financial statement analysis assignment example

A | Financial Statement Analysis

Financial statement analysis.

Financial statement analysis reviews financial information found on financial statements to make informed decisions about the business. The income statement, statement of retained earnings, balance sheet, and statement of cash flows, among other financial information, can be analyzed. The information obtained from this analysis can benefit decision-making for internal and external stakeholders and can give a company valuable information on overall performance and specific areas for improvement. The analysis can help them with budgeting, deciding where to cut costs, how to increase revenues, and future capital investments opportunities.

When considering the outcomes from analysis, it is important for a company to understand that data produced needs to be compared to others within industry and close competitors. The company should also consider their past experience and how it corresponds to current and future performance expectations. Three common analysis tools are used for decision-making; horizontal analysis, vertical analysis, and financial ratios.

For our discussion of financial statement analysis, we will use Banyan Goods. Banyan Goods is a merchandising company that sells a variety of products. The image below shows the comparative income statements and balance sheets for the past two years.

Keep in mind that the comparative income statements and balance sheets for Banyan Goods are simplified for our calculations and do not fully represent all the accounts a company could maintain. Let’s begin our analysis discussion by looking at horizontal analysis.

Horizontal Analysis

Horizontal analysis (also known as trend analysis) looks at trends over time on various financial statement line items. A company will look at one period (usually a year) and compare it to another period. For example, a company may compare sales from their current year to sales from the prior year. The trending of items on these financial statements can give a company valuable information on overall performance and specific areas for improvement. It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item. If multiple periods are not used, it can be difficult to identify a trend. The year being used for comparison purposes is called the base year (usually the prior period). The year of comparison for horizontal analysis is analyzed for dollar and percent changes against the base year.

The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis.

Using Banyan Goods as our example, if Banyan wanted to compare net sales in the current year (year of analysis) of $120,000 to the prior year (base year) of $100,000, the dollar change would be as follows:

The percentage change is found by taking the dollar change, dividing by the base year amount, and then multiplying by 100.

Let’s compute the percentage change for Banyan Goods’ net sales.

This means Banyan Goods saw an increase of $20,000 in net sales in the current year as compared to the prior year, which was a 20% increase. The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items. The image below shows the complete horizontal analysis of the income statement and balance sheet for Banyan Goods.

Depending on their expectations, Banyan Goods could make decisions to alter operations to produce expected outcomes. For example, Banyan saw a 50% accounts receivable increase from the prior year to the current year. If they were only expecting a 20% increase, they may need to explore this line item further to determine what caused this difference and how to correct it going forward. It could possibly be that they are extending credit more readily than anticipated or not collecting as rapidly on outstanding accounts receivable. The company will need to further examine this difference before deciding on a course of action. Another method of analysis Banyan might consider before making a decision is vertical analysis.

Vertical Analysis

Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. For example, a company may compare cash to total assets in the current year. This allows a company to see what percentage of cash (the comparison line item) makes up total assets (the other line item) during the period. This is different from horizontal analysis, which compares across years. Vertical analysis compares line items within a statement in the current year. This can help a business to know how much of one item is contributing to overall operations. For example, a company may want to know how much inventory contributes to total assets. They can then use this information to make business decisions such as preparing the budget, cutting costs, increasing revenues, or capital investments.

The company will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. These percentages are considered common-size because they make businesses within industry comparable by taking out fluctuations for size. It is typical for an income statement to use net sales (or sales) as the comparison line item. This means net sales will be set at 100% and all other line items within the income statement will represent a percentage of net sales.

On the balance sheet, a company will typically look at two areas: (1) total assets, and (2) total liabilities and stockholders’ equity. Total assets will be set at 100% and all assets will represent a percentage of total assets. Total liabilities and stockholders’ equity will also be set at 100% and all line items within liabilities and equity will be represented as a percentage of total liabilities and stockholders’ equity. The line item set at 100% is considered the base amount and the comparison line item is considered the comparison amount. The formula to determine the common-size percentage is:

For example, if Banyan Goods set total assets as the base amount and wanted to see what percentage of total assets were made up of cash in the current year, the following calculation would occur.

Cash in the current year is $110,000 and total assets equal $250,000, giving a common-size percentage of 44%. If the company had an expected cash balance of 40% of total assets, they would be exceeding expectations. This may not be enough of a difference to make a change, but if they notice this deviates from industry standards, they may need to make adjustments, such as reducing the amount of cash on hand to reinvest in the business. The image below shows the common-size calculations on the comparative income statements and comparative balance sheets for Banyan Goods.

Even though vertical analysis is a statement comparison within the same year, Banyan can use information from the prior year’s vertical analysis to make sure the business is operating as expected. For example, unearned revenues increased from the prior year to the current year and made up a larger portion of total liabilities and stockholders’ equity. This could be due to many factors, and Banyan Goods will need to examine this further to see why this change has occurred. Let’s turn to financial statement analysis using financial ratios.

Overview of Financial Ratios

Financial ratios help both internal and external users of information make informed decisions about a company. A stakeholder could be looking to invest, become a supplier, make a loan, or alter internal operations, among other things, based in part on the outcomes of ratio analysis. The information resulting from ratio analysis can be used to examine trends in performance, establish benchmarks for success, set budget expectations, and compare industry competitors. There are four main categories of ratios: liquidity, solvency, efficiency, and profitability. Note that while there are more ideal outcomes for some ratios, the industry in which the business operates can change the influence each of these outcomes has over stakeholder decisions. (You will learn more about ratios, industry standards, and ratio interpretation in advanced accounting courses.)

Liquidity Ratios

Liquidity ratios show the ability of the company to pay short-term obligations if they came due immediately with assets that can be quickly converted to cash. This is done by comparing current assets to current liabilities. Lenders, for example, may consider the outcomes of liquidity ratios when deciding whether to extend a loan to a company. A company would like to be liquid enough to manage any currently due obligations but not too liquid where they may not be effectively investing in growth opportunities. Three common liquidity measurements are working capital, current ratio, and quick ratio.

Working Capital

Working capital measures the financial health of an organization in the short-term by finding the difference between current assets and current liabilities. A company will need enough current assets to cover current liabilities; otherwise, they may not be able to continue operations in the future. Before a lender extends credit, they will review the working capital of the company to see if the company can meet their obligations. A larger difference signals that a company can cover their short-term debts and a lender may be more willing to extend the loan. On the other hand, too large of a difference may indicate that the company may not be correctly using their assets to grow the business. The formula for working capital is:

Using Banyan Goods, working capital is computed as follows for the current year:

In this case, current assets were $200,000, and current liabilities were $100,000. Current assets were far greater than current liabilities for Banyan Goods and they would easily be able to cover short-term debt.

The dollar value of the difference for working capital is limited given company size and scope. It is most useful to convert this information to a ratio to determine the company’s current financial health. This ratio is the current ratio.

Current Ratio

Working capital expressed as a ratio is the current ratio. The current ratio considers the amount of current assets available to cover current liabilities. The higher the current ratio, the more likely the company can cover its short-term debt. The formula for current ratio is:

The current ratio in the current year for Banyan Goods is:

A 2:1 ratio means the company has twice as many current assets as current liabilities; typically, this would be plenty to cover obligations. This may be an acceptable ratio for Banyan Goods, but if it is too high, they may want to consider using those assets in a different way to grow the company.

Quick Ratio

The quick ratio, also known as the acid-test ratio, is similar to the current ratio except current assets are more narrowly defined as the most liquid assets, which exclude inventory and prepaid expenses. The conversion of inventory and prepaid expenses to cash can sometimes take more time than the liquidation of other current assets. A company will want to know what they have on hand and can use quickly if an immediate obligation is due. The formula for the quick ratio is:

The quick ratio for Banyan Goods in the current year is:

A 1.6:1 ratio means the company has enough quick assets to cover current liabilities.

Another category of financial measurement uses solvency ratios.

Solvency Ratios

Solvency implies that a company can meet its long-term obligations and will likely stay in business in the future. To stay in business the company must generate more revenue than debt in the long-term. Meeting long-term obligations includes the ability to pay any interest incurred on long-term debt. Two main solvency ratios are the debt-to-equity ratio and the times interest earned ratio.

Debt to Equity Ratio

The debt-to-equity ratio shows the relationship between debt and equity as it relates to business financing. A company can take out loans, issue stock, and retain earnings to be used in future periods to keep operations running. It is less risky and less costly to use equity sources for financing as compared to debt resources. This is mainly due to interest expense repayment that a loan carries as opposed to equity, which does not have this requirement. Therefore, a company wants to know how much debt and equity contribute to its financing. Ideally, a company would prefer more equity than debt financing. The formula for the debt to equity ratio is:

The information needed to compute the debt-to-equity ratio for Banyan Goods in the current year can be found on the balance sheet.

This means that for every $1 of equity contributed toward financing, $1.50 is contributed from lenders. This would be a concern for Banyan Goods. This could be a red flag for potential investors that the company could be trending toward insolvency. Banyan Goods might want to get the ratio below 1:1 to improve their long-term business viability.

Times Interest Earned Ratio

Time interest earned measures the company’s ability to pay interest expense on long-term debt incurred. This ability to pay is determined by the available earnings before interest and taxes (EBIT) are deducted. These earnings are considered the operating income. Lenders will pay attention to this ratio before extending credit. The more times over a company can cover interest, the more likely a lender will extend long-term credit. The formula for times interest earned is:

The information needed to compute times interest earned for Banyan Goods in the current year can be found on the income statement.

