Financial Analysis

By Walid Badr
Oct. 2024
AUC- SCE
Objectives

Understand the concept of financial analysis and its

purpose

Understand Key Financial Statements

Interpret Financial Ratios

Conduct Financial Analysis

Understand the Role of Financial Analysis in Strategic

Planning
Understand the concept of
financial analysis and its
purpose
Financial Analysis Definition and purposes
Definition of Financial Analysis

Financial analysis is the process of evaluating a

company's financial data to assess its performance,

stability, and profitability

This analysis involves examining financial statements to:

 identify trends

 measure financial health

 make informed decisions about investments, budgeting, and future

strategies
Purpose of Financial Analysis

Financial analysis is crucial for businesses because it

provides a clear understanding of their financial health and

helps drive strategic decision-making. Here’s why:

Budgeting and Forecasting: Financial analysis is essential for creating

Risk
Cash Identification
Informed and Management:
FlowDecision-Making:
Management: By analyzing
Financial It helps
cash
analysis inassess
flow, identifying
businesses potential
can ensure
Performance
Profitability
Investment
realistic budgets Evaluation:
Attractiveness:
Analysis: It allows
It enables
and forecasting businesses
A thorough
businesses
future to guides
to
financial
financial
management
determine
analysistheir
performance, their
helps in in that
financial
ensuring
profitability
presentingare
resources the
through
company’s
metrics
allocated financial
like gross
efficiently. stability
and netto profit
investors,
margins,
stakeholders,
helping them
and
financial
they
makinghave risks and
enough
data-driven
performance, devising
liquidity
comparing strategies
to cover
decisions, such
revenues, to mitigate
day-to-day
as them,
operations
investments, such as excessive
and avoid
expansions, cost-
evaluate
lenders,
Overall, increasing
the effectiveness
financial the likelihood
analysis of their
provides aexpenses,
ofoperational
securing profits,
roadmapinvestments and or
strategies
for improving losses
loans over time.
operational
efficiency, enhancing profitability, and ensuring long-term sustainability
debt or measures,
financial
cutting
This helpsdeclining
shortfallssales
or pricing
in identifying strategies
strengths and areas for improvement
Purpose of Financial Analysis

Internal Purposes External Purposes

 Decision-making
 Investor relations
 Cost management
 Credit Assessment
 Cash Flow
 Evaluating
Management
 Investment choices Performance
Financial Statements
Balance Sheet, Income Statement, Statement of Shareholders
Equity, Statement of Cash Flows
Financial Statements

Balance Sheet Income Statement

Financial
Statement
s
Statement of Statement of Cash
Shareholders Flows
Equity
Balance Sheet

It can be called “Statement of Financial Position” too, it

provides information on what the company owns (assets)
and what it owes (liabilities) as of a particular date

Presents information on the financial position of a business on a

specific date
Balance Sheet Components

- Current - Current -
Assets Liabilities Shareholder
s Equity
- Long Term - Long Term
Assets Liabilities
Balance Sheet Components

Liabilitie
s

Asset
s
Equity
Balance Sheet Components - Assets
Resources owned or - Current Assets are assets
controlled by a firm that are expected to be converted into cash
expected to provide future or used up within one year
economic benefits - Long term Assets are assets not
expected to be converted into cash
within one year

Current Assets
Assets

Long Term Assets

Balance Sheet Components -
Liabilities
- Current Liabilities are obligations
Financial Obligations or debts that are expected to be settled within
a firm owes to others one year or operating cycle, which
is longer
- Long term Liabilities are
Obligations are due after one year

Current Liabilities
Liabilities

Long Term Liabilities

Balance Sheet Components –
Shareholders Equity
Also known as owners' equity or stockholders' equity

It represents the residual interest in the assets of a firm after

deducting its liabilities

It is a key indicator of the financial health of a firm, as it reflects the

net worth of the company owned by its shareholders
Balance Sheet - Example

manager guide [Link]

Income Statement

Provides information regarding the results of a company’s

operations for a specified period of time (a year, for example)

Net income indicates the profitability of the firm and is often used as
a benchmark to determine dividend payments.
Income Statement Components

