Business Analysis

Types of Business Analysis

Credit Analysis
Equity Analysis
Business Environment and strategy Analysis
Financial Analysis
Prospective Analysis
Valuation
 Roadmap to Financial Analysis
Business Analysis

Business Environment Analysis – Company’s

economic & industry circumstances, SWOT Analysis ,
industry analysis

Business strategy Analysis – Company’s business

decisions leading to a competitive advantage , its
product mix , cost structure

Company profile and significant events

Company shareholding pattern

Company Analysis

Financial performance
Revenues
Profitability
Asset Utilisation
Cash flows
Working capital Management

Stock performance
RATIO ANALYSIS
Terms
 Capital employed =
Equity shareholders funds + Preference share
capital + Long term borrowed funds

 Net worth = Equity shareholders funds +/-

Deferred tax
= Equity share capital + Reserves & surplus –
Miscellaneous Expenditure not written off +
Deferred tax

Turnover = Sales
ROI ratios
1. ROI = NP before tax and interest
Total capital employed
This ratio indicates the return earned by the company
on its total investment. This is very important to
shareholders and other stake holders as it is the
ultimate measure of the company’s overall
performance. This ratio when compared with industry
average gives an indication about the financial
performance of the company.

2. RONW = PAT – Preference dividend * 100

Net worth ( ESHs Fund )
This ratio indicates the return earned by equity
shareholders. High ratio means high dividend , better
growth prospects and high valuation in capital market.
3. EPS = PAT – Preference dividend
Number of equity shares

This ratio gives the return earned on each

share. It is an important measure of
profitability for the investors. This ratio is the
basis for valuation of companies in the event of
mergers etc, strategic investments by owners.
Higher ratio shows company in a positive light.
Higher ratio indicates higher returns
Comparative Standards / Benchmarking
 Industry leader
 Industry average
 WACC
 Cost of borrowings

Influencing factors
 Sales
 Cost economies
 Optimum capital structure
Structural ratios / Gearing ratios / Long term solvency ratios

1. Debt equity ratio = Long term Debt

Total net worth ( ESHs Funds + PC )

This ratio helps in assessing whether the company is relying on own funds
or borrowed funds. Higher the debt more fixed liabilities by way of interest.
FI s generally look for a D/E of 1.5 :1 while financing projects. This ratio
also indicates whether the company has a optimum capital structure to
improve the returns available to equity shareholders.

2. Debt service coverage ratio = NPBIT

Interest + Loan repayment
This ratio indicates the profits available to service the debts. This ratio is
very important for lenders. Higher the ratio higher is the ability of the
company to finance the debt and less risk of default.

3. Interest coverage ratio = NPBIT

Interest
 Comparative Standards / Benchmarking
 Industry average
 NAV of industry leader / laggard
 Institutional norms
 Growth / Decline over the previous years

Influencing factors
 ROI & EPS
 Dividend policy
Liquidity ratios
1. Current ratio = Current Assets, loans & Advances
Current liabilities & Provisions

2. Quick ratio =
Current Assets, loans & Adv – inventories – prepaid Exp
Current liabilities & Provisions– Bank overdraft

These 2 ratios helps in analyzing the current assets and current

liabilities of the company and its ability to discharge its day to
day obligations Quick ratio is more realistic. It indicates the
extent to which the company has current assets to meet its
current liabilities. Higher the ratio higher is the solvency level of
the company and less risk of default.
Comparative Standards / Benchmarking
 Institutional norms
 Effective asset utilisation
 Cost economies
 Proportion of non cash charges in expense
structure

Influencing factors
 Proper asset liability management
 Credit period availed and credit period allowed
 Inventory management / Supply chain
management/ level of obsolescence
Efficiency ratios
1.Fixed assets turnover ratio = Net sales
Net block of fixed assets

Fixed assets are income generating assets for any company.

This ratio indicates the efficiency with which the fixed assets
are used to generate revenue. Higher the ratio better is the
utilization of assets for generating sales.

