Hello, in the previous session of financial

statement analysis, we discussed about the different types of financial statements, like

balance sheet income statement, cash flow statement and their content.

We also discussed about where do get this financial statement information, like annual

report, websites etcetera, analysts reports, and we also talked about how to analyze the

financial figures provided by this financial statements, we started discussing about it,

in that we discussed about comparative statement, train analysis and common size statement.

In this session of financial statement analysis, we are going to discuss about analyzing the

financial statements with the help of financial ratios.

When you say financial ratios, we mean that there are as usual the ratio means, the relation

between numerator and denominator.

So, you have certain figures in numerator and certain

figures in denominator, and fine comparing those two figures, we find a ratio, and this

ratios can be found out for different companies the s c s can be found out for one company

for different years, and this ratios also on them, on their own, do not mean anything,

but when you compare this ratio with another company, relatively we can say which company

is better than the other one. Or if you are comparing this ratio of one company with,

you know, about one year with another year, then we compare, we find out whether this

particular company has done better than the previous year or the last year or it has done

worst then that.

So, ratio on its own may not convey much, but ratio when it is compared

with a previous figure or a, another company’s comparable, company figure, then it makes

a lot of sense. So, coming to the next, what are different

types of Financial Ratios, we have one the first category ratio is the Profitability;

Profitability ratio means the profit relation to certain things of the company another,

at basically two types of profitable ratio is, one is profit relation to the activity

of the business like revenue or income of the business how much profit has happened

compare to the income that has been generated by the company during a particular period.

Similarly, another profitable ratio that we have is their profit in relation to the investors

money, if the investors have given x Rupees throughout a in a particular period or on

a particular period, how much profit this company has earn on this particular investments.

So, those investors can find out, whether they have earned enough, what they have expected

or not.

So, there are two types of ratios, profitable ratios, one is the relation to

the income of the company, another relation to the investors money of the company.

Then we have the next one is efficiency ratio; efficiency ratio indicates how efficiently

the assets or the resources of the company have been used. So, better efficiency refer

to the better ratio will say better efficiency. So, we can say that, yes, this company has

used assets in a better way or not, so that is called an efficiency ratio.

Then we have the Liquidity ratio; Liquidity ratio talks about how liquid is the company

in a short run, and how solvent is the company, whether this company will be able to meet

the obligations, during a particular period of time or not, how comfortable the company

is in meeting the current obligations. So, this Liquidity is also known as short term

solvency ratio.

Then we have the solvency ratio, since you

have already covered the short term solvency in terms of Liquidity, this solvency ratio

talks about the Long Term Solvency over a long term, how comfortable with the company

in repaying the loan, and how much dare the company has taken relation to the equity of

the company, because high dare could be high risk for the company also; so, those things

are measured in terms of solvency ratio. Then we have some other ratio, where we talk

about the capital Market standing of the company. So, in this case, unlike the previous four

types of ratio, where we get the figures from the financial statement, like balance sheet

or income statement or something else, that is published by the company; in this ratio,

this type of measurement, that is capital Market standing, we talk about certain figures

from the financial statement of the company, also certain figures from the Market, like

capital Market for that matter.

For instance, there is a popular ratio called

price to Earnings per share p ratio, as such; in that case, Earnings per share figure is

found out with the help of information from the annual report or financial statement,

where as the Market price per share is found out from the Market asses; so, that is capital

Market standing. Then we go one by one different types of ratio

here, and discuss what are the implication in the profitable ratio that we have is the

first one is the profit margin. So, profit margin means, how much profit this company

has made in relation to sales of the company, where the income of the company as such, and

the profit are of different types as such, different type in the different stages of

profit, the first level of profit of the company could be gross profit to gross profit of the

company as such. So, gross profit means, actually whatever

the sales have taken place, and how much cost of goods sold is the relation to sales, that

difference actually gives us the gross profit.

So, gross profit can measured in different

ways, and the gross profit to sales ratio, it is always given in terms of percentage,

and that shows, yes, this much profit has been generated out of the sales, which will

take care of rest of the expenses, and the thing, that is not covered in cost of goods,

now will be covered out of gross profit. Then we have something called operating profit

to sales, gross profit might not have include certain expenses, but they are essential to

the business.

So, typically what happens in the gross profit,

when you say, it is sales minus cost of, cost of goods sold; this cost of goods sold COGS

does not include something called selling expenses. So, in that case, the operating

profit will take care of this gross profit less any other expense excluding interest.

So, that is operating profit; that means, having got the gross profit how much this

company has earn, So, that it can meet other expenses including selling and distribution

expenses then we deduct that we got the operating profit, and how much operating profit is there

relation to sales that is giving as a operating profit margin, and this operating profit margin

once you have higher, that means, the company has been able to do the business at a lower

cost of operation, if the operating margin has increased, that implies, that the operating

cost of the company has actually declined in relation to sales over a period of time.

