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Financial Statement Analysis

Basic EPS
Basic EPS = Net Income Attributable to Common Equity Shareholders
Weighted average number of shares outstanding

Dilluted EPS
Diluted EPS = Net Income Attributable + Preferred Dividend on + Interest (1-Tax) on
to common ESH convertible PS convertible debt
WANES + Equity shares on convertible securities

Stock Options and Warrants - Treasury Method

Number of shares to = (Avg Market Price – Exercise Price) x Number of shares
add in denominator upon conversion.
Avg market price

Free Cash Flow to Firm (FCFF)

FCFF = Net Income + Interest (1-Tax) + Non-cash charges – WCinv – FCinv

Free Cash Flow to Equity (FCFE)

FCFE = Net Income + Non cash charges – WCinv – FCinv + Net Borrowings

Relationship between FCFF and FCFE

FCFE = FCFF – Interest paid (1-Tax) + Net Borrowings.

LIFO Reserve
→ LIFO Reserve = FIFO inventory − LIFO inventory
→ ∆ LIFO Reserve = LIFO COGS – FIFO COGS

Average age of Asset

→ Total Useful Life = Original Cost or Gross Block
Annual Depreciation
→ Average Age of Assets = Accumulated Depreciation
Annual Depreciation
→ Remaining Useful Life = Net PPE
Annual Depreciation

Defined Benefit Plan

Fixed sum p.a = x % x Last Drawn Salary x Number of years worked

Income Tax Expense

Income Tax Expense = Tax Payable + ∆DTL - ∆DTA.

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Effective Tax Rate

Effective Tax Rate = Income Tax Expense / Pre-Tax Income.

Cash Tax Rate

Cash Tax Rate = Cash Taxes Paid / Pre-Tax Income.
Activity Ratios

Receivables T/O = Revenue

Avg Receivables

Payables T/O = Purchases

Avg Trade Payables

Inventory T/O = COGS

Avg Inventory

Asset T/O = Revenue

Avg Assets

Fixed Assets T/O = Revenue

Avg Net Fixed Assets

Working Capital T/O = Revenue

Avg Working Capital

→ Days Outstanding Ratios –

Receivables Holding period or Day sales O/S = (1/Receivables turnover) x 365

Inventory Holding Period = (1/Inventory turnover) x 365
Number of days Payables = (1/ Payables turnover) x 365.

Cash Conversion Cycle = Receivables Holding period + Inventory Holding period –

Payables holding period

Profitablity Ratios

Net Profit Margin = Net Profit

Revenue

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Gross Profit Margin = Gross Profit

Revenue

Operating Profit Margin = Operating Income

Revenue

Pre-Tax Margin = Pre-Tax Profit

Revenue

Return on Assets = Net Income + Interest (1-Tax)

Avg Total Assets

Operating ROA = Operating Income

Avg Total Assets

Return on Invested Capital = After Tax Operating Profit

Avg Long Term Capital

Return on Equity = Net Income

Avg Total Equity

Return on Common = Net Income - Preferred Dividend

Equity Avg Common Equity

Liquidity Ratios

Current Ratio = Current Assets

Current Liabilities

Cash Ratio = Cash + Marketable Securities

Current Liabilities

Quick Ratio = Cash + Marketable Securities + Receivables

Current Liabilities

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Defensive Interval Ratio = Cash + Marketable Securities + Receivables

Average daily cash expenditures

Solvency Ratios

Debt : Equity = Total Debt

Shareholders’ Equity

Debt : EBITDA = Debt

EBITDA

Debt : Capital = Total Debt

Total Debt + Shareholders Equity

Financial Leverage Ratio = Average assets

Average Equity

Debt : Asset = Total Debt

Total Assets

Interest = Earnings Before Interest & Tax (EBIT)

Coverage Ratio Interest Payments

Fixed charge coverage = EBIT + lease payments

Interest + lease payments

Coverage ratios = Earnings available for distribution

Relevant liability
DuPont Analysis
→ 3 Part Dupont –
ROE = Net Income x Revenue x Avg. Assets
Revenue Avg. Assets Avg. Equity

→ 5 Part Dupont –
ROE = Net Income x EBT x EBIT x Revenue x Avg. Assets
EBT EBIT Revenue Avg. Assets Avg. Equity

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Fixed Income
Pricing a bond between Coupon Dates
→ Full Price = Value of bond on last coupon date x (1 + yield)n/N
→ Accrued Interest = Coupon Amount x number of days since the last coupon was paid
Total number of days between two coupon dates.
→ Flat price = Full price – Accrued Interest.

