL STATEMENT

INCOME SHOWING THE FINANCIAL

PEFORMANCE OF AN
ENTITY FOR A GIVEN

STATEMENT
PERIOD OF TIME.

FINANCIAL PERFORMANCE
OF AN ENTITY - is a
primarily measured in
terms of level of income
earned by the entity
through the effective and
efficient utilization of its
resources financial
performance is also known
as the results of operation
of the entity.
USES AND LIMITATIONS
OF FINANCIAL
STATEMENTS
 Uses of Financial Statement
1. Bridging the Gap in Management 2. Availing Credits from Lenders
Financial statements basically reflect a company’s Every business needs to borrow funds for
financial performances. They show profits and functioning. They have to rely on lenders like
liabilities of the business. They show how successful a banks and financial institutions for this purpose.
company’s decisions have been. Since shareholders
Financial statements play a huge role in this
have access to these statements, they can gauge their
purpose. Since they show a company’s liabilities,
company’s performance. This further helps in bridging
the gap between lapses in management and debts and profits, investors can use them to
expectations of owners. make informed decisions.

3. Use for Investors

Investors also extensively use a company’s financial statements to
asses its finances. That helps them figure out how the company’s
solvency will be in the longer term. Thus, the better a company’s
financial position is, the greater the investment it will receive.
 Uses of Financial Statement
4. Use for Government 5. Use for Stock Exchanges
Governmental policies pertaining to corporates Regulatory bodies like SEBI and stock exchanges
depend heavily on financial statements. This is like BSE and NSE also use financial statements for
because these statements depict how companies many reasons. SEBI can assess a company’s internal
are functioning in general. The government can matters using them to ensure the protection of
use this information to decide taxation and investors. Even stock advisers require them to frame
regulatory policies. their quotes. They are also a great source of
information for stock traders and investors.

6. Information on Investments
The shareholders of a company rely on these statements to understand
how their investments are paying off. If a company is earning profits, they
might decide to invest even more money. On the contrary, stagnant
profits or even losses will prompt them to pull out. Despite all these uses
of financial statements, there are some limitations to them as well.
Limitations of Financial Statement
1. Not a reflection of the present
Financial Position
2. Possibility of Bias

Firstly, financial statements do not show

Financial statements might not
how well a company is performing in the
always be an accurate
present times. This is because they are
representation of a company. This
made at the end of every financial year.
happens because they are based
Hence, they only depict performances of
on several personal judgments,
the previous twelve months. Even the
conventions and internal policies of
value of assets and liabilities change as
accountants.
money’s purchasing power fluctuates.
Limitations of Financial Statement
3. The Absence of Vital 4. Lack of Qualitative
Information Information
Although companies portray their
Accountants might skip a lot of vital numbers and finances in annual
information while making financial statements, a lot of qualitative data
statements. For example, the nature of is skipped. Hence, details of the
company’s industrial relations,
agreements signed by the company is
employees’ productivity, etc. are
important information, but it is never
generally missing from these
mentioned in annual statements.
statements.
Limitations of Financial Statement
5. Lack of Details

Financial statements might state the total

value of assets, but they do not disclose the
nature of these assets. Similarly, a lot of
minute details like these do not find
mention.
RATIO ANALYSIS
 Meaning of RATIO?
A ratio is a simple arithmetical expression of the
relationship of one number to another.

Also it can be expressed as; ratio is one number

expressed in terms of another and can be worked
out by dividing one number into the another.
What is RATIO
ANALYSIS?
Ratio analysis is a
technique of analysis
and interpretation of
financial statements for
helping in decision
making.
INTERPRETATION

Single Absolute Ratio

Group of ratios
Historical Comparison

Inter Firm Comparison

USES OR SIGNIFICANCE
Managerial uses

Help in decision-making
Financial forecasting and planning

Help in coordination
Help in control
Utility to shareholders

Utility to creditors

Utility to employees
LIMITATIONS
Limited use of Lack of adequate
single ratio standard

Change of accounting
Personal Bias
procedures

Uncomportable
CLASSIFICATION OF
RATIOS
1. LIQUIDITY RATIO
Liquidity refers to the ability of the concernto
meet its current obligation as and when these
become due.
To measure the liquidity of the firm following
ratios are calculated:
Current ratio
Quick or Acid test or Liquidity ratio
Cash ratio
a. Current Ratio/Crude Ratio
Relationship between current asset and current
liabilities.
Current Asset
Current Ratio =
Current Liability
b. Quick/Acid Test/ Liquidity Ratio
It is more rigorous test of liquidity than the
current ratio. It is the relationship between the
liquid asset and quick asset and current
liabilities.

