Mod-01 Lec-09 Financial Statement Analysis

Hello, in this unit of security analysis and
portfolio management we are going to discuss financial statements and their analysis; financial
statements mean, the reports that are published by different companies at the end of a particular
accounting period; why do we need this financial statement? It is because when the investors
have invested lot of money in the company they like to know about the performance of
the company at the end of the particular period; having kept that in mind and also taking into
consideration different other stake holders interest like government, suppliers, creditors,
banks and all, the companies report their financial performance at certain points of
time.

In this particular session we are going to
discuss about what the financial statements are and what is their typical content, why
we should go for financial statement analysis, why it is the purpose and what are the tools
that we can use for financial statement analysis. As we discussed financial statements are supposed
to provide information that bridge the gap between the company and the investors in terms
of what the company is doing so that the investors come to know at certain period of time. In this, coming to the first one regarding
what the financial statements that we have are – financial statements we have…one of
the major statements is called the balance sheet, then we have another called income
statement and then we have got a cash flow statement. Balance sheet, income statement
and cash flow statement – they are published regularly; if it is annual accounting year
then at the end of the particular year we will find these three reports getting published.
What happens is that at the end of the year – after the accounts are audited – the company
comes with the financial results and also comes with something documental – annual report;
annual report will have these things and at the same time if the company is also listed
in the stock exchange, as per Indian law, the companies are supposed to disclose their
financial status every quarter – they will be disclosing the summary balance sheet or
summary income statement at the end of every quarter.

They will disclose to stock exchange
and also they will publish the same thing in the leading news papers – financial news
papers and other news papers; through that the investors can come to know about it.
Coming to the major aspect of balance sheet – balance sheet is essentially a statement
of financial position; it says what the company has at a particular point of time, it is also
a statement of assets and liabilities; assets are what the business owns and only with those
things can the business prosper, can generate revenue. So, assets indicate what the company
has, how well it can do, what revenue it can generate, what the source of revenue and all
those things can be known. That means, how efficiently an asset can be
utilized, whether these assets are relevant assets are not; investors can come to know
from these financial statements called balance sheets – these assets.

Liabilities are something,
which the business owes to non-owners; then, we have something called equities – it is
what the business owes to the owners. In fact, whatever the business owes to the
owners or outsiders, it is broadly known as liability – it is liability of the business
to the outsiders assess; broadly outsiders can include the owners, but in a very management
point of view the owners are the insiders of the company and they have invested in the
company they also expect something from the company – to that extent the business is liable
to the owners.

Broadly owners’ stake is a liability for
the company, but they are insiders of the company because they own the company assets;
otherwise whatever they owe to the banks, suppliers – because they have taken certain
credit – banks, because they have taken a loan or other investors like debenture holders,
bond holders from whom they have borrowed money they come under liabilities of the business.
Then, we have another major statement, which talks about the periodic financial performance
– how this company did, that is called income statement; income statement essentially gives
a summary of revenues and expenses; revenue from the main line of activity, revenue from
other sources of income; like, the company might have invested some thing in securities
and other investments in some other companies; from that the company might have got some
interest or dividends; that also comes as one of the sources of revenue and then something
called expenses also is there. Revenues and expenses are the major part of
income statement and expenses will be given a broad classification like manufacturing
expenses, other operating expenses, financial expense like interest, then tax provision
and subsequently after the tax is paid by the company then one has the profit after
tax and how the profit is distributed; all these things are given in the income statement.
Another major statement that we have is, called cash flow statement; it talks about where
the cash has come from and where the cash has gone; this cash flow statement classifies
the cash flows in three ways: one is operating, another investing and next is financing.

We will be discussing about these typical
statements one by one in detail; coming to the balance sheet which give the assets, the
assets are actually classified on different heads and the first asset is called the fixed
asset, then we have got investments; fixed, then we have got current assets, then we have
got intangible assets; when we talk about fixed assets, fixed assets means the company
owns this particular asset or holds on to the asset for a long period of time. It is
not necessary that asset should be fixed with the land or something like that rather the
company has the intention of holding this asset for a long period of time for a particular
purpose. One simple example could be the plant and
machine for a manufacturing company or building for a manufacturing company or any company
for that matter – that becomes a fixed asset, because this plant and machine could operate
for long period of time and generate goods which can be sold over a period of time.
That is why plant and machinery is called a fixed asset, but these same plant and machineries
which are sold by an outlet is like a trading concern – it is not a fixed asset, it is like
a short term asset because they are not be held for a long period of time.
Next, in the assets category is investment; investment means the investments made by the
company in group companies or some other company or subsidiary companies, where the intention
of the investment is for a long term; the company does not make short term investments
rather it has made the investment for a long period of time – like a strategic control
– they have another company.