The $43,000 is the operating income, representing earnings before interest and taxes. The 21.5 times outcome suggests that Banyan Goods can easily repay interest on an outstanding loan and creditors would have little risk that Banyan Goods would be unable to pay.

Another category of financial measurement uses efficiency ratios.

Efficiency Ratios

Efficiency shows how well a company uses and manages their assets. Areas of importance with efficiency are management of sales, accounts receivable, and inventory. A company that is efficient typically will be able to generate revenues quickly using the assets it acquires. Let’s examine four efficiency ratios: accounts receivable turnover, total asset turnover, inventory turnover, and days’ sales in inventory.

Accounts Receivable Turnover

Accounts receivable turnover measures how many times in a period (usually a year) a company will collect cash from accounts receivable. A higher number of times could mean cash is collected more quickly and that credit customers are of high quality. A higher number is usually preferable because the cash collected can be reinvested in the business at a quicker rate. A lower number of times could mean cash is collected slowly on these accounts and customers may not be properly qualified to accept the debt. The formula for accounts receivable turnover is:

Many companies do not split credit and cash sales, in which case net sales would be used to compute accounts receivable turnover. Average accounts receivable is found by dividing the sum of beginning and ending accounts receivable balances found on the balance sheet. The beginning accounts receivable balance in the current year is taken from the ending accounts receivable balance in the prior year.

When computing the accounts receivable turnover for Banyan Goods, let’s assume net credit sales make up $100,000 of the $120,000 of the net sales found on the income statement in the current year.

An accounts receivable turnover of four times per year may be low for Banyan Goods. Given this outcome, they may want to consider stricter credit lending practices to make sure credit customers are of a higher quality. They may also need to be more aggressive with collecting any outstanding accounts.

Total Asset Turnover

Total asset turnover measures the ability of a company to use their assets to generate revenues. A company would like to use as few assets as possible to generate the most net sales. Therefore, a higher total asset turnover means the company is using their assets very efficiently to produce net sales. The formula for total asset turnover is:

Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year.

Banyan Goods’ total asset turnover is:

The outcome of 0.53 means that for every $1 of assets, $0.53 of net sales are generated. Over time, Banyan Goods would like to see this turnover ratio increase.

Inventory Turnover

Inventory turnover measures how many times during the year a company has sold and replaced inventory. This can tell a company how well inventory is managed. A higher ratio is preferable; however, an extremely high turnover may mean that the company does not have enough inventory available to meet demand. A low turnover may mean the company has too much supply of inventory on hand. The formula for inventory turnover is:

Cost of goods sold for the current year is found on the income statement. Average inventory is found by dividing the sum of beginning and ending inventory balances found on the balance sheet. The beginning inventory balance in the current year is taken from the ending inventory balance in the prior year.

Banyan Goods’ inventory turnover is:

1.6 times is a very low turnover rate for Banyan Goods. This may mean the company is maintaining too high an inventory supply to meet a low demand from customers. They may want to decrease their on-hand inventory to free up more liquid assets to use in other ways.

Days’ Sales in Inventory

Days’ sales in inventory expresses the number of days it takes a company to turn inventory into sales. This assumes that no new purchase of inventory occurred within that time period. The fewer the number of days, the more quickly the company can sell its inventory. The higher the number of days, the longer it takes to sell its inventory. The formula for days’ sales in inventory is:

Banyan Goods’ days’ sales in inventory is:

243 days is a long time to sell inventory. While industry dictates what is an acceptable number of days to sell inventory, 243 days is unsustainable long-term. Banyan Goods will need to better manage their inventory and sales strategies to move inventory more quickly.

The last category of financial measurement examines profitability ratios.

Profitability Ratios

Profitability considers how well a company produces returns given their operational performance. The company needs to leverage its operations to increase profit. To assist with profit goal attainment, company revenues need to outweigh expenses. Let’s consider three profitability measurements and ratios: profit margin, return on total assets, and return on equity.

Profit Margin

Profit margin represents how much of sales revenue has translated into income. This ratio shows how much of each $1 of sales is returned as profit. The larger the ratio figure (the closer it gets to 1), the more of each sales dollar is returned as profit. The portion of the sales dollar not returned as profit goes toward expenses. The formula for profit margin is:

For Banyan Goods, the profit margin in the current year is:

This means that for every dollar of sales, $0.29 returns as profit. If Banyan Goods thinks this is too low, the company would try and find ways to reduce expenses and increase sales.

Return on Total Assets

The return on total assets measures the company’s ability to use its assets successfully to generate a profit. The higher the return (ratio outcome), the more profit is created from asset use. Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year. The formula for return on total assets is:

For Banyan Goods, the return on total assets for the current year is:

The higher the figure, the better the company is using its assets to create a profit. Industry standards can dictate what is an acceptable return.

Return on Equity

Return on equity measures the company’s ability to use its invested capital to generate income. The invested capital comes from stockholders investments in the company’s stock and its retained earnings and is leveraged to create profit. The higher the return, the better the company is doing at using its investments to yield a profit. The formula for return on equity is:

Average stockholders’ equity is found by dividing the sum of beginning and ending stockholders’ equity balances found on the balance sheet. The beginning stockholders’ equity balance in the current year is taken from the ending stockholders’ equity balance in the prior year. Keep in mind that the net income is calculated after preferred dividends have been paid.

For Banyan Goods, we will use the net income figure and assume no preferred dividends have been paid. The return on equity for the current year is:

The higher the figure, the better the company is using its investments to create a profit. Industry standards can dictate what is an acceptable return.

Advantages and Disadvantages of Financial Statement Analysis

There are several advantages and disadvantages to financial statement analysis. Financial statement analysis can show trends over time, which can be helpful in making future business decisions. Converting information to percentages or ratios eliminates some of the disparity between competitor sizes and operating abilities, making it easier for stakeholders to make informed decisions. It can assist with understanding the makeup of current operations within the business, and which shifts need to occur internally to increase productivity.

A stakeholder needs to keep in mind that past performance does not always dictate future performance. Attention must be given to possible economic influences that could skew the numbers being analyzed, such as inflation or a recession. Additionally, the way a company reports information within accounts may change over time. For example, where and when certain transactions are recorded may shift, which may not be readily evident in the financial statements.

A company that wants to budget properly, control costs, increase revenues, and make long-term expenditure decisions may want to use financial statement analysis to guide future operations. As long as the company understands the limitations of the information provided, financial statement analysis is a good tool to predict growth and company financial strength.

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A Guide to Writing Effective Assignments on Financial Statement Analysis

The ability to analyze financial statements is a key competency for finance professionals because it allows them to evaluate the financial health of an organization and make wise decisions. Writing an essay on this subject helps you to better understand it while also honing your analytical skills. An extensive tutorial on how to write a financial statement analysis assignment is provided in this blog post. We will go over every important detail, from comprehending the fundamental ideas to conducting an exhaustive analysis. The goals of financial statement analysis, such as assessing profitability, liquidity, and solvency, will be covered in detail. We'll examine various methods and tools, including ratio analysis, common-size analysis, and trend analysis, that can be used to efficiently interpret financial statements. We will also describe the assignment writing process in detail, including how to define the assignment's scope, conduct research, and organize the content. You can demonstrate your mastery of this important area of finance by producing a high-quality assignment on financial statement analysis by adhering to our professional advice and tips.

Understanding Financial Statement Analysis

It's essential to build a solid foundation in this subject before starting to write a financial statement analysis assignment. It is essential to have a thorough understanding of financial statement analysis before diving into the assignment's complexity. You will receive a brief introduction to this field as well as the key ideas that underpin it in this section. You can complete the assignment more successfully if you have a solid understanding of financial statement analysis. The main financial statements involved (balance sheet, income statement, and cash flow statement), as well as the tools and techniques typically used in analyzing these statements, will all be covered in this section. By understanding these basic ideas, you will lay a solid foundation for the subsequent steps involved in writing your financial statement analysis assignment.

Introduction to Financial Statement Analysis

In order to evaluate a company's financial performance and health, financial statement analysis entails looking at its financial statements. The balance sheet, income statement, and cash flow statement are the three main financial statements that are analyzed. These statements give important details about the assets, liabilities, revenue, costs, and cash flows of a company. You can gain a thorough understanding of a company's financial situation, profitability, and cash flow management by examining these statements. Investors, creditors, and other stakeholders can assess a company's financial performance and potential risks with the help of financial statement analysis .

Objectives of Financial Statement Analysis

The evaluation of a company's profitability, liquidity, solvency, and operational effectiveness are the goals of financial statement analysis. Financial statement analysis allows you to evaluate a company's capacity for profit generation, short-term debt management, long-term financial commitment fulfillment, and operational efficiency enhancement. You can spot trends, strengths, and weaknesses in a company's financial performance by looking at its financial statements. Making informed investment decisions, determining creditworthiness, and gauging a company's general financial health are all made easier thanks to the insights provided by this analysis.

