CB SESSION 4 03-SEP-2021

MSc FE
COMMERCIAL BANKING

SESSION 4 : 03 SEPTEMBER 2021

GUEST FACULTY : SHRIDHAR S

ANALYSIS OF FINANCIAL STATEMENTS

MSc FE: COMMERCIAL BANKING – OVERVIEW OF COMMERCIAL BANKS

SESSION PLAN – SESSION 4
Analysis of Financial Statements
• What are Financial Statements

• Purpose of Analysis of Financial Statements by Bankers

• Introduction to Business Model Diagram for manufacturing

Companies and mapping to Financial Statements

• Rearranging the items in the Financial Statements for Analysis

• Techniques used in Analysis of Financial Statements

GUEST FACULTY : SHRIDHAR S PAGE 1 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

What are Financial Statements ?

Summary reports that show how a firm has used (or proposes to use) the funds entrusted to it by its
shareholders and lenders, and what is its current financial position.
• The three basic financial statements are the
(1) Balance sheet, which shows firm's assets, liabilities, and net worth on a stated date;
(2) Profit & loss account (also called income statement), which shows the net profit of the firm over
a stated period,
(3) Cash flow statement, which shows the inflows and outflows of cash caused by the firm's
activities during a stated period.
• Periodic Stock / debtor / creditor statement, QFS, etc.
• Projected Financial Statements
• Director’s report, Auditor’s report
• Detailed Project Report, TFEV report

Purpose of Analysis of Financial Statements by Bankers

Analysis of Financial Statements –
The process of studying or examining various financial statements of a firm, in order to gain a better
understanding of
a. the existing and future profitability of the business activities of a firm, and
b. its existing and future financial position. (Liquidity and Solvency)
Bankers:
a. Lending Banker : Directly lends to a firm
b. Investing Banker: Invests in securities issued by a firm
c. Merchant Banker : Arranges funds for a firm
d. Private Banker(Wealth/Portfolio Manager) : Recommends / invests in firms on behalf of his clients

In this Session, we shall be discussing how a Lending Banker would analyse financial statements.
Purpose:
Understanding the existing and future profitability of the business activities of a firm and its financial position
helps a banker decide
a. whether to lend (or continue to lend) to the firm
b. If so, how much to lend and in what manner and on what terms and conditions to lend.

GUEST FACULTY : SHRIDHAR S PAGE 2 OF 14

CB SESSION 4 03-SEP-2021

BASIC BUSINESS MODEL OF A FIRM AND ITS STAKEHOLDERS

SUPPLIERS FOR INPUT EXTERNAL STAKEHOLDERS :
GOODS & SERVICES NEIGHBOURHOOD,
ECONOMY, SOCIETY,
ENVIRONMENT
INPUT
GOODS INPUT
& SVS COST &
EXP.
ENTREPRENEUR PROM. CONTRIB. &
EQUITY INV.
PARTNERS/ RM, S&S, FG OUTPUT
CUSTOMERS FOR
DIVIDEND + G&S
EQUITY
CAP. APPR.
INVESTORS OUTPUT
SALES +
LENDERS, DEBT
LOANS + ENTERPRISE OTH. INCOME GOODS &
DEBT INV.
SECURITY RPMT.: PRIN. SERVICES
L&B, P&M, F&F, MV
INVESTORS + INTT. PAID

ENTERPRISE PROFIT = (SALES + OTHER INCOME) – (INPUT COSTS & EXPENSES + INTT.PAID)

BASIC BUSINESS MODEL OF A FIRM AND ITS STAKEHOLDERS: MAPPING TO FIN. STATEMENTS
SUPPLIERS OF INPUT EXTERNAL STAKEHOLDERS :
NEIGHBOURHOOD,
GOODS & SERVICES ECONOMY, SOCIETY,
BAL.
BAL. SHEET ENVIRONMENT
SHEET – INPUT
–CURR. INPUT P&L A/C
LIAB. (CR) GOODS
ASSETS (DR) COSTS & EXPENSES
& SVS
EXP. (incl. (DR)
Intt. )
ENTREPRENEUR PROM. CONTRIB. &
PARTNERS/ EQUITY INV. RM, S&S, FG
OUTPUT
EQUITY DIVIDEND + CUSTOMERS FOR
G&S
INVESTORS CAP. APPR.
ENTERPRISE OUTPUT
LOANS + SALES +
LENDERS, DEBT DEBT INV. OTH. INCOME GOODS AND
SECURITY L&B, P&M , F&F, MV
PRINCIPAL SERVICES
INVESTORS REPAYMENT
BAL. SHEET - P&L A/C ENTERPRISE PROFIT =
BAL. INCOMES (SALES + OTHER INCOME)
FIXED
SHEET – (CR) – (INPUT COSTS &
ASSETS. (DR)
LIAB. (CR) EXPENSES + INTT.PAID)

GUEST FACULTY : SHRIDHAR S PAGE 3 OF 14

CB SESSION 4 03-SEP-2021

BASIC BUSINESS MODEL OF MSME : EXTERNAL STAKEHOLDER ACTIONS : EXAMPLES

EXTERNAL STAKEHOLDER ACTIONS: EXAMPLES

- Toothukudi – Copper Smelter Plant – still not operational

- Koodankulam - Nuclear Power Plant – now operational

- Mahul (Mumbai) – Air Pollution – hefty fines even on PSUs

Purpose of Analysis of Financial Statements by Bankers

Generic Business Model of a Firm

Trading firm: M → Goods (G) → M’

Manufacturing/Service firm: M→(G/S)INPUT→(G/S)OUTPUT → M’

✓ M = Σ (Pi x Qi) M’ = Σ (Po x Qo)

✓ Pi AND Qi= Price AND Quantity of Input goods and services

✓ Po AND Qo= Price AND Quantity of Output goods and services

✓ M’ > M =» Profit =» Value Added

✓ M’ < M =» Loss =» Value Destroyed

GUEST FACULTY : SHRIDHAR S PAGE 4 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

• Profit (value addition): M’ > M i.e. (Σ (Po x Qo) > Σ (Pi x Qi)
• Loss (value destruction): M > M’ i.e. (Σ (Po x Qo) < Σ (Pi x Qi)
• SOURCES OF VALUE ADDITION/DESTRUCTION
• Ageing
• Transportation
• Assembling
• Bundling / Unbundling
• Processing
• Manufacturing
• Packaging and Re-packaging
• Intermediation
• ………..Advertising (including branding, renaming)………….
• ……….Entrepreneurship…….

Purpose of Analysis of Financial Statements by Bankers

M → (G/S)I → (G/S)O → M’
M is raised from M = Money value of M’ = Money value M’ is available for
Own funds (Equity) (G/S)I = of (G/S)O =
further business and
+ Borrowed funds
Σ (ΣΣ (Pi xQi)Pi ΣΣ (Po x Qo) / or distribution to
x Qi) Σ (Pi x Qi)
Owners and Lenders
Financing Activities Operating Activities
-Leveraging Purchasing Activities Value Adding Activities Sales Activities
-Sourcing - Sourcing/EoQ /SCM - Ageing - Marketing & Sales
-Terms of borrowing - Purchase Mgt - Assembling - Terms of sales
-Terms of issue - RM/SIP Inventory - Bundling/Unbundling - FG Inventory
-Cash Mgt - Vendor Mgt - Processing - Packaging
- Creditors and - Logistics - Manufacturing…etc. - Advertising
Receivables Mgt. - Recruitment / HR - Logistics
- Investment
Management

GUEST FACULTY : SHRIDHAR S PAGE 5 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

M → (G/S)I → (G/S)O → M’

M is raised from M = Money value M’ = Money M’ is available for

Own funds of (G/S)I value of (G/S)O further business and / or
(Equity) + = Σ (Pi x Qi) = distribution to Owners
Borrowed funds Σ (Po x Qo) and Lenders
Balance Sheet : Balance Sheet P&L P&L Profit & Loss Statement
Liabilities Side : Assets Side Statement : Statement: Net result
Expenses Income