If they have made some investment equity of
the company, they are stake holders of a particular company – may be inside the country or outside
country – or a certain joint venture they have participated in – some ownership, in
that case investments where they are supposed to get certain income in terms of may be dividend
or interest from that company where they have invested their money.
The next thing that we have is called the current assets; current assets typically mean
the assets which can be converted into liquid cash over a short period of time – typically
it is one year; whatever asset that they have – the company has – that can be converted
to into cash or the company has intention to convert it in to cash in a short period
of time – that is called current assets; current assets have got different types of assets
– the first type of asset is cash and cash equivalents.
Whatever cash there is with the company or whatever is with the bank by the company that
is called cash; cash equivalent is – the company might have put some short term deposits with
the intention that instead of keeping the money idle they can earn some small amount
of interest on that; they may have put the money in some short investments, but the idea
is to get back the money whenever we need; in that case, they will sell the investments
and get the cash.

Then we have the receivables; receivables
mean…where we have got the…companies made some credit sales and after the credit sales
whatever amount is not collected they are known as receivables or daters; that is also
supposed to be collected back within a short period of time, that is why it is called as
current assets. We also have one more aspect – marketable
securities, which are also like cash equivalent where the company has invested in treasure
bill or some certificate deposit or commercial paper and this money can come whenever the
company needs; the temporary investments can be sold and cash can be generated to meet
the regular requirement. The next category of current asset is the
inventory; inventory means that which is kept for production or for sales; inventory can
be like raw material of the company, it can be the working process of the company, it
can be the finished goods of the company, it can also be spare parts of the company;
but, the inventory is supposed to be converted into finished goods and sold.

If the company
is a trading concern typically their inventory will be the finished goods, which they have
procured from suppliers and they are going to sell them.
Like some retail outlets or some shopping malls where they hold so many types of stock
for the customers – those things are called the inventory; they do not produce them rather
they procure from different suppliers and sell them, but they are categorized as inventory
and they are supposed to be sold in a very short period of time that is why it is called
a current asset.

The next that we have is loans and advances;
loans and advances is short term loans or short term advances given to the group companies
or employees have been given some advances which they are going to pay back within a
very short period of time, that is called the loan advances and this is also known as
a current asset. Then, we have what other current assets which
is not covered under this earlier category – like, some company might have paid some
expense in advance that is called pre paid expenses; that is also called a current asset,
because having paid the expense earlier we are going to get the benefit of that expense
within a very short period of time that is why it is called pre paid expense.
Any other current asset is also part of this particular group; essentially, this current
asset talks about that how liquid the company is; that means, if the there is a need for
meeting certain expenses does this company have the to meet the expenses or not; or the
company will either go for liquidating some other non-current assets or fixed assets and
meet the obligation or maybe it will go for borrowing or something, which is not a proper
sign – it is not a good sign for the company; if there is a need and you have to meet the
regular expenses – you should have the liquid assets in your hand so that you can get the
expenses on time.

Another category of assets is called intangible
assets; for instance the fixed assets investments, current assets – they are tangible, because
you can feel that and you can see those assets; whereas, intangible assets are something which
you can feel, but you cannot see that and intangible assets can be classified as like
goodwill of the company; if the company has got some patents, or company has got some
copyrights, company has made some R &D and technology has been developed and patented;
all those things come under intangible assets; as long as this…but all the assets which
have got some economic benefit to accrue to the company then this company can report as
an asset. If there is no economic benefit to come from
this particular holding of the asset then it is better that company does not show that;
rather, it should write off this asset for at a particular period of time; asset means
that which can give some economic benefit in future, which can be classified into all
this types that we have discussed just know. Next, we go to the balance sheet that is called
liabilities; the liabilities we have…again the classification we have are: first one
is called current liabilities and provisions; current liability is something which the company
has to pay within a very short period of time – typically, one year; just like the current
assets can be converted into cash within one year and similarly current liability is liability
which the company has to meet within one year period of time.
There we have the categories like creditors, then we have accounts or notes payable; creditors
mean…the company might have purchased certain goods from the supplier on credit which has
to be paid may be within one month or two months or something or whatever the supplier
has asked; till the money is paid, that is a liability of the company; it is a short
term liability it has to be taken care of within a certain period – a short period of
time.

