Financial Statement Analysis

Session Three
 Introduction
• The financial health of a company can be assessed
from two viewpoints:
– its financial statements, giving its financial position, its
operating results, and net cash flows
– capital market response to firm performance
• The basic purpose of providing two-year information
(current year and previous year) in financial
statements is to facilitate comparison
• However, simple comparison of absolute numbers in
the financial statements does not offer much insight
due to size disparity, accounting policy changes etc.

1–2
 Relation and Comparison of Data

• Accounting data in absolute terms do not provide much

meaning – their analysis involves comparison and
relation
• Ratio analysis - Whenever one item is expressed (as a
fraction or a decimal fraction or an integer) in terms of
another item
• Example – A firm earns a net profit of Rs. 20,000 on a
sale of Rs. 500,000. We could express this relationship
in terms of sales margin of 4%
• Comparisons could be made
– With Company’s past performance
– With Competing Firms
– With Industry/Economy trend
– With Budgets (Planning and Control)
1–3
 Fund Flow Analysis

• Where Got Where Gone Statement

• Sources of Funds = Uses of Funds

1–4
 Financial Ratios
• Financial ratio represents a relative measure
where both the numerator and the
denominator are financial numbers.
• There are three class of financial ratios:
– Balance Sheet Ratio
• Where both the variables are taken from the Balance
Sheet.
– Profit and Loss Ratio
• Where both the variables are taken from Profit and Loss
Account.
– Mixed Ratio
• Where one variable is taken from Balance Sheet and the
other from Profit and Loss Account.

1–5
Performance Analysis: Four window approach

Liquidity

Efficiency Shareholders’ Profitability

value

Leverage

1–6
 Liquidity Ratios
• These ratios indicate the ability of the firm
to meet its short-term obligations (e.g.,
payment of salary, taxes, loans etc.)
• The timeframe for the expression “short-
term” is generally twelve months.
• The challenge for any treasury manager is
to manage the cash flow leads and lags.
• Liquidity management essentially involve
constant monitoring of cash flow position.

1–7
 Liquidity Ratios
• Current Ratio
Current Assets
Current Liabilities

• Quick Ratio
Current Assets – Inventory
Current Liabilities

• Financial Slack
Cash & Bank balances *100
Total Assets
1–8
 Liquidity Ratios

Tata Asian
Maruti Marico Colgate Infosys Steel Paints TCS

Liquidity

Current Ratio 1.888 2.018 0.859 4.913 0.815 1.264 2.026

Quick Ratio 1.444 1.277 0.647 4.913 0.397 0.619 2.021

Financial Slack 25.37 5.606 31.94 49.34 2.35 3.98 6.87

1–9
 Liquidity Ratios: Story of three companies

Year Mar 1999 Mar 2000 Mar 2001 Mar 2002 Mar 2003 Mar 2004
Maruti Udyog Ltd.
Current Ratio 1.29 1.02 1.08 1.16 1.67 1.26
Quick Ratio 0.87 0.49 0.78 0.79 1.36 0.77
Financial slack 19.27 0.65 1.74 1.49 18.06 4.18
Infosys Technologies Ltd.
Current Ratio 6.43 4.20 2.70 3.12 3.29 1.52
Quick Ratio 6.43 4.19 2.70 3.12 3.29 1.52
Financial slack 61.43 42.91 22.23 29.93 36.94 31.57
Indian Oil Corpn. Ltd.
Current Ratio 0.70 0.94 1.23 0.67 0.80 0.84
Quick Ratio 0.56 0.84 1.00 0.58 0.60 0.59
Financial slack 1.49 1.43 1.40 1.19 1.59 1.09
1–10
 Efficiency Ratios

• Total asset turnover ratio.

• Fixed assets turnover ratio.
• Working capital turnover ratio.
• Working capital cycle:
– Inventory holding period.
– Collection period.
– Suppliers credit period.

1–11
Overall Efficiency Sales/Capital Employed

Fixed Assets Efficiency Sales/(Net Block + Capital WIP)

(or Turnover) Ratio

Working Capital Sales/ Working Capital

Efficiency(Turnover)

Inventory Turnover Cost of Goods Sold / Average Inventory

Debtors Turnover Credit Sales / (Average Debtors + Average Bills Receivable)

Creditors Turnover Credit Purchase / (Average Creditors + Average Bills Payable)

Average Inventory (Average Inventory/Cost of Goods Sold) x No. of Days/Months in a

Inventory Holding Year
Period
Debtors Collection ((Average Debtors + Average Bills Receivables)/ Credit Sales) x No. of
Period Days/Months in a Year

Suppliers Credit Period ((Average Creditors + Average Bills Payable)/ Credit Purchases) x No.
of Days/months in a year

