Financial Statement Analysis

Introduction to Financial Statement Analysis

• Financial statement analysis is an exceptionally powerful tool for a variety of users of financial
statements, each ratio having different objectives in terms of indicating the financial circumstances
of the entity.
• It is not any single ratio that can give the entire story of the financial performance, rather a
collective study of all the ratios help to understand the complete scenario.
• It is always advisable to analyse each ratio in the context of the Industry parameters to judge the
over all company performance. Within the company each ratio can be compared with the past
couple years trend (for e.g., past five years) to judge the over all performance of the company.
• There are two key methods for analyzing financial statements. (1) use of horizontal analysis (2)
vertical analysis.
• Horizontal analysis is the comparison of financial information over a series of reporting periods,
over a couple of years we say how the company is performing.
• Vertical analysis is the proportional analysis of a financial statement, where each line item on a
financial statement is listed as a percentage of another item. Typically, this means that every line
item on an income statement (for e.g., operating expenses, other expenses, other income etc.) is
stated as a percentage of gross sales, while every line item (for e.g., current asset, tangible fixed
asset, liquid asset etc.) on a balance sheet is stated as a percentage of total assets.
 Financial Statement Analysis

• Liquidity position
• Profitability
• Solvency
• Financial Stability
• Quality of the Management
LIQUIDITY RATIOS
Current assets Ability to satisfy current
Current ratio = liabilities using current assets
Current liabilities
Short−term Ability to satisfy current
Cash + + Receivables
Quick ratio = investments liabilities using the most liquid of
Current liabilities current assets.
 Current Ratio
HUL Industry
2008 0.63 0.97
2009 0.9 1.11
2010 0.8 1.03
2011 1.05 1.07
2012 1.21 1.18
2013 0.99 1.16
2014 1.03 1.14
2015 1.05 1.11
2016 1.03 1
Source: www.moneycontrol.com/
Source: www.capitaline.com/SiteFrame.aspx?id=1
 Current Ratio
FMCG Steel Software Airlines Oil Exploration Constuction
2008 0.97 1.68 2.5 1.11 1.25 1.48
2009 1.11 1.5 2.22 0.77 1.3 1.58
2010 1.03 1.24 2.05 0.58 1.23 1.7
2011 1.07 1.53 2.39 0.72 1.33 2.06
2012 1.18 1.68 2.85 0.98 1.49 2.4
2013 1.16 1.54 3.02 0.9 1.57 2.54
2014 1.14 1.44 3.14 0.93 1.6 2.48
2015 1.11 1.36 3.11 1.02 1.58 2.44
2016 1 1.32 2.92 1.07 1.61 2.53
Source: www.capitaline.com/SiteFrame.aspx?id=1
 RATIOS INDICATING MANAGEMENT OF CURRENT ASSETS

Net Sales
Receivables turnover =
Average receivables

How many times accounts receivable are created and collected during the period

Number of days of receivables = 365/Receivables turnover

Average days it takes to create and sell inventory

 Receivable Receivable
Turnover Turnover 45
(Industry) (HUL) 40
Mar '15 26.91 40.92 35
Mar '14 25.61 35.83 30
Mar '13 26.34 36.08 25
Mar '12 24.85 28.58 20
Mar '11 22.05 25.56 15
Mar '10 25.66 30.12 10
Mar '09 40.58 35.28 5
Dec '07 8 33.26 0
Mar Mar Mar Mar Mar Mar Mar Dec Dec Dec
Dec '06 27 27.04
'15 '14 '13 '12 '11 '10 '09 '07 '06 '05
Dec '05 24.93 23.64
Receivable Turnover (Industry)
Receivable Turnover (HUL)
 Cost of goods sold
Inventory turnover =
Average inventory
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐌𝐚𝐭𝐞𝐫𝐢𝐚𝐥 𝐂𝐨𝐧𝐬𝐮𝐦𝐞𝐝
Inventory turnover =
Average inventory

