Financial Statement Analysis

The Big Question

Company A Company B
Net Income 1,00,000 10,00,000
Current Assets 50,000 5,00,000

Company A Company B
Equity 5,00,000 100,000,000
Current 25,000 10,00,000
Liabilities
 Financial Analysis
• Assessment of past, present and future

• Identify ‘Red Flags’ or ‘Gold Nuggets’

• Primary Tools:
– Financial Statements
– Comparison of financial ratios to past, industry,
sector and all firms
ABC of
Financial
Statements

Financial Statements
Financial Statements

Income Balance Sheet

Statement

Cash Flow Retained

Statement Earnings

Assets = Liabilities + Capital

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 Information about What?
Basically on:

Assets

Liabilities
Health
Capital

Incomes
Performance
Expenses
Non traditional Sustainable – Green & Blue Information
6
 Information about What?

• Useful for investment decisions

 About economic resources and claims on

resources

 About financial performance during a period

 About cash flows

7
 ABC of Financial Statements
Four Financial
Three
Five Elements: Statements:
Transactions:
Assets; Liabilities; Income Statement;
Operating;
Capital; Incomes ; Balance Sheet;
Investing:
Expenses Cash Flow:
Financing
Retained Earnings

Two systems: One Equation:

Cash Vs Accrual A = L +E

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 Analysis of Financial Statements
• The Common Tools
– Comparative Statement (Horizontal Analysis)
– Common size Statement (Vertical Analysis)
– Trend Analysis
– Ratio Analysis

• Standardize numbers and facilitate comparisons.

• Used to highlight weaknesses and strengths.

Financial
Statements
Analysis –
The Income
Statement

Financial Statements
 How is the Income Statement useful?

• Managing Budgets

• Managing Profits

• Evaluating Business Strategy

Common Size Income Statement
 Operating Ratios
COGS/
Year Sales SGA/Sales EBITDA/Sales ROS
1991 50.56 18.59 30.84 13.99
1992 50.31 19.39 30.29 14.57
1993 51.85 20.54 27.60 13.49
1994 53.48 23.25 23.27 12.00
1995 64.91 27.89 7.20 -5.84
1996 (Q3) 64.07 28.91 7.02 -4.80
 Profitability Ratios

• Gross Margin

• Operating Ratio

• Net Margin

• ROA

• ROI

• ROE
 Profitability Ratios
Company Name PBDITA as % of total income PBT as % of total income PAT as % of total income
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 17.15 22.61 3.58 9.97 2.22 6.41
           
A P L Apollo Tubes Ltd. 3.91 4.46 1.29 1.64 0.95 1.26
Coal India Ltd. 96.36 93.46 95.33 92.58 94.33 92.51
Hindalco Industries Ltd. 11.7 15.1 1.72 5.28 1.46 3.81
Hindustan Copper Ltd. 15.37 20.32 3.5 7 3.32 4.6
Hindustan Zinc Ltd. 51.83 57.11 47.68 47.65 44.54 39.09
J S W Steel Ltd. 18.08 21.33 -12.33 8.82 -8.54 6.25
Jindal Stainless (Hisar) Ltd. 11.14 13.49 0.43 4.26 0.35 2.85
Jindal Steel & Power Ltd. 18.96 22.04 -15.52 -9.28 -9.45 -6.28
M O I L Ltd. 36.59 43.02 30.48 38.14 19.51 25.25
N M D C Ltd. 57.48 49.56 49.84 41.27 32.14 26.59
National Aluminium Co. Ltd. 23.18 20.36 15.09 11.45 9.92 7.9
Steel Authority Of India Ltd. -4.39 0.97 -15.56 -9.67 -9.03 -5.63
Vedanta Ltd. -17.52 36.55 -36.89 21.02 -25.02 21.35
Welspun Corp Ltd. 10.64 15.54 -4.44 5.62 -3.06 3.72
Financial
Statements
Analysis –
The Balance
Sheet

