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Файл:Сравнительный анализ финансового состояния международных нефтяных компаний. Учебное пособие
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2.2. Methods of financial analysis
Practice of financial analysis developed the basic methods of
reading financial reports, among which are the methods: (1) Vertical
Analysis involves the conversion of items appearing in statement
columns into terms of percentages of a base figure to show the relative
significance of the items and to facilitate comparison. For example,
individual items appearing on the income statement can be expressed as
percentages of sales.
On the balance sheet, individual assets can be expressed in terms
of their relationship to total assets. Liabilities and shareholders’ equity
accounts can be expressed in terms of their relationship to total liabilities
and shareholders’ equity. On the income statement, each item is stated
as a percentage of sales. On the retained earnings statement, beginning
retained earnings is 100 percent (http://worldacademyonline.com/); (2)
Horizontal Analysis spotlights trends and establishes relationships
between items that appear on the same row of a comparative statement.
Horizontal analysis discloses changes on items in financial statements
over time. Each item (such as sales) on a row for one fiscal period is
compared with the same item in a different period.
Horizontal analysis can be carried out in terms of changes in dollar
amounts, in percentages of change, or in a ratio format. Examples of
horizontal analysis are comparative statement analysis and trend
statement analysis. In the case of a horizontal analysis the same item is
compared of one year with the preceding year. In this case more than
one year's companies’ financial statements are essential. (3) Ratio
Analysis is a useful measure to provide a snapshot of a firm’s financial
position at any particular moment of time or to provide a comprehensive
idea about the financial performance of the company over a particular
period of time. Use of financial ratios in finance is multi-dimensional. It
is not only useful for judging the financial health or performance of a
particular firm over time, it is also a useful tool for comparing a firm’s
financial position and performance with respect to others in the same or
different industry to pinpoint problem areas or to identify areas of
further improvements (De - Bandyopadhyay - Chakraborty, 2011, p.14).
Ratio analysis is such a significant technique for financial analysis.
It indicates relation of two mathematical expressions and the
relationship between two or more things. Financial ratio is a ratio of
selected values on an enterprise's financial statement. There are many
standard ratios used to evaluate the overall financial condition of a
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corporation or other organization. Financial ratios are used by managers
within a firm, by current and potential stockholders of a firm, and by the
firm’s creditors. Financial analysts use financial ratios to compare the
strengths and weaknesses in various companies.
Financial ratios are used by bankers, creditors, shareholders and
accountants to evaluate data presented on a financial statement.
Depending on the results of the evaluations, bankers and creditors may
choose to extend or retract financing and potential shareholders may
adjust the level of commitment in a company. Financial ratios are
important tools that judge the profitability, efficiency, liquidity and
solvency of an entity. Ratio analysis is a tool used by management and
fundamental investors to determine a company's general position in an
industry or sector as it compares to their peers.
Steps in Ratio Analysis are the following. Step 1: Collection of
information, which are relevant from the financial statements and then to
calculate different ratios accordingly. Step 2: Comparison of computed
ratios with the past ratios of the same organisation or within the
industry. Step 3: Interpretation, drawing of inferences and report-writing
Classification of Ratios. (Robinson – Greuning – Henry - Broihahn,
2009, p. 230).
To evaluate the performance of one firm, its current ratios will be
compared with its past ratios. When financial ratios over a period of
time are compared, it is called time series or trend analysis. It gives an
indication of changes and reflects whether the firm‘s financial
performance has improved or deteriorated or remained the same over
that period of time. It is not the simply changes that has to be
determined, but more importantly it must be recognized why those ratios
have changed. Because those changes might be result of changes in the
accounting polices without material change in the firm‘s performances.
Another method is to compare ratios of one firm with another firm
in the same industry at the same point in time. This comparison is
known as the cross sectional analysis. It might be more useful to select
some competitors which have similar operations and compare their
ratios with the firm‘s. This comparison shows the relative financial
position and performance of the firm. Since it is so easy to find the
financial statements of similar firms through publications or Medias this
type of analysis can be performed so easily.
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Financial ratios allow for comparisons and, therefore, are
intertwined with the process of benchmarking, comparing one's business
to that of others or of the same company at a different point in time.
Benchmarking is the process of comparing the ratios of a particular
company with those of a smaller group of “benchmark” companies,
rather than with the entire industry. Benchmarking makes it easy for a
firm to see exactly where the company stands relative to its competition.
(Brigham - Houston, 2012, p.118).
Benchmarking using ratio analysis can be useful to various
audiences. From an investor perspective, benchmarking can involve
comparing a company to peer companies that can be considered
alternative investment opportunities from the perspective of an investor.
In this process, the investor may compare the focus company to others in
the peer group (leaders, averages) on certain financial ratios relevant to
those companies and the investor's investment style. From a
management perspective, benchmarking using ratio analysis may be a
way for a manager to compare their company to peers using externally
recognizable, quantitative data.
