Financial Ratio Analysis and Interpretation

Of
ITC Limited

Submitted to:
Dr. M. M. Ali
Associate Professor
Submitted by:
Soujanya
Roll No. - 2
Semester - 1
Session - 2022-2024

PGDM 4 Batch
th

Administrative Staff College of India, Hyderabad

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Introduction to Financial Analysis
Financial analysis is the process of evaluating businesses, projects, budgets, and other
finance-related transactions to determine their performance and suitability. Typically,
financial analysis is used to analyse whether an entity is stable, solvent, liquid, or profitable
enough to warrant a monetary investment.

 If conducted internally, financial analysis can help fund managers make future
business decisions or review historical trends for past successes.
 If conducted externally, financial analysis can help investors choose the best possible
investment opportunities.
 Fundamental analysis and technical analysis are the two main types of financial
analysis.
 Fundamental analysis uses ratios and financial statement data to determine the
intrinsic value of a security.
 Technical analysis assumes a security's value is already determined by its price, and
it focuses instead on trends in value over time.

Financial analysis is used to evaluate economic trends, set financial policy, build long-term
plans for business activity, and identify projects or companies for investment. This is done
through the synthesis of financial numbers and data. A financial analyst will thoroughly
examine a company's financial statements—the income statement, balance sheet, and cash
flow statement. Financial analysis can be conducted in both corporate finance and
investment finance settings.

One of the most common ways to analyse financial data is to calculate ratios from the data
in the financial statements to compare against those of other companies or against the
company's own historical performance.

For example, return on assets (ROA) is a common ratio used to determine how efficient a

company is at using its assets and as a measure of profitability. This ratio could be
calculated for several companies in the same industry and compared to one another as part
of a larger analysis.

Types of Financial Analysis:

1. Horizontal Analysis –
It refers to the analysis of financial statement figures that are dynamic in nature and
analysis the businesses finances from one year to next.
2. Vertical Analysis –
It is the analysis of the relationship between various items on a financial statement.
The relationship is expressed in terms of percentage.
3. Liquidity Analysis –
It is used to explain whether a company is able to pay the debts or any other expenses
using the ratios. It can predict financial troubles in the future.
4. Profitability Analysis –

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 The company’s rate of return is calculated. Margin ratios and return ratios are two
types of profitability analysis.
5. Variance Analysis –
It refers to the process of evaluating any differences between a business’s budget and
actual cost incurred.
6. Valuation Analysis –
It analyses the business present value and can be utilized for various instances such
as mergers and acquisitions.
7. Sensitivity Analysis –
The value of an investment is measured based on current scenarios and changes. It is
helpful in predicting outcomes based on different variables.

Importance of Financial Analysis

The goal of financial analysis is to analyse whether an entity is stable, solvent, liquid, or
profitable enough to warrant a monetary investment. It is used to evaluate economic trends,
set financial policy, build long-term plans for business activity, and identify projects or
companies for investment.

The analysis of financial statements is crucial for the following reasons.

 The shares investment and holding

Shareholders own the company; such investments happen with repeated transfers and shares.
Time and again, they may have to decide on whether to continue based on the price, profit,
and reliability factors. Therefore, a company's analysis of the financial statement is crucial to
making decisions as it reflects all information that is meaningful to the shareholder's
decision process.

 Plans, decisions, and management

Financial statement analysis is essential for a company's decisions, planning, and
management. As a result, the company management makes smart and intelligent calls on
investment plans. These are backed by data analytics when planning for a bright future and
maximum profits accrual.
Thus, compared to statements in the recent past, the future goals and predicted performances
are endemic to the decision-making of shareholders, companies, and analysts.

 Providing credit
Shareholders offer loans to the company as its capital. The decision to provide and extend
capital credit is based on a financial examination. The examination is based on the
company's financial statements and performance over time. All capital loans carry an
interest rate and determine the best rate. They are also a part of the decision process in
making credit loans to companies.

 Decisions on investments
Investors with surplus investable capital always look for opportunities to place their funds as
investments in profitable and profit-potential companies. Before investing such capital
funds, investors look at the past performance and predicted profit

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Need of Financial Analysis
Financial analysis is needed for various purposes and is very important for any
organisation.

