1. FINANCIAL STATEMENT ANALYSIS
(RATIO ANALYSIS)

2. FINANCIAL STATEMENTS SOLVENCY RATIOS
Financial Structure Analysis (Solvency Ratios):
This category of ratios are used to determine the ability of a company to meet long-term obligations.
Financial structure analysis enables to determine capital structure of a company. Capital structure refers to the sources of financing for a company. Capital structure is a significant issue in analyzing the company’s financial stability and risk of insolvency depend on its financing activity and decisions.

3. The Importance of Financial Structure Analysis
FINANCIAL STATEMENTS
SOLVENCY RATIOS
The Importance of Financial Structure Analysis
Capital structure consists of debt and equity (financial leverage ratio). A company’s financial stability and risk of insolvency depend on its financing sources and the types of assets.
Assets refer to investing activity, debt and equity refer to financing activity of an entity.
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
Cash and cash equivalents
Bank Loans
Financial Assets
Trade Payables
DEBT STRUCTURE
Trade Receivables
Tax Payable
Inventories
Provisions
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
Property, Plant and Equipment
EQUITY

4. Financial Structure Analysis
FINANCIAL STATEMENTS
SOLVENCY RATIOS
Financial Structure Analysis
(Solvency Ratios):
Solvency ratios consists of;
Common-sized ratios.
Debt to Equity Ratio and
Financial Leverage Ratio,
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
Cash and cash equivalents
Bank Loans
Financial Assets
Trade Payables
DEBT STRUCTURE
Trade Receivables
Tax Payable
Inventories
Provisions
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
Property, Plant and Equipment
EQUITY

5. FINANCIAL STATEMENTS SOLVENCY RATIOS
Common-Sized Ratios (Vertical Analysis)
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
Cash and cash equivalents
Bank Loans
Financial Assets
Trade Payables
Trade Receivables
Tax Payable
Inventories
Provisions
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
Property, Plant and Equipment
EQUITY

6. FINANCIAL STATEMENTS SOLVENCY RATIOS
Debt to Equity Ratio (Capitalization Ratio)
Debt to Equity ratio refers to the ability of equity in covering total debt.
In traditionally financed companies, this ratio equals to 1. The increase in this ratio means the proportion of debts is increasing and the equity is not enough to cover the total debt.
The use of debt is not necessarily a negative signal about a firm. In interpreting these measures, the financial leverage index and coverage ratios must be taken into account.
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
EQUITY

7. FINANCIAL STATEMENTS SOLVENCY RATIOS Financial Leverage Ratio:
Financial Leverage Ratio indicates the proportion of debt, in other words the proportion of asset financed with debt.
This ratio measures the claims of creditors on the firm’s assets.
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
DEBT STRUCTURE
Property, Plant and Equipment
EQUITY

8. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
Financial Leverage
(Debt Structure)
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
EQUITY
Leverage means use of debt in the capital structure of the firm.
How much leverage should be there in a firm?

9. Why is the leverage important?
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
ABC CO X1 BALANCE SHEET
CURRENT ASSETS
CURRENT LIABILITIES
Financial Leverage
(Debt Structure)
NON-CURRENT ASSETS
NON-CURRENT LIABILITIES
EQUITY
Why is the leverage important?
Because of two reasons:
a higher debt ratio can increase the rate of return on equity capital during good economic times (depend on interest rate)
a higher debt ratio also increases the risk of the firm’s earnings stream

10. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
For Example
The expected Earnings Before Interest and Taxes (EBIT) of ABC Co. is $ 50 and plans to invest a fixed asset which costs $100 (or total assets=$100). The average rate of interest is %30 and the tax rate is %20.
I. Case: ABC Co. intends to use 100% of equity in financing the investment
II. Case: ABC Co. intends to use 50% of equity and 50% of debt to finance the investment
III. Case: ABC Co. intends to use 50% of equity and 50% of debt to finance the investment and the interest rate is %60.

11. I. CASE: %100 Equity, Investment= 100 TL
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
I. Case:
ABC Co. intends to use 100% of equity in financing the investment costs 100 TL. EBIT= 50 TL, Interest Rate=30%, Tax Rate = 20%
I. CASE: %100 Equity, Investment= 100 TL
Earnings Before Interest and Tax (EBIT) 50
Interest Expense -
Earnings Before Tax
Tax (50 *0,2)
(10)
Net Income 40
Return on Equity (Net Income/Equity)
40/100=40%

12. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
II. Case:
ABC Co. intends to use 50% of equity and 50% of debt to finance the investment costs 100 TL. EBIT= 50 TL, Interest Rate=30%, Tax Rate = 20%
I. CASE: %100 Equity, Investment=100 TL
II. CASE: %50 Equity, %50 Debt, Investment =100 TL
Earnings Before Interest and Tax (EBIT) 50
EBIT
Interest Expense -
Interest Expense (50*0,30) 15
Earnings Before Tax 35
Tax (50 *0,2)
(10)
Tax (35 * 0,2)
(7)
Net Income 40 28
Return on Equity (Net Income/Equity)
40/100=40%
Return on Equity
28/50=
56%

13. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
III. Case:
ABC Co. intends to use 50% of equity and 50% of debt to finance the investment costs 100 TL and the interest rate is %50: EBIT= $50, Interest Rate=60%, Tax Rate = 20%.
I. CASE: %100 Equity, Investment 100 TL
II. CASE: %50 Equity, %50 Debt, Investment = 100 TL
Interest rate = %30
III. CASE: %50 Equity, %50 Debt, Investment = 100
Interest rate=60%
EBIT 50
Interest Expense -
Interest Expense (50*0,30) 15
Interest Expense (50*0,60) 30
Earnings Before Tax 35 20
Tax (50 *0,2)
(10)
Tax (35 * 0,2)
(7)
Tax (20 * 0,2)
(4)
Net Income 40 28 14
Return on Equity (Net Income/Equity)
40/100=40%
Return on Equity
28/50=56%
14/50= 28%

14. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
I. CASE: %100 Equity, Investment 100 TL
II. CASE: %50 Equity, %50 Debt, Investment = 100 TL
Interest rate = %30
III. CASE: %50 Equity, %50 Debt, Investment = 100
Interest rate=60%
EBIT 50
Interest Expense -
Interest Expense (50*0,30) 15
Interest Expense (50*0,60) 30
Earnings Before Tax 35 20
Tax (50 *0,2)
(10)
Tax (35 * 0,2)
(7)
Tax (20 * 0,2)
(4)
Net Income 40 28 14
Return on Equity (Net Income/Equity)
40/100=40%
Return on Equity
28/50=56%
14/50= 28%
As you see in this example since interest is a fixed cost (which can be written off against revenue) a debt can cause an increase in return o equity without a corresponding increase in the equity.
But in making capital budgeting decisions the interest rate must be taken into account. As you see in case III, the return on equity decreases to 28%, in order to increase in interest expense.
The financial leverage ratio must be interpreted by regarding profitability ratios.

15. LEVERAGE AND PROFITABILITY
FINANCIAL STATEMENTS
LEVERAGE AND PROFITABILITY
I. CASE: %100 Equity, Investment=100 TL
II. CASE: %50 Equity, %50 Debt, Investment = 100 TL
III. CASE: %50 Equity, %50 Debt
Interest rate=60%
Earnings Before Interest and Tax (EBIT) 50
EBIT
Interest Expense -
Interest Expense (50*0,30) 15
Interest Expense (50*0,60) 30
Earnings Before Tax 35 20
Tax (50 *0,2)
(10)
Tax (35 * 0,2)
(7)
Tax (20 * 0,2)
(4)
Net Income 40 28 14
Return on Equity (Net Income/Equity)
40/100=40%
Return on Equity
28/50=56%
14/50= 28%
Return on Total Capital
/100=50%
/100=48%
Financial Leverage Ratio
Financial Leverage
%50
For III. Case we cannot mention about the advantage of financial leverage.

16. Assets ABC CO. Balance Sheet 1.1.20X1 Liabilities
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Assets ABC CO. Balance Sheet X1 Liabilities
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Profitability ratios identify the success of the management in managing operating, financing and investment activities.
Income Statement X X1
I. Sales
II. Cost of Goods Sold (-)
Gross Profit/Loss
III. Operating Expenses (-)
Operating Profit/Loss
IV. Other Revenue and Income
IV. Other Expense and Loss
V. Interest Expense
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

17. Assets ABC CO. Balance Sheet 1.1.20X1 Liabilities
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Assets ABC CO. Balance Sheet X1 Liabilities
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Profitability analysis is important for all users but especially for equity investors and creditors.
For equity investors, net income means dividends and change in security values.
For creditors, income and operating cash flows are the main sources of interest and principle payments.
Income Statement X X1
I. Sales
II. Cost of Goods Sold (-)
Gross Profit/Loss
III. Operating Expenses (-)
Operating Profit/Loss
IV. Other Revenue and Income
IV. Other Expense and Loss
V. Interest Expense
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

18. Income is defined as revenue less expenses over a reporting period.
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Income Statement X X1
I. Sales
II. Cost of Goods Sold (-)
Gross Profit/Loss
III. Operating Expenses (-)
Operating Profit/Loss
IV. Other Revenue and Income
IV. Other Expense and Loss
V. Interest Expense
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)
Income is defined as revenue less expenses over a reporting period.
In analyzing income, the accounting methods and the estimation issues must be taken into account.