Refers to the total Refer to the costs a

amount of money business incurs in
generated by a its effort to
business from its generate revenue
normal operation,
typically through
the sale of goods
and services
Income Statement- Example

manager guide [Link]

Statement of Shareholders Equity

Presents the beginning and ending balances in the

shareholders’ equity accounts and the changes that occurred
in these accounts during the accounting period
Statement of Shareholders Equity-
Example
manager guide [Link]
Statement of Cash Flows

Provides a detailed summary of how cash moves in and out

of a business over a specific period of time

There are two common formats for presenting the Cash Flow
Statement: the direct method, and the indirect method
Statement of Cash Flow – Indirect
Method

This section Refer to the refer to

tracks cash cash inflows transactions
inflows and and outflows that result in
outflows from associated changes to the
the regular, with the company’s
day-to-day acquisition or capital
operations of a disposal of structure
business long-term
assets and
Statement of Cash Flow – Indirect
Method
The rule governing the relationship between Cash & Assets ,
and Cash & Liabilities is:

The relationship between Assets and Cash is negatively correlated:

an increase in assets leads to a decrease in cash, and vice versa

The relationship between Liabilities and Cash is positively

correlated: an increase in liabilities leads to a increase in cash, and
vice versa
Statement of Cash Flow- Example

manager guide [Link]

Financial Statements - Conclusion
Financial statements provide a comprehensive picture of a company’s financial
health, including its performance, liquidity, and shareholder equity

Analyzing the Balance Sheet, Income Statement, Cash Flow Statement, and
Statement of Shareholders’ Equity offers valuable insights for decision-making

The Audit Report ensures the accuracy and reliability of the financial information

The Notes to the Financial Statements provide essential details and context for a
complete understanding of the numbers

Together, these components form the foundation for evaluating a company’s

financial stability and making informed business or investment decisions
Financial Statement Analysis
Horizontal, Vertical, and Ratio Analysis
Horizontal Analysis

Analyzing the increases and decreases in a given financial statement

item over two or more periods is called horizontal analysis

The changes are shown both in dollar amounts and as a percentage

The percentage change is computed by dividing the dollar amount of

the change by the amount of the financial statement item for the
earlier period

manager guide [Link]

Vertical Analysis
Vertical analysis is used to examine the elements of financial
statements of a single period, Such statements are often called
common-size financial statements

For the balance sheet, each element is shown as a percentage of

total assets

For the income statement, each element is shown as a percentage of

net sales

manager guide [Link]

Ratio Analysis
Financial ratios are intended to evaluate a company’s operating,
investing, and financing strategies considered in both historic and
prospective contexts

The analysis may be done for a company over a period of time, or for
a company in comparison to another firm or industry statistics at a
specific point in time
Investors in a company’s stock are mainly interested in profitability,
both in the short-run and the long-run.
Short-term creditors are concerned with liquidity, long-term creditors
want to know whether the company will be able to meet its
obligations for interest payments and principal repayment over the
time horizon of the debts
Ratio Analysis Categories

Profitability Liquidity

Financia
l Ratios

Activity Debt & Equity

 Profitability Ratios
Ratio Formula Unit Description

Gross Profit Margin Gross Profit / Net % Indicating how efficiently a company
Sales produces or sells its products

Net Profit Margin Net Profit / Net Sales % Indicating how much profit a company
generates from its total sales

Operating Profit Operating Profit / % Indicating a company's efficiency in

Margin Net Sales managing its core business operations

Return on Assets Net Profit / Average % Indicating how efficiently a company uses
(ROA) Total Assets its assets to generate profit

Return on Equity Net Profit / Average % Indicating how effectively a company uses
(ROE) Total Shareholders shareholders' equity to generate profit
Equity
 Profitability Ratios … Cont.
Ratio Formula Unit Description

Earning per Share (Net Profit – $ indicating the portion of a company's profit
(EPS) Preferred Stock allocated to each outstanding share
Dividends) /
Weighted Average
Number of Common
Shares Outstanding
Price Earning Ratio Share Market Price / Times Indicating how much investors are willing
(PE) Earning per Share to pay per dollar of earnings