Matrix Pricing – Spread based variation

Credit spread ≈ Yield on Corporate Bond - Yield on Benchmark Security
(where both bonds are of same maturity)

Effective Annual Yield

EAY = (1 + stated YTM / n) n

Current Yield
Current Yield = Annual cash coupon payment
Bond Price

Simple Yield
Simple Yield = Annual cash coupon payment + amortized discount – amortized
premium
Bond Price

Callable Bond
Vcallable Bond = Vstraight Bond – Vcall option

Putable Bond
Vputable Bond = Vstraight Bond + Vput option

Valuing Annual Coupon Paying bonds using Spot Rates

→ Value of bond = Coupon + Coupon + Coupon +Face Value
(1+S1) (1+S2)2 (1+S3)3
→ Value of bond = Coupon x ∑ discount factors + (Face Value x DF3)

Spreads
→ Benchmark Yield Spread = Yield on corporate bond – Yield on a benchmark
security
→ G-Spread = Yield on corporate bond – Yield on govt bond
→ I Spread = Yield of bond – MRR

Discount Yield
Par Value – Discount = Purchase Price

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Bonds with Credit Risk

→ Coupon = MRR + Quoted Margin
→ Discount Rate = MRR + Required Margin

Valuing semi-annual coupon paying bond using spot rates

Value of bond = Coupon/2 + Coupon/2 + Coupon/2 + Coupon/2+ Face Value
(1 + S0.5/2) (1 + S1/2)2 (1 + S1.5/2)3 (1 + S2/2)4

Macaulay Duration
Macaulay Duration is weighted average time.
Where, weight = PVCFi
∑PVCF

Reinvestment Risk & Price Risk

→ Capital gain / (Capital loss) = Selling price of bond – Carrying Value of Bond
→ Duration gap = Macaulay Duration – Investment Horizon.

Modified Duration
→ Modified duration = Macaulay Duration
(1+YTM)
→ Modified duration (semi) = Macaulay Duration (semi)
(1+YTM/2)
→ % change in price of bond = -Mod Dur x ΔYTM

Approximate Modified Duration

Approximate Modified Duration = V1 – V 2
2.V0.Δytm

Money duration / Dollar Duration

Money duration = Annual ModDur x Price of bond

Price Value Basis Point

PVBP = V1 – V2
2

Factors Affecting Duration

Duration of a perpetuity = (1+YTM)
YTM

Approximate Convexity
→ Approximate Convexity = P2 + P1 – 2P0
(∆y)2 . P0
→ % change in price of bond = [-Mod Dur x Δytm] +[ 0.5 x Convexity x (Δytm) 2]

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Money Convexity
→ Money Convexity = Annual Convexity x Price of bond
→ $ change in price of bond = Annual ModDur x Price of bond + Annual Convexity
x Price of bond

Effective Duration
Effective duration = V1 – V 2
2.V0.Δcurve

Effective Convexity
→ Effective Convexity = V2 + V1 – 2V0
(∆curve)2 . V0
→ % change in price of bond = [-Effective Dur x Δcurve] + [0.5 x Effective Convexity
x (Δcurve) 2]

Key Rate Duration

→ The key rate duration of a cash flow = modified duration x weight in the
portfolio.
→ % Change in value of portfolio = -Key rate duration x Δyield

Measuring Credit Risk

→ Expected loss = Probability of Default x LGD
→ Loss severity = (1-Recovery Rate)
→ LGD (in monetary terms) = Expected Exposure x (1-Recovery Rate)
→ Expected Exposure = O/S amount of debt – Value of collateral.
Here, O/S amount of debt is accrued interest & principal O/S both.
→ Expected Credit Spread = P(Default) x (1-Recovery Rate)
→ Actual Credit Spread = Yield on Corporate Security – Yield on benchmark
security of similar maturity

Market Factors
→ Liquidity spread = yield at bid price – yield at ask price
→ Total spread = Liquidity spread + Credit Spread.

