Financial Statement Analysis

Prof. Sobhesh Kumar Agarwalla

Indian Institute of Management Ahmedabad

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 Purpose

Purpose of FSA
Evaluate Financial Performance
I Income Statement

Evaluate Financial Position

I Balance Sheet

Evaluate Efficiency
I Linking Income Statement and Balance sheet

Assess Cash Flow Statement

I Bird’s-eye view

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 Industry Parameters

Indigo

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 Industry Parameters

Drreddys

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 Industry Parameters

Infosys

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 Industry Parameters

TCS

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 Industry Parameters

Reliance

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 Industry Parameters

D-Mart

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 Industry Parameters

Reliance-Retail

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 Industry Parameters

Ujjivan - MF/Bank

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 Purpose

Purpose of FSA
Evaluate Financial Performance
I Income Statement

Evaluate Financial Position

I Balance Sheet

Evaluate Efficiency
I Linking Income Statement and Balance sheet

Assess Cash Flow Statement

I Bird’s-eye view

Prof. Sobhesh K. Agarwalla (IIMA) Financial Statement Analysis 11 / 26

 Benchmarking

Benchmarking
Trend Analysis
Company X Company X Company X
Year(t) Year (t-1) Year (t-2)

Cross Sectional
Company X Company Y Company Z
Year(t) Year (t) Year (t)

Combination of both
Company X Company Y Company Z
Y(t) Y(t-1) Y(t-2) Y(t) Y(t-1) Y(t-2) Y(t) Y(t-1) Y(t-2)

Company X Industry Average

Y(t) Y(t-1) Y(t-2) Y(t) Y(t-1) Y(t-2)

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 Revenue

Income Statement
Trend in sales: Increasing/ Decreasing/ Stagnant

Reasons:
I Volume Effect

Market Size

Market Share [reflects level of competition in the industry]

Mix

I Price Effect

Capacity
I Utilization (Yield)

I Expansion (Capacity addition / Acquisition)

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 Profitability

Profitability Ratios
Profit Margins: Sales Vs. Profit
I Gross Margin = Gross Profit
Sales

I Operating profit PBIT

Operating Margin = Sales
= Sales

I EBITDA
Cash Operating (EBITDA) Margin = Sales

I Net Profit
Net Profit Margin = Sales

Cost Analysis: Expense Ratios

I Personnel expenses ratio = Personnel Cost
Sales

I Administration Cost
Administration expense ratio = Sales

I Selling Cost
Selling expense ratio = Sales

Shortcut: Common-size income statement

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 DOL/DFL

Relationship between sales and profits

Cost structure (Fixed vs. Variable Costs): Leverage effects of fixed cost

Two types of fixed costs

I Operating fixed costs: Operating Leverage

I Interest costs: Financial leverage

Example

Particulars Year 1 Year 2 Change

Sales 100 200 +100%
Variable Operating Exp. 40 80 +100%
Contribution 60 120 +100%
Fixed Operating Exp. 30 30 -
PBIT 30 90 +200%
Interest 10 10 -
PBT 20 80 300%

DOL= Contribution/PBIT 2
DFL= PBIT/PBT 1.5

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 Return

Return Ratios: Return vs. Investment

Return on Equity (ROE) or Return on Net Worth(RONW) =
PAT
Avg(Shareholders 0 equity )

Return on Invested Capital (ROIC/ROI) or Return on Capital Employed (ROCE) =

This assumes that long-term liabilities are permanent capital.

PBIT(1-Tax Rate† ) Profit after tax + after-tax interest

Avg(Capital Employed)
or Avg(Capital + Long term debts)

†
Tax rate = Effective Tax Rate and not Corporate Tax Rate

Return on assets = Return on all resources including current assets.

