Financial Statements Analysis

Getting Judgemental
 Blended learning

Finally we reached at the goal post!

1 Business Transaction

2 Recording for future reference Accounting

(Journals, Ledgers, Memo)

3 Proper presentation Financial Reporting

(Balance sheet, P/L, Cash Flow St)

4 Use of information by stakeholder Financial

Statement Analysis

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 Blended learning

Stakeholders (Who) interested in FSA

Stakeholder Objective
► Lender ► Credit worthiness
► Entrepreneur ► Business Viability
► Investor / Shareholders ► Returns from the investment
► Supplier ► Liquidity Position
► Customer ► Sustainability of operations
► Capital Markets ► Corporate Governance
► Government ► Revenue generation ability
► Employees ► Impact on wages/salaries

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 Blended learning

6 steps in FSA

1. Determine
2. Gather
the Objective
Data
and Context

6. Update the 3. Process

Analysis the Data

5. Report the
4. Analyze
Conclusions or
and interpret
Recommendati
the data
ons

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 Blended learning

Tools of FSA

• Under the framework of the financial analysis, step #3 was to Process the data
after gathering it from different sources

• We use the following techniques:

Ratio Analysis Common Sizing

Time Series Analysis Graph / Charting

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Let us create a list of characteristics that a ‘good business’ has?

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 Blended learning

5 Contours (What) of FSA (Excl. Qualitative Aspects)

BSNL / Sahara Group

AirIndia Activity Liquidity

Jet Airways
Solvency / Leverage

F&B vs Marble Profitability Byju’s

(Management + Valuation/Investment Reliance
Ratios Industries
Capital Provider)

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 Top 10 Ratios
1. Operating Profit Margin

2. Net Profit Margin

3. Return on Equity
4. Current Ratio
5. Cash Ratio
6. Debt to Equity
7. Interest Coverage Ratio
8. Inventory Holding Period

9. Customer collection period

10. Supplier payment period
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 Blended learning

Key Profitability Ratios

• Different levels of profits

• Parity between capital providers and corresponding profits
• Tax parity
• Create your own ratios
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 Blended learning

Key Liquidity Ratios

Nr. Dr.

• What are different Current Assets?

• How are CA different than QA? And Cash
Assets?
• How are CL related to Debt?

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 Blended learning

Key Solvency Ratios

Nr. Dr.

• What constitutes Debt?

• What is Equity?
• Which Assets to be taken?
• Should we take accrual interest or cash interest?

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 Blended learning

Key Activity Ratios

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 Blended learning

Importance of the reference point

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 Blended learning

What can be a suitable reference point?

Peer Group Industry Average

Best
?

Specific Competitor Own Historical

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Return on Equity: The most important ratio = Net Profits / Equity

Asset

Turnover

Profitability Activity Solvency

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Limitations of Return of Equity
1. It does not capture the liquidity theme. It is based on profits and hence accrual, not
cash

2. R stands for Return, and does not capture the risk involved in getting Debt on the
capital structure.

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What is ‘Analysis’?
Spot the difference …60 Seconds

3 differences in 60 seconds is a genius in making

2 differences in 60 seconds is an extraordinary mind
1 differences in 60 seconds is above average
0 differences in 60 seconds is…

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Why do we analyze at all?

Information Analysis Inference Decision

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What is the trend that you read?

Year 1 Year 2 Year 3

Sales Bn $

What the key dimensions of the trend?

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Does your reading change in #2? Why?

Year 1 Year 2 Year 3

Hike
Salesin
BnSalary
$

Salesin
Hike BnSalary
$

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How about 1 versus 3?

Year 1 Year 2 Year 3

Sales
Hike Growth
Salesin $ (%)
BnSalary

Hike in Salary
Sales
No. Growth
ofBn
Sales km$ run(%)

No. of km run

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 Is there any relationship?

Liquidity

23 Profitability Solvency
Revision: Financial Statements
 Blended learning

How would you judge the

health of any business?