Financial Analysis is needed to:

 Measure the profitability and earning potential of a business: It helps to check

whether the profits earned are up to the expectations or not. After analysing the
financial statements, the trend of profit can be ascertained, and earning potential of
the company can be checked. 
 Measure the financial strength of the business: It helps to understand how strong
a business is financially and judge its position in the market.
 Comparative study: Financial Analysis is helpful to compare the position of two
firms in the market or compare the growth of a firm.
 Efficiency of management: The trend of the profits and losses of a business allows
us to judge if the business is being managed efficiently or not, which means that the
resources of a business are being utilised effectively or not.
 Useful to the management: An insight into the business helps the management to
make very important decisions about the business.
 Analyse the short-term and long-term solvency: It also helps to analyse whether a
business will be able to clear its short-term and long-term debts or not.
 Reasons for deviation: To identify the reasons for any change in the
profitability/financial position of the firm.

Literature Review
The analysis and interpretation of financial statements are an attempt to determine the
significance and meaning of financial statements data so that the forecast may be made of the
prospects for future earnings, ability to pay interest and debt matureness (both current and
long term) and profitability and sound dividend policy (Kennedy and Muller, 1999).

Financial analysis using ratios between key values help investors cope with the massive
amount of numbers in company financial statements (Susan Ward, 2008).

Financial statements provide a summarized view of the financial position and operations of a
firm. Therefore, much can be learnt about a firm from a careful examination of its financial
statements as invaluable documents / performance reports (M Y Khan & P K Jain 2011).

Profitability is the ability of an entity to earn income. It can be assessed by computing various
relevant measures including the ratio of net sales to assets, the rate earned on total assets etc
(I.M Pandey, 2005).

Rate of return on investment (ROI) is a test of management’s efficiency in using available

resources (Meigs and Meigs 2003).

A written report summarizes the financial status of an organization for a stated period of time.
It includes an income statement and balance sheet or statement of the financial position

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describing the flow of resources, profit and loss and the distribution or retention of profit (J.
A Ohison, 1999).

About ITC Ltd

ITC Limited is an Indian conglomerate company headquartered in Kolkata.  ITC has a
diversified presence across industries such
as FMCG, hotels, software, packaging, paperboards, specialty papers and agribusiness. The
company has 13 businesses in 5 segments. It exports its products in 90 countries. Its products
are available in 6 million retail outlets. ITC's equity shares are listed on Bombay Stock
Exchange (BSE), National Stock Exchange of India (NSE) and Calcutta Stock
Exchange (CSE). The company's Global Depository Receipts (GDRs) are listed on
the Luxembourg Stock Exchange. ITC is a constituent of two major stock market indices of
India which are BSE SENSEX and NIFTY 50 of NSE.

The company was converted into a Public Limited Company on 27 October 1954. The first
step towards Indianization was taken in the same year with 6% of the Indian shareholding of
the company. ITC also became the first Indian company to foray into consumer research
during this time. During the 1960s, technology was given more focus on setting up cigarette
machinery and filter-rod manufacturing facilities aimed at achieving self-sufficiency in
cigarette-making. The shareholding went over 60% in 1976 and more hotels were started by
the company in the following years. ITC Sangeet Research Academy was set up at Calcutta
in 1977. In 1979, ITC entered the paperboards business by promoting ITC Bhadrachalam
Paperboards Limited. J N Sapru took over as the company's chairman in 1983 and the
international expansion started with the acquisition of Surya Nepal Private Limited in 1985.

Objectives of the study

There are four main objectives of this study. They are,

1. To study the financial performance analysis of ITC ltd.

2. To know the profitability, solvency, liquidity, activity, market efficiency and turnover
ratios of the company.
3. To know the Du-Pont analysis.
4. To analyse the reasons for change in profitability and financial position of the
company.

Limitations of the study

 This study is carried out mainly on the secondary data provided in the financial
statement.
 This study is based on past 20 year’s financial statement data.

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Research Methodology
Analytical Research

The facts and information which are already available is used in the research. Using this
information, analysis is done and critical evaluation is made.