Tools and Techniques for Financial Statement Analysis

In financial statement analysis, a variety of tools and techniques are frequently employed. These consist of comparative analysis, trend analysis, ratio analysis, and common-size analysis. Calculating and interpreting different financial ratios, such as liquidity ratios, profitability ratios, and solvency ratios, are all part of ratio analysis. In order to make comparisons easier, common-size analysis involves expressing financial statement line items as a percentage of a base figure. In order to spot patterns and changes over time, trend analysis looks at financial data over a number of time periods. The comparative analysis involves evaluating a company's financial performance against that of companies in a similar industry or against rival businesses. These methods and tools facilitate benchmarking, support decision-making, and offer insightful information about a company's financial performance.

Writing an Assignment on Financial Statement Analysis

It is now time to investigate how to write an assignment on this topic after gaining a basic understanding of financial statement analysis. This section acts as a step-by-step manual, arming you with the resources you need to create a thoroughly organized assignment. You will discover how to efficiently organize your assignment by referring to the provided instructions, ensuring that your arguments are coherent and clear. You will learn how to clearly define the parameters of your assignment, conduct exhaustive background research, and organize your work logically. The section will also go over crucial elements like using the right tools and techniques to analyze financial statements, interpreting the findings, and coming to meaningful conclusions. With the help of this thorough manual, you will be equipped to produce a superb assignment on financial statement analysis that will demonstrate your expertise and analytical abilities in this area.

Define the Scope of Your Assignment

Setting a clear definition of your project's parameters is crucial before you start writing your financial statement analysis assignment. Think about whether you need to concentrate on a particular business, sector, or financial statement. You can focus your research and keep a clear, cogent focus throughout your assignment by defining the scope. By defining the scope, you can determine the parameters of your analysis and make sure that you focus on the pertinent facets of financial statement analysis that are in line with the goals of your assignment.

Conduct Background Research

It is essential to conduct in-depth background research to compile pertinent data before beginning the writing process. Make use of reliable resources like financial journals, scholarly works, industry reports, and dependable online databases. Make sure the data you compile is accurate, trustworthy, and supports your analysis. You can learn important information about the selected company, market trends, financial regulations, and other elements that could affect the financial statement analysis by conducting thorough research. You will have the background knowledge from this research to critically analyze and decipher the financial data you come across in your assignment. To reference your sources correctly and to uphold academic integrity throughout your work, always provide accurate documentation.

Structure Your Assignment

Clarity, coherence, and effective communication of your financial statement analysis depend on a well-structured assignment. To arrange your assignment and present your findings in a clear and thorough way, think about using the following format:

• Introduction: Get things going with an interesting introduction that gives a quick rundown of financial statement analysis and its importance in gauging a company's financial well-being. Give a clear description of the assignment's goals.
• Methodology: Describe the equipment and procedures you'll use to analyze financial statements. Give an explanation of the thinking behind your chosen techniques and argue for their applicability to the goals of your assignment.
• Company Profile : Describe the business you've chosen for analysis and give any pertinent background information. Include any pertinent information that aids in contextualizing the financial statement analysis, such as information about the sector, company size, business model, and industry.
• Financial Statements Analysis: Examine the financial statements of the company using a variety of methods and tools. Divide the analysis into sections such as operational efficiency analysis, profitability analysis, liquidity analysis, and solvency analysis. To improve clarity and visual appeal, present your findings using the appropriate charts, graphs, and tables.
• Interpretation of Results: Give an explanation of your analysis' conclusions and insights into the business's financial health. Highlight important patterns, attributes, shortcomings, and potential areas for development. Provide pertinent information and references to back up your interpretations.
• Conclusion: List your main findings and inferences from the financial statement analysis. Point out how your analysis affects the company's finances and potential future prospects. On the basis of your analysis, make suggestions that focus on problem areas or suggest potential solutions.

Analyzing Financial Statements

Take into account the following actions to properly analyze financial statements:

• Review the Balance Sheet: The company's balance sheet, which gives a quick overview of its assets, liabilities, and shareholders' equity, should be examined first. Calculate pertinent ratios, such as liquidity ratios (such as current ratio, quick ratio), leverage ratios (such as debt-to-equity ratio, interest coverage ratio), and efficiency ratios (such as asset turnover ratio, inventory turnover ratio), as well as the composition and quality of the company's assets.
• Analyze the Income Statement: Review the income statement of the business to learn more about its sales, costs, and general profitability. Calculate important ratios like the gross profit margin, operating margin, and net profit margin. Analyse trends in revenue. You can use this analysis to determine the company's capacity for profit-making and to pinpoint potential areas for cost- or revenue-revenue optimization.
• Examine the Cash Flow Statement: Examine the cash flows from operating, investing, and financing activities for the company as shown on the cash flow statement. Examine the business's capacity to generate cash from its core operations, as well as its choices regarding investments and financing. The management of the company's cash flow, its capacity to finance operations and investments, and its overall financial flexibility will all be analyzed.
• Compare with Industry Benchmarks: You can learn more about a company's financial performance by comparing its financial ratios to those of similar businesses in the same industry. Establish industry norms for different financial ratios, then evaluate how the company's ratios compare. You can use this comparison to evaluate the company's competitive position in the market, understand its relative performance, and spot any areas of strength or weakness.

Writing a financial statement analysis assignment requires a combination of research, analytical skill, and effective communication. Following the detailed instructions in this blog post will enable you to efficiently structure your assignment and conduct a thorough analysis of financial statements to draw out insightful conclusions. Your findings must be presented logically and coherently, supported by pertinent data and industry standards. You will develop a solid understanding of financial statement analysis through practice and application, which will improve your capacity to assess a company's financial health. You will improve your ability to interpret complex financial data, spot trends, and reach well-informed conclusions as you keep honing your abilities. You have the chance to hone your skills and establish your comprehension of this crucial facet of financial analysis by writing an assignment on financial statement analysis.

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Financial Statement Analysis (FSA)

Financial Statement Analysis: this article explains the Financial Statement Analysis or ( Financial Analysis ) in a practical way. After reading you will understand the basics of this powerful financial management and investment tool.

Introduction

Financial Statement Analysis (FSA) or Financial Analysis refers to the process of analysing the feasibility, stability and profitability of an organization, business unit or project. It identifies the financial strengths and weaknesses of an organization by establishing the relationship between the items of the balance sheet and the profit and loss account.

Financial Statement Analysis

Financial statement analysis is often reported to senior management and the board of directors. They use this information of the Financial Statement Analysis as input in the decision-making process. The FSA is also used by external parties, such as investors and supervisory bodies to gain insight into organizations.

There are several Financial Statement Analysis methods and techniques that can be used to analyse a balance sheet and a profit and loss account. The two most common types of financial statement analysis are:

Horizontal & Vertical analysis

Ratio analysis, financial statement analysis : horizontal analysis.

A horizontal analysis consists of a two-year comparison of financial data with other years. This type of financial analysis is also known as trend analysis. The horizontal analysis is often expressed in monetary terms (currency) and percentages.

Comparisons of currency amounts provide analysts with an insight into aspects that might contribute significantly to the profitability or the financial position of the organization. An example of a horizontal analysis in currency: In 2011, an organization turned over two million more than in the previous year.

This increased turnover appears to be a very positive development. This is true, however, when the analysis is examined more closely, it shows that the procurement costs of goods and services have increased by 2.5 million. The wonderful picture of an additional turnover of 2 million is at once adjusted to a less positive picture.

A horizontal analysis expressed as a percentage, provides more insight and feeling about the significance of an increase or decrease. An example of a horizontal analysis expressed as a percentage is a representation of an increase in turnover of 1 million on revenues of 2 million in the previous year.

This is an increase of 50%, which is a remarkable growth in turnover for an organization. However, if the increase is compared with a turnover of 20 million in the previous year, then the increase will amount to 5%, which represents a normal growth of an organization. Expressing an analysis as a percentage provides a much better insight into the increase than when expressed as a currency.

Financial Statement Analysis : Vertical Analysis

A vertical analysis consists of a representation of standard headings on a financial statement that are expressed as percentage of those headings. In a vertical analysis both the assets and liabilities are considered equal to 100%. Some examples of headings are: equity, short-term and long-term liabilities.

These are expressed as a percentage of the total assets. By doing this every year, insight will be created into the change in the distribution of total assets. A vertical analysis is also often used to compare companies with one another in the form of benchmarking . Because the headings occur in any given organization, this makes it easy to compare organizations.

For example borrowed capital compared to the total assets.A vertical analysis can also be applied to the profit and loss accounts. By representing the standard heading as a percentage of the total turnover of that year, it is easy to obtain insight into the division of each currency with the different costs, expenditures and profit. This makes it possible to compare the successive years to identify certain trends.

Ratios, a ratio between two quantities, are used to represent relationships between various figures on a balance sheet, profit and loss account or other accounting records. Ratios always represent a ratio of one figure related to another. The four most common ratios are:

Profitability ratio & profitability

Profitability ratio & profitability measure the results of an organization’s day-to-day management or overall performance and effectiveness of management.

Some of the most commonly used profitability ratios are: gross profit ratio, net profit ratio, operating ratio and return on equity capital, return on capital employed ratio, dividends yield ratio and earnings per share ratio.

Liquidity ratio

Liquidity ratios evaluate the current solvency of an organization’s financial position. These ratios are calculated to find out whether an organization has the ability to meet its current obligations. Two common liquidity ratios are the current ratio and the quick ratio .

Efficiency ratio

Efficiency ratios measure the effectiveness of the means that are deployed in an organization. Another name for this ratio is turnover ratio. Many common aspects with which the turnover ratio is calculated are: working capital turnover ratio, fixed assets turnover ratio and debtors’ turnover ratio.