Quick Ratio = Liquid Asset

Current Liabilities
c. Cash Ratio/ Absolute Liquid
Ratio

Absolute Liquid Asset

Cash Ratio =
Current Liabilities
 2. Efficiency /Activity/Asset Management Ratio
These ratio is calculated to measure the efficiency with
which resources of the firm have been employed. These
ratio are also called turnover ratio because they indicate
the speed with which asset are being turnover into sales.
Following are the ratios covered under this:
Stock turnover ratio Creditors turnover ratio
Debtors turnover ratio Working capital turnover
ratio
 a. Inventory/Stock Turnover ratio
It indicates the number of times the stock has
been turned over during the period and evaluate
the efficiency with which the firm is able to
manage its inventory.
Cost of Good Sold
Inventory turnover Ratio =
Average Inventory

Inventory conversion period = Days in a year

Inventory to ratio
b. Debtors turnover ratio
Trade debtors are expected to be converted into cash within a
short period of time are included in current asset. Hence the
liquidity position of a concern to pay its short term obligation
in time depends upon the quality of its trade debtors

Net credit annual sales

Debtors turnover Ratio = Average trade debtors

No. of working days

Average collection period =
Debtors turnover ratio
c. Creditors turnover ratio
The ratio indicates the velocity with which the creditors are
turnover over in relation of purchases

Net credit annual purchases

Creditors turnover Ratio = Average trade creditors

No. of working days

Average payment period =
Creditors to ratio
 d. Working Capital turnover ratio
It indicates the velocity of the utilisation of the net working
capital and the efficiency with which working capital is being
used by a firm.

Working capital turnover Ratio =

Cost of Sales
Average working capital
3. SOLVENCY RATIO
Solvency refers to the ability of the concern to meet its long term
obligation. Long term solvency ratios indicate the firm ability to
meet the fixed interest and cost and repayment schedule
associated with its long term borrowing.

a. Debt-Equity Ratio
It is calculated to measure the relative claims of outsiders and
owners against firm asset.

Debt Equity Ratio = Outsiders Funds / Sahreholders Funds

 b. Funded Debt to Total Capitalisation Ratio
It establishes a link between the long term fund raised from
outsider and total long term funds available in the business.

Funded debt to total capitalisation ratio = (funded debt/total

capitalisation) x 100

c. Proprietory or Equity Ratio

This ratio establishes the relationship between shareholder
funds to total asset of the firm.

Proprietory Ratio = Shareholder Fund/Total Assets

 d. Solvency Ratio
It is a small variant of rquity ratio and can be calculated as 100 -
equity ratio. It indicates the relationship between total liabilities
to outsiders to total asset of the firm.

Solvency Ratio = Total Liabilities to Outsiders/ Total Asset

e. Fixed Asset to Net Worth Ratio

Fixed Asset to Net Worth Ratio = Fixed Asset(after

dep.)/Shareholders Funds
 f. Fixed Asset Ratio

Fixed Asset Ratio = Fixed Asset (after dep.)/Total Long Term Funds

g. Current Asset to Proprietor Ratio

Current Asset to Proprietor Ratio = (Current Asset/Shareholder Fund) x

100

h. Debt Service or Interest Coverage Ratio

Interest Coverage Ratio = Debit/Fixed Interest Charges

4. PROFITABILITY RATIOS (GENERAL)
a. Gross Profit Ratio = (Gross Profit/Net Sales) x 100
b. Net Profit Ratio = (Net Profit After Tax/Net Sales) x 100
c. Operating Ratio = (Operating Cost/Net Sales) x 100

d. Operating Profit Ratio = (Operating Profit/Net Sales) x 100

e. Cash Profit = (Cash Profit/Net Sales) x 100
Where cash profit = net profit + dep.
f. Expense Ratio = (Paticular Expense/Net Sales) x 100
4.2 FOR INVESTMENT ANALYSIS
a. Return on Shareholder Investment/Net Worth
Return on Shareholder Investment = EAIT/Shareholder
Fund
b. Return on Equity Capital
Return on Equity = Net Profit After Tax-Pref. DIV./Equity
Share Capital(paid up)
c. Earning per Share
EPS = Net Profit After Tax - Pref. DIV./No. of Equity Shares
 5. MARKET TEST RATIO or VALUATION
RATIOS
- Dividend Yield Ratio = Div Per EQ. SH./Market Value Per SH.

- Dividend pay-out ratio = Div. Per EQ. SH./EPS

- Price Earning Ratio = Market Price Per EQ. SH./EPS

- Earning Yield Ratio = (EPS/Market Price Per Share) x 100

 6. LEVERAGES RATIO
-- Capital Gearing Ratio = EQ. SH CAPITAL + RESERVE &
SURPLUS/PREF CAP + LONG TERM DEBT (bearing fixed interest)

- Financial Leverage = EBIT/EARNING BEFORE INTEREST AND TAX

AND PREF DIV

- Operating Leverage = CONTRIBUTION ( = SALES-VARIABLE

COST)/EBIT

- Combined Leverage = Leverage x Operating Leverage

 FINACIAL
FORECASTING ,
PLANNING AND
BUDGETING
 Thank you
for listening!