fsa reliance mdp

7/27/2019 FSA Reliance MDP

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Padmini Srinivasan - iimb

You can manage only

what you can measure

Financial statement Analysis


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Session Plan

Understanding the financial statements

Financial statement Analysis


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Identification

Select economiceventsAnd Monetary

Business transactions

Recording

Record, classifyand summarize

Based on certain rules

Accounting

Reports

SOFTBYTE

Annual Report

Accountingreports

Analyze and interpretfor users

Communication

ACCOUNTING SYSTEM

FILTERS

Audit

Input Process Output

Monetary


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FIRMS GENERATES REPORTS !!

Accounting system generates 3 reports giving

the status and performance of the firm

The Balance sheet /status report The Profit and loss account (Income

statement)

The Cash flow statement


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BALANCE SHEET/STATUS REPORTS

It is the status report at a particularpoint of

time

Statement giving the position of assets and

liabilities (claimants)

Snap shot view of the continuously

changing enterprise


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PROFIT AND LOSS ACCOUNT

Gives the profit (income less expenses) for a

time period

It gives all the incomes and expenses and

gains and losses made by a firm

Revenues or Incomes arise from selling of goods

or services to customers.

Expenses related to earnings are deducted from

revenues


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CASH FLOW STATEMENT

Why the status changed during the period

Cash flow from financing activities

Cash from investing activities Cash flow from operations


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Balance Sheet: ASSETS

Resources owned by a firm

Capable of giving future cash flows (by use

or disposal value)

Objectively verifiable


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LIABILITIES

Liabilities are Debts

They are present obligations a firm

owes. They are claims against the assets the

firm.

Liabilities may be to the owners or tooutsiders


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Balance Sheet of ABC LTD as on

31

ST

MARCH, 2005Uses of Funds

Fixed Assets

Investments Current Assets,

Loans and

Advances

Sources of Funds

(Liabilities)

Share Capital

Reserves and Surplus

Borrowings:

Secured

Unsecured

Current Liabilities

and Provision


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FIXED ASSETS

Depreciation is treated as Expenses and is

charged to the profit and loss account

Accumulated Depreciation its the sum of

depreciation charged to the profit and loss

account till the end of the current financial

year


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INVESTMENTS

Are assets held as stores of value with a view

to get interest, dividend or capital appreciation

TYPES: Long Term/ Current (holding period)

Quoted / Not Quoted


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CURRENT ASSETS, LOANS AND

ADVANCE Current assets are assets that form part of the operating

cycle and take interrelated form

Expected to be converted into cash in next 12 months

Consists of :

Cash

Sundry Debtors

Inventory Others


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LIABILITIES

They are present obligations a firm owes.

They are claims against the assets the firm.

Liabilities may be to the owners or to anoutsider

Discharging the liability will result in the

decline of the assets

Classified: Current and Long

Secured/ Unsecured


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OWNERS EQUITY

Share Capital

Amount contributed by owners towards the capitalof the firm

They are divided into units called share Have a face Value

RESERVES AND SURPLUS

They are the accumulated profits or retainedearnings not distributed and owed by the businessto the equity share holders

Share Capital + R & S is called Net Worth


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LOANS

Are borrowing to be repaid as per agreed

terms on which interest needs to be paid

irrespective of availability of profits.

TYPES:

SECURED LOAN OR UNSECURED LOANS

LONG TERM OR SHORT TERM


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Current liabilities and Provisions

Arising on account of acquiring

goods/services on credit or incurring

expenses which are paid for laterNormally they are to be settled within a

period of 12 months


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PROFIT AND LOSS ACCOUNT FOR

THE YEAR ENDED 31/3/2006

SALES 1579

Expenses

RAW MATERIALS 700

WAGES & SALARIES 374

OTHER Overheads 100

Depreciation 100

SAD Expenses 100

PBIT (Operating Profit) 205

INTEREST 38PBT 167

INCOME TAX 59

PROFIT AFTER TAX 108


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Depreciation

Some Myths about Depreciation

It is a process of valuation

It generates cash

It helps in replacement to new machine Truths ..

Depreciation is the allocation of cost (depreciablevalue) of an asset to the periods that benefit from

its use.

