Module 2: Analysing Financials

Session: Ratio Analysis

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Video 1:
In the previous session, you learned the different ratios used to evaluate a company's
financial condition. Let's now learn about each type of ratio in detail, how to compute
them, and what they interpret about the financial condition of an organisation. Have
you ever thought about why someone would start a business and the motives behind it?
Well, despite any challenges, the main motive or objective behind starting a business is
to earn profits. These profits help the shareholders get richer and also help the business
grow and survive over time.

Therefore, profitability is a crucial factor when analysing the performance of any

company or organisation. Think about it. All companies that are applying for an IPO
start focusing heavily on showcasing profitability. This is because profitability is what
people usually judge a business over. You might be running a billion-dollar company,
paying all your employees salaries on time, paying your vendors on time, and running
smooth operations.

But at the end of the month, if you are not generating profits, how will you grow? And if
you cannot grow, what is the point of a business? You might be happy taking home a
hefty salary, but you run the risk of employee stagnation, quality, talent, attrition,
competitors running you out of business, and much more. So how do we measure
profitability? You can simply say we can look at the profit after tax and there we have
it.

But profitability is very different from profit. For example, Company A nets a profit of
rupees two million every year. Company B nets a profit of rupees five million every year.
Which company is more profitable? The answer is no.

Comments because profit is the net value generated by the business. While profitability
measures how much profit can the business generate in relation to other elements. This

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makes a big difference. Let's say I give you more details now. Company A generates a
revenue of Rs.4 million every year. Company B generates a revenue of Rs. 818 million
every year. Now you can clearly see that company A is doing much better. Why?

Because it seems to be able to generate a 2 million profit from just 4 million of sales,
while company B is generating 5 million after doing 18 million sales. So assuming both
companies are in the same industry, the processes and practises followed at company
A are much more efficient. So if growth is prioritised, they could surpass company B by
a mile. Obviously, this is a very basic example and there are multiple factors to
consider. But you can understand how profitability ratios are a better metric compared
to profit.

So what are profitability ratios? These ratios measure the performance of a business
with respect to its sales and capital invested. These ratios can be classified into two
types. Profitability ratios that measure cost relative to the revenue a company is
generating are called margin ratios. Profitability ratios that measure the income
generated in comparison to the funds invested in the business are known as return
ratios.

Please note that we will use the words strength and weakness in this session. When we
talk about ratios here, we do not mean the strength of the ratio, but when is this ratio a
strength for your business and when is it a weakness? For example, a higher gross
profit ratio is a strength, while a lower one is a weakness for the company.

Video 2:
Let's now look at some key profitability ratios. Starting gross profit margin measures
the profitability of the core business activities of a company by showing the percentage
of revenue that exceeds the cost of goods sold, which is cogs. It measures the
efficiency of production and pricing strategies. It is calculated using the following
formula. Gross profit margin is equal to revenue minus cost of goods sold divided by
revenue multiplied by 100.

The benchmark for measuring gross profit margin can vary significantly by industry.
Generally, a higher gross profit margin indicates better efficiency in production and
pricing strategies. For instance, industries with high manufacturing costs might achieve
lower gross profit margins compared to service industries. Lastly, let's understand how
to interpret the value of gross profit margin strength. A high gross profit margin
indicates that the company can generate more profit from each unit of sale after
covering its production cost weakness.

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A declining gross profit margin suggests inefficiencies in production, unit pricing or
increased cost of goods sold. The second is the operating profit margin. It reflects the
company's ability to generate profit from its core business activities after accounting
for its operating expenses. In simpler terms, it reflects the efficiency of operations in
generating profits after deducting operating expenses. It is calculated using the
following.

The operating profit margin is equal to the operating profit divided by revenue
multiplied by 100. Similar to gross profit margin, benchmarks for operating profit
margin vary by industry. Industries with high fixed costs, like manufacturing
companies, may have lower operating margins compared to service industries. A
benchmark range of 10% to 20% is often used. However, this can vary widely.

Let's understand how to interpret the value of operating profit margin strength. A
higher operating profit margin indicates better efficiency in managing operating
expenses relative to revenue weakness. Declining operating profit margins may
indicate increased operating costs or inefficiencies in operations. The third important
ratio is the net profit margin. It measures the company's profitability after all the
expenses, including taxes and interest, have been deducted from revenue.

It is calculated using the following formula. Net profit margin is equal to net income
divided by revenue multiplied by 100. As already mentioned, benchmark values can
vary widely by industry and company. For instance, industries with high regulatory
costs, like pharmaceuticals, might have lower net profit margins compared to
technology companies. Generally, a net profit margin of 5% or higher is considered
healthy, but this can vary significantly.

Let's now understand how to interpret the value of net profit margin strength. A higher
net profit margin indicates effective expense management, including taxes and interest
weakness. Declining net profit margins may indicate rising costs or declining revenue
relative to expenses. The next key ratio is the EBITDA margin ratio. EBITDA margin
stands for earnings before interest, taxes, depreciation and amortisation Margin
measures a company's operating profitability as a percentage of its total revenue,
focusing on earnings from core business operations without the effect of capital
structure, tax rates and non-cash items like depreciation and amortisation.

Essentially, it helps to understand the operating efficiency of a company. The EBITDA

margin is calculated using the following formula. EBITDA margin is equal to EBITDA
divided by revenue multiplied by 100 where EBITDA is earnings before interest, taxes,
depreciation and amortisation and revenue is the total income generated from sales or
services coming to its benchmark. EBITDA margin can vary widely across industries.

