CS Executive · Corporate Accounting and Financial Management

Financial Statement Analysis: formula sheet

Full chapter guide

Key formulas

Basic process of analysis: Classify data → Compare → Find relationships → Interpret; Use this sequence to structure any descriptive answer on how analysis is done.
Main areas assessed: Profitability + Liquidity + Solvency + Efficiency (+ Growth); These are the core objectives. List all of them in an objectives question.
Types of analysis by user: External analysis (outsiders) and Internal analysis (management); Internal analysts have access to detailed records. Outsiders rely on published statements.
Types of analysis by method: Horizontal (across years) and Vertical (within one year); Horizontal uses trends. Vertical uses common-size percentages. Ratio analysis can support both.
Absolute change: Absolute change = Current year figure − Base year figure; A positive result is an increase. A negative result is a decrease. Show the sign.
Percentage change: Percentage change = (Absolute change ÷ Base year figure) × 100; Always divide by the base (earlier) year, never the current year.
Percentage change on a zero or negative base: If base year figure = 0, percentage change is not defined; Show 'N/A' or a dash. Do not compute. Be careful with negative bases, as the percentage is hard to interpret.
Balance sheet check: Total assets = Total equity + Total liabilities, in each year; Use this to verify the figures you pick up before computing changes.
Gross profit and net profit: Gross profit = Net sales − Cost of goods sold; Net profit = Total income − Total expenses (before or after tax as asked); Compute missing totals in each year before working out the changes.
Common size percentage: Common size % = (Item amount ÷ Base amount) × 100; Base is net sales for the profit and loss statement and total assets (or total equity and liabilities) for the balance sheet.
Trend percentage: Trend % = (Current year amount ÷ Base year amount) × 100; Base year is always 100. Use the same item in both numerator and denominator.
Absolute change in a comparative statement: Change = Current year amount − Previous year amount; Positive means increase, negative means decrease.
Percentage change in a comparative statement: % change = (Change ÷ Previous year amount) × 100; The denominator is the earlier year. If the earlier figure is zero, percentage change cannot be computed.
Increase over base year: Increase over base % = Trend % − 100; A trend figure of 125 means a 25% rise over the base year.
Current ratio: Current assets ÷ Current liabilities; Liquidity. A common rule of thumb is 2:1, but it varies by industry.
Quick (liquid) ratio: Quick assets ÷ Quick liabilities; Quick assets = current assets − inventories − prepaid expenses. Quick liabilities = current liabilities − bank overdraft (if overdraft is a permanent source). Rule of thumb 1:1.
Debt-equity ratio: Long-term debt ÷ Shareholders' funds; Solvency. Define the terms used in your answer, as books differ.
Interest coverage ratio: EBIT ÷ Interest on long-term debt; Shows how many times interest is covered by earnings.
Inventory turnover ratio: Cost of goods sold ÷ Average inventory; Average inventory = (Opening + Closing) ÷ 2.
Debtors turnover ratio: Credit sales ÷ Average trade receivables; Collection period = 365 ÷ ratio (or 12 months ÷ ratio).
Gross profit ratio: Gross profit ÷ Net sales × 100; Profitability on sales.
Net profit ratio: Net profit ÷ Net sales × 100; State whether profit is before or after tax.
Return on capital employed: EBIT ÷ Capital employed × 100; Capital employed = shareholders' funds + long-term borrowings (or total assets − current liabilities).
Current ratio: Current ratio = Current assets ÷ Current liabilities; Common benchmark is 2 : 1, but it varies by industry. Expressed as a ratio, e.g. 2 : 1.
Quick ratio (liquid ratio): Quick ratio = Quick assets ÷ Current liabilities, where Quick assets = Current assets − Inventory − Prepaid expenses; Common benchmark is 1 : 1. Some books also deduct bank overdraft from current liabilities; follow the question's instruction.
Debt-equity ratio: Debt-equity ratio = Long-term debt ÷ Shareholders' funds; Shareholders' funds = Share capital + Reserves and surplus (less accumulated losses). Some texts use total debt; state your definition.
Interest coverage ratio: Interest coverage = EBIT ÷ Interest on long-term debt; EBIT = Profit before interest and tax. Result is in 'times'. Higher means safer.
Proprietary ratio: Proprietary ratio = Shareholders' funds ÷ Total assets; Can be shown as a ratio or percentage. Some texts use total assets less current liabilities in the denominator; state which you use.
Working capital: Working capital = Current assets − Current liabilities; Useful to cross-check the current ratio.
Gross profit ratio: Gross profit ÷ Net sales × 100; Gross profit = Net sales − Cost of goods sold. Net sales means sales less returns.
Net profit ratio: Net profit ÷ Net sales × 100; Use the profit figure the question specifies (before or after tax). If unclear, state your assumption.
Operating profit ratio: Operating profit ÷ Net sales × 100; Operating profit = Net sales − COGS − operating expenses. Exclude non-operating items such as interest and gains on investments.
Return on capital employed (ROCE): EBIT ÷ Capital employed × 100; Capital employed = Equity share capital + Reserves + Preference capital + Long-term debt. It also equals Fixed assets + Working capital. Use average capital employed if opening figures are given.
Return on equity (ROE): (Net profit after tax − Preference dividend) ÷ Equity shareholders' funds × 100; Equity shareholders' funds = Equity share capital + Reserves and surplus. Use the average if opening and closing are given.
Stock turnover ratio: Cost of goods sold ÷ Average stock; Average stock = (Opening stock + Closing stock) ÷ 2. Holding period in days = 365 ÷ ratio.
Debtors turnover ratio: Net credit sales ÷ Average trade receivables; Receivables include bills receivable. Collection period = 365 ÷ ratio (or 12 months ÷ ratio).
Creditors turnover ratio: Net credit purchases ÷ Average trade payables; Payables include bills payable. Payment period = 365 ÷ ratio.
Fixed asset and total asset turnover: Net sales ÷ Net fixed assets; Net sales ÷ Total assets; Working capital turnover = Net sales ÷ Working capital.
Current ratio: Current assets ÷ Current liabilities; Use it to find current assets once current liabilities are known, or the reverse.
Quick ratio: (Current assets − Inventory) ÷ Current liabilities; Some questions also exclude prepaid expenses. Follow the definition given in the question.
Gross profit ratio: Gross profit ÷ Sales × 100; Cost of goods sold = Sales − Gross profit.
Net profit ratio: Net profit ÷ Sales × 100; Check whether the question means profit before or after tax.
Stock turnover ratio: Cost of goods sold ÷ Average stock; If only closing stock is given, use it as the stock figure. Stock = COGS ÷ ratio.
Debtors turnover and collection period: Credit sales ÷ Debtors; Collection period = Debtors ÷ Credit sales × 365; Use 365 days unless the question says 360.
Creditors turnover and payment period: Credit purchases ÷ Creditors; Payment period = Creditors ÷ Credit purchases × 365; Credit purchases = COGS + Closing stock − Opening stock, if no other data is given.
Fixed assets turnover: Sales ÷ Net fixed assets; Gives fixed assets when sales are known.
Debt-equity ratio: Long-term debt ÷ Shareholders' funds; Check whether the question defines debt as total outside liabilities.
Proprietary ratio: Shareholders' funds ÷ Total assets; Total assets = Shareholders' funds ÷ ratio.
Return on capital employed: EBIT ÷ Capital employed × 100; Capital employed = Shareholders' funds + Long-term debt.
Balance sheet identity: Total assets = Shareholders' funds + Long-term liabilities + Current liabilities; Use this as the final check, and to find a balancing figure.

