Financial Statement Analysis

ABC of
Financial
Statements

Financial Statements
Financial Statements

Income Balance Sheet

Statement

Cash Flow Retained

Statement Earnings

Assets = Liabilities + Capital

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 Information about What?
Basically on:

Assets

Liabilities
Health
Capital

Incomes Performance
Expenses
Non traditional Sustainable – Green & Blue Information
4
 Information about What?

• Useful for investment decisions

 About economic resources and claims on

resources

 About financial performance during a period

 About cash flows

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 ABC of Financial Statements
Four Financial
Three
Five Elements: Statements:
Transactions:
Assets; Liabilities; Income Statement;
Operating;
Capital; Incomes ; Balance Sheet;
Investing:
Expenses Cash Flow:
Financing
Retained Earnings

Two systems: One Equation:

Cash Vs Accrual A = L +C

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 Financial Analysis
• Assessment of past, present and future

• Identify ‘Red Flags’ or ‘Gold Nuggets’

• Primary Tools:
– Financial Statements
– Comparison of financial ratios to past, industry,
sector and all firms
 Analysis of Financial Statements
• The Common Tools
– Comparative Statement (Horizontal Analysis)
– Common size Statement (Vertical Analysis)
– Trend Analysis
– Ratio Analysis

• Standardize numbers and facilitate comparisons.

• Used to highlight weaknesses and strengths.

Financial
Statements
Analysis –
The Income
Statement

Financial Statements
 How is the Income Statement useful?

• Managing Budgets

• Managing Profits

• Evaluating Business Strategy

Common Size Income Statement
 Operating Ratios

Year CGS/Sales SGA/Sales EBITDA/Sales ROS

1991 50.56 18.59 30.84 13.99
1992 50.31 19.39 30.29 14.57
1993 51.85 20.54 27.60 13.49
1994 53.48 23.25 23.27 12.00
1995 64.91 27.89 7.20 -5.84
1996 (Q3) 64.07 28.91 7.02 -4.80
 Profitability Ratios

• Gross Margin

• Operating Ratio

• Net Margin

• ROA

• ROI

• ROE
 Profitability Ratios
Company Name PBDITA as % of total income PBT as % of total income PAT as % of total income
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 17.15 22.61 3.58 9.97 2.22 6.41

A P L Apollo Tubes Ltd. 3.91 4.46 1.29 1.64 0.95 1.26

Coal India Ltd. 96.36 93.46 95.33 92.58 94.33 92.51
Hindalco Industries Ltd. 11.7 15.1 1.72 5.28 1.46 3.81
Hindustan Copper Ltd. 15.37 20.32 3.5 7 3.32 4.6
Hindustan Zinc Ltd. 51.83 57.11 47.68 47.65 44.54 39.09
J S W Steel Ltd. 18.08 21.33 -12.33 8.82 -8.54 6.25
Jindal Stainless (Hisar) Ltd. 11.14 13.49 0.43 4.26 0.35 2.85
Jindal Steel & Power Ltd. 18.96 22.04 -15.52 -9.28 -9.45 -6.28
M O I L Ltd. 36.59 43.02 30.48 38.14 19.51 25.25
N M D C Ltd. 57.48 49.56 49.84 41.27 32.14 26.59
National Aluminium Co. Ltd. 23.18 20.36 15.09 11.45 9.92 7.9
Steel Authority Of India Ltd. -4.39 0.97 -15.56 -9.67 -9.03 -5.63
Vedanta Ltd. -17.52 36.55 -36.89 21.02 -25.02 21.35
Welspun Corp Ltd. 10.64 15.54 -4.44 5.62 -3.06 3.72
Financial
Statements
Analysis –
The Balance Sheet

Financial Statements
Balance Sheet - Vertical Analysis
 Important Ratios to analyze BS
Analysis Ratios
Liquidity Management Working Capital (Gross and Net)
Current Ratios
Quick Ratios
Cash Ratios
Asset Management Inventory Turnover
Receivables Turnover
Working Capital Turnover
Operating Cycle
Assets Turnover
Debt Management Payables Turnover
Debt Ratio
Debt Equity Ratio
Interest Coverage Ratio
Balance Sheet
Analysis-
Liquidity
Management