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Capital-intensive industries like manufacturing or telecom, which have high
depreciation costs, often focus on EBITDA margins to assess operating performance as
it excludes non-cash expenses.

Service industries that have lower fixed costs and lower fixed asset costs may show
higher EBITDA margins. Generally, a higher EBITDA margin indicates a company's
strong operational profitability and efficient management of its core business
activities. Now the interpretation of the resulting Strength A high EBITDA margin
suggests that the company is good at converting its revenue into actual profit from its
core business without being heavily affected by capital structure or non-cash expenses.
This means the company is efficient in its operations and can generate substantial
operating cash flow. Weakness A declining EBITDA margin can indicate increased
operating costs, reduced pricing power or inefficiencies in managing core business
operations.

It may also suggest challenges in scaling the business profitability. Next is the cash
flow margin ratio. Cash flow margin measures the amount of cash a company
generates from its operating activities relative to its total revenue. It indicates how well
a company can convert its sales into actual cash, which is crucial for meeting its
operational needs, paying debts and reinvesting in the business. The cash flow margin
is calculated using the following Cash flow from operations divided by revenue
multiplied by 100.

Cash flow margin benchmarks can also vary by industry. Companies in industries that
require high working capital like retail or manufacturing might have lower cash flow
margins due to the significant cash tied up in the inventory and receivables.
Conversely, software or service companies with subscription-based models often show
higher cash flow margins as they have lower variable costs and consistent revenue
streams. Interpretation of Results Strength A high cash flow margin indicates that a
company efficiently converts its sales into cash, which is crucial for sustaining
operations, paying off liabilities and funding future growth. It suggests good liquidity
and cash management practices.

Weakness A declining cash flow margin might suggest that the company is facing
difficulties in collecting receivables has high inventory levels or is experiencing rising
operational costs. This can be a red flag for potential liquidity issues.

Video 3:
The next key ratio is the return on total assets, also called ROA. It measures the
profitability of a company relative to its total assets. It shows how efficiently the

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company is using its assets to generate profit. It is calculated using the following
formula. Return on asset, I.e.

ROA is equal to net income divided by total assets multiplied by 100. As mentioned
earlier, benchmark values vary by industry and the nature of the business. Companies
with high asset turnover, like retail, typically have a lower return on total assets
compared to those with significant capital investments like utilities. A benchmark range
of 5% to 10% is often used. However, this can vary.

Lastly, let's understand how to interpret the value of return on total assets. Strength. A
higher return on total assets indicates better utilisation of assets to generate profit.
Weakness. A declining return on total assets may suggest inefficiencies in asset
management or declining profitability relative to asset base.

The next key ratio is the return on equity, also called ROE. ROE is a measure of a
company's profitability that takes the net income earned relative to shareholders'
equity. It shows how effectively a company uses the money invested by its
shareholders to generate profits. ROE is a key metric for investors as it provides
insights into how well a company is managing its equity to produce earnings growth.
The ROE is calculated using the following net income divided by shareholders's equity
multiplied by 100.

ROE benchmarks can vary significantly by industry. High-tech companies and financial
institutions often have higher ROEs due to lower capital requirements and higher profit
margins. In contrast, industries with high capital intensity, like utilities or
manufacturing, may have lower ROEs. A general benchmark for a healthy ROE is
around 15% or higher, but this can vary widely based on industry standards and
economic conditions. Now, the interpretation of the results is Strength.

A high ROE indicates efficient management of shareholders' equity and a strong ability
to generate profit. It suggests that the company is good at converting the invested
capital into profit, making it attractive to investors looking for high returns on their
investments. Weakness. A low or declining ROE might indicate that the company is not
effectively utilising its equity base to generate profit, which could be due to poor
management decisions, increasing costs or declining revenue. It could also suggest
that the company is overleveraged or investing in low-return projects.

The last type of ratio is the return on invested capital, also called ROIC measures a
company's ability to generate returns from its capital. It indicates how efficiently the
company is using its capital, including debt and equity, to generate profits. ROIC is a
comprehensive profitability measure because it takes into account the returns

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generated on both equity and debt, giving a full picture of how well the company is
deploying its capital resources. The ROIC is calculated using the following formula Net
operating profit after taxes which is also called NOPAT divided by invested capital
multiplied by 100. ROIC varies by industry due to differences in capital requirements
and operational efficiency.

Capital-intensive industries like manufacturing and utilities typically have lower ROICs
compared to less capital-intensive sectors like technology or service industries.
Generally, an ROIC higher than the company's cost of capital indicates that the
company is creating value for its investors. Interpretation of Results Strength A high
ROIC indicates that the company is efficiently using its capital to generate profitable
returns. It suggests strong management and sound investment decisions which lead to
value creation for both equity and debt holders. Weakness A low or declining ROIC can
indicate inefficiencies in capital allocation such as investing in projects with low returns
or not effectively managing operational costs.

It may also suggest that the company is struggling to generate returns that exceed its
cost of capital which could lead to long-term financial challenges.

Video 4:
Let us start with the profitability ratio analysis for Hindustan Unilever. We will be doing
a profitability ratio analysis for March 2024. As we know profitability ratios are divided
into two parts, margin ratios and return ratios. Margin ratios basically will help us to
understand the profitability generated over the sales or revenue from sales from the
business. Where else?

