Financial Accounting

FINANCIAL ACCOUNTING 2INDIVIDUAL ASSIGNAMENT

NAVIN BAFNAINVESTMENT BANKING

GMBA08A125

Answer -1: Ratio concepts:

Current Ratio:

Current Ratio = Current Assets/ Current Liabilities

Current ratio is used to determine the liquidity of the company. However it is inversely proportional to profits. As Liquidity goes up, the profitability goes down if the liquidity is due to any external funds for which cost has to be paid. It is generally used to state the working capital of the company. Current ratio actually helps us to predict whether the organization is able to meet its short term fund requirements with the current availability of resources i.e. current assets. Current assets comprises of Cash, Cash equivalents, Debtors, marketable securities and Inventories. To analyze the cost of liquidity it is important to analyze the components of Current liabilities. Ex: if CR is very high for company, but the majority of current assets are due to the Sundry debtors, then the business is not in a situation to pay off the liabilities until the money is realized from the debtors.

Return on Equity (ROE):

ROE = (PAT – Preference Dividend) / Total Equity Capital

Return on Equity states the actual profitability of the company with respect to the Equity shareholders. It states the company’s net profit available to equity shareholder’s to get the net returns on the total share holder equity. Shareholder equity is an accounting terminology which represents the General reserves & Surplus created by the retained earnings and the paid up capital. It can be also used to descript how well the company is using its resources to generate wealth for its share holders. Any company which gives a high return on equity is more likely to be on the priority charts of the prospective investors.

Return on Total Assets (ROTA)

ROTA= EBIT/ Total Net Assets

This ratio is considered as an indicator of how effectively a company is using its assets to generate earnings before contractual obligations must be paid. The greater the company's earnings in proportion to its

assets the more effectively that company is said to be using its assets. To compute ROTA, the net income figure from a company's income statement, plus interest and taxes that were paid for the year. The calculated number will give the company's EBIT. The EBIT should then be divided by the company's total net assets (total assets less depreciation) to reveal the earnings that company has generated for each unit or value of assets on its books.

Earnings per Share (EPS)

EPS= Profit for Equity Shareholders/Outstanding Shares

Earning per Share (EPS), is used to compute the earning of the shareholder on a per share basis, and is used in evaluating share price by using the Price / Equity method. EPS serves as an indicator of a company's profitability. An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal would be a "better" company Thus the Earnings per share should also be looked together with the face value of shares. It is important that we use figures but we should not rely on any financial measure, but to use the measure the same in conjunction with statement analysis and other measures.

Return on Capital Employed:

ROCE = PBIT/ (Total Assets – Current Liabilities)

ROCE states the profit generating capacity of the company for the investment made into company in the mode of equity capital and debts. It indicates the efficiency and profitability of a company with respect to the total earning before servicing the shareholders and the cost of debt. It shows how well a company is utilizing its capital resources in operating its business and whether the generated revenue is more than the cost of capital or not. ROCE measures the ability of the company to generate returns which is higher than the cost of capital. It should be higher otherwise any increase in debts will reduce the shareholder’s equity. Only drawback of ROCE is that even if cash flows remains same, ROCE increases as fixed assets depreciates with time.

Economic value of return (EVA)

EVA = NOPAT - (Cost of Capital * Capital Employed)

EVA determines the total profit/loss incurred by a company after deducting the capital costs from the net profits. NOPAT is computed by taking the PBIT. It is also calculated by using direct method (reducing the COGS, expenses and taxes from Sales proceeds). To calculate EVA – WACC is the most important parameter, which determines weighted average cost of debt, preference shares and equity. Cost of equity capital is the opportunity cost of an investment. The basic reason behind calculating EVA is to make sure that shareholders are earning a return uniform with the risk taken by them. If EVA is negative irrespective of whatever the PAT is, there is no real profit made by the company and it means company is destroying the wealth of its shareholders.

The two companies Analyzed are

Reliance Capital and India bulls

Securities both are counted in the

top most companies in the financial

sector in India. In the last three

years the equity markets have flared

up and thus the footprints of the

financial sector has seen a very high

rate of growth both in real and

actual numbers. In this case we are

reporting to the managing director

of Reliance capital with a view on

comparing the data with the

competitor’s data as India bulls.

