Analysis of financial Analysis of financial statementsstatements

1.1. Revision of B/S and P/L Account – Need of financial Revision of B/S and P/L Account – Need of financial literacy . Introduction to Business Analysisliteracy . Introduction to Business Analysis

2.2. Assessing business performance through ratiosAssessing business performance through ratios3.3. Du pont AnalysisDu pont Analysis4.4. Cash flow analysis – financial flexibility , life cycle of a Cash flow analysis – financial flexibility , life cycle of a

companycompany5.5. Free Cash flows – meaning & computationFree Cash flows – meaning & computation6.6. Valuation models - a brief overviewForecasting free Valuation models - a brief overviewForecasting free

cash flows and security valuationcash flows and security valuation7.7. EVA – meaning ,computation , strategiesEVA – meaning ,computation , strategies8.8. Mergers and acquisitions Mergers and acquisitions 9.9. Consolidation of balance sheets / minority interestConsolidation of balance sheets / minority interest10.10. Equity Analysis , stock splits & buy backsEquity Analysis , stock splits & buy backs11.11. Managing productivity of corporate capitalManaging productivity of corporate capital

Business AnalysisBusiness Analysis

Types of Business AnalysisTypes of Business Analysis

Credit AnalysisCredit Analysis Equity AnalysisEquity Analysis Business Environment and strategy Business Environment and strategy

AnalysisAnalysis Financial AnalysisFinancial Analysis Prospective AnalysisProspective Analysis ValuationValuation

Roadmap to Financial Roadmap to Financial AnalysisAnalysis

Business AnalysisBusiness Analysis

Business Environment Analysis – Company’s Business Environment Analysis – Company’s economic & industry circumstances, SWOT economic & industry circumstances, SWOT Analysis , industry analysis Analysis , industry analysis

Business strategy Analysis – Company’s Business strategy Analysis – Company’s business decisions leading to a competitive business decisions leading to a competitive advantage , its product mix , cost structure advantage , its product mix , cost structure

Company profile and significant eventsCompany profile and significant events

Company shareholding patternCompany shareholding pattern

Company Analysis Company Analysis

Financial performanceFinancial performance

RevenuesRevenues

ProfitabilityProfitability

Asset UtilisationAsset Utilisation

Cash flowsCash flows

Working capital ManagementWorking capital Management

Stock performanceStock performance

RATIO ANALYSISRATIO ANALYSIS

TermsTerms1.Capital employed = 1.Capital employed =

Equity shareholders funds + Preference Equity shareholders funds + Preference share capital + Long term borrowed share capital + Long term borrowed funds funds

2.Net worth = Equity shareholders funds 2.Net worth = Equity shareholders funds

+/- Deferred tax+/- Deferred tax= Equity share capital + Reserves & = Equity share capital + Reserves & surplus – Miscellaneous Expenditure not surplus – Miscellaneous Expenditure not written off + Deferred taxwritten off + Deferred tax

3.Turnover = Sales3.Turnover = Sales

ROI ratios ROI ratios 1. ROI = 1. ROI = NP before tax and interestNP before tax and interest

Total capital employedTotal capital employedThis ratio indicates the return earned by the This ratio indicates the return earned by the company on its total investment. This is very company on its total investment. This is very important to shareholders and other stake holders important to shareholders and other stake holders as it is the ultimate measure of the company’s as it is the ultimate measure of the company’s overall performance. This ratio when compared overall performance. This ratio when compared with industry average gives an indication about the with industry average gives an indication about the financial performance of the company.financial performance of the company.

2. RONW = 2. RONW = PAT – Preference dividendPAT – Preference dividend * 100 * 100 Net worth ( ESHs Fund )Net worth ( ESHs Fund )

This ratio indicates the return earned by equity This ratio indicates the return earned by equity shareholders. High ratio means high dividend , shareholders. High ratio means high dividend , better growth prospects and high valuation in better growth prospects and high valuation in capital market.capital market.