The return ratios help us to understand how much returns are generated by the
business from the capital invested in the business. The first ratio that we are going to
analyse is the gross profit margin ratio. It is given as revenue minus the cost of goods
sold divided by revenue into 100. So basically, gross profit helps us to understand how
much margins are we generating from the sales after deducting the direct expenses or
the directly attributable cost of the product. Here the gross profit is calculated as sales
61,896 minus cost of sales or cost of goods sold, which is 26,833.

And the gross profit is 35,063. So we'll take 35,063. The revenue for March 2024 is 61,000.

Here the ratio would be calculated as gross profit divided by revenue multiplied by 100,
which will give us 56.65%. The second ratio that we will calculate is the operating profit
margin ratio and it is given as operating profit divided by revenue multiplied by 100.
Operating profit here is nothing but the profit generated from the core business. And

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operating profit for March 2024 is 14,260 and the revenue is 61,896. The operating profit
margin ratio would be 14,260 divided by 61,896 multiplied by 100, which will give us an
operating profit margin of 23.04%.

The third ratio that we will calculate is the net profit ratio. So basically net profit ratio is
where we compute the profits after deducting all the expenses in the business including
the interest as well as taxes. So we'll be taking net income for March 2024, which is
10,282 and the revenue as we know is 61,896.

Hence the net profit margin will be 10,282 divided by 61,896 multiplied by 100, which will
give us 16.61%. The next ratio that we are calculating is the EBITDA margin ratio.
EBITDA margin ratio. Again a ratio that helps us to understand how much profits we
have generated from operations but after excluding the non-cash expense. So basically
we look at the ability of the company to generate cash flows from its core business.

So EBITDA for March 2024 is 15,476 and the revenue is 61,896. So let us calculate 15,476
divided by 61,896 multiplied by 100. That will give us 25% of EBITDA margin. Cash flow
Margin ratio. The cash flow Margin ratio is given as cash flow from operations divided
by revenue multiplied by 100 cash flow from operations.

We will get this number from our cash flow statement. So basically we understand how
much actual cash is generated in March 2024 from operations. So you don't have to
take profit from operations. Here we will be taking cash flows from operating activities.
So we are looking at the actual cash flows generated on total sales of the business.

Total sales as we are aware are 61,896. So let us compute 15,469 divided by 61,896
multiplied by 100. That gives us 24.99%. The next ratio that we will calculate is the
return on total asset ratio. Now, now onwards, whatever ratios that we are going to
calculate are going to be our return ratios.

So we are always going to look at, okay, whatever we have invested, whatever capital
that we have employed on that investment, what is the return that we are generating?
The ratios that we computed earlier were our margin ratios. So we were looking at,
okay, from revenue, what is the margin after deducting the direct expenses? After
deducting only operating expenses. After deducting all the expenses, what is the
margin that was generated by the business?

So let's start with the first return ratio which is the return on total assets net income. So
we are looking at okay, finally, what is the profit generated after deducting all the
expenses? 10,282. Not on sales but on the total assets. So we are looking at the
productivity of the assets and the number we will get from our balance sheet.

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So total assets for March 2024 are 78,480. So on 78,489, we were able to generate a net
income of 10,282. This brings down to the returns on the total assets of approximately
13%. So 13.10% is the answer that we got. The next return ratio that we will calculate is
the return on equity.

So we are looking at the returns generated or the value created only for equity
shareholders. So again, equity shareholders are the owners of the business and hence
what income are we generating for them or what returns are we giving to them? The
net income returns. The net income. The net profit after deducting all the expenses.

So again we would consider the profits after taxes, which is the net income. And here
we are not going to take the entire capital. We are factoring only for shareholders'
equity. So we will take shareholders equity for March 2024, which is 78,000. The
shareholder's equity is 51,218 and the ratio will be computed as 10,000 divided by
51,218 multiplied by 100, which will give us a return on equity of 20.07%.

So this is the return that we, the company HUL have generated on the investments
done by the shareholders. And the last ratio that we are going to calculate is the return
on invested capital. It is also called as return on average capital employed. So there are
many terms to define this particular ratio. So interchangeably used.

Sometimes we call it ROIC. Sometimes we also call it a return on capital employed.

Return on average capital employed. Now, when you say capital capital is the funds
that we have received not just from shareholders, but also from the debt holders. So
now we are checking that, okay, whatever total investment that the company has made
on that total investment, how much profit did we make?

How many returns did we generate? So the returns that we calculate. Again, why do we
fund a business? We fund a business to operate it. So we are going to always consider
the operating profits here.

However, please understand that we will be deducting taxes from it. Now why do we
deduct taxes from it? Because when you're generating returns for your stakeholders,
for your debt holders, the amount of tax that you pay means paying it to the
government and not to the stakeholders. So we will take operating profits. So here we
will be taking operating profits.

However, from our operating profits, we will be deducting taxes. So 14,260 is the
operating profit. From there we will deduct our income tax amount, which is 3644. This
will give us the net operating profit after tax. The total capital investment would be the
share capital, that is the equity share capital, other equity, and also the debt.

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So come down to your balance sheet. Over here we will take our total shareholders
equity, which includes the equity share as well as the earnings plus. Now we are not just
factoring the returns for shareholders, we are factoring it for all the stakeholders, all
the lenders. All the stakeholders, that is the shareholders as well as the lenders. So we
will also add long-term debt to the capital which is 1471.

