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You can manage only
what you can measure
Financial statement Analysis
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Session Plan
Understanding the financial statements
Financial statement Analysis
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Identification
Select economiceventsAnd Monetary
Business transactions
Recording
Record, classifyand summarize
Based on certain rules
Accounting
Reports
SOFTBYTE
Annual Report
Accountingreports
Analyze and interpretfor users
Communication
ACCOUNTING SYSTEM
FILTERS
Audit
Input Process Output
Monetary
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FIRMS GENERATES REPORTS !!
Accounting system generates 3 reports giving
the status and performance of the firm
The Balance sheet /status report The Profit and loss account (Income
statement)
The Cash flow statement
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BALANCE SHEET/STATUS REPORTS
It is the status report at a particularpoint of
time
Statement giving the position of assets and
liabilities (claimants)
Snap shot view of the continuously
changing enterprise
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PROFIT AND LOSS ACCOUNT
Gives the profit (income less expenses) for a
time period
It gives all the incomes and expenses and
gains and losses made by a firm
Revenues or Incomes arise from selling of goods
or services to customers.
Expenses related to earnings are deducted from
revenues
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CASH FLOW STATEMENT
Why the status changed during the period
Cash flow from financing activities
Cash from investing activities Cash flow from operations
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Balance Sheet: ASSETS
Resources owned by a firm
Capable of giving future cash flows (by use
or disposal value)
Objectively verifiable
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LIABILITIES
Liabilities are Debts
They are present obligations a firm
owes. They are claims against the assets the
firm.
Liabilities may be to the owners or tooutsiders
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Balance Sheet of ABC LTD as on
31
ST
MARCH, 2005Uses of Funds
Fixed Assets
Investments Current Assets,
Loans and
Advances
Sources of Funds
(Liabilities)
Share Capital
Reserves and Surplus
Borrowings:
Secured
Unsecured
Current Liabilities
and Provision
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FIXED ASSETS
Depreciation is treated as Expenses and is
charged to the profit and loss account
Accumulated Depreciation its the sum of
depreciation charged to the profit and loss
account till the end of the current financial
year
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INVESTMENTS
Are assets held as stores of value with a view
to get interest, dividend or capital appreciation
TYPES: Long Term/ Current (holding period)
Quoted / Not Quoted
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CURRENT ASSETS, LOANS AND
ADVANCE Current assets are assets that form part of the operating
cycle and take interrelated form
Expected to be converted into cash in next 12 months
Consists of :
Cash
Sundry Debtors
Inventory Others
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LIABILITIES
They are present obligations a firm owes.
They are claims against the assets the firm.
Liabilities may be to the owners or to anoutsider
Discharging the liability will result in the
decline of the assets
Classified: Current and Long
Secured/ Unsecured
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OWNERS EQUITY
Share Capital
Amount contributed by owners towards the capitalof the firm
They are divided into units called share Have a face Value
RESERVES AND SURPLUS
They are the accumulated profits or retainedearnings not distributed and owed by the businessto the equity share holders
Share Capital + R & S is called Net Worth
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LOANS
Are borrowing to be repaid as per agreed
terms on which interest needs to be paid
irrespective of availability of profits.
TYPES:
SECURED LOAN OR UNSECURED LOANS
LONG TERM OR SHORT TERM
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Current liabilities and Provisions
Arising on account of acquiring
goods/services on credit or incurring
expenses which are paid for laterNormally they are to be settled within a
period of 12 months
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PROFIT AND LOSS ACCOUNT FOR
THE YEAR ENDED 31/3/2006
SALES 1579
Expenses
RAW MATERIALS 700
WAGES & SALARIES 374
OTHER Overheads 100
Depreciation 100
SAD Expenses 100
PBIT (Operating Profit) 205
INTEREST 38PBT 167
INCOME TAX 59
PROFIT AFTER TAX 108
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Depreciation
Some Myths about Depreciation
It is a process of valuation
It generates cash
It helps in replacement to new machine Truths ..
Depreciation is the allocation of cost (depreciablevalue) of an asset to the periods that benefit from
its use.
