Financial Analysis of Manufacturing Industry

EXECUTIVE SUMMARY :

In this report our objective is to provide a detailed financial analysis for the industrial manufacturing industry for the period ranging from 2006-2015 so as to gain an insight on the financial performance and growth of the industry as a whole and achieve the following objectives:

1. Assessment of Past Performance/position

2. Assessment of current performance/ position

3. Prediction of profitability and growth prospects

4. Prediction of bankruptcy and failure

5. Assessment of the operational efficiency

6. To ascertain the investment value of the firm

We will critically analyze the various financial statements of five companies in the manufacturing sector namely :

a)Siemens Ltd.

b)BEML Ltd.

c)Bharat Electronics Ltd.

d)Bharat Forge Ltd.

e) Bharat Heavy Electrical Ltd.

For this purpose the financial tools that we would use to aid us to achieve this objective are as follows:

a) Horizontal analysisb) Vertical Analysisc) Trend Analysisd) Ratio analysis

OVERVIEW OF THE INDUSTRIAL MANUFACTURING SECTOR:

Growth:

Manufacturing has risen as one of the highest growth sector. India’s ranking among the world’s 10 largest manufacturing countries has improved by three places to sixth position in 2015.The Government of India has set an ambitious target of increasing the contribution of manufacturing output to 25 per cent of Gross Domestic Product (GDP) by 2025, from 16 per cent currently.

Market Size:

India’s manufacturing sector has the potential to nudge US$ 1 trillion by 2025. There is a huge potential for the sector to account for 25-30 per cent of the country’s GDP and create up to 90 million domestic jobs by 2025. Business conditions in the Indian manufacturing sector continue to remain positive.

Investments:

In a major boost to the 'Make in India' initiative, the Make in India week which was held in Mumbai between February 13 to 18, 2016, received an astounding response from investors. The fair had closed with INR 15.2 trillion (US$225.32billion) in investment commitments in many manufacturing companies including Siemens etc.

Government Initiatives:

The Government of India has undertaken many initiatives to promote a healthy

environment for the growth of industrial manufacturing sector in the country. Some of the initiatives and developments are:

The National Institution for Transforming India (NITI Aayog), aims to

persuade the Government for support in the manufacturing sectors

with large-scale employment generation opportunities, such as electrical and

electronics engineering,

Gujarat government is planning to lay up an electronics products

Manufacturing center in the state, through its newly announced Electronics

Policy 2016, which will generate about 500,000 jobs in the electronics sector

in the next five years, indigenously made defense products and 25 per cent share of defense production will be open to private firms.

The Government plans to organize a ‘Make in India week’ in Mumbai

between February 13-18, 2016 to boost the ‘Make in India’ initiative and

expects 1,000 companies from 10 key sectors to participate in the exhibition

of innovative products and processes, a hackathon and sessions on urban

planning, among other events.

Financial Analysis:

ON THE BASIS OF PROFIT

In 2014-15 FY sales decreased by 11%, expenses decreased by 11% and PAT decreased by 16% for the industry

Net sales for Bharat Forge have shown consistency from 2011 with an increase in sales of 34% in 2015 due to increase in exports while amongst the companies taken BHEL has performed dismally as compared to its counterparts showing drop of sales in 2015 by 23% .

Siemens PAT was decreasing from 2011-13 and then jumped up by 210% in 2014 due to profit on sales of fixed asset and by 96% due to profit on sales of investments (exceptional items).BEl, bharat forge showed a steady increase but BEML showed a jump in 2015FY by 44% due to decrease provision for tax .BHEL showed an increase of 6% in 2013FY but after that it has been drastically declining after 2013 to 2015 indicating margin pressues

BHEL ,Siemens and BEML have shown a consistent decline in total expenses which is in contrast of Bharat Forge which showed a jumped of 27% in 2014-15FY and BEL which showed a decrease of 1.34% in 2013-14 FY but again had a jump of 5.20% in the year 2014-15FY.In BHEL the decline of 8% in the employee wages expenses in mainly accounted by the decrease in manpower.

While Siemens and BEL has shown a consistent trend of increase in the total liabilities which can be attributed to the increase in total debts of both the companies with the only dip taking place in 2011-12FY with -0.16% and -3.26% respectively while BHEL and BEML have shown a steady decline in the total liabilities with a steep decline 2014-15FY of 6% and 2.8% respectively (both current and non current) which can be attributed mainly due to lower level of operations and decrease in level of advances from

customers.Bharat Forge has shown decline in total liabilies due to decrease in short term borrowings and other outstanding liabilities.

