Analysing Financial Performance using Financial Statements

Financial management revision article series

Analytical Methods or Components


Ratio analysis


Ratios are calculated using line items from financial statements. For certain ratios there are ideal values indicated in the financial literature. Certain ratios need to have specific values based on company's declared policies. Like debtor turnover ratio must have a range of values based on the credit period specified or offered by the company to its credit customers.

Dupont analysis

It breaks down the return on equity into component parts.

Comparative analysis

Comparing similar ratios of other companies, one can assess the relative strength of the company under consideration.

Applications


Assessment of Financial Health of the Company

Statistical models using financial information or ratios

Two statistical models designed to predict the likelihood of severe financial distress for a corporation. One of these models is the Altman Z-Score [Altman, 2002]. This model is applicable to any type of firm. The other model is a scoring approach developed by Pilarski and Dinh that is applicable specifically to air carriers [Pilarski and Dinh, 1999].

Altman's 1968 Model
The following calculation is used to arrive at the total Z-Score:
Z = 1.20(X1) + 1.40 (X2) +3.30(X3) +.60(X4) + .99(X5)

X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings before Interest and Taxes / Total Assets
X4 = Market Value Equity / Book Value of Total Debt
X5 = Sales / Total Assets
Z = Overall Score

Credit granting decisions

Equity investment decisions



Problems

Different company may use accounting policies with some differences. Hence comparison may sometimes create problems.

Guidelines
Inflation
Concept of Balanced Scorecard
 
Prasanna Chandra, Financial Management, 5th Ed.,  Tata McGraw Hill, 2001
Brealey and Myers, Corporate Finance, Fifth Edition, Prentice Hall India, 2001
 


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