financial statement analysis 2010

8/3/2019 Financial Statement Analysis 2010

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Financial Statement Analysis

Padmini Srinivasan


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Financial

Statements

Accounting

System

Measurement

&

Reporting

Business

Activities

Operating

Investment

Financing

Accounting

Environment

Capital Market

Structure,

GAAP,Audit,&Legal system

Business

Environment

Labor MarketCapital Market

Product Market:

Suppliers

Customers

Accounting Strategy

Choice of:

Accounting Policy

Reporting Format

Supplementary-

Disclosures

Business

StrategyKey factors

And Risk

From Business Activities to Financial Statements

Story So far ..


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Need for Financial statement

analysis. The goal of a FSA is to assess the performance of

a firm in the context of its stated goals and

strategies It provides a link to the different statements

Provides answers to questions like:

How has the business performed during the year

Does the earnings record a growth, stability ordecline

How is profit derived


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Need for Financial statement

analysis

Some Additional purposes:

How is the financial condition of the companyHow investment activities have performed

during the year

How does the unit stand in comparison to theindustry

Preparation of Forecasts


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Where to look for data

The Annual reports

Directors Report - Working of the

Company

Auditors Report

Profit and loss account

Balance Sheet

Cash Flow statements


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Where to look for

Management Discussion &Analysis

Supplementary schedules and Notes Segmental analysis

Accounting Policies

Subsidiary Company Information

look further... Fine prints


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Other Data Sources

Forms filed with the ROC (In the US 10K and

10Q reports filed with SEC: Edgar Data Base)

Data bases CMIE: Prowess; Capitaline.com,insight.asiancerc.com

-Info on industry norms/ratios (Crisil )

Articles in press Ever-expanding websites


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Steps in

Financial Statement Analysis


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STEPS in Financial Statement

Analysis4 Step Approach to Analysis

1. Business Strategy Analysis

2. Accounting Analysis

3. Financial Analysis

4. Prospective Analysis


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4 Step Approach to Analysis

1. Business strategy analysis

- Identifying the company's strategy to create asustainable competitive advantage & profit

- Study the COMMON characteristics of theIndustry in which the firm operates and relate theindustry climate to current and projectedeconomic developments

- For e.g. Type of Industry Are we dealing with agrowth industry? A dying industry? A changingindustry?...


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4 Step Approach to Analysis

Business strategy analysis

Identify the strategies adopted by the firm

Choice of industry, competitive positioning

Creating synergies ie corporate strategy

are they taking advantage of opportunities?

are they innovative, forward-looking, etc? (Industry growth, Scale Economies, Existing Rivalry, New

entrants, substitute products legal barriers, etc)


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4 step Approach to Analysis2. Accounting Analysis

Involves evaluating the accounting polices which

helps capture the degree of distortion in the firmsaccounting numbers.

Evaluate and Understand the financial numbers(number-crunching !)

Look into non recurring & unusual items, priorperiod items

Indian Annual Repots need to be re- organized

Looking into accounting policies changes


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4 step Approach to AnalysisIndian Annual Repots need to be re- organized:

Items such as Secured loans : To divide into current

and Non Current

Gross Profit: Cannot be found

Secured loans also include Bank overdraft facilities

Look for : Inter Divisional Transfers, Excise duty inSales etc.

& many such adjustments to be made


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4 step Approach to Analysis

3. Financial Analysis

To evaluate current and pastperformance of a firm.

Some of the common tools used are

Ratio Analysis , cash flow analysis etc


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4 step Approach to Analysis

4. Prospective Analysis

Final step is forecasting firms futureIe. Using Financial Statement

Forecasting and Valuation tools

These tools use inputs from steps 1,2,and 3 in order to make predictions


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Analyzing the Company

Now that some of the tools of financial

analysis have been identified, whats next ?


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Steps in a FSA Establish objectives of the analysis

Who are you and why are you interested in this

company?What questions would you like to have

answered?

What info is vital to the decision at hand?

Summarize findings

Reach conclusions about the firm relevant toyour established objectives


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MANAGEMENT PREPARES financialstatements

Analyst should be alert to the potential for

management to influence reporting to make datamore appealing

Therefore, Supplement analysis with informationapart from Annual Report prepared by

management Financial analysis is only as good as the

information upon which it is based

CAUTION

!!!