BHARAT FORGE recorded an increase in total current assets due to increase in cash and surplus while BHEL recorded steady declining trend in this field with a decline of 7% in 2014-15 due to 17% decrease in cash which was in stark contrast of its performance 2013-14FY where it recorded a 54% growth in cash.Change in receivables is in line with operations and the increase in deferred tax assets is due to the change in depreciation policy.

Portfolio of long term investors can be:

For the long term investors BHARAT FORGE AND BEL are found to be better than a debentures investors should seek the debentures of BHEL, and BEML

RATIO ANALYSIS:

Analyzing the net profit ratio our companies vs industry we deduce that BEL, BHARAT FORGE and Siemens have fared better than the industrial average of 5% while BHEL and BEML lies below it.

With BEML leading at 22.55% ,BEL,SIEMENS and Bharat Forge lies above the industrial average of 6.07% indicating very efficient asset utilisation while BHEL trudges at 2 % showing incompetent asset utilization

With an industrial average of 8.63% all companies with the exception of BHEL and BEL with BHARAT FORGE having an ROE of 21% due to less amounts of shareholders equity and BHEL underscores due to relatively very less PAT when compared to the company’s equity shareholders’ funds

With an industrial average of 0.4 of debt to equity ratio Bharat Forge has the least amongst the companies analyzes with a ratio 0.05 with Siemens leading with a ratio of 0.6 .

Siemens has an debt to asset ratio of 37% while the industry average in of 26.6% indicating that amongst the five companies Siemens is relying the most on its own capital rather than debts to finance its assets

Bharat Forge and Siemens lie above the industry average of 4.65 times inventory turnover indicating high level of operations and production vis-à-vis BHEL,BEL and BEML

In terms of current ratio Bharat Forge again leads with a ratio of 3.025 and the industrial average of 1.81 and all the other companies above the industrial average with the exception of Siemens.

Revenue recognition policies:

BHEL:

Revenue Recognition Sales are recorded based on significant risks and rewards of ownership being transferred in favor of the customer. Sales include goods dispatched to customers by partial shipment. A.) For construction contracts entered into on or after 1.4.2003 Revenue is recognized on percentage completion method based on the percentage of actual cost incurred up to the reporting date to the total estimated cost of the contract. B.) For all other contracts

(i) Recognition of sales revenue in respect of long production cycle items (Hydro and Thermal sets including gas-based power plants, boilers, boiler auxiliaries, compressors and industrial turbo sets) is made on technical estimates. When the aggregate value of shipments represents 30% or more of the realizable value, they are considered at 97.5% of the realizable value or in its absence, quoted price.

Annual Accounts standalone Otherwise, they are considered at actual/ estimated factory cost or 97.5% of the realizable value, whichever is lower. The balance 2.5% is recognized as revenue on completion of supplies under the contract.

(ii) Income from erection and project management services is recognized on work done based on: Percentage of completion; or The intrinsic value, reckoned at 97.5% of contract value, the balance 2.5% is recognized as income when the contract is completed.

(iii) Income from engineering services rendered is recognized at realizable value based on percentage of work completed.

(iv) Income from supply/erection of non BHEL equipment/systems and civil works is recognized based on dispatches.

SIEMENS:

From 2011-15,

1. Revenue is recognised to the extent it is probable that the economic benefits will flow to the group and the revenue can be reliably measured.

2. Revenue from sale of products is recognised on the transfer of significant risk and rewards of ownership of the product to the customers, which is generally on the dispatch of goods ther than revenue from sale of healthcare equipments which is recognized upon installation at customer premises. Sales are started exclusive of sales tax and net of trade and quantity discount.

3. Revenue from services is recognised as per the terms of the contract with the customer using the proportionate completion method.

4. Revenue from services represents service income other than from services which are incidental to sale of products and projects.

5. Income from fixed price construction contracts is recognised by reference to the estimate overall profitability of the contract under the percentage of completion method. Percentage of completion is determined as a proportion of the costs incurred upto the reporting date of the total estimated contract costs. Contract revenue earned in excess of billing has been reflected as ‘Project excess cost’ under ‘Other current assets’ and ‘billing in excess’ of contract revenue has been reflected under “other current liabilities” in the balance sheet. Provisions for expected loss is recognized immediately when it is probable that the total estimated contracts costs will exceed total contract revenue

6. Interest income is recognised on the time proportion basis.7. Commission income is recognised when proof of shipment is received from the supplier.

