TiEcon Delhi Oct 2011 - Deloitte Financial Ratios

TiEcon

Financial Statements and Ratio Analysis

30 September 2011

©2011 Deloitte Touche Tohmatsu India Private Limited.

Agenda

• Overview

• Ratio Analysis of ABC Limited

2

Overview of financial

statements and ratio

analysis

3


What are Financial Statements

• Formal records of the financial

position (health) of a business

• Three main types:

Balance Sheet (B/S) - reports a

company’s assets, liabilities, and

ownership equity at a given point

in time

Profit and Loss (P/L) Statement

reports on a company’s income,

expenses, and profits over a

period of time

Cash Flow Statement. Reports

changes in B/S and P/L

4

Sources of funds Applications of funds

Share Capital Fixed assets

Equity Net fixed assets

Reserves

Investments

Debt

Secured loans Current assets

Unsecured loans Current liabilities

Total liabilities Total assets

Income

Operating expenditure

EBIDTA

Depreciation

EBIT

Interest

Profit Before Tax

Tax

Profit After Tax


Why financial ratios

• Financial numbers/statements aren't always enough to:

Provide indications of performance of business

Convince an investor that the business is a viable proposition

• Financial ratios are tools for financial analysis used by entrepreneurs and

investors

• Entrepreneurs need to track their business in terms of:

Short term business viability/liquidity

Financial leverage

Profitability and return from their investment

5


Ratios – interpreting financial data

6

Liabilities Assets

Shareholders funds Fixed Assets

Equity Gross Block - dep

Reserves & surpluses Net Fixed Assets

Borrowings Net Current Assets

Long term Current Assets

Short term -Current Liabilities

Total Funds Total Assets

Revenue

(Operating costs)

Gross profit

(Selling and Admin)

Operating Margin

EBIDTA

(Depreciation)

PBIT

(Interest)

PBT

(Tax)

PAT

Financial Leverage

Asset utilisation

Liquidity

Profitability

Ratio analysis of ABC

Limited

7


ABC Limited

ABC Limited (ABC or the Company) is an engineering consultancy company providing

engineering design and supervision services.

8

Featured of business operations:

• Promoted by a team of three engineers with wide ranging industry experience in 2003

• Service oriented business with revenue coming from engineering services, supervision

and project management

• Supervision contracts with uniform/regular revenue cycle

• Largely private customers – customers are large companies with good financial

background

• Being service oriented, skilled staff constitutes main operating resources as well as

cost

• Sector witnessing growth but competition increasing at fast pace


ABC’s financial statements

The Company’s Balance Sheet and Profit & Loss Account are presented below:

9

Particulars 2007-08 2008-09 2009-10

Sales 4,000 4,800 5,800

Cost of sales 3,040 3,820 4,760

Gross profit 960 980 1,040

Selling expenses 320 370 430

General and admin expenses 270 300 340

EBIDTA 370 310 270

Depreciation 50 70 90

EBIT 320 240 180

Interest expense 40 40 40

Profit before tax 280 200 140

Income taxes (33%) 92 66 46

Net profit 188 134 94

Particulars 2008 2009 2010

Equity 100 100 100

Retained earnings 275 350 400

Total equity 375 450 500

Long-term debt 500 500 500

Total liabilities and equity 875 950 1,000

Gross fixed assets 1,000 1,125 1,260

Accumulated depreciation 180 250 340

Net fixed assets 820 875 920

Cash 30 40 50

Accounts receivable 275 335 400

Total current assets 305 375 450

Accounts payable 250 300 370

Total current liabilities 250 300 370

Net current assets 55 75 80

Total assets 875 950 1,000


ABC’s commonsize and trend analysis

ABC’s commonsize and growth analysis of P/L account:

10

Particulars 2007-08 2008-09 2009-10

Sales 100% 100% 100%

Cost of sales 76% 80% 82%

Gross profit 24% 20% 18%

Selling expenses 8% 8% 7%

General and admin expenses 7% 6% 6%

EBIDTA 9% 6% 5%

Depreciation 1% 1% 2%

EBIT 8% 5% 3%

Interest expense 1% 1% 1%

Profit before tax 7% 4% 2%

Income taxes (33%) 2% 1% 1%

Net profit 5% 3% 2%

Particulars 2008-09 2009-10

Sales 20% 21%

Cost of sales 26% 25%

Gross profit 2% 6%

Selling expenses 16% 16%

General and admin expenses 11% 13%

EBIDTA -16% -13%

Depreciation 40% 29%

EBIT -25% -25%

Interest expense 0% 0%

Profit before tax -29% -30%

Income taxes (33%) -29% -30%

Net profit -29% -30%

Commonsize Growth (y-o-y)


Analysing ABC using ratios

Short term liquidity/viability

• Current Ratio (CR) - Measures a company's ability to pay short-term

obligations for its operations Current Assets

CR = = Current Liabilities

Current ratio of ABC indicates that the Company is reasonably well positioned

to meet its short term obligations.