How many times inventory is created and sold during the period
In both the formula
Number of days of inventory =365 /Inventorty turnover meaning is same
and we have to take
the Cost of Goods
Average days it takes to collect on accounts receivable Sold = Opening
Inventory +
Purchase –Closing
Inventory

Note: Irrespective of what kind of inventory has been used i.e., company may use raw material, consumables,
supplies, packing materials we are expected to take all of them together. In the HUL Case they have two different
types of inventory but we are considering them all. This is because while taking the figure of inventory from B/S we
are not differentiating among different inventory category.
 Accounts Payable Turnover Ratio= Cost of Goods Sold
Average Accounts Payable

• The measure shows how many times per period the company pays its average payable
amount.

365
Number of days of payables =
Accounts payables turnover

Average days it takes to pay its suppliers

 Net operating cycle Number of days Number of days Number of days
or = + −
Cash conversion cycle of inventory of receivables of payables

The lower the number the better, a low number compared to peers within an
industry indicates strong cash flow creation from internal operations.
 Average Inventory
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑦𝑎𝑠𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑

Average Receivables
Average days of revenues

Average Accounts payable

Average 𝑑𝑎𝑦𝑠
of Cost of Goods Sold

Net operating cycle Number of days Number of days Number of days

or = + −
Cash conversion cycle of inventory of receivables of payables
 Working Capital Ratios
Net Working Capital (NWC) : NWC = Current Assets – Current Liabilities
Working Capital Turnover Ratio
Net sales
(Beginning working capital + Ending working capital) / 2

• A high working capital turnover ratio can potentially give you a competitive edge in your
industry. It indicates you use up your working capital more times per year, which suggests that
money is flowing in and out of your small business smoothly. This gives you more spending
flexibility and can help avoid financial trouble.

Days Working Capital = Average Working Capital * 365/ Annual Sales Revenue

• It indicates how many days it will take for a company to convert its working capital into
revenue. The faster a company does this, the better. In other words, a high number is
indicative of an inefficient company and vice versa.
 Over all Performance Measure
Price/Earnings Ratio (PE Ratio) Market Price Per Share
Net Income Per Share

Return on Asset Ratio Earning Before Interest and Tax (EBIT)

Average Total Asset

Return on Invested Capital Earning Before Interest and Tax (EBIT)

Long Term Debt + Average Shareholder Equity

Return on Equity Net Income

Average Shareholder Equity
 Price/Earnings Ratio Market Price Per Share
Net Income Per Share

2016-17 2016-17
Profit for the year 447000,00,000 449000,00,000
Authorised Shares 2,25,00,00,000 2,25,00,00,000
Outstanding and Issued Shares 2164349639 2164349639
Share Price (31st March 2017) 909.75 909.75
Market Cap 1969017084080.25 1969017084080.25
Earnings per share 20.65 20.75
Share Price (17th May 2017) 1006.35
P/E Ratio (31st March 2017) 43.85
P/E Ratio(17th May 2017) 48.51
ICICI REPORT SHARE PRICE 1158
ICICI Report 55.82
Earnings Yield (1/PE Ratio) 0.02
 2016-17 2016-17
Profit for the year 447000,00,000 449000,00,000
Authorised Shares 2,25,00,00,000 2,25,00,00,000
Outstanding and Issued Shares 2164349639 2164349639 4,12,668
Share Price (31st March 2017) 909.75 909.75 21647,62,307
Market Cap 1969017084080.25 1969017084080.25 20.74
Earnings per share 20.65 20.75
Share Price (17th May 2017) 1006.35
P/E Ratio (31st March 2017) 43.85
P/E Ratio(17th May 2017) 48.51
ICICI REPORT SHARE PRICE 1158
ICICI Report 55.82
Earnings Yield (1/PE Ratio) 0.02
 Price/Earnings Ratio Market Price Per Share
Net Income Per Share
Mar-16 Mar-15
Profit For the Year (PAT) 40823700000 43152600000
Authorised Shares 2250000000 2250000000
Outstanding Issued Shares 2163936971 2163464851
08 September 2016 08 September 2015
Share Price (NSE) 947.45 802.45
Market Capitalisation 2050222083173.95 1736072369684.95
Earnings Per Share (Profit/Share
Outstanding) EPS 18.87 19.95
Price/Earnings Ratio (PE Ratio)
50.22 40.23
Note: Earnings Yield = 1/ (PE Ratio) = Divide the earnings by the price (E/P). The earnings yield tells
an investor how much return (on a per-share basis) the stock's shareholders earned over the past
12 months, based on the current share price.
 Market Related Measures
• Earnings Per Share (EPS) = Net Profit/ No. of outstanding shares
• Price Earning Ratio (PE Ratio) = Market Price Per Share/ Earnings per share