Data Source

 Secondary Data - Secondary data describes those collected for a purpose other than
the task at hand. Secondary data can come from within an organization but more
commonly originate from an external source. If it helps to make the distinction,
secondary data is essentially just another organization’s primary data. 

Tools used for Analysis:

Ratio Analysis
Du-Pont Analysis

Data Analysis
Ratio Analysis:

Ratio analysis refers to the analysis of various pieces of financial information in the financial
statements of a business. They are mainly used by external analysts to determine various
aspects of a business, such as its profitability, liquidity, and solvency.

1. Liquidity Ratio - Liquidity ratios are a measure of the ability of a company to pay off
its short-term liabilities.

Current Ratio: This ratio measures the company’s liquidity situation by comparing its current
assets with its current liabilities. A ratio of more than 1 means that the company has current
assets more than its current liabilities. This ratio is also known as Working Capital Ratio.

Current Ratio = Current Assets / Current Liabilities

The firm has highest current ratio of 4.1 in the financial year 2020-21 and the lowest of 1.0 in
the financial year 2004-05. From the analysis, we can say that the company has good
liquidity position.

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Quick Ratio: This is a more stringent version of the liquidity ratio as it does not consider
assets, which although current in nature, but cannot be converted into cash immediately.
Prominent example of such current assets is inventories.

Quick Ratio = (Current Assets – Inventories) / current liabilities

The firm has the highest quick ratio of 3.13 in the year 2020-21 and the lowest of 0.48 in the
year 2005-06. The standard quick ratio is 1:1. The analysis shows that the company’s liquid
position is not good in 2005.

Super Quick Ratio: It is otherwise called as Absolute Liquid Ratio or Cash Ratio or Cash
Position Ratio. This ratio is calculated when liquidity is highly restricted in terms of cash and
cash equivalents. The standard ratio of Super Quick Ratio is 0.5:1.

It has increased significantly from the year 2015-2021 YoY basis and is more than 1; greater
than the standard ratio. It is estimated that company might not be have a problem while
repaying its short-term obligation.

2. Solvency Ratio - A solvency ratio is a key metric used to measure an enterprise’s

ability to meet its long-term debt obligations and is used often by prospective business
lenders. A solvency ratio indicates whether a company’s cash flow is sufficient to
meet its long-term liabilities and thus is a measure of its financial health.

Debt Equity Ratio: High levels of debt in a business can prove to be detrimental for a
company. In absence of its ability to pay to the lenders, business may have to face
bankruptcy. When businesses create assets aggressively out of borrowed money, it could be
quite dangerous if the assets are unable to generate the expected revenues and profitability.

D/ E Ratio = Long Term Debt / Net-worth

It has decreased to 0.00 in year 2022-23 from 0.02 in 2004-05. Hence, it could be possible
that equity has grown up or debt has gone down. It indicates less risk in the business because
the company has decreased its debt and largely depended on equity.

Debt to Capital Ratio: The debt-to-capital ratio is a measurement of a company's financial

leverage. The debt-to-capital ratio is calculated by taking the company's interest-bearing debt,
both short- and long-term liabilities and dividing it by the total capital.

It has decreased to 0.00 in year 2022-23 from 0.02 in 2004-05. It indicates less risk in the
business because the company has decreased its debt and largely depended on capital. It can
be inferred that the company has the better financial structure and is suitable for investment.

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Financial Leverage Ratio: Financial leverage ratios measure the overall debt load of a
company and compare it with the assets or equity. This shows how much of the company
assets belong to the shareholders rather than creditors.

Here, the ratio has decreased in year 2022-23 as compared with year 2004-05. It signifies that
equity has higher weightage compared to debt in the company.

Propriety Ratio: The proprietary ratio (also known as the equity ratio) is the proportion of
shareholders' equity to total assets, and as such provides a rough estimate of the amount of
capitalization currently used to support a business. If the ratio is high, this indicates that a
company has a sufficient amount of equity to support the functions of the business, and
probably has room in its financial structure to take on additional debt, if necessary.

