Module III

Understanding of Financial
Statements
WHAT IS AN ACCOUNTING?
Accounting is a Language of Business

Accounting is an information processing
system and the products of this process
are Financial Statements
Sources of Information
Private Information
Public Information
Annual Reports
Quarterly Results
Prospectus
Others
Quarterly Results
SEBI WHAT ?
SEBI asks companies to mandatorily publish
and file quarterly results

Prospectus
What is a Prospectus?

What is red herring prospectus?

What does it contain?

Examples, if any
Prospectus

Examples, if any

Coal India Ltd (Sept. 2010)
Muthoot Finance (April 2011)
[Link]
Herring-Documents-filed-with-ROC
SEBI
Sources of red herring prospectus
and final prospectus
Question

What does an Annual Report
Consists of
Financial Statements
Balance Sheet
Profit and Loss Account
Cash Flow Statement
Balance Sheet consists of
Chairmans message
Key Financials
Executive team profile
Highlights & Objectives
Driving sustained growth
MDA or MAD
Directors reports
Report on Corporate Governance
Auditors report
Financial Statements
Schedules
Notes to Accounts
Consolidated Financial Statements
AGM invitations etc.

Analysis of Financial Statement
Analysis
Depends upon the need of the users and
information available
Users
Availability of information

Analysis
Quantitative Analysis

Qualitative Analysis

Annual Reports/Quarterly results/Other
information
Financial Statements
Balance Sheet
The entity in order to achieve its objectives has arrived at a
decision to apportion the resources and deployed it in fixed
assets and in current assets-Assets side
The proportions of funds that are borrowed on short term, on
long term as well as what is the contribution of owners towards
the total financial requirement of the entity-Liability side
Profit & Loss Account
Gives the cost structure of the business and the relationship of
costs to the revenues
It gives the information relating to margin available on the sales
Types of Quantitative Analysis
Cash Flow Statement Analysis
Comparative Statement Analysis
Common size Statement Analysis
Trend Analysis
Ratio Analysis
Dupont Analysis
Cash Flow Statement Analysis
Cash from Operations activities (A)

Cash from Investments activities (B)

Cash from Financing activities (C)
Relation and Comparison of Data
Accounting data in absolute terms do not provide much
meaning the analysis involves comparison and relation
Ratio Whenever one item is expressed (as a fraction or a
decimal fraction or an integer) in terms of another item
Example A firm earns a net profit of Rs. 20,000 on a sale of
Rs. 500,000. We could express this relationship as ____?
4 percent or 4% profit margin
Comparisons could be made
With Companys past performance
With Competing Firms
With an Absolute Standard
With Industry/Economy trend
With Budgets (Planning and Control)
But
In most cases, there are no standards against which a
particular ratio value could be tested
We make relative conclusions by comparing the ratios with
industry averages
Thus, at best the conclusions could be better than or worse
than or average
Possible pitfalls in these comparisons could be the different
accounting conventions
Inventory valuation (LIFO vs. FIFO)
Different methods of depreciation
Typical items (eg. Retirement benefits)
Ratio Analysis
1. Liquidity Ratios
2. Profitability Ratios
3. Leverage Ratios
4. Coverage Ratios
5. Efficiency Ratios
6. Investors Ratios
7. Dupont Analysis

Profitability Ratios

Margin
on sales
Gross Profit Margin
Operating Profit Margin
Earnings Before Interest & Tax
Profit before tax
Net Profit Margin (i.e., Profit after tax)
Return on
Investment
Operating Profit to Operating Assets
Net Income to Total Assets
Return on Equity

Efficiency
Total Asset Turnover
Operating Asset Turnover
Working Capital Turnover
Shareholder Equity Turnover
Return
per share
Earnings per share
Earnings to price
Dividends per share
Solvency Ratios


Short-term
Net Working Capital
Current Ratio
Quick Ratio
Accounts Receivable Turnover
Collection Period
Inventory Turnover
Conversion Period


Long-term
Total Debt to Total Capital
Long Term Debt to Total Capital
Long Term Debt to Fixed Assets
Interest Cover
Times Fixed Charges Covered
Gearing
Equity Multiplier
Liquidity Ratios
Current Ratio

Quick Ratio

Net Working Capital
Profitability Ratios
Gross margin or Operating Profit Ratio

Net Profit Ratio

ROCE

ROE
Leverage Ratios
Debt Equity Ratios

Debt to Capital Employed
Efficiency Ratios/Turnover Ratios
Receivables or Debtors Turnover

Inventory or Stock Turnover

Assets Turnover
Investors Ratios
EPS

PE ratio

DPS


Implied growth rate equation
Also called sustainable growth rate

= Return on Shareholders equity X Profit
retention rate
Du Pont Analysis
A combination of margin on sales ratio, efficiency ratio, and
long-term solvency ratio is popularly known as the DuPont
analysis
Return on Equity (ROE) =
Net Profit Margin (defined as Net Profit/Sales) x Asset
Utilization Ratio (defined as Sales/Total Asset) x Equity
Multiplier Ratio (Total Assets/Owners Equity)
The DuPont analysis approach helps in identifying and
pinpointing the reasons behind high or low profitability of a
firm vis--vis its competitors
Dupont Analysis

ROE = NPM X Asset Turnover X Leverage
Qualitative Analysis


Look at handout on questions to be asked
Basics of Accounting

Understanding


Analyzing

Questions



Thank you