Then we have the next figure that is called

net next ratio, that is called net profit to sales or net profit that is also known

as net profit margin. So, in net profit margin nothing but the profit after tax, after taking

care of all the expenses, operating expenses, any other non operating expenses and interest

expense, financial expense, and tax, whatever profit is leftover that is known as net profit,

and the net profit, we say is popularly known as net profit margin. At the end of the day,

all these ratios, that is profit margin should always be higher, higher is always better,

and that shows the company is able to comfortable comfortably meet the expenses, and still creates

some surplus for the investors Then we have the return on assets, return

on investment, which related to investment, in this we talk about what is the profit that

has been earned on the total investment of the company, see total investment is always

reflected as total assets of the company, and the numerator for this ratio is profit

before interest and tax or Earnings before interest and tax.

So, Earnings before interest

and tax, after total assets gives us the profit return on investment, and this particular

ratio should always be in any case higher. So, that the company can satisfy the investors,

yes, the investor can feel happy about it, that is the company has earned a lot of return

on the investment or adequate return on the investment, that they have made in the company. So, if we go back to our example, we have

got the profit before interest and tax for this particular company 68.48, which was actually

64 .27, it was earlier 46. 39 and this profit by interest and tax, which also can be known

as something, some other way then other also it said operating profit.

So, this total assets of the company of the of this company is 494.9, which is in 2008-09

and PBIT 68.46 as the ratio between these two is 13.84 percent, which was actually 13.6

6 percent in 2006-07 and 2007-08 it has gone up to 15.3, whereas, it has declined to 13.84

percent in the latest year.

So, one has to now find out, why this particular decline

has taken place from 15.93 percent to 13.84, because it could be, because of different

reason; that means, the profit might not have increased substantially compare to or this

sales of the see total assets of the company has gone up from 403 to 494.69 is a lot of

increase, where as the profit before interest and tax has gone of marginally. So, because

of that, we can, one can see there is a fall in the ratio, that is profit before return

on investment from 15.93 percent to 13.84 percent.

Another way of measuring this particular ratio is to find out the net profit to total assets,

in that case, we talk about the net profit of the company and the divide by total asset

of the company total assets and net profit is always there, then that ratio in this company

has gone down from 8.

97 percent 2006-07, 64 percent in 2008-09, this also could be

because of the company has made less profit or company has made more profit, by the profit

growth is not adequate to compensate for the growth in the total assets that has happened

during these two year period of time; so, this is one. Another way that is discussed as per the net

profit total assets, instead of taking the total assets of the latest year, that is closing

total assets, one can also look at the total average total assets on, when you say, average

total assets, average total assets nothing but total assets, what is there in the opening

and the beginning of the year, opening total assets which is nothing but the closing of

previous year.

So, closing total assets whatever is there divided by 2, that gives us the average

total assets, and instead of measuring the profit to ratio on closing total assets, we

do measure an average of these two, that is average total assets, what is the superiority

of this particular measure, instead of taking closing asset, why should we take average

total assets, that the company might have acquired the assets, in the, at the, it was

the end of the particular period; in that case, it is not, it is not right that we expect

the profit should be earn on those total assets, which has those assets which have been acquired

in the latest time of the period as such. So, to take care of that particular program,

instead of taking closing total assets, there is a better, that if we take the average total

assets of, that is average opening and closing and this way.

This company has return on total assets or

return on investment of, in the, when return is defined as per net profit, which has 10.78

percent, it has gone down to9.52 percent, one can see here, when he net profit as a

total assets is measured in terms of closing asset is 8.64 percent, whereas if it is measured

in terms of average total assets, this has come, gone up to 9.52 percent, possibly because

that is profit to total assets was profit, was more in the previous relation total assets

as such. So, this is one of the important ratios, that all the investors look at, and

next we go to the next type of ratio, that is your du point financial analysis. What happens, in this case we have got a combination

of profit margin and asset efficiency and in this what happens, we have the du point

chart is a very simple formula, what is very useful formula, useful analysis method, where

we talk about the profit to total assets, that is net profit to average total assets

is the return on investment, and which is nothing but if you expand further, it is nothing

but net profit to sales into sales by average total assets.

So, what is the beauty of this particular analysis is that, one is talking about here

net profit margin, and they talking about here the sales by average total of assets,

which is essential talk about the efficiency of utilization of assets, and this talks about

how profitable the operations are there; that means, the profitability multiplied the efficiency

talks about how much return has been earned as far as the investment is concerned.

So, the investment return cannot be on its

own, rather it will be based on the how profitably the operations have taken place at the same

time, how efficiently these particular assets have been utilized to generate something called

the revenue of the company. So, more this particular ratio, even if this particular

ratio remains constant, if this ratio is higher, then also this particular ROI can be higher;

similarly, if this ratio may remain constant, whereas the profitability of this activity

could be higher, that also can lead to higher return on investment, and if the, both the

things are taken care, it is higher over a period of time, then there is a double benefit

of on the return on investment. So, instead of saying return on investment

as a function of profit to total assets is actually the function of how profitably the

company has made the revenue, and also how efficiently the assets have been utilized,

that is with by du point analysis.