Solvency ratio

Solvency ratios measure an organization’s ability to meet their long-term interest expenses and repayment obligations. Common ratios are debt-to-equity ratio, equity ratio and interest coverage ratio.

Advantages of a Financial Statement Analysis

It’s Your Turn

What do you think? How do you apply the Financial Statement Analysis in today’s business? Are the ratios, mentioned in the post, common for you or do you use other or more ratios? If so, which one do you use and why?

Share your experience and knowledge in the comments box below.

More information

• Will, I., Subramanyam, K. R., & Robert, F. H. (2001). Financial statement analysis . McGraw-Hill Internation.
• Stickney, C. P. (1993). Financial statement analysis . Dryden.
• Lev, B. (1974). Financial statement analysis: a new approach . Prentice Hall .

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Course Resources

Assignments.

The assignments in this course are openly licensed, and are available as-is, or can be modified to suit your students’ needs. Answer keys are available to faculty who adopt Lumen Learning courses with paid support. This approach helps us protect the academic integrity of these materials by ensuring they are shared only with authorized and institution-affiliated faculty and staff.

If you import this course into your learning management system (Blackboard, Canvas, etc.), the assignments will automatically be loaded into the assignment tool.

You can view them below or throughout the course.

• Module 0: Personal Accounting— Assignment: Creating a Budget
• Module 1: The Role of Accounting in Business— Assignment: Lopez Consulting
• Module 2: Accounting Principles— Assignment: Accounting Principles
• Module 3: Recording Business Transactions— Assignment: Recording Business Transactions
• Module 4: Completing the Accounting Cycle— Assignment: Completing the Accounting Cycle
• Module 5: Accounting for Cash— Assignment: Accounting for Cash
• Module 6: Receivables and Revenue— Assignment: Manilow Aging Analysis
• Module 7: Merchandising Operations— Assignment: Merchandising Operations
• Module 8: Inventory Valuation Methods— Assignment: Inventory Valuation Methods
• Module 9: Property, Plant, and Equipment— Assignment: Property, Plant, and Equipment
• Module 10: Other Assets— Assignment: Other Current and Noncurrent Assets
• Module 11: Current Liabilities— Assignment: Calculating Payroll at Kipley Co
• Module 12: Non-Current Liabilities— Assignment: Non-Current Liabilities
• Module 13: Accounting for Corporations— Assignment: Collins Mfg Stockholders’ Equity
• Module 14: Statement of Cash Flows— Assignment: Kachina Sports Company Cash Flows
• Module 15: Financial Statement Analysis— Assignment: Coca Cola FSA

Discussions

The following discussion assignments will also be preloaded (into the discussion-board tool) in your learning management system if you import the course. They can be used as is, modified, or removed. You can view them below or throughout the course.

• Module 0: Personal Accounting— Discussion: Winning the Lottery
• Module 1: The Role of Accounting in Business— Discussion: The Crafty Coffee Crook
• Module 2: Accounting Principles— Discussion: SoftSheets
• Module 3: Recording Business Transactions— Discussion: Baker’s Breakfast Bars
• Module 4: Completing the Accounting Cycle— Discussion: Closing the Books in QuickBooks
• Module 5: Accounting for Cash— Discussion: Counter Culture Cafe
• Module 6: Receivables and Revenue— Discussion: Maximizing Revenue
• Module 7: Merchandising Operations— Discussion: Inventory Controls
• Module 8: Inventory Valuation Methods— Discussion: LIFO, FIFO, Specific Identification, and Weighted Average
• Module 9: Property, Plant, and Equipment— Discussion: Cooking the Books
• Module 10: Other Assets— Discussion: Other Assets
• Module 11: Current Liabilities— Discussion: Current Liabilities
• Module 12: Non-Current Liabilities— Discussion: Off-Balance Sheet Financing
• Module 13: Accounting for Corporations— Discussion: Home Depot
• Module 14: Statement of Cash Flows— Discussion: Facebook, Inc.
• Module 15: Financial Statement Analysis— Discussion: Financial Statement Analysis

Alternative Excel-Based Assignments

For Modules 3–15, additional excel-based assignments are available below.

Module 3: Recording Business Transactions

• Module 3 Excel Assignment A
• Module 3 Excel Assignment B

Module 4: The Accounting Cycle

• Module 4 Excel Assignment A
• Module 4 Excel Assignment B
• Module 4 Excel Assignment C
• Module 4 Excel Assignment D

Module 5: Accounting for Cash

• Module 5 Excel Assignment

Module 6: Receivables and Revenue

• Module 6 Excel Assignment A
• Module 6 Excel Assignment B

Module 7: Merchandising Operations

• Module 7 Excel Assignment

Module 8: Inventory Valuation Methods

• Module 8 Excel Assignment A
• Module 8 Excel Assignment B
• Module 8 Excel Assignment C

Module 9: Property, Plant, and Equipment

• Module 9 Excel Assignment A
• Module 9 Excel Assignment B

Module 10: Other Assets

• Module 10 Excel Assignment

Module 11: Current Liabilities

• Module 11 Excel Assignment

Module 12: Non-Current Liabilities

• Module 12 Excel Assignment A
• Module 12 Excel Assignment B

Module 13: Accounting for Corporations

• Module 13 Excel Assignment A
• Module 13 Excel Assignment B
• Module 13 Excel Assignment C

Module 14: Statement of Cash Flows

• Module 14 Excel Assignment A
• Module 14 Excel Assignment B

Module 15: Financial Statement Analysis

• Module 15 Excel Assignment

Review Problems

There are also three unit review assignments and a final review. These reviews include a document which sets up the problems and an excel worksheet.

Unit 1 Review Problem (After Module 6)

• Review Problem Document

Unit 2 Review Problem (After Module 8)

Unit 3 review problem (after module 9), final review (after module 15).

• Assignments. Authored by : Cindy Moore and Joe Cooke. Provided by : Lumen Learning. License : CC BY: Attribution

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What Is Financial Analysis?

Understanding financial analysis, corporate financial analysis, investment financial analysis, types of financial analysis, horizontal vs. vertical analysis.

• Example of Financial Analysis
• Financial Analysis FAQs

The Bottom Line

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Financial Analysis: Definition, Importance, Types, and Examples

Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent , liquid , or profitable enough to warrant a monetary investment.

Key Takeaways

• If conducted internally, financial analysis can help fund managers make future business decisions or review historical trends for past successes.
• If conducted externally, financial analysis can help investors choose the best possible investment opportunities.
• Fundamental analysis and technical analysis are the two main types of financial analysis.
• Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a security.
• Technical analysis assumes a security's value is already determined by its price, and it focuses instead on trends in value over time.

Investopedia / Nez Riaz

Financial analysis is used to evaluate economic trends, set financial policy, build long-term plans for business activity, and identify projects or companies for investment. This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company's financial statements —the income statement , balance sheet , and cash flow statement . Financial analysis can be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance.

For example, return on assets (ROA) is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several companies in the same industry and compared to one another as part of a larger analysis.

There is no single best financial analytic ratio or calculation. Most often, analysts use a combination of data to arrive at their conclusion.

In corporate finance, the analysis is conducted internally by the accounting department and shared with management in order to improve business decision making. This type of internal analysis may include ratios such as net present value (NPV) and internal rate of return (IRR) to find projects worth executing.

Many companies extend credit to their customers. As a result, the cash receipt from sales may be delayed for a period of time. For companies with large receivable balances, it is useful to track days sales outstanding (DSO), which helps the company identify the length of time it takes to turn a credit sale into cash. The average collection period is an important aspect of a company's overall cash conversion cycle .

A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin , into an estimate of the company's future performance. This type of historical trend analysis is beneficial to identify seasonal trends.

For example, retailers may see a drastic upswing in sales in the few months leading up to Christmas. This allows the business to forecast budgets and make decisions, such as necessary minimum inventory levels, based on past trends.

In investment finance, an analyst external to the company conducts an analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach. A top-down approach first looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the best companies within that sector. From this point, they further analyze the stocks of specific companies to choose potentially successful ones as investments by looking last at a particular company's  fundamentals .

A bottom-up approach, on the other hand, looks at a specific company and conducts a similar ratio analysis to the ones used in corporate financial analysis, looking at past performance and expected future performance as investment indicators. Bottom-up investing forces investors to consider  microeconomic  factors first and foremost. These factors include a company's overall financial health, analysis of financial statements, the products and services offered, supply and demand, and other individual indicators of corporate performance over time.

Financial analysis is only useful as a comparative tool. Calculating a single instance of data is usually worthless; comparing that data against prior periods, other general ledger accounts, or competitor financial information yields useful information.

There are two types of financial analysis: fundamental analysis and technical analysis .

Fundamental Analysis

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

Technical Analysis

Technical analysis uses statistical trends gathered from trading activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the  statistical analysis of price movements . Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

When reviewing a company's financial statements, two common types of financial analysis are horizontal analysis and vertical analysis . Both use the same set of data, though each analytical approach is different.

Horizontal analysis entails selecting several years of comparable financial data. One year is selected as the baseline, often the oldest. Then, each account for each subsequent year is compared to this baseline, creating a percentage that easily identifies which accounts are growing (hopefully revenue) and which accounts are shrinking (hopefully expenses).