Forward PE Ratio = Current Trailing PE Ratio = Current Market

Market Price/ Forecasted Earnings Price/ Last Four Quarter Earnings

• Diluted earnings per share, or Diluted EPS, is a firm's net income divided by the
sum of it's average shares and other convertible instruments.

• Cash earnings per share (Cash EPS) is a measure of financial performance that
looks at the cash flow generated by a company on a per share basis.
Return on Asset Ratio Earning Before Interest and Tax (EBIT)
Average Total Asset

Mar-16 Mar-15
Profit Before Tax (PBT) 5870.59 6187.42
Interest Expenses 0.18 16.82
EBIT (PBT + Interest Expenses) 5870.77 6204.24
Total Assets (from Balance Sheet) 14167.03 13634.06
Average Total Assets 13900.545 13634.06
Return on Total Asset(%) 42.23 45.51

Total Fixed Asset 3300.70 2936.54

Tangible Fixed Asset 2902.73 2435.50
Average Total Fixed Asset 3118.62 2936.54
Average Tangible Fixed Asset 2669.115 2435.50
Return on Total Fixed Asset (%) 188.25 211.28
Return on Tangible Fixed Asset (%) 219.95 254.74
Return on Invested Capital Earning Before Interest and Tax (EBIT)
Long Term Debt + Average Shareholder Equity

Mar-16 Mar-15
Profit Before Tax (PBT) 5870.59 6187.42
Interest Expenses 0.18 16.82
EBIT (PBT + Interest Expenses) 5870.77 6204.24

Equity Share Capital 216.39 216.35

Reserves and Surplus 3,470.90 3,508.43
Total Shareholders Funds 3,687.29 3,724.78
Average Sharehlder Fund 3706.035 3,724.78
Long Term Debt 0 0
Return on Invested Capital (%) 158.41 166.57
 Return on Equity Net Income
Average Shareholder Equity

Mar-16 Mar-15
EQUITIES AND LIABILITIES
Equity Share Capital 216.39 216.35
Reserves and Surplus 3,470.90 3,508.43
Total Shareholders Funds 3,687.29 3,724.78
Average Sharehlder Fund 3706.035 3,724.78
Profit For the Year (PAT) 4082.37 4315.26
Retrun on Equity (ROE) % 110.15 115.85

Note: For all practical purpose whenever data is available it is advised to take average shareholder
equity.
 Some More Concepts
• Price Earnings Growth Ratio (PEG ratio) = PE Ratio/Annual EPS Growth Rate
• PE Ratio = Market Price Per Share/ Earnings per share
• P/E ratio shows how much you are paying in relation to earnings, the PEG ratio
expresses how much you are paying in relation to the growth.
• PEG < 1 as meaning that you are getting more growth than you are paying for.
• PEG > 1 as getting less growth than what you are paying for.
• PEG ratio =1 implies that the stock is fairly valued given the expected growth
rate.
• There can be a negative PEG ratio.
• If the PEG ratio is negative because of a negative P/E ratio it is a red warning of
poor performance.
• If PEG ratio is negative due to company’s growth is negative. But, companies
lose growth every once in a while, especially temporarily.
 PEG Ratio: A Comparison
HUL PEG Ratio
Mar-16 Mar-15
PE Ratio 50.22 40.23
Earnings Yield (1/PE Ratio) 0.020 0.025
Basic EPS (Rs.) 18.87 19.95
Growth Rate in EPS -5.41
PEG Ratio -9.28
Agro Tech Foods Mar-16 Mar-15
PE Ratio 50 50
Earnings Yield 0.02 0.02
Basic EPS (Rs.) 9.59 15.3
Growth Rate in EPS -37.32
PEG Ratio -1.34