Its a charge of the asset over the useful life of anasset
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Depreciation
Some Terms:
Original cost (OC) of the asset
Expected Useful life of the asset (This is notthe physical life)
Residual Value (RV) at the end of the
useful life Depreciable Value of the asset (OC-RV)
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Depreciation
Methods of Charging Depreciation
Straight Line Method
Reducing Balance Method
Which ever method you use the total
depreciation to be charged over the useful
life will be the same
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Depreciation
Straight Line Method
Formula: Cost -Residual Value
Useful life
Reducing Balance Method
Formula for computation of rate
1 - Residual valueCost
n= useful life in years
n
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Straight Line Method
Depreciable Value = 6,50,00050,000
= 600,000
Depreciation = 600,000 / 3 Rs. 200,000
p.a. =200,000/650,000 * 100 30.6 %
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Straight line method
Year Gross
Block
Depr Acc. Depr Net
Block
1 650000 200000 200000 450000
2 650000 200000 400000 250000
3 650000 200000 600000 50000
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Written down value method
Initial years the depreciation should be
high as subsequently the Asset will incur
higher repair expenses. Hence over the years the Repairs and
depreciation together will even out
Rate 1- n s /c n = useful life, s=scrap value c= cost
57.5%
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Written Down value method
GBV Depreciatio Net Book
650000 373750 276250
276250 158843.75 117406.3
117406.3 67508.594 49897.66
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Financial Statement Analysis
(Analysis of Financial Performance)
From Business Activities to Financial Statements
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Financial
Statements
AccountingSystem
Measurement
&
Reporting
Business
Activities
Operating
Investment
Financing
Accounting
Environment
Capital Market
Structure,
GAAP,Audit,&Legal system
Business
Environment
Labor Market
Capital MarketProduct Market:
Suppliers
Customers
Accounting StrategyChoice of:
Accounting Policy
Reporting Format
Supplementary-
Disclosures
Business
Strategy
Key factorsAnd Risk
From Business Activities to Financial Statements
Story So far ..
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Need for Financial statement analysis
How has the business performed during the year
How is the financial condition of the company
How investment activities have performed during the year
How does the unit stand in comparison to the industry
Preparation of Forecasts
Evaluation of SBUs and departments
Credit rating
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Where to look for data
The Annual reports(An annual report and financials therein represents a snapshot
at a given moment. By the time it is mailed, an annualreport is more history than news. )
1. Directors Report - Working of the Company2. Auditors Report
3. Management Discussion &Analysis
Profit and loss account
Balance Sheet
Cash Flow statements
Supplementary schedules and Notes
Accounting Policies
Subsidiary Company Information
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Other Data Sources
Forms filed with the ROC (In the US 10K and
10Q reports filed with SEC)
Computerized data bases
Info on industry norms/ratios
Info on particular company/industries
Articles in press
Ever-expanding websites
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4 Step Analysis Process
Business Strategy Analysis
Accounting Analysis
Financial Analysis
Prospective Analysis
(Also do a SWOT analysis )
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TOOLS FOR EVALUATION
COMMON SIZE STATEMENTS
HORIZONTAL ANALYSIS
RATIO ANALYSIS CASH FLOW ANALYSIS
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Common Size Statements
Common size income statement
Expresses each income statement category as a
percentage of net sales
Common size balance sheet
Expresses each item on balance sheet as a
percentage of total assets or equities
Both statements facilitate structural analysisof the firm
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HORIZONTAL ANALYSIS
Year to year changes Changes in amounts and percentages
Reveals a trend & direction
For long term trends prepare a index numbertrend series
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RATIO ANALYSIS
GIVES THE LINK BETWEEN
INVESTMENT, FINANCING AND
OPERATING ACTIVITY
i.e. how various items in the financial
statements relate to one and another
Analysis of Past performance helps in
forecasting the future performance
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Financial Statement Analysis
PROFITABILITY
LIQUIDITY
SOLVENCY
Note: Different authors take slightly different approach
