Financial analysis

1. Financial analysis Introduction

2. How accounting helps • Analysis of financial statement helps provide right information of the strength and weakness • Helps companies manage business efficiently

3. What financial statements contain? • Contains financial information of the company’s operation during the period • Contains comparative figures • Also contains qualitative information about the management and key decisions

4. Uses of financial statements • Legal obligation • Balance sheet and profit and loss account can be studied to ascertain the status • Stakeholders like investors, regulators, stakeholders use the statements to study performance • Organisation uses the data to study internal performance like cost of operations, liquidity etc.,

5. Helps in management decisions • Budgeting and profit planning • Management of cash flow • Operations management and control • Major decisions • Trade off between buying and leasing • Helps choice of products and product lines • Marketing techniques to be adopted • Choosing the right operations

6. Why we need to understand • Our competitors run the business as a commercial organisation • For evaluation of performance we need to understand how industry works and the standards

7. Reading financial statements Overview

8. Balance sheet - Introduction • A snapshot of financial position of a company • Reveals • Company’s assets • Liabilities • Owner’s equity (net worth) • Formula Assets = Liabilities + Shareholder’s equity

9. Assets • Things that a company owns • Assets have a value, can be sold • Used by companies to make products or provide services that can be sold • They include • Plant and machinery • Other equipments • Inventory (stock of raw material, work-in-progress and finished goods) • Cash and its equivalent • Can be classified as current, non current and intangible

10. Liabilities • Money that company owes to others • Includes all kinds of obligations • Categorised as long term and short term (current) liabilities • Long tem liabilities include debt and other non-debt financial obligations • Current liabilities are those that are short term borrowings and other payments due for payment within one year

11. Shareholder’s equity • This is the initial investment into business by investors • It may also include the retained earnings • Together it is called networth of a company

12. Balancing • The left side of the balance sheet has the liabilities and net worth • The right side has the assets • For the balance sheet to balance, total assets on the right side has to equal total liabilities plus net worth

13. Sample balance sheet • Balance sheet of Dabur India Limited • Shows in the form of Sources and Uses of funds

14. Financial statement • Balance sheet • Income statement • Cash flow statement

15. Balance sheet analysis • Sources of funds • Capital • Reserves & Surplus • Term Liabilities • Current Liabilities

16. Balance sheet analysis • Uses of funds • Fixed Assets • Intangible assets • Non current assets • Current assets

17. Balance sheet analysis • Capital • Authorised capital • Issued capital • Subscribed capital • Paid up capital

18. Balance sheet analysis • Reserves • General reserves • Revaluation of fixed assets • Issue of shares at premium • Surplus • The credit balance in Profit and loss account

19. Balance sheet analysis • Tangible net worth • Refers to total funds arrived at adding up capital, reserves and surplus less intangible assets

20. Balance sheet analysis • Long term liabilities • Redeemable preference shares • Debentures • Deferred payment guarantees • Public Deposits(Repayable after 12 months) • Term loans and unsecured loans from friends, relatives, directors repayable over a period of time

21. Balance sheet analysis • Current liabilities • Working capital bank borrowings • Term loans deferred credit installments falling due in 12 months • public deposits maturing within 12 months • unsecured loans, unless the repayment is on deferred terms • sundry creditors • advances from dealers and customers • interest accrued but not paid • tax provisions • Dividend declared and payable

22. Balance sheet analysis • Contingent liabilities • Tax disputes • Legal litigations • Bills and cheques discounted with banks • Claims against the company not acknowledged

23. Balance sheet analysis • Fixed Assets • Infrastructure like land & building • plant & machinery • Vehicles • Furniture & fixtures • Depreciation • Straight line method • Written down Value Method

24. Balance sheet analysis • Investments • Shares And Securities • Associate Companies • Fixed deposits with banks/finance companies Remarks • While analysing bal sheet we can analyse necessity of such investments • While fixed deposits with banks are considered as fixed assets, the investments in associate concerns are treated as non current assets.

