Financial Statement

Analysis
BY:
CA VAIBHAV JAIN
FCA, ACS, LL.B, MBF (ICAI), FAFD (ICAI),
Registered Valuer (S&FA) - IBBI
Phone: +91 9711310004
E-mail id: [email protected]
 Analysis of
Assets, Liabilities &
Equity and Income
and Expenses
 Assets, Liabilities & Equity and
Income and Expenses

Assets
• In simple meaning Asset means what the
company owns
• Various types of Assets are mentioned below :
 Non – Current Assets
 Current Assets
 Assets, Liabilities & Equity and
Income and Expenses

Assets
• Current Assets :
 Cash or expected to be turned in cash in the next
year
 Cash
 Marketable Securities
 Accounts Receivables
 Inventories
 Other Current Assets (Prepaid Expenses)
Assets, Liabilities & Equity and
Income and Expenses

Assets
• Non – Current Assets
 Long Term Assets :
Book value = Acquisition cost – Accumulated depreciation
The firm reduces the value of fixed assets (other than land) over time
according to a depreciation schedule that depends on the asset’s life
span.

 Goodwill and Intangible Assets :

If the firm assesses that the value of these intangible assets declined
over time, it will reduce the amount listed on the balance sheet by an
amortization or impairment charge that captures the change in value
of the acquired assets.

 Other Long - Term Assets (E.g. Investments in Long-Term

Securities)
Assets, Liabilities & Equity and
Income and Expenses

Liabilities
• In General Meaning Liabilities means what
company owns
• Various types of Liabilities are mentioned
below :
 Long – Term Liabilities
 Stockholder’s Equity
Assets, Liabilities & Equity and
Income and Expenses

Liabilities
• Long – Term Liabilities :
 Long – Term Debt
 Capital Leases
 Deferred taxes : Deferred taxes are taxes that
are owed but have not yet been paid.

• Stockholder’s Equity :
 Book value of Equity
Book value of Assets – Book Value of Liabilities
Assets, Liabilities & Equity and
Income and Expenses

Income Statement

• Whereas the balance sheet shows the firm’s

assets and liabilities at a given point in time, the
income statement shows the flow of revenues and
expenses generated by those assets and liabilities
between two dates.

• The income statement is sometimes called a

profit and loss, or “P&L” statement, and the net
income is also referred to as the firm’s earnings.
Assets, Liabilities & Equity and
Income and Expenses

Income Statement

• Whereas the balance sheet shows the firm’s

assets and liabilities at a given point in time, the
income statement shows the flow of revenues and
expenses generated by those assets and liabilities
between two dates.

• The income statement is sometimes called a

profit and loss, or “P&L” statement, and the net
income is also referred to as the firm’s earnings.
Assets, Liabilities & Equity and
Income and Expenses

Income
• Revenue from operations :
 Sale of product less returns
 Sale of Services
 Other operating revenues

• Other Income
 Rent income
 Dividend Income
 Transfer fees
 Profit on sale of Fixed Assets
Assets, Liabilities & Equity and
Income and Expenses
Expenses
• Cost of Material Consumed
 (Opening Stock + Purchases – Closing Stock).
• Changes in Inventories
 (Opening Stock – Closing Stocks).
• Employee Benefit Expenses
 Salary.
 Staff Welfare Expenses.
• Finance Cost
 Interests.
 Discounts.
• Depreciations and Amortisation Expenses.
Performance
Analysis
Performance Analysis
Financial Performance

• One of the most fundamental facts about

businesses is that the operating performance of
the firm shapes its financial structure.

• It is also true that the financial situation of the

firm can also determine its operating performance.
Performance Analysis
Measure of Financial Performance
• Return on Equity (ROE) :

 The most popular measure of financial performance

(for many audiences) is ROE.

 ROE measures accounting earnings for a period per

dollar of shareholders’ equity invested.

 ROE = Net Income / Shareholder’s Equity

Performance Analysis
Measure of Financial Performance
• Profit Margin :

 This ratio measures the fraction of each rupee

of sales that makes it through to net income.
(Net Income/Sales)

 The “gross margin” measures profitability

relative to variable costs. (Gross Profits/Sales)
Performance Analysis
Measure of Financial Performance
• Asset Turnover :
 This ratio measures the sales generated per
dollar of assets employed.
 Asset turnover = Sales / Assets.