11

2008 2009 2010

1.22 1.25 1.22


Operating efficiency

• Measured by the efficiency with which credit sales are collected and payment is made

• Lower collection period and higher payment days considered favourable

• Average Collection period (ACP) Accounts receivable

ACP = = Annual sales/365

ACP depends on industry and customer specific factors. In general, 30 days

and below signify favourable position. However, lower ACP may indicate

potential to increase revenue through higher credit period to customers

• Average payment period (APP) Accounts payable

APP = = Annual purchase/365

APP not very favourable as it is almost same to ACP – generally it should be

higher than ACP

12

2008 2009 2010

25.09 25.47 25.17

2008 2009 2010

25.14 25.39 24.42



Financial leverage

• Provides indication of loan against equity (owner’s capital) and the Company’s capability

to pay back interest on loan

• Long term debt to equity

Long term debt

DER = = Total equity

Reducing DER shows improving financial leverage

• Times Interest Earned Ratio (Interest Coverage Ratio) - Indicates the extent

of which earnings are available to meet interest payments. Earnings before interest & tax

TIE = = Interest

Significant reduction shows worsening financial position even though DER seems

reasonable/to be improving

13

2008 2009 2010

1.33 1.11 1.00

2008 2009 2010

8.00 6.00 4.00



Profitability and return on investment

Assesses a business's ability to generate earnings as compared to its expenses and other

relevant costs incurred during a specific period of time.

• Gross profit margin (GPM) – shows the proportion of money left after direct cost of

sales. Gross profit serves as source for paying for overheads and other costs.

Gross profit

GPM = = Sales

• EBIDTA margin – shows money left after paying for sales cost and overheads

EBIDTA

EBIDTA % = = Sales

Declining GPM and EBIDTA may be due to:

• Relatively higher growth in people cost (ABC being a service company)

• Pressure on pricing due to competition, market environment

• Ineffective management of overhead costs such as marketing and administration

costs

14

2008 2009 2010

24.00% 20.42% 17.93%

2008 2009 2010

9.25% 6.46% 4.66%



• Net profit margin (NPM) – shows money left after paying for all costs

Net Profit

NPM = = Sales

Mainly on account of lower EBIDTA margin since no significant change in depreciation,

interest and tax expense

• Return on Total Assets (ROA)

Total assets

ROA = = Net Profit before interest after tax

• Return on Equity (ROE)

Total equity

ROE = = Net Profit

15

2008 2009 2010

4.69% 2.79% 1.62%

2008 2009 2010

26.01% 19.07% 13.72%

2008 2009 2010

50.03% 29.78% 18.76%



Some comments

• Initial analysis of ABC Limited suggests

reasonable sales management

(growing revenue, reasonable sales

credit cycle) and leverage

• However, declining profitability margins

may indicate:

Pricing pressure (competition, economic

factors)

High fixed cost

Inefficient management of overheads

Thus:

• Financial ratio analysis comes handy

in identifying ‘pain’ points

• Deeper analysis of operations and

industry may be required to identity

real issues

16

2008 2009 2010

Current ratio

1.22 1.25 1.22

ACP 25.09 25.47 25.17

APP 25.14 25.39 24.42

Debt to Equity

1.33 1.11 1.00

Interest coverage

8.00 6.00 4.00

GPM 24.00% 20.42% 17.93%

EBIDTAM 9.25% 6.46% 4.66%

NPM 4.69% 2.79% 1.62%

ROA 26.01% 19.07% 13.72%

ROE 50.03% 29.78% 18.76%


Some more ratios

• Apart from those discussed, there are ratios and financial metrics to gain insight into a business

• Feasibility ratios and metric generally used to assess greenfield/brownfield project: Net Present Value – captures timing of cashflow to financers

Internal Rate of Return – intrinsic rate of return at which NPV is zero

Debt service coverage ratio – indicates fund available to pay interest and principal

Payback – time period within which investments are recovered

17


Some more ratios

• Industry specifics Employee driven sectors

• Revenue/employee or seat; Revenue/faculty hours; Revenue/billable hours

Manufacturing • Margin (USD/bbl, USD/Kg, USD over raw material, % of raw material cost)

Banks

• Spread • NPA ratio

Hotels

• ARR: Average Room Rate • Occupancy rate • RevPAR: Average Revenue per Available Room

Telecom

• ARPU: Average Revenue per User Airlines

• RPK: Revenue Per Kilometer • Yield (Passenger Revenue/ RPKs) • RASK: Revenue per Available Seat Kilometre, CASK: Cost per Available Seat Kilometre

18


Important Tips

• A single ratio rarely tells enough to make a sound judgment • Comparable firms Product Locations Size Brand (s)

• Consistency in time and method of computation • Duration Generally latest 5 years….but remember Changes in regulation Changes in performance/external scenario Mergers and acquisition/divestments

19

©2011 Deloitte Touche Tohmatsu India Private Limited. 20

Contact

Kalpana Jain

Senior Director

Tel: +91 (0) 124 679 2266

Email : [email protected]

Deloitte Touche Tohmatsu India Private

Limited

Building 10, Tower B, 7th Floor,

DLF Cyber City, Gurgaon 122 022

Tel : +91 (0124) 679 2000

Fax : + 91 (0124) 679 2012

mailto:[email protected]

©2011 Deloitte Touche Tohmatsu India Private Limited

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TiEcon Delhi Oct 2011 - Deloitte Financial Ratios

Economy & Finance