Accounts and notes payable are something…which
are certain instruments which indicate that the company owes something to someone over
a short period of time, which has to be honored within a short period of time. The next item
is called accrued liabilities, where the company has incurred the expense, but it has not been
paid in cash; till it is paid in cash – may be something like this, that some employees
have worked for the company where their salary is yet to be paid, till the salary is paid
it is called a accrued liability or outstanding expense for that matter and it is a short
term liability; it is also current liability where this has to be taken care of within
a very short period of time. Another type of asset – the liability we have,
current liability is called the taxes payable or income tax payable; the company has made
a provision to pay the tax, but it is yet to be paid by the company till it is paid
the provision has been created and that is called the income tax payable.
The next category of liability we have is the debt or loan; debt means where the company
has borrowed some money and the company is going to repay the amount over a period of
time; also periodically the company is supposed to pay certain interest and the debt can be
short term or long term; short term can one to three years period then you can also have
medium term – three to five years, more than five years can be taken as long term.
Long term or short term depends upon the tenure – within how many years the company is going
to honor the obligation in terms of paying repaying back the money; that indicates whether
it is short term, medium term or long term; the loan also can be classified into secured
and unsecured; secured means, the company can place, hypothecate or mortgage certain
assets the company has and the lender has a comfort level that, yes, if there is a problem
in repaying the loan by the company then these assets can be sold and they can get the money;
if something is left over the it can be given back to the company; that is called secured.
There should be some form of security; if there is a security given by the company in
terms of mortgage, a guarantee or something like that it is called secured debt otherwise
it is known as an unsecured debt; unsecured debt means if the company pays – well and
good if the company does not pay then there is no mortgage or there is no place of some
assets some guarantee which the lender can take a recourse and get back the money.

We have another type of liabilities called
the debt – the debt which is known as debentures or bonds; debenture or bond…instead of having
a loan of let us say 1000 crores rupees the company can go for a loan of rupees 1000 crores
from a bank or a financial institution; instead of that there are certain people in the retail
market who will also like to give a loan to this company; this 1000 crore loan amount
can be divided into…of rupees one thousand is; so, there is one crore instruments and
these instruments are called bonds or debentures.

Typically the bonds are written like this
– let us say x percent n year bond of rupees 1000 each; this x percent is the interest
per annum, n year is within how many years the bond is going to be repaid – the amount
is going to be given back to the investor; what happens in this…and this value of the
bond – on the face value let us say it is rupees 1000.
These bonds can be issued for rupees one thousand to different investors; what happens here
is instead of getting on 1000 crore from a particular bank or financial institution this
is now raised through as many investors who can give 1000 rupees each and one crore bonds
are issued; you have one crore – maximum one crore bond holders – who have might have subscribed
to one bond for that matter; if they have subscribed to more than one bond that will
be less than one crore number of bond holders.

What happens in this case is that the company
can raise a loan from ordinary investors – this is called bonds; similarly, same bond also
can be termed as something called debenture; for debenture and bond there is no financial
instrument type of difference – both are loan instruments, both also have got this x percent,
n year – may be ten percent seven year bond 10 percent interest and within 7 years the
bond has to be or debenture has to be repaid; they are also loan as the debt of the company.
Next we have what is called the preference share capital; in the preference share capital
what happens is preference share holders have got preference over the equity holders regarding
two things; the first thing that they have preference over is that the preference share
holder has got the preference regarding two things one is the dividend and the second
is principle being repaid – repayment. If the company has profit company can declare
dividend and if the dividend is declared it means it has to first declare to preference
share holders then it can be declared for any equity share holder; without declaring
to the preference share holder dividends can be paid to equity share holder; that is why
they are the first preference dividend payment; similarly, if there is a need that the company
is likely to repay the money because of – whatever it maybe – the company is liquidating the
business, where all the stake holders are given money, first thing that has to be paid
is to the liability holders – like bonds, debentures, secured, unsecured, current liability
all those things have to be honored; then comes the share holders part and when the
share holders have to be given back the money the first preference is given to the preference
share holder, that is why they are known as preference share capital.
Preference share capital holder they have got two preferences – two cases – one is regarding
dividend payment, another regarding the principle repayments; that is why they are called preference
share capital.

Next, we have got the equity share capital
which is known as owners capital; it is a popular source of finance and equity capital
is – first thing is called paid up capital; if the company…let us say for example, if
the company has issued 1000 crore shares of rupees one each face value then 1000 into
– that comes to 1000 crores paid up capital; if the company has put the money into different
assets and then the assets have generated some sales and sales have generated profit
and subsequently if the profit has accumulated, then this accumulated profit is known as accumulated
reserve; this profit gets transferred to other different reserves also.

All those things
are called reserves and surplus which includes something like retained earnings.
Retained earnings mean – the company has made a profit of 100 crores; this profit, after
paying all the tax and all the obligations are taken care of, then that hundred crores
now belongs to the share holders; assuming that the company has no preference share capital,
in that case, all the hundred crores belongs to the equity share holder and out of this
hundred crore the company may choose to transfer certain amount to some reserve like general
reserve or other reserves as the company feels right or maybe it is that instead of keeping
all the hundred crores as profit they can transfer to certain reserve and…let us say
they have transferred like hundred crores rupees of profit; profit after tax to the
company is rupees100 crores and they have transferred, let us say, 10 crore rupees to
certain reserves – that is 90 crores and out of 90 crores possibly the company can declare
a dividend of 20 crores for the equity holders; then, 70 crores is known as retained earnings
that is the balance of your income statement or profit and loss account that is left over
now – profit left over for the owner.

