SESSION: 10

Financial statement analysis – part 2

Analysis of liabilities
Dr. Reddy Labs

10-1
Learning objectives

1. Identify major liabilities of a company

2. Analyze footnotes of the company relating to SE and borrowings
various liabilities
3. Calculate ratios to evaluate leverage

10-2
 50 MCQ 3hr2.

Investment 10 .

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10
SE
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in • Leases 2

Intangible 3

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Annual -
 10.1. Quick look at liabilities of Dr. Reddy Labs

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EQUITY i

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Liabilities
Financial liabilities
Borrowings
All these liabilities (expect for trade
Other financial liabilities payables) are further classified as
Trade payables • CURRENT
• NONCURRENT
Provisions
Deferred tax liabilities
Other liabilities

10-3

?⃝
 Common size
Dr. Reddy Labs extract of Ind AS Balance sheet 31-Mar-19 31-Mar-20 2019 2020
Total asse ts 2,24,656 2,32,253

¥-7
Equity share capital 830 831
Other equity 1,39,406 1,55,157
Share holde rs' e quity
-
67% of all d- are
&
formed 1,40,236 1,55,988

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62%
1-7
67%

by risk
.

SE : .

Liabilitie s
Non-curre nt liabilitie s
Financial Liabilities

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Borrowings 22,000 1,304 10% 1%

Other financial liabilities 102 0 0% 0%
Provisions 793 745 0% 0%
Deferred tax liabilities, net 473 20 0% 0%
Other non-current liabilities 2,079 2,055 1% 1%
Total non-curre nt liabilitie s 25,447 4,124 11% 2%

Curre nt liabilitie s
Financial Liabilities b
Borrowings
#
12,125 16,532 5% 7%

Iowa
Trade payables
Total outstanding dues of micro enterprises and small enterprises 77 55 0% 0%

.IT
Total outstanding dues of creditors other than micro enterprises and small enterprises 13,594 15,193 6% 7%
Derivative instruments 68 1,602 0% 1%
Other financial liabilities 22,670 27,006 10% 12%
Liabilities for current tax, net 181 572 0% 0%

0
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Provisions 4,789 4,669 2% 2%
Other current liabilities 5,469 6,512 2% 3%
-
Total Curre nt liabilitie s
Total Liabilitie s
.mn 58,973
84,420
72,141
76,265
26%
38%
31%
33%
Total e quity and liabilitie s 2,24,656 2,32,253 100% 100%

10-4
?⃝
Analyzing equity footnotes and statement of shareholders’ equity

Refer to the statement of shareholders’ equity and footnote 2.5 Share Capital (page
222-223) from Dr. Reddy Labs’ annual report and answer the following questions-
Q1. How many shares is the authorized to issue? How many did it issue and how many
are outstanding?
-
4¥ ¥7M .

shares? 166.17-tm-3-95950166.AM
Q2. Show the computation of EQUITY CAPITAL using par value and number of
.
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=
83dm
issued por

①
Q3. Approximately at what average price were the shares issued ? How is the cash
E-
received on issue of shares accounted?

10-5
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Q4. As on the balance sheet date how many shares are held by the ESOP trust and at
what average price were they bought?
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Q5. Reconcile the beginning and ending balances of retained earnings.

Q6. The company’s stock price was INR 3,911 on Mar 31, 2020. Determine the

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company’s market capitalization on that day.

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Mcap MVE =

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=
64989%
Q7. Calculate and interpret the company’s market-to-book ratio on Mar 31, 2020.

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10-8
10.1 Analyzing footnotes relating to borrowing

Refer to the footnote 2.10 A & 2.10B Borrowings (page 224-227) from Dr. Reddy Labs’
annual report and answer the following questions-
BANK .

Q1 How much has the company borrowed and from where?

→

STILT = 16532 +7304 = 17836 ,

Q2. What are the terms relating to security and interest rates of these borrowings ?

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Q3. What portion of this borrowing is to be repaid within one year?

16532/17836 =
next yr I -

Q4. What is the repayment schedule of the borrowings?

4266=6582-426+4
10-9
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 10.2. Recap of Dupont analysis

What drives the ROE of a company ?

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• Profit margin: profitability i.e. profit generated for each $ of sale

• Asset turnover: productivity i.e., sales generated for each $ invested in assets
• Leverage: equity multiplier or level of borrowing
• The benefit of borrowing is that managers can operate from a larger asset base than the
amount that would be financed only from shareholders’ equity.
• This would result in greater profits for shareholders as long as the business generates a
higher return on its assets than what it must pay to service the debt.
• The risk is the company commits to pay certain interest and return the borrowings in
certain pre-committed manner irrespective of profit / loss

10-13
 10.3. Ratios used in analysis of liabilities

ROE

ROA LEVERAGE

PROFITABILITY PRODUCTIVITY

Liquidity Coverage
Solvency
Current ratio Interest coverage
Total liabilities / ratio
Total assets Quick ratio
Debt service
Debt / Equity coverage ratio

Analysis of liabilities
10-14
 1. Total Liabilities/ Total Assets -
Measures the proportion of total assets financed by external funds. Higher this ratio, greater is the
reliance on external funds, and higher is the risk.

2. Debt/Equity Ratio
Indicates how much of interest bearing liabilities a company is using to finance its assets relative
to the value of shareholders’ equity.

Select numbers as per Ind AS 31-Mar-19 31-Mar-20

Total assets 2,24,656 2,32,253
-
high?
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Total liabilities 84,420 76,265
Total liabiltiie s / Total asse ts Risks .