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Financial Statement Analysis Financial statement analysis is a collective

name for the tools and techniques that

provide the users with relevant informationfor decision making

Helps Develop an understanding of theStatus and Performance of the firm

Helps in forecasting and predicting theValue of the firm


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TOO

LS FO

R EVALUATION

Common size financial statements

Horizontal analysis (Year to Year

Comparison) Financial Ratio analysis

Index analysis

Cash Flow Analysis

Common sense and judgment (often the

hardest to use)


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Common Size Statements Common size income statement

Expresses each income statement category as a

percentage of net sales

Common size balance sheet

Expresses each item on balance sheet as a

percentage of total assets or equities Facilitate structural analysis of the firm


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Common Size Statements Common size income statement

Explains cost structures and the changes

Distribution policy and change

Common size balance sheet

Explains the distribution of assets How the funds are distributed among assets

The financing pattern of the firm


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2002 2003

SALES 8000 100.00% 10000 100.00%

Cost of Goods Sold 7000 87.50% 8800 88.00%

Gross Profits 1000 12.50% 1200 12.00%

Admn and Selling Exp 500 6.25% 550 5.50%

Operating Profit 500 6.25% 650 6.50%

Non Operating Income

Profit On saLe of Fixed Assets 10 0.13% 20 0.20%

EBIT 510 6.38% 670 6.70%

Interest 60 0.75% 100 1.00%

Profit berfore tax 450 5.63% 570 5.70%

Provisoion for Tax 150 1.88% 220 2.20%PROFIT AFTER TAX 300 3.75% 350 3.50%

Dividends 100 1.25% 150 1.50%

Profit and Loss Statement OF ABC LTD


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COMMON SIZE : BALANCE SHEETBALANCE SHEET OF ABC LTD. AS ON MAR 31, 2003

LIABILITIES 2002 2003

% %

SHARE CAPITAL

Equity Share Capital 2400 20.34 3160 20.65

RESERVES & SURPLUS

Share Premium A/c ???? 900 7.63 1340 8.76

Profit and Loss A/c. 2100 17.80 2300 15.03

NET WORTH 5400 6800

SECURED LOANS

Debentures 300 2.54 700 4.58

CURRENT LIABILITIES

Creditors 500 4.24 800 5.23

Provisions 200 1.69 200 1.31

TOTAL 11800 100 15300 100


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HORIZONTAL ANALYSIS

Year to year changes

Changes in amounts and percentages

Reveals a trend & direction

Helps understand the growth in size of the firm

Look at growth in sales and other parameters,asset growth inventory growth etc


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HORIZONTAL ANALYSISPROFIT AND LOSS ACCOUNT FOR YEAR ENDING MAR 31,

2002 2003 HORIZONT

SALES 8000 10000 25%

Cost of Goods Sold 7000 8800 26%

Gross Profits 1000 1200 20%

Admn and Selling Exp 500 550 10%Operating Profit 500 650 30%

Non Operating Income

Profit On saLe of Fixed Assets 10 20 100%

EBIT 510 670 31%

Interest 60 100 67%

Profit berfore tax 450 570 27%Prov. For tax 150 220 47%

PROFIT AFTER TAX 300 350 17%

Dividends 100 200 100%


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HO

RIZON

TAL AN

ALYSISASSETS 2002 2003 2000

FIXED ASSETS

Gross Block 5500 6500

Acc. Depr. -1500 -1700

NetB

lock 4000 62.50% 4800 56.47% 20.00

INVESTMENTS 1100 17.19% 2100 24.71% 90.91

CURRENT ASSETS LOANS..

Cash 200 3.13% 100 1.18% -50.00

Receivables 350 5.47% 450 5.29% 28.57

Inventories 750 11.72% 1050 12.35% 40.00

Others

TOTAL 6400 100.00% 8500 100.00%


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RATIO ANALYSIS


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RATIO

AN

ALYSIS GIVES THE LINK BETWEEN INVESTMENT,

FINANCING AND OPERATING ACTIVITY

i.e. how various items in the financial statements

relate to one and another

Used to understand the sources of profit, theefficiency of resources

To understand the risk associated wit the business

To understand the short term liquidity

Analysis of Past performance helps in forecastingthe future performance


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Ratio AnalysisRatio Analysis to assess the:

Profitability

Asset Utilization

Liquidity

Long term solvency

Other Ratios for investor


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FSA-Basic Structure

Leverage or

Financial risk

Fixed Asset Turnover

Debtors Turnover or

Collection Period

Inventory Turnover

Current Asset TOR

Asset Turnover ratios

Interest / Sales

Other expenses / Sales

Raw material/Sales

Profit Margins

Return on Investment

Return on Equity

Current Ratio


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Financial Ratio Analysis

Profitability Ratios

Measures the overall performance of a firm and

its operational efficiency

Is a function of Sales, Efficiency and Leverage

What performance are we looking into ?


