Financial Statement Analysis Jan

8/3/2019 Financial Statement Analysis Jan

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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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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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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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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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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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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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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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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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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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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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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

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Financial Statement Analysis Jan