PERFORMANCE POSITION LIQUIDITY

Income Balance Cash Flow

Statement Sheet Statement

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 Blended learning

Basic Definitions
All entities can be divided into 5 basic categories

Liability
Assets
Future probable Future probable
economic benefits economic obligations

Income Expense
Revenue Stream Cost Incurred to earn
the income

Owner’s Equity
Net benefit after
meeting all the
obligations

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 Blended learning

Classification of Activities
1. Operating activity: transactions that involve the firm’s primary activities.
1. This includes the main route by which any company intends to make profits
2. It includes the day to day business functions of a company

2. Investing activity: activities associated with the

• acquisition and disposal of long term assets or
• anything to do with non-business assets

4. Financing activity: activities related to obtaining or repaying capital to be used in

the business.

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 Blended learning

Manager’s way of looking at Income Statement

Particulars
Sales
(Less) COGS (All direct expenses)

Basic
trade
Operating
Gross Profit
(Less) Marketing Expense
(Less) Administrative/ General Expense

Business
expense
(Less) Distribution Expense
EBITDA
(Less) Depreciation / Amortisation
EBIT
Operating
Non-

(Less) Interest (Finance Cost)

(Add) Non Operating Income
EBT
(Less) Income Tax Expense
PAT or Net Income

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 Blended learning

Balance Sheet (includes Assets, Liabilities and Equity)

Assets Liabilities and Equity

1. Property, Plant & Equipment 1. Share Capital
Long Term Risk
Long Term
2. Intangible Assets finances 2. Reserves
Capital
Capital
Non-operation
al
3. Investments Structure
3. Long term loan Borrowed
4. Prepaid expenses Short Term 4. Short term loan
capital

finances
5. Inventory (Stocks) 5. Accounts payable
6. Accounts Receivables 6. Advanced received
Short Term Operational
7. Cash & Bank obligations 7. Unearned revenue
8. Accrued expenses

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Let us see if you can apply…

• Current Liabilities
• Financing Liabilities
• Total Capital Employed
• Owners stake
• Reserve vs Capital

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Let us see if you can apply…

• Business Assets
• Total Assets
• Long term Business Assets
• Short term Business Assets

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Publically Available Databases

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Reading the Financial
Information
How to read Income Statement? (1/2)
FY17 FY18 FY19 FY17 FY18 FY19
Sales 2,000 4,800 8,000 Sales 100% 100% 100%
Cost of Production 1,240 2,832 4,800 Cost of Production 62% 59% 60%
Gross Profit 760 1,968 3,200 Gross Profit 38% 41% 40%
Marketing & Sales Expense 80 450 1,000 Marketing & Sales Expense 4% 9% 13%
Depreciation 100 400 660 Depreciation 5% 8% 8%
Operating Income 580 1,118 1,540 Operating Income 29% 23% 19%
Interest Cost 60 158 340 Interest Cost 3% 3% 4%
Profit Before Tax 520 960 1,200 Profit Before Tax 26% 20% 15%
Tax Expenses 156 288 360 Tax Expenses 8% 6% 5%
Final Profit 364 672 840 Final Profit 18% 14% 11%

• How has the company performed over a period of time?

• Which expenses have increased? All? None? How would you identify the areas of concerns?
• Since Profits have increased from Rs. 364 (Y1) to Rs. 840 (Y3), is it fair to praise management for a good job?

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How to read Income Statement? (2/2)

FY17 FY18 FY19

Sales 100% 100% 100%
Cost of Production 82% 89% 95%
Gross Profit 18% 11% 5%
Marketing & Sales Expense 4% 5% 4%
Depreciation 5% 5% 5%
Operating Income 9% 1% -4%
Interest Cost 3% 3% 4%
Non-Operating Income 20% 30% 40%
Profit Before Tax 26% 28% 32%
Tax Expenses 8% 8% 10%
Final Profit 18% 20% 22%

• Any sign / cause of concern?

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How to read Balance Sheet? (1/2)

Liabilities and Equity Amt. (Rs.) Assets Amt. (Rs.)