2. Net worth turnover ratio = Net sales

Net worth

This ratio indicates the overall financial and operational

efficiency of the company
It is an indication about the optimum capital structure and
production efficiencies of the company.
3. Debtors Turnover ratio = Net Sales
Avg. Debtors

This ratio indicates the number of times the

debtors are converted into cash.

4. Average debt collection period =

Avg. Debtors * 360 days
Sales
5.Inventory Turnover ratio = COGS
Avg. inventories

This ratio shows the number of times a

company’s inventory is turned into sales.

6. Avg. Inventory holding period =

Avg inventories * 360
COGS
Comparative Standards / Benchmarking

 Industry average
 Industry leader
 Trend over a period of time

Influencing factors
 Production efficiencies
 Investment in relevant technologies
 Price and quality of products
Profitability ratios
1.GP ratio = GP*100
Sales

2. Net profit ratio = PAT * 100

Sales

These ratios study the profitability in relation to sales.

It helps to assess the business performance starting
from Gross Profit. Multi level profitability ratios helps
to understand the levels at which there is pressure on
margin ( profit )
Comparative Standards / Benchmarking
 Trend over a period of time
 Industry average
 Industry leader / laggard
 WACC

Influencing factors

 Qualitative and quantitative growth in sales

 Age of fixed assets ( depn )
 Cost of borrowing
 Efficient tax planning
Valuation ratios
1. P/E ratio = Market price of equity share
EPS

This ratio is the most popular ratio for valuation of a company

by the investors. This ratio indicates market confidence in the
company and its future prospects.

2. Book value per share ( Net Asset Value ) = Net worth

No. of equity
shares

This ratio measure the net worth per equity share. This ratio
indicates the efficiency of the company’s management in
building up reserves and its prudent financial practices.
Comparative Standards / Benchmarking
 Industry average
 Leaders & laggards in industry
 Trend over a period of time

Influencing factors
 Dividend policy
 Size of the company
 Market conditions
 NAV
 Cash flow ratios
Relevance

Large non cash expenses

Rapid growth
Window dressing – reality check
1.Cash flow to net income =

Cash from operations / Net income

2.Cash flow adequacy =

Cash from operations / Cash paid for
investment

Cash paid for investment = cash paid for capital

expenditure + cash paid for acquisitions

The denominator can also include cash paid for dividend

3. Cash times interest earned =

Cash from operations before interest & tax

Cash paid for interest
Analysts should take the following precautions

 Analysis of trends over a long period of time

 Interpretation of observation against industry
bench mark
 Analysis of core ratios only
 Inter firm comparison for variations in
accounting policies
 In case of conglomerates comparative
performance of different lines of business
Potential red flags

Unexplained change in accounting policy

Unusual increase in receivables, inventory,
creditors & depreciation.
Increase in unusual short term financing
Qualified audit opinion
Change in external auditor
Increase in related party transactions
1. Which company is more successful in using
leverage ?
A B

PBIT 18000 20000

Interest on debentures 3000 14400
Income tax 7000 2500
Debentures 20000 60000
Avg. total assets 70000 90000
Avg. shareholders equity 35000 20000
 Comment on the capital market standing of
both the companies . Which company’s share
would you recommend to a risk taking investor.

A B
EPS 3.50 6.75
DPS 2.00 3.00
Market price per share 60.00 95.00
Beta 1.30 1.50
 Du Pont Analysis

Return on Assets =
Profit margin * Asset Turnover

PAT * 100 = PAT * 100 * Sales

Total Assets Sales Total Assets

Return on Assets indicates the overall efficiency of

he business driven by profitability and efficiency in
use of assets.
ROE = Profit margin * Total Assets T.O * Equity M

NPAT = NPAT * Sales * Total Assets

Net worth Sales Total Assets Net worth

Equity multiplier depends upon the leverage of

the company. A highly levered firm will have a
high equity multiplier whereas a low levered firm
will have a low equity multiplier.
Illustration
2009 2008
Sales 121000 110000
PAT 15396 13545
Avg. Total Assets 74800 66094