Financial Statements
Balance Sheet - Vertical Analysis
 Important Ratios to analyze BS
Analysis Ratios
Liquidity Management Working Capital (Gross and Net)
Current Ratios
Quick Ratios
Cash Ratios
Asset Management Inventory Turnover
Receivables Turnover
Working Capital Turnover
Operating Cycle
Assets Turnover
Debt Management Payables Turnover
Debt Ratio
Debt Equity Ratio
Interest Coverage Ratio
Balance Sheet
Analysis-
Liquidity
Management

Financial Statements
Liquidity Management - Working Capital
• Working Capital
– Assets/liabilities required to operate business on
day-to-day basis
• Cash
• Accounts Receivable
• Inventory
• Accounts Payable
• Accruals

– Short-term in nature—turn over regularly

DMRC – Liquidity Analysis
Types of Working Capital
 Type of Working Capital
• Gross working capital = Current assets
– Gross Working Capital (GWC) represents
investment in current assets
• (Net) working capital =
Current assets – Current liabilities
• Both are equally important:
• One is a measure of the level of current assets
• Other measures the extent to which long-term
sources of financing have been used to finance
Negative Working Capital
• Retail and restaurant companies like
– Amazon, Wal-Mart, and McDonald’s often have
negative Working Capital

• Because customers pay upfront

– Cash generated used to pay off Accounts Payable
– No need of keeping a large cash balance on-hand

• This can be a sign of business efficiency

Walmart – Annual Report 2016
 Non Cash Working Capital
• Back out from current assets
– cash and investments in marketable securities

• Unlike other current assets, cash earns a fair

return

• Back out from current liabilities

– interest bearing short term debt
 Permanent & temporary working capital

Amount Variable Working Capital

of
Working
Capital

Permanent Working Capital

Time
Matching approach to asset financing
Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
Capital

Fixed Assets

Time
Conservative approach to asset financing

Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
capital

Fixed Assets

Time
Aggressive approach to asset financing

Total Assets
Short-term
Debt
$
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
capital

Fixed Assets

Time
Ratios to analyze working capital
 Liquidity Ratios
Company Name Quick ratio (times) Current ratio (times)
Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 0.33 0.38 0.68 0.83
       
A P L Apollo Tubes Ltd. 0.52 0.31 1.02 0.81
Coal India Ltd. 3.09 1.77 3.19 1.86
Hindalco Industries Ltd. 1.16 0.96 1.9 1.52
Hindustan Copper Ltd. 0.98 0.7 1.48 1.29
Hindustan Zinc Ltd. 2.34 1.6 2.42 1.7
J S W Steel Ltd. 0.16 0.23 0.51 0.64
Jindal Stainless (Hisar) Ltd. 0.26 0.4 0.61 1
Jindal Steel & Power Ltd. 0.27 0.3 0.54 0.58
M O I L Ltd. 12.07 9.64 12.77 10.31
N M D C Ltd. 2 1.58 2.07 1.66
National Aluminium Co. Ltd. 2.78 1.41 3.48 2
Steel Authority Of India Ltd. 0.17 0.14 0.58 0.51
Vedanta Ltd. 0.38 0.53 0.51 0.67
Welspun Corp Ltd. 0.97 0.74 1.37 1.23
 Working Capital Trade-offs
Inventory
High Levels Low Levels
Benefit: Cost:
• Happy customers • Shortages
• Few production delays (always have needed • Dissatisfied customers
parts on hand) Benefit:
Cost: • Low storage costs
• Expensive • Less risk of obsolescence
• High storage costs
• Risk of obsolescence

Cash
High Levels Low Levels
Benefit: Benefit:
• Reduces risk • Reduces financing costs
Cost: Cost:
• Increases financing costs • Increases risk
 Working Capital Trade-offs
Accounts Receivable
High Levels (favourable credit terms) Low Levels (unfavourable
terms)
Benefit: Cost:
• Happy customers • Dissatisfied customers
• High sales • Lower Sales
Cost: Benefit:
• Expensive • Less expensive
• High collection costs
• Increases financing costs

Accounts Payable and Accruals

High Levels Low Levels
Benefit: Benefit:
• Reduces need for external finance--using a • Happy suppliers/employees
spontaneous financing source Cost:
Cost: • Not using a spontaneous
• Unhappy suppliers financing source
 The Trade-Off