Let us calculate the return on invested capital. 10,616 is what we generated on 52,689
multiplied by 100, which is 20.15%. Now when you look at all the ratios, we understand
that, okay, from our core sales, we managed to get margins of 56%. After paying for
operating expenses, we get margins of 23%. After paying for other expenses, interest,
expenses and taxes, we get a margin of 60%, 16% from Hindustan Unilever.

And then from a cash perspective, when we look at so we approximately get 25% from
the seats. And when you look at the return ratios in total, we understand, okay, by using
all the assets, 13% is what we are generating. After deducting all the expenses for
shareholders, we are generating 20%. And also collectively, 20% is what we are
generating on the total capital invested by shareholders as well as debt holders. We can
also calculate these ratios for previous years in order to understand the trend.

In order to understand, okay, whether these profitability ratios are increasing, or

decreasing as to understand whether the company has grown the profitability or
whether the company needs to work on or take certain corrective measures in order to
earn better profits in the business.

Video 5:
In inefficiency or turnover ratio analysis, we try to analyse the liquidity from how long it
will take for the firm or business to convert inventory and receivables into cash or the
time it takes to pay its suppliers. In simpler terms, it measures the ability of a company
to effectively employ its resources such as capital and assets to produce income. For
example, out of two companies working in the same sector, a company that used Rs.1
crore worth of raw materials to produce Rs.50 crores worth of finished products within
two months is much better than a company that used 1 crore of raw materials to
produce only 40 crore of finished products in three months. By focusing on operational
efficiency, efficiency ratios help assess various aspects of business operations such as

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inventory management, asset turnover and cash flow management. The first of these
efficiency ratios is the receivable turnover ratio. It measures how effectively a
company collects its accounts receivable or manages the credit it extends to its
customers. It indicates how many times a company's receivables are converted into
cash during a specific period.

It is calculated using the following formula.

The receivables turnover ratio is equal to net credit sales divided by average accounts
receivable. Industry benchmark varies significantly, but a higher turnover ratio
indicates a quicker collection of receivables, which is generally favourable. Lastly, let's
understand how to interpret the value of the receivables turnover ratio. A high turnover
ratio suggests effective credit management and timely collection of receivables.

Weakness.

A declining ratio may indicate issues with credit policies, customer credit worthiness or
collection practices. The next efficiency ratio is the inventory turnover ratio. It
measures how effectively and efficiently the inventory is managed and how quickly it is
sold and replaced over a specific period.

It is calculated using the following Inventory.

The turnover ratio is equal to the cost of goods sold divided by the average inventory.
Benchmark values vary significantly by industry, but generally high turnover ratios are
typically better, indicating faster inventory. Turnover benchmarks can range from 4 to
10 or higher depending on the industry. Let's now understand how to interpret the value
of inventory turnover ratio strength. A high turnover ratio suggests effective inventory
management, reduced holding costs and better cash flow.

Weakness.

A low turnover ratio may indicate overstocking, slow-moving inventory or inefficient

purchasing practices. The third is the payables turnover ratio. It measures how
efficiently a company pays its suppliers and manages its accounts payable. It shows
how many times a company pays off its accounts payable during a particular period.

It is calculated using the following formula.

The payable turnover ratio is equal to net credit purchases divided by average
accounts payable. Benchmarks vary widely, but Similar to other turnover ratios, a

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higher payables turnover ratio indicates faster payment to the supplier which can
improve relationships and potentially leverage discounts. Lastly, let's understand how
to interpret the value of payable turnover ratio strength. A high turnover ratio suggests
effective management of trade, credit and working capital.

Weakness.

A declining ratio may indicate liquidity issues or strained supplier relationships. The
fourth is the average receivables collection period. It is also known as days of sales
outstanding. Also called Dso. It represents how long it takes on average for a company
to collect the money owed by the customers after making a sale.

It is calculated using the following formula.

The average receivables collection period is equal to the average accounts receivable
divided by sales per day. Here, sales per day is equal to sales revenue divided by 360
days. Benchmarks vary by industry, but typically 30 to 45 days is considered good.
Lower daily sales outstanding indicate a quicker collection of receivables which is
favourable. Let's now understand how to interpret the value of the average receivables
collection period. A shorter collection period suggests efficient credit policies and
effective accounts receivable management.

Weakness.

A longer collection period may indicate credit issues, customer payment delays or
inefficient collection processes. Next comes the average inventory processing period. It
measures the average number of days it takes for a company to sell and replace its
inventory.

It is calculated using the following formula.

An average inventory processing period is equal to the average inventory divided by

the cost of goods sold per day. Here, the cost of goods sold per day is equal to the cost
of goods sold divided by 360 days. Industry benchmarks can vary widely, but typically
a lower processing period indicates faster inventory turnover and better liquidity. Let's
take a look and understand how to interpret the value of average inventory processing
period strength. A shorter processing period suggests efficient inventory management
and reduced carrying costs.

Weakness.

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A longer processing period may indicate excess inventory, slow sales or inefficient
production. Then there is the average payable days or payment period. It measures the
average number of days it takes for a company to pay its suppliers. It shows how
quickly the company pays its bills after receiving goods or services.

It is calculated using the following formula.

Average payable days are equal to average accounts payable divided by the cost of
goods sold per day. A longer payment period indicates better cash flow management
but should be balanced with maintaining good supplier relationships. Benchmarks vary
by industry practises and supplier terms. Now let's understand how to interpret the
value of the average payable days or the payment period strength. A longer payment
period can improve cash flow and working capital management weaknesses. A longer
payment period may strain supplier relationships or lead to missed discounts. The next
is the cash collection cycle also called as cash conversion cycle. It measures the time it
takes for cash to flow back into the company after the outlay.