PBIT(1-Tax Rate† ) Profit after tax + after-tax interest
Avg(Total assets)
or Avg(Total assets)

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 Efficiency

Efficiency Ratios: Asset (and liability) Utilization

Sales
Fixed Asset Turnover = Average Fixed Assets

Sales
Current Assets Turnover = Average Current Assets

I COGS
Inventory Turnover: Average Inventory

I Sales
Debtors Turnover: Average debtors

Current Liabilities Turnover =

I Purchases
Creditors Turnover: Average Creditors

Current Assets - Current Liabilities = Working Capital (function of sales)

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 Short-term debt

Borrowings: Short term

Concern of suppliers of Short term loans and Creditors: Repayment on due date/ in short
notice
†
I Current Ratio = Current Assets
Current Liabilities

I Current Assets† - Inventories

Quick Ratio = Current Liabilities

†
Should I consider A/R or inventory more than x months old? Some banks don’t.

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 Long-term debt

Borrowings: Long term

Suppliers of Long Term Loans: Concerned with repayment of interest and instalments
I PBIT PBIT (year)
Interest Coverage Ratio = Interest
or Interest + Instalments due in next 12 months

Are you repaying the interest/ instalments from profits or new loans?

Their interest is also affected by the share of capital contributed by them vs. equity
holders (Riskiness)
I Debt
Debt Ratio or Debt Capitalization = Debt + Equity

I Debt
Debt-Equity Ratio = Equity

Shortcut: Common-size balance sheet

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 Summary

Financial Performance - Key Ratios

Financial Performance Company A Company B
Year t t-1 t-2 t t-1 t-2
Liquidity:
Current ratio = CA/CL
Quick ratio = (Cash + AR)/CL

Asset Utilization:
Total assets turnover=Sales/avg(FA+WC)
Days’ inventory=365/(COGS/Avg(inv))
Days’ receivable= 365/(Sales/Avg(Receivable))
Day’s payable = 365/(Purchases/Avg(Payable))

Leverage:
Debt-equity
Debt Ratio
Interest coverage (1) =(EBIT+Depn)/Interest
Interest coverage (2)=EBIT/Interest

Profitability/Margins:
Gross profit margin = GP/Sales
Net profit margin = PAT/Sales
ROE=PAT/Avg.(Equity)
ROA=(PAT+Int.)/Avg.(Equity + Debt)

Others:
Sales growth

Industry Specific

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 Dupont/ Linking

Linking Various Ratios

PAT
ROE = Equity

PAT Sales
= Sales
× Equity

PAT Sales Assets

= Sales
× Assets × Equity

Sales - COGS - G & A exp - S & D exp - . . . 1 Assets

= Sales
× Assets × Equity
Sales

COGS G&Aexp S&Dexp 1 Assets

= (1 − Sales
− Sales
− Sales
− . . .) × Fixed Asset + Current Asset - Current Liabilities × Equity
Sales

COGS G&Aexp S&Dexp

= (1 − Sales
− Sales
− Sales
− . . .) (Profitability ratios)

1 Assets
× P&M Building Inventory (Efficiency ratios) × Equity (Leverage)
Sales
+ Sales + Sales + Debtors
Sales
− Creditors
Sales

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 Cash Flow Statement

Cash Flow Statement

Cash Flow statement is prepared using Income Statement and Balance sheet and it
summarizes important portion of I/S and B/S

Bird’s-eye view:

Major sources: Major uses of cash

I Operations or financing? I CAPEX

I Asset disposal/ sale of operations? I Dividend and buy backs

I Financing - Equity or Debt I Repayments of Debt

Trends: Net Income, CFO, Dividends, Debts, Working Capital

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 Cash Flow Statement CFO

Cash Flow from Operation

CFO: Positive or Negative (Important source of liquidity)

CFO vs. NI

Changes in Working Capital

Sale of Assets - Profit or Loss (view about accounting policies)

CFO vs. CAPEX

CFO vs. CAPEX + Dividend

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 Cash Flow Statement CFI

Cash Flow from Investing

Investment of Excess Cash:Fixed Assets or Purchase of Businesses

Investment in Fixed Assets: Expansion or Replacement

Sale of assets/ sale of operations

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 Cash Flow Statement CFF

Cash Flow from Financing

Borrowings:
I Net Repayments or new borrowings

I Long term or short term

Financing Pattern:
I Equity or Debt

I Public Offers

I Net Borrowings or Repayments

I Dividends / Buy backs

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 Thank you.

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