Current Assets High Level Low Level

Profitability Lower Higher

Risk Lower Higher

Assets Management - Financial Ratios
WC Management - Financial Ratios
 Accounts Payable Value Addition

Raw WIP
Materials

THE WORKING CAPITAL

Cash CYCLE Finished
(OPERATING CYCLE) Goods

Accounts SALES
Receivable
Cash Conversion Cycle Analysis

Inventory 365
Conversion =
Inventory Turnover
Period
Receivables Accounts Receivable × 365
Collection =
Annual Credit Sales
Period
Payables Accounts Payable × 365
Deferral =
Cost of Goods Sold
Period
Operating Vs Cash Cycle
 Operating and Cash Conversion Cycle

Inventory conversion period

plus: Receivable collection period
equals: Operating cycle
minus: Payables deferral period
equals: Cash conversion cycle

• Shortening cash conversion cycle frees up cash to

reinvest in business or to reduce debt and interest
 An Example
• Profit and Loss Account Data

Sales 3000
Cost of goods sold 1800

• Balance Sheet Data

April 2013 March 2014

•  
• Inventory 300 310
• Accounts receivable 180 170
• Accounts payable 85 95
•  
• What is the duration of the cash cycle?
 Solution
Inventory Period (300+310) / 2 61.87
= =
1800/365

Accounts receivable (180 + 170)/2 21.30

period
= =
3000/365

Accounts payable (85 + 95) / 2 18.25

= =
1800/365

Cash Cycle = 64.9 days

Balance Sheet
Analysis-
Assets
Management

Financial Statements
Questions – Need to be answered

Liabilities Assets

Assets
Equity
in Place
What Proportion What Proportion
Value Value
How Risky How Risky
Growth
Debt Assets
 Assets Utilization – Tata Steel
Finished goods turnover Net fixed asstes utilisation
Company Name Debtors turnover (times) (times) ratio(times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 51.59 33.58 9.4 8.66 1.18 0.92
           
A P L Apollo Tubes Ltd. 16.98 13.64 20.75 20.7 10.26 8.89
Coal India Ltd. 13.56 23.96 2.71 5.02 1.02 1.28
Hindalco Industries Ltd. 18.68 19.93 39.74 43.46 1.26 1.18
Hindustan Copper Ltd. 13.68 10.19 43.74 18.93 5.65 4.62
Hindustan Zinc Ltd. 40.08 153.09 149.61 174.41 1.56 1.86
J S W Steel Ltd. 16.68 17.43 10.58 12.74 0.96 1.17
Jindal Stainless (Hisar)
Ltd. 8.22 8.08 11.11 11.54 2.86 3.31
Jindal Steel & Power Ltd. 13.11 18.26 10.85 20.24 0.42 0.37
M O I L Ltd. 5.08 5.15 3.34 4.7 2.1 3.11
N M D C Ltd. 3.51 4.08 4.09 6.62 3.97 4.56
National Aluminium Co.
Ltd. 33.82 32.6 29.46 25.98 1.1 1.17
Steel Authority Of India
Ltd. 10.09 11.99 5.79 7.12 1.06 1.03
Vedanta Ltd. 18 16.18 109.52 82.17 1.36 1.18
Welspun Corp Ltd. 2.87 3.89 17.65 19.92 1.45 1.82
Balance Sheet
Analysis-
Debt
Management

Financial Statements
 Debt Management
• Long term solvency

• Balance between Cost of Capital and rating

• Provisioning for long term obligations

Long Term Debt Paying Ability
 Leverage Ratio or Death Strategy
Year Total Debt Equity Debt/Capital Interest Int Cov Ratio

1991      3.5 10.14

1992 236.3 84.7 73.61 6.5 10.43

1993 250.2 147.3 62.94 14.6 7.85

1994 384.3 243 61.26 16.5 7.26

1995 586.5 207.8 73.84 43.2 1.38

1996 654.5 180.5 78.38 42.7 0.96

VIDEOCON – The Red Flag
 D/E Ratio
Company Name Debt to equity ratio (times)
Mar-16 Mar-17
Tata Steel Ltd. 0.67 0.59
   