Its a charge of the asset over the useful life of anasset


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Depreciation

Some Terms:

Original cost (OC) of the asset

Expected Useful life of the asset (This is notthe physical life)

Residual Value (RV) at the end of the

useful life Depreciable Value of the asset (OC-RV)


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Depreciation

Methods of Charging Depreciation

Straight Line Method

Reducing Balance Method

Which ever method you use the total

depreciation to be charged over the useful

life will be the same


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Depreciation


Formula: Cost -Residual Value

Useful life

Reducing Balance Method

Formula for computation of rate

1 - Residual valueCost

n= useful life in years

n


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Depreciable Value = 6,50,00050,000

= 600,000

Depreciation = 600,000 / 3 Rs. 200,000

p.a. =200,000/650,000 * 100 30.6 %


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Straight line method

Year Gross

Block

Depr Acc. Depr Net

Block

1 650000 200000 200000 450000

2 650000 200000 400000 250000

3 650000 200000 600000 50000


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Written down value method

Initial years the depreciation should be

high as subsequently the Asset will incur

higher repair expenses. Hence over the years the Repairs and

depreciation together will even out

Rate 1- n s /c n = useful life, s=scrap value c= cost

57.5%


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Written Down value method

GBV Depreciatio Net Book

650000 373750 276250

276250 158843.75 117406.3

117406.3 67508.594 49897.66


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Financial Statement Analysis

(Analysis of Financial Performance)

From Business Activities to Financial Statements


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Financial

Statements

AccountingSystem

Measurement

&

Reporting

Business

Activities

Operating

Investment

Financing

Accounting

Environment

Capital Market

Structure,

GAAP,Audit,&Legal system

Business

Environment

Labor Market

Capital MarketProduct Market:

Suppliers

Customers

Accounting StrategyChoice of:

Accounting Policy

Reporting Format

Supplementary-

Disclosures

Business

Strategy

Key factorsAnd Risk

From Business Activities to Financial Statements

Story So far ..


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Need for Financial statement analysis

How has the business performed during the year

How is the financial condition of the company

How investment activities have performed during the year

How does the unit stand in comparison to the industry

Preparation of Forecasts

Evaluation of SBUs and departments

Credit rating


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Where to look for data

The Annual reports(An annual report and financials therein represents a snapshot

at a given moment. By the time it is mailed, an annualreport is more history than news. )

1. Directors Report - Working of the Company2. Auditors Report

3. Management Discussion &Analysis

Profit and loss account

Balance Sheet

Cash Flow statements

Supplementary schedules and Notes

Accounting Policies

Subsidiary Company Information


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Other Data Sources

Forms filed with the ROC (In the US 10K and

10Q reports filed with SEC)

Computerized data bases

Info on industry norms/ratios

Info on particular company/industries

Articles in press

Ever-expanding websites


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4 Step Analysis Process

Business Strategy Analysis

Accounting Analysis

Financial Analysis

Prospective Analysis

(Also do a SWOT analysis )


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TOOLS FOR EVALUATION

COMMON SIZE STATEMENTS

HORIZONTAL ANALYSIS

RATIO ANALYSIS CASH FLOW ANALYSIS


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Common Size Statements

Common size income statement

Expresses each income statement category as a

percentage of net sales

Common size balance sheet

Expresses each item on balance sheet as a

percentage of total assets or equities

Both statements facilitate structural analysisof the firm


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HORIZONTAL ANALYSIS

Year to year changes Changes in amounts and percentages

Reveals a trend & direction

For long term trends prepare a index numbertrend series


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RATIO ANALYSIS

GIVES THE LINK BETWEEN

INVESTMENT, FINANCING AND

OPERATING ACTIVITY

i.e. how various items in the financial

statements relate to one and another

Analysis of Past performance helps in

forecasting the future performance


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Financial Statement Analysis

PROFITABILITY

LIQUIDITY

SOLVENCY

Note: Different authors take slightly different approach

(formulas) for eg: PBIT instead of PAT etc.,PBIT (NOPAT) is a good measure for inter divisions

evaluation


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FSA-Basic Structure

Leverage or

Financial risk

Fixed Asset Turnover

Debtors Turnover or

Collection Period

Inventory Turnover

Current Asset TOR

Asset Turnover ratios

Interest / Sales

Other expenses / Sales

Raw material/Sales

Profit Margins

Return on Total Assets(ROI)