-
38% 33%

Debt -
Borrowings - current (
bonds / bank / leased
12,125 16,532
Borrowings - noncurrent boars 22,000 1,304
Total debt 34,125 17,836

Equity
D/E
-
Risk & 1,40,236
0.24
1,55,988
-
0.11
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10-15
?⃝
 3. Current ratio = (Current Assets) / (Current Liabilities)

=
• High current ratio indicates greater ability to meet short term obligations
• Low current ratio indicates greater reliance on operating cash flows or external financing to
meet short term obligations
• Typically a ratio of 2 : 1 or better is considered good

4. Quick ratio = (Cash + ST marketable securities + AR ) / Current liabilities

• More conservative that current ratio because it considers -
• Inventory may not be quickly converted into cash
• Prepaid expenses, deferred taxes etc. can’t be converted back into cash

Select numbers as per Ind AS 31-Mar-19 31-Mar-20

Current assets (1) 1,11,101 1,25,991
Cash (2) 2,228 2,053
Marketable securities (3) 22,529 23,687

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Accounts receivables (4) 39,869 50,278

⑧
Current liabilities (5) 58,973 72,141
Curre nt ratio (1/5) 1.88 1.75

10-16
Quick ratio (2 + 3 + 4)/5
_= 1.10 1.05
 5. Interest coverage ratio = EBIT / Interest expense
• EBIT = Earnings (income) before Interest expense and income Taxes
• Measures how many times a firm’s net income before interest expense and income taxes
exceeds its interest expense.
• Interest coverage ratios less than 2.0 suggest a risky situation.
• Some analyst’s use CFO or EBIDTA in the numerator

6. Fixed charge coverage = EBIT / (Interest payments + Current portion of debt)

• Current potion of long term debt and current portion of lease payments will reflect the
principal repayment due next year. Should include any other repayments also.
• This ratio is also called Debt Service Coverage Ratio (DSCR)
• The ratio of less than 1 indicates that cash generated form operations is not sufficient to
service debt. The debt will have to be refinanced or cash from some other sources has to
be introduced.

10-17
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 Select numbers as per Ind AS 31-Mar-19 31-Mar-20

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Net income 19,500 20,260
Interest expense 889 983
Tax 3,858 -1,403

198041/983
EBIT 24,247 19,840
.

Debt to be repaid with 1 year

Interest coverage ratio

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4,256

27.27
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4,266

20.18 *
Fixed charge coverage ratio 6.81
AHA 4.55

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10-18
 10.4. Overall evaluation

How well is the company doing compared to (i) its past, and (ii) competition ?

Dr. Reddy Labs Sun Pharma

Select numbers as per Ind AS (Rs mil) 2019 2020 2021 2019 2020 2021
Net income S 19500 20260 19149 26654 37649 29038
R
.

Sales 1,54,482 1,75,170 1,89,722 2,90,659 3,28,375 3,34,981

Net income / Sales (1) I -0 12.62% 13.11% 10.93% 9.17% 12.95% 8.84%
→E÷ iii. to
Average total assets • at 2,25,050 2,28,455 2,48,866 6,46,051 6,64,731 6,79,595
Sales / Avg total assets (2) 2- ° 0.69 0.77 0.76 0.45 0.49 0.49
Thongs .

Thanga
Avg SE 1,32,976 1,48,112 1,64,985 4,34,604 4,69,236 4,58,636
Avg total assets / Avg SE (3) 1.69 1.54 1.51 1.49 1.42 1.48
"
ROE (1) X (2) X (3)
by 14.66% 15.51% 12.57% 6.13% 9.06% 6.46%

10-19
 How does stock market process this information?

• Three commonly used valuation ratios are -

• P/E = Stock price / Earnings per share
• P/B = Stock price / Book value per share or Market capitalization / Book value of equity
• P/S = Stock price / Sales per share or Market capitalization / Sales

• These ratios can be interpreted as the price investors are willing to pay to buy a share of a
company has $1 as EPS, BVE/Share, or Sales/share.

• These ratios are often used as a part of relative valuation where we want to pick a relatively
overvalued or undervalued stock among a group of stocks

• All else equal- firms with higher growth prospects and lower risk will have higher valuation ratios

• P/E and P/B can’t be calculated when EPS and Book value of equity are negative

• Will learn more about these ratios in FSA / Valuation class

10-20
 ¥§aT
Price (INR) [1]
①
Analysis as of June 2021 DRL
5,460
SUN
681
Shares outstanding (# mil) [2] 166 2,399

iE ÷¥É
Market cap (INR, mil) [ 3 = 1*2] 9,04,804 16,34,000

-5EPS [4]
P/E [5 = 1/4]

Book value of Equity (SE) [6]

115.14
47.42

1,64,985
12.10
56.28

4,58,636
P/B [7 = 3/6] 5.48 3.56

Sales [8] 1,89,722 3,34,981

P/S [9 = 3/8] 4.77 4.88

If you have to pick between the stock of Dr. Reddy Labs and Sun Pharma, which one would you pick?

You would be able to answer this question correctly if you take the FSA and BVFS electives

10-21
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Closing thoughts

• Accounting is like mapping of actions and events into financial statements. But the
mapping is often incomplete and subjective

• Be very careful with your calculations so that mapping can be completed to the extent
possible. That’s why in financial accounting we give a great importance to numbers.

• That been said, don’t lose sight of the bigger picture. Numbers tell a story. Don’t just
fixate on numbers and convert the analysis into a mindless spreadsheet exercise.

• GOOD LUCK

10-22