1

Financial Analysis of a Company

Rupesh Puri

King’s College/ Westcliff University

BUS 334 Corporate Finance

Professor: Dr Tim Kyle, Sarthak Thapa

October 3, 2020
 2

Financial Analysis of a Company

It was from the past 6 months that I started my journey as a small investor. I started investing in

stocks through the technical analysis and the recommendations from my friends. Having the

basic knowledge of accounting from +2, I completed Accounts and currently running Corporate

Finance. Till this moment I realized the very importance of Financial Statement before investing,

what does it tells you about the company, how you see the growth of the company and many

more.

Investing is gambling when you don’t know to analyze where you’re investing and Investing is a

Game when you know to how to play and when to play, you’ll defend all and kick a GOAL. And

yes, that’s a GOALLLL. Before getting into the topic we need to understand what financial

statement actually is. As our exam result shows our progress of where we stand and in what

subject we need to improve. Financial statement is the result of how well a company is doing, it

shows the money. It shows you where a company’s money came from, where it went and where

it is now. There are four main financial statement 1- Balance Sheet, 2- Income Statement, 3-

Cash Flow Statement and 4- Statement of Share Holder’s Equity.

Balance Sheet shows what your company owns such as machinery, account receivable,

Inventory, cash etc. and what it owes such as loan, accounts payable, notes payable etc. Income

Statement shows how much a company earned or revenue and what it spent over time such as

operating expenses, sales etc. Cash Flow statement shows the exchange of money between a

company and outside world, basically cash inflow and outflow of the company[ CITATION
 3

Wil174 \l 1033 ]. Statement of Shareholder equity shows the changes in value to stockholder or

shareholder’s equity from beginning of accounting period to the end of that period. It basically

comes under Balance Sheet.

To show the financial position and analyzing the performance of the firm through financial

statement we need to use ratio analysis. Ratio analysis is a quantitative method which shows the

liquidity of a company, profitability, operational effectiveness reviewing the financial statement.

It shows how a company is performing over the time comparing with other company of same

industry or sector by which we can estimate the future performance of the company. Being an

analyst, we need to rely on present and past financial statement to obtain data and evaluate

financial performance. Basically, there are three uses of Ratio analysis.

First, Comparison of company with similar industry to understand the company’s position in

market. It helps management to identify the market gaps and examine its competitive

advantages, weaknesses and strength and make future decision to improve the position of

company. Second, Trend line, companies collect data from previous years which help them to

predict the future financial performance and turbulence. Third, Operational Efficiency- It help to

know the efficiency of how well company manage assets and liabilities because inefficient use of

assets results in redundant expense which can be eliminated[ CITATION Bar02 \l 1033 ]. The

different financial ratios are, Liquidity Ratio, Financial leverage ratio and Profitability Ratio.

Liquidity ratio measure how fast a company can turn its current assets into cash to meet its

debts compulsions. Some liquidity ratios are, Current ratio, Cash Ratio and Quick ratio. It is

mainly used by banks, creditors to see the ability of company to honor financial obligation as

they are due.

 4

Financial Leverage Ratio shows the use of debt by company to finance the purchase of assets.

Positive leverage ratio means the acquired asset funded by the creditors or preferred stock holder

gives the higher rate of return than the rate of interest or dividend. Negative leverage shows the

asset acquired with debt gives less rate of return than interest rate or dividend. Some of them are-

Total debt ratio, Debt/Equity ratio etc.

Profitability Ratio measure company’s ability to generate income comparative to its operating

cost, revenue, shareholders’ equity. It shows how company effectively generates profit and value

for its shareholder. Some of them are- Return on Equity (ROE), Return on Assets (ROA). These

are two important ratios used by many investors or in financial world. ROE state how

shareholder investment is generating income and ROA measure how management if using its

assets/ resources to generate more income[ CITATION Vat17 \l 1033 ].

1- Standardized Financial Statement

Nepal Factory

Balance Sheet as of 2018 & 2019

2018 2019 Change

Assets
Current Assets
Cash $50 (1.60) $80 (1.55) 0.05%
Account Receivable 80 (2.55) 70 (1.36) 1.19 %
Total 130 (4.16) 150 (2.92) 7.08
Fixed Assets 3,000 (95.84) 5,000 (97.08) - 1.24
Total Assets 3130 (100) 5150 (100)
It compares the financial statement year to year. Every filed is divided by Total assets and

multiplied by 100 i.e. cash/ TA= 50/3130 *100 = 1.60.

 5

2- ROE

and ROA.

ROE= Net Income/ Total Equity, ROA= Net Income/ Total Assets. To calculate these two, we

need to look Balance sheet and Income Statement, Let’s look at Apple’s balance sheet and

income. Apple’s Net Income in 2014 and 2015 respectively, 39510 and 53394. Total assets in
 6

2014 and 2015, 231,839 and 290,479. Total Equity in 2014/2015- 111,547 and

119,335[ CITATION USS14 \l 1033 ].

ROE in 2014= Net income/ Total Equity. = 39510/111,547 = 35.42%, 2015= 53394/119335=

44.74%. It denotes in every investment of 100$ in apple, investor would get 35 and 44 return.

The ROE has increased by 9.32%.

ROA in 2014= Net Income/ Total Assets. = 39510/231839 = 17.1%, 2015= 53394/ 290479 =

18.4%. It denotes company earned $0.171 for $1 it has in assets.