BEL:

(i) Revenue from sale of goods is recognized as under: 1. In the case of FOR contracts, when the goods are handed over to the carrier for

transmission to the buyer after prior inspection and acceptance, if stipulated, and in the case of FOR destination contracts, if there is a reasonable expectation of the goods reaching destination within the accounting period. Revenue is recognized even if goods are retained with the company at the request of the customer.

2. In the case of ex-works contracts, when the specified goods are unconditionally

appropriated to the contract after prior inspection and acceptance, if required.

3. In the case of contracts for supply of complex equipment’s/systems where the normal cycle time of completion/delivery period is more than 24 months and the value of the equipment/ system is more than ` 100 crores, revenue is recognized on the “percentage completion” method. Percentage completion is based on the ratio of actual costs incurred on the contract up to the reporting dates to the estimated total cost of the contract. Since the outcome of such a contract can be estimated reliably only on achieving certain progress, revenue is recognized up to 25% progress only to the extent of costs. After this stage, revenue is recognized on proportionate basis and a contingency provision equal to 20% of the surplus of revenue over costs is made while anticipated losses are recognized in full.

4. If the sale price is pending finalization, revenue is recognized on the basis of price expected to be realized. Where break up prices of sub units sold are not provided for, the same are estimated.

5. Price revisions and claims for price escalations on contracts are accounted on admittance.

6. Where installation and commissioning is stipulated and price for the same agreed separately, revenue relating to installation and commissioning is recognized on conclusion of installation and commissioning activity. In case of a composite contract, where separate fee for installation and commissioning is not stipulated and the supply is effected and installation and commissioning work is pending, the estimated costs to be incurred on installation and commissioning activity is provided for and revenue is recognized as per the contract.

7. Sales exclude Sales Tax / Value Added Tax (VAT) and include Excise Duty.

(ii) Other income is recognized on accrual.

Bharat Forge: Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Company and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized:

i. Sale of products a) Revenue from domestic sales are recognized when all the significant risks and rewards of ownership of the goods have been passed to the buyer, usually on dispatch from the point of sale, consequent to property in goods being transferred. The Company collects sales taxes and value added taxes (VAT) on behalf of the government and, therefore, these are not economic benefits flowing to the Company. Hence, they are excluded from revenue. Excise duty deducted from revenue (gross) is the amount that is

included in the revenue (gross) and not the entire amount of liability arising during the year. b) Revenue from export sales are recognized when all the significant risks and rewards of ownership of the goods have been passed to the buyer, usually on the basis of dates of bill of lading. Summary of significant accounting policies (Contd.): f) Foreign currency translation (Contd.)

Export incentives Revenue from export incentives are accounted for on export of goods if the entitlements can be estimated with reasonable assurance and conditions precedent to claim is fulfilled.

Sale of services Revenues from sales of services are recognized pro-rata over the period of the contract as and when services are rendered. The Company collects service tax on behalf of the government and, therefore, it is not an economic benefit flowing to the Company. Hence, it is excluded from revenue.

Die design and preparation charges Revenues from die design and preparation charges are recognized as per the terms of the contract as and when the significant risks and rewards of ownership of dies are transferred to the buyers. The Company collects excise duty and value added tax (VAT) on behalf of the government and, therefore, it is not an economic benefit flowing to the Company. Hence, it is excluded from revenue. Excise duty deducted from revenue (gross) is the amount that is included in the revenue (gross) and not the entire amount of liability arising during the year.

Sale of electricity – Windmill Revenue from sales of electricity is recognized when all the significant risks and rewards of ownership have been passed to the buyer, usually on transmission of electricity based on the data provided by the electricity department.

Interest income Interest income is recognized on a time proportion basis taking into account the amount outstanding and the applicable interest rate.

Dividend income Dividend income is recognized when the Company’s right to receive is established by the reporting date.

Profit / loss on sale of investment Profit/loss on sale of investment is recognized when all the significant risks and rewards of ownership in investment is transferred.

Certified emission reduction units / renewal energy certificates

Revenue from certified emission reduction units / renewal energy certificates is recognized when there is reasonable assurance that the entity will comply with the conditions attached to it and the grants will be received. At a minimum, these conditions will only be met when the actual emission reductions have been realized and the entity has reasonable assurance these reductions will be confirmed during the verification and certification process by the respective independent authority.

BEMLRevenue is considered as

In the case of contracts for supply of complex equipment/systems where the normal cycle time of completion and delivery period is more than 12 months and the value of the equipment/system is more than `25 crores, revenue is recognised on the 'percentage completion method'.

Percentage completion is based on the ratio of actual costs incurred onthe contract up to the reporting date to the estimated total cost of the product.