Sahare Price Comparision Mar-16 Mar-15 Return (%)

HUL 869.5 837 3.88
Agro Tech Foods 469.8 638.35 -26.40
Investment Utilisation for Managerial Performance
Asset Turnover Net Sales Revenue
Average Total Asset
Equity Turnover Net Sales Revenue
Shareholder Equity
Invested Capital Turnover Net Sales Revenue
Long Term Debt + Shareholder Equity
Capital Intensity Net Sales Revenue
Tangible Fixed Assets
Advertisement Intensity Advertising Expenditures
Net Sales
R&D Intensity R&D Expenditure
Net Sales
 Mar-16 Mar-15
Income Statement Information
Revenue From Operations [Gross] 34,417.48 32,721.44
Less: Excise/Sevice Tax/Other Levies -2,430.31 -1,915.82
Revenue From Operations [Net] 31,987.17 30,805.62
Balance Sheet Information
Equity Share Capital 216.39 216.35
Reserves and Surplus 3,470.90 3,508.43
Total Shareholders Funds 3,687.29 3,724.78
Average Sharehlder Fund 3706.035 3,724.78
Long Term Debt 0 0
Total Assets 14167.03 13634.06
Tangible Fixed Asset 2902.73 2435.50
Average Total Assets 13900.55 13634.06
Average Tangible Fixed Asset 2669.115 2435.50
Asset Turnover (Times) 2.30 2.26 Net Sales Revenue/ Average Total Asset

Equity Turnover (Times) 8.63 8.27 Net Sales Revenue /Shareholder Equity
Invested Capital Turnover (Times) 8.63 8.27 Net Sales Revenue/Invested Capital
Capital Intensity (Times) 11.98 12.65 Net Sales Revenue/Tangible Fixed Assets
Fixed Asset Turnover Ratio of Different Industry
Year Software Construction
Automobiles
Farma FMCG Entertainment CEMENT Steel
2008 4.9 4.4 3.04 2.31 1.96 1.75 1.27 1.28
2009 4.55 3.23 2.54 2.23 7.4 1.68 1.2 1.22
2010 3.53 3.2 2.72 2.13 4.87 1.63 1.22 1.12
2011 3.76 3.23 3.05 2.53 4.71 1.55 1.02 1.11
2012 4.02 2.76 3.11 1.52 5.49 1.46 1.12 1.11
2013 4.19 3.06 3.06 1.37 5.42 1.27 1.09 0.95
2014 4.64 2.4 2.78 1.42 5.24 1.27 1.03 0.92
2015 3.85 1.8 2.38 0.76 4.78 0.97 0.99 0.78
2016 4.29 0.49 1.68 0.62 4.65 0.54 0.76 0.43
 DuPont Analysis Components
• DuPont analysis breaks ROE into three components to determine which of these
components is most responsible for changes in ROE.
• ROE = Profit Margin x Asset Turnover Ratio x Equity Multiplier (or leverage Ratio).
• ROE = (Net Income/Revenues) x (Revenues/Total Assets)
x (Total Assets/ Shareholders' Equity)