Sensitivity of bond price due to change in spread

Change in bond price due to change in spread = - Mod dur x ( Δ spread) +
½ x convexity x (Δ spread)2

Debt Service Coverage Ratio

Debt Service Coverage Ratio = Net Operating Income
Debt Service

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Derivatives
Forward contract – Price & Value
No arbitrage forward price = Spot Price + Interest + FV (Storage costs) – FV
(Benefit of holding asset)

Long Forward (F+)

Payoff on Long Forward = Spot Price at maturity – Forward Price

Short Forward (F-)

Payoff on Short Forward = Forward Price – Spot Price at maturity

Forward Rate Agreements

Net Settlement at Maturity = ( Fixed Rate – MRR ) x period of loan x Notional
Principal
(1 + MRR x period of loan)

Interest Rate Futures Price Quoting

→ Interest Rate Futures Price = 100 – (100 x MRR)
→ PVBP = Notional Principal x 0.01% x n/12

Pricing a Swap
Price of swap = $100 (1- last df)
∑ df

Put Call Parity

P + S = C+ PV(X)

Option Replication

+P C+PV(X)-S

-P -C-PV(X)+S

+C P+S-PV(X)

-C -P-S+PV(X)

+S C+PV(X)-P

-S -C-PV(X)+P

PV(X) P+S-C

-PV(X) -P-S+C

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Put-Call Forward Parity

P-C = X-F
(1+Rf)t

Hedge Ratio
Hedge ratio (h) = ∆ Option
∆ Stock

Risk Neutral Probalities

→ P(u) = 1 + Rf – d
u-d
→ P(d) = 1-p(u)

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Corporate Issuers
Turnover Ratios

Receivables T/O = Revenue

Avg Receivables

Inventory T/O = COGS

Avg Inventory

Payables T/O = Purchases

Avg Trade Payables

Cash Conversion Cycle (CCC)

Cash Conversion Cycle = Receivables Holding period + Inventory Holding Period
– Payables holding period

Working Capital
Working Capital = Current Assets – Current Liabilities
Net Working Capital = Operating current assets – Operating current liabilities

Supplier Financing Rate

Supplier Financing Rate = [1 + a/(1+a)]365/(c-b) – 1

Liquidity
Liquidity cost % = ∑Liquidity cost
∑ FMV of assets

Return on Invested Capital (ROIC)

ROIC = Net Operating PAT
Avg Invested Capital
ROIC = Post Tax operating profit margin x Capital Turnover Ratio

Real Options
Value of project with = NPV + Value of Real Option – Any cost to acquire the
embedded real option option

Weighted Average Cost of Capital (WACC)

WACC = {We x Ke} + {Wd x Kd(1-t)}
MM Proposition II : With Taxes
VLevered Firm = VUnlevered Firm + (Debt x Tax Shield)
Static Trade Off Theory (MM with Taxes & Financial Distress)
VLevered Firm = VUnlevered Firm + (Debt x Tax Shield) – PV of financial distress cost
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Economics
Fiscal Multiplier
The total increase in aggregate demand = Initial Increase in Govt Spending x
Fiscal Multiplier
Where Fiscal Multiplier = 1
1 – MPC (1-tax rate)

Balanced Budget Multiplier

The total decrease in aggregate demand for an increase in taxes
= Initial increase in Tax (MPC) x 1
{ 1– (MPC (1-Tax Rate)}

Money Neutrality
Money Supply x Velocity = Price x Real Output

Real Exchange Rate

Real Exchange Rate = Nominal Exchange Rate x CPI of base currency
CPI of price currency

Alternative Investments
Calculation of returns
Multiple of invested capital: Total capital returned + Value of remaining assets
Total capital paid during life of investment

Use of leverage
Leveraged portfolio return = r x (V0 + VB) – (rB x VB)

Return calculation for Alternative Investments

Rate of return for an investor after fees = V1 – V0 – Total fees
V0

Equity Interest
Equity interest = Value of property – Value of O/S debt

Futures Price
Futures price = Spot Price (1+Rf) + FV of storage costs – FV of convenience yield

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Portfolio Management
Basic Formulae
Std Deviation =
√(∑x – x̄)2
n-1
Covariance(a,b) = ∑ (Ra – Ra)(Rb-Rb)
n-1
Correlation(a,b) = Covariance(a,b)
σa.σb

Expected Return of Pf
ERpf = (Wa)(ERa) + Wb(ERb)

Total Risk of Pf (σ)

σpf = √ (Wa.σ a)² + (Wb.σ b)² + 2 Wa.σ a .Wb.σ b. r(a,b)