(formulas) for eg: PBIT instead of PAT etc.,PBIT (NOPAT) is a good measure for inter divisions
evaluation
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FSA-Basic Structure
Leverage or
Financial risk
Fixed Asset Turnover
Debtors Turnover or
Collection Period
Inventory Turnover
Current Asset TOR
Asset Turnover ratios
Interest / Sales
Other expenses / Sales
Raw material/Sales
Profit Margins
Return on Total Assets(ROI)
RReturn on Equity E
Current Ratio
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Financial Ratio Analysis
Profitability Ratios
measure the overall performance of a firm and
its efficiency in managing assets, liabilities and
equity
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Return Ratios
Return on Equity
PAT/ AVG Stockholders Equity
Measure overall efficiency of the firm in managing
investment in assets and generating return to
stockholders
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Return Ratios
Return on Total Assets (ROCE)
PAT /Avg Total Assets or
- PBIT/ AVG Total Assets*
- NOPAT / Total Assets
The ratio measures the overall efficiency of
the firm in managing investment in assets andgenerating return to stockholders
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Profitability Ratios
Net Profit Margin
Net Profit After Tax/Net Sales
Operating Profit Margin
PBIT (Profit before interest and tax)/Net Sales
Various Expenses to Sales
Salary/Net Sales
All measure firms ability to translate salesinto profits
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Turn Over Ratios(Resource
Utilization)The Ability of different assets like Fixed
Assets, current assets and both to generate
sales (turnover)
Total Asset Turn over Ratio
Sales / average Total Assets
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Fixed Assets Turn Over Ratio
Sales / Avg Fixed Assets
Assess the effectiveness of the fixed assets to
generate sales
Also reflects the investment strategies
i (
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Inventory Turnover Ratio (Not
Relevant)
Cost of Goods Sold (Sales) / AVG
Inventory
Number of Days Stock
Avg Inventory / Sales(COGS) per day
(Measures efficiency of inventorymanagement (not the inventory policy of
the management)
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Debtors Turnover Ratio
Debtors Turnover Ratio
Net Sales/ Average Debtors
Average Collection Period
Accounts Receivable/Average Daily Sales
(Avg daily sales = Credit sales/365)
Another measure of efficiency of firms ability to collect
fast
Helps gauge liquidity of accounts receivable (ability to
collect cash from customers)
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Financial Leverage
It Pays to have Debt in your Capital
Structure
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Financing Pattern
Leverage Ratios
measure the extent of a firms financing with
debt relative to equity and its ability to cover
interest and other fixed charges also called asthe Solvency ratios
Liquidity Ratios
Measures the firms ability to meet cash needsas they arise
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Leverage: Debt Ratios (!!)
Debt to Equity Ratio
Long Term Debt/Equity
Debt Asset Ratio
Total Outside Liability / Total Assets
Interest Cover Ratio
Operating Profit/Interest Expense
Indicates how well operating earnings cover fixed
interest charges
They measure the extent of firms financing with debt and
the financial risk
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Liquidity Ratios
Current Ratio Current Assets/Current Liabilities
Measures ability to meet short-term cash needs
Quick or Acid Test Ratio Current Assets-Inventory/Current Liabilities
Measure ability to meet short-term cash needs more
rigorously
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Other Ratios : For the Investor
Earnings per Share
PAT /Average Equity Shares
Indicates return on a per share basis
Book Value of the Share
Net worth / Number of shares
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CASH FLOW STATEMENT
CASH IS CASH REST IS
ACCOUNTING!!!
Accounting profits do not help in assessing
the firms ability to meet its debts
As they are based on accrual concept
As they are based on subjective judgements like
depreciation
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CASH FLOW STATEMENT
Cash flow statement can be taken as a summary of the
cash book
Need for cash flow statement arises from the
deficiencies in the profit and loss a/c and the balance
sheet, as these numbers are influenced by the
accounting policies etc
Cash flow statement helps in forecasting future value.
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Objectives of a CFS
Provide information to the user on: -
- ability of the enterprise to generate cashand cash equivalents and the timing and
certainty of their generation.- the manner in which the enterprise putscash and cash equivalents to use.