Quick revision

Analysis converts raw figures into judgements on liquidity, solvency, profitability and efficiency.
Comparative statements show absolute change and percentage change, with the earlier year as base.
Common size statements express items as a percentage of one total, such as total assets or revenue from operations.
Trend analysis uses a base year taken as 100 and shows how items move across years.
Current ratio = current assets ÷ current liabilities.
Quick ratio = (current assets − inventories − prepaid expenses) ÷ current liabilities.
Debt-equity ratio = debt ÷ equity, with both terms defined as in the question or the study material.
Gross profit ratio = gross profit ÷ revenue from operations × 100.
Inventory turnover ratio = cost of goods sold ÷ average inventory.
Debtors turnover ratio = net credit sales ÷ average trade receivables.
When working back from ratios, start with the item that can be found directly, then build the rest.

Common mistakes

Writing only a definition and stopping. Fix: Add objectives, users and limitations. Marks are usually spread across these parts.
Treating all users as wanting the same information. Fix: Write each user with the specific need, such as lenders wanting liquidity and solvency.
Dividing the change by the current year figure Fix: Always divide by the base year. Write the formula at the top of your answer.
Dropping the sign of a decrease Fix: Always do Year 2 minus Year 1. Show decreases as negatives or in brackets.
Using total assets as the base for the profit and loss statement. Fix: Profit and loss items use net sales. Balance sheet items use total assets. Write the base at the top of the table.
Computing trend percentage against the previous year instead of the base year. Fix: In trend analysis, the denominator is always the fixed base year. Only the comparative statement uses the previous year.
Using total sales instead of credit sales in the debtors turnover ratio. Fix: Use credit sales when given. If only total sales is given and no credit data, state the assumption that all sales are credit.
Including inventory in quick assets. Fix: Remove inventories and prepaid expenses from current assets before dividing.
Including inventory and prepaid expenses in quick assets. Fix: Always write Quick assets = Current assets − Inventory − Prepaid expenses before substituting.
Using only equity share capital as shareholders' funds. Fix: Shareholders' funds = share capital (equity and preference) plus reserves and surplus, less any debit balance in profit and loss.

Exam tips

Expect theory questions on meaning, objectives, users and limitations. Prepare each as a short, structured answer.
Always link a user to a need. A bare list of users earns fewer marks.
Give limitations with a reason in each line. Examiners reward explanation, not keywords.
Use the same frame of meaning, objectives, users and limitations. It keeps answers complete under time pressure.
Revise this topic along with ratio analysis, since later numerical questions use these ideas.
Draw the five-column format first. A neat layout earns presentation marks even if an item is wrong.
Always show the formula once and use Year 1 as the divisor.
Write 3-4 lines of interpretation. Many questions say 'comment' or 'interpret', and marks are allotted for it.