© Prentice-Hall of India Private Limited, All rights reserved.1 Financial Accounting: A Managerial Perspective Second Edition Prepared by R. Narayanaswamy Indian Institute of Management Bangalore

© Prentice-Hall of India Private Limited, All rights reserved.2 Financial Statement Analysis Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.3 Objectives of Financial Statement Analysis  Evaluation of past performance and financial position  Prediction of future performance Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.4 Standards of Comparison  Rule-of-thumb indicators  Can be applied across firms and industries  Too general to be of use in specific companies  Past performance of the company  Past is a useful indicator  A firm’s competition is with other firms, not with own past  Industry standards  Getting comparable firms is difficult Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.5 Sources of Information  Company reports  Stock exchanges  Business periodicals  Information services Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.6 Quality of Earnings  What is quality of earnings?  Accounting methods and estimates used  Extraordinary items  Prior period adjustments  Discontinuing operations  Changes in accounting policies  Income from non-operating sources Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.7 Using Financial Ratios  Profitability  Liquidity  Solvency  Capital market standing Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.8 Profitability  Profit margin  Asset turnover  Return on assets or return on investment  The Du Pont financial analysis  Return on equity  Effect of leveraging  Earnings per share Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.9 Liquidity  Current ratio  All current assets  Quick ratio  Excludes inventories  Debtor turnover  Average debt collection period  Inventory turnover  Operating cycle Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.10 Solvency  Debt-to-equity ratio  Use of leverage  Liabilities-to-equity ratio  Interest coverage ratio Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.11 Capital Market Standing  Price-earnings ratio  Dividend-yield  Price-to-book ratio  Beta Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.12 Corporate Disclosure Policy  Voluntary disclosure  Why do firms provide voluntary disclosures?  Factors that influence disclosure level  Capital market  Competitors  Managerial reputation  Shareholder litigation  Disclosure level and the cost of capital Chapter 11

© Prentice-Hall of India Private Limited, All rights reserved.13 Efficient Market Hypothesis and Financial Statement Analysis  The efficient market hypothesis  Accounting information affects stock prices, but...  The market is not fooled by accounting method differences  Mandatory disclosures do not evoke significant stock price reaction Chapter 11