In fact, this particular analysis was used for the

first time by the du point that is the chemical company, and in that, after that this particular

analysis has been named by the du point itself is a very popular analysis; one can start

the financial analysis, in fact, with this particular ratio as such.

Then, we move on to the next type of ratio, that is your return on equity, when we talk

return on equity here, instead of talking about the investors as total, we talk about

only the, all the equity holders of the company.

So, investors can comprise of all the people,

that are equity holders as well as debt holders, but here you talk about the equity holders

only, and that is we find out the return on equity as a percentage of profit after tax

to net worth of the company. So, that talks about how much return that has been earned

by the on the equity holders money. So, if you, if we go back to our excel sheet,

we will find out that return on equity of this particular company, which was 16.91 percent,

which is based on profit after tax, that is the reported profit is 13.46 on equity of

the company, that is nothing but total share holders’ money, which total share holders’

funds is giving as one 80.14 in the 2006-07, and similarly is 2.257.9 2, two core is in

2008-09. And this is the denominator, whereas it reported

profit of the company is 42.74, that is 42.74 divided by 257.9 2. So, 42.74 divided by 257.9

into 100 has got return on equity of this particular company for this particular year,

that is, 2008-09 which is nothing but 716.57 percent.

So, 16.57 percent return on equity which has

actually 18.27 percent in 2007-08 which has gone down to 2000 in 2008-09, it has gone

down to 16.57 percent, which is obviously not a good sign that return on equity of this

particular company has actually declined, but it could be, because of, that is company

might have gone more equity or it could be because of the profit itself has not gone

up substantially lesson to what the equity has actually moved up. This ratio also can be found out with the

help of average equity, when you say average equity, we talk about the opening equity plus

closing equity divide by 2, as we discuss in the average total assets, this average

of the equity of beginning and ending or average of ending, ending equity of last year and

ending equity of this year.

In that way, this ratio is actually 17.92

percent which was actually 20.06 percent in the previous year there. In this ratio also

there is a decline, which is not a good sign for any company as such the company return

equity has declined. It is return on equity declines over a period of time continuously,

there is a warning signal as such, and the possibly the investors will withdraw investing

from this particular company, they may sell the shares in the Market, and the share price

of the company can slowly come down. So, the company has to be very careful, that under

what any circumstance the return on investment returns on equity all those things should

not actually come down. Then we have the next ratio, that is your

Earnings per share, Earnings per share is the how many, how much profit has been earned

on a per share basis, if the company has got let us say 10 core shares, and the company

has made a profit of 30 core; so, 30 by 200 that 30 core Rupees by 10 core number of share

that gives you Rupees3 per share.

So, per shares Rupees 3 has been earned in

a particular company. So, higher this particular Earnings per share is always better, and any

company which is increasing return on equity is quite likely, that Earnings per share of

this particular company might have gone up. So, if we look at our example of nacho Parma,

we have got a number of shares, in this case as 2.804 core, and the Earnings per share

which is nothing but the profit after tax, that is 42.74, in case of the latest year,

that is 42.74, and divide by number of share is 2.804, so Earnings per share this particular

company is 15.24 in the latest year, which has actually gone up from 11.02 in the 2006-07,

it has gone up to 14.28, now it has moved up to 15.24, in the Earnings per share performance

the company is actually done well.

And then we have the next ratio, that is the

dividend per share, that is nothing but the dividends declared by a particular company,

during a particular year divide by again number of shares in for some investors, like senior

citizens, who earn their bread and butter from this investment in the Market, because

they put money in the Market or they put money when the company is comes with the first initial

public offering. So, they buy these shares with the expectation

that they are going to get some regular return in terms of dividend for the company. So,

for such type of people, the dividend per share makes a lot of sense. So, they will

always go for those companies which pays a high dividend per share, there will be certain

companies; we will find they pay very high dividend per share, there will be some company,

which may pay very less dividend per share, but the company may believe, that instead

of declaring dividend, the dividend can be plowed, this profit can be plowed back into

the business, and that they can earn a high rate of return on equity, and that should

reflect with that, that is reflect in a higher Market price of the particular share of the

company.

So, in any case, so, dividend per share is

found out with the help of this ratio, that dividend declared by divide by number of shares,

and in the our case, we have got this dividend per share of almost same which is 1.23 Rupees

per share which has gone down to 1.2 has become now 1.25 or 1 Rupees 25 paisa per share has

been declared as dividend to the share holders of this particular company.

So, this is one more ratio which is actually relevant for those people, who will like to

earn a bread and butter from this investment, as such and they look at the dividend as a

regular source of income to meet their a regular expenses as such.

Then we move on to the next category of ratio,

that is the Efficiency Ratio of the company. So, when you say Efficiency Ratio of the company,

we talk about the efficiency in asset utilization, we talk about efficiency in terms of the relationship

between the sales and the assets, and in this we have different classification, that is

we have this efficiency, that is total assets turnover Fixed asset turnover, current asset

turnover, and this ratios are actually known as turnover ratios, otherwise known as turnover

ratios, efficiency ratios are otherwise known as turnover ratio. The turnover means, how

many cycles have actually been made with the utilizing this particular assets.