• Current & other Inventory (Raw • Cost of • Sales • Net Profit (Value Addition)
Liabilities Mat., WIP, Input goods Revenue
• Term Liabilities Finished • Cost of input • Other
• Capital & Reserves Goods) services Income
• Debtors
• Net Fixed
Assets
• Other
Assets

BASIC BUSINESS MODEL OF A FIRM AND ITS STAKEHOLDERS: MAPPING TO FIN. STATEMENTS : RECAP
SUPPLIERS OF INPUT EXTERNAL STAKEHOLDERS :
NEIGHBOURHOOD,
GOODS & SERVICES ECONOMY, SOCIETY,
BAL.
BAL. SHEET ENVIRONMENT
SHEET – INPUT
–CURR. INPUT P&L A/C
LIAB. (CR) GOODS
ASSETS (DR) COSTS & EXPENSES
& SVS
EXP. (incl. (DR)
Intt. )
ENTREPRENEUR PROM. CONTRIB. &
PARTNERS/ EQUITY INV. RM, S&S, FG
OUTPUT
EQUITY DIVIDEND + CUSTOMERS FOR
G&S
INVESTORS CAP. APPR.
ENTERPRISE OUTPUT
LOANS + SALES +
LENDERS, DEBT DEBT INV. OTH. INCOME GOODS AND
SECURITY L&B, P&M , F&F, MV
PRINCIPAL SERVICES
INVESTORS REPAYMENT
BAL. SHEET - P&L A/C ENTERPRISE PROFIT =
BAL. INCOMES (SALES + OTHER INCOME)
FIXED
SHEET – (CR) – (INPUT COSTS &
ASSETS. (DR)
LIAB. (CR) EXPENSES + INTT.PAID)

GUEST FACULTY : SHRIDHAR S PAGE 6 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

M → (G/S)I → (G/S)O → M’

If M’ < M, the lending banker

may not get his money back

UNLESS

the Firm borrows from somewhere else,

to repay the banker.

Purpose of Analysis of Financial Statements by Bankers

... Mn : (G/S)i(n) → (G/S)o(n) : M(n+1) : (G/S)i(n+1) → (G/S)o(n+1) : M(n+2)…

------------------------------------ -------------------------
(Working Capital Cycle-WCC)(n) (Production Cycle-PC)

An accounting period (usually an FY) may contain more than one WCC.
What do the Financial Statements show?

Balance Sheet:

Where M came from and where deployed as on a particular date

P&L (For given accounting period, usually an FY) :

Whether Mn > = < M(n+x) (Flow) in the period (x cycles)

(Side Note: Shorter the WCC, more is the profit (loss) in the accounting period)

Cash Flow Statement:

How much cash flowed in/out from Financing Activity and how much Cash flowed in/out from Operating Activity
in the period.

GUEST FACULTY : SHRIDHAR S PAGE 7 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

What do Financial Statements show?...contd..
Balance Sheet:
1. Own funds (Equity) vs. Borrowed funds (TOL/TNW) (Solvency)
2. Current Assets vs. Current Liabilities (CR = CA/CL) (Liquidity)

P&L:
1. Level of Profit/Loss, major items of cost/revenue
2. Return on Sales
3. PBDIT, PBIT, PAT

Cash Flow Statement:

1. Cash generated from financing and operations activities
2. Cash deployment to financing and operations activities
3. Interest / Debt Service Coverage ratio
4. Diversion / Siphoning of Funds

Purpose of Analysis of Financial Statements by Bankers

What can a lending banker find out by analysing Financial
Statements - Balance Sheet + P&L + Cash Flow (Existing and
projected)?
1. Length of Working Capital Cycle

2. Return on Equity, Capital, Assets

3. Assessment of safety of existing Loans

4. Assessment of requirement of fresh Loans

5. Terms and conditions to be stipulated for lending

GUEST FACULTY : SHRIDHAR S PAGE 8 OF 14

CB SESSION 4 03-SEP-2021

Purpose of Analysis of Financial Statements by Bankers

Other Statements analysed by a banker:
Auditors’ Report
- Reliability of the Financial Statements

Chairman / CEO / Director’s Report

- Risks, significant events, and way forward as perceived by Mgt.