RReturn on Equity E

Current Ratio


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Financial Ratio Analysis

Profitability Ratios

measure the overall performance of a firm and

its efficiency in managing assets, liabilities and

equity


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Return Ratios

Return on Equity

PAT/ AVG Stockholders Equity

Measure overall efficiency of the firm in managing

investment in assets and generating return to

stockholders


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Return Ratios

Return on Total Assets (ROCE)

PAT /Avg Total Assets or

- PBIT/ AVG Total Assets*

- NOPAT / Total Assets

The ratio measures the overall efficiency of

the firm in managing investment in assets andgenerating return to stockholders


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Profitability Ratios

Net Profit Margin

Net Profit After Tax/Net Sales

Operating Profit Margin

PBIT (Profit before interest and tax)/Net Sales

Various Expenses to Sales

Salary/Net Sales

All measure firms ability to translate salesinto profits


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Turn Over Ratios(Resource

Utilization)The Ability of different assets like Fixed

Assets, current assets and both to generate

sales (turnover)

Total Asset Turn over Ratio

Sales / average Total Assets


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Fixed Assets Turn Over Ratio

Sales / Avg Fixed Assets

Assess the effectiveness of the fixed assets to

generate sales

Also reflects the investment strategies

i (


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Inventory Turnover Ratio (Not

Relevant)

Cost of Goods Sold (Sales) / AVG

Inventory

Number of Days Stock

Avg Inventory / Sales(COGS) per day

(Measures efficiency of inventorymanagement (not the inventory policy of

the management)


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Debtors Turnover Ratio

Debtors Turnover Ratio

Net Sales/ Average Debtors

Average Collection Period

Accounts Receivable/Average Daily Sales

(Avg daily sales = Credit sales/365)

Another measure of efficiency of firms ability to collect

fast

Helps gauge liquidity of accounts receivable (ability to

collect cash from customers)


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Financial Leverage

It Pays to have Debt in your Capital

Structure


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Financing Pattern

Leverage Ratios

measure the extent of a firms financing with

debt relative to equity and its ability to cover

interest and other fixed charges also called asthe Solvency ratios

Liquidity Ratios

Measures the firms ability to meet cash needsas they arise


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Leverage: Debt Ratios (!!)

Debt to Equity Ratio

Long Term Debt/Equity

Debt Asset Ratio

Total Outside Liability / Total Assets

Interest Cover Ratio

Operating Profit/Interest Expense

Indicates how well operating earnings cover fixed

interest charges

They measure the extent of firms financing with debt and

the financial risk


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Liquidity Ratios

Current Ratio Current Assets/Current Liabilities

Measures ability to meet short-term cash needs

Quick or Acid Test Ratio Current Assets-Inventory/Current Liabilities

Measure ability to meet short-term cash needs more

rigorously


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Other Ratios : For the Investor

Earnings per Share

PAT /Average Equity Shares

Indicates return on a per share basis

Book Value of the Share

Net worth / Number of shares


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CASH FLOW STATEMENT

CASH IS CASH REST IS

ACCOUNTING!!!

Accounting profits do not help in assessing

the firms ability to meet its debts

As they are based on accrual concept

As they are based on subjective judgements like

depreciation


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CASH FLOW STATEMENT

Cash flow statement can be taken as a summary of the

cash book

Need for cash flow statement arises from the

deficiencies in the profit and loss a/c and the balance

sheet, as these numbers are influenced by the

accounting policies etc

Cash flow statement helps in forecasting future value.


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Objectives of a CFS

Provide information to the user on: -

- ability of the enterprise to generate cashand cash equivalents and the timing and

certainty of their generation.- the manner in which the enterprise putscash and cash equivalents to use.