So, if the turnover ratio is 2, that means, the two cycles has been made utilized these

particular assets.

So, if the total asset is 10 crore, and the revenue of the company

is let us saying 20 crores. So, total assets turnover ratio becomes 20 by 10, that is 2

times the turnover has also higher, this particular ratio is always better.

So, any Efficiency Ratio should always be higher. So, total asset turnover ratio, if

it is going up; that means, the overall the total assets have been utilized very high.

So, we have total assets, we have fixed assets total turnover ratio, then we have current

assets turnover ratio in inventory turnover ratio. So, as far as these ratios are concerned,

we talk about the asset utilization efficiency. Then we have the next ratio is called the

current inventory turnover ratio; in inventory turnover ratio what happens, we find out the

inventory turnover ratio which is known as ITR by having this cost of goods sold divided

by average inventory, and when we say average inventory, we mean that average of opening

stock and closing stock.

If for any reason, closing stock opening stock

figures are not there, then closing stock can be taken as the average inventory. So,

this talks about how efficiently this inventory has been utilized to generate sales, in terms

of cost of goods sold; so, whatever that value comes x or y, whatever that may be, we will

always expect this particular value to be going up over a period of time.

So, higher the ratio is actually better, and from this inventory turnover ratio, one can

also find out something called inventory conversion period, which is nothing but

the 365, that is the average, that is the number of working days, in a number of days

in a year divided by inventory turnover ratio; so, if ITR of any company is let us say 6,

and then, in that case, the inventory turnover ratio if is 6, then the inventory conversion

period will be 365 by 6, which is around 61 days.

That means, what is the implication this is that, if this say, if the inventories acquired,

and certain day, it takes 61days for the company to convert into sales.

So, in this case, you

can interpret, if this particular value is the 61 days is less, then it is always better;

instead of 61, this 61 days has become less, and subsequently this is 50; that means, on

an average, the inventories held only for 50 days to convert which was actually 61.

So, the company will should always like to reduce this inventory conversion period from

for as many days to as less as possible, and this particular thing 61 days, which were

talking about, if this particular 61 days can come down, it can come down over a period

of time, if this inventory turnover ratio actually goes up.

So, in that case, if the inventory turnover

ratio has to go up, then this average inventory has to actually come down. So, inventory held

during a particular period has to come down, then this ITR goes over; the moment ITR goes

up, then the inventory conversion period actually falls, which should be a good sign of for

any company. And companies which go for something like

just in time approach inventory; in that case, the inventory is likely to be 0 or almost

0, and the inventory becomes almost 0, then ITR becomes very high, and this ITR becomes

very high, then inventory conversion period also become as less as possible; in those

cases, actually the Austin time concept, the inventory turnover ratio may not main mean

anything, because in any case the company has no intension of holding an inventory to

convert it into sales.

Then we have the next ratio called Receivables

turnover ratio, Receivables arise as per the companies are concerned, receivers arise because

of credit sales of the company. So, it is quite natural, that the companies make sales

on credit basis, and it is also possible that the company may give a period of let 30 days

credit period, and companies may end up getting the back money, after 30 days or within 30

days or less than 30days or may be possibly after 30 days for that matter.

So, for to know how much money is due, and what the liquid condition of the particular

company is, when are you going to get back the money as such, we got something like Receivables

turnover ratio; in Receivables turnover ratio, we define by credit sales divided by average

debtors. So, this is our receivable turnover ratio

or otherwise known as debtors, and DTR that is known as debtor’s turnover ratio. So,

when has to look at here, it is taken as credit sales, and if for any reason, if the credit

sales figures are not available, we presume that all the sales are happening one credit.

So, all the sales can be taken as a credit sales as such.

So, credit sales divide average debtors, average debtors as we have discussed earlier, any

average figure is nothing but average of opening and closing figure.

So, this ratio should

always be again, if this is a y, in that case, this ratio should be always as high as possible.

So, higher the ratio means, that means, you are having less money due from the customers,

who are have taken the goods or who have purchase the goods and credit from this debtors turnover

ratio, one can also go to find out something called average collection period; average

collection period is nothing but how many days on an average it takes for the company

to get back the money from the debtors or from Receivables, how many days, it takes

to realize the Receivables into cash. So, if the average debtor turnover ratio,

for example, is let says 5, and the land in that case, average collection period will

be number of days, in a particular year divided by 5. So, that comes to 63 days, that means,

if 5 is the receivable turnover ratio for this company, it has taken 63 days to collect

the money from their Receivables.

Now, these 63 days can be compared with such

figures of different companies of in this particular sector. So, you can see here, whether

this company is taking more days to collect the Receivables or this company is taking

less days to collect the Receivables compare to the companies, in other company in particular

sector. So, lower this particular value is always

good and this can be lower, only if the debtor turnover ratio is higher or the debtor turnover

ratio can be higher, only the average debtor is actually lower.