Business Overview:

Reliance Capital – Reliance Capital is the flagship company of the ADAG

group owned by Mr. Anil Ambani, The Company was stripped from the

flagship group of Reliance Industries managed by the Ambani family. Since

then the company has almost ventured into every financial market in India

(Stock and Commodities Broking, Asset Management, Portfolio Services,

Consumer Loans, Life and General Insurance Business) Company has a

huge inter holding in other group companies as well as the new investment

of the group for ex: ADLABS and Reliance Creative thus major proportions

of PAT come from the investment income due to the exorbitant Stock

Markets.

India Bulls Financials: India bulls has been one of the most prominent

success stories in the last decade in Indian context .The group was started

by the IIM graduate Sameer Gehlaut who moulded the financial group into

one of the major players of the financial sector. The company has footprints

in the Broking Business as well as the Real Estate Business, in the latest

venture the company has started the consumer loans business, company is

also looking for venturing into Asset Management and Insurance business

together with some foreign Partners. Mr. L.N Mittal, the steel tycoon holds

a decent stake in the group as a whole.

ANALYSISThe analysis is done with respect to the Cash flow of both the

companies for the year 2005, 2006 & 2007 to know about the

external investment deals industry reports and news articles

have also been referred to. Most of the analysis is done n the

liquidity and company’s ability to manage the working Capital

and service the industry components.

RELIANCE CAPITAL INDIA BULLS

RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007

A) Cash Flow from Operation (CFO)

418.07

(1239.00)

(1985.09)

150.52

278.34

(24.68)

Cash Flow from Financial activity (CFF)

(371.81)

1112.85

1597.06

(21.49)

283.04

(314.30)

Cash Flow from Investment activity(CFI)

(66.17)

123.65

338.25

(50.30)

(19.22)

(40.47)

The profit component has risen by 6.5 times

Approximately 70% of the total profits are from

Investments

Interest cost down to 10 %

Trade receivables increased more than thrice

The profit component has risen by 4 times

Interest charge is almost 15 % of the total PAT

Investments in Assets is almost 35 % of PAT

Huge increase in Short term Borrowings,

almost 5 times of PAT.

The company is doing fairly well with respect to the normal course of

business and profit has increased not only in terms of real value but also in

compare to the competitor’s. The company in the robust business

environment has leveraged itself quite highly in compare to the past periods

which has increased the cost burden on the profitability. The short term

borrowings has increased 6 times, there is a positive flow from the

investments side but still the trade credits has increased the liquidity

requirements of the business.


B) Cash Flow from Operation (CFO) 418.07

(1239.00)

(1985.09)

150.52

278.34

(24.68)

Total profit 111.20 550.5

7 731.4

5 49.1

1 180.

29 199.8

2

Operating Profit 165.18 80.34 259.9

7 54.4

7 174.

14 167.9

3

694.45 (608.0

9)(993.6

7) 254.

10 632.

77 343.0

7 CFO has turned negative to the

tune of 6 times

In the current trend majority of

the earning to the tune of almost

70 % comes from the investment

income

Trade receivables has turned

negative to the rune of 140 %

In the past periods the company

profitability has been quite

uniform and the margins has been

quite buoyant.

Our companies is doing very well in terms of the business but if analyzed in

depth the operating profits is similar with our competitors but the most

important part is that our capital base is almost 7 times of the competitor

and also the rate of profitability is not uniform and the major of PAT is

dependent on the extraordinary profits due to unlocking of the value of

investments in subsidiaries which is not a regular affair and thus the

profitability margins are something for which we should be concerned for.


Changes in working Capital - Trade receivables 720.1

6 (1271

.00)(2149.

54) 81.0

5 (11.1

6)(30.1

8)Inventories 96.78 8.29 5.37 0.00 0.00 0.00 Trade payables (253.

62) 6.53 24.02 74.9

8 225.

53 (51.4

7)

563.3

2 (1256

.18)(2120.

15) 156.

03 214.

37 (81.6

5)The trade receivables has increased

four times negatively and the overall

change in the working capital

structure has become quite

leveraged and the company requires

more working capital

The company’s trade Receivables

changes has turned negative with

respect to the past periods because

of the margin books in the Broking

companies which is a risky

proportion.

