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B S E T R A I N I N G I N S T I T U T E 1
Financial Statement Analysis
MANISH BANSAL
Jeetay InvestmentsEmail: [email protected]
Phone: +91 98924 86751
www.jeetay.com
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Financial Statements
Financial Statements are records of allfinancial transactions in a business:
Income
Expenses
Assets
Liabilities
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FSA ingredients
Earnings
Assets
Cash flows
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Financial Statements
Summary of financial transactions is provided inthree major statements: Income Statement
Better to call P/L Statement
Provides picture of business over a period of time Balance Sheet
Statement of Liabilities (sources of funds) and Assets(application of funds)
Provides static picture of business at a point in time
Cash Flow Statement Cash inflows and outflows over a period of time As accounting is on accrual basis and not cash basis, need
this statement to see the flow of cash Divided into operating, investing and financing cash flows
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Basic Concepts of Accounting
Entity Concept Business as an entity
Going Concern Concept Business as a going concern
Conservatism Concept Provide for all potential losses but do not
provide for potential gains
Dual Aspect Concept - Asset = Equity + Liability
Accounting Period Concept Accounts for a period
Accrual Concept Record transaction at occurrence irrespective of
cash payment/receipt
Matching Concept Revenues and costs should be recognized in the
same accounting period
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Business flow
Source - Investopedia
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Understanding financials
Operating income income from businessoperations
Other income generally recurring but from sourcesother then business income e.g. from dividend,
interest, commission, rent etc. Extraordinary items nonrecurring
income/expenditure. For example, profit from sale ofasset etc.
Income in the P/L should be net of VAT, ServiceTax, Excise, Sales tax etc..
Foreign Exchange differences Arising from FXtransactions.
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Understanding financials
Expenses Capitalized Means the expenses whichhave been categorized as assets. Capitalization ofan expense as an asset means deferring theexpense recognization.
Operating profit Profit from operations. It is knownas EBIDTA
EBIDTA Earning before Interest, Depreciation,Taxes and Amortization. Also called as PBIDTA
Sales to EBIDTA is an operational journey
Depreciation Expense the asset over a period oftime.
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Understanding financials
Amortization Is another name for Depreciation.Use this term for intangible assets Depreciation.
Deferred taxes Taxes allowed to be legally
deferred. Reported net profit Profit as reported in Annual
Report
Adjusted net profit Profit adjusted for extraordinary
items EBIDTA to net profit is a financial journey
Cash profit Net profit plus non cash expenses
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Understanding financials
Appropriations Accounting allocations for variouspurposes. Little/no economic consequences.
Dividend absolute amount to be shared with
owners. In % terms of face value per share. Earning per share (EPS) Net profit per share.
Divide total net profit by no. of outstanding shares.
EPS diluted EPS adjusted for extended equity on
account ofFCCBs, Convertible bonds, ESOPs,Warrants etc.
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Understanding financials
Retained earnings Net earnings after payingdividend
Book Value per share Net-worth distributed
over all shares. It is net-worth per share.
Net-worth Total owners capital, which is sharecapital plus reserves.
Share capital Capital contribution by owners. Itis face value of share multiplied by total no. ofoutstanding shares.
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Understanding financials
Reserves Reserves created out of retainedprofits, share premium and revaluation ofassets etc.
Secured loans Loans backed bysecurity/collateral
Unsecured loans Clean loans without
security/collateral Gross block Fixed Assets in business
recorded at their historical acquisition costs.
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Understanding financials
Accumulated Depreciation To the extent FixedAssets are expensed over their life of usage.
Impairment Means damage of asset, physical or
commercial Net bock Book value of fixed assets. It is gross
block minus accumulated depreciation.
Goodwill Sometimes, Fixed Assets will have head
called goodwill. Differentiate between accounting goodwill and
economic goodwill
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Understanding financials
Capital work in progress Money invested in fixedassets, which have not started being utilized in thebusiness yet.
Once commercial usage of an asset under capitalwork in progress starts, it shifts from capital work in
progress to gross block. And, depreciation meterstarts from here.
Investments Investments in marketable securities
MFs, Shares, Debentures etc. Current Assets Assets, which are close to cash or
can be converted in to cash easily.
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Understanding financials
Inventories Raw material, work in progress,finished goods etc. This work in progress isdifferent from capital work in progress.
Debtors Accounts receivable. Where businesshas extended credit.
Cash and bank balance Amount lying in banksin checking/current account or term deposits
Loans and advances Business advancesextended to various business partners
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Understanding financials
Current liabilities Liabilities falling due soon.