• The DuPont Analysis is important determines what is driving a company's

ROE; Profit margin shows the operating efficiency, asset turnover shows the
asset use efficiency, and leverage factor shows how much leverage is being
used.
• The method goes beyond profit margin to understand how efficiently a
company's assets generate sales or cash and how well a company uses debt to
produce incremental returns.
 ROE = (Net Income/Revenues) x (Revenues/Total Assets) x (Total Assets/
Shareholders' Equity)
Required Information from Balance Mar-16 Mar-15
sheet and Income Statement
Revenue From Operations [Gross] 34,417.48 32,721.44
Less: Excise/Sevice Tax/Other Levies -2,430.31 -1,915.82
Revenue From Operations [Net] 31,987.17 30,805.62
Total Shareholders Funds 3,687.29 3,724.78
Average Sharehlder Fund 3706.035 3,724.78
Total Assets (from Balance Sheet) 14,167.03 13,634.06
Profit For the Year (PAT) 4082.37 4315.26
(A) Profit Margin (Net Profit/ Net Sales) 0.1276252 0.14008 Mar-16 Mar-15
EQUITIES AND LIABILITIES
(B) Asset Turnover ( Net Sales / Total Asset) 2.25786 2.25946 Equity Share Capital 216.39 216.35
Reserves and Surplus 3,470.90 3,508.43
(c ) Equity Multiplier (Total Asset / Equity Capital)
3.8226919 3.660367 Total Shareholders Funds 3,687.29 3,724.78
Retrun on Equity (A X B X C) 1.10 1.16 Average Sharehlder Fund 3706.035 3,724.78
Profit For the Year (PAT) 4082.37 4315.26
Retrun on Equity (%) 110.15 115.85 Retrun on Equity (ROE) % 110.15 115.85
Profit Margin Ratio Can
be Further Divided in to
three Sub Parts i.e., Tax
Burden, Interest burden
and EBIT Margin
 Financial Condition Ratios
Debt to Equity Ratio Long Term Debt
Shareholder Equity
Debt Capitalisation Ratio Long Term Debt
Note: Measures the debt component of a company's capital Long Term Debt + Shareholder Equity
structure, or capitalization (i.e., the sum of debt and Equity)
Interest Coverage Ratio Earning Before Interest and Tax (EBIT)
Note: Measures a company's ability to make interest Interest Expenses
payments on its debt in a timely manner.
Cash Flow to Debt Ratio Cash Flow from Operation
Note: Measures the ability of a business to support its debt Long Term Debt + Short Term Debt
obligations from its operating cash flows.
 Mar-16 Mar-15
Profit Before Tax (PBT) 5870.59 6187.42
Interest Expenses 0.18 16.82
EBIT (PBT + Interest Expenses) 5870.77 6204.24
Equity Share Capital 216.39 216.35
Reserves and Surplus 3,470.90 3,508.43
Total Shareholders Funds 3,687.29 3,724.78
Average Sharehlder Fund 3706.035 3,724.78
Long Term Debt 0 0
Debt to Equity Ratio 0 0
Debt Capitalisation Ratio 0 0
Interest Coverage Ratio (Times) 32615.39 368.86088
Note: HUL is a debt free company the amount of interest (i.e., finance cost) is only because of some over draft. It is not purely an
interest expenses. Hence you may ignore in this case to include it for calculation. It has been given here is just for developing
your understanding. Practically speaking as it is a debt free company we can comfortably say it has no interest coverage
requirement. For this calculation we are assuming that Finance cost is similar to Interest expenses.
HUL Annual Report (2015-16) Page no. 6
HUL Is Debt Free Since 2009-10
 Comparison of Debt/Equity Ratio of Different Industry
Year Software FMCG CEMENT Entertainment Farma Automobiles Construction Steel
2008 0.04 0.21 0.53 0.44 0.84 0.39 0.78 0.75
2009 0.1 0.26 0.44 0.56 0.9 0.5 0.92 0.83
2010 0.12 0.16 0.43 0.53 0.73 0.48 1.28 0.96
2011 0.11 0.19 0.49 0.43 0.67 0.41 1.49 1
2012 0.1 0.24 0.51 0.61 0.48 0.47 1.19 1.04
2013 0.1 0.22 0.5 0.77 0.36 0.51 1.08 1.13
2014 0.07 0.2 0.5 0.73 0.36 0.54 1.34 1.26
2015 0.06 0.18 0.52 0.64 0.28 0.51 1.46 1.33
2016 0.06 0.23 0.61 0.47 0.19 0.3 1.15 1.3
Source: www.capitaline.com/SiteFrame.aspx?id=1
 Dividend Policy
Dividend Yield Dividend Per Share
Market Price Per Share
Dividend Pay-out Ratio Dividends
Net Income
Retention Rate (b) (1-Dividend Pay-out Ratio)

