Financial Statement Analysis

Objectives:
01 Trend Analysis

02 Common size analysis

03 Percentage change analysis

04 The Dupont Analysis

05 Uses and Limitations of ratio analysis

 TREND ANALYSIS
Excerpt taken from Nestle Pakistan Annual Report 2019

An analysis of a firm’s financial

ratios over time;

Used to estimate the likelihood of

improvement or deterioration in
its financial condition.
 Trend Analysis
Excerpt taken from Nestle Pakistan Annual Report 2019
Common Size Analysis
Common size analysis, also referred as vertical analysis, is a tool
that financial managers use to analyze financial statements.
These three core statements are intricately. It evaluates financial
statements by expressing each line item as a percentage of
the base amount for that period.
 Percentage Change Analysis
In this type of analysis, growth rates are calculated for all
income statement items and balance sheet accounts.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 𝐹𝑖𝑔𝑢𝑟𝑒 − 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝐹𝑖𝑔𝑢𝑟𝑒

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒= 𝑥 100
𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝐹𝑖𝑔𝑢𝑟𝑒

A percent change analysis shows how two

items changed as a percentage from one
period to another period.
Example-Percentage Change Analysis Income Statement
Working demonstrated in excel
Income statement Nestle Pakistan
2019 2018 2019
Sales - net 115,962,473 120,701,038 - 4,738,565 -3.93%
Cost of goods sold 82,613,501 81,887,248 726,253 0.89%
Gross profit 33,348,972 38,813,790 - 5,464,818 -14.08%

Distribution & selling expenses 14,656,501 15,625,633 - 969,132 -6.20%

Administration expenses 3,667,718 3,108,623 559,095 17.99%
Operating profit 15,024,753 20,079,534 - 5,054,781 -25.17%

Finance cost 3,187,695 1,855,789 1,331,906 71.77%

Other expenses 1,390,138 1,512,112 - 121,974 -8.07%
4,577,833 3,367,901 1,209,932 35.93%
Other income 268,790 255,308 13,482 5.28%
Profit before taxation 10,715,710 16,966,941 - 6,251,231 -36.84%
Taxation 3,361,243 5,355,382 - 1,994,139 -37.24%
Profit after taxation 7,354,467 11,511,559 - 4,157,092 -36.11%
Example Solution-Percentage Change Analysis Income Statement
Working demonstrated in excel
Statement of financial position Nestle Pakistan
Assets 2019 2018 2019
Non-current assets
Property, plant and equipment 30,333,121 30,363,333 - 30,212 -0.10%
Capital work-in-progress 3,441,066 3,679,302 - 238,236 -6.48%
Intangible assets 7,396 15,464 - 8,068 -52.17%
Long term loans 239,499 305,333 - 65,834 -21.56%
34,021,082 34,363,432 - 342,350 -1.00%
Current assets
Stores and spares 2,376,057 1,951,900 424,157 21.73%
Stock-in-trade 18,876,441 19,711,784 - 835,343 -4.24%
Trade debts 2,164,888 3,116,948 - 952,060 -30.54%
Current portion of long term loans 132,045 132,729 - 684 -0.52%
Salex tax refundable 4,599,004 4,552,598 46,406 1.02%
Advance, prepayments & other receiv. 2,785,138 2,584,926 200,212 7.75%
Cash and bank balances 318,753 745,694 - 426,941 -57.25%
31,252,326 32,796,579 - 1,544,253 -4.71%
65,273,408 67,160,011 - 1,886,603 -2.81%
 EQUITY AND LIABILITIES