- financial structure, liquidity, solvency,netassets and adaptability of the enterprise

-


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CASH FLOW STATEMENTS

Provides information on cash flow related

to operation financing and investing

activities Firms follow the accrual and matching

principle to record transactions and hence

the company's incomes/ expenses are notrelated to cash


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CASH FLOW STATEMENTS

CASH FLOWS ARE DIVIDED INTO 3SEGMENTS AS :

CASH FLOW FROM OPERATING ACTIVITY CASH FLOW FROM INVESTING ACTIVITY

CASH FLOW FROM FINANCING ACTIVITY


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OPERATING ACTIVITIES

Includes the cash flows derived from principal

revenueproducing activities of enterprise.

Cash receipts from main business of

company.

Cash receipts from royalties, fees, etc.

Cash payment to supplier.

Cash payment to and behalf of employees.

Cash payments or refunds of income tax.


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INVESTMENT ACTIVITIES

Shows the expenditure that have been made

to generate future income and cash flows.

Cash payment to acquire fixed assets.

Cash receipts from disposal of fixed

assets(including intangibles)

Cash payment to acquire shares ,warrants

or debt instrument of other firms.

Cash receipts from disposal of shares etc


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FINANCING ACTIVITIES

Cash proceeds from issuing shares or

other similar instruments

Cash received from debentures,loans

bonds and other borrowings

Cash repayments of amount borrowed.


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Profitable, yet in Trouble?

A firm is defined as profitable if it has a

positive net income

A positive net income results from revenues

exceeding expenses

A firm may have a positive net income, but

this does not guarantee that the firm has the

CASH to meet its obligations!


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Cash Flow from operations

1.Started business with share capital of Rs.50000

2. Purchased goods for Rs. 50000 paid 60 % in cash,balance payable

3. Sold goods costing Rs. 40000 for Rs. 100000 on onemonth credit.

4. Purchased equipment for Rs. 15000

5. Depreciation of Eqpt. Rs. 3000The month end. Prepare the Financial Statements

The company wants to declare dividends of Rs. 40000 ?

Operating Results: Transaction


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Operating Results: Transaction

analysis

1. BS: Capital 50000 = Cash 50000

2. Capital 50000 + Crs 20000 = Inventory 50000 +Cash 20000

3. OE 50000+ Profit 60000+ Crs 20000= Drs 100000 + Inv 10000 + Cash 20000

4. OE 50000+ Profit 60000+Crs 20000 =Eqpt 15000+DRs 100000+ Inv 10000+Cash 5000

5.

OE 50000+ Profit 57000+Crs 20000 =Eqpt 12000+DRs 100000+ Inv 10000+Cash 5000

There is profit of 57000 after depreciation but no cash ?


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Cash Flow (Direct Method)

1. CFO:

Paid Creditors (30000)

2 CFF

Capital +50000

CFI

Equipment (15000)

Ending Cash Balance 5000

Cash Flow (Indirect Method)


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Cash Flow (Indirect Method)

1. CFO:PAT 57000

Add: Depreciation 3000

Cash flow before WC Changes 60000

Increase Creditors 20000

Increase in Drs - 100000

Increase in Inv - 10000 -90000

Net outflow -30000

2 CFF

Capital +50000

3 CFIEquipment (15000)

Ending Cash Balance 5000

ACE Inc produced and sold Cassette Tapes. The cost of the Cassettes

R 8 d ld t R 10/ Th h d li f k i


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was Rs. 8 and were sold at Rs.10/- The company had a policy of keeping

inventory for 30 days. It also paid its suppliers by the due dates. The

company gave a credit of 30 days to its customers. The company had an

opening inventory of Rs. 80000, Cash of Rs. 100000 and Equity of Rs.280000 and Receivable Rs 1lac. The MD was happy with a whopping

profit of Rs. 210000, but the conservative accountant predicted a crisis

at this rate.

Particulars Sales ProductionApr 100000 12000 units

May 120000 16000

June 160000 18000July 180000 24000

Aug 240000 25000

Sep 250000 28000


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Ways to minimize cash holdings

Synchronize inflows and outflows.

Use a remote disbursement account. Increase forecast accuracy to reduce need for

safety stock of cash.

Hold marketable securities (also reduces need

for safety stock).

Negotiate a line of credit (also reduces need

for safety stock).

fsa reliance mdp

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