Financial Statement Analysis

Question 1

What is the objective of the financial statement analysis?

Answer 1

To gain information about the overall situation and performance of the company.

Question 2

What kind of information are financial statement users needing from an analysis?

Answer 2

Earnings forecast (equity investors)
Business valuation (potential future investors)
Insolvency forecast (creditors)
Corporate benchmarking (competitors)
Corporate development (analysts, public)
Time series analysis (identifying trends)

Question 3

What are the information sources to create a financial statement analysis?

Answer 3

Single / consolidated fin. statements:
- Financial position (Balance sheet)
- comprehensive income
- cash flows
- changes in equity
- notes to the accounts
- segment reporting

Management report

Question 4

What are the different types of financial statement analyses?

Answer 4

Financial Analysis, Performance Analysis, Analysis of investment potential

Question 5

What are the different Benchmarking methods?

Answer 5

Past period achievements, budgeted achievements, other business achievements, averages of business achievements in the same area

Question 6

What is a ratio and what types of ratios are there?

Answer 6

A ratio expresses the mathematical relationship between two or more items from the financial statements that are logically linked.

Ratios that measure financial strength.
Ratios that measure performance.
Ratios that measure investment potential.

Question 7

What are the Financial status ratios and what do they implement?

Answer 7

Investment Ratios:
Indicate the nature and composition of assets and analyze the operating cycle.

Solvency Ratios:
Indicate the ability of the company to generate cash internally and from external sources in order to meet long-term financial obligations.

Liquidity Ratios:
Indicate the ability of the company to generate cash to meet short-term obligations.

Question 8

What are the three investment ratios?

Answer 8

Non-current asset ratio, Turnover ratios, Operating cycle & cash gap

Question 9

Explain the following:

non current assets / total assets

Answer 9

Non-current asset ratio (Investment Ratio; Financial Measurement)

provides insights into the extent to which a company relies on long-term assets in its operations. It indicated the proportion of a company´s asset base that is invested in long-term, fixed assets.

The lower it is:
- the higher the entities flexibility
- the higher the entities potential liquidity
- the higher the entities adaptability

The higher it is:
- the higher the tied up capital
- the higher the market entry barriers

The noncurrent asset ratio is highly industry specific (manufacturing vs. service companies)

Question 10

Explain the following:

Cost of goods sold / Average inventory

Answer 10

Inventory turnover (Turnover Ratio, Financial Measurement)

Turnover ratios reflect the number of times assets flow into and out of the company during the period. Turnover ratios reflect the efficiency and effectiveness with which a company utilizes its assets to generate sales or revenue. -> A turnover is a gauge of the efficiency of putting assets to work.

How many times inventory is created and sold during the period.

Question 11

Explain the following:

Total revenue / Average receivables

Answer 11

Receivables turnover (Turnover ratio; financial measurement)

Turnover ratios reflect the number of times assets flow into and out of the company during the period. Turnover ratios reflect the efficiency and effectiveness with which a company utilizes its assets to generate sales or revenue. -> A turnover is a gauge of the efficiency of putting assets to work.

How many times accounts receivables is created and collected during the period.

Question 12

Explain the following:

Total revenue / Average total assets

Answer 12

Total asset turnover (Turnover ratio; financial measurement)

Turnover ratios reflect the number of times assets flow into and out of the company during the period. Turnover ratios reflect the efficiency and effectiveness with which a company utilizes its assets to generate sales or revenue. -> A turnover is a gauge of the efficiency of putting assets to work.

The extent to which total assets create revenues during the period.

Question 13

Explain the following:

Total supplier purchases / Average accounts payable

Answer 13

Accounts payable turnover (Turnover ratio; Financial measurement)

Turnover ratios reflect the number of times assets flow into and out of the company during the period. Turnover ratios reflect the efficiency and effectiveness with which a company utilizes its assets to generate sales or revenue -> A turnover is a gauge of the efficiency of putting assets to work.

How many times accounts payable are created and paid off during the period.

Question 14

Explain the following:

365 / turnover ratio = x days

Answer 14

The operating cycle:

The length of time from when a company makes an investment in goods/services to the time it collects cash from its accounts receivable.

Question 15

What is cash gap?

Answer 15

The cash gap shows the amount of time between cash going out and cash coming ack into business from operating activities.

Question 16

What kind of Solvency ratios are there?

Answer 16

Equity, Debt, Debt-to-Equity

Question 17

Explain the following:

borrowed capital / total assets

Answer 17

Debt ratio (Solvency, Financial Measurement)

It can be interpreted as the proportion of a company´s assets that are financed by debt. -> Shows the share of borrowed capital in total capital.

A ratio greater than ! shows that a considerable amount of a company´s assets are funded by debt, which means the company has more liabilities than assets.