Financial Statements
 Liquidity Management - Working Capital
• Working Capital
– Assets/liabilities required to operate business on
day-to-day basis
• Cash
• Accounts Receivable
• Inventory
• Accounts Payable
• Accruals

– Short-term in nature—turn over regularly

DMRC – Liquidity Analysis
Types of Working Capital
 Type of Working Capital
• Gross working capital = Current assets
– Gross Working Capital (GWC) represents
investment in current assets
• (Net) working capital =
Current assets – Current liabilities
• Both are equally important:
• One is a measure of the level of current assets
• Other measures the extent to which long-term
sources of financing have been used to finance
Negative Working Capital
• Retail and restaurant companies like
– Amazon, Wal-Mart, and McDonald’s often have
negative Working Capital

• Because customers pay upfront

– Cash generated used to pay off Accounts Payable
– No need of keeping a large cash balance on-hand

• This can be a sign of business efficiency

Walmart – Annual Report 2016
 Non Cash Working Capital
• Back out from current assets
– cash and investments in marketable securities

• Unlike other current assets, cash earns a fair

return

• Back out from current liabilities

– interest bearing short term debt
 Permanent & temporary working capital

Amount Variable Working Capital

of
Working
Capital

Permanent Working Capital

Time
Matching approach to asset financing
Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
Capital

Fixed Assets

Time
Conservative approach to asset financing

Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
capital

Fixed Assets

Time
Aggressive approach to asset financing

Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
capital

Fixed Assets

Time
 Liquidity Ratios
Company Name Quick ratio (times) Current ratio (times)
Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 0.33 0.38 0.68 0.83

A P L Apollo Tubes Ltd. 0.52 0.31 1.02 0.81

Coal India Ltd. 3.09 1.77 3.19 1.86
Hindalco Industries Ltd. 1.16 0.96 1.9 1.52
Hindustan Copper Ltd. 0.98 0.7 1.48 1.29
Hindustan Zinc Ltd. 2.34 1.6 2.42 1.7
J S W Steel Ltd. 0.16 0.23 0.51 0.64
Jindal Stainless (Hisar) Ltd. 0.26 0.4 0.61 1
Jindal Steel & Power Ltd. 0.27 0.3 0.54 0.58
M O I L Ltd. 12.07 9.64 12.77 10.31
N M D C Ltd. 2 1.58 2.07 1.66
National Aluminium Co. Ltd. 2.78 1.41 3.48 2
Steel Authority Of India Ltd. 0.17 0.14 0.58 0.51
Vedanta Ltd. 0.38 0.53 0.51 0.67
Welspun Corp Ltd. 0.97 0.74 1.37 1.23
Balance Sheet
Analysis-
Assets
Management

Financial Statements
Questions – Need to be answered

Liabilities Assets

Assets
Equity
in Place
What Proportion What Proportion
Value Value
How Risky How Risky
Growth
Debt Assets
 Assets Utilization – Tata Steel
Finished goods turnover Net fixed asstes utilisation
Company Name Debtors turnover (times) (times) ratio(times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 51.59 33.58 9.4 8.66 1.18 0.92

A P L Apollo Tubes Ltd. 16.98 13.64 20.75 20.7 10.26 8.89

Coal India Ltd. 13.56 23.96 2.71 5.02 1.02 1.28
Hindalco Industries Ltd. 18.68 19.93 39.74 43.46 1.26 1.18
Hindustan Copper Ltd. 13.68 10.19 43.74 18.93 5.65 4.62
Hindustan Zinc Ltd. 40.08 153.09 149.61 174.41 1.56 1.86
J S W Steel Ltd. 16.68 17.43 10.58 12.74 0.96 1.17
Jindal Stainless (Hisar)
Ltd. 8.22 8.08 11.11 11.54 2.86 3.31
Jindal Steel & Power Ltd. 13.11 18.26 10.85 20.24 0.42 0.37
M O I L Ltd. 5.08 5.15 3.34 4.7 2.1 3.11
N M D C Ltd. 3.51 4.08 4.09 6.62 3.97 4.56
National Aluminium Co.
Ltd. 33.82 32.6 29.46 25.98 1.1 1.17
Steel Authority Of India
Ltd. 10.09 11.99 5.79 7.12 1.06 1.03
Vedanta Ltd. 18 16.18 109.52 82.17 1.36 1.18
Welspun Corp Ltd. 2.87 3.89 17.65 19.92 1.45 1.82
Balance Sheet
Analysis-
Debt
Management