- financial structure, liquidity, solvency,netassets and adaptability of the enterprise
-
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CASH FLOW STATEMENTS
Provides information on cash flow related
to operation financing and investing
activities Firms follow the accrual and matching
principle to record transactions and hence
the company's incomes/ expenses are notrelated to cash
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CASH FLOW STATEMENTS
CASH FLOWS ARE DIVIDED INTO 3SEGMENTS AS :
CASH FLOW FROM OPERATING ACTIVITY CASH FLOW FROM INVESTING ACTIVITY
CASH FLOW FROM FINANCING ACTIVITY
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OPERATING ACTIVITIES
Includes the cash flows derived from principal
revenueproducing activities of enterprise.
Cash receipts from main business of
company.
Cash receipts from royalties, fees, etc.
Cash payment to supplier.
Cash payment to and behalf of employees.
Cash payments or refunds of income tax.
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INVESTMENT ACTIVITIES
Shows the expenditure that have been made
to generate future income and cash flows.
Cash payment to acquire fixed assets.
Cash receipts from disposal of fixed
assets(including intangibles)
Cash payment to acquire shares ,warrants
or debt instrument of other firms.
Cash receipts from disposal of shares etc
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FINANCING ACTIVITIES
Cash proceeds from issuing shares or
other similar instruments
Cash received from debentures,loans
bonds and other borrowings
Cash repayments of amount borrowed.
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Profitable, yet in Trouble?
A firm is defined as profitable if it has a
positive net income
A positive net income results from revenues
exceeding expenses
A firm may have a positive net income, but
this does not guarantee that the firm has the
CASH to meet its obligations!
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Cash Flow from operations
1.Started business with share capital of Rs.50000
2. Purchased goods for Rs. 50000 paid 60 % in cash,balance payable
3. Sold goods costing Rs. 40000 for Rs. 100000 on onemonth credit.
4. Purchased equipment for Rs. 15000
5. Depreciation of Eqpt. Rs. 3000The month end. Prepare the Financial Statements
The company wants to declare dividends of Rs. 40000 ?
Operating Results: Transaction
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Operating Results: Transaction
analysis
1. BS: Capital 50000 = Cash 50000
2. Capital 50000 + Crs 20000 = Inventory 50000 +Cash 20000
3. OE 50000+ Profit 60000+ Crs 20000= Drs 100000 + Inv 10000 + Cash 20000
4. OE 50000+ Profit 60000+Crs 20000 =Eqpt 15000+DRs 100000+ Inv 10000+Cash 5000
5.
OE 50000+ Profit 57000+Crs 20000 =Eqpt 12000+DRs 100000+ Inv 10000+Cash 5000
There is profit of 57000 after depreciation but no cash ?
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Cash Flow (Direct Method)
1. CFO:
Paid Creditors (30000)
2 CFF
Capital +50000
CFI
Equipment (15000)
Ending Cash Balance 5000
Cash Flow (Indirect Method)
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Cash Flow (Indirect Method)
1. CFO:PAT 57000
Add: Depreciation 3000
Cash flow before WC Changes 60000
Increase Creditors 20000
Increase in Drs - 100000
Increase in Inv - 10000 -90000
Net outflow -30000
2 CFF
Capital +50000
3 CFIEquipment (15000)
Ending Cash Balance 5000
ACE Inc produced and sold Cassette Tapes. The cost of the Cassettes
R 8 d ld t R 10/ Th h d li f k i
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was Rs. 8 and were sold at Rs.10/- The company had a policy of keeping
inventory for 30 days. It also paid its suppliers by the due dates. The
company gave a credit of 30 days to its customers. The company had an
opening inventory of Rs. 80000, Cash of Rs. 100000 and Equity of Rs.280000 and Receivable Rs 1lac. The MD was happy with a whopping
profit of Rs. 210000, but the conservative accountant predicted a crisis
at this rate.
Particulars Sales ProductionApr 100000 12000 units
May 120000 16000
June 160000 18000July 180000 24000
Aug 240000 25000
Sep 250000 28000
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Ways to minimize cash holdings
Synchronize inflows and outflows.
Use a remote disbursement account. Increase forecast accuracy to reduce need for
safety stock of cash.
Hold marketable securities (also reduces need
for safety stock).
Negotiate a line of credit (also reduces need
for safety stock).