A P L Apollo Tubes Ltd. 1.33 0.93
Coal India Ltd. 0.07 0.02
Hindalco Industries Ltd. 0.68 0.57
Hindustan Copper Ltd. 0.19 0.45
Hindustan Zinc Ltd. 0 0.26
J S W Steel Ltd. 1.82 1.64
Jindal Stainless (Hisar) Ltd. 2.87 3.93
Jindal Steel & Power Ltd. 1.12 1.16
M O I L Ltd. 0 0
N M D C Ltd. 0.05 0
National Aluminium Co. Ltd. 0 0.01
Steel Authority Of India Ltd. 0.9 1.15
Vedanta Ltd. 0.54 0.67
Welspun Corp Ltd. 1.15 0.82
Profitability Analysis
 Strategic Profitability Analysis
Company Name Return on total assets Return on capital employed PAT as % of net worth
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 0.97 3.15 1.26 4.56 1.67 7.32
           
A P L Apollo Tubes Ltd. 5.13 3.7 6.53 5.35 9.18 10.62
Coal India Ltd. 73.79 71.97 97.75 92.41 101.24 96.78
Hindalco Industries Ltd. 0.43 1.54 0.51 1.85 1.39 3.48
Hindustan Copper Ltd. 0.79 2.1 1.37 4.04 2.57 5.85
Hindustan Zinc Ltd. 15.34 15.25 19.95 22.1 20.27 24.48
J S W Steel Ltd. -5.08 3.93 -7.39 5.69 -15.91 16.53
Jindal Stainless (Hisar) Ltd. 1.25 3.29 3.52 5.69 4.03 28.91
Jindal Steel & Power Ltd. -2.53 -1.45 -3.3 -2.06 -7.97 -4.4
M O I L Ltd. 4.69 8.35 5.06 9.08 5.06 9.77
N M D C Ltd. 6.44 7.51 8.85 10.78 8.83 10.03
National Aluminium Co. Ltd. 4.06 4.27 5.21 5.79 6.06 5.71
Steel Authority Of India Ltd. -3.84 -2.5 -5.43 -3.65 -9.73 -7.53
Vedanta Ltd. 10.13 5.53 13.85 7.57 -21.05 13.93
Welspun Corp Ltd. -1.71 2.54 -3.19 4.78 -7.04 10.15
 The DuPont System

ROE

ROA E quity M ultiplie r

Profit M a rgin T ota l A s s e t T urnove r

ROE  Profit Margin  Total Asset Turnover  Equity Multiplier

Net Income Sales Total Assets
  
Sales Total Assets Common Equity
Ratios –Comparison of Business Models
 The Value Chain
Cimarron Meritage White (per the case)
Vineyard
Revenue 12.99 P/S = 26.2%
Operating Costs 9.59 S/A = .14
Margin 3.40 ROA =3.6%
Assets93.97 + $.27 handling cost
Winery
Revenue 76.00
Costs:
Grapes 13.26 P/S = 5.2%
Winemaking21.07 S/A = .30
Bottling 16.80 ROA =1.6%
Bottle Aging 1.60
SG&A 19.29 + $2.25 freight
Margin 3.98 + 1.56 tax
Assets255.00

Distributor
Revenue 106.41
Wine Cost 79.81 P/S = 10.8%
Operating Cost 15.08 S/A = 2.59
Margin 11.52 ROA = 28%
Assets41.06

Retailer
Revenue 142.43 P/S = 4.5%
Wine Cost 106.41 S/A = 2.93
Operating Costs 29.65 ROA = 13%
Margin 6.37
Assets48.68

The Overall Value Chain

Revenue $142.43 P/S = 17.8%

Profit $ 25.27 S/A = .32
Assets $439.00 ROA = 5.7%
ROE Net Income/ Equity (BV)

ROA EBIT*(1-t) = NOPAT/Total Operating

Assets
ROCE NOPAT/(D+E)
Market Value
Analysis

Financial Statements
 Analyzing the market value ratios

• P/E: How much investors are willing to pay for $1 of

earnings?
• P/CF: How much investors are willing to pay for $1 of
cash flow?
• M/B: How much investors are willing to pay for $1 of
book value equity?
• Ratio - Higher the better
• High P/E and M/B - ROE is high and risk is low
 Valuation/Market Ratios
Company Name EPS (INR) P/E Ratio (Times) P/B Ratio (Times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 11.26 36.01 28.39 13.41 0.71 1.02
           