Typically, what happens is that, this earnings
return means that this profit is getting ploughed back in the company and the company generates
surplus and surplus and surplus like that the company goes on; this is categorized in
the reserves and surplus of the company; equity capital essentially consists of paid up capital
and reserves and surplus; if the company has issued some shares at a premium, let us say,
10 rupees face value, but the shares are issued at let us say at another 10 rupees premium;
that means, 20 rupees has been collected from the investor per share; that 10 rupees is
also known as securities premium or share premium, that is also part of the reserves
and surplus. Whatever money the investors have put that
is the share capital surplus as well as if there is any profit owned by the company on
the investors money after taking care of all the obligations that also belong to share
holders; that is called the internal equity or reserves and surplus of the company.
Then, we go to the next financial statement called the income statement; income statement
has the major part – that is income; then, they have got sales; is something which is
from the main line of activity of the company; if the company is into selling automobiles,
automobile parts – whatever the company has got revenue from selling – automobiles, cars
or whatever that may be; those things are called the sales of the company; net of anything
that has been returned by the customer; net of excise duty; all these come as a net sales
of the company.

Besides sales, the company has got other sources
of revenue, but the company is not meant for that particular activity – the company might
have got some interest on deposits, interest on investment, dividend on investment, that
comes under the category of other income. That is the total income, then the company
can have expenses – something called operating expenses; operating expenses those expenses
which are essentially required for the operation of the business. If you take the example of
an automobile company, those machines use…machine expenses, labor expenses, raw material expenses
or the spare parts they have purchased or marketing expenses, distribution expenses
– all those are totally totally called as operating expenses and having done that if
the company has borrowed some money – that is, if the company has to pay interest on
the loan – that is called financial expense.

After that, whatever the profit is left the
company pays the tax and then after paying the tax there is a net profit and this net
profit is appropriated as we discussed earlier; it will be appropriated by transferring some
amount reserves and distribute some profit or dividend, whatever is left over that is
called retained earnings of the company. What we have next is a very prominent statement
these days – that is called the cash flow statement; what happens in a preparation of
income statement is that certain accounting principles, accounting assumptions are actually
followed.

In that case, what happens is the expense recognition by a particular company
can have different aspects, different rules as such. Let us take a simpler example; there is a
company that has something called a fixed asset of rupees 10 crores and the asset has
a life of 10 years at the at the end of the tenth year the salvage value of the asset
is, let us assume, rupees 1 crore; that means, rupees 10 crores minus rupees 1 crore has
to be spread over a life of 10 years – this is actually called depreciation of asset,
that is, of rupees 0 point 9 crores. This method of depreciation – when you reduce
the salvage value from the original cost and divide by the number of years of life that
is called the straight line method of depreciation; the company can also follow – subject to the
accounting rules – the company also can follow another depreciation method called written
down value method.

What happens in this case is the company,
let us say…in this method also there is a ten percent rate of depreciation, but…in
the first year – year 1, in both the methods the depreciation is straight line method as
well as in the wdv method – the method depreciation is ten percent, then is also 1 at the end
of the year the value of the asset is 9 crores as per both the methods.
In year 2 as per straight line method the value of asset is 9 crores, as per written
down value method the value of the asset is also 9 crores; but, in straight line methods
amount depreciation is same across the time period – whatever has been there it is1 rupee;
1 crore is 10 percent, original cost is taken as depreciation – so, 9; in this case also
again 10…9 9 minus 1 it becomes 8; whereas, in case of written down value method it will
be ten percent of nine that become 0 point 9; so, now it becomes 8 point 1.
There is a difference in depreciation amount, that is, 1 crore versus 0 point 9 there is
a difference in the value of the asset that is 8 versus 8 point 1; you have taken a different
example here there is an asset of 10 crore and there is no salvage value – in this case
you have assumed – and we have taken 10 percent depreciation method; depreciation both the
method and the 1 year 1 crore 1 crore 9 crore 9 crore is the at the end of the value, then
in the year 2 you have 9 crore versus 9 core also in written down value method, but depreciation
amount is different in straight line method and W D method.
What happens in this case is, if the company has made a profit before depreciation and
tax of 6 crores in second year, in that case depreciation has to be taken out – in this
case we take out depreciation of 1 in s l m and in w d method we take out depreciation
of this much amount that is 0 point 9 – so, the profit before tax as per this is 5 whereas,
as per this is 5 point 1.