3. EPS = 3. EPS = PAT – Preference dividendPAT – Preference dividend Number of equity sharesNumber of equity shares

This ratio gives the return earned on each This ratio gives the return earned on each share. It is an important measure of share. It is an important measure of profitability for the investors. This ratio is the profitability for the investors. This ratio is the basis for valuation of companies in the event basis for valuation of companies in the event of mergers etc, strategic investments by of mergers etc, strategic investments by owners. Higher ratio shows company in a owners. Higher ratio shows company in a positive light. Higher ratio indicates higher positive light. Higher ratio indicates higher returnsreturns

Comparative Standards / BenchmarkingComparative Standards / Benchmarking Industry leaderIndustry leader Industry averageIndustry average WACCWACC Cost of borrowingsCost of borrowings

Influencing factorsInfluencing factors SalesSales Cost economiesCost economies Optimum capital structureOptimum capital structure

Structural ratios / Gearing ratios / Long term solvency ratiosStructural ratios / Gearing ratios / Long term solvency ratios

1. 1. Debt equity ratio = Debt equity ratio = Long termLong term DebtDebt Total net worth ( ESHs Funds + PC )Total net worth ( ESHs Funds + PC )

This ratio helps in assessing whether the company is relying on This ratio helps in assessing whether the company is relying on own funds or borrowed funds. Higher the debt more fixed own funds or borrowed funds. Higher the debt more fixed liabilities by way of interest. FI s generally look for a D/E of 1.5 :1 liabilities by way of interest. FI s generally look for a D/E of 1.5 :1 while financing projects. This ratio also indicates whether the while financing projects. This ratio also indicates whether the company has a optimum capital structure to improve the returns company has a optimum capital structure to improve the returns available to equity shareholders. available to equity shareholders.

2. 2. Debt service coverage ratio = Debt service coverage ratio = NPBIT NPBIT Interest + Loan repaymentInterest + Loan repayment

This ratio indicates the profits available to service the debts. This This ratio indicates the profits available to service the debts. This ratio is very important for lenders. Higher the ratio higher is the ratio is very important for lenders. Higher the ratio higher is the ability of the company to finance the debt and less risk of default.ability of the company to finance the debt and less risk of default.

3. Interest coverage ratio = 3. Interest coverage ratio = NPBITNPBIT InterestInterest

Comparative Standards / BenchmarkingComparative Standards / Benchmarking Industry averageIndustry average NAV of industry leader / laggardNAV of industry leader / laggard Institutional normsInstitutional norms Growth / Decline over the previous yearsGrowth / Decline over the previous years

Influencing factorsInfluencing factors ROI & EPSROI & EPS Dividend policyDividend policy

Liquidity ratios Liquidity ratios 1. 1. Current ratio = Current ratio = Current Assets, loans & Advances Current Assets, loans & Advances

Current liabilities & ProvisionsCurrent liabilities & Provisions

2. 2. Quick ratio = Quick ratio = Current Assets, loans & Adv – inventories – prepaid Current Assets, loans & Adv – inventories – prepaid

ExpExp Current liabilities & Provisions– Bank overdraftCurrent liabilities & Provisions– Bank overdraft

These 2 ratios helps in analyzing the current assets and These 2 ratios helps in analyzing the current assets and current liabilities of the company and its ability to current liabilities of the company and its ability to discharge its day to day obligations Quick ratio is more discharge its day to day obligations Quick ratio is more realistic. It indicates the extent to which the company realistic. It indicates the extent to which the company has current assets to meet its current liabilities. Higher has current assets to meet its current liabilities. Higher the ratio higher is the solvency level of the company and the ratio higher is the solvency level of the company and less risk of default.less risk of default.