Vertical analysis entails choosing a specific line item benchmark, then seeing how every other component on a financial statement compares to that benchmark. Most often, net sales is used as the benchmark. A company would then compare cost of goods sold, gross profit, operating profit, or net income as a percentage to this benchmark. Companies can then track how the percent changes over time.

Examples of Financial Analysis

In the nine-month period ending Sept. 30, 2022, Amazon.com reported a net loss of $3 billion. This was a substantial decline from one year ago where the company reported net income of over $19 billion.

Financial analysis shows some interesting facets of the company's earnings per share (shown above. On one hand, the company's EPS through the first three quarters was -$0.29; compared to the prior year, Amazon earned $1.88 per share. This dramatic difference was not present looking only at the third quarter of 2022 compared to 2021. Though EPS did decline from one year to the next, the company's EPS for each third quarter was comparable ($0.31 per share vs. $0.28 per share).

Analysts can also use the information above to perform corporate financial analysis. For example, consider Amazon's operating profit margins below.

• 2022: $9,511 / $364,779 = 2.6%
• 2021: $21,419 / $332,410 = 6.4%

From Q3 2021 to Q3 2022, the company experienced a decline in operating margin, allowing for financial analysis to reveal that the company simply earns less operating income for every dollar of sales.

Why Is Financial Analysis Useful?

The financial analysis aims to analyze whether an entity is stable , liquid, solvent, or profitable enough to warrant a monetary investment. It is used to evaluate economic trends, set financial policies, build long-term plans for business activity, and identify projects or companies for investment.

How Is Financial Analysis Done?

Financial analysis can be conducted in both corporate finance and investment finance settings. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance. A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin, into an estimate of the company's future performance.

What Techniques Are Used in Conducting Financial Analysis?

Analysts can use vertical analysis to compare each component of a financial statement as a percentage of a baseline (such as each component as a percentage of total sales). Alternatively, analysts can perform horizontal analysis by comparing one baseline year's financial results to other years.

Many financial analysis techniques involve analyzing growth rates including regression analysis, year-over-year growth, top-down analysis such as market share percentage, or bottom-up analysis such as revenue driver analysis .

Last, financial analysis often entails the use of financial metrics and ratios. These techniques include quotients relating to the liquidity, solvency, profitability, or efficiency (turnover of resources) of a company.

What Is Fundamental Analysis?

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

What Is Technical Analysis?

Technical analysis uses statistical trends gathered from market activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

Financial analysis is a cornerstone of making smarter, more strategic decisions based on the underlying financial data of a company. Whether corporate, investment, or technical analysis, analysts use data to explore trends, understand growth, seek areas of risk, and support decision-making. Financial analysis may include investigating financial statement changes, calculating financial ratios, or exploring operating variances.

Amazon. " Amazon.com Announces Third Quarter Results ."

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Analysis of Financial Statement Formal Assignment Report

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BUS202: Principles of Finance

Unit 2 Financial Statement Analysis Exercises

Complete these exercises and problems and then check your work.

The income statement captures all activity related to revenues and expenses over a particular time period. For instance, the quarterly income statement includes all revenue and expense items for that quarter. The beginning of the quarter is treated the same as the end of the quarter. The same applies for annual income statements. However, balance sheets represent a firm's assets, liabilities, and owners' equity at a particular point in time. The quarterly balance sheet only reflects the last day of that quarter and the annual balance sheet only reflects the last day of the year. As such, the balance sheet is more open to seasonality issues and short-term fluctuations. For instance, if the balance sheet is prepared 1 day prior to a large cash payment the cash account will appear artificially large. On the other hand, if it is prepared 1 day after the payment the cash account will appear artificially small.

The firm has $60 million in total liabilities.

A = L + OE $100M = L + $40M $60M = L

Depreciation is a noncash expense. While it lowers net income, the firm is not actually paying anything for depreciation so it has no impact on cash flows (ignoring taxes…when considering taxes, depreciation lowers net income but increases cash flows as less cash is paid in taxes). The cash flow impact of an asset purchase from a finance perspective occurs when the asset is purchased. Spreading the cost equally over the assets useful life ignores the time value of money and understates the true cost of the purchase. A few other issues that may create a difference between cash flows and earnings include (this is not a complete list) –

• Revenue recognition
• Inventory accounting method
• Prepaid expenses
• Accounts Payable/Receivable

While many people use ratio analysis, the primary parties interested are

• Competitors
• Stockholders (and potential stockholders)
• Long-Term Creditors
• Short-Term Creditors

When analyzing  Liquidity Ratios , the most interested parties are management and short-term creditors. Management needs to understand the firm's liquidity position in order to properly manage the firm. Short-term creditors typically do not care much about the long-term health of the firm, but only if they have enough liquid capital to meet the short-term obligations. Long-term creditors and stockholders would also be interested, but primarily only if the liquidity ratios were weak enough to damage the long-term health of the firm.

When analyzing  Asset Management Ratios , the most interested parties are management, competitors, and stockholders. Again, management must be interested in all the ratios as they must manage all aspects of the firms operations. Competitors are interested as a gauge of their own performance. If our competition has a total asset turnover of 2.50 and ours is only 1.95 we must understand what they are doing to outperform us in this measure. By identifying our weaknesses, we can address them. Stockholders have some interest in that often asset management ratios impact a firm's ability to generate profits and increase firm value. Long-term and short-term creditors are typically not significantly concerned with these measures as they do not share in any “extra” profits the company generates. As long as the firm is able to meet interest and principle obligations, debt holders are happy.

Management, long-term creditors, short-term creditors, and stockholders are all focused on  Debt Management Ratios . These ratios measure a firm's ability to meet their debt obligations, so creditors want to see these ratios strong in order to be confident of receiving their full interest and principle payments. Long-term creditors are probably more focused on this as short-term creditors hope to be repaid quickly enough that they are more concerned about the liquidity issues. Stockholders are concerned because if the firm is unable to meet its debt obligations it will be forced into bankruptcy and the stockholders will likely lose all of their investment.

Profitability Ratios  are a concern primarily for management, competitors, and stockholders. Creditors, both LT and ST, do not participate in profits so their only concern with profitability ratios is if they are negative and threaten the ability of the firm to meet interest and principal payments. Like asset management ratios, competitors use profitability ratios as a method to gauge their strengths and weaknesses. Since stockholders “own” the business, the profits belong to them. Therefore, the stronger the profitability ratios, the happier the stockholders are.

Market Value Ratios  are looked at by stockholders and management. These ratios measure how “cheap” or “expensive” the stock is. Management typically wants these ratios to be high as it is a sign that they are maximizing firm value. Potential stockholders typically want them low as that is an indication that the stock may be cheap (except for dividend yield). As a side note, market value ratios are often much more difficult to analyze than many people would like.

The key to this question recognizing the role of the equation A = L + OE in these two ratios. Because all firms use some degree of liabilities (long-term debt, accounts payable, accruals, etc.), we know that Assets must be larger than Owners' Equity. The greater the amount of debt financing (liabilities), the greater the difference between Assets and Owners Equity will be. Also, since the difference between ROA and ROE is the denominator (ROA is NI/Assets while ROE is NI/OE), ROE will always be higher than ROE (for firms with positive NI). Finally, the greater the amount of debt financing (liabilities), the greater the difference between ROA and ROE will be.

When considering the above paragraph, we can now comment on the specific ROA and ROE numbers for Company A and B. Since Company B has a lower ROA and a higher ROE (relative to Company A), we know that Company B is using more leverage (debt financing) than Company A.

Neither approach is necessarily “better” or “worse” than the other. They are just different. Company B is using a more aggressive (riskier) strategy of financing. The higher level of debt increases the risk, but also means stockholders earn a greater return on their money when the company does well. However, if the company does poorly, the higher leverage (debt financing) will magnify the losses (as the interest must still be paid and the loss is spread over less shareholder capital). Thus, higher amounts of debt financing are riskier, but also increase the potential return. Which approach is better depends on the level of risk aversion for each shareholder.

The DSO ratio does provide an indication of how long it is taking a firm to collect its credit sales. Thus, a high DSO ratio can be an indication of a problem in managing a firm's accounts receivables. However, one must be very careful in jumping to conclusions. First, DSO can be very industry dependent. Second, and the issue in this question, is that DSO uses both balance sheet and income statement values to calculate the ratio. As the Annual Income statement is not subject to seasonality while the Annual Balance Sheet is, there is the potential for seasonality issues to distort the ratio. Specifically, Company A has larger accounts receivable on their annual balance sheet due to the seasonal nature of their sales. This inflates their DSO ratio. Company B has had plenty of time to collect their accounts receivable. This is a prime example of why you need to consider seasonality when evaluating ratios.

If we think of the inventory turnover ratio, Company A should appear to be doing better. Specifically, they will have less inventory on hand at the end of the year (as their heavy sales season is winding down and they approach seasonally lower sales). Alternatively, Company B's inventory will be high to meet their seasonally high 1st and 2nd quarter sales that are right around the corner.

Subject to Seasonality – Quarterly Income Statement, Quarterly Balance Sheet, Annual Balance Sheet

Not Subject to Seasonality – Annual Income Statement

This is a FALSE statement. While it is true that everything else equal, a higher profit margin is better than a lower profit margin there is not enough information to make this a true statement. We are ignoring both trend analysis and comparative analysis, so we don't have the necessary context to evaluate the profit margin number. For instance company A could be in a low profit margin industry (such as banking or retail) while company B could be in a high profit margin industry (such as software or pharmaceuticals). Also, profit margin is only one ratio and to label one company as outperforming another based on a single ratio is shortsighted. We need to consider the larger picture before making such a statement. The purpose of this question is to illustrate that one ratio without context is close to meaningless.