Net Income x (1-Dividend Pay-out Ratio)

Implied Growth Rate Shareholder’s Equity

Or (ROE X b)
 Mar-16 Mar-15
Profit For the Year (Rs. in Crore) 4082.37 4315.26
Profit For the Year (PAT) 40823700000 43152600000
Authorised Shares 2250000000 2250000000
Outstanding Issued Shares 2163936971 2163464851
08 September 2016 08 September 2015
Share Price (NSE) 947.45 802.45
Dividend Paid (Rs. in Crore) 3342.62 2912.3
Dividend Paid 33426200000 29123000000
Dividend Per Share 15.45 13.46
Dividend Yield (%) 1.63 1.68
Dividend Pay-out Ratio (%) 81.88 67.49
Retention Rate 0.18 0.24
Retrun on Equity (ROE) 1.10 1.16
Implied Growth Rate 0.20 0.27
 Other Valuation Ratios
Shareholder’s Equity - Preferred Stock
Book Value Per Share No. of Shares Outstanding

Book To Market Ratio

Note: A high ratio is often interpreted as a value stock (the market is Book Value Per Share
valuing equity relatively cheaply compared to book value). Market Price Per Share
Price-to-Sales Ratio
Note: Is the perceived value of a stock by the market compared to the Price Per Share
revenues of the company. Also known as sales multiple or revenue Revenue Per Share
multiple. The price-to-sales ratio is an indicator of the value placed on each
dollar of a company’s sales or revenues. Stocks having a low ratio (
considered as value stock) outperform those with a high price to sales ratio
(considered as Growth Stock).
Enterprise Value to EBITDA Ratio (EV/EBITDA) Enterprise value
EBITDA
Note: It is a comparison of enterprise value and earnings before interest,
taxes, depreciation and amortization. Used for estimating the business Enterprise Value = The market capitalization of
valuations. It gives a true picture of a company's valuation and its earning a firm's equity + the market value of the firm's
potential. Also known as the enterprise multiple. In its formula, the book debt (i.e., preferred shares, minority interest, etc)
value of debt can be used as a substitute to approximate its market value.
 Shareholder’s Equity - Preferred Stock
Book Value Per Share No. of Shares Outstanding
Book To Market Ratio
Note: A high ratio is often interpreted as a value stock (the Book Value Per Share
market is valuing equity relatively cheaply compared to book Market Price Per Share
value).

Mar-16 Mar-15
Equity Share Capital 216.39 216.35
Reserves and Surplus 3,470.90 3,508.43
Total Shareholders Funds (Rs. in Crore) 3,687.29 3,724.78
Total Shareholders Funds 36872900000 37247800000
Outstanding Issued Shares 2163936971.00 2163464851.00
Book Value Per Share 17.0397292 17.21673453
08 September 2016 08 September 2015
Share Price (NSE) 947.45 802.45
Book-To Market Ratio 1.80 2.15
 Price-to-Sales Ratio Price Per Share
Note: Is the perceived value of a stock by the market
compared to the revenues of the company.
Revenue Per Share