Because of change in depreciation method the
profit before tax has actually changed; in that case, what happens is…actually depreciation
does not involve any cash flow, but there is a method that has to be followed and depreciation
has to be allowed; it is an allowed expense; by having allowed different amounts of depreciation
different methods the company is able to show different amount of profit as per different
method, but the company can choose only one among them.
There will be lot of subjectivity that could be involved in preparation of income statement
balance sheet; in that case, the actual profit can be different from one person to another
person – the way they actually calculate; that is why somebody say that profit is an
opinion because like an opinion can change from person to person profit also can change
from one person to another person – the way they calculate.
To take care of this particular problem there is a statement called cash flow statement;
cash flow statement talks about how much cash has come to the business during the period
and how much cash has gone besides telling anything else it also talks about how liquid
the company is, what is the liquid source of money for the company and how it is able
to honor the obligations, where has the money been put – all those can be there.
The cash flow statement takes care of certain limitations as a balance sheet and income
statement; in the cash flow statement what happens is…in that case, the cash flow is
classified into three major activities; first one is called the operating activities; in
operating activities what happens is that whatever cash has been generated by regular
business operation which does not consider any income from other sources, rather from
the main line of activity – like sales, whatever cash has been generated – net cash having
taken care of all the expenses – that is called the cash flow statement; as it is mentioned
this in this, profit is adjusted for depreciation – gains or loss on sale of non-current assets.
That means, if the company has got a profit after tax of rupees 5 crores and the company
has charged depreciation of, let us say, 1 crore earlier, in that case, because the depreciation
does not involve any cash outflow this depreciation gets added and that means that company has
actually made a cash profit of cash profit or cash operation of 6 crore; it has been
actually showing 5 crore profit because of the depreciation that has been deducted; now,
depreciation does not involve any cash flow and the depreciation has been added back.
Similarly, if you presume that this profit after tax has also considered certain other
income from other activity – it is not the main line activity of the company – let us
say, another rupees 0 point 8 crores; in that case, there will be reducing effect to find
the cash because this profit after tax which typically should be profit from the operation
includes 0 point 8 crore of income from, let us say, investment; that means, if the 0 point
8 crore income was not there the profit would have been something less.
So, this will be having a negative effect and possibly now it becomes 5 point 2 crores;
if there is any such income or expense which is not operating in nature which does not
involve any cash flow like depreciation, in that case, those things have to be adjusted
for and the cash flow operation is actually found out.
Next thing that we have is the cash flow investment activities; in this case, the cash flow is
purchase of non-current assets like fixed assets and if the fixed becomes cash out flow
and if the fixed assets have been disposed and some cash is generated that becomes the
inflow of the company; that is called the investment cash in flow.
That means, the company is putting money into the assets which is going to generate revenue
or income over a period of time so that the company can sustain on its own over a period
of time, because they can meet the expense – expense and projects, activation of fixed
assets, activation of building, activation of land for expense and all those things they
come under cash flow applied in investment activities.
If these assets have been disposed and sold and some cash is realized that becomes cash
inflow for the company; next thing that cash flow statement has is cash flow from financing
activities; financing activities mean whether the company has gone for raising any loan,
the company has gone for initial public offering, or further public public I p o for that matter
company has raised certain loans from some financial institutions – short term, long
term, medium term whatever that may be; these are the financing ways of the particular company;
that becomes the financing inflow for the company.
At the same time, if the company has paid interest, company has paid the dividend back
to the share holders, company might have repaid the loan, company might have paid back the
debentures, redeemed the debenture, redeemed the bonds, whatever has been given back to
the investors because they have financed earlier that is called the financing out flow.
Net of this cash from operating activities – net of inflow and outflow, then net of investment
activities – net of inflow and outflow, similarly net of financing inflow and net of financing
out flow these three figure will be there; if the company has got a net operating cash
flow as rupees 7 crores – that means 7 crores has been…net of that is inflow is more than
outflow, then financing is, let us say, there is 2 crores – within brackets – means that
is a net of net outflow whereas, investment there is another 3 crores of also outflow.
Then, net cash flow during the particular period – combination of this is – 2 crores
and this is the 2 crores cash that has come to the business in a net having – that means,
the 2 should be the net of all cash receipts and all cash payments during a particular
accounting period.