So, this can be achieved with the help of giving some incentive to the debtors, that

you please pay within time or if you pay within this many days, we will give certain discounts

to you.

So, in that case, it can be achieved, so, that the money kept with the debtors is

as far as many days is less as far as, that is concerned, and then obviously, with the

number of days is reduced 63 days has gone down to let us say 61, like 60, that it is

also, obviously the good sign for the company, because the money left with them is for a

shorter period of time, but then what happens, whatever money is due, if that money comes

to the company; that means, they are actually converting the Receivables which is also obviously

known as liquid assets, but is converted into Cash is more liquid assets.

So, higher the

data turnover ratio, that means, lower the invent, lower the average collection period

talks about a better Liquidity management of this particular company.

And we will always like that the company are managed as per Liquidity frontier is concerned

and Liquidity front they should manage very well. So, that money should not be kept idle

or money should not be with the debtors, rather it should be with the company.

So, a company

has to get back the money as quickly as possible. Next we category ratio, that we will move

on is the Liquidity in terms of different other method Liquidity or short term solvency.

In this we have very popular ratio known as Current Ratio; the Current Ratio is nothing

but the ratio of current assets to current liabilities. As we have discussed in the previous

session of finance statement analysis, current assets are those assets, which can be converted

into cash, within a short period of time, and current liabilities are those liabilities,

which has to be honored within a very short period of time or typically one year.

So, in the Current Ratio, one has to find the ratio between current assets and current

liability. So, in this case, the current asset in the numerator, and the current liabilities

in the denominator, if the current asset of the particular company is let us said 30,

a current liability of the company is let say a 15 crore. So, Current Ratio becomes

2 is to 1, this ratio is always measured in terms of a something is to 1.

That means, for in this, if the Current Ratio is 2, in that case we say for every 1 Rupees,

the current liability the company has got 2 Rupees of current assets.

So, in that case,

the company can meet all the current liabilities out of the current asset still 1 Rupees of

it 2 is to 1 Current Ratio have been met 1 rupee as the current liability, the company

can now have 1 Rupees to take care of the expenses, that is going to happen over a period

of time. So, higher this particular Current Ratio is obviously better for the company

that the company is liquid, but very high Current Ratio indicates that the piling of

the current assets; actually, current assets on their own does not yield anything, the

current asset have to be cycled over a period of time, the current assets like inventories

should be converted into sales, that is Receivables; in a Receivables has to be collect back in

terms of cash, and cash has to be there; so, that we can again process the inventory.

So, that has to be there, if any part of this particular current asset, in the current asset

cycle, it is piling up that shows that the money is idle, and money is always finance

base certain financers, where we are paying some interests or they are expecting some

rate of return, in that case, actually we will be losing money, because the investment

is piling up which is also not; that means, excess Current Ratio is obviously not good.

So, what is excess or low or something like that one can compare, this Current Ratio of

this particular company with the average Current Ratio of the companies in this particular

sector.

So, next ratio that we have is the Quick Ratio,

and as far the Quick Ratio is concerned, see in the Current Ratio, there could be some

current assets which cannot be converted into cash as quickly as possible. Current assets

typically consist of inventory that consist of inventory, that is if goods meant for sale

or goods meant for conversion, then we have another Current Ratio asset called Receivables,

then we have got cash and cash equivalents. So, if this, and there could be other current

assets. So, if you look at this inventory Receivables, and cash and cash equivalent,

obviously, this particular current asset called cash and cash equivalent is already liquid,

and whenever if somebody needs the money it can be paid out of this they Receivables are

little more liquid compare to inventory, and inventory the least liquid among the current

assets. So, the company having one company, if the

company, let us say we have company a as well as company b, which has got total current

assets of 200, whereas this company has 100 Rupees in terms of inventory, 50 in terms

of Receivables, 40 in terms of cash, and 10 in terms of other current assets, whereas

this company has got 70 in terms of inventory, 60 in terms of Receivables, then 50 in terms

of cash, and 20 in terms of other current assets.

See if we look at this, though both the companies has got 200 and 200 as current assets and

presuming, that this current liabilities of the company, both the companies are 100 as

well as 100.

So, the Current Ratio is obviously 2 is to

2 for company a, as well as 2 is to 1 for company b, but if you look at compare these

two companies, we have here in this company 100 Rupees in terms of inventory, which is

not going to be easily convert in to cash, like any other current asset, here it is 70

also, the same that it can be converted easily, but in this case, inventory amount is quite

higher for compare to company b, and other assets non inventory current asset is higher;

in this case, non inventory current asset is lower in this case.

So, since the inventory is not that liquid, so what happens in this case, we go for something

called Quick Ratio; in Quick Ratio, we talk about the quick assets to current liabilities,

and the quick assets is defined as current assets except the inventories.

So, in this

case, in this, in our example, we have at the quick assets that is q a for company a

and company b; if you look at that is 200 minus 100, that is 100 for company a, and

200 minus 70 that is 130, and the current liability for both the companies are 100,

in that case, the Quick Ratio appears to be one is to one and 1.3 is to 1.