Mar-16 Mar-15
Revenue From Operations [in Crore)] 31987.17 30805.62
Revenue From Operations 319871700000.00 308056200000.00
Outstanding Issued Shares 2163936971.00 2163464851.00
Sales Per Share 147.82 142.39
08 September 2016 08 September 2015
Share Price (NSE) 947.45 802.45
Sales to Price Ratio 0.16 0.18
Free Cash Flow to Equity
• Interest cost is a cash flow to one of the stakeholder’s of the firm
(debt holders) and hence, it forms a part of FCFF
• This definition of working capital excludes cash and cash equivalents
and short-term debt (notes payable and the current portion of long
term debt payable).
 Net Operating Profit After Tax (NOPAT)
• Net operating profit after tax (NOPAT) is a measure of profit that
excludes the costs and tax benefits of debt financing.
• NOPAT is a company's potential cash earnings if its capitalization
were unleveraged – that is, if it had no debt.
• It is a profitability measurement that calculates the theoretical
amount of cash that a company could distribute to its shareholders
if it had no debt.
• NOPAT = Operating Income x (1 - Tax Rate)
• NOPAT = Net Profit + Net Interest x (1 - Tax rate)
• NOPAT = EBIT(1-Tax rate)
 The Economist has pointed out during the four years
under Cyrus Mistry most Tata companies had registered a
negative economic value add, which means their earnings
before interest and tax were less than the cost of capital.
For instance, for every Rs.100 of the capital employed the
average interest paid was about Rs.8.5 but the earnings
were less than that.

Seven of the nine-largest listed

Tata entities in terms of capital
employed have negative
economic value added, meaning
that their earnings before interest
and tax translate into a return
below their overall cost of
capital. https://www.economist.com/news/business/21707595-indias-most-important-business-group-socially-responsible-
financially
 Economic Value Added (EVA)
• A successful performance measure evaluates how well an organisation performs in
relation to its objectives. Since the primary objective of commercial organisations is
normally assumed to be the maximisation of the wealth of its shareholders, it follows
that performance measures should evaluate this.

• Profit ignores the cost of equity capital. Companies only generate wealth when they
generate a return in excess of the return required by providers of capital – both equity
and debt. In financial statements, the calculation of profit does take into account the cost
of debt finance, but ignores the cost of equity finance.

• Economic Value Added is calculated as the difference between the Net Operating Profit
After Tax (NOPAT) and the opportunity cost of invested Capital. This opportunity cost is
determined by multiplying the Weighted Average Cost of debt and equity Capital
(WACC) and the amount of Capital employed. EVA = NOPAT - WACC*Capital
 Economic Value Added#
• EVA = Net Operating Profit after Taxes (NOPAT) - Cost of Capital
Employed (COCE)
where,
• NOPAT = Profits after depreciation and taxes but before interest costs.
NOPAT thus represents the total pool of profits available on an ungeared
basis to provide a return to lenders and shareholders, and
• COCE = Weighted Average Cost of Capital (WACC) x Average Capital
Employed
• We can calculate Economic Value Added® by multiplying Capital by the
difference between the Return on Capital (ROC) and the WACC. EVA =
Capital*(ROC - WACC)
• #Developed by Stern Stewart & Co
 Market Value Added (MVA)

• Market Value Added = Market Value - Capital Invested

• The market value added (MVA) is a performance measurement tool that

computes for the increase in the value of the company's stock price.

• The MVA is derived by comparing the total market value of the firm and
the book value of the invested capital.

• The higher the MVA, the better. Investors apparently want their invested
capital to grow.
Additional Readings Discussed in The class
• http://www.livemint.com/Home-
Page/AChB65bPgQqACtcGmsCCUI/The-curious-case-of-Ricoh-Indias-
balance-sheet.html
• http://www.moneycontrol.com/news/current-affairs/ricoh-india-
case-identical-to-satyam-fraud-anil-singhvi_6712421.html
• http://www.livemint.com/Money/Y0UJEQnYpRlkCMNSYSje5K/Ricoh-
India-its-parent-company-and-investors-have-all-lived.html