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Financial Management
MBA ZG 521
BITS Pilani Krishnamurthy Bindumadhavan, CFA, FRM

Associate Professor, Management - Finance
Pilani Campus
Email: k.bindumadhavan@pilani.bits-pilani.ac.in
BITS Pilani
Pilani|Dubai|Goa|Hyderabad
Financial Statements Analysis

- Part 1
FSA - Agenda
• Session overview/ objectives
• Principles of Financial Statements Analysis
• Tools and Techniques used in financial statements analysis
• Horizontal Analysis
• Vertical Analysis
• Ratio Analysis
• Introduction to Ratio Analysis
• Calculation of all key ratios (and their interpretation)
• Activity
• Liquidity
• Solvency
• Profitability
• Valuation ratios
• Basic Dupont Analysis - Application and interpretation
• Limitations of financial statements analysis
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

References
Module Title: Foundations of Financial Management
Topic Title Reference
Principles of Financial Statements Analysis Chapter 3, 4, 5, and 6 of text (T1)
Tools and Techniques used in financial statements Chapter 3, 4, 5, and 6 of text (T1)
analysis
Limitations of financial statements analysis Chapter 3, 4, 5, and 6 of text (T1)
Topic Title Reference

Introduction to Ratio Analysis Chapter 3, 4, 5, and 6 of text (T1)
Calculation of all key ratios including Activity, Liquidity, Chapter 3, 4, 5, and 6 of text (T1)
Solvency, Profitability and Valuation ratios and their
interpretation
Application of Dupont Analysis and its interpretation Chapter 3, 4, 5, and 6 of text (T1)

Objective of Financial Statements
Analysis
Financial statement analysis helps various stakeholders (such as investors,
lenders, etc.) to make better decisions by assessing the present condition of
the firm and comparing it to past periods or to industry peers.
Internal Stakeholders:
• Managers
• Officers
• Internal Auditors
External Stakeholders:
• Shareholders
• Lenders
• Customers

Internal Financial Analysis
• To evaluate the performance of employees and determine their pay raises

and bonuses
• To compare the financial performance of the firm’s different divisions
• To prepare financial projections, such as those associated with the launch

of a new product
• To evaluate the firm’s financial performance in light of its competitors and

determine how the firm might improve its operations

External Financial Analysis
• Banks and other lenders deciding whether to lend money to the firm.
• Suppliers who are considering whether to grant credit to the firm.
• Credit-rating agencies trying to determine the firm’s creditworthiness.
• Investment analysts who work for investment companies considering investing in

the firm or advising others about investing in the firm.
• Individual investors deciding whether to invest in the firm.

Basic Accounting Principles
The following three fundamental principles are adhered to by

accountants when preparing financial statements:
• The revenue recognition principle

• The matching principle
• The historical cost principle
An understanding of these basic principles allows us to be a more

informed user of financial statements and thereby be more
effective in our analysis

Revenue recognition principle
• According to this principle, revenue should be included in the

firm’s income statement for the period in which:
• Goods and services were exchanged for cash or

accounts receivable (OR)
• The firm has completed what it needs to do to be

entitled to the cash

Matching principle
• The matching principle determines whether specific costs or

expenses can be attributed to this period’s revenues
• The expenses are matched with the revenues they helped

produce:
• For example, employees’ salaries are recognized when the
product produced as a result of their work is sold, and not
when the wages were paid

Historical cost principle
• This principle is the basis for determining the dollar amounts

the firm reports in its balance sheet.
• Most assets and liabilities are reported in the firm’s financial

statements at historical cost i.e. the price the firm paid to
acquire them.
• The historical cost generally does not equal the current

market value of the assets or liabilities.

Tools and Techniques
1) Common size/ Vertical financial statements analysis:

• This is a standardized version of a financial statement in which all entries are
converted into percentages of a key financial statement component
• A common size financial statement helps to compare entries in a firm’s financial
statements, even if the firms are not of equal size.
2) Horizontal financial statements analysis:
• Here also all entries are presented in percentages
• However the focus is on trends over time
• Horizontal financial statements analysis helps a financial statement user to see
relative changes over time and identify both positive and negative trends
3) Ratio Analysis
• Ratio Analysis is another method for standardizing the financial information on the
income statement and balance sheet.
• A ratio is typically compared to:
• Ratios from previous years
• Ratios of peers (other firms in the same industry)
• If differences are significant a more in-depth analysis will help uncover the drivers

Thank You
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Financial Management

BITS Pilani Krishnamurthy Bindumadhavan, CFA, FRM

Financial Statements Analysis

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Topic Title Reference

Principles of Financial Statements Analysis Chapter 3, 4, 5, and 6 of text (T1)

Topic Title Reference

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

• To evaluate the performance of employees and determine their pay raises

• To compare the financial performance of the firm’s different divisions

• To prepare financial projections, such as those associated with the launch

• To evaluate the firm’s financial performance in light of its competitors and

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

• Suppliers who are considering whether to grant credit to the firm.

• Credit-rating agencies trying to determine the firm’s creditworthiness.

• Investment analysts who work for investment companies considering investing in

• Individual investors deciding whether to invest in the firm.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

The following three fundamental principles are adhered to by

• The revenue recognition principle

An understanding of these basic principles allows us to be a more

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

• According to this principle, revenue should be included in the

• Goods and services were exchanged for cash or

• The firm has completed what it needs to do to be

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

• The matching principle determines whether specific costs or

• The expenses are matched with the revenues they helped

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

• This principle is the basis for determining the dollar amounts

• Most assets and liabilities are reported in the firm’s financial

• The historical cost generally does not equal the current

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

1) Common size/ Vertical financial statements analysis:

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

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