Std Deviation pf
std Deviation pf =
√Variance – Covariance
n
+ Covariance

Utility function
U = Rpf – 0.5 x Var.A

Performance Evaluation
→ Sharpe Ratio = (ERpf – Rf)
σpf } higher the better (slope of CML / CAL)
→ Treynor Ratio = (ERpf – Rf)
βpf } higher the better (slope of SML)

→ Jensen’s α = Rpf – {Rf + (ERm – Rf) x βpf} higher the better

M-Squared Alpha
→ M-squared Return = Rf + (ERpf – Rf) x σm
σpf
→ M-Squared Alpha : M-squared Return – ER (mkt)

Return generating Models

→ ERi - Rf = Factor1(β1) + Factor2(β2) + Factor3(β3)+… Factorn(βn)
→ Market Model : Ri = α + Rm β + ei

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Diversification Ratio
Diversification ratio = risk of an equally weighted portfolio of n securities
risk of a single security selected at random from the n securities

Capital Market Line

Securities Characterstic Line (SCL)

Slope of the SCL is beta (β)
β = Covariance (i,m) = Correlation(i,m) x σi
Variance (m) σm

Securities Market Line and CAPM

Return generating Models

→ ERi - Rf = Factor1(β1) + Factor2(β2) + Factor3(β3)+… Factorn(βn)
→ Market Model : Ri = α + Rm β + ei

Real Exchange Rate

Real Exchange Rate = Nominal Exchange Rate x CPI of base currency
CPI of price currency

Risk of portfolio with different r ; Diversification benefit

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Equity Investments
Leverage
Margin loan = 1 – Initial margin
Leverage ratio = [Assets / Equity] OR [1 / Initial margin]
Margin call price = P0 (1 – Initial Margin)
(1 – Maintenance Margin)

Price Weighted Index

Formula: Sum of stock prices in the index
No. of stocks in the index adjusted for splits

Market Capitalisation Weighted Index

Formula: ∑ P1Q1 - 1
∑ P0Q0

Cost of equity, ROE, Required return concepts

→ Book value of equity = BV of assets – BV of liabilities
→ MV of equity = No of equity shares outstanding x Market price of the equity
share
→ Return on Equity (ROE) = Net Income available to common equity shares
Average Book Value of Equity
→ Price to book ratio = Mkt Value of equity
Book Value of equity
→ Low P/B are value stocks, high P/B are growth stocks
→ Cost of equity is the minimum required rate of return for anyone to invest in
your shares.
→ Capital asset pricing model: Rf + (Rm – Rf) x Beta
→ Attractive investment if ROE > Cost of equity

Costs
→ Operating Profit = [(Price – Variable costs) x Qty] – Fixed cost
→ Contribution margin = Price – Variable cost
→ Degree of Operating leverage = % change in operating profit = Contribution
% change in sales EBIT
→ Gross Profit = Revenue – Cost of sales
→ EBITDA = Gross profit – Operating expenses
→ EBIT = EBITDA – Depreciation & Amortization
→ Degree of Financial leverage = EBIT
PBT
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→ Degree of total leverage = DOL x DFL

Return On Invested Capital (ROIC)

ROIC= NOPAT = EBIT (1 – Tax)
Avg invested capital Avg (Debt + Equity)

Market Share
Market share: Company’s annual revenue
Industry size

Working Capital forecasting

→ Accounts Receivable: DSO x 365
Forecasted revenues
→ Accounts Payable: DPO x 365
Forecasted COGS
→ Inventory: DOH x 365
Forecasted COGS

Dividend discount models

→ 1 year holding period DDM: V0 = (D1 + P1)
(1 + Ke)
→ Multiple-year holding period DDM: V0 = D1 + D2 + .… + Dn + Pn
2
(1 + Ke) (1 + Ke) (1 + Ke)n
→ Sustainable growth rate (g) = ROE x Retention ratio (RR)
→ Retention ratio = 1 – Dividend Payout ratio
→ Cost of equity (CAPM) = Rf + (Rm – Rf) x Beta
→ Valuing using Gordon Growth Formula:
→ Constant growth rate: P0 = D1
(Re – g)
→ Multi-stage growth rate: V0 = D1 + D2 + .… + Dn + Pn
2
. (1 + Ke) (1 + Ke) (1 + Ke)n
→ Where Pn = Dn+1
Ke - g

