Financial Statement Analysis Useful for your practical record Rules Read and copy in your practical record

and discuss if you have any doubts. Make sure that these four problems must be recorded under topic Financial statement analysis in your practical record.
SOLVED PROBLEMS
1) A Firms current assets and current liabilities are 1600 and 1000 respectively. How much can it borrow on a short term basis without reducing the current ratio below 1.25? Solution Let the maximum short term borrowings be B. The current ratio with this borrowing should be 1.25. 1600+ B 1000+ B Solving this equation , we get B = 1400. Hence the maximum permissible short term borrowing is 1400. 2) Determine the cost of goods sold of a firm given the following information: Current Ratio Acid Test Ratio Current Liabilities Inventory Turnover Ratio Solution The cost of goods sold figures may be derived as follows: Current assets = Current liabilities * Current ratio =1,600*1.4 = 2240 = 1.4 = 1.2 = 1,600 =8 = 1.25

Current assets-Inventories

=Current liabilities * Acid test Ratio

=1,600 *1.2 =1,920 Inventories Sales =2,240-1920= 320 =Inventories*inventories turnover ratio =320*8 = 2,560

3) The following ratios are given for Mintex Company Net profit Margin ratio Current ratio Return on net worth = 4% =1.25 =15.23 %

Total debt to total assets ratio =0.4 Inventory turnover ratio =25

Complete the following statements Profit and Loss Account Rs. Sales Cost of goods sold Operating expenses PBIT Interest PBT Tax provisions(50%) PAT ------------------------------700 ------

Balance Sheet Net Worth Long Term Debt(10% interest) Short Term Debt(10.42% interest) ---Fixed Assets Current Assets -------------------Cash Receivables Inventory 180 ----

Solution: The blanks in the above statements may be filled as follows: a) Short term debt. The value of the short term debt the only current liabilities is derived as follows.

Current assets Current ratio = ----------------------- = 1.25 Current liabilities

Current assets 180 Current liailities = ----------------------- = -------- = 144 1.25 1.25

So ,the short term debt is 144.

b) Long term debt. The long term debt carries 10% interest rate. Hence the long term debt is equal to Interest -.1042(144) 45-15 -------------------------- = -------- = 300 0.10 c) Total Assets: As the ratio of the total debt to total assets is 0 .4, total assets(the total of the balance sheet) is simply: Total Debt 144 +300

------------- = ------------ = 1110 0.4 0.4

d) Net Worth: The difference between the total assets and the total debt represents the net worth. Hence it is equal to: 1110-(444)=666 e)Fixed Assets: The difference between the total assets and the current assets represents fixed assets. So , Fixed Assets = 1110-180 = 930

f) Profit after tax(PAT): This is equal to: net worth * return on net worth = 666*0.1523 =101.40 g)Tax : As the tax rate is 50 %, the tax provision is simply equal to the profit after tax ,i.e,101.4 h) Profit before tax :The sum of the profit after tax and the tax provisions is equal to the profit before tax. So ,it is equal to: 101.4 + 101.4 = 202.8

i) Profit before interest and taxes: This is equal to profit before tax plus the interest payment .Hence it is equal to: 202.8 + 45 = 247.8 j) sales : The figure of sales may be derived as follows: Profit after tax 101.4

------------------- ----------= ---------- = 2535 Net profit margin ratio 0.04

k) Cost of goods sold : This figure of cost of goods sold may be derived from the following accounting identity: Sales- Cost of goods sold operating expenses = PBIT 2535- cost of goods sold 700 = 247. 8 Hence the figure of cost of goods sold is l) Inventory: This is equal to: cogs ------------------------------- = Inventory turnover ratio 1587.2 -------------- = 63 25 1587.2

m) Cash : This may be obtained as follows: Current assets receivables-inventory = 180-60-63 = 57

4. The financial statements of Matrix limited are given below: Matrix Limited: Profit and Loss Account for the year ending 31st March 20X1

(Rs. In Million)

20X1
Net sales Cost of goods sold Stocks Wages and salaries Other manufacturing expenses Gross profit Operating expenses Depreciation Selling and general administration Profit before interest and tax Interest Profit before tax Tax Profit after tax Dividends Retained earnings 1065 805 600 120 85 260 90 50 40 170 35 135 50 85 35 50