That means, if the cash balance in the beginning
of the period was rupees 7 crores – assuming that – then the ending cash balance should
be rupees 7 crores plus this rupees 2 crores – that should be rupees 9 crore; net of the
cash flow statement will be reflected in the net of the different cash flow, that is, operating
financial or investment cash flow. We can go to look at different sources of
financial information – where do the investors get this – because all this information is
required for the investor to make a decision – whether the company’s shares should be
bought or not, to hold on to the investment or not, to sell this or not; because, these
sources of information – these final statements – give very vital information to the investor
about the performance of the company so that the investor can decide whether to hold on
to an investment or not. This information can be found out as you discussed
at the end of every year; the company publishes something like annual report; the information
is also available from different secondary data base by subscribing to that or there
are certain information services for a particular subscription for a particular payment they
can also give; there are also stock exchange that….

Also, because there the company is
supposed to disclose the information and stock is also publish that information on the website
or some other document. At the same time, there is a very good print
media where the company’s reports are published, certain periodicals…there are exclusive
reports that are also published by different research agencies; then, the companies own
website or website of different analyst companies from where this information can be found. What we can do now we can now is we can look
at a certain example of annual report; this is an annual report of the company called
Infosys Technologies and the annual report is for 2008-09.
The annual report has got the content of whatever the company has been doing; it talks about
the company’s performance, it talks company’s activities – who are the main players, who
are the employees – major employees, talks about everything in this case; at the same
time, the company also publishes what the company talks about, what the management thinks
about – that is called management discussion analysis – called m d a; they talk about how
they feel about their financial performance, operating performance of the company; this
company company also has something like risk management report getting published as a part
of annual report – what is the risk of this company where they have been exposed to.
It also publishes the information that we are discussing – that is called the balance
sheet and income statement; one can look at it…these are the different sources of funds,
they are called liabilities; we have the share holders’ funds, then we have share capital
and as we discussed and we have reserves and surplus.
What happens in this is that they give for two years – this is for the year ending 31st
March, 2009 and this for the year ending 31st March, 2008; that means, one can compare the
differences easily – what was there in previous year, what is now in this year and each major
item has been supplemented by something to the schedule which is given at the end of
the particular statement as a part of this particular report.
If you can one see here, the share capital of this company was 286 crores earlier it
is also 2 86 crores this year; the reserve surplus of the company has gone up from 13,204
crores to 17,523 crores – like that, these are the liabilities; then the company has
got the application fund that is called the assets of the company – it has got fixed assets,
it has got investments, then it has got certain assets called deferred tax assets net, then
it has got the current assets, loans and advances where debtors…cash and bank balance loans
and advances; these current liabilities – instead of showing as a part of liability of the company
– these have been shown as a deduction from the current assets.
These current assets minus current liabilities is called net current assets and then the
company has got total assets of 17,809 which was actually earlier 13,490 crores in the
previous year; similarly, the company has also got the income statement that is called
profit and loss account and this the income major activity like software – whether the
company is in software development – software expenses, income from software products, then
it has got software development expenses – it is a major expense.
Next line is called the gross profit; it has got the next expense called selling and marketing
expense; then they have got general expenses; after that they have got operating profit
before depreciation; then depreciation taken out we have got operating profit before tax;
then what they have done is they have added the other income and then they have got net
profit tax; then, they have made a tax provision of whatever amount; in this also they have
got the provision of 8 90 4 5 crore which was 6 34 previous year.
In this statement also, alongside you have got the previous year’s values so that the
investor can compare about what has happened before and what it is now – as a part of income
statement; balance – we have net profit after tax – and whatever the balance was there in
the previous it has has come and then the amount has been distributed like dividend
– company has paid dividend, interim dividend, final dividend or special dividend, total
dividend and some amount has been transferred to general reserve.
Now, whatever is left over that is 12,460 crore is the reserves and surplus of the particular
company; this can be checked here also in the balance sheet that as a part of reserves
surplus this 12,460 is the part of reserve surplus – that is 17,523 crore – and the details
of the reserve surplus is given in a at the end of the financial statements.
Next thing that we have is the cash particular company; as you discussed it has got first
the cash flow from operating activities, then cash flow from investing activities and cash
flow from the financing activities; net of all these three different cash flows is this
amount that is 73; net of the cash flow has been increased by 73 crores during the particular
year which was 18 crores in the previous year; this is the way the companies publish their
financial statements as a part of their annual report.
Next, we move on to the unit that is called the analysis of financial statement; having
got this information from different sources or this annual report from this cash flow
statement or from this balance sheet from income statement one can make an analysis
of the financial statement – with different tools and techniques – how this particular
company is actually doing.

