Financial Statement Analysis and Corporate Finance
Financial Statement Analysis and Corporate Finance tests the analytical layer above credit: reading statements for quality of earnings and cash conversion, building comparable ratios, spotting accounting distortion, and applying capital budgeting and cost-of-capital logic to a borrower's investment decisions and to the bank's own pricing.
Ratio families
- Liquidity: current ratio, quick ratio, cash conversion cycle (DSO + DIO − DPO).
- Leverage: debt/equity, net debt/EBITDA, interest cover (EBIT/interest).
- Profitability: gross margin, EBIT margin, ROE via DuPont (net margin x asset turnover x equity multiplier).
- Quality: operating cash flow / net income, accruals ratio, revenue growth versus receivables growth.
Cash flow and valuation
- Free cash flow to the firm = EBIT x (1 − tax) + depreciation − capex − increase in working capital.
- WACC = E/V x Ke + D/V x Kd x (1 − tax). Use after-tax cost of debt, market-value weights, and a project-specific rate where risk differs.
- Decide with NPV; IRR is a ranking aid and fails with non-conventional cash flows (multiple IRRs) and ignores scale.
Worked example
Equity market value 600m, debt 400m, cost of equity 12%, pre-tax cost of debt 6%, tax 25%. After-tax Kd = 4.5%. WACC = 0.6 x 12% + 0.4 x 4.5% = 7.2% + 1.8% = 9.0%. A project costs 100m and returns 25m a year for five years. The five-year annuity factor at 9% is 3.890, so PV = 97.25m and NPV = −2.75m. The project destroys value and should be rejected despite an IRR near 8% only if returns are level - check the IRR against the 9% hurdle before deciding.
Traps that cost marks
- Mixing year-end and average balance sheets in ratio computation.
- Comparing EBIT-based coverage with EBITDA-based coverage across peers.
- Book-value weights in WACC, or forgetting the tax shield on debt.
- Treating EBITDA as cash flow when working capital and capex absorb it.
- Accepting stated revenue growth without checking receivables and inventory build.