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Subject COMMERCE

Paper No and Title 14. SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

Module No and Title 21. COMPANY ANALYSIS

Module Tag COM_P14_M21

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
MODULE No.21: COMPANY ANALYSIS
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TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3. Company Analysis
4. Financial Statement analysis.
5. Classification of Ratio
6. Annual Report
7. Summary

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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MODULE No.21: COMPANY ANALYSIS
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1. Learning Outcomes
After studying this module, you would be able to

 Know about the Company Analysis.

 Learn the meaning of financial statement analysis
 Classification of Ratio’s
 Learn the meaning of Annual Report.

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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2. INTRODUCTION
Efficient market hypothesis suggests that all the information relating to industry,
economy or company is reflected in the prices of shares in an efficient market. The EIC
analysis is the main activity in fundamental approach to security analysis. Thus it is
indispensable for an investor to go in detail study of all these analysis before investing. In
this chapter we will study about company Analysis. The company analysis presupposes
that the industry analysis and the economic analysis have already been made. So here we
will discuss about the company specific factors like the number of years for which
company has been working, quality of its management, firm’s position in the market and
various other factors.

3. Company Analysis
Company analysis as the name suggests deals with the analysis of company. The aim of
company analysis is to find out which is the most attractive company to invest in within
an attractive industry. For this investors collect and study lot of data about the company.
But an investor should always keep in its mind that recent data are always more reliable
than a long term before past data to be studied. The fundamental analyst is always very
much interested in firm’s financial statements. The actual value of a share depends upon
the type and capacity of the firm to make its place among all firms. An investor must
analyze the profitability, asset utilization, sales, debt proportion etc. Many researchers
and analysts recommend that the financial statements of a company must be analyzed
carefully before investing in it. The financial statements of a company such as statement
of profit and loss account, balance sheet, cash flow statement, notes to accounts etc must
be analyzed in depth. Also one should look for the strategy of company. Its concern for
people etc. Company analysis helps to know the risk and return of individual shares.

4. Financial statement analysis

Financial statement analysis is an important step in company analysis. It is used to
estimate the financial performance of the company. Many investors go for ratio analysis
to know the potency and limitation of the companies. Different ratios measure different
aspects of a company.

Ratio analysis is the process of forming and understanding the numerical relationships
based on financial statements. A ratio is a statistical standard that provides a measure of
the relationship between two variables.

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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MODULE No.21: COMPANY ANALYSIS
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This relationship can be expressed as a percent or as a quotient. Ratios can be of interest
to owners, creditors and financial executives. Investors need mainly a foundation for
estimating earning capability. Creditors are concerned primarily with liquidity and ability
to pay interest and redeem loan within a specified period. Management is involved in
developing logical tools that will measure costs, efficiency, liquidity and profitability
with a view to make intelligent decisions.

5. Classification of Ratios:
Financial ratios can be classified into various categories. There are various kinds of ratios
like Liquidity ratio, Solvency ratio, Profitability ratio and some other ratios.

5.1 Liquidity Ratio:

Liquidity ratio is used to extent the liquidity position of a firm. They are also called as a
ratio indicating short term solvency of a firm. There are two kinds of liquidity ratio:
Current ratio and Acid test ratio. Liquidity ratio states a company's ability to repay short-
term creditors out of its total cash. It is the result of dividing the total cash by short-term
borrowings. It shows the number of times short-term liabilities are covered by cash. If the
value is greater than 1.00, it means fully covered.

The formula is the following:

LR = liquid assets / short-term liabilities

i. Current ratio: It is computed by dividing current assets by current liabilities. This

ratio is usually an acceptable amount of short-term solvency as it indicates the
extent to which the entitlements of short term creditors are covered by assets that
are likely to be converted into cash in a period corresponding to the maturity of
the claims.
ii. Acid-test ratio: It is also termed as quick ratio. It is resolute by dividing “quick
assets”, i.e., cash, marketable investments and sundry debtors, by current
liabilities. This ratio gives no importance to inventory as it is not quickly get
converted into cash.

5.2 Turnover ratios

These are also called as efficiency ratios. They indicate how efficiently assets are being
managed. They are found out by measuring the relationship between sales and different
types of assets (current and noncurrent).

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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Formula:

A high ratio suggests either that a company activates on a cash basis or that its extension
of credit and collection of accounts receivable is proficient. While a low ratio implies the
company is not making the timely collection of credit.

There are four types of turnovers:

i. Voluntary is the type of turnover, which arises when an employee voluntarily

chooses to resign from the organization. Voluntary turnover could be the result of
a more appealing job offer, staff conflict, or lack of advancement opportunities.
ii. Involuntary, which arises when the employer makes the decision to release an
employee and the employee against your will leaves his or her position.
Involuntary turnover could be a result of poor performance, staff conflict, etc.
iii. Functional, which occurs when a low-performing employee leaves the
organization. Functional turnover decreases the amount of paperwork that a
company must file in order to rid itself of a low-performing employee. Rather
than having to go through the potentially difficult process of proving that an
employee is inadequate, the company simply respects his or her own decision to
leave.
iv. The fourth type of turnover is Dysfunctional, which occurs when a high-
performing employee leaves the organization. Dysfunctional turnover can be
potentially costly to an organization, and could be the result of a more appealing
job offer or lack of opportunities in career advancement.

5.3 Solvency Ratio:

These ratios are calculated to know whether a firm will be able to pay its debts in long
term or not. Solvency ratios are calculated to know whether the company can meet its
financial obligations or not.