• Fixed Asset Turnover :

 Fixed-Asset Turnover is perhaps a “purer”
reflection of the capital intensity of a firm.
 Fixed-Asset Turnover = Sales/Net Fixed Assets.
Performance Analysis
Measure of Financial Performance
• Financial Leverages :
 Financial Leverage which is also known as leverage,
refers the use of Debt to acquire additional Assets.
 Financial Leverage = Assets / Shareholder’s Equity.
 An increase in the value of the assets will result in a
larger gain on the owner's cash, when the loan
interest rate is less than the rate of increase in the
asset's value.
 A decrease in the value of the assets will result in a
larger loss on the owner's cash.
 Analysis of
Capital Structure
CAPITAL STRUCTRE ANALYSIS
• Capital structure analysis is a periodic evaluation
of all components of the debt and equity financing
used by a business.
• The intent of the analysis is to evaluate what
combination of debt and equity the business
should have. This mix varies over time based on
the costs of debt and equity and the risks to which
a business is subjected.
• Capital structure analysis is usually confined to
short-term debt, leases, long-term debt, preferred
stock, and common stock
CAPITAL STRUCTRE ANALYSIS
Objectives for analyzing Capital Structure
• To determine if the proportion of debt to equity
enables an entity to create wealth without unduly
jeopardizing the firm.

• Capital structure composition

 Consists of long-term liabilities, preferred stock,
common stock, and retained earnings.
 Sufficient equity must exist to provide financial stability
 Debt can be used as leverage to increase returns to
shareholders, but it can also reduce returns on
shareholders’ investments
CAPITAL STRUCTRE ANALYSIS
Capital Structure Measures
• Capital Structure Composition

• Financing activities should correspond to investing

activities

• Lack of correspondence signals financial distress

• Common size statements

CAPITAL STRUCTRE ANALYSIS
Events where Capital Structure is must

• The upcoming maturity of a debt instrument, which may

need to be replaced or paid off
• The need to find funding for the acquisition of a fixed
asset.
• The need to fund an acquisition.
• A demand by a key investor to have the business buy
back shares
• A demand by investors for a larger dividend
• An expected change in the market interest rate
Cash Flow
Analysis
Cash Flow Analysis
 It simply means studying or analysing the Cash
Flow Statement comprising part of Financial
Statements.
 It provides information about cash inflows and
outflows during an accounting period.
 Is developed from Balance Sheet and Income
Statement Data.
 Important as an Analytical Tool.
IMPORTANCE OF CASH FLOW
 Accrual-based accounting requires reporting
revenues when earned and expenses when
incurred- not when cash is exchanged.
 Explains the reasons for a change in cash.
 Reconciles net income with cash flow from
operations.
 Valuation models used in financial analysis
are often based on projection of future cash
flows..
Preparing Cash Flow Statement
 Four Parts of a statement of cash flows:

 Cash
 Operating Activities
 Investing Activities
 Financing Activities
CASH

 Cash includes Cash and Cash-equivalents

 Cash Equivalents
 Treasury Bills maturing within 90 days or
less.
 Investment Funds.
 Foreign Currency on hand
 Checking Account
 Free Savings Account
 Operating Activities
 Cash flows related to selling goods and services;
that is, the principle business of the firm.
 The cash effects of transactions and other events
that enter into the determination of income.
Examples of Operating Activities
 Cash received from customers through sale of
goods or services performed;
 Cash payments to suppliers or employees.
 Cash payment for taxes and other expenses.
Operating Activities

Direct
DirectMethod
Method Indirect
IndirectMethod
Method
 Investing Activities
 Acquiring/disposing of securities that are not cash equivalents
 Cash flows related to the acquisition or sale of non-current assets.
 Lending money/collective on loans

Examples of Investing Activities:

 Cash received from sales of assets that are not held for the regular trading purposes such as sale
of building; marketable securities such as trading and available for sale securities, and
investments
 Cash payments to acquire property,plant, and equipment (PPE), other tangible or intangible
assets, and other long term assets.
 Cash received from sale of, and paid for purchases of derivative instruments
 Loans extended to other companies and collection of such loans.
 Financing Activities
 Borrowing from creditors/repaying the principal
 Obtaining resources from owners
 Providing owners with a return on investment
Examples of Financing Activities
 Cash received from issuing share capital
 Cash proceeds from issuing bonds, loans, notes, mortgages and other short or long-term
borrowings
 Cash payments to shareholders to redeem exisiting shares-treasury stock
 Cash repayment of loans and other borrowings;and
 Cash payment to shareholders as dividends.
Limitations of Cash Flow Analysis
 Non- cash transactions are ignored
 Not a substitute for Income Statement
 Not a test for Total Financial Position
 Historical in Nature.
 Analysis of Cash Flow
 When analyzing the cash outflows, the
analyst should consider the necessity of
the outflow and how the outflow was
financed.
 Generally, it is best to finance short-term
assets with short-term debt and long
term-assets with long-term debt or
issuance of stock.
Credit
Analysis
 Credit Analysis
 Credit analysis is the method by which one calculates
the creditworthiness of a business or organization. In other words, It is the
evaluation of the ability of a company to honor its financial obligations. The
audited financial statements of a large company might be analyzed when it
issues or has issued bonds. Or, a bank may analyze the financial statements
of a small business before making or renewing a commercial loan. The term
refers to either case, whether the business is large or small.