The proprietary ratio was highest in the year 2005-06 with 2.0 and lowest during the year
2011-12 with 1.1. It can be inferred that the company has a sound capital structure.

Interest Coverage Ratio: Companies having high debt need to pay high interest as well.
Whether a company is headed for a trouble can be simply seen by comparing its earnings
with the interest. This ratio, popularly known as Interest Coverage Ratio, tells us how many
times the earnings of the business is, vis a vis its interest obligation.

Interest Coverage Ratio = EBIT / Interest Expense

It has increased to 571.51 in year 2022-23 from 146.70 in the year 2004-05. It shows that the
business is in comfortable zone and the company is earning more than its interest payment.

3. Profitability Ratio - Profitability ratios define how profitable the operations of the
company are on per rupee of sales basis. It is evident that if the industry is very
competitive and there are pricing pressures on the business, profitability will suffer.
However, if the business is unique with significant entry barriers, or if it is an initial
entrant in a sunrise industry profitability of the business would be high. A very high
level of profitability will not sustain over a long period. With new entrants and
competition, revenues and profits will moderate.

Gross Profit Ratio: It is a profitability ratio that compares the gross margin of a company to
its revenue. It shows how much profit a company makes after paying off its Cost of Goods
Sold (COGS). The ratio indicates the percentage of each dollar of revenue that the company
retains as gross profit. The ratio measures how profitably a company can sell its inventory. A
higher ratio is more favourable.

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Here, there is no much difference from 2004-05 and 2022-23. There are only moderately
increasing. It can be inferred that there is not much growth in gross profit margin in the
company.

Net Profit Ratio: Net Profit Margin (also known as “Profit Margin”) is a financial ratio used
to calculate the percentage of profit a company produces from its total revenue. A firm with a
higher ratio is seen as more efficient in managing costs and earning profits. A trend of
increasing margins means improving profitability.

The firm’s Net profit ratio was highest in the year 2020 which was 32.34% and lowest in the
year 2009 which was 14.10%, there is a fluctuation in net profit during the study period. It
can be inferred that the company is performing good as compared to previous years.

Operating Ratio: Operating Profit Margin differs across industries and is often used as a
metric for benchmarking one company against similar companies within the same industry.

From the analysis, we can say that the operating ratio of the firm remained constant from 2004-
05 to 2022-23.

Return on Assets Ratio: Return on Assets (ROA) is a type of return on investment (ROI)
metric that measures the profitability of a business in relation to its total assets. This ratio
indicates how well a company is performing by comparing the profit (net income) it’s
generating to the capital it’s invested in assets.

The firm has highest Return on assets ratio of 22.39% in the year 2014-15 and lowest ratio of
14.91% in the year 2004-05.

Return on Capital Employed: Return on Total Capital can be used to evaluate how well a
company’s management has utilized its capital structure to generate value for both equity and
debt holders. ROTC is a better measure to assess management’s abilities than the Return on
Capital Employed ratio since the latter only monitors management’s use of common equity
capital.

Here, it has increased to 0.24 in 2022 from 0.22 in 2004. It indicates that the management has
properly put in place its capital structure to create value for both equity and debt holders.

4. Activity Ratio - An activity ratio broadly describes any type of financial metric that
helps investors and research analysts gauge how efficiently a company uses its assets
to generate revenues and cash.

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Stock Turnover Ratio: Inventory turnover is a financial ratio showing how many times a
company turned over its inventory relative to its cost of goods sold (COGS) in a given
period. A good inventory turnover ratio is between 5 and 10

From the analysis, the firm has the highest stock turnover ratio of 5.93 in the year 2019 and the
lowest of 1.55 in the year 2021. There is a low inventory turnover ratio from 2021 which may
be a sign of weak sales or more inventories.

Stock Velocity: Inventory velocity is the time period from the receipt of raw materials to the
sale of the resulting finished goods. Thus, it is the period over which a business has
ownership of inventory.

The firm has the highest stock velocity in the year 2019 and low stock velocity in the year
2021.