So, Quick Ratio is supposed to be a more stringent measure of Liquidity, unlike the Current Ratio,

and if you look at the Current Ratio, in this case, say in this case we have both the companies

has same that is 2 is to 1, 2 is to 1 Current Ratio, whereas in Quick Ratio, we have got

1.3 is to 1 as the Current Ratio, for company b compare to 1 is to 1 for the company a.

So, company b is actually overall liquid manage in better than company a, because it has got

a better Quick Ratio. So, that is the implication of having a Quick Ratio as such.

Then in the Liquidity short term solvency is also, we do talk about inventory conversion

period and average collection period, as we have discussed in the previous slide, we talk

about efficiency ratio, we talked about inventory conversion and average collection period.

So, inventory conversion talks about how well, how quickly this particular inventory purchase

is procured is converted into cash, that is inventory gets into sales then sales; that

means, credit sales then credit sales may Receivables the Receivables gets converted

into cash.

So, how much time it takes actually for converting the inventory that is from

inventory sales level is known as the inventory collection conversion period, from these sales

Credit sales to collection of the cash that is called average collection period.

So, these two components are major components of something known as working capital cycle,

working capital cycle is something you one purchases inventory, then it go and comes

back in terms of cash by realizing from the Receivables, that full cycle is known as working

capital cycle and out of that inventory conversion period and average collection period are actually

major components. So, these two ratios as we have discussed

earlier, these two ratio also should ideally be as low as possible. So, that is the known

as these are the things that we talked about Liquidity or short term solvency.

Now, we talk about something called Long Term Solvency; the Long Term Solvency we talk about

over a long period of time, how comfortable with the company in repaying the debt or debt

obligations for that matter.

So, the fast ratio that we have in this case

is debt to equity ratio. So, debt to equity ratio talks about something like leverage

of the company; that means, a company having all the finances from equity is known as unlevered

company or 0 Leveraged company, and why it is called leverage is that, by having the

debt in the capital structure of the company, the Earnings for the equity holders can be

maximized. So, that actually that is why with the same

profit level, but one company with in debt as a component to capital structure can earn

a better return on equity than a company having no debt or less debt in the capital structure

that is why, that means, leveraging the position with the help of debt, that is why there as

known as leverage ratio. So, use of leverage will lead to the, if the

company has no debt also, then which we do not talk about anything like Long Term Solvency

debt to equity ratio or any other ratio for that matter.

So, debt to equity on this case

equity is defined as the network of the particular company, instead of saying only the paid of

capital, we talk about paid of capital plus any reserves and surplus that the company

has got. So, debt equity ratio is measured by debt to equity as such.

Then we have the next one is called liabilities to equity ratio; in this case, we do not distinguish

between long term debt or short term, all the liabilities except the equity is captured

in the numerator, and as accordingly it is found out, and there is no rule that debt

equity ratio is should be high, because it gives the leverage, rather high debt equity

ratio can lead to high risk in the company, we have discussed in the risk and return that

we talk about the financial leverage risk as such.

The company which has got more debt to equity ratio is absolutely more risky than company

which has got the less debt equity ratio. At the same time, 0 debt equity ratio is also

not advisable the company has ability to raise the debt; it can as we will go for.

So, that

because of leverage the return on equity can be magnified. So, to take care of that particular

problem, one can as well go for a moderate level of debt, but high debt equity ratio

is not advisable for any company. So, if you look at our example, we have got

the debt equity ratio of this particular company the debt network which was 0.424 in the 2006-07,

it has become 0.490 in latest year. The interpretation of this 0.49 figure is that, for every 1 Rupees

equity of this company, the company has got around 50 paisa or 49 paisa of debt, that

means, a total is 1.50 total of debt, and equity this company has got 1 Rupees as equity,

and 49 paisa as debt, certain bankers will look at the equity level of this particular

company, before they actually lend.

If a banker has a policy that it can give

a loan to the extent of 2 is to 1 debt equity ratio, and if the company has got 100 Rupees

as 100 crore Rupees as equity; obviously, this company should be having Rupees 2 crore

as debt that is the limit the bank can tolerate. If another company has got100, same Rupees

100 core as equity, and it has got, let us say 60 core as debt, in that case 6 is to

10, 602 or 6 to 6 is to 10 or 0. 6 is to 1 is the debt equity ratio, in this case looking

at this particular value, if the banker can feel happy to the extent of giving 2 is to1

to the debt to the extent of maintaining debt which is 2 is to 1; that means, if it is 2

is to 1.4 is to 1 debt equity ratio can still be taken care with the additional debt.

So, 1.4 is to 1, this is becomes 2 is to 1, that means, the company can go to the extent

of 1.4 times of equity that is 100, another 140 core Rupees of debt can be taken by this

company comfortably, because this banker themselves believe for this company 2 is to 1 debt equity

ratio is ideal, and in that case, the company can go for another 100 and 40 core Rupees

of debt.