Detailed Project Report (DPR)

- Details of Project/Activity proposed to be undertaken

Technical Feasibility – Economic Viability Report (TF-EV Report / Study)

- Reliability of the DPR : Basically, Validating Qi & Qo and Validating Pi and
Po and thereby PiQi and PoQo – Costs and Revenues of the Project

Rearranging the items in the Financial Statements for Analysis

Why Bankers re-arrange FS?

• FS are general purpose statements prepared as per certain accounting

standards – US-GAAP, IndAS, IFRS etc.

• FS prepared according to these standards may not show what a lending banker
needs to see.

• Lending Banker is interested in the actual working capital cycle, real liquidity
position, total outside liabilities, tangible assets and real cash profit, and needs
to be able to assess the loan requirement.

• FS, even if drawn and presented as per accounting standards, needs to be re-
arranged to give lending banker the information necessary for him.

GUEST FACULTY : SHRIDHAR S PAGE 9 OF 14

CB SESSION 4 03-SEP-2021

Rearranging the items in the Financial Statements for Analysis

Basic Re-arrangements

• Banker’s definition of Current Assets - All tangible assets (which are part of the
WCC) and convertible into cash within next 12 months.

• Banker’s definition of Current liabilities - All liabilities (including term liabilities)

which are falling due within next 12 months

• All items which do not satisfy above definitions shall be re-classified as OA/OL.

• Thus, the rearranged CA/CL figures gives better picture of liquidity position.

• CR (CA/CL) calculated as above, should be above 1.33 for mfg Cos.

Rearranging the items in the Financial Statements for Analysis

Basic Re-arrangements …continued

• Intangible assets (Accumulated Losses, Patents/Trademarks, Brand Equity,

Good-will as also some liability items like revaluation reserves, DTL wherever
appearing), shall be deducted from Net-worth to arrive at Tangible Net-worth.
• Subordinate debt / Redeemable Preference shares will normally be reckoned as
outside liabilities and not as own funds.

• All loans and advances to / Investments in associates and subsidiaries will be

treated as Intangible asset (unless listed and quoted in stock exchange)

The position of borrower’s real stake in the business and the firm’s true
capacity to repay debt would be more clear after such re-arrangement.

GUEST FACULTY : SHRIDHAR S PAGE 10 OF 14

CB SESSION 4 03-SEP-2021

Rearranging the items in the Financial Statements for Analysis

Liability Amount Asset Amount
Sundry Creditors (Goods and expenses) L1 Cash & Bank balances A1
Bank borrowings L2 Inventory A2
TL instalments /Term Liabilities (<12 mo) L3 Sundry Debtors A3
Other CL & Provisions for expenses L4 Other CA / short term investments A4
Current Liabilities CL=L1+L2+L3+L4 Current Assets CA=A1+A2+A3+A4
Term loans from Bank L5 Net Fixed Assets A5
Other term loans (F&R) L6 Other (Non-current) assets / investments A6
Long Term Liabilities LTL=L5+l6 Total Non Current Assets TNCA=A5+A6
Equity capital L7 Loans / Investment in Associates A7
Reserves (revenue) & Provisions for Losses L8 Intangible assets /Accumulated losses A8
Total Own funds TOF=L7+L8 Total Intangible Assets TIA=A7+A8
CHECK TOTAL CL+LTL+TOF CHECK TOTAL CA+TNCA+TIA
TOTAL OUTSIDE LIABILITIES = TOL = CL+LTL
TANGIBLE NET-WORTH = TNW = TOF-TIA
TOL/TNW = TOL/TNW
CURRENT RATIO = CR = CA/CL
NET WORKING CAPITAL = NWC = CA-CL