For inventory, it is calculated using the following formula.

The cash collection cycle is equal to the average receivable collection period plus the
average inventory processing period minus the average payable days. As mentioned
earlier, benchmarks can vary by industry and company, but usually, a shortage cycle is
preferred as it employs quicker cash flow and better liquidity management. Lastly, let's
understand how to interpret the cash collection cycle strength. A shorter cash collection
cycle indicates more efficient management of working capital and faster conversion of
inventory and receivables into cash. A longer cash collection cycle indicates problems
with collecting payments, managing inventory, or paying suppliers on time, which
might lead to cash flow issues. In summary, efficiency ratios provide valuable insights
into different aspects of operation. They help stakeholders evaluate how effectively a
company manages its resources, utilises assets, and handles working capital. By
analysing these ratios alongside industry benchmarks and historical trends,
stakeholders can identify strengths, weaknesses, and opportunities for improvement
within the organization's operations.

Video 6:
Let us calculate the turnover or efficiency ratios for Hindustan Unilever. We will be
doing the efficiency ratio analysis for March 2024. The first ratio that we will calculate is
the receivables turnover ratio. This is given as net credit sales divided by average
accounts receivable. So right now we will assume our net sales or revenue amount as
net credit sales.

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So the revenue that we will consider is 61,896. In order to calculate average accounts
receivable we will be taking the previous accounts receivable balance. We'll add it to
our current receivables balance and we'll calculate the average. So the opening
receivable balance here will be our previous year's balance which is 3007 plus the
current receivable balance is 2997. And we will calculate the average by dividing it by
two.

So how much average receivables do we have? We have 3,038. Let's calculate the
receivable turnover ratio net credit sales of 61,896 divided by the average accounts
receivable of 3,038. This gives us a receivables turnover ratio of 20.37 times.

We'll calculate the inventory turnover ratio. The inventory turnover ratio is calculated as
the cost of goods sold divided by the average inventory. The cost of goods sold for
March 2024 is 26,833 average inventory. Again, we will be calculating it as opening
inventory plus closing divided by two which is nothing but previous years' inventory.

Previous year's inventory plus current year's inventory divided by 2. That gives us the
average inventory.

That gives us an average inventory of 4136.5. Let us calculate the ratio. This ratio is
26833 of the cost of goods sold divided by an average inventory of 4001 136. This gives
us an inventory turnover ratio of 6.49 times. We'll calculate the payables turnover ratio.

The payable turnover ratio is given as net credit purchases divided by average
accounts payable. Okay, so again net credit purchases you would consider the cost of
goods sold.

So cogs for the current year are 26,833. And average accounts payable will be the
previous year's accounts payable which is 9574 plus the current year's accounts
payable which is 10,486. The whole divided by 2 gives us the average account payable
of 10,030. Let us calculate the payables turnover ratio 26833 divided by 10,030. That
gives us a payable turnover ratio of 2.67.

Now how do we interpret these ratios? So we got a receivable turnover ratio of 20.37
times, an inventory turnover ratio of 6.49 times and a payables turnover ratio of 2.68
times. Right. This basically means how many times you are churning your receivables.
Or how many times are you receiving the sales that you have during the year?

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So if I have an average receivable of 1 rupee, then how many times do I receive? How
many times are my sales to it? 20.37 times, which is very high in this case and the credit
sales are 20.37 times the accounts receivables.

When we look into the inventory turnover ratio again. Now how do we interpret this? If
an average inventory is 1, how much is the cost of goods sold? It is 6.49 times the
inventory. So if we want to interpret this, we could say that 6.49 times your inventory
would be churned in order to have the X amount of sales that you have during the year.

And how do we interpret payables turnover times? So payables, whatever payables

that you have during the year, have to pay them. The total credit sales are twice of your
average accounts period. Now let's calculate the average receivables collection period.
The average receivables collection period is given as the average accounts receivable
divided by sales per day.

Sales per day. We will calculate sales per day as sales revenue divided by 360. So sales
revenue is 61,000. Right. So we'll take 61,896.

And we will divide in order to get our per day sales. So per day sales are how much?
6,61,896 divided by 360 days. So each day on average, how much sales are we making?
Making 171.93.

How much are our average accounts receivable? So we have already calculated them
before. We'll just pick it from here. Average Accounts receivable are 3038. And how
much is sales per day?

Sales per day is 171.93. Let us calculate the average collection period. The average
collection period is the average receivables day. Average accounts receivables divided
by sales per day. That gives us 17.6 days.

Now what is the interpretation here? How many days are we taking in order to receive
or in order to encash our sales? We take 17 days. So whatever credit sales are done
normally HUL takes 17 to 18 days to cash them coming down to the inventory
processing period. This ratio is calculated as the average inventory divided by the cost
of goods sold per day.

So cost of goods sold per day, let us take it from March 2024, the amount is 26,833
divided by 360 days will give us how much worth of goods are we selling each day
divided by 360 days. This gives us 74.54. We have our average inventory. So on average
inventory for the year was 4136.5 and the cost of goods sold each day was 74.5. Let us

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calculate the average inventory precession day which is 4136.5 divided by 74.54 which
is 55.50.