5. Market Efficiency Ratio - The efficiency ratio is typically used to analyse how well
a company uses its assets and liabilities internally. An efficiency ratio can calculate
the turnover of receivables, the repayment of liabilities, the quantity and usage of
equity, and the general use of inventory and machinery. 

Earnings per Share: Earnings per share (EPS) is calculated as a company's profit divided by
the outstanding shares of its common stock. The resulting number serves as an indicator of a
company's profitability. 

The firm has highest EPS of 88.88 in the year 2005 and lowest of 5.95 in the year 2006.

Dividend Ratio: The dividend pay-out ratio is the ratio of the total amount of dividends paid
out to shareholders relative to the net income of the company. It is the percentage of earnings
paid to shareholders via dividends.

The firm has the highest dividend pay-out ratio of 94.00 in the year 2010 and the lowest of
31.09 in the year 2004.

6. Turnover Ratios - The turnover ratio or turnover rate is the percentage of a mutual
fund or other portfolio's holdings that have been replaced in a given year (calendar
year or whichever 12-month period represents the fund's fiscal year).

Capital Turnover Ratio - Capital turnover (also called equity turnover) is a measure that
calculates how efficiently the company is managing the capital invested by the shareholders
in the company to generate revenues.

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Capital Turnover Ratio = Total Shares/ Shareholder’s Equity

The highest capital turnover is in the year 2010 which is 1.34 and the lowest is in the year
2020 which is 0.7. A ratio of 2 is typically an indicator that the company can pay its current
liabilities and still maintain its day-to-day operations.

Fixed Assets Turnover Ratio: The fixed asset turnover ratio (FAT) is, in general, used by
analysts to measure operating performance. This efficiency ratio compares net sales (income
statement) to fixed assets (balance sheet) and measures a company's ability to generate net
sales from its fixed-asset investments, namely property, plant, and equipment (PP&E).

The highest Asset turnover ratio is of 87.88 in 2013 and lowest is of 0.77 in 2022. A higher
ratio implies that management is using its fixed assets more effectively.

Working Capital Turnover Ratio: Working capital turnover is a ratio that measures how
efficiently a company is using its working capital to support sales and growth. Also known as
net sales to working capital, working capital turnover measures the relationship between the
funds used to finance a company's operations and the revenues a company generates to
continue operations and turn a profit.

The highest Working capital turnover ratio is in the year 2022 and the lowest was in the year
2020.

Current Assets Turnover Ratio: The asset turnover ratio measures the efficiency of a

company's assets in generating revenue or sales. It compares the dollar amount of sales
(revenues) to its total assets as an annualized percentage. Thus, to calculate the asset turnover
ratio, divide net sales or revenue by the average total assets.

The highest Current assets turnover ratio is in the year 2008 and the lowest was in the year
2011.

Total Assets Turnover Ratio: The total asset turnover ratio compares the sales of a company
to its asset base. The ratio measures the ability of an organization to efficiently produce sales,
and is typically used by third parties to evaluate the operations of a business. Ideally, a
company with a high total asset turnover ratio can operate with fewer assets than a less
efficient competitor, and so requires less debt and equity to operate.

Total Asset Turnover Ratio = Net Sales/ Total Assets

From the analysis, the firm has no significant change in the total asset turnover ratio drom
2004 to 2022. It lies between 0.6 to 0.8.

Du-Pont Analysis

When studying ratios, analyst often try to synthesise by reading various ratios together to see
if it provides any additional insight. For instance, if sales are growing but the collection
period is increasing along with it, it probably indicates that the company is being very lenient
with its credit terms in order to boost sales. One of the popular frameworks that synthesizes
ratios is the Dupont analysis. It breaks return on equity into multiple components in order to

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understand how various factor contribute to ROE. It can also be used to do diagnostic study
to understand fall or rise in ROE.

Dupont analysis breaks ROE as follows:

As you can see, the above equation expresses return on equity as a product of three factors:
 Net profit margin: It has increased, it may be because of net profit got increased as
compare to proportionate of sales.
 Asset turnover ratio: Efficiency of assets may be decreasing as compare to previous
year that is why sales are affecting. Therefore, it has decreased.
 Leverage: Company is lower the position of debt, largely depending on equity.

Conclusion

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