Rearranging the items in the Financial Statements for Analysis

Expenses Amount Revenues Amount
Raw Materials Consumed (Opening Stock of E1 Sales revenue R1
RM +Purchases –Closing Stock of RM)
Stores and spares, consumables consumed E2 Other Income R2
Direct Mfg expenses E3 Closing stock of FG – Opening stock of FG R3
Overheads and selling expenses E4 Total Sales and Income – Sales Revenue (SR) SR=R1+R2+R3
Depreciation (D) E5
Interest (I) E6
Income Taxes (T) E7
PBDIT SR - (E1+E2+E3+E4)
PBDT PBDIT-I
PBT PBDT-D
PAT PBT-T
CHECK TOTAL (E1+…+E7)+PAT CHECK TOTAL SR
PAT/SALES = PAT/SR
RoE = PAT/NW
RoCE = PBIT/CL+LTL+OF
RoA = PAT/TA
CAUTION: THE RATIOS ARE DEFINED DIFFERENTLY BY DIFFERENT TEXTS / MANUALS / PURPOSES.
PLEASE BE AWARE OF THE DEFINITION USED TO CALCULATE THE RATIOS WHILE ANALYSING THE STATEMENTS

GUEST FACULTY : SHRIDHAR S PAGE 11 OF 14

CB SESSION 4 03-SEP-2021

Techniques for Analysis of Financial Statements

1. Rearranging the FS

2. Sanity Checks – Validations

3. Computation of components of the WCC

4. Computation of various Analytical Ratios

- Stock Ratios – B/S items e.g. CR, TOL/TNW

- Flow Ratios – P&L / Cash Flow items – e.g. PAT/Sales, DSCR

- Hybrid Ratios – P&L items to B/S ratios – RoE, RoA

5. Interpretation of the Parameters and ratios to answer the following Questions:

a. Whether to lend (or continue to lend) to the firm

b. If so, how much to lend and in what manner and on what terms and conditions to lend.

MSc FE: COMMERCIAL BANKING – OVERVIEW OF COMMERCIAL BANKS

SESSION 4 - RECAP
Analysis of Financial Statements
• What are Financial Statements

• Purpose of Analysis of Financial Statements by Bankers

• Introduction to Business Model Diagram for manufacturing

Companies and mapping to Financial Statements

• Rearranging the items in the Financial Statements for Analysis

• Techniques used in Analysis of Financial Statements

GUEST FACULTY : SHRIDHAR S PAGE 12 OF 14

CB SESSION 4 03-SEP-2021

COMMERCIAL BANKING : Analysis of Financial Statements

ASSIGNMENT CB – 6
1. Go to the website of one or two small listed companies of your
choice, and explore their latest Annual Report. Identify and go
through the Directors’ report, Auditors’ report, Management
Discussions and other components of the same. Can you draw a
diagram of the Companies’ business mode from the Annual
Report? Do the reports reveal anything which you think may
affect a lending banker?
2. Look up “CMA format for bank finance” on the web. Explore
various definitions and discussions on the same, for
additional/supplementary information.

COMMERCIAL BANKING : Analysis of Financial Statements

CAUTION WHILE USING WEB-RESOURCES

BE MINDFUL OF COPYRIGHT AND CYBER-SECURITY

CONSIDERATIONS WHILE USING WEB - BASED RESOURCES.

AVOID UN-TRUSTED WEB-SITES THAT ASK YOU FOR

PERSONAL INFORMATION / HAVE SET UP PAY-WALLS /
SEEK PERMISSION TO SEND YOU NOTIFICATIONS OR ASK
YOU TO REGISTER FOR ALLOWING ACCESS TO
RESOURCES/INFORMATION.

GUEST FACULTY : SHRIDHAR S PAGE 13 OF 14

CB SESSION 4 03-SEP-2021

COMMERCIAL BANKING SESSION 4 : Q AND A & CONTACT

ANY QUESTIONS ?

PLEASE CONTACT ME ON
E-mail: shridhar58@gmail.com

WhatsApp: 9818547778

GUEST FACULTY : SHRIDHAR S PAGE 14 OF 14