20X0
950 720 520 110 90 230 75 40 35 155 30 125 40 80 30 50

Matrix Limited: Balance sheet as at 31st March 20X1 Rs. In Million 20X1 Sources of Funds 1. Shareholders funds
(a) Share capital (b) Reserve and surplus 2. Loan funds (a) Secured loans (i) Due after 1 year (ii)Due within 1 year (b)Unsecured loans (i) Due after 1 year (ii)Due within 1 year Total II Application of Funds 1.Net Fixed Assets 2.Investments (a) Long term investments (b) Current investments 3. Current assets, loans and advances (a) Inventories (b) Sundry Debtors (c) Cash and bank balances (d) Loans and advances Less: Current liabilities and provisions Net current assets Total

20X0

505
125 380 280 180 130 50 100 60 40 785

455
125 330 260 160 135 255 100 70 30 715

550 30 20 10 355 160 120 25 50 150 205 785

495 25 20 5 333 138 115 20 60 13 195 715

a. Calculate the following ratios

Current ratio Acid-test ratio Cash ratio Debt-equity ratio Interest coverage ratio Fixed charges coverage ratio Inventory turnover ratio Debtors turnover ratio Average collection period Fixed assets turnover Total assets turnover Gross profit margin Net profit margin Return on assets Earning power Return on equity

b. Set up the DuPont equation Solution a. Current ratio = Current assets, loans and advances + current investments Current liabilities and provisions + short term debt

= 355 + 10 = 1.52 150 + 90 Interpretation: One unit of current liability is supported by 1.52 units of current assets. Acid-test ratio = Quick assets Current liabilities = 365 160 = 0.85 240

Interpretation: One unit of current liability is supported by 0.85 units of quick assets. Thus huge load of inventory is indicated by significant difference between current ratio and quick ratio. Cash ratio = Cash and bank balances + Current investment Current liabilities = 25 + 10 = 0.15 240

Interpretation: One unit of current liability is supported by 0.15 units of cash.

Debt-equity ratio =

Debt = Equity

280 505

0.55

Interpretation: This is favourable as debts are less as compared to equity.

Interest coverage ratio = PBIT

= 170 =

4.9

Interest

35

Thus we have 4.9 units of PBIT available for one unit of interest. Fixed charges coverage ratio = PBIT + Depreciation Interest + Repayment of loan 1-Tax rate Inventory turnover = Cost of goods sold Average inventory = 805 (160 + 138)/2 = 170 +50 35+90 1- .37 = 5.40 = 1.24

Thus inventory are turned into outputs 5.4 times in a year. Thus average day of supply between two consecutive supply is 365/5.4= 66 days. Debtors turnover = Net credit sales = 1065 = 9.06 Average debtors (120 + 115)/2 Debtors are turning into cash approx 9times in a year. Average collection period = 365 365 = 40.3 days Debtors turnover = 9.06 On an average basis debtors are turning into cash after every 40 days. Thus we have effective credit policy.

Fixed assets turnover = Net sales Average net fixed assets

1065 = (550 + 495)/2

2.04

Total assets turnover =

Net sales Average Total assets

1065 = (785 + 715)/2

1.42

Gross profit margin =

Gross profit = 260 = 24.4% Net sales 1065 Interpretation: It is favourable as it shows efficiency of production.

Net profit margin

Net profit = 85 = 7.98% Net sales 1065 Interpretation: It is unfavourable as net profit ratio is very low and it means firm has very much indirect expenses.

Return on assets

Net profit Average total assets

85 = 11.3% (785 + 715)/2

Interpretation: This is favourable as the assets invested in the business are giving satisfactory return.

Earning power

PBIT Average total assets

170 = 22.7% (785 + 715)/2

Interpretation: It is favourable as earning power of the firm is satisfactory.

Return on equity =

Equity earnings Average equity

85 = 17.7% (505 + 455)/2

Interpretation: It is favourable as it is showing satisfactory return on equity.

b. DuPont equation Return on equity = Net profit margin x Total assets turnover ratio x leverage multiplier Net profit Net sales 85 1065 x x Net sales Average total assets 1065 x (785 + 715)/2 x Average total assets Average equity (785 + 715)/2 (504 + 455)/2

= =

= =

7.98% x 1.42 x 1.5625 17.7%