Analyse ROA using Du Pont framework

 2009 2008

Net income 973 1841

Sales 26996 24006
T. Assets 37039 34621
Equity 9781 9063

Analyse the ROE using Du Pont Framework

2. The numbers below are for Iffy Co. and Model Co.
Explain the reason of low return on equity.
Iffy Model
Cash 120 900
Receivables 600 4500
Inventory 480 6000
Property, plant & equipment 3440 15000
Total liabilities 3190 18150
Shareholders equity 1450 8250
Sales 10000 75000
COGS 9200 66750
Wage expenses 700 5250
Net income 100 3000
Below is the data extracted from Doyle co.
2009 2008
Sales 211200 177600
Total Assets 201600 168000
Shareholders equity 52800 48000

Net income 17280 11520

Cash from operations 23040 31200
Cash paid for capital exp. 21360 15840
Cash paid for acquisitions 6000 480
Cash paid for interest 3600 2640
Taxes paid 9840 9600

In which year did the company perform better. Explain.

Which questions would you ask the management
before you invest in the said company
The following is the incomplete set of financial
statements of Arogya Co.
Income Statement for the y.e 31.03.09
Net sales 33000
COGS ?
Gross Profit 9000
PBIT ?
Interest ?
PBT ?
IT ?
PAT 35000
Balance Sheet as on 31.03.09
Shareholders fund
Share capital 28000
Reserves & Surplus ?
Liabilities
Secured loans 21000
Unsecured loans 17000
Current liabilities ?
Assets
Fixed Assets ?
Investments 2400
Inventories ?
Debtors ?
Cash 1500
Other Current Assets 600
a) Profit margin 7%
b) Current ratio 1.3
c) Debt equity 1.5
d) Inventory turnover 2 times
e) Avg. debt collection period 73 days (365 days
f) Interest coverage is 8 times
g) Return on assets is 3.5
 Predicting financial distress

Beaver and Altman employed statistical

techniques to predict financial distress. Five
financial ratios were able to discriminate
between bankrupt and non bankrupt
companies.
Manufacturing companies
Z = 1.2X1 + 1.4 X2 + 3.3X3 + 0.6X4 + 1.0 X5

Pvt. Manufacturing companies

Z1 = 0.717X1 + 0.847X2 + 3.107X3 + 0.42X4A
+ 0.998 X5

General use
Z2 = 6.56X1 + 3.26X2 + 6.72X3 + 1.05 X4A
X1 = Working capital to total assets
X2= Retained earnings to total assets
X3= EBIT to total assets
X4= Market value of equity to book value of total
liabilities
X4A = Net worth to Total liabilities
X5 = Sales to total assets
Scores

Safe Grey Bankrupt

Z > 2.99 1.81-2.99 <1.81
Z1 > 2.90 1.23 – 2.90 < 1.23
Z2 > 2.60 1.10 – 2.60 < 1.10
Illustration

Determine impact of the transactions listed on the

following ratios :

1. Current ratio
2. Asset turnover ratio
3. Debt Equity ratio
4. Debtors turnover ratio
5. Quick ratio
6. Inventory ratio
7. Return on equity
8. Return on capital employed
9. Profit margin
10. Debt service coverage ratio
1.Received dividend from an associate
2.Made down payment for purchase of machinery
3.Sold investments for cash
4.Received payment from customer
5.Issued convertible debentures for cash
6. Accrued income tax
7.Paid advance to a supplier of materials
8.Exchanged equipment for a motorcar
9.Sold machinery for a loss
10.Retired a fully depreciated plant form use.
 Calculate cash flows from operating activities, investing activities and
financing activities.
Rs. lacs
1. Issue of shares 10.00
2. Dividend received 0.25
3. Dividend paid 0.50
4. NPAT 12.00
5. Depreciation 1.00
6. Goodwill w/off 1.00
7. Increase in Drs 3.00
8. Increase in Crs 3.00
9. Repayment of loan 5.00
10. Purchase of fixed assets 6.00
11. Sale of investments 0.55
12. Tax 2.50
13. Capital advances paid 1.75
14. Interest paid on loans 0.25
15. Impairment loss on fixed assets 1.35
16. Interest received on ICDs 0.45