Ratio Analysis

Ratio analysis is the quantitative interpretation of the company’s financial performance. It provides valuable information about the organization’s profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.

This is the most comprehensive guide to Ratio Analysis / Financial Statement Analysis.

This expert-written guide goes beyond the usual gibberish and explores practical Financial Statement Analysis as used by Investment Bankers and Equity Research Analysts.

Here I have taken Colgate Case Study (2016 to 2020 financials) and calculated Ratios in excel from scratch.

Please note that this Ratio Analysis of the financial statement guide is over 9000 words and took me 4 weeks to complete. To save this page for future reference and don’t forget to share it :-)

Step 1 – Download the Colgate Excel Model Ratio Analysis Template. You will be using this template for the analysis

Step 2 – Please note you will get two templates – 1) Unsolved Colgate Model 2) Solved Colgate Model

Step 3- You should start with the Unsolved Colgate Model Template. Follow the step-by-step Ratio Analysis calculation instructions for analysis.

Step 4 – Happy Learning! :-)

Table of Contents

Framework for Ratio Analysis

Ratio analysis of financial statements is another tool that helps identify changes in a company’s financial situation. A single ratio is not sufficient to adequately judge the financial situation of the company. Several ratios must be analyzed together and compared with prior-year ratios, or even with other companies in the same industry. This comparative aspect of the analysis is extremely important in financial analysis. It is important to note that ratios are parameters and not precise or absolute measurements. Thus, ratios must be interpreted cautiously to avoid erroneous conclusions. An analyst should attempt to get behind the numbers, place them in their proper perspective, and, if necessary, ask the right questions for further types of ratio analysis.

#1 – Vertical Analysis

What is Vertical Analysis?

Vertical analysis is a technique used to identify where a company has applied its resources and in what proportions those resources are distributed among the various balance sheets and income statement accounts. The analysis determines the relative weight of each account and its share in asset resources or revenue generation

Vertical Analysis – Income Statement

• On the income statement, vertical analysis is a universal tool for measuring the firm’s relative performance from year to year in terms of cost and profitability.
• It should always be included as part of any financial analysis. Here, percentages are computed in relation to Sales, which are considered to be 100%.
• This vertical analysis effort in the income statement is often referred to as margin analysis since it yields different margins in relation to sales.
• It also helps us do the time series analysis ( how the margins have increased/decreased over the years) and also helps in cross-sectional analysis with other comparable companies in the industry.

Colgate Case Study

• For each year, Income Statement line items are divided by their respective year’s Top Line (Net Sales) number.
• For example, for Gross Profit, it is Gross Profit / Net Sales. Likewise for other numbers

What can we interpret with Vertical Analysis of Colgate?

• Vertical Ratio Analysis helps us with analyzing historical trends.
• Please note that from vertical analysis, we only get to the point of asking the right questions (identification of problems). However, we do not get answers to our questions here.
• In Colgate, we note that the gross profit margin (Gross Profit / Net Sales) has been in the range of 59.4% to 60.8%. Why almost constant?
• We also note that the Selling General and administrative expense (SG&A) have increased from 33.8.1% in 2016 to 36.5% in the year ending 2020. Why?
• Also, note that the operating income dropped significantly in 2019. Why?
• Net income increased to less than 16.4%. Why?
• Also, effective tax rates are decreasing over the years (from 30.8% in 2016 to 21.6% in 2020). Why?

Ratio Analysis – Explained in Video