So, lower debt equity ratio gives the, provides an ability to the company to

go for a higher debt, whenever it is actually required. So, in any case as we have discussed debt

equity ratio should not be very high, it should be moderately there. So, that and also the

company which will like to preserve the borrowing power. So that, they will have initially the

very lower equity ratio, whenever they need money, they can go for a higher debt, and

then the debt equity ratio actually can go up.

Next we have is the total debt to total capital, in this case, nothing it is same thing as

debt equity ratio, but here instead of saying debt to equity, we said debt to total capital.

That means, if you look at this particular

example, where 100 Rupees, 100 is equity 2 is debt, so, we say 200 by100, that is 2 is

to 1 is the debt equity ratio, whereas as per debt to total capital is concerned, we

say it is 200 debt divided by equity plus debt that is 100 plus 200, that becomes 200

by 300, and that is nothing, but 0. 67, that means, approximately 67 percent of total finance

of this company is raised through debt. So, this is, in as per debt equity ratio is

concerned, this ratio can vary from any figure to any figure, from 0 to anything, whereas

in this case, the figure can vary from 0 to maximum100 percent. So, interpretation wise,

this figure becomes little better than the debt equity ratio, otherwise the implication

of both the ratio is one and same.

Then the other category of financial ratio,

that we have the leverage or Long Term Solvency ratio we have, instead of taking the debt

as total debt, one can talk about something like long term debt to total capital.

So, when you say long term debt to total capital, we do not talk about short term debt, only

long term debt, because capital is supposed to be long term. So, finance, so, total capital

is any way, again total debt plus debt plus equity, and in that, we take only long term

debt to total capital, this is the another variation of ratio.

And next another important

ratio, that we have is called the interest coverage ratio; in the interest coverage ratio,

we talk about is, what is we say Earnings before interest and tax divided by interest. So, what happens in this case, if Earnings

before interest and tax of particular company is Rupees 60 core for one company, for another

company, company a is Rupees 61, and for company b is Rupees, let us say also 60 crore, both

the company has got same Earnings before interest and tax, but because of degree of leverage

or interest rate whatever reason, interest amount as a total debt raised, whatever reason

for that may be, interest amount for this particular company is, let us say 12, and

for this company the interest amount is actually 10 crore. So, Rupees 10 core, Rupees 12 core,

so the interest coverage ratio which is EBIT by interest is nothing but 60 by 12, that

is 5 times in case of a company a, and 60 by 10, that is 6 times in case of a company

b. Now, one can obviously feel here, that the

company has this company b has earned 6 times of interest as far as EBIT is concerned.

So,

the company has earned 5 times of interest as far the company a is concerned. That means,

for every 1 rupee of interest required 1 Rupees as interest, the company has an Rupees 5,

and this case the company have Rupees 6, what happens in this case, after meeting the interest

expense of 1 rupee in this case Rupees 4 is left, in this case Rupees 5 is left. This

Rupees 4 or Rupees 5 as the case may be, will be now taking care of the tax, and then we

find profit after tax, then we find how much dividend is there.

So, higher the interest coverage ratio is obviously good for the company; this talks

about how well the company can meet the interest obligation of the company, very low interest

coverage ratio is not advisable for any company. In fact, a lower interest coverage ratio will

lead to no lending by any company for further requirement as such the lenders, obviously

lend lot of importance on this type of company, which has got a high interest of ratio, they

will be very much willing to lend to this company.

So, a company which is not able to

earn enough money to take care of its Fixed obligations, like the interest one of the,

one of the permanent, one of the compulsory obligation, because interest something which

is mandatory, which has to be paid by the company come, what may, whether company makes

profit or company makes loss the interest has to be paid.

If the company is not able to comfortable pay, the interest and not earns that much

money to take care of interest, where interest coverage ratio is very low; obviously, this

company cannot be that much attractive for any other investor.

So, investor equity investors,

though they are not bother about interest, as such they may still look at this ratio,

because only if the interest is taken care any profit left over that belongs to equity

holder. So, high interest coverage ratio can also give a some sort of comfort level, even

for the equity levels besides lenders, who will always look for this particular ratio. Then we have the next one is called Fixed

charges coverage ratio; in this we talk about the Earnings before interest and tax plus

any other thing, which is Fixed for the company to be taken care. For instance the other fixed charges for the

company could be, all fixed charges could be the one is the interest which has to be

taken care then the company has got something like a preference dividend that also has to

be paid by this company, then any loan repayment portion that also has to be taken care.

So, instead of taking only interest as in the denominator, one can take for the, in

this we have Earnings for before interest and tax as the numerator at the end of the

day, the company has to earn as much operating surplus to take care of interest, to take

care of tax, and then to take care of preference dividend also take care of loan repayment,

though the loan repayment is not a part of income statement, but still the surplus created

by this company should take care of all the obligations of company towards the outsiders

including government because of tax of interest tax preference dividend, who has to prevents

or who has to which has to be paid to the preference share holders, and any loan repayment

that is scheduled for that day has to be taken care.