The higher the ratio…
- the higher the indebtedness of the entity
- the higher future repayments
- the higher the financial risk
- the higher the future interest expenses

Question 18

Explain the following:

equity capital / total assets

Answer 18

Equity Ratio (Solvency, Financial Measurement)

Equity: the total amount of money that you will receive when the company pays off all its debt, and liquidates its assets. (Asset - Liability)

The equity ratio is a financial metric that measures the proportion of a company´s total assets that are financed by shareholders´ equity. It indicates the extent to which a company´s assets are funded by its owners, rather than external sources such as debt or loans.

The higher the equity ratio, the greater the proportion of a company´s assets that are funded by shareholders´ equity indicating a lower reliance on debt financing.
-> A higher equity ratio reduces entities financial risk
-> A lower equity ratio means a higher debt ratio

! Ratios differ between countries!
- bank-oriented: usually lower ratio
- market-oriented: usually higher ratio

Question 19

Explain the following:

borrowed capital / equity capital

Answer 19

Debt-to-equity ratio (Solvency; financial measurement)

It is an important metric as it is a measure of degree to which a company is financing its operations with debt rather than its own resources.

A high ratio is often associated with high investment risk = a company relies primarily on debt financing.
The higher the debt-to-equity ratio, the higher the entities indebtedness and the financial risk of the company.

> 100% = debt > equity
=100% = debt = equity
<100% = debt < equity

Question 20

What are liquidity ratios?

Answer 20

Fixed assets ratio, quick ratio, cash ratio, current ratio.

Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash. The more liquid an asset is, the easier it is to turn it into cash.

Liquidity is the ability to satisfy the company´s short-term obligations using assets that can be most readily converted into cash.

Question 21

Explain the following:

equity capital + long term debt / net fixed assets

Answer 21

Fixed Assets Ratio (Liquidity; Financial Measurement)

Fixed assets: long term tangible piece of PPE a firm uses to generate income.

Net fixed assets: the residual value of the fixed assets

The fixed assets ratio is a financial metric that measures the efficiency with which a company utilizes its fixed assets to generate sales. It provides insight on how effectively a company is deploying its long-term assets to generate revenue. It offers information about long-term liquidity of the company.

The fixed asset ratio indicated the amount of sales generated per unit of fixed asset investment.
- a higher ratio suggests better utilization and efficiency of fixed assets in generating revenue.

GOLDEN RULE: Fixed assets should be financed by long term funds.
-> A fixed asset ratio > 1 means that all fixed assets are financed by long term funds.
-> the fixed asset ratio should not be reduced below 1.

Question 22

Explain the following:

current assets / current liabilities

Answer 22

Current Ratio (Liquidity; Financial Measurement)

This ratio measures a company´s ability to pay short-term obligations or those due within one year.

-> Ability to satisfy current liabilities using current assets.

Question 23

Explain the following:

current assets - inventories / current liabilities

Answer 23

Quick ratio (Liquidity; Financial Measurement)

The quick ratio measures a company´s ability to meet its short-term obligations with its most liquid assets.

-> Ability to satisfy current liabilities using the most liquid of current assets.

Question 24

Explain the following:

Cash + short term investments / current liabilities

Answer 24

Cash Ratio (Liquidity; Financial Measurement)

Shows a company´s ability to cover its short-term obligations using only cash and cash equivalents.

-> Ability to satisfy current liabilities using only cash and cash equivalents.

Question 25

What does the Performance Analysis encompass?

Answer 25

Margin ratios, Return ratios

Question 26

What are Margin and return ratios?

Answer 26

Margin and return ratios provide information on the profitability and the efficiency of a company.

Margin ratios: Show how successful management is in creating profit from a given quantity of sales.

Return ratios: A comparison of a profit with the investment necessary to generate profit.

Question 27

Explain the following:

(sales - cost of goods sold) / total sales

Answer 27

Gross profit margin (Performance Analysis)

Gross profit: the profit a company makes after deducting the costs associated with making and selling its products, or costs associated with providing its services.

Gross profit = Revenue - costs of goods sold

-> The gross profit margin shows the percentage of gross profit earned from each Euro of revenue.
-> The higher the margin, the better the company´s profitability.

Question 28

Explain the following:

operating profit / total sales

Answer 28

Operating profit margin (Performance Measurement)

Operating profit: A company´s total earnings from its core business functions for a given period.

-> The operating profit margin shows the percentage of operating profit earned from each Euro of revenue.
-> The higher the margin, the better the company´s profitability!

Question 29

Explain the following:

costs of goods sold / total sales or other expenses / total sales

Answer 29

Material intensity (Performance measurement)

Material intensity is the extent to which a company´s operations or products rely on the use of materials.

The ratio compares the cost of materials used in production to the company´s total revenue. It indicates the proportion of revenue allocated to materials.

Question 30

What do efficiency ratios do?

Answer 30

• Efficiency ratios show how much of sales revenues are already consumed by the production costs incurred. -> Therefore, low ratios are preferable in terms of profitability!
• Efficiency ratios can inform about the cost structure of the entity.
• Efficiency ratios should be analyzed over time and compared to competitors to ensure production efficiency.
• These ratios tend to be industry specific.