Now what is the understanding? Understanding here is whatever inventory HUL has, it
takes around about 55 to 56 days to sell that inventory, right? So each day, if I am
selling 74.54 worth of goods and in my inventory, I have 4,136 worth of goods, how
many average days will I take? I take 55 to 56 days to sell the entire inventory. Let's
calculate the average payable days.

Average payable days are calculated as average accounts payable divided by the cost
of goods sold per day. So we have both the numbers. Now we have average accounts
payable calculated earlier. So let's just pick that number which is 10,030 and the cost of
goods sold per day is 74.54. So now again the same understanding that okay, if each
day I'm selling 74.54 worth of goods and now I'm supposed to pay 10,030 worth of
goods, how many days will I take to pay that?

So calculating 10,030 divided by 74.54 gives us our payable days. So HOL is paying the
suppliers 134 days. After 134 days. Now the time taken in order to pay the suppliers is
approximately 134 to 135, which could be very high. So HUL can introspect can see,
okay, what is the industry average?

How much is how much are the other companies taking to pay the suppliers? Or is HUL
missing any discounts? What if they pay a little earlier? Would they be given certain
discounts? So that is what HUL can introspect.

Now the last ratio that we can we will be calculating is the cash collection cycle. So
basically this tells us the net conversion period that okay, right from the time I started
investing in the inventory till the time I sold it. And I actually attached that inventory.
How many net days HUL has taken? So we will take average receivable days.

Our average receivable days calculated was 17.66 days. The average inventory
processing period calculated was 55.50 days. And the average payable days that we
calculated was 134.57 days. Now how is this collection period calculated? It is
receivables plus inventory processing period minus our average payable days.

So that gives us a negative 61.40 days. Now what is a negative cash cycle? Here it
means that you are actually using your supplier's money in your working capital. You
are actually using your supplier's money to run your day-to-day operations. Basically, if
you just mathematically see this, what is the understanding?

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Understanding is that once I sell the goods, I or the HUL takes 55 days to sell the goods
and then another 17 days to cash it. So approximately it takes let's say 55 17. If we just
do 55 days plus 17.6 days total, it takes 73 days to get the goods and get the cash from
the sale of goods. The total period. But when is it making payments for the supplies
that it has taken?

It makes the payment only after 134 days or only on 1 34th day. So what is the
understanding here? For almost 61 days the company has actually made use of the
money that they are actually supposed to pay to the suppliers. So negative working
capital cycle or negative cash collection cycle doesn't mean it is bad. Okay?

It could mean that they have negotiated so well with their suppliers that the
requirement of working capital is lesser now. So they are able to make use of their
supplier's money in order to run the operations. However, this has to be done carefully.
However,r this has to be carefully analysed. Now what if the company is not doing
good, which is not a profit-making company, which is actually declining and if it has the
cash collection as negative then it is going to be a red flag?

Now why it is going to be a red flag? Imagine you are not able to make the payment.
So if. What if this was not Hul? HUL is a growing company, a company, well-established
company.

Now imagine a company that was a loss-making company. So why do we have 134
days of payables? Because we are not able to make the payments. Why is it taking 55
days to sell the inventory? Because there is no demand.

And because there is no demand that even if they are managing to receive the cash
from their sales within 17 days, are they making enough cash to pay their obligations?
No. So if the company was not a profit-making company and if it has a negative cash
collection cycle, then it is a red flag. But in our case, if we look at Hol and if we look at
the profits of the company, this is a growing company, we can see that every year
there is consistent profit that the company is making. If we look at the gross profits or
if we look at the operating profits, we say that okay, every year that the company is
generating profit.

Video 7:
Every company needs money to conduct its day-to-day operations, including small
expenditures like conveyance to large expenditures like annual sites. As a manager, you

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must ensure that the company can cover these costs effectively. This ability to pay
short-term debts and obligations is known as liquidity. Maintaining good liquidity
ensures that all operations run smoothly and that the company can meet its financial
commitments as they arise. To analyse a company's liquidity position, we use metrics
known as liquidity ratios.

These ratios measure how easily the company's assets can be converted into cash
compared to its current liabilities. Look at an example to better understand how easily
assets can be converted into cash compared to current liabilities. Imagine a company
named Grenovate Technologies which specialises in producing renewable energy
products. Now the company is assessing how effectively it can manage its short-term
financial obligations. Here's an overview of some of their key assets and their liquidity
ratios.

Firstly, cash and cash equivalents. Grenovate Technologies has $50,000 in its bank
account. This amount is immediately available to pay off any bills or debts. Next is
accounts receivable. The company is waiting to collect $90,000 from customers who
have bought its products on credit.

Even though this money is not yet in the bank, it is expected to be collected soon,
usually within a month or two. Then there are short-term investments. Grenowitz
Technologies owns $30,000 in stocks and bonds that can be quickly sold if needed.
These are almost as good as cash for meeting short-term needs. Lastly, inventory.

The company has $80,000 worth of products in stock. To turn this into cash, the
company would need to sell these products which can take time depending on demand.
In summary, Grenovit Technologies needs to assess how quickly it can convert these
assets into cash to meet its short-term liabilities. Cash and cash equivalents provide
immediate liquidity. Accounts receivables and short-term investments offer relatively
quick conversion.

While inventory requires more time to be turned into cash. Understanding this liquidity
helps the company manage its financial obligations effectively moving forward. There
are three common liquidity ratios. Let's start with the current ratio. It measures the
ability of a company to fulfil its short-term obligations using its most liquid assets.