FCFE
FCFE = Net income + Dep & Amort − Increase in working capital – FC Inv − Net
borrowing
= Cash Flow from Operations – FC Inv − Net borrowing
Enterprise Value
EV / EBITDA = Enterprise Value
EBITDA
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Quantitative Methods
Normal vs Real Rate
→ (1 + Nominal Rf) = (1 + Real Rf) X (1 + Expected Inflation)
→ Nominal Rf ≈ Real Rf + Expected Inflation

Holding Period Return

HPR =
{ V1 – V0 + Intermittent CF
V0 } -1
Arithmetic Mean
AM = (R1 + R2 + R3 + … Rn)
N

Geometric Mean
n
GM = √ (1 + R1)(1 + R2)(1 + R3)… (1+Rn) – 1

Harmonic Mean
HM = n
1
+ 1 + ......+ 1
X₁ X₂ Xₙ

Annualized return
Annualized return = (1 + HPR)³⁶⁵/ᵈᵃʸˢ − 1

Leveraged Return
Leveraged Return = r(V0 + VB) - rBVB
V0

TVM - Basics
→ FV = PV (1 + r)t
→ PV = FV (1 + r)-t
In case of continous compounding
→ FV = PV x ert
→ PV = FV x e-rt

Zero Coupon Bonds

PV = FV
(1 + YTM)t

Perpetual bonds
PV of perpetual bonds = PMT
R
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Equity Securities
Value of preferred stock = Preferred dividend
Kp

Forward Interest Rate

(1 + S3)3 = (1 + S1) (1 + 1y1y) (1 + 2y1y)

Central Tendency and Dispersion

→ Sample mean = Sum of all values / n
→ Median: Mid-point of a data set when arranged in ascending / descending order
→ For odd number of observations: Median is the (N + 1)th observation
2
→ For even number of observations: It is the average of Nth and (N + 1)th observation
2 2
→ Mode: Value that occurs most in the dataset
→ Trimmed Mean: Excludes a stated % of the most extreme outcomes
→ Winsorized Mean: Substituting all values after the Nth percentile with the value
at Nth percentile
→ Range: Maximum value – Minimum Value
→ Mean absolute deviation: ∑|xi – x|
N
2
→ Sample variance =∑|xi – x|
n–1
→ Sample standard deviation = √ Sample variance
→ Coefficient of variation = Std deviation of x
Mean of x

Covariance
Covariance: ∑|x – x||y – y|
n–1

Correlation
Correlation of X and Y : Covariance of X and Y
(Std Dev of X) (Std dev of Y)

Probability Models
→ Expected Value = Probability x Weight
→ P(A U B) = P(A) + P(B) – P(A B) ∩
→ P(A/B) = P(A ∩
B)
P(B)

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Bayes Formula
Updated probability = Probability of new info for a given event x Prior probability
Unconditional probability of new info
OR
P(A/B) = P(B/A) x P(A)
P(B)

Portfolio Mathematics
→ Variance of portfolio of 2 assets A & B = wa2 Var(Ra) + wb2 Var(Rb) + 2 wa wb Cov(Ra,Rb)
→ Correlation = Cov (A,B)
σA σ B
→ Safety first ratio = E(Rpf) – RL
σpf

Central Limit Theorem

Standard error of sample mean = σ
√n

Testing if population correlation is zero

→ Pearson Correlation Coefficient: Measures the linear relationship between the
variables
→ Correlation = Cov (A,B)
σA σ B
→ Spearman Rank Correlation: Non-parametric test to test whether two sets of
ranks are correlated.
= 1 - 6∑d2
n(n2 – 1)
→ Test statistic (follows t-dist with n – 2 dof) to measure if the population
correlation = 0 is:
r√n–2
√ 1 – r2

Simple linear regression

→ Linear Regression Model: Y = b0 + b1X + Error term
→ Equation of Regression Line: Ŷ = b̂₀ + b̂1X
→ Estimated slope coeffecient (b̂1) = Covariance (X,Y)
Variance (X)
→ Total Sum of Squares = Regression Sum of Squares + Sum of Squared Errors
→ Standard error of estimate (SEE) = √ MSE
→ Coefficient of Determination (R2) = SSR / SST

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Hypothesis test for a regression coefficient (T-test)

Test statistic = estimated slope coefficient – hypothesized value of slope coefficient
Standard error of slope coefficient

The F-Statistics
F statistic = MSR / MSE

Predicted Values (ŷ)

Ŷ = b̂₀ + b̂1X

Constructing confidence intervals for predicted values (ŷ)

Confidence interval = ŷ + (Critical value x Standard error of forecast)

Summary of the different tests

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