25. Balance sheet analysis • Non Current Assets • Deferred receivables/Overdue receivables(like disputed amounts and overdue > 6 months) • Non moving stocks/inventory/unusable spares • Investment/Lending to associate concern • Borrowing of the directors from the company • Telephone deposits/ ST deposits etc

26. Balance sheet analysis • Intangible Assets • Preliminary & Preoperative expenses • Deferred Revenue Expenditure • Goodwill • Trade mark • Patents

27. Balance sheet analysis • Current Assets • Raw materials, work-in-progress,finishedgoods,spares and consumables • Sundry debtors and receivables < 6 mths • Advances paid to suppliers of raw materials • Cash and bank balances • Interest receivables • Other current assets such as Government securities, Bank deposits ..etc

28. Balance sheet analysis • Notes • Management competence • Investment decision • Resorting to window dressing • experience of the promoters • Board comprises of only family members • The key personnel of the company • The structure of the organisation • The authority and decision making are decentralised

29. Balance sheet analysis • Notes • The state of industrial relations • Financial systems and procedures • management control • planning, budgeting, forecasting • capacity utilisation • status of the technology • awareness of the market, competitions ..etc • for listed co: share prices, EPS, book value, dividend record, public response ..etc

30. Exercise 1

31. Profit and loss account • It is a summary of revenue earned and expenses incurred which ultimately results in profit or loss of to the company • No defined format in law • Operating revenue = Sales revenue • Non-operating revenue = Other income ( out of sale of investments, interest, commission and discount etc) • Hence operating profit is a yard stick for operating profit of the company • Operating profit = Sales Revenue- Operating Cost

32. Profit and loss account • Gross Sales • Gross sales includes excise duty to be charged to the customer, central sales tax applicable, state sales tax applicable, the discount o be allowed to distributors/dealers/customers. The gross sales appears in the P&L account comprises of all the above part from the basic unit price. • Net Sales • The sales figure excluding all the factors explained above are the net sales

33. Profit and loss account • Cost of production • This is the cost incurred right from the procurement of raw material to the finished good. • For ex in a garment firm following cost is incurred while production • cost of raw material cloth, buttons, canvas, hooks, zips etc • Maintenance of sewing machines • payment of wages to workers • Power • Washing, ironing, packing etc. • Cost of Production excludes selling & admin exp & interest cost

34. Profit and loss account • Selling And General Administrative Expenses • Maintaining office staff for admin & accounting • marketing effort • payment of salaries/Allowances to marketing personnel • All the expenses which are not directly connected to manufacturing are classified as selling and/or general expenses

35. Profit and loss account • Cost of goods sold • Cost of goods sold includes all manufacturing expenses and the adjustments for opening and closing stock • Cost of Goods sold = Opening stock + Purchases + Manufacturing expenses - Closing stock • Gross Profit • arrived deducting figure of cost of goods sold from the sales figure • Gross profit = Sales - Cost of goods sold.

36. Profit and loss account • Operating Profit is arrived deducting selling, administrative and general expenses , provision for bad debts, interest and miscellaneous expenses from the gross profit. • ie Op Profit = Gr Prof - (Sel & adm exp + Prov bad debt + mis exp ) • Profit Before Tax When other income is added and other expenses are deducted from the operating profit we get profit before Tax • ie PBT = Op Profit + oth Inc - oth exp • Net Profit When provision for taxes is deducted from the Profit Before Tax we get Net profit • ie Net Profit = PBT - taxes

37. Profit and loss account • Non Operating Income/Expenses • The income earned by the unit from other than manufacturing and selling operations is classified under this head . i.e • Interest earned on fixed deposits • Dividends and profit earned by sale of assets and share. • All those expenses which are not directly connected with operations of the unit are classified under this head. i.e • Preliminary expenses written off • Loss suffered due to sale of assets & share

38. Ratio analysis • Standardize numbers across industry – facilitate comparison • Used to highlight weaknesses and strengths

39. Categories of ratios • Liquidity – Can the business make required payments as they fall due? • Asset management – Does the organisation have the right amount of assets for the level of shares • Debt management – Does the company have the right mix of debt and equity

40. Categories of ratios • Profitability – Do the sale prices exceed the unit cost

41. Debt to equity ratio • Compares company’s total debt to shareholder’s equity • Data for calculation can be found in company’s balance sheet • To calculate the ratio, divide the company’s total liabilities by the shareholders’ equity Debt-to-equity ratio = Total liabilities/shareholders’ equity • If the ratio is 1.5:1, the company has a debt of Rs. 1.50 for every Re 1/- of the equity

42. Inventory turnover ratio • Compares the company’s cost of sales to the inventory for a given period Inventory turnover = Sales/Inventories • A higher ratio indicates quick movement of stock • A low ratio indicates slow movement and accumulation of old stock

43. Operating margin • Compares company’s operating income (before interest and taxes) to revenues • Expressed as a percentage of revenue • Shows the amount of income for every rupee of sale • Indicator of the profit margin

44. Price/Earning ratio • Compares company’s common stock price with its earning per share P/E Ratio = Price per share/Earnings per share

45. Working capital • Working capital is the money left after paying the current liabilities Working capital = Current assets – Current liabilities

46. Exercise 2