The company’s buoyant expansion growth has been funded by the debts and

other external sources and the increase in trade cycle as turned negative 4

times in compare to the positive figures in 2005 but the same can be

inferred that the same is due to company’s new consumer loan business and

the recent broking business in which the company has just started its new

venture just each of the business has opened a new venue of increase

revenue for the company but together with the same the leverage over the

assets has increased.


D)

Free Cash Flows Cash Flow from Operation (CFO) 418.07

(1239.00)

(1985.09)

150.52

278.34

(24.68)

less : Purchased fixed asset (0.04) (1.45)(29.15

) (16.1

7)(37.2

8)(71.7

0)

418.03 (1240.

45)(2014.

24) 134.

35 241.

06 (96.3

8)The company’s free cash flow is affected

by the new business venture of consumer

loans thus the trade receivables has

increased highly but still the investments

in the fixed assets is very small. Taking

into account the market aspect the

expense on the asset side to add to the

expansion stage should be given much

more importance in compare to the

company’s strategy of investing in

acquisitions.

The company is using much of

its free cash flows into its

expansion strategy. Almost to

the tune of 45% of the total

profits of the year 2007 is

invested in the asset side. The

investment in fixed asset is

also seeing a growth of almost

100 % with respect to previous

year’s investments.

The company has to look on the investment part in the fixed asset as the

competitors are investing a majority of the profits in the asset base and in

real numbers are increasing by 100 % on year to year basis but as our

strategy we invest in companies by acquiring over them, but still the same

can be thought again.


F)

CFO 418.07 (1239.

00)(1985.

09) 150.

52 278.

34 (24.6

8)

Dividend (41.89)(43.74

)(59.72

) (5.60

)(0.99

) 0.00

376.18 (1282.

74)(2044.

81) 144.

92 277.

35 (24.6

8)Dividend has been

paid in the range of

7 – 15 %

No dividend has been paid to the equity share

holders but the same has been compensated with the

stock dividends and other stock assets resulted in the

form of the company’s de-merger


G)

Composition of CFF Proceeds from share issues (10.00

)2228.

25 445.2

7 0.00 (45.2

7) 0.00 Proceeds from long term borrowings 0.00 20.08 0.00 0.00 0.00 0.00 Proceeds from short term borrowings 189.66 0.00

1211.51 0.00

536.27

810.94

Repayment of long term borrowings

(509.58)

(19.24) 0.00 0.00 0.00 0.00

Repayment of short term borrowings 0.00

(1072.50) 0.00

(15.89)

(206.97)

(1125.24)

Dividend paid (41.89)

(43.74)

(59.72)

(5.60) (0.99) 0.00

(371.81)

1112.85

1597.06

(21.49)

283.04

(314.30)

The company has diluted stake in

2006

The company has borrowed short

and long term debt to fund the

companies capital requirements

The borrowing has overall

increased in the company by more

than 4 times.

The company has increased its short term

borrowings to funds its expansion plans

The company’s plan to enter the real estate

market by buying new properties

The company hasn’t diluted any stake directly

but the same has been done by selling the

stakes in the subsidiaries .

Company is quenching its thirst for funds to nurture the expansion plans

but the same has to be re-looked as the DER looks to be highly leveraged

and it more than any business standards and also with respect to the

competitor strength the business need much more focus on its core work.


I)

Composition of CFI Purchase of fixed assets

(0.04) (1.45)(29.15

) (16.1

7)(37.2

8)(71.7

0)Sale of fixed assets 0.09 1.28 0.00 0.00 0.00 0.00 Purchase of investments (140.9

7)(2874.

42)(2585.

52) 0.00 0.00 0.00 Sale of investments

65.79 2990.8

4 2918.

39 0.00 0.00 0.00 Loan to group / subsidiary cos. 0.00 0.00 0.00

(35.00) 0.00 0.00

Interest received0.09 0.26 0.00 0.87

18.06 25.45

Dividend received 8.87 7.14 34.53 0.00 0.00 5.78

(66.17

) 123.65 338.2

5 (50.3

0)(19.2

2)(40.4

7)

Company’s turnover in investments

is almost thrice than the total

revenue of the company and the

same is used due to the recent equity

market turmoil where the company

has

The company has increased it

investment in fixed assets by 100 %

on tear to tear basis

This is almost 40 % on year to year

basis with respect to the company

current year’s profits.

Financial Accounting

Education

Transcript of Financial Accounting