1–12
 Asian
Marut Mari Colg Infosy Tata Paint
i co ate s Steel s TCS

Efficiency

Overall Efficiency 2.175 2.086 4.094 1.178 1.233 3.422 1.842

Fixed Assets Efficiency 6.723 3.387 6.667 4.2321 1.534 7.519 6.734

working Capital Eff 6.813 6.362 -22.7 1.8424 -15.8 17.12 5.612

Inventory Turnover 12.06 7.665 12.45 - 4.328 6.071 881.9

Debtor's Turnover 18.35 21.1 152.4 5.7369 28.06 13.19 5.336

Creditor's Turnover 6.199 3.397 1.775 0 1.066 2.577 0.013

1–13
 Working Capital Cycle: Two wheeler Companies

HERO HONDA 1999 2000 2001 2002 2003 2004

Working capital cycle
Holding period (no. of days)
Raw materials & spares 29 28 23 17 14 13
Production 3 2 1 1 1 1
Finished goods 3 3 3 3 3 3
Debtors 6 4 4 5 8 5
Gross working capital cycle 41 37 31 26 26 22
Credit availed from creditors 40 37 31 32 35 42
Net working capital cycle 1 0 0 -6 -9 -20
BAJAJ AUTO 1999 2000 2001 2002 2003 2004
Holding period (no. of days)
Raw materials & spares 27 26 26 18 11 9
Production 3 3 3 2 1 1
Finished goods 8 7 11 10 9 9
Debtors 18 19 15 13 13 9
Gross working capital cycle 56 55 55 43 34 28
Credit availed from creditors 40 49 49 43 42 45
Net working capital cycle 16 6 6 0 -8 -17

Which company is managing its working capital more efficiently? 1–14

 Working Capital Cycle: FMCG Companies

BRITANNIA 2009 2008 2007 2006

Working capital cycle

Holding period (no. of days)
Raw materials & spares 40.28 43.55 35.44 45.63
Production 0.4 0.03 0.05 0.27
Finished goods 12.8 14.59 14.67 51.05
Debtors 5.6 5.2 4.11 6.94
Gross working capital cycle 59.08 63.47 54.27 103.89
Credit availed from creditors 19.60 42.86 30.83 31.72
Net working capital cycle 39.48 42.86 30.83 72.17
MARICO 2009 2008 2007 2006
Holding period (no. of days)
Raw materials & spares 29.71 33.34 29.86 36.46
Production 13.08 11.40 8.52 7.26
Finished goods 26.46 27.08 24 20.28
Debtors 9.8 9.65 12.1 16.82
Gross working capital cycle 79.05 82.19 74.48 80.82
Credit availed from creditors 68.28 80.19 78.3 86.12
Net working capital cycle 10.77 2 -3.82 -5.3
15
 Profitability Ratios

• Sales-based
– Operating margin
– Net profit margin
• Asset-based
– Return on Total Assets (ROTA)
– ROCE/ROI
• Profitability indicators for shareholders:
– RONW
– EPS
– DPS
– Pay out ratio

1–16
Operating Profit Margin [Operating Profit/Sales] x 100
Net Profit Margin [Profit After Tax (PAT)/Sales] x 100
Return on Total (Profit Before Interest and After Tax/Total
Assets (ROTA) Assets) x100
Return on Capital (Operating Profit/Capital Employed) x 100
Employed (ROCE) or
Return on
Investment (ROI)

Return on Net (PAT/Net Worth) x 100

Worth (RONW)
Dividend Per Share Proposed Dividend/Number of Shares
(DPS)
Pay-out Ratio (Proposed Dividend/PAT) x 100
Basic Earning Per Share (PAT – Dividend on Preference Shares)/Weighted Average
(EPS) Number of Equity Shares

1–17
 Asia
n
Infosy Tata Paint
Profitability Maruti Marico Colgate s Steel s TCS

Operating Profit
Margin 17.11 14.09 19.5 35.151 40.85 14.69 30.24
Net Profit Margin 9.896 9.461 12.2 28.77 23.17 7.693 25.15
ROTA 21.76 20.39 50.1 33.898 29.47 27.07 46.36
ROCE/ROI 37.21 29.39 79.84 41.408 50.39 50.27 55.7
RONW 21.81 35.64 50.76 33.892 35.94 30.18 46.62

1–18
Capital Structure (or Long-term solvency)

• Debt-equity ratio.
• Interest coverage ratio.
• Debt service coverage ratio.

1–19
 Long-term Solvency Ratios Defined

Debt-Equity Ratio (D/E) Long-term Debt/Equity

Debt-Service Coverage Cash Flow from Operating Activities After Tax/ (Interest +
Ratio (DSCR) Installments Paid during the year on long-term loans).