Ratio analysis and industry benchmarking are used by the
organization as financial analysis tools to compare actual and targeted
performance levels. Ratio analysis and industry benchmarking are
among the most commonly used financial analysis tools. The objective,
clear, relevant, reliable and useful information they produce leads to
timely, informed decisions regarding the organization’s financial
performance.
To determine the financial condition and performance of a firm, its
ratios may be compared with average ratios of the industry to which the
firm belongs. This method is known as the industry analysis that helps to
ascertain the financial standing and capability of the firm in the industry
to which it belongs.
Industry ratios are important standards in view of the fact that each
industry has its own characteristics, which influence the financial and
operating relationships. But there are certain practical difficulties for this
method. First finding mean or median ratios for the industries is such a
headache and difficult. Second, industries include weak and strong
companies so the averages include them also. Sometimes the value
range may be so wide that the average might be of little utility. Third,
the average may be meaningless and the comparison not possible if the
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firms with in the same industry widely differ in their accounting policies
and practices.
2.3. Financial ratios and their interpretation
Ratios can be divided into four major categories (Figure 2).
(Robinson – Greuning – Henry - Broihahn, 2009, p.319)
Liquidity Ratios
Ability to meet short-term,
immediate obligations.
Activity Ratios
Effectiveness in putting its
asset investment to use.
Profitability Ratios
Ability to manage expenses to
produce profits from sales
Solvency Ratios
Ability to satisfy debt
obligations
Figure 2. Classification ratios
(Robinson – Greuning – Henry - Broihahn, 2009, p. 319)
Liquidity Ratios
Liquidity ratios indicate a company’s ability to pay short-term
debts. They focus on current assets and current liabilities. Liquidity
ratios are some of the most widely used ratios, perhaps next to
profitability ratios. They are especially important to creditors. These
ratios measure a firm’s ability to meet its short-term obligations.
The level of liquidity needed varies from industry to industry.
Certain industries are more cash-intensive than others. For example,
grocery stores will need more cash to buy inventory constantly than
software firms, so the liquidity ratios of companies in these two
industries are not comparable to each other. It is also important to note a
company’s trend in liquidity ratios over time.
The relationship of current assets to current liabilities is an
important indicator of the degree to which a firm is liquid. Working
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capital and the components of working capital also provide measures of
the liquidity of a firm. Ratios that directly measure a firm’s liquidity
provide clues concerning whether or not a firm can pay its maturing
obligations. The current (or working capital) ratio and the acid-test (or
quick) ratio are important ratios that are used to measure a firm’s
liquidity.
a) Net working capital: It shows how much a firm has its current
assets after deducting all its current liabilities. Mathematically it is given
by:
Positive working capital means the business is able to pay off its
short-term liabilities. A high working capital indicates that the company
might be able to expand its operations. Negative working capital means
that the current business is unable to meet its short term liabilities with
its current assets.
b) Current ratio: It measures firm ability to pay its debt in a short
term notice (within 12 months). It is a ratio of current assets upon
current liabilities.
If current ratio is below 1, then the company will have problems in
paying its bill on time. It has one disadvantage as it includes inventory
which is difficult to liquidate easily so it is not an accurate measure of
liquidity. The current ratio is expressed as the number of dollars of
current assets for each dollar of current liabilities.
c) Quick (acid-test) ratio: A quick measure of the debt-paying
ability of a company is referred to as the quick ratio or acid-test ratio.
The quick ratio expresses the relationship of quick assets (cash,
marketable securities, and accounts receivable) to current liabilities.
Inventory and prepaid expenses are not considered quick assets because
they may not be easily convertible into cash.
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The acid-test ratio is a more severe test of a company’s short-term
ability to pay debt than is the current ratio. A rule of thumb for the quick
ratio is suggested as 1:1. If it is lower than 1:1, it may indicate that the
firm relies too much on inventory or other assets to pay its short-term
liabilities. Again, industry practices and the company’s special operating
circumstances must be considered.
d) Cash ratio: It measures the immediate amount of cash available
to the firm to satisfy its short-term liabilities. It is the ratio of cash and
marketable securities to current liabilities.
It is the most conservative look at a company’s liquidity since; it
considers only the cash and marketable securities. It is used by creditors
when deciding how much credit; they would be willing to extend to the
company.
Profitability Ratios
Profitability refers to the ability of a company to earn income.
Investors and creditors have a great interest in evaluating the current and
prospective profitability of an enterprise. Profitability ratios have been
developed to measure operational performance. The numerator of the
ratios consists of profits according to specified definition (gross margin,
operating income, net income); the denominator represents a relevant
investment base. There are five important profitability ratios, such as:
1. Net profit margin
The net profit margin measures the percentage of each monetary
unit from sales remaining after all costs and expenses, including interest,
taxes, and preferred stock dividends, have been deducted. The net profit
margin is calculated as follows:
2. Gross profit margin
This ratio reveals the percentage of each dollar left over after the
business has paid for its goods. The higher the gross profit earned, the
better. Gross profit equals net sales less cost of goods sold.