Trend Analysis refers to looking at a firm's ratios over a period of 3-5 years to identify whether specific areas are strengthening or weakening. Comparative analysis refers to looking at a firm's ratios relative to other firms in the same industry to evaluate whether they are better or worse than industry averages. Trend/comparative analysis provides us some of the necessary context to properly interpret the ratios.

QUESTION 10

Potential problems with trend analysis include

Potential problems with comparative analysis include

QUESTION 11

A very low quick ratio may be cause for concern because it could indicate liquidity concerns. A low level of cash and accounts receivable relative to our current liabilities could indicate that we will have a hard time paying those current liabilities when they are due. A very high quick ratio may be cause for concern because it indicates an inefficient allocation of resources. Cash and accounts receivable are not high return assets. We would likely be better off allocating our assets to areas with higher rates of return.

QUESTION 12

The primary objective of financial statement analysis from the perspective of management is to identify potential strengths and weaknesses of our firm relative to our competitors so we can take full advantage of our strengths and work on fixing our weaknesses.

There are several difficulties that management might encounter in conducting a complete financial statement analysis. Some are mentioned in the question on potential problems with trend analysis and comparative analysis above. Other problems include comparability of financial statements across firms in the industry due to different fiscal years and/or different accounting procedures. Also, the need to dig beyond the numbers is critical. For example, is a high ROE due to a well-run company or due to too much leverage that could cause significant problems if we hit a small rough patch? Another issue is that financial statement analysis may help us identify potential strengths and weaknesses. However, even after confirming them by digging deeper, the financial statement analysis often does not recommend HOW we can fix the weakness or exploit the strength.

The primary objective of financial statement analysis from the perspective or the stockholder is to identify companies to invest in (potential stockholders) or evaluate the companies the stockholder currently owns (current stockholders).

Stockholders face many of the same problems discussed above with management. However, an important challenge for stockholders is that they must not only analyze the company's financial health, but also evaluate how much they are paying for it. There may be situations where buying stock in a company with poor financial health is a good opportunity (the stock price is “cheap” enough and there is a chance for the company to rebound). There may also be situations where selling shares of stock in a company with strong financial health is good (the stock price is so expensive that the firm's success is already more than fully reflected in the stock price). Too often stockholders get caught up in what they are buying and don't think enough about how much they are paying for it.

CR = CA/CL = 7,000,000/4,500,000 = 1.56 QR = (CA – Inv)/CL = (7,000,000 – 2,000,000)/4,500,000 = 1.11 ITR = CGS/Inv = 6,000,000/2,000,000 = 3 times DSO = AR/(Sales/365) = 2,000,000/(15,000,000/365) = 48.67 days FAT = Sales/Fixed Asst = 15,000,000/10,000,000 = 1.5 times TAT = Sales/Total Asst = 15,000,000/17,000,000 = 0.88 times TD/TA = 10,000,000/17,000,000 = 58.8% TD/OE = 10,000,000/7,000,000 = 142.86% TIE = EBIT/Int = 4,000,000/1,000,000 = 4 times GPM = (Sales – CGS)/Sales = (15,000,000 – 6,000,000)/15,000,000 = 60% NPM = NI/Sales = 2,100,000/15,000,000 = 14.0% ROA = NI/Asst = 2,100,000/17,000,000 = 12.4% ROE = NI/OE = 2,100,000/7,000,000 = 30.0% PE = Price/EPS = 25/1.05 = 23.81 M/B = Price/BV = 25/(7,000,000/2,000,000) = 7.14 DY = Div/Price = $0.50/$25 = 2.00%

CR = CA/CL = 11,050,000/7,000,000 = 1.58 QR = (CA – Inv)/CL = (11,050,000 – 4,000,000)/7,000,000 = 1.01 ITR = CGS/Inv = 11,000,000/4,000,000 = 2.75 times DSO = AR/(Sales/365) = 4,000,000/(20,000,000/365) = 73 days FAT = Sales/Fixed Asst = 20,000,000/11,000,000 = 1.82 times TAT = Sales/Total Asst = 20,000,000/22,050,000 = 0.91 times TD/TA = 15,000,000/22,050,000 = 68.0% TD/OE = 15,000,000/7,050,000 = 212.77% TIE = EBIT/Int = 3,000,000/1,500,000 = 2 times GPM = (Sales – CGS)/Sales = (20,000,000 – 11,000,000)/20,000,000 = 45% NPM = NI/Sales = 1,050,000/20,000,000 = 5.25% ROA = NI/Asst = 1,050,000/22,050,000 = 4.76% ROE = NI/OE = 1,050,000/7,050,000 = 14.89% PE = Price/EPS = 17.5/0.525 = 33.33 M/B = Price/BV = 17.5/(7,050,000/2,000,000) = 4.96 DY = Div/Price = $0.50/$17.50 = 2.86%

Each item in the income statement is expressed as a percentage of sales (revenues) and each item in the balance sheet is presented as a percentage of total assets.

To start the analysis of finding strengths and weaknesses, I started with the common size statements. The first thing that I noticed was the increase in Cost of Goods Sold from 40% of sales in 2015 to 55% of sales in 2017. This indicates that our production costs jumped significantly and will act to lower our net income. Selling and Administrative expenses dropped slightly from 20% of sales to 17.5% of sales. This is a strength, but is not a very large change so I don't place much emphasis on it. The declines in EBIT and Net Income as a % of sales are due to the increase in CGS, so do not need further analysis. Thus, from the Common Size Income statement, I focus on the increase in CGS as a significant weakness and would classify the decline in S&A Expenses as a small strength.

Next I proceed to the Common Size balance sheet. The first things I notice are the increases in accounts receivable and inventory as a % of total assets. This is a concern that needs more analysis before I declare it a weakness. Consider accounts receivable first. AR could increase due to higher sales levels. If 25% of my sales are done on credit and sales increase, my AR will automatically increase as well. This could result in AR being a bigger portion of my firm's assets and would not be seen as a negative. On the other hand, AR may be increasing because fewer customers are paying their bills on time. This could lead to more bad debt expense or higher collection costs. I can not tell which explanation is causing the increase in AR from the CS balance sheet, so I will make a note of it and look more at the issue as I move through my analysis. Like AR, inventory increases may or may not be a weakness. If sales increase, I will need more inventory on hand to handle the increase in sales which is likely to cause inventory to make up a larger portion of my firm's assets. Alternatively, if I am getting stuck with more out-of-date inventory it will also make up a larger portion of my firm's assets until I am forced to do a write down and take the loss. From the CS balance sheet I can't tell which scenario is taking place so this is also something to investigate further.

Net PPE shows a large drop in the CS Balance sheet, but that is primarily a result of the increase in current assets caused by the jump in AR and Inv which have already been discussed, so I will not pay much attention to the decline in Net PPE. Notes Payable shows a large jump, however that could just be a function of me financing some of my increase in current assets so again that is not something that would concern me too much. I would probably want to note it and make sure I find out the reason for the increase but it likely is not a strength/weakness. The jump in Total Liabilities as a % of total assets is something that might concern me. Higher levels of liabilities as a % of total assets indicates higher risk levels. The firm has a greater chance of serious financial problems is there is a slowdown. This is not necessarily bad as the higher debt levels also have the chance to increase our profits if things go well, however it is something to note with a degree of caution due to the higher risk. Finally, the drop in OE is merely the flip side to the increase in TL, so needs no further analysis.

Next I move on to the ratio analysis. My liquidity ratios appear to be sound as both are stable from year to year and similar to the industry averages. Next is my Inv. Turnover Ratio. This, combined with the increase in inventory on the CS balance sheet indicates a problem. If my inventory increase was merely a result of increased sales, the inventory turnover ratio would hold steady or increase slightly. Instead it has decreased slightly and is noticeably lower than the industry average. This means that I am tying up more of my capital as inventory and probably ending up with older inventory that will need to be marked down and sold at a loss.

I also notice problems with my Days Sales Outstanding ratio. The significant jump in the DSO ratio tells me its taking me an about 24 days longer on average to collect each dollar in sales. Since this is also much higher than the industry average it means one of two things. Either I have a lot of customers that aren't paying on time and may end up with higher levels of bad debts or that I have to offer more favorable credit terms to my customers to keep sales from dropping. Both of these possibilities are bad, so my accounts receivable situation is a definite cause for concern.

Fixed Asset Turnover and Total Asset Turnover both look good. FAT is up and both are higher than the industry average. This is a sign that I am doing a good job overall of using my assets (especially my LT assets) to generate sales.

The debt management ratios are troublesome. My TD/TA and TD/OE ratios have increased by quite a bit and are higher than the industry averages. Also, my TIE ratio has dropped and is lower than the industry average. This means that our firm is using more debt financing and has less margin for error. If we experience an off year or two our firm is likely to run into severe financial problems and could face bankruptcy. On the other hand, if we have a couple of strong years, we will make higher returns for our shareholders due to the leverage provided by debt. This is not necessarily a strength/weakness but is a sign of high financial risk.