Financial Statements
 Debt Management
• Long term solvency

• Balance between Cost of Capital and rating

• Provisioning for long term obligations

Long Term Debt Paying Ability
 Leverage Ratio or Death Strategy
Year Total Debt Equity Debt/Capital Interest Int Cov Ratio

1991 3.5 10.14

1992 236.3 84.7 73.61 6.5 10.43

1993 250.2 147.3 62.94 14.6 7.85

1994 384.3 243 61.26 16.5 7.26

1995 586.5 207.8 73.84 43.2 1.38

1996 654.5 180.5 78.38 42.7 0.96

VIDEOCON – The Red Flag
 D/E Ratio
Company Name Debt to equity ratio (times)
Mar-16 Mar-17
Tata Steel Ltd. 0.67 0.59

A P L Apollo Tubes Ltd. 1.33 0.93

Coal India Ltd. 0.07 0.02
Hindalco Industries Ltd. 0.68 0.57
Hindustan Copper Ltd. 0.19 0.45
Hindustan Zinc Ltd. 0 0.26
J S W Steel Ltd. 1.82 1.64
Jindal Stainless (Hisar) Ltd. 2.87 3.93
Jindal Steel & Power Ltd. 1.12 1.16
M O I L Ltd. 0 0
N M D C Ltd. 0.05 0
National Aluminium Co. Ltd. 0 0.01
Steel Authority Of India Ltd. 0.9 1.15
Vedanta Ltd. 0.54 0.67
Welspun Corp Ltd. 1.15 0.82
Beyond Profit-
EVA and
Dilution

Financial Statements
Measuring Corporate Success

• Revenue?
• Earnings per share?
• ET/CNBC survey of
market value of equity?
• Stock market share
price?
• Market value added?
 Wealth Creation

• Warren Buffet:
We feel noble intentions should be checked periodically against
results. We test the wisdom of retaining earnings by assessing
whether retention, over time, delivers shareholders at least $1 of
market value for each $1 retained.

• Translation:
Ultimate litmus test of any company’s success
lies in increasing its market value by more than
it increases its capital.
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 Market Value Added

Market
Premium value added
Total market
value

Debt &
equity
capital Investment

43
Market Value Vs Value Added on July 05,
2023

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45
 Measuring Value Addition

• Market Value Added:

– MV – BV

• Market-to-Book Ratio
– Ratio of market value of equity to book value of
equity
– MV/BV – Popularly known as M/B or P/B ratio
– M/B > 1 indicates market value added
How much value IOCL has added?
Market Value Vs Value Added on July 05,
2023

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 From Dividend to Earning Base

• Dividend = Earnings * (1- Retention Rate)

E1 * (1  b)
P0 
Ke  g

P 1 b

E Ke  g
 From Earnings to Book Value

• Earnings = BV of Equity * ROE

BV * ROE * (1  b)
P0 
Ke  g

P ROE * (1  b)

B Ke  g
 Redefining P/B Ratio

• Growth = RR * ROE

g
ROE * (1  )
P ROE

B Ke  g

P ROE  g

B Ke  g
How does market add Value?
Based on the relationship of Return on and cost of
capital.
EVA is the difference of ROE and COE
– ROE = COE
– ROE > COE
– ROE < COE

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 Fundamental Strategies

 NOPAT 
EVA    Cost of capital * Capital
 Capital 

Operate: Improve the Decrease: WACC

return on existing
operating capital
Build: Invest as long as returns
exceed the cost of capital

Harvest: Re-deploy capital when returns fail to achieve

the cost of capital.