The solvency ratio defined as:

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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The solvency ratio is a measure of the risk an underwriter faces of claims that it cannot
absorb. The amount of premium written is a better measure than the total amount insured
because the level of premiums is linked to the likelihood of claims.

Different countries use dissimilar methodologies to compute the solvency ratio, and have
different requirements. There are some other ratios also which are also used to analyze a
company and its share price. These are:

(i) Debt Ratio is a financial ratio that specifies the percentage of a company's
assets that are provided via debt. It is the ratio of total debt (the amount of
current liabilities and long-term liabilities) and total assets (the amount of
current assets, fixed assets, and other assets such as 'goodwill').

or alternatively:

(ii) A going concern is a business that functions without the threat of liquidation
for the predictable future, generally regarded as at least within 12 months. It
implies for the business the basic declaration of intention to keep running its
activities at least for the next year, which is a basic assumption to prepare
financial statements considering the conceptual framework of the IFRS.
Hence, the pronouncement of going concern means that the entity has neither
the objective nor the need to liquidate materially the scale of its operations.
(iii) Accounting liquidity is a measure of the ability of a debtor to pay their debts
as and when they fall due. It is usually expressed as a ratio or a percentage of
current liabilities. Liquidity is the ability to pay short-term obligations.

5.4 Profitability ratios

Profitability ratio measure the effectiveness of management in the employment of

business resources to earn profits. These ratios indicate the achievement of a business
enterprise for a specific period of time. Profitability ratios are used by unevenly all the
parties connected with the business. A strong productivity position ensures common
stockholders a higher dividend income and appreciation in the value of the common stock
in future.

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
MODULE No.21: COMPANY ANALYSIS
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There are some other ratios also which are also used to analyze a company and its share
price. These are:

i. Earning to price ratio: this is calculated by allocating the EPS (earning per share) by
the market price of share.
ii. Dividend yield ratio: It is the ratio of DPS (dividend per share) and Market price of
share.
iii. Payout ratio: It is used to measure the portion of EPS given as dividend. It is
calculated by dividing the DPS by EPS
iv. Return on Equity: The return on equity (ROE) ratio is similar to the ROA ratio in that
it reports how effective company management is at generating profit with investors'
capital. However, ROE is more particular than ROA because it pay no attention to the
role that company liabilities play in producing profit.
v. Gross Profit Margin: It measure the percentage of revenue that remains after a
company covers its operating expenses, also identified as cost of goods sold (COGS).
However, the GPM doesn't extent a company's overall profit as it ignores the general,
selling and managerial expenses that don't directly relate to producing the revenue. To
calculate the ratio, divide total sales by the COGS.
vi. Analysing Profitability Ratios: Whenever you evaluate a company using profitability
ratios, you need to understand the limitations. In most circumstances, the ratios
provide limited understanding unless you analyse trends over a number of years and
relate it to financial results of its competition.

6.Annual Reports
Investors also study and analyze annual reports of a company. They are very interested to
know what is communicated by board of directors. Now a day’s investors are also
becoming interest in corporate social responsibility disclosures and reporting by
company. Annual repots give an idea about what company’s management is thinking and
how firm will be taken further. They tell about company’s business plans and
performance targets. One can get a little idea about the trends for the future and scope for
growth.

i. Timely Compliance With Legal Requirements.

A company which is very active in timely complying with the legal requirements
is successful in building its good image. This also increases the value of shares of
the company. A company which is actively calling meetings on time, filing

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

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MODULE No.21: COMPANY ANALYSIS
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returns and various reports, meeting the required rules and regulations is valued
more by investors and analysts.
ii. Other factors

There are various other factors like inventory with company, how much capacity is
utilized, segment performance, employee welfare activities, companies concern for
environment etc that affect the company’s share valuation. Other factors could be change
in the business plan and strategy, mergers and acquisitions, joint ventures etc. company’s
environment (both internal and external), feasibility of survival and growth of the
company.

So we have seen how and what is analyzed by investors about a company. Company
analysis is the final analysis in the EIC analysis. The economic analysis deals with the
prospects for growth of the economy and its impact on the environment in which
businesses operate. Industry analysis aids the investors in choosing the right industry to
invest in. Once industry is decide the investor want to make a decision about a company
whose shares he will buy. For this he has to do company analysis. Company analysis take
in hand the risk and return of individual shares for which annual reports, public
announcements, financial reports etc are used to study and reach at a decision.

7.SUMMARY
Company analysis is the final analysis in the EIC analysis.Many researchers and
analysts studies the variety of information about the company.It is assumed that a person
doing company analysis has already done economic analysis and industry
analysis.Company analysis can be done by studying financial statements. They make use
of financial ratios such as liquidity ratio, solvency ratio, profitability ratio, efficiency
ratio price earnings ratio etc. to get more information about it. Investors also study and
analyze annual reports of a company. A company which is very active in timely
complying with the legal requirements is successful in building its good image. A
company which is continually filing returns and reports, complying with the different but
necessary rules and regulations is valued more by investors and analysts. Various Other
factors like change in the business plan and strategy, mergers and acquisitions, joint
ventures etc. company’s environment (both internal and external), feasibility of survival
and growth of the company. An investor has to make use of all such information wisely
for a better and logical decision in choosing a company and investing in its shares.

COMMERCE PAPER No. 14: . SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
MODULE No.21: COMPANY ANALYSIS