It indicates the short-term liquidity position of the firm. It is calculated using the
following formula. The current ratio is equal to current assets divided by current
liabilities. A current ratio of one or higher is generally considered acceptable, indicating

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that current assets are sufficient to cover current liabilities. Benchmark values can vary
by industry.

For instance, a ratio of about two may be expected in industries with stable cash flows
like utilities. Whereas industries with More variable cash flows like retail might have
lower benchmarks. Let's now understand how to interpret the value of current ratio
strength. A higher current ratio indicates better liquidity and the ability to meet
short-term obligations without relying heavily on external financing. Too high a current
ratio might suggest inefficient use of resources such as excess cash or inventory that
could be better utilised elsewhere.

Next is the quick ratio or acid test ratio. It assesses the ability of a company to meet its
short-term obligations with its most liquid assets, excluding inventory, which might take
longer to convert into cash. It is calculated using the following quick ratio is equal to
current assets minus inventory divided by current liabilities. A quick ratio of one or
higher is often considered satisfactory. It provides a more stringent assessment of
liquidity than the current ratio by excluding inventory which might not be easily
convertible into cash.

Benchmarks vary by industry, with some requiring higher quick ratios such as service
industries, compared to those with higher inventory turnover such as manufacturing.
Let's now understand how to interpret the value of quick ratio strength. The quick ratio
provides a more conservative measure of liquidity compared to the current ratio
focusing on the most liquid assets. Weakness. An excessively high quick ratio might
indicate inefficient asset management or underutilization of resources.

Then comes the cash ratio. It is the most conservative liquidity ratio focusing solely on
the ability of the company to cover its short-term liabilities with cash and cash
equivalents. It is calculated using the following formula. Cash ratio is equal to cash and
cash equivalents divided by current liabilities. A cash ratio of 0.5 or higher is generally
considered prudent, indicating that the company holds enough cash to cover at least
half of its current liabilities.

Industries with stable cash flows might have higher benchmarks, whereas those with
more variable cash flows might have lower thresholds. Lastly, let's understand how to
interpret the value of the cash ratio strength. The cash ratio provides the most
conservative measure of liquidity. Focusing only on the most liquid assets holding
excessive cash could mean missed investment opportunities or efficiencies in capital
utilisation. These liquidity ratios, I.e.

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The current ratio, quick ratio and cash ratio, play crucial roles in assessing a company's
ability to manage its short-term financial obligations.

Video 8:
Let's start with liquidity ratio analysis For Hindustan Unilever. We'll be doing a liquidity
ratio analysis for March 2024. Let's first calculate the current ratio. The current ratio is
given as current assets divided by current liabilities. Liquidity ratios basically are going
to help us to understand the short-term credibility of the business.

This means how much cash is available or how many resources we'll be able to convert
into cash in order to pay out our obligations. So, the current ratio is current assets on
current liabilities. Current assets for March 2024 are 19,095. And current liabilities for
March 2024 are 25,800. The current ratio will be equal to current assets divided by
current liability which is 0.74.

That means there is a current liability of let's say rupee one. How many resources are
available that can be quickly converted into cash? There is 0.74 paisa in comparison to
the 1 rupee or 1 penny of current liability.

Let's calculate quick ratio, quick ratio. Here we consider the assets which are which can
be quickly converted into cash. Now inventory is something that might take time. What
if there is no demand? What if it's a slow-moving inventory?

So it might take some time to be sold into in cash. Hence in quick ratio, we take current
assets and from the current assets we reduce the inventory amount. These are called
quick assets. So when you reduce your inventory's amount which is 4200 4022, you will
get quick assets. Current liabilities would remain the same.

Current liabilities for March 2024 are 25,800. Let's calculate the quick ratio. As I said,
the quick ratio will be current assets minus your inventory divided by current liabilities.
The cash ratio is equal to 7,559 divided by 25,800. This shows that the cash ratio is 0.29
times.

Now here again to further understand whether the liquidity position of the company
has improved or deteriorated. We can calculate these ratios for our previous years to
understand the trend. Now, just because the ratios are less than 1 or for the current
ratio or quick ratio wouldn't mean that the ratio is bad. Wouldn't mean that, okay, the
company is going to face some liquidity issues. There could be some strategy that the
company might have in place or might have in mind because of which they might not
have kept the current assets or the quick assets more than the current liabilities.

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Video 9:
Do you think any lender would lend money to a company without analysing its financial
situation? The answer is no. So what, according to you, would be the most important
factor of consideration for the lenders of the company? Well, the lenders would want to
invest in a company that will be able to pay back their interest amounts timely and
repay their principal amount duly. But how do they ensure this?

This is where the metric of solvency becomes crucial. Solvency measures the long-term
financial health of a company. It refers to the financial health of an organisation in
terms of its ability to meet its long-term financial obligations and debts. It essentially
assesses whether the organisation has sufficient assets to cover its liabilities over the
long term. One straightforward method to gauge the long-term solvency of an
organisation is by comparing its total assets against its total liabilities.

There are three common solvency ratios. First is the debt to equity or DE ratio. It is a
critical measure used to assess the extent to which a business is financed by debt
relative to its equity. The debt-equity ratio reveals the balance between debt financing
and equity financing over time. Monitoring this ratio provides insights into how
effectively a company manages its financial position.