Why you should go for the financial state analysis is that
it helps us evaluate the past performance and the past financial positions.
How has this company been doing in the previous period and what has been the particular company’s
position, what are the strengths, what are weaknesses of this particular company and
those things can be found out with the help of financial statement analysis. It also helps us in predicting the future
performance and it also helps in estimating risk. So, we have already discussed in risk
and return what is the risk involved these particular companies and possibly this information
source – these final statement analyses can give an indication to how risky the business
is with certain tools that are being applied; also, financial statement analysis can help
us finding out what is the cost of capital of a particular company.
When we say cost of capital we mean the return expected by the investors; it could be equity
investors, it could be debt investors this financial statement analysis can also help;
because, we always expect the company to outperform the expectation of the investors if the investors
overall expect, let us say, twelve or fourteen percent return the company – let us say, fourteen
percent return – in that case company should earn a return more than fourteen percent then
it is says it has made the investors requirement in terms of what they have required as per
return is concerned; then, capitalization – that is also same thing like cost of capital
and it also…this financial statement analysis also helps in estimating the appropriate valuation
multiples; we will discuss that in a subsequent session when you talk about valuation of shares;
in that case, what would be the different methods price multiple, possibly one will
be aware of a multiple like price to earnings called p e multiple; p e multiple is actually
found out by dividing the price of particular share with something like earnings per share.

Say, the price of a particular company is
rupees one hundred fifty and the earnings per share, which is known as profit after
tax divided by number of shares; let us say, it is thirty crores is the profit and ten
crores number of shares are there, then rupees three is the earnings per share; price earning
multiple is now 150 by 3, that is 50. That means, multiple…the price is fifty
times of the earning per share; this is called a relative valuation method technique also;
because, one can find out the p multiple of different companies like this; this is 50,
there could be 20, 30 like this and taking an average like that and this average p multiple
can be taken as a base of say p multiple of this target company that you one is evaluating
is high or low. If the average p multiple of this, let us
say, comes to thirty five and if you have that this company’s is 50 obviously, this
company’s share is overvalued. So, this is called relative evaluation; relative to
other companies p multiple what is this p multiple here and accordingly is it over valued
or undervalued? These valuation multiples can be found out
with the source of information that is there in the financial statement; with the help
of financial statement analysis tools and techniques one can help, one can estimate
the value of the particular company; by using this valuation p multiple is one of the value
multiple there can be different valuation multiples which one can discuss in subsequent
valuations of the share session.

Then, coming to the next thing – what are
the different tools, we have got the first thing that is called a trend analysis; in
trend analysis what happens is that the company’s major financial figures are compared over
a time period and then one can observe a particular trend in the same; let us say, for 5 years
the company sales are observed and how these sales have actually moved for a particular
period of time. Sales might have gone up from hundred crore
1 20 10 30 like that up to 5 50 or figure might have reached, and what is the trend
– whether the sales is declining, sales is fluctuating or sales is continuously increasing
like that; similarly, this trend can be observed for any major financial figure of the particular
company; it can be observed for major expenses, raw material consumption, labor expenses electricity
expenses other operating expenses; similarly, financial expenses like interest, how this
interest expense is going up or coming down what has been happening.
Then, at the end in the income statement the company’s profit after tax – whether it
has gone up or come down, whether the sales have gone up by certain percentage over a
period of time, whether profit after tax has also gone up by that percentage or more than
that or less than that of the profit is after tax of the company is declining or increasing.
All those things can be observed with the help of a trend analysis; essentially, one
can take a period of and see how these particular major financial figurse are changing; beside
income statement the trend analysis can be applied for the balance sheet how the total
assets have been decreasing or increasing or increasing for some period then declining
or the other way around.

Total asset is increasing or decreasing, whether
the fixed asset of the company is increasing or decreasing, then current assets – how do
they trade in that; all those things can be observed by comparing these figures over a
period of time – that comes under trend analysis; analysis of that company – the analyst can
do or financial statement can do is to make comparative statement also.
In this case, one compares the financial performance of the company for one year with another – that
we have already seen in the example of Infosys – we have got the financial statement here
and, we see the income statement – what has happened in this case is that the income from
software service and products of Infosys for 2009 is 20,264 crorea which is actually 15,648
crores in the previous year.

Where around thirty increase is there compared
to the previous year – this called the comparison of particular company’s financial performance
over a two year period of time; at the same time, the comparison can be done with any
other company; let us say, Infosys’ performance can be compared with TCS or it can be compared
with a company like Wipro any other company which is in the same software sector, that
can be compared and one can find out which company has done better, which company has
not done better compared to the other. This is comparative finance statement; because,
the investor is going to compare different instruments of different companies.

Let us
see equity share of different companies…they can take the financial different companies
and compare which company has been doing better than the other company and make a decision
whether to buy or sell the share of the particular company or not; that is called comparative
financial statement. Next, what we have is the common size statement;
in this case, the financial statement is presented by representing each item as a percentage
of a major figure in that particular financial statement like income statement or the balance
sheet; in income statement what happens is each of the item is compared with this net
sales; taking net sales as hundred how other items have actually gone up or is more or
less – is it hundred is in five or ten or eight something like that.
The common size statement essentially gives a breakup of the different items compared
to the main item of the statement income statement called sales; similarly, common size balance
sheet also can be prepared where the total assets of the particular company – total liability
of the particular company – is taken as hundred and compared to that how the other assets
or liabilities are there, that is explained.