19. PROFITABILITY ANALYSIS
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
For example:
ABC Co.’s sales revenue is 200 TLand Cost of Goods Sold is 100 TL. The depreciation costs in cost of goods sold is 30 TL. If ABC Co. changes its depreciation method, the depreciation costs in cost of goods sold increases to 40 TL and the gross profit decreases to 90 TL.
Income Statement
Sales
200
Cost of Goods Sold
(100)
(110)
Gross Profit
100 90

20. PROFITABILITY RATIOS Return Ratios and Common-Size Ratios
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Assets ABC CO. Balance Sheet X1 Liabilities
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
PROFITABILITY RATIOS
Profitability ratios comprise of:
Return Ratios and
Common-Size Ratios
Income Statement X X1
I. Sales
II. Cost of Goods Sold (-)
Gross Profit/Loss
III. Operating Expenses (-)
Operating Profit/Loss
IV. Other Revenue and Income
IV. Other Expense and Loss
V. Interest Expense
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

21. Return Ratios FINANCIAL STATEMENTS PROFITABILITY ANALYSIS
Assets ABC CO. Balance Sheet X1 Liabilities
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return Ratios
Return on Assets (ROA)
Return on Equity (ROE)
Return on Total Capital (ROC)
(Ekonomik Rantabilite, Toplam Kaynakların Karlılığı)
Income Statement X X1
I. Sales
II. Cost of Goods Sold (-)
Gross Profit/Loss
III. Operating Expenses (-)
Operating Profit/Loss
IV. Other Revenue and Income
IV. Other Expense and Loss
V. Interest Expense
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

22. PROFITABILITY ANALYSIS
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Balance Sheet
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return On Assets Ratio
ROA is composed of two components:
Net Profit Margin
Assets Turnover
Income Statement
NET SALES
Operating Profit/Loss
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

23. PROFITABILITY ANALYSIS
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Return On Assets Ratio
In this equation we can see that ROA is a function of a firm’s profitability and efficiency. A firm can increase ROA by improving profitability and efficiency.
For Example: ABC Co.’s Net profit margin is 9% and Assets Turnover Ratio is 2. Then, ROA ratio of ABC Co. is 18%.

24. Return On Assets Equity
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Balance Sheet
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return On Assets Equity
This ratio measures return generated relative to capital provided from owners.
Income Statement
NET SALES
Operating Profit/Loss
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

25. Return On Assets Equity
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Balance Sheet
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return On Assets Equity
This ratio measures return generated relative to capital provided from owners. ROE is a function of;
Profitability
Equity Turnover
Income Statement
NET SALES
Operating Profit/Loss
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

26. Return On Capital Employed (or Total Investment or Total Capital)
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Balance Sheet
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return On Capital Employed
(or Total Investment or Total Capital)
Return on Total Capital ratio measures the overall performance of the business. When interpreting this ratio , Return on Equity ratio must be taken into account.
Income Statement
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

27. Return On Capital Employed (or Total Investment or Total Capital)
FINANCIAL STATEMENTS
PROFITABILITY ANALYSIS
Balance Sheet
I. Current Assets
III. Current Liabilities
II. Non-Current Assets
IV. Non-Current Liabilities
V. Equity
Profit/Loss
Total Assets
Total Liabilities
Return On Capital Employed
(or Total Investment or Total Capital)
To mention about the profitability of equity, the ROE ratio must be higher than ROCE ratio.
Otherwise, the interest costs are high and firm can not take advantage of financial leverage. Therefore the financial leverage effects the return on equity.
Income Statement
Profit/Loss of the Period (Profit/Loss Before Tax )
Tax Expense (-)
Net Profit/Loss of the Period (Profit/Loss After Tax)

28. FINANCIAL STATEMENTS EXERCISES
The financial leverage ratio of ABC Co. is %70. Calculate the Debt-Equity Ratio.

29. FINANCIAL STATEMENTS EXERCISES
Beginning Work-In Process is TL, ending work-in process is TL. The cost of beginning finished goods is TL and the cost of ending finished goods is TL. The reported amount of cost of goods sold is TL. Calculate the current year’s cost of product. TL
Beginning Workin-In Process
2.000
The Current Period’s Cost of Product
59.000
Ending Workin-In Process (-)
(3.000)
The Current Period’s Finished Goods
58.000
Beginning Finished Goods
5.000
Ending Finished Goods (-)
Cost of Goods Sold
55.000

30. FINANCIAL STATEMENTS EXERCISES
The A/R collection period is 90 days, the trade payables payment period is 20 days and selling or holding days of finished goods is 80 days. Calculate the cash operating cycle period.
Operating Cycle
Finished goods holding period
80 days
Receivables collection period
90 days
Payables payment period
(20 days)
Cash Operating Cycle Period
150 days

31. FINANCIAL STATEMENTS EXERCISES Calculate the items stated below:
Current Ratio
1,6
Total Assets
6.500
Equity
2.500
Non-current Liabilities
3.000
Working Capital ?
Non-Current Assets
Answers:
Working Capital
600 TL
Non-Current Assets
4.900 TL