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EVA Components of HUL

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 Relationship of EVA & MVA

EVA EVA EVA EVA

Year 1 Year 2 Year 3 .... Year n

MVA
Market
Value
Market EVA + EVA + EVA + ... + EVA
value = 1+r (1 + r)2 (1 + r)3 (1 + r)n
Capital Market value is based on establishing the
economic investment made in the company
(capital), making a best guess about what
economic profits (EVA) will happen in the future,
and discounting those EVAs to the present to get
market value added.
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 Value Proposition: EVA Drives MVA
Value Value
PV
EVA
C

PV MVA PV EVA3
PV EVA2
NOPAT
C PV EVA1

PV CF3
Capital
PV CF2

PV CF1

Discounted Free Cash Flow Discounted Economic Value Added

 The discounted present value of a company’s expected EVA is its market value premium or
discount to book value (“MVA”).
 A company’s discounted EVA plus its level of capital employed will always equal the discounted
present value of expected Free Cash Flow.
 EVA is the only integrated measure of growth and profitability which relates directly to stock
value.
The Dilution Risk of IOCL
Profitability Analysis
 Strategic Profitability Analysis
Company Name Return on total assets Return on capital employed PAT as % of net worth
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 0.97 3.15 1.26 4.56 1.67 7.32

A P L Apollo Tubes Ltd. 5.13 3.7 6.53 5.35 9.18 10.62

Coal India Ltd. 73.79 71.97 97.75 92.41 101.24 96.78
Hindalco Industries Ltd. 0.43 1.54 0.51 1.85 1.39 3.48
Hindustan Copper Ltd. 0.79 2.1 1.37 4.04 2.57 5.85
Hindustan Zinc Ltd. 15.34 15.25 19.95 22.1 20.27 24.48
J S W Steel Ltd. -5.08 3.93 -7.39 5.69 -15.91 16.53
Jindal Stainless (Hisar) Ltd. 1.25 3.29 3.52 5.69 4.03 28.91
Jindal Steel & Power Ltd. -2.53 -1.45 -3.3 -2.06 -7.97 -4.4
M O I L Ltd. 4.69 8.35 5.06 9.08 5.06 9.77
N M D C Ltd. 6.44 7.51 8.85 10.78 8.83 10.03
National Aluminium Co. Ltd. 4.06 4.27 5.21 5.79 6.06 5.71
Steel Authority Of India Ltd. -3.84 -2.5 -5.43 -3.65 -9.73 -7.53
Vedanta Ltd. 10.13 5.53 13.85 7.57 -21.05 13.93
Welspun Corp Ltd. -1.71 2.54 -3.19 4.78 -7.04 10.15
 The DuPont System

RO E

RO A E quity M ultiplie r

Profit M a rgin T ota l A s s e t T urnove r

ROE  Profit Margin  Total Asset Turnover  Equity Multiplier

Net Income Sales Total Assets
  
Sales Total Assets Common Equity
Ratios –Comparison of Business Models
 Decomposition of ROEs for
judging Operating Strategies
Redhook Pete’s and Boston Beer
• Provided lower returns on • Stable & somewhat higher
equity ROE
• More volatile profitability, • Lower degree of operating
Leverage
• A higher degree of operating
• Free from capital
leverage
investment,
• Invest heavily in production
• Invested heavily in brand
facilities
building
• Spent little on sales and
marketing
 The Value Chain
Cimarron Meritage White (per the case)
Vineyard
Revenue 12.99 P/S = 26.2%
Operating Costs 9.59 S/A = .14
Margin 3.40 ROA = 3.6%
Assets 93.97 + $.27 handling cost
Winery
Revenue 76.00
Costs:
Grapes 13.26 P/S = 5.2%
Winemaking21.07 S/A = .30
Bottling 16.80 ROA = 1.6%
Bottle Aging 1.60
SG&A 19.29 + $2.25 freight
Margin 3.98 + 1.56 tax
Assets 255.00

Distributor
Revenue 106.41
Wine Cost 79.81 P/S = 10.8%
Operating Cost 15.08 S/A = 2.59
Margin 11.52 ROA = 28%
Assets 41.06

Retailer
Revenue 142.43 P/S = 4.5%
Wine Cost 106.41 S/A = 2.93
Operating Costs 29.65 ROA = 13%
Margin 6.37
Assets 48.68

The Overall Value Chain

Revenue $142.43 P/S = 17.8%

Profit $ 25.27 S/A = .32
Market Value
Analysis

Financial Statements
 Analyzing the market value ratios

• P/E: How much investors are willing to pay for $1 of

earnings?
• P/CF: How much investors are willing to pay for $1 of
cash flow?
• M/B: How much investors are willing to pay for $1 of
book value equity?
• Ratio - Higher the better
• High P/E and M/B - ROE is high and risk is low
 Valuation/Market Ratios
Company Name EPS (INR) P/E Ratio (Times) P/B Ratio (Times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 11.26 36.01 28.39 13.41 0.71 1.02