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Quality of Earnings Will be affected by:- Accounting Method and Estimates

- Extra Ordinary Items- Prior Period Adjustments

- Discontinued Operations

- Change in Accounting Policies- Income from Non Operating items to

investment in non operating items


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Return RatiosReturn on Total Assets

PAT /Avg Total Assets or

PBIT/ AVG Total Assets*

NOPAT / Total Assets

The ratio measures the overall efficiency of the firmin managing investment in assets and generatingreturn to stockholders


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Return RatiosReturn on Investment

PBIT/ Total Assets*

NOPAT / Total Assets

Here the difference is the total assets includes theWorking Capital only ( CA CL)

The ratio measures the overall efficiency of the firmin managing investment in assets and generatingreturn to stockholders


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Profitability Ratios Net Profit Margin

Net Profit After Tax/Net Sales

O

perating Profit MarginOperating Profit /Net Sales

Various Expenses to Sales

Raw Materials/Net Sales

Salaries / Net Sales

All measure firms ability to translate sales into

profits


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Performance of Assets

Firms use different assets

Fixed Asset Current Assets

How Productive are these assets ?


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Turn Over Ratios or Activity

Ratios Total Asset Turn over Ratio

Sales / average Total Assets

Total Assets = All Assets in the Balance sheet

Current Asset = Inventory + Debtors+ others

Average = Opening + Closing /2

Shows how well the Resource are Utilized

The Ability of different assets like Fixed Assets,

current assets and both to generate sales


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Inventory Turnover Ratio Cost of Goods Sold / AVG Inventory

Indicating the number of times inventory can berotated (COGS = All operating Exp

including Depreciation)

Number of Days Inventory

Avg Inventory / Sales per day(Measures efficiency of inventory

management (not the inventory policy ofthe management)


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Debtors Turnover Ratio Debtors Turnover Ratio

Net Sales/ Average Debtors

Average Collection Period Accounts Receivable/Average Daily Sales

Avg Sales = Total Sales/365

(A measure of efficiency of firms ability tocollect ie realize sale into cash from customers)

Helps gauge liquidity of accounts receivable


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Payables Turnover Ratio Payables TO R = Purchases (COGS) /

Average Accounts Payable

Source of financing of the operating activity

Used for computing the cash cycle


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Financing Pattern : Short term Liquidity

Liquidity Ratios

Measures the firms ability to meet cash needs

as they arise


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Liquidity Ratios Current Ratio

Current Assets/Current Liabilities

Short term obligations are to be met from shortterm assets as and when they arise

Measures the ability of the firm to meet short-term obligations

Normally a ratio acceptable is 1.33: 1(Traditionally a ratio of 2:1 was the bench

mark) What does higher ratio indicate ?

Needs considerable rework into current and non

current. Also include current investment


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Liquidity Ratios Quick or Acid Test Ratio

(Current Assets-Inventory)/Current Liabilities

Measure ability to meet short-term cash needsmore rigorously (ratio of 1:1 is the norm taken)

Assumption made is inventory are not easily

convertible into cash

All adjustment as in earlier ratio needed


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Financial Leverage

It Pays to have Debt in your Capital Structure

Of course it is only true when: The rate of return ismore than the cost of debts

Interest is tax deductible, while dividends are not

W

hen the there is high business risk you musthave a low financial risk


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Financing Pattern : Long term Solvency

Leverage Ratios

measure the extent of a firms financing with

debt relative to equity and its ability to coverinterest and other fixed charges also called as

the Solvency ratios


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Solvency RatiosDebt to Equity Ratio

Short Term+ Long Term Debt/ Share holders funds

TO

TALO

utside liabilities /Share holders funds * (* Useful when companies have liabilities that are short

term in nature but constantly roll over)

Debt Asset Ratio:

Total outside liabilities / Total Assets

They measure the extent of firms financing withdebt and thereby the financial risk


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Coverage Ratios

Interest Cover Ratio

PBIT/Interest Expense

Indicates how well operating earnings cover

fixed interest charges


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Importance of Debt Ratios

Proportion and amount of debt in capital

structure is important to analyst to

determine the Financial Risk of the business

Tradeoff between risk and return

Use of debt involves risk -- commitment to

fixed charges

Fixed charges must be covered


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Return on Equity

Return on Equity

PAT/ AVG Stockholders Equity

Tells you the return the Share holders earn

This ratio is a function of ROA and the

Leverage multiplier Expectation is: ROE > Cost of Capital


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Other Ratios : For the Investor

Earnings per Share

PAT /Average Equity Shares

Indicates return on a per share basis

Dividend Pay out

Dividends /Net Income %


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Other Ratios : For the Investor

Dividend Yield

Dividend per share/ Market price (year end average)

(Div per share+ change in stock price over the period)/Market price

PE Ratio:

Market Price (year end avg)/ Earnings per Share

The multiple that stock market places on theearnings which reflects the growth prospects, riskcharacteristics, corporate image and degree ofliquidity


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Market Ratios

Price to book ratio:

Market price / Book value

Low ratio indicates undervaluation


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End of Ch 11

Now to Cash flow

financial statement analysis 2010

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