Since the outcome of such a contract can be estimated reliably only on achieving certain progress, revenue is recognised up to 25% progress only to the extent of costs thereafter revenue is recognised on proportionate basis and a contingency provision equal to 20% of the surplus of revenue over costs is made while anticipated losses are recognised in full.

inventory valuation policies:

BHEL: I) Inventory is valued at actual/estimated cost or net realizable value, whichever is lower.

(ii) Finished goods in Plant and work in progress involving Hydro and Thermal sets including gas based power plants, boilers, boiler auxiliaries, compressors and industrial turbo sets are valued at actual/estimated factory cost or at 97.5% of the realizable value, whichever is lower.

(iii) In respect of valuation of finished goods in plant and work-in-progress, cost means factory cost; actual/estimated factory cost includes excise duty payable on manufactured goods.

(iv) In respect of raw material, components, loose tools, stores and spares cost means weighted average cost.

(v) a) For Construction contracts entered into on or after 01.04.2003: Where current estimates of cost and selling price of a contract indicates loss, the anticipated loss in respect of such contract is recognized immediately irrespective of whether or not work has commenced.

b) For all other contracts: Where current estimates of cost and selling price of an individually identified project forming part of a contract indicates loss, the anticipated loss in respect of such project on which the work had commenced, is recognized.c) In arriving at the anticipated loss, total income including incentives on exports/deemed exports is taken into consideration. (vi) The components and other materials purchased/manufactured against production orders but declared surplus are charged off to revenue retaining residual value based on technical estimates. In the case of BGGTS Traded stock is valued at the lower of cost and net

SIEMENS: 1) Inventories comprise all costs of purchase, conversion and other costs incurred in bringing the inventories to their present location and condition.

1. Raw materials are valued at the lower of cost and net realisable value (NRV). Cost is determined on the basis of the weighted average method (WDM).

Work in progress, finished goods and traded goods are valued at the the lower of cost and net realisable value (NRV). Excise duty is included in the value of finished goods inventory. Cost is determined on a weighted average basis

BEL: All inventories of the Company other than disposable scrap are valued at lower of cost or net realizable value. Disposable scrap is valued at estimated net realizable value. Cost of materials is ascertained by using the weighted average cost formula. Cost of work in progress and finished goods include Materials, Direct Labor and appropriate overheads. Finished goods at factories include applicable excise duty. Adequate provision is made for inventory which is more than five years old which may not be required for further use.

BHARAT FORGE:

In respect of Bharat Forge America Inc. and Bharat Forge Kilsta AB, Sweden

The cost of inventory is determined on the basis of first-in first out (FIFO) method in contrast to Bharat Forge Limited which determines on the basis of weighted average. In the current year, there is no material impact on the results for the year as the amount of difference is immaterial and hence ignored.

BEML

Inventory Valuation

(i) Raw materials, Components, Stores and Spare parts are valued at lower of Weighted Average Cost and estimated net realizable value.

(ii) Work-in-progress is valued at lower of cost of materials, labour & production overheadsbased on normative capacity and estimated net realizable value.

(iii) Finished stock is valued at lower of cost and estimated net realizable value.

(iv) Estimated costs are considered wherever actual costs are not available.

(v) The cost is adjusted for decline in value by writing down the value based on specificidentification. Necessary provision is made for non-moving items.

(vi) Based on technical assessment, provision is made for revalidation/refurbishment offinished goods.

(vii) Scrap is valued at estimated net realizable value.

Fixed Assets and Depreciation Policies:

BHEL:

(i) Depreciation on fixed assets (other than

those used abroad under contract) is charged upto the total cost of the assets on straight-line method as per the rates prescribed in Schedule XIV of the Companies Act, 1956, except where depreciation is charged at rates determined on the basis of the technically assessed estimated useful lives shown hereunder:- Single Shift Double Shift Triple Shift General Plant & Machinery 8% 12% 16% Automatic / Semi-Automatic Machines 10% 15% 20% Erection Equipment, Capital Tools & Tackles 20% Township Buildings – Second Class 2.5% – Third Class 3.5% Railway Sidings 8% Locomotives & Wagons 8% Electrical Installations 8% Office & Other Equipments 8% Drainage, Sewerage & Water supply 3.34% Electronic Data Processing Equipment 20% In respect of additions to/deductions from the fixed assets, depreciation is charged on pro-rata monthly basis.

(ii) Fixed assets used outside India pursuant to long term contracts are depreciated over the duration of the initial contract.

(iii) Fixed assets costing ` 10,000/- or less and those whose written down value as at the beginning of the year is ` 10,000/- or

Siemens:

1. Fixed assets are stated at cost of acquisition or revalued amounts less accumulated depreciation and impairment losses, if any. The cost of fixed assets includes taxes, duties, freight and other incidental expenses related to the acquisition and installation of the respective assets.

2. Depreciation is provided on the straight line method (SLM). The depreciation rates prescribed in Schedule XIV to the Act are considered as the minimum rates. If management’s estimate of the useful life of a fixed asset at the time of acquisition of the asset or of the remaining useful life on a subsequent review is shorter than that envisaged in the aforesaid schedule, Depreciation is provided at a higher rate based on the management’s estimate of useful life/remaining life.

BEL:

Tangible depreciable Fixed Assets are generally depreciated on straight-line method over the useful life of the assets estimated by the Management and in the manner prescribed in Schedule II to the Companies Act, 2013. Where cost of a part of the asset is significant to total cost of the asset and useful life of that part is different from the useful life of the remaining asset, useful life of that significant part is determined separately and the significant part depreciated on straight-line method over its estimated useful life. Special instruments are amortized over related production. Intangible Assets are amortized over a period of three years on straight-line method. Prorate depreciation / amortization is charged from / up to the date on which the assets are ready to be put to use  /  are deleted or discarded. Leasehold land is amortized over the period of lease.

BHARAT FORGE:

a) In respect of Indian subsidiaries (except BF Infrastructure Limited and Kalyani Strategic Systems Limited)

Depreciation expense is calculated using “Straight Line” basis on all the assets. This is in contrast to the practice followed by the Company where the depreciation on assets is calculated by using “Straight Line” basis or “Written Down Value” basis depending on asset classification. The practice would not have any material impact over the life of the asset and on the profit for the year.

b) In respect of certain Indian subsidiaries i.e. BF Infrastructure Limited and Kalyani Strategic Systems Limited

BEML

(a) Depreciation is charged on Straight Line Method basis adopting 'Useful Lives' as perSchedule-II of the Companies Act, 2013 (or such shorter useful lives which in the opinionof the management are appropriate), calculated from the month following themonth of capitalization. Depreciation on additions or extensions to existing assets isprovided so as to co-terminate with the life of the original asset if it becomes integral part ofthe existing asset or on useful life of the asset if it is capable of independent use.

(b) For Assets whose unit cost does not exceed`5000/- depreciation is provided at the rate ofhundred percent in the year of capitalization.

(c) Cost of leasehold land is amortized over the period of lease on pro-rata basis.

(d) Jigs & Fixtures which are capitalized are depreciated over a period of three years

LIST OF EXCEPTIONAL AND EXTRAORDINARY ITEMS:

BHEL:

In the financial year 2013-14 only one exceptional item was found namely :

waiver of interest with the figure of -4.14

SIEMENS:

1. In Nov 2014 Siemens decided to sell its metal technologies business, a subsidiary of Siemens VAI metals technologies, Germany which recorded the profit of 7120 cr.

2. Employee benefit expenses were 359 cr

Reversal of impairment loss and other provisions gained 1067 cr

BEL:

In the profit and loss statement for year ended 31 march 2013 the amount of 255.79 (pertains to BELOP) represents amount charged off towards TOT expenses, in the year 2011-12, written back due to change in the funding pattern in respect of grant towards TOT cost

Bharat Forge:

Profit on sales of fixed assets in 2014 : 43 crores

loss on sale of investments in 2015 : 4.12 crores

BEML

Income

Liability written back in 2011= 2,882.42

Liability written back in 2012= 1011.90

Warranty provision written back in 2013= 1,211.69

Liability Written back in 2014=376.94

Liability Written back in 2015= 14.66

Du Point Analysis:

DuPont analysis breaks ROE into its constituent components to determine which of these components is most responsible for changes in ROE.

Net margin: Expressed as a percentage, net margin is the revenue that remains after subtracting all operating expenses, taxes, interest and preferred stock dividends from a company's total revenue.

Asset turnover ratio: This ratio is an efficiency measurement used to determine how effectively a company uses its assets to generate revenue. The formula for calculating asset turnover ratio is total revenue divided by total assets. As a general rule, the higher the resulting number, the better the company is performing.

Equity multiplier: This ratio measures financial leverage. By comparing total assets to total stockholders' equity, the equity multiplier indicates whether a company finances the purchase of assets primarily through debt or equity. The higher the equity multiplier, the more leveraged the company, or the more debt it has in relation to its total assets.

DuPont analysis involves examining changes in these figures over time and matching them to corresponding changes in ROE. By doing so, analysts can determine whether operating efficiency, asset use efficiency or leverage is most responsible for ROE variations.