A P L Apollo Tubes Ltd. 21.2 17.74 31.66 66.2 4.53 7.04
Coal India Ltd. 26.23 23.35 11.13 12.53 11.49 13.05
Hindalco Industries Ltd. 1.7 5.99 51.89 32.58 0.43 0.92
Hindustan Copper Ltd. 0.23 0.61 215.87 108.42 3.3 4.17
Hindustan Zinc Ltd. 19.04 19.83 9.64 14.56 2.08 3.98
J S W Steel Ltd. -166.79 13.84  13.59 1.56 1.92
Jindal Stainless (Hisar) Ltd. 3 8.14 8.81 17.45 0.98 3.89
Jindal Steel & Power Ltd. -16.14 -10.81    0.24 0.51
M O I L Ltd. 10.3 21.35 21.14 14.7 1.06 1.49
N M D C Ltd. 7.03 9.05 13.95 14.71 1.33 1.87
National Aluminium Co. Ltd. 2.63 3.51 15.02 21.79 0.77 1.45
Steel Authority Of India Ltd. -9.71 -6.71    0.45 0.7
Vedanta Ltd. 45.18 32.6 1.99 8.43 0.34 1.02
Welspun Corp Ltd. -4.52 6.12  13.51 1.61 1.21
 Valuation Ratios
Market Capitalisation (Rs.
Company Name Million) MarketCap / EV (Times) EV / PBDITA (Times)
Mar-16 Mar-17 Mar-16 Mar-17 Mar-16 Mar-17
Tata Steel Ltd. 310497.58 468805.69 0.51 0.63 8.23 6.1
           
A P L Apollo Tubes Ltd. 15728.5 27705.22 0.77 0.88 16.09 22.58
Coal India Ltd. 1844062.59 1816598.3 1.04 1.02 10.5 12.13
Hindalco Industries Ltd. 181615.5 437546.71 0.39 0.62 10.55 11.47
Hindustan Copper Ltd. 46584.73 61156.91 1.01 0.94 26.48 23.87
Hindustan Zinc Ltd. 775768.57 1220272.13 1 1 8.15 10.01
J S W Steel Ltd. 310189.81 454920.89 0.47 0.55 8.88 6.8
Jindal Stainless (Hisar) Ltd. 6114.86 33526.32 0.25 0.5 3.11 6.52
Jindal Steel & Power Ltd. 55122.95 110717.93 0.18 0.31 10.85 10.47
M O I L Ltd. 36573.6 41787.67 4.53 2 2.49 4.01
N M D C Ltd. 388542.17 421113.82 1.52 1.14 5.28 7.63
National Aluminium Co. Ltd. 101800.92 147869.06 2.01 1.18 2.76 7.29
Steel Authority Of India Ltd. 178025.64 253201.2 0.34 0.38 0 136.11
Vedanta Ltd. 266377.78 815142.68 0.4 0.61 0 7.05
Welspun Corp Ltd. 26177.82 21907.68 0.6 0.62 10.13 4.87
Analysis of
Cash Flow
Statement

Financial Statements
 How is the Cash Flow Statement useful?

• Cash Generation

• Cash Burn Rate

• Valuation Analysis
 Insights: Cash Burn Rates

• Cash burn rate a popular metric for assessing

how quickly firms use up their cash reserves

– Cash used for operations plus cash used for capital

expenditures and purchases divided by the
number of months
 The Measures of Money Making
• Growth

• Cash generation

• Return on Assets
TRAPs of
Financial
Analysis

Financial Statements
 Five Traps of Performance Measurement

• Measuring Against Yourself

• Looking Backward

• Putting your faith in numbers

• Gaming your matrices
• Sticking to your numbers
 Qualitative factors
• Are the firm’s revenues tied to 1
– key customer, product, or supplier?

• Percentage of the firm’s business generation

– Domestic Vs overseas?

• Competition

• Future prospects

• Legal and regulatory environment

THA
NK
YO
U
Financial Statement Analysis 71