 The objective of credit analysis is to look at both the borrower and the
lending facility being proposed and to assign a risk rating. The risk rating is
derived by estimating the probability of default by the borrower at a given
confidence level over the life of the facility, and by estimating the amount of
loss that the lender would suffer in the event of default.
5C’s of Credit Analysis

 Character
 Capacity(Cash Flow)
 Capital
 Collateral (or Gurantees)
 Conditions
 Character
 This is the part where the general impression of the protective borrower is
analysed. The lender forms a very subjective opinion about the trust –
worthiness of the entity to repay the loan. Discrete enquires, background,
experience level, market opinion, and various other sources can be a way to
collect qualitative information and then an opinion can be formed, whereby
he can take a decision about the character of the entity.
Capacity (Cash Flow)
 Capacity refers to the ability of the borrower to service the loan from the
profits generated by his investments. This is perhaps the most important of
the five factors. The lender will calculate exactly how the repayment is
supposed to take place, cash flow from the business, timing of repayment,
probability of successful repayment of the loan, payment history and such
factors, are considered to arrive at the probable capacity of the entity to
repay the loan.
Capital
 Capital is the borrower’s own skin in the business. This is seen as a proof of
the borrower’s commitment to the business. This is an indicator of how much
the borrower is at risk if the business fails. Lenders expect a decent
contribution from the borrower’s own assets and personal financial guarantee
to establish that they have committed their own funds before asking for any
funding. Good capital goes on to strengthen the trust between the lender and
borrower.

Conditions
 Conditions describe the purpose of the loan as well as the
terms under which the facility is sanctioned. Purposes can be
Working capital, purchase of additional equipment, inventory,
or for long term investment. The lender considers various
factors, such as macroeconomic conditions, currency
positions, and industry health before putting forth the
conditions for the facility.
Collateral(or Guarantees)
 Collateral are form of security that the borrower provides to
the lender, to appropriate the loan in case it is not repaid
from the returns as established at the time of availing the
facility. Guarantees on the other hand are documents
promising the repayment of the loan from someone else
(generally family member or friends), if the borrower fails to
repay the loan. Getting adequate collateral or guarantees as
may deem fit to cover partly or wholly the loan amount bears
huge significance. This is a way to mitigate the default risk.
Many times, Collateral security is also used to offset any
distasteful factors that may have come to the fore-front
during the assessment process.
 Credit Analysis Ratios
 A company’s financials contain the exact picture of what the business is going through,
and this quantitative assessment bears utmost significance. Analysts consider various
ratios and financial instruments to arrive at the true picture of the company.
 Liquidity ratios – These ratios deal with the ability of the company to repay its
creditors, expenses, etc. These ratios are used to arrive at the cash generation capacity
of the company. A profitable company does not imply that it will meet all its financial
commitments.
 Solvability ratios – These ratios deal with the balance sheet items and are used to judge
the future path that the company may follow.
 Solvency ratios – Solvency ratios are used to judge the risk involved in the
business. These ratios take into picture the increasing amount of debts which may
adversely affect the long term solvency of the company.
 Credit Analysis Ratios
 Profitability ratios – Profitability ratios show the ability of a company to an earn a
satisfactory profit over a period of time.
 Efficiency ratios – These ratios provide insight in the management’s ability to earn a
return on the capital involved, and the control they have on the expenses.
 Cash flow and projected cash flow analysis – Cash flow statement is one of the
most important instrument available to a Credit Analyst, as this helps him to gauge
the exact nature of revenue and profit flow. This helps him get a true picture about
the movement of money in and out of the business
 Collateral analysis – Any security provided should be marketable, stable and
transferable. These factors are highly important as failure on any of these fronts will
lead to complete failure of this obligation.
 SWOT analysis – This is again a subjective analysis, which is done to align the
expectations and current reality with market conditions.
THANK YOU!

CA. Vaibhav Jain, Partner

B.Com (Hons.), FCA, ACS, LL.B., MBF (ICAI),
CIDT, FAFD (ICAI), Registered Valuer (S&FA)
+91 97113 10004
[email protected]