A P L Apollo Tubes Ltd. 21.2 17.74 31.66 66.2 4.53 7.04

Coal India Ltd. 26.23 23.35 11.13 12.53 11.49 13.05
Hindalco Industries Ltd. 1.7 5.99 51.89 32.58 0.43 0.92
Hindustan Copper Ltd. 0.23 0.61 215.87 108.42 3.3 4.17
Hindustan Zinc Ltd. 19.04 19.83 9.64 14.56 2.08 3.98
J S W Steel Ltd. -166.79 13.84 13.59 1.56 1.92
Jindal Stainless (Hisar) Ltd. 3 8.14 8.81 17.45 0.98 3.89
Jindal Steel & Power Ltd. -16.14 -10.81 0.24 0.51
M O I L Ltd. 10.3 21.35 21.14 14.7 1.06 1.49
N M D C Ltd. 7.03 9.05 13.95 14.71 1.33 1.87
National Aluminium Co. Ltd. 2.63 3.51 15.02 21.79 0.77 1.45
Steel Authority Of India Ltd. -9.71 -6.71 0.45 0.7
Vedanta Ltd. 45.18 32.6 1.99 8.43 0.34 1.02
Welspun Corp Ltd. -4.52 6.12 13.51 1.61 1.21
 Valuation Ratios
Market Capitalisation (Rs.
Company Name Million) MarketCap / EV (Times) EV / PBDITA (Times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 310497.58 468805.69 0.51 0.63 8.23 6.1

A P L Apollo Tubes Ltd. 15728.5 27705.22 0.77 0.88 16.09 22.58

Coal India Ltd. 1844062.59 1816598.3 1.04 1.02 10.5 12.13
Hindalco Industries Ltd. 181615.5 437546.71 0.39 0.62 10.55 11.47
Hindustan Copper Ltd. 46584.73 61156.91 1.01 0.94 26.48 23.87
Hindustan Zinc Ltd. 775768.57 1220272.13 1 1 8.15 10.01
J S W Steel Ltd. 310189.81 454920.89 0.47 0.55 8.88 6.8
Jindal Stainless (Hisar) Ltd. 6114.86 33526.32 0.25 0.5 3.11 6.52
Jindal Steel & Power Ltd. 55122.95 110717.93 0.18 0.31 10.85 10.47
M O I L Ltd. 36573.6 41787.67 4.53 2 2.49 4.01
N M D C Ltd. 388542.17 421113.82 1.52 1.14 5.28 7.63
National Aluminium Co. Ltd. 101800.92 147869.06 2.01 1.18 2.76 7.29
Steel Authority Of India Ltd. 178025.64 253201.2 0.34 0.38 0 136.11
Vedanta Ltd. 266377.78 815142.68 0.4 0.61 0 7.05
Welspun Corp Ltd. 26177.82 21907.68 0.6 0.62 10.13 4.87
Peer Performance for 2022-23
Peer Performance for 2022-23
Analysis of
Cash Flow
Statement

Financial Statements
 How is the Cash Flow Statement useful?

• Cash Generation

• Cash Burn Rate

• Valuation Analysis
 Insights: Cash Burn Rates

• Cash burn rate a popular metric for assessing

how quickly firms use up their cash reserves

– Cash used for operations plus cash used for capital

expenditures and purchases divided by the
number of months
 The Measures of Money Making
• Growth

• Cash generation

• Return on Assets
TRAPs of
Financial
Analysis

Financial Statements
 Five Traps of Performance Measurement

• Measuring Against Yourself

• Looking Backward
• Putting your faith in numbers
• Gaming your matrices
• Sticking to your numbers
 Qualitative factors
• Are the firm’s revenues tied to 1
– key customer, product, or supplier?

• Percentage of the firm’s business generation

– Domestic Vs overseas?

• Competition

• Future prospects

• Legal and regulatory environment

TH
AN
K
YO
U Financial Statement Analysis 78