Example Solution Issued, subscribed and paid up capital

Share premium
453,496
249,527
453,496
249,527
-
-
0.00%
0.00%
Percentage Change General reserve 280,000 280,000 - 0.00%
Analysis Accumulated profit 2,272,943
3,255,966
3,037,201
4,020,224
-
-
764,258
764,258
-25.16%
-19.01%
Balance Sheet Non-current liabilities
long term finances 3,780,294 9,064,730 - 5,284,436 -58.30%
Working demonstrated in lease liabilities 303,729 217,530 86,199 39.63%
excel Deferred taxation 1,960,850 2,443,197 - 482,347 -19.74%
Retirement benefits 2,777,502 2,098,020 679,482 32.39%
8,822,375 13,823,477 - 5,001,102 -36.18%
Current liabilites
Current portion of long term liabilites 395,084 420,285 - 25,201 -6.00%
Short term borrowings 17,217,473 15,242,800 1,974,673 12.95%
Running finance 6,141,325 1,418,301 4,723,024 333.01%
Customer security deposits 192,724 195,431 - 2,707 -1.39%
Unclaimed dividend 20,608 20,608 - 0.00%
Trade and other payables 25,782,895 31,745,031 - 5,962,136 -18.78%
Interest and mark-up accrued 444,958 273,854 171,104 62.48%
53,195,067 49,316,310 3,878,757 7.87%
65,273,408 67,160,011 - 1,886,603 -2.81%
 DuPont Equation

A formula that shows that the rate of return on equity can be

found as the product of profit margin, total assets turnover, and
the equity multiplier.

It shows the relationships among asset management, debt

management, and profitability ratios
 DuPont Equation
𝑅𝑂𝐸=𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 𝑋 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑋 𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑅𝑂𝐸= 𝑋 𝑋
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦

ROA

What is equity multiplier ?

The equity multiplier is a risk indicator that
measure the portion of a company’s
assets that is finance by stock holder equity
rather than debt
 Practice Question
Donaldson & Son has an ROA of 10%, a 2% profit margin, and a return on equity equal to
15%. What is the company’s total assets turnover? What is the firm’s equity multiplier?

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠

𝑅𝑂𝐴= 𝑋
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
10 %=2 %  𝑋 𝑇𝐴𝑇 Total Asset Turnover (TAT)=
10 %
=𝑇𝐴𝑇
2%
5=𝑇𝐴𝑇 Net Profit Margin =
 Example - Nestle ROE 2019
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑅𝑂𝐸= 𝑋 𝑋
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
7,354,467 115,962,473 65,273,408
𝑅𝑂𝐸= 𝑋 𝑋
115,962,473 65,273,408 3,255,966

𝑅𝑂𝐸=6.34 %  𝑋 1.78 𝑋 20.04

𝑅𝑂𝐸 =11.27 %  𝑋 20.04The more leverage, the less the equity, hence
the higher the equity multiplier
𝑅𝑂𝐸 =225.9 %
 Practice Question
Donaldson & Son has an ROA of 10%, a 2% profit margin, and a return on equity equal to
15%. What is the company’s total assets turnover? What is the firm’s equity multiplier?

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑅𝑂𝐸= 𝑋 𝑋
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
15 %=10 % 𝑋 𝐸𝑀
15 %
= 𝐸𝑀
10 %
1.5=𝐸𝑀
 Uses and Limitations of Ratio Analysis
Ratio analysis is used by three main groups:

1. Managers, who employ ratios to help analyze, control, and thus improve their
firms’ operations;
2. Credit analysts, including bank loan officers and bond rating analysts, who
analyze ratios to help ascertain a company’s ability to pay its debts;
3. Stock analysts, who are interested in a company’s efficiency, risk, and growth
prospects
 Uses and Limitations of Ratio Analysis
Some potential problems are listed below:

1. It is more useful for narrowly focused firms than for large, multidivisional ones
2. Inflation may have badly distorted firms’ balance sheets
3. Seasonal factors can also distort a ratio analysis
4. Firms can employ “window dressing” techniques
5. Different accounting practices can distort comparisons.
6. It is difficult to generalize about whether a particular ratio is “good” or “bad.”
7. A firm may have some ratios that look “good” and others that look “bad,” making it
difficult to tell whether the company overall is strong or weak
8. Financial statements are not always accurate