So, what happen in this case, EBIT in the numerator, interest is in the denominator

plus preference dividend, and the loan repayment portion, whatever is there, that is to be

there, but that has to adjusted for 1 minus tax, because interest something where you

have got the tax effect, because your tax really because you claim interest, whereas

in 1 minus t it is more divided, because you do not get anything any tax benefit, by claiming

preference dividend or by claiming loan repayment.

So, to take care of that to tax effect, it

divide 1 minus t and at the end of the day the Fixed average, Fixed average coverage

ratio should always be as high as possible, that talks about that yes, the company is

going to meet the Fixed obligations as comfortable as possible. So, all the investors will always

like to see that the fixed assets cover ratio is very high. So, higher the fixed assets

cover ratio better preferred by investors across the world as such. Then we go to the next ratio, that is our

capital Market standing as we discussed; in this ratio, we talk about what are the, how

this particular Market, particular company stands in the capital Market the first ratio,

that we have in this case is the price Earnings ratio, where we talk about the Market price

per share to Earnings per share. So, in this case what happens we find the

Market price for this particular share, we find from the capital Market, and instead

of taking Market price per share on a particular day, one can take the average Market price

during a particular period and divided by Earnings per share of the particular company.

Then if you look at our example, we have Earnings

per share of this company as 15.24 and the 30 days average Market price prior to march

31 is 89.4. So, the 89.4 divided by 15.24 gives us a price Earnings multiple of 5.8

7, and this price Earnings ratio of this company is 11.7 5 2006-07, which has gone down to

9.89, it is going to 5. 87, though the Earning in this is because of 2 things, one is that

Earnings per share itself has gone up, second one is that the Market price of the share

has gone down from 129.4 5 to 89.4, suppose because of decrease in the numerator value,

and increase in the denominator value, that is Earnings per share, this price Earnings

ratio actually has come down. Now, this price Earnings ratio to mean, if

the price Earnings ratio of this particular company is taken as let us say as in this

particular case is 5.87 is the price Earnings ratio of this company in 2089, what does it

mean, that if this company is going to earn same amount of Earnings per share, that is

Earning in 2089, it will take 5.87 years for the company to cover all the price in terms

of Earnings as such.

So, in this case, lower the p ratio is always

in good sign, in a way that the company shares can be actually bought. So, how to know lower

or higher that will be certain benchmark price Earnings ratio, benchmark price Earnings ratio

can be defined as median p ratio of different companies as such.

If the median p ratio of the particular company, a particular group or particular sector is

let us say 10, and we let us say this price Earnings ratio of this target company is less

than 10 in that case, obviously, it says that we can go for buying this particular, because

that shows this particular company is undervalued compare to the peer group or compare to the

Market as such, but if the p ratio average or median p ratio of the industry group is

10, whereas the p ratio particular company, that we are evaluating is, let us say 12,

that means, 12 is more than 10, that means, this company is actually over value.

So, in

that case, that is the sign that company can go the investor can actually sale the shares,

because it is overvalued and or not go for any more acquisition in this particular sector

p ratio is relative evaluation measure, where we can say relative to the Market by the industry,

whether this particular share is overvalued or undervalued. Then we go to the next one, that is our next

ratio is called the enterprise value to EBITA, in this case, what you say instead of taking

the value of only the equity in the numerator, we take the value of the entire company, that

we talk about the value Market value of equity as well as Market value obtained divided by

Earnings before interest depreciation tax and amortization. And in that case, what you

will say, in this case, this is also popularly known as EBITA multiple, EBITA multiple, and

this particular thing is taking care of the leverage effect is neutralized, the asset

structure is also the, because the asset structure instead of Fixed asset structure depreciation

is also neutralized. So, this makes a more comparable across the

company in the different particular sector of the new company or the old company, it

can be compared with the entire value EBITA, and again higher or lower, it can be multiply

compare to the average multiple, and accordingly one can say is overvalued or undervalued.

Then we have got next category of the ratio is the dividend yield, and then we have got

price-to-book ratio; so, dividend is nothing but the dividend per share to Market price

per share.

So, if the dividend is 2 Rupees Market price is let us saying 10 Rupees, So,

2 by 10 comes to 20 percent of the dividend yield.

And then we have got the price-to-book ratio, where we talk about the book value of the

share is defined as the net worth divided by number of share, the Market price per share

is 50, and the book value per share is let us say 40. So, price-to-book ratio is known as now 50

to 40, that is 1.25. So, again, in this can be the benchmark comparable ratio is, let

us say for the industry is 1.20, if this company is 1.25, obviously, this company is overvalue

than the industry, and we will, if I have already invested in this company, then we

will like to sale this shares of the company or if I am not invested not like to go for,

but if you find a company, which has got if p by v ratio is our benchmark and the average

p by ratio of the industry 1.20, if you come across a company was a p by ratio is 1.15,

then that case we will always like to go for a buy decision for this particular share.

So, these are the different tools of financial statement analysis, this is, this is not an

exertive list, rather can be n number of ratios, that can be found out with the help of information

from capital Market, as well as from the statements published by the company in terms of the balance

sheet income statement all; so, this is the end of the financial statement analysis unit.

Thank you.