The profitability ratios are all showing an interesting pattern that ties back into my CGS observation from the CS income statement. My profitability (PM, ROA, ROE) is down due to the increase in CGS. However, all three ratios are consistent with the industry average. This might be an indication that the increase in CGS is more of an industry issue rather than firm specific. If a key input had a price increase, this is likely to impact all firms in the industry equally. For example, if grain prices jumped significantly both Kellogg's and General Mills may see a jump in their CGS and a decline in their profit margins. It doesn't indicate a management problem, but an industry issue. If my profitability ratios declined significantly AND were lower than the industry average I would be more concerned about company specific problems.

Finally we have the market value ratios which are difficult to interpret in this instance. The PE ratio has increased significantly as my stock price fell, but earnings fell faster. It is also higher than the industry average which indicates the stock is more expensive in terms of what investors pay for each dollar of earnings (possibly indicating that they believe the earnings drop is not permanent). The MV/BV ratio has decreased significantly which indicates the stock is cheaper. This is because book value is less sensitive to the recent earnings decline which lowered the stock price (making the stock cheaper relative to its book value). However, the stock is still slightly more expensive than the industry average. While our dividend yield increased and is higher than the industry average (which is good), there is a danger sign here. If earnings drop any further, we may have to cut our dividend which would cause the yield to drop.

To summarize, our financial statement analysis indicates

• The firm needs to address the CGS issue, but that it is probably an industry issue instead of a company specific problem. This doesn't mean we can ignore it, just that it will be more difficult to fix.
• The firm needs to get control of its credit policies and improve its collections process.
• The firm needs to get control of its inventory concerns
• The firm is doing a good job at generating sales from its LT Assets.
• The firm has a high degree of financial risk
• The firm does not appear to have any major liquidity constraints.
• The stock is relatively expensive relative to the industry average and the dividend yield (while attractive) should be viewed with caution as it may not be sustainable.

You know that you need the current stock price and the book value per share in order to get the MV/BV ratio. To get current stock price, you can use the PE ratio: PE = Price/EPS ⇒ Price = (PE)×(EPS)

To get EPS, you need Net Income which you can get from the net profit margin: Net Profit Margin = Net Income/Sales ⇒ Net Income = Net Profit Margin×Sales

You have the Profit Margin, so you need Sales. You can get Sales from the Total Asset Turnover Ratio: Total Asset Turnover = Sales /Assets ⇒ Sales = TA Turnover×Assets

Sales = (1.5)×($6,000,000) = $9,000,000 Net Income = (0.05)×($9,000,000) = $450,000 EPS = ($450,000)/(600,000 shares) = $0.75 per share Stock Price = (13)×(0.75) = $9.75

Now you need to solve for Book Value which is Owners' Equity per Share. We know the Return on Equity, so we can use that (along with Net Income) to get Owners' Equity: ROE = Net Income/Owners Equity ⇒ Owners Equity = NI/ROE

Owners' Equity = ($450,000)/(0.14) = $3,214,285.71 Book Value = $3,214,285.71)/(600,000 shares) = $5.36 per share MV/BV = ($9.75)/($5.36) = 1.82

Our MV/BV ratio is 1.82. This is a tough problem as it not only tests your knowledge of ratios, but your problem solving skills. Don't worry if you didn't get it at first, but hopefully once you see the solution it makes sense.

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[SPMANACS37 GROUP 2] Assignment 2 Financial Statement Analysis

Financial Analysis Sample Assignment

FINANCIAL ANALYSIS

Introduction

Financial statement analysis facilitates the financial managers to make the decision regarding investment and therefore financial statement analysis is to be found as one of the most crucial of financial management. In this context, it is to mention that the financial statement analysis considers the ratios to identify the trends of the financial positions of a company ( [i] ). Therefore, the researcher shall consider ratio analysis for identifying the trend of the performance of the company. In the initial part of the study, the researcher shall consider the business and strategic analysis of IRESS limited- Melbourne. In this part, the researcher shall consider the industry analysis, economic analysis and the analysis of the performance of the competitors of the company. After this part, the researcher shall analyze the accounting analysis and the financial analysis to identify the trends of the ratios and the reasons for changes in the performance of the company. In the next part of the study, the researcher shall make discussion on the sales growth rate and the asset quality of the company to make the comparison with the competitive firms. In addition to that, the researcher shall make the recommendation on the basis of the strategic analysis, financial analysis, and the prospective analysis.

1. Business and Strategic Analysis

1.1 Analysis of the economy

In Australia, the software industry is to be considered as one of the most emerging industries and this industry creates the most employment in the country after the banking industry ( [ii] ). As this industry enhances the employability in the country, the government encourages the industry owners by providing the subsidy to the companies of this industry. Therefore, the company could avail the subsidy from the government in future. On the other hand, the researcher is to mention that the software industry in Australia earns foreign income and therefore this industry contributes 21% of the total GDP of the country ( [iii] ).

On the other hand, the researcher is to mention that the intellectual property in Australia is generated by the engineering universities in the country (). As the country has an immense source of intellectual properties from the internal and external sources, the company could get the advantage of skilled employees for the business operation. The software industry relies on the advancement of the technologies and Australia is to be considered as technologically advanced as per as the software technology is concerned ( [iv] ). In this context, it is to mention that students from all around the globe come to Australia for the job opportunity and therefore the company could get the internationally approved technological support.

1.2 Industry analysis

Identification of the industry

IRESS limited involved in selling the software services in the internal market as well as in the external market. Therefore, the researcher is to mention that the company is in the software industry in Australia. In this context, the researcher is to mention that the company has earned the highest revenue in 2015 and 2016 among the Australian software companies. In this context, the researcher is to mention that the market share of the company in the stock market is the second highest after XERO. As per as the international business is concerned, the researcher is to mention that the company has made third highest foreign revenue among the software companies in the country.

Competitors of the company

While making discussion on the competitors of IRESS limited, the researcher is mention that MYOB holding limited has earned the highest operating revenue in the industry since 2011, and therefore this company is required to be considered as the most impactful competitor of IRESS limited.

Competitive positioning analysis through Porter’s five forces model:

Bargaining power of supplier:

The company purchases software related products from foreign countries, which includes China, Japan, the United States, and India. Moreover, it is also to mention that the competitors of the company including MYOB holding limited purchases raw materials from the USA and China. Bargaining in the international business relies upon the treaties that a company makes with other companies, and therefore, the issue of bargaining with the suppliers is a macroeconomic issue. Therefore, this factor could not affect the strategic decision making of the company ( [v] ).

Bargaining power of the customers:

MYOB holding limited sells its software to the domestic customers as well as to the foreign clients. As this company has initiated the foreign trading in 2012, the bargaining power of the foreign customers is to be considered as high. Therefore, the researcher is to mention that the high degree of the bargaining power of the customers affects the strategic and comparative decision making of the company.

The threat of new entrants:

The software industry is to be considered as a capital intensive industry and therefore the new firms could not enter into the industry due to lack of capital. On the other hand, the researcher is to mention that the company does not face any problem regarding the threat of new entrants.

The threat of substitutes:

As the software industry relies upon the advancement of the technology, the industry offers a high number of substitutes to the customers. In this regard, it is to mention that the competitors of the company offer customized products to the clients, which could enhance the threat of substitutes for the company.

Rivalry among the existing competitors:

Large software firms form the cartel in Australia to set a price of the software services in the domestic market. In this context, the researcher is to mention that as the company is involved in international business and therefore it faces strong competition in the global stage. In this context, the researcher is to mention that the company does not face such competition as its face in the international platform.

From the above discussions, the researcher is to mention that the company faces competition in terms of the threat of substitutes. This force could result in the decrease in the profitability of the companies in the industry. On the other hand, the researcher is to mention that the advancement of the technology could facilitate the industry to enhance the profitability level.

Growth potential of the software industry

Companies in Australia consider the advancement in the software as the most impactful factor for achieving the organizational goal. In this context, the researcher is to mention that the software industry is required to be considered as the most emerging industry as this industry has reflected the most steady growth as compared to the other service-providing industries (). Therefore, the researcher is to mention that the industry is required to make the large investment in order to enhance the innovation that would facilitate the companies to enhance the return on investment in future.

1.3 Company’s competitive and corporate strategy

The company’s competitive strategy

IRESS limited has a separate team for serving the post sales services to the foreign clients ( [vi] ). On the other hand, the researcher is to mention that the company appoints employees from internal sources along from the foreign countries. Therefore, the base of knowledge within the company is required to be considered as one of the most crucial core competencies as the company involves in an industry that is affected by the advancement in the technology. Therefore, the knowledge base and the post-sale services are required to be considered as the core competencies of the company. Along with the core competencies, the company has risk drivers, which creates constraints to the company. This includes a risk of duplication of products and the piracy of the company outputs. Therefore, the researcher is to mention that the post sales service and the prevention of the piracy and duplicity of products could enhance the profitability of the company.

The corporate strategy of the company

The company has adopted cost leadership strategy as the primary base of corporate strategy. In this context, the researcher is to mention that the high level of competition in the software industry is to be considered as the main reason that it has adopted the strategy of cost minimization and minimization of a price of the products.

Income statement of IRESS limited

Income statement of MYOB holdings limited

Balance sheet

Cash flow statement of the company

2. Accounting Analysis

In the accounting analysis, the researcher shall make discussion on the three significant items in the financial statement of IRESS limited and MYOB Holding limited.