It is calculated using the following formula. The debt-to-equity ratio is equal to total
debt divided by shareholders' equity. Here, total debt includes both short-term and
long-term debt obligations of the company. Shareholders equity represents the net
assets of the company available to shareholders. The ideal ratio varies by industry and
company, but generally, a lower ratio indicates a lower financial risk and less reliance
on debt.

Benchmark values can range from 0.5 to 2, but this can vary significantly depending on
the industry and business model. Let's now understand how to interpret the value of the
debt-to-equity ratio strength. A lower debt-to-equity ratio typically signifies a more
conservative financial structure and might indicate better solvency and financial
stability weakness. A higher debt-equity ratio suggests a higher financial risk as the
company is more leveraged and vulnerable to economic downturns or interest rate
increases. Next is the debt to total-assets ratio.

It is used to indicate the degree of financial leverage used to finance the company's
assets. It is calculated using the following formula. The debt to total assets ratio is
equal to total debt divided by total assets. Total debt includes all the liabilities of the
company, both short-term and long-term. Total assets represent all the resources
owned by the company including current and non-current assets.

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A lower ratio indicates a lower financial risk and a more conservative capital structure.
Benchmarks can vary widely by industry, but a ratio of above 0.5 or 0.6 might suggest
higher financial leverage and risk. Now let's understand how to interpret the value of
debt to total assets Ratio Strength A lower ratio indicates less reliance on debt
financing and better financial health weakness. A higher ratio suggests higher financial
risk and potential challenges in meeting debt obligations, especially during economic
downturns. The third is the interest coverage ratio.

This ratio is a measure of the company's ability to meet the interest expense on its
debt. It estimates how many times the earnings can cover the interest expense. It is
used in combination with the Debt-to-equity and Debt to total assets ratio, giving a
good picture of both current and long-term solvencies. Lenders often use the interest
coverage ratio to ensure their protection from default on interest payments. It is
calculated using the following formula.

The interest coverage ratio is equal to operating income or EBIT, which is earnings
before interest tax divided by interest expense. Operating income or EBIT refers to the
earnings before interest and taxes representing the company's profitability from core
operations. Interest expense refers to the cost of servicing the debt obligations of the
company. A higher ratio indicates that the company can comfortably cover its interest
expenses from operating earnings. A ratio of 2 or higher is generally considered healthy
indicating sufficient earnings to meet interest obligations.

Lastly, let's understand how to interpret the value of interest coverage ratio strength. A
higher interest coverage ratio reflects strong financial health and indicates a lower
financial risk regarding debt servicing. A lower interest coverage ratio suggests that
the company may have difficulty meeting its interest payments, potentially signalling
financial distress or liquidity issues.

Video 10:
Let us start with a solvency ratio analysis For Hindustan Unilever. We'll be doing a
solvency ratio analysis for March 2024. The first ratio that we are going to calculate is
the debt-equity ratio. Before we start calculating the ratios again, remind you that
solvency ratios are going to help us understand the long-term credibility of the
business. The ability of the business to pay off its obligation in the long run.

So we will check the entire resources that. Okay, what are the resources, how much is
the money, how much is the asset that we have that can be converted into cash in
order to pay off the debt? So let us start. The first ratio is a debt-equity ratio. Total debt
divided by shareholders equity.

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Total debt. We would be taking short-term as well as long-term debt here. So for March
2024 in your balance sheet, we'll first pick our long-term debt which is 1471 plus. We'll
take the short-term debt from our current liabilities which are notes and loans payable
of 30 and the current portion of long-term debt which is 10,486. So this will give us the
total debt available in the business.

The total debt that the company is obliged to pay. And what is the shareholder's
equity? Shareholders' equity will be the total equity plus the retained earnings or the
other equity. The shareholder's total is 51,280. Calculate the ratio.

The debt-equity ratio is 11,970 divided by 51,280 which is 0.23. How do we interpret this
ratio? So, let's say we have 1 rupee invested by shareholders' equity, only 23 pairs are
coming from liability or the lenders. So even if we talk about credibility, whatever
resources, whatever investment that we have from our owners, only 0.23 would go
towards paying the obligation. Let's calculate the next ratio.

Debt to total asset ratio. Again total debt we have already calculated as 11,970
short-term plus long-term total assets. So let's take the total asset which is 78,489. The
debt to total asset ratio will be equal to 11,970 divided by 78,489. The ratio is 0.15.

Now what does this mean? If I have total assets, okay, which I can and which I can in
cash. So if I have one rupee worth of assets, how much is going to go towards debt?
Only 15 paisa or the other way to interpret this ratio is whatever total assets we have,
how much is contributed by debt? Only 15% only 15 paisa out of 1 rupee invested in the
asset is contributed by debt.

The next ratio that we will calculate is the interest coverage ratio. The interest coverage
ratio is given as ebit, that is the operating income divided by interest expense. This is a
coverage ratio. See what are we covering? So we are covering our interest expense
with our earnings.

So how much earnings are available with the business in order to cover the interest
expense? So operating income for March 2024 is 14,260 and the interest expense is 334.
So let us calculate the ratio. 14,260 divided by 334. The interest coverage ratio is 42.69
times, which is a very good ratio.

What is the understanding here? Our earnings are 42 times higher than the expense
that is there towards interest. Or the other way around would be with the available
operating income of the current year we will be able to pay the interest 42 times. So the
same interest if we have to pay, we'll be able to pay it for 42 months or 42 years in our
case because this is the annual interest that we have. So 42 years worth of interest we
can pay with the available earnings which shows a very good solvency position of Hulk.

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