Debt Ratio [Long-term Debt/(Long-term Debt + Equity)] x 100

Interest Coverage Ratio (PAT + Interest)/Interest

1–20
Long term solvency: Story of four companies

Asia
n
Marut Maric Colgat Infosy Tata Paint
Long Term Solvency i o e s Steel s TCS

Debt Equity Ratio 0.013 0.806 0.016 0 0.258 0.146 0.006

Debt Ratio 0.013 0.446 0.016 0 0.205 0.128 0.006

Interest coverage 59.29 20.69 234.2 3784 21.82 24.02 1096

Debt Service
coverage 72.93 26.96 287.1 4252.7 26.07 29.25 1196

1–21
 Market-based ratios

• Price-earning (P/E) multiple.

• Price-to-book ratio.
• Dividend yield.
• Total shareholder return (TSR)

1–22
 Price-Earning Market Price/Earning per share
Multiple

Price-to-Book Market price/Book value per share

Multiple

Dividend Yield (Proposed Equity Dividend/Market

(on market value Capitalization) x 100
basis)

Total Return to [Dividend Per Share + (Closing Market

Shareholders Price – Opening Market Price)]/Opening
(TRS) Market Price

1–23
 Limitations of Financial
Ratio Analysis
• Financial ratio analysis, however, has
some limitations:
– Comparing an organization that is in a
single line of business with an organization
that is a competitor but has multiple lines of
business is likely to be a meaningless
comparison of unlike organizations
– Even though organizations might be
comparable because they are in similar
lines of business, they may use different
accounting conventions making ratio
comparisons between the two
organizations meaningless
1–24
 Intra-firm and Inter-firm analyses

• When the performance of a particular

firm is evaluated over a time period, it is
known as intra-firm analysis.
• When the performance of cross section
of firms within the same industry are
evaluated for a particular year or over a
period of time, it is known as inter-firm
analysis.

1–25
Time series and Cross sectional analyses

• The performance of a particular firm

may be observed over a time period by
following the trend of financial ratios.
Such analysis of performance is known
as time series analysis.
• When performance of cross section of
firms in the same industry is analysed
for a particular year, such analysis is
called cross sectional analysis.

1–26
Inter-firm Comparisons: Liquidity Analysis

Current Ratio Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Maruti 1.89 1.85 1.32 1.88 1.44

Tata Steel 0.82 0.78 0.66 0.88 1.03

Net Working Capital cycle
in days Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Maruti 53.58 45.58 19.53 66.30 33.27

Tata Steel -23.15 -28.48 -50.13 -20.36 5.25

1–27
Inter-firm Comparisons: Profitability Analysis
Operating Margin (%) Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Maruti 17.11% 16.46% 14.37% 9.15% 7.61%

Tata Steel 40.85% 42.40% 32.87% 24.77% 17.60%

PAT Margin (%) Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Maruti 9.90% 7.81% 5.95% 2.04% 1.48%

Tata Steel 23.17% 23.97% 16.32% 11.61% 3.06%

Operating Margin (%) Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Bajaj Auto Ltd 16.90% 14.91% 16.93% 18.92% 15.84%

Hero Honda Motors Ltd. 15.85% 15.97% 17.17% 17.45% 15.96%

PAT Margin (%) Mar 06 Mar 05 Mar 04 Mar 03 Mar 02

Bajaj Auto Ltd 14.55% 12.46% 15.24% 12.73% 14.32%

Hero Honda Motors Ltd. 11.14% 10.91% 12.48% 11.38% 1–28

10.36%
 Trend Analysis

• Consider the first year of the time period

as the base year.
• The variables (e.g., ratios) in the first
year are considered as 100 and
variables of all the subsequent years
are expressed as percentages of the
base year.
• This gives a trend line for each variable.

1–29
 Trend statement
Maruti
Trend Statement Mar 06 Mar 05 Mar 04 Mar 03 Mar 02
Current Assets 3,749.60 2,972.00 2,018.90 2,782.80 2,110.00
Current Liabilities 1,985.80 1,608.00 1,531.80 1,478.60 1,465.20
Current Ratio 1.888206 1.848259 1.317992 1.882051 1.440076
Trend Statement Mar 06 Mar 05 Mar 04 Mar 03 Mar 02
Current Assets 177.71 140.85 95.68 131.89 100
Current Liabilities 135.53 109.75 104.55 100.91 100
Current Ratio 131.12 128.34 91.52 130.69 100

Tata Steel
Trend Statement Mar 06 Mar 05 Mar 04 Mar 03 Mar 02
Current Assets 4,237.60 4,083.58 2,808.52 3,648.10 3,095.39
Current Liabilities 5,197.43 5,214.25 4,278.43 4,134.60 2,999.03
Current Ratio 0.82 0.78 0.66 0.88 1.03
Trend Statement Mar 06 Mar 05 Mar 04 Mar 03 Mar 02
Current Assets 136.90 131.92 90.73 117.86 100
Current Liabilities 173.30 173.86 142.66 137.86 100
Current Ratio 78.99 75.88 63.60 85.49 100
1–30