These items are discussed as follows.

• Retained earnings:

The retained earnings of IRESS limited in 2016 were $19,136,000, whereas the retained earnings of MYOB holding limited were $353,800 in 2016. In this context, the researcher is to mention that the previous discussion reflects that the software manufacturing firms need to make the regular investment in research and development ( [vii] ). For this purpose, the companies in this industry are to use their retained earnings as the primary source of investment in the research and development sectors. Therefore, the researcher is to mention that IRESS limited is in a competitively advantageous position as compared to its competitive firm.

• Borrowings:

As discussed earlier, software industry players face risks related to the advancement in the technology ( [viii] ). In this context, it is to mention that the enhanced amount of borrowings would enhance the financial risks of a company and therefore the companies with high debt capital are to incur more interest costs. In this context, the researcher is to mention that IRESS limited has a debt capital of $177,805,000. On the other hand, the debt capital of the company was $434,800 in 2016. Therefore, the researcher is to mention that IRESS limited is riskier as compared to MYOB limited as per as the financial risks are concerned.

• Intangible assets:

Intangible assets are to be considered as the base of the research and development as this assets helps the companies to develop a core competence ( [ix] ). In this context, it is to mention that the intangible assets of IRESS limited are $568,759,000. On the other hand, MYOB holdings limited has an intangible asset of $1210,2000 on 2016. As IRESS limited had a higher amount of intangible asset, it could build up a profitable product cycle in the market ( [x] ).

Quality of disclosures

IRESS limited has disclosed the financial and non-financial aspects of the company as the annual report includes audit report and directors report. On the other hand, the researcher has mentioned that the company has disclosed the workings for deriving the account balances as per the IFRS rule. On the other hand, the researcher is to mention that MYOB holdings limited has not disclosed its cash flow statement, therefore it can be said that IRESS limited has reported a quality financial statement as per as the requirements of the IFRS are concerned. This will help the stakeholders of the company to assess the financial reports properly and thus, will be able to make better investment decisions. It will also provide the company a better image in the market.

Three potential red flags of the company

As the company is involved in the business of selling software in the market, it needs to rely upon the intangible assets, and therefore, the intangible assets are the initial red flag of the company. The intangible assets are significant in the company’s growth and survivability in the, market. On the other hand, the company has hold a significant amount of investment, from which it can earns its profit, hence this item is also required to be considered as a red flag item. The market base of the company is strong and the results are3 reflected in the in its investment. Thus the company needs to perform better in order to maintain their level of investment. Moreover, he researcher is to mention that the company has made international sales during 2016, which is reflected in the net sales figure. As revenue from operations is the primary source of profit of the company, this could also be considered as a red flag of the organization. The profit earned by the organization if retained can be used for several purposes like expansion or growth, for payment of dividend to the shareholders, etc. Thus, it becomes necessary for the organization to increase its productivity from operation and thus increase the profitability of the firm

3. Financial Analysis

Return on equity and its decomposition:

The return on equity or return on net worth is a tool for measuring an organization's profitability based on the profit margin generated by amount of shareholder's equity. The return on equity of a firm is given by,

ROE = Net Income / Shareholder’s equity.

In other words, return on equity is the amount of net income earned as a percentage of shareholder’s equity. It is an important tool for measuring the firm's profitability based on the profit generated by the firm with the money invested by the shareholders.

In light of the given situation, the return on equity of IRESS is given below,

Thus, IRESS had a return on equity of 14.83 % in the year 2016 and 16.32 % in the year 2015. From the above results, it is evident that the company had better profitability in the year 2015 than in 2016.

As the return on equity is used to measure the company profitability, the higher the return on the shareholder's equity, the better for the company. However, in the given case, the ROE of IRESS is better in the year 2015 where the company had a ROE of 16.32 %. In the year 2016 the company had a ROE of 14.83 % which indicates that the revenue earned by the company was not expected as compared to the shareholder’s equity. The factor that affects the return on equity of a company includes the net profit earned, the sales revenue generated, total assets the company holds and the total equity. Notable, the company had higher leverage ratio in the year 2015 as compared to 2016, which indicates that the company had more risk in 2015 than in 2016. Thus, it can be interpreted that due to more risk the company was able to earn more return on shareholder’s equity as compared to 2016 where the company had a leverage ratio of 1.65.

Financial analysis of IRESS limited and MYOB holding limited for the financial year 2016:

a) Operating ratio: The operating ratio of an organization is calculated to measure its efficiency by comparing the organization's operating expense to its net sales. The lower the operating ratio the better for the organization as it indicates the organization's ability to earn the profit. However, it should be noted that debt payment or expansion is taken into account while calculating the operating ratio. The operating ratio of an organization is given by operating expenses / net sales.

i) Total Assets Turnover ratio: this ratio is used to measure the company’s ability to generate sales compared to its total assets. The ratio is given by,

Total asset turnover = net sales / average total assets

ii) Equity Turnover ratio: Equity turnover ratio is used to measure the organization’s ability to generate sales compared to its investment in total equity. The higher the ratio the better it is for the company as it indicates the revenue generated with respect to every dollar the company has invested in total equity. The equity turnover ratio is given by,

Equity turnover = net sales / average total equity

iii) Fixed assets turnover ratio: This ratio is used to measure the company’s ability to generate sales with respect to its investment in fixed assets. It is given by,

Fixed assets turnover ratio = net sales / net fixed assets

b) Investment ratio: The investment ratio is a relationship between the amount of money an organization has invested and the amount of profit earned from it. Two of the significant investment ratios are returned on equity and profit margin of the organization.

i) Return on equity: Return on equity can be defined as the amount of net income earned by an organization with respect to its shareholder’s equity. It is given by

Return on equity = (net profit / sales) * (sales / total assets) * (total assets / total equity)

ii) Profit margin: Profit margin is used to measure the amount of profit earned by an organization. It is given by,

Profit margin = net profit / net sales

iii) Current ratio: Current ratio is one of the liquidity ratios that is used to measure the company's ability meet short-term obligations. It is given by,

Current ratio = Current assets / current liabilities

iv) Return on assets: It is one of the financial ratios that is used to measure the percentage of profit the company earns with respect to its overall resources. It is given by,

Return on assets = net income / total assets

c) Financial leverage ratio: While carrying outs its day-to-day business activity, an organization has to rely on various factors that includes the owner’s equity and the debt taken to finance its operations. A leverage ratio is used to assess the company’s ability to meet its financial obligations by measuring the amount of capital that comes in form of debt.

i) Debt - equity ratio: The debt-equity ratio indicates the extent to which an organization depends on the amount of borrowed capital to carry out its day-to-day operation. This ratio is calculated to ascertain the soundness of the organization's financial position in the long run.

It is given by,

Debt - Equity ratio = long term debt / shareholder’s fund or total debt / total shareholder’s fund

ii) Debt to the total capital ratio: Debt to total capital ratio is used to show a relationship between the long-term debts of an organization with the total capital employed. In this case, the total capital includes both long-term liabilities and shareholder's equity. It is given by,

Debt to total capital ratio = long term debt / total capital or Total debt / total capital

iii) Interest Coverage ratio: This ratio is used to determine the company’s ability to pay interest expenses on its outstanding debt. It is given by,

Interest coverage ratio = EBIT / interest expenses

iv) Debt ratio: This ratio is one of the solvency ratios and is used to measure the total liabilities of the firm with respect to its total assets. It is given by,

Debt ratio = total liabilities / total assets.

4. Prospective Analysis

Sales growth

Forecasting of the financial data

From the above analysis, the researcher could identify that the financial leverage of IRESS limited is lower than its competitor company MYOB holdings limited. Therefore, the researcher is to mention that it has a lower risk profile than its competitor. Moreover, the sales revenue has been shown as increasing and it has a growth rate of above 7%.

On the other hand, the researcher has seen that the working capital to sales has also increased by 10% from 2015 to 2016. On the other hand, the researcher is to mention that the long-term assets to sales ratio have been seen as decreasing, which could be identified as the result of enhancement in the forecasted sales of the company. The debt-equity ratio has been seen as increasing, which could be identified as the reason of decreasing finance cost of the company. The company has earned higher earnings per share as compared to 2015; however, the dividend per share has been constant over the periods.

From the above calculation, the researcher is to mention that the value of the form has been calculated at $578091 million under the abnormal earning approach. On the other hand, the value of the firm has been calculated at $635900.1 million under the market. In this context, the researcher is to mention that the market value of the assets and liabilities have been calculated by considering the growth at the rate of 10%.

5. Conclusions and Recommendation

From the above discussions, the researcher has identified that IRESS limited has earned a steady profit. On the other hand, the researcher has seen that the sale of the company is increasing along with the assets turnover. Hence, it could be said that the investors could invest in this company for availing growth in earnings. In this context, it is to mention that the earning per share has also increased over 2015 and 2016. This could also be considered as a crucial point that justifies the decision to make the investment in the company.

In this context, the researcher is to mention that the company has performed more efficiently as compared to its competitor firm MYOB holdings limited. In this context, the recharger is to mention that the performance of the company has been seen as improving as the revenue figure and the profit figures are increasing for the company. Therefore, the shares of the company could be retained or purchased by an investor. Furthermore, the researcher is to mention that the company has shown an enhancement in the operating cash flow, which is to be considered as a good sign for the investor in making the investment in the company.

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