Shareholders’ Fund 100 Long Term Business Assets 50
Bank Loan 150 Short Term Business Assets 200
Total 250 Total 250
1. What kind of a firm does it look like – Trading or Manufacturing?
2. Any cause of concern from funding point of view?

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How to read Balance Sheet? (2/2)

Liabilities and Equity Amt. (Rs.) Assets Amt. (Rs.)

Shareholders’ Fund 200 Long Term Business Assets 275
Short Term Bank Loan 100 Short Term Business Assets 25
Total 300 Total 300
• Any cause of concern?

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How to read Cash Flow Statement? (1/3)

CFO -100
+ CFI -1,100
+ CFF +1,500
= Net change in cash +300
+ Beginning cash 50
= Ending cash +350

1. What kind of company does it look like?

2. Where is the money coming from?
3. If the same performance continue next year, when would the company have to raise next
round of funding?

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How to read Cash Flow Statement? (2/3)

CFO -1,100
+ CFI -100
+ CFF +1,500
= Net change in cash +300
+ Beginning cash 50
= Ending cash +350

1. Is this company expanding?

2. Is there anything alarming for the company to worry about?

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How to read Cash Flow Statement? (3/3)

CFO +1,000
+ CFI -100
+ CFF - 200
= Net change in cash +700
+ Beginning cash 450
= Ending cash +1,150

1. What kind of company does it look like? Is this company expanding?

2. Where is the money coming from?

3. If the same performance continue next year, when would the company have to raise next round of funding?

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Effect of Business Transactions on Financial Health of Businesses

1. Tesla Motors making a sale of $100 (COGS $80) on credit

2. Oyo making outstanding payment to hotel associates $900

3. Muthoot Finance taking a loan of $500

Profitability Solvency
4. Reliance raising equity $300 from Aramco

5. BHEL expanding and buying machinery $400 Liquidity

6. Mercedes shipping cars to dealerships on stock t/f $300

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Analyzing Business by Reading Financial Statements (1/4)

• A company is looking for a bigger warehouse to accommodate its inventory.

What could be the different reasons for a growing inventory? What
implications you expect to see on the forthcoming financial statements?

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Analyzing Business by Reading Financial Statements (2/4)

• Proportion of Credit Sales in the Total Sales has increased from 40% to 70%
over a period of 3 years. What could be the reason? How would you verify if
this increase is not bogus sales?

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Analyzing Business by Reading Financial Statements (3/4)

• The CEO is proud of a increasing the Supplier Payment Period, from 80 days
to 190 days, as a sign of market dominance. Is the CEO right? What could be
the implications and associated impact on financial statements?

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Analyzing Business by Reading Financial Statements (4/4)

• If a promoter tells you that her company is getting orders ‘beyond

expectations’ how would you verify the same?

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Sample case: Anandam Manufacturing

Manufacturing Firm
Small Size
Private Limted

Stakeholders Objective (Decision)

Lender Credit worthiness

Company needs a working capital loan for INR5 Cr.
Questions (1/2)
1. Do you think it is important for you to enquire about the industry and economy before
deciding?
2. The promoter tells you that the company is getting the orders beyond expectations.
What parameters should you focus on to verify his claim?
3. Is asset utilisation an issue for the company? Verify your opinion after checking both
kinds of business assets.
4. What is the trend in the collection period? What do you think may be the reason?
5. The CEO is looking for a bigger inventory warehouse. What do you read from the
inventory values?
6. The CEO is proud of a increasing the supplier payment period, as a sign of market
dominance. Critically argue the above hubris.

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Questions (2/2)
7. Is owners’ stake thinning over a period of time? What is the cause? What are the implications?
8. There has been a 63% increase in the gross profit in FY19 from FY18. CEO claims that his
leadership has led the company in good profits. Do you agree?
9. Which expenses are responsible for fall in the profitability?
10. Is the company facing any production cost over-run?
11. Is interest payment a challenge for the company?
12. Why do you think depreciation is increasing so much? How is this related to the working capital
problem?
13. After all, would you prefer to lend money to this company?

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