3- Current Ratio

Current Ratio is a liquidity ratio, current assets divides by current liabilities. It denotes that how

our current assets are handling our current liabilities[ CITATION INC20 \l 1033 ]. Current assets

and liabilities of Apple 2014 and 2015, 89,378, 68531 and 80610, 63448. Formula, CR = CA/CL

CR in 2014 = 1.08 times and in 2015- 89378/80610 = 1.11 times. It denotes every dollar apple

owes, it can raise $1.08 and $1.11.

There is different sector a company can invest their money and have on their portfolio. Some of

them are- Secondary Stock Market, Government Bonds, Energy Sector, project related to

company, Branches Technology, Banking industries etc. However, it might not be good decision

a company investing in Fixed Deposit because a company needs liquidity for their future or

uncertain investment[ CITATION Amb20 \l 1033 ]. Imagine I had an investment company and I

invested in stocks. Share market is the most volatile industry that we can’t predict the time for

return of investment but we can definitely predict. The ways a company generate its fund is,
 7

loan/debt, common shareholders and preferred share holder. I had to invest 200,000 in hydro

project. Let’s calculate the Cost of capital or the minimum rate of return I should be gaining

through that investment.

Weighted Average cost of capital is the minimum rate of return a company should get from any

investment to get return on the firm’s assets. It uses single cost of capital to find the average cost

of capital of the firm. The average rate determines the rate of interest we should pay for our

capital generation such as interest rate of loan, dividend paid to preferred and common share

holder[ CITATION Kin90 \l 1033 ]. For example- stock price of company $80, 2000 common

stock shares, 30,000 preferred share and 40,000 debt and rate of interest for common share

holder is 12%, preferred share holder 10% and 8% for debt and 40% Tax rate. We need to sum

the capital structure and convert it in percentage, Common Stock = 80*2000= 160,000.

Average= 160,000+30,000+ 40,000 = 230,000. (V). E/V = 160000/230,000 = 0.7%, P/V =

0.13%, D/V = 0.17%.

Using the WACC formula, E/V × RE + P/V × RP + D/V × RD (1 − TC).

= 0.7%*12% + 0.13*10 + 0.17*8(1-40%)

= 8.4 +1.3 + 0.816 = 10.52%. This shows 10.52% is minimum return I should get before

investing into any project.

Net present Value is the difference between the present value of cash inflow and present value of

cash outflow. It finds the present value of cash flow and subtract it with the initial investment to

achieve the net present value. NPV is especially used when we have multiple projects waiting for

the investment and the simple decision rule for NPV is, If the NPV is positive accept the project

and if its negative then reject he project[ CITATION Ros18 \l 1033 ]. It is used in capital
 8

budgeting process to examine profitability for probable investment. To calculate NPV we can

use PV formula. For example, if we invested 150,000 and 1st year cash flow is 40,000, 2nd year-

55,000 and 3rd year – 66,000 and the required rate of return is 12%. Each year the cash flow gets

respective year in interest such as 1st year = 1year interest, 2nd year = 2 yrs and 3rd year= 3.

Using the formula, 1st year = (40000)/ (1.12) ^1= 35,715. 2nd year= (55,000)/(1.12)^2 = 43846.

3rd year = 66000/(1.12)^3 = 46,978. Sum all and subtract it with, initial investment.

NPV= (35,715 + 43846 + 46978) – 150,000 = -23,461. Here’s the NPV is negative which

denotes that project should be rejected and we should head towards another project with similar

calculations.

Another analysis tool for investment is Internal Rate of Return (IRR) which is widely used as

alternative to NPV. IRR is the discount rate that makes the NPV to 0. The simple decision rule

for IRR is Accept if the IRR is greater than the required rate of return. In NPV we put the value

of R and solve and in IRR we put NPV to 0 and in case of R we plug in IRR. The difference

between IRR and NPV is IRR can’t rank mutually exclusive projects.

Conclusion

The concepts can be used when you’re investing in different portfolio. As an investor the

financial ratios helps you to get insights on how well the company is running and the different

analysis tools gives you a glimpse you being a company and how would you choose the correct

project for the investment. If you’re investing in Bank for FD you can use simple analysis of

Future value and Present value. FV= P(1+R) ^T. Though some factor influences the time you get

your desired return such as political, pandemic, market interest rate.

 9

References
Barton, S. D. (2002). Ratio analysis: Where investments meet mathematics. The Mathematics

Teacher, 60-62.

Corp, I. (2020, Feburary 6). Retrieved from INC: https://www.inc.com/encyclopedia/financial-

ratios.

Deter, A. (2020, January 17). Retrieved from IvestmentU: https://investmentu.com/stock-market-

sectors-performance/

Kincheloe, S. C. (1990). The weighted average cost of capital - the correct discount. The

Appraisal Journal, 88.

Ross, S. A., & Jordan, B. D. (2018). Essentials of corporate finance. McGraw-Hill.

SEC, U. (2014). Apple's Financial Statement . U.S Securities and Exchange Comission, 38-70.

Vats, S., & Patel, K. (2017). Ratio Analysis of a Private Limited Company with Relevance to

Change in Type of Enterprise-A Case Study of Write Fine Products Pvt. Ltd. Journal of

Applied Management , 37-43.

 10

Wild, J. J. (2017). Fundamental accounting principles. New York: McGraw-Hill Education.