Comparative Standards / BenchmarkingComparative Standards / Benchmarking Institutional normsInstitutional norms

Effective asset utilisation Effective asset utilisation Cost economiesCost economies Proportion of non cash charges in Proportion of non cash charges in

expense expense structurestructure

Influencing factorsInfluencing factors Proper asset liability managementProper asset liability management Credit period availed and credit period Credit period availed and credit period

allowedallowed Inventory management / Supply chain Inventory management / Supply chain

management/ level of obsolescencemanagement/ level of obsolescence

Efficiency ratios Efficiency ratios 1.Fixed assets turnover ratio = 1.Fixed assets turnover ratio = Net salesNet sales

Net block of fixed Net block of fixed assetsassets

Fixed assets are income generating assets for any Fixed assets are income generating assets for any company. This ratio indicates the efficiency with which the company. This ratio indicates the efficiency with which the fixed assets are used to generate revenue. Higher the fixed assets are used to generate revenue. Higher the ratio better is the utilization of assets for generating sales.ratio better is the utilization of assets for generating sales.

2. 2. Net worth turnover ratio = Net worth turnover ratio = Net salesNet sales

Net worthNet worth

This ratio indicates the overall financial and operational This ratio indicates the overall financial and operational efficiency of the companyefficiency of the companyIt is an indication about the optimum capital structure and It is an indication about the optimum capital structure and production efficiencies of the company. production efficiencies of the company.

Comparative Standards / BenchmarkingComparative Standards / Benchmarking

Industry averageIndustry average Industry leader Industry leader Trend over a period of timeTrend over a period of time

Influencing factorsInfluencing factors Production efficienciesProduction efficiencies Investment in relevant technologiesInvestment in relevant technologies Price and quality of productsPrice and quality of products

Profitability ratios Profitability ratios

1.GP ratio = 1.GP ratio = GPGP*100*100

SalesSales

2. Net profit ratio = 2. Net profit ratio = PAT * 100PAT * 100 Sales Sales

These ratios study the profitability in relation to These ratios study the profitability in relation to sales. It helps to assess the business sales. It helps to assess the business performance starting from Gross Profit. Multi performance starting from Gross Profit. Multi level profitability ratios helps to understand the level profitability ratios helps to understand the levels at which there is pressure on marginlevels at which there is pressure on margin ( profit )( profit )

Comparative Standards / BenchmarkingComparative Standards / Benchmarking Trend over a period of timeTrend over a period of time Industry average Industry average Industry leader / laggardIndustry leader / laggard WACCWACC

Influencing factorsInfluencing factors

Qualitative and quantitative growth in salesQualitative and quantitative growth in sales Age of fixed assets ( depn )Age of fixed assets ( depn ) Cost of borrowing Cost of borrowing Efficient tax planning Efficient tax planning

Valuation ratios Valuation ratios 1. 1. P/E ratio = P/E ratio = Market price of equity shareMarket price of equity share

EPSEPS

This ratio is the most popular ratio for valuation of a This ratio is the most popular ratio for valuation of a company by the investors. This ratio indicates market company by the investors. This ratio indicates market confidence in the company and its future prospects.confidence in the company and its future prospects.

2. 2. Book value per share ( Net Asset Value ) = Book value per share ( Net Asset Value ) = Net Net worthworth

No. of equity No. of equity sharesshares

This ratio measure the net worth per equity share. This This ratio measure the net worth per equity share. This ratio indicates the efficiency of the company’s ratio indicates the efficiency of the company’s management in building up reserves and its prudent management in building up reserves and its prudent financial practices.financial practices.

Comparative Standards / BenchmarkingComparative Standards / Benchmarking Industry averageIndustry average Leaders & laggards in industryLeaders & laggards in industry Trend over a period of timeTrend over a period of time

Influencing factorsInfluencing factors Dividend policyDividend policy Size of the companySize of the company Market conditionsMarket conditions NAVNAV

Analysts should take the following Analysts should take the following precautionsprecautions

Analysis of trends over a long period of timeAnalysis of trends over a long period of time Interpretation of observation against Interpretation of observation against

industry bench markindustry bench mark Analysis of core ratios onlyAnalysis of core ratios only Inter firm comparison for variations in Inter firm comparison for variations in

accounting policiesaccounting policies In case of conglomerates comparative In case of conglomerates comparative

performance of different lines of businessperformance of different lines of business