That is what happens in this case, over a
period of time one can find out if…for example, if in a particular year, let us say, we have
a balance sheet of a particular company where we look at the asset side and asset side 2009
– 03 – 2009, March and 2008, March asset total was, let us say, two hundred crores – it was
two hundred crore in 2009 – it was actually one hundred eighty in the previous year.
This 200, 180 respectively is taken as hundred; then, this 200 crores comprises of fixed asset
of 120 and the fixed asset of…then we have a current assets like investments of let us
say 20 and another other asset 60; total becomes now 200 which was there in this total; similarly,
this 180 it was actually 100 as far as fixed assets is concerned then as far as investment
concerned it was 20; similarly, current assets was actually 60; total is now 180.
So, if one looks at…the 20 of investment remains 20 current asset also remains 60 whereas
fixed assets have gone up from 100 to 120.

This is a comparative analysis; this 120 has
a percentage – 200 taking the total as hundred can be converted; this becomes like 60 percent,
this becomes 10 percent and this becomes 30 percent; likewise, one can also find out hundred
by 180, 20 by 180 and 60 by 180. Like that one can find out the percentage
and compare the percentage with this one. One can find out that, yes, whether they had
more fixed asset total asset are less; how this fixed asset x percent has become sixty
60 percent; whether it is increasing or decreasing the asset is changing or not; that can be
shown with the help of a common size statement. Both, common size income statement as well
as common size balance sheet can be prepared and one can see that. We can have a look at an example of one company
that is called Natco Pharma; here, we have got the income statement of the company – this
is sales turnover, excise duty, the net sales and other income; then we have a stock adjustments,
total income – this comes at 288.29 for the year 2008- 09.
Similarly, we have got expenses for raw material, power and fuel, employee cost, manufacturing
expenses, selling expenses, operating profit, depreciation like that; we have made a comparison
here that in the net sales of this particular company for 2008-09 which is 269.69 crores
it has been taken as hundred; accordingly, rest of the items in income statement have
been covered and we can see here hundred, hundred and hundred for three different years
the financial statement has been given.

Take an example, the raw material which was 42.93
as related to sales it has now become 40.14 in 2007-08, it has now become 35.82 in 2008-09.
That means as a percentage of sales, raw materials has actually declined, which is actually a
good sign for any company because the cost as percent of total sales has…this particular
raw material cost has actually declined; similarly, power and fuel costs which was 5.48 in 2006-07
this declined 4 point 5 4 point 8 1 it has now become 5.65; like that, employee cost,
which was 13.5 which has remained almost same 13.23 as a percent of sales.
Like that, all those expenses – everything has been categorized as a percentage of sales
where sales is taken hundred item has been taken; similarly, it can also be done for
common size balance sheet, where the total of the balance sheet, total liability or total
assets have been taken as hundred, like 2006-07 339.65 is taken as hundred and similarly for
2008-09 total assets is taken as 494 is taken as 100; accordingly, how these other assets
have actually moved or declined or whatever may be.
That means, if you look at it here the share capital which has 8.14 percent total liabilities
it has declined to 5.67 percent; similarly, the total share holder fund which was 53 has
become now 52 marginal decrease in the share holders fund.
Coming to the asset side, earlier 40 point on average the company has maintained some
40 to 43 percent total asset as net fixed asset; whereas, inventories which was 14.52percent
which has now become 13.07 percent.

Like that, all the assets have been now classified
and the compositions have been given. This composition how it has been there in the earlier
year, how it is in this year – it talks about – or this company has put more money and fixed
assets, more money on investments or more assets are in term of current assets.
In current assets more in terms of inventory, receivables or like that this can be classified
and show how this company is actually investing in assets and how this company also gets the
different money from different source of liabilities; whether insiders source like owner source
of money is more or the outsider source like liability is more like that can be analyzed.
So, up to this we have discussed financial statement, different types of financial statement,
what are the major sources of financial statements, information like annual reports, secondary
databases; have also started discussing about different tools of final statement analysis
where we talked about the comparative financial performance, we have also talked about the
trend analysis and then we talked of the common size financial statement.
In the subsequent session, we will discuss about the financial statement analysis with
the help of receive analysis where we will find out different financial statements, receivers
with the help of information from financial statements like balance sheet and income statement
and judge whether this company is doing well as per different financial parameters or not.
Thank you.

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