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3. Return on Assets (ROA) is a useful ratio for interpreting profit
performance, aside from determining financial gain (or loss). ROA is a
capital utilization test - how much profit before interest and income tax
was earned on the total capital employed by the business. The basic idea
is that it takes money (assets) to make money (profit); the final test is
how much profit was made on the assets. Formula for Return on Assets:
Alternatively, this can also be expressed as ROA =
(Earnings/Sales)*(Sales/Assets), or ROA = Net Margin*Asset Turnover
4. Return on Equity (ROE) is another very important measure of a
company's profitability that reveals how much profit it generates with
the money shareholders have invested.
Return on stockholders’ equity (ROE) indicates management’s
success or failure at maximizing the return to stockholders based on
their investment in the company. This ratio emphasizes the income yield
in relationship to the amount invested. Financial leverage can be
estimated by subtracting return on total assets from return on
shareholders’ equity. If the return on shareholders’ equity is greater than
the return on total assets, financial leverage is positive to the extent of
the difference. If there is no debt, the two ratios would be the same.
Return on stockholders’ equity is computed as follows:
5. Operating profit margin. It measures the percentage of each
monetary unit from sales remaining after all costs and expenses other
than interest, taxes, and preferred stock dividends are deducted (GitmanZutter, 2011, p.80). If a company's margin is increasing, it is earning
more per 1 monetary unit of sales. A high operating profit margin is
preferred:
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Activity Ratios
Activity (asset utilization, turnover) ratios are used to determine
how quickly various accounts are converted into sales or cash. Overall
liquidity ratios generally do not give an adequate picture of a company’s
real liquidity, due to differences in the kinds of current assets and
liabilities the company holds. Thus, it is necessary to evaluate the
activity or liquidity of specific current accounts. Various ratios exist to
measure the activity of receivables, inventory, and total assets.
The Activity Ratios are also known as turnover ratios or efficiency
ratios. They indicate the efficiency with which the capital employed is
rotated in the business. The two factors on which overall profitability of
the business depends are: (i) the rate of return on capital employed; (ii)
the turnover (the speed at which the capital employed in the business
rotates).
The important activity ratios are as follows:
1. Accounts receivable turnover. This ratio gives the number of
times accounts receivable is collected during the year. It is found by
dividing net credit sales (if not available, then total sales) by the average
accounts receivable. Average accounts receivable is typically found by
adding the beginning and ending accounts receivable and dividing by
two.
2. Inventory Turnover generally measures the efficiency of
inventory. The resulting turnover is meaningful only when it is
compared with similar companies in the same industry or to the past
data. It is calculated as follows in case of trading firms only:
Average Collection Period represents the approximate amount of
time that it takes a company to receive payments owed, in terms of
receivables, from its customers and clients:
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The average collection period (the number of days' sales in
receivables ratio) is the number of days it takes to collect on receivables.
The average collection period is meaningful only in relation to the
company’s credit terms.
The operating cycle is the time needed to turn cash into inventory,
inventory into receivables, and receivables back into cash. It is the time
from the purchase of inventory to collection of cash. The company’s
operating cycle can be computed by adding the number of day sales in
receivables to the number of days in the company’s inventory.
A company with a short operating cycle typically requires only a
small amount of working capital, reflected in relatively low current and
quick ratios. A company with a long operating cycle typically requires a
larger cushion of current assets and higher current and quick ratios,
unless the firm’s suppliers extend their credit terms.
The net operating cycle is the length of time from when a company
makes an investment in goods and services, considering the company
makes some of its purchases on credit, to the time it collects cash from
its accounts receivable.
The operating cycle is illustrated in Figure 3.
Accounts receivable arrow should end at cash received position.
Inventory
purchased
Inventory period
Accounts payable
period
Inventory
Cash paid for
inventory
Operating cycle
sold
Accounts receivable period
Cash cycle
Cash received
Figure 3. Operating cycle
(Ross-Westerfield-Jordan, 2007, p.482)
Operating cycle and net operating cycle can calculate with the
following formula:
Operating cycle =Inventory turnover + Accounts receivable turnover
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So, the other indicators can calculate with formulas:
3. Total Assets Turnover. It measures a company's efficiency at
using its assets in generating sales or revenue - the higher the number
the better. The total asset turnover ratio is helpful in evaluating a
company’s ability to use its asset base efficiently to generate revenue. A
low ratio may be due to many factors, and it is important to identify the
underlying reasons.
Solvency Ratios
Solvency is the company's ability to satisfy long-term debt as it
becomes due. You should be concerned about the long-term financial
and operating structure of any firm in which you might be interested.
Another important consideration is the size of debt in the firm's capital
structure, which is referred to as financial leverage.
Solvency also depends on earning power; in the long run a
company will not satisfy its debts unless it earns profits. A leveraged
capital structure subjects the company to fixed interest charges, which
contributes to earnings instability. Excessive debt may also make it
difficult for the firm to borrow funds at reasonable rates during tight
money markets.
Financial risk is the risk resulting from a company’s choice of how
to finance the business using debt or equity. Financial leverage ratios are
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