Dividend Yield Dividend per Share / % Indicating the percentage of a company's

Share Market Price stock price that is paid out as dividends
annually
Dividend Payout Total Dividends to % Indicating the percentage of a company's
Common Shares / earnings distributed to shareholders as
Net Profit dividends
 Liquidity Ratios
Ratio Formula Unit Description

Working Capital Current Assets – $ Indicating a company's short-term financial

Current Liabilities health and operational efficiency

Current Ratio Current Assets / Times Indicating a company's ability to meet its
Current Liabilities short-term liabilities with its short-term
assets, assessing liquidity and financial
stability
Quick Ratio (Cash + Marketable Times Indicating a company's ability to meet its
Securities + short-term liabilities with its most liquid
Receivables) / assets, excluding inventory, providing a
Current Liabilities stricter measure of liquidity than the
current ratio
 Activity Ratios
Ratio Formula Unit Description
Inventory COGS / Average Times Indicating how efficiently a company manages its
Turnover Inventory inventory by measuring how many times inventory is
sold and replaced over a specific period
Inventory Days 365 / Inventory Day Indicating the average number of days a company takes
on Hand Turnover to sell its entire inventory, reflecting inventory
management efficiency and sales performance
A/R Turnover Net Credit Sales / Times Indicating how efficiently a company collects payments
Average Accounts from its credit customers
Receivables
A/R Days 365 / A/R Turnover Day Indicating the average number of days it takes a
company to collect payment from its customers after a
sale, reflecting the efficiency of credit and collection
processes
A/P Turnover Net Credit Times Indicating how quickly a company pays off its suppliers
Purchases /
Average Accounts
Payables
A/P Days 365 / A/P Turnover Day Indicating the average number of days a company takes
to pay its suppliers after receiving goods or services,
reflecting its cash flow management and payment
 Activity Ratios …Cont.
Ratio Formula Unit Description
Assets Turnover Net Sales / Times Indicating how efficiently a company uses its assets to
Average Total generate revenue
Assets
 Debt and Equity Ratios
Ratio Formula Unit Description

Debt to Equity Ratio Debt / Shareholders Times Indicating the proportion of a company's
Equity financing that comes from debt versus
shareholders' equity, showing its financial
leverage and risk level
Equity Multiplier Total Assets / Times Indicating a company's financial leverage
Shareholders Equity by showing how much of its assets are
financed by shareholders' equity versus
debt
Times-Interest- EBIT / Interest Times Indicating how easily a company can cover
Earned Ratio Expenses its interest expenses with its operating
income, reflecting its financial stability and
ability to meet debt obligations
Assets Conversion Cycle
The assets conversion cycle (also known as the cash conversion
cycle) measures the time it takes for a company to convert its
investments in inventory and other operational inputs into cash flow
from sales

+ Inventory Days on Hand

+ A/R Days
- A/P Days

This cycle helps assess a company’s efficiency in managing its

working capital and liquidity
DuPont Analysis
The DuPont analysis is a financial performance framework that
breaks down a company's return on equity (ROE) into three
components

(Net Profit Margin) X Assets Turnover X Equity Multiplier

Net Income Sales Total Assets

= --------------- X -------------- X ------------------------------
Sales Total Assets Shareholders
Equity
DuPont analysis helps identify the drivers behind a company's ROE
and provides insight into profitability, efficiency, and financial
leverage
 Altman “Z” Score
It is a formula used to predict the likelihood of a company entering
bankruptcy within two years. It combines various financial ratios,
weighted by coefficients,Retained
Working Capital
to generate
Earnings
a single score that
EBIT
indicates
Equity Market Value
financial
Sales health
Z=(1.2 X -------------------)+(1.4 X ---------------------)+(3.3 X --------)+(0.6 X-------------------------)
+(1X-----------)
Total Assets Total Assets Total Total Liabilities
Total
Assets
Assets
Z-score > 2.99: Low risk of bankruptcy (safe zone).
Z-score between 1.8 and 2.99: Moderate risk (grey zone).
Z-score < 1.8: High risk of bankruptcy (distress zone).
The Z-score helps investors and analysts assess a company's financial
stability and credit risk
Understand the Role of Financial
Analysis in Strategic Planning

manager guide [Link]