Provisions Liabilities recognized but not paidout/written off.
Net current assets Current assets minus currentliabilities
Contingent liabilities Liabilities not recognized bybusiness. These are off balance sheet items.
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Understanding financials
Operating cash flows Cash flows from businessoperations. Incoming cash is positive and outgoingcash is negative.
Investing cash flows - Cash flows from assets.
Buying asset is negative cash flow and selling assetis positive cash flow.
Financing cash flows Cash flows from sources offunds. Borrowing money or raising equity is positivecash flow. Repaying debt or equity is negative cash
flow. Negative investing cash flows are financed through
either positive operating cash flows or positivefinancing cash flows.
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Cash flow statement
Generating Cash is critical for a firms long term survival.
P/L and B/S do not focus on cash flows.
Picture source Investopedia
Looking at net cash flowscould be deceptive
One needs to analyzeeach of the cash flowstreams independentlyObjective is to focus onsustainable and recurring
cash flowsIdentify and adjust fornon recurring /extraordinary items
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Market terminology
Market Price
Market capitalization Price per share multiplied byoutstanding no. of shares
Price earning ratio Price per share divided byearning per share. Or, market capitalization dividedby net profits.
Last financial year earning Last ended FY earning
Trailing earning Latest 4Qs earning
Forward earning Earnings of coming financialyears.
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Market terminology
Price to book value ratio Price per sharedivided by book value per share.
Dividend yield Last dividend paid divided bymarket price per share
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Coloring financials
True and fair viewnot essentially a correct view
What is critical is consistency and not a specific methodology of
accounting
Past financials help you understand revenues/cost dynamics
and assets/liability dynamics
Future, anyway, is uncertain
Work of an analyst starts when work of CA is over
Management discussion and notes to accounts are more
important than accounts themselves
Closely scrutinize off-balance sheet items (financing , liabilities
guarantees, MTM on outstanding derivatives etc.)
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Coloring financials
Accounting future revenues in the previous year Violation of
matching concept.
Postponing expenditure Capitalization of expenses like R&D
expenses, Brand building expenses (Advertisements and
sales force cost).
Change in depreciation policy Inflate/deflate P/L.
Extra provisions in good years and writing them back in
difficult years.
Not providing sufficiently for known and contingent liabilities.
Revaluation of assets to create impression of hefty reserves.
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Financial analysis
Profitability Ratios and growth
Return Ratios
Solvency Ratios Liquidity Ratios
Efficiency Ratios
Valuation Ratios
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Profitability and growth
Profitability refers to the margin on per $ ofsales.
EBIDTA/Operating profit margin
EBIT margin
Net profit margin
Growth means Q to Q orY to Y or CAGRover a period of time.
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Return
Return on capital employed EBIT/Capitalemployed in the business
Return on Equity Net profit/owners capital
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Solvency
Financial leverage refers to the use of debtcomponent in Capital Structure
Leverage is equally important to both lenders
and owners Important checks are:
Coverage of debt by equity Debt/Equity
Coverage of interest by EBIT or EBDIT
Coverage of debt service by cash profit Coverage of interest and debt service by operating
cash flow
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Liquidity
Liquidity refers to the ability of firm to meetits obligations in short run.
Does the company have sustainable
positive operating cash flows? Current Ratio Current Assets/Current Lib.
Quick Ratio Quick Assets/Current Lib.
Cash Ratio Cash and cashequivalents/Current liabilities
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Efficiency
Working Capital turnover Sales/W.C.
Debtors turnover Sales/Debtors
Inventory turnover Cost of goodssold/Inventory
Reversing turnover nos. would give us w.c.,debtors and inventory days. Lower the better.
Fixed Assets turnover Sales/F.A.
Total Assets turnover Sales/T.A.
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Valuation parameters
Dividend Yield
Price to Earning Ratio
PEG Ratio EV to EBIDTA Ratio
Price to Book Value Ratio
Price to Sales Ratio DCF Valuation
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Important points
PE for a leveraged firm may be deceptive
Leverage improves ROE
Differentiate between RO
CE and NPM Differentiate between ROCE and ROE
ROCE and ROE should be closely knit. Anywide variation should trigger investigations.
EV and not the market capitalization is thetrue value of the firm for private owner.
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I am not afraid of storms, for I am learninghow to sail my ship
Louisa May Alcott, American Novelist (1832-1888)
Become a learning machine
Charlie Munger
Concluding remarks
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Thank youPlease feel free to reach me at
[email protected]+91 98924 86751