AFS ratio main

Business Analysis:

Business Analysis Types of Business Analysis Credit Analysis Equity Analysis Business Environment and strategy Analysis Financial Analysis Prospective Analysis Valuation

Roadmap to Financial Analysis:

Roadmap to Financial Analysis Business Analysis Business Environment Analysis – Company’s economic & industry circumstances, SWOT Analysis , industry analysis Business strategy Analysis – Company’s business decisions leading to a competitive advantage , its product mix , cost structure Company profile and significant events Company shareholding pattern

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Company Analysis Financial performance Revenues Profitability Asset Utilisation Cash flows Working capital Management Stock performance

RATIO ANALYSIS:

RATIO ANALYSIS

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Terms Capital employed = Equity shareholders funds + Preference share capital + Long term borrowed funds Net worth = Equity shareholders funds +/- Deferred tax = Equity share capital + Reserves & surplus – Miscellaneous Expenditure not written off + Deferred tax Turnover = Sales

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ROI ratios 1. ROI = NP before tax and interest Total capital employed This ratio indicates the return earned by the company on its total investment. This is very important to shareholders and other stake holders as it is the ultimate measure of the company’s overall performance. This ratio when compared with industry average gives an indication about the financial performance of the company. 2. RONW = PAT – Preference dividend * 100 Net worth ( ESHs Fund ) This ratio indicates the return earned by equity shareholders. High ratio means high dividend , better growth prospects and high valuation in capital market.

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3. EPS = PAT – Preference dividend Number of equity shares This ratio gives the return earned on each share. It is an important measure of profitability for the investors. This ratio is the basis for valuation of companies in the event of mergers etc, strategic investments by owners. Higher ratio shows company in a positive light. Higher ratio indicates higher returns

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Comparative Standards / Benchmarking Industry leader Industry average WACC Cost of borrowings Influencing factors Sales Cost economies Optimum capital structure

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Structural ratios / Gearing ratios / Long term solvency ratios 1. Debt equity ratio = Long term Debt Total net worth ( ESHs Funds + PC ) This ratio helps in assessing whether the company is relying on own funds or borrowed funds. Higher the debt more fixed liabilities by way of interest. FI s generally look for a D/E of 1.5 :1 while financing projects. This ratio also indicates whether the company has a optimum capital structure to improve the returns available to equity shareholders. 2. Debt service coverage ratio = NPBIT Interest + Loan repayment This ratio indicates the profits available to service the debts. This ratio is very important for lenders. Higher the ratio higher is the ability of the company to finance the debt and less risk of default. 3. Interest coverage ratio = NPBIT Interest

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Comparative Standards / Benchmarking Industry average NAV of industry leader / laggard Institutional norms Growth / Decline over the previous years Influencing factors ROI & EPS Dividend policy

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Liquidity ratios 1. Current ratio = Current Assets, loans & Advances Current liabilities & Provisions 2. Quick ratio = Current Assets, loans & Adv – inventories – prepaid Exp Current liabilities & Provisions– Bank overdraft These 2 ratios helps in analyzing the current assets and current liabilities of the company and its ability to discharge its day to day obligations Quick ratio is more realistic. It indicates the extent to which the company has current assets to meet its current liabilities. Higher the ratio higher is the solvency level of the company and less risk of default.

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Comparative Standards / Benchmarking Institutional norms Effective asset utilisation Cost economies Proportion of non cash charges in expense structure Influencing factors Proper asset liability management Credit period availed and credit period allowed Inventory management / Supply chain management/ level of obsolescence

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Efficiency ratios 1.Fixed assets turnover ratio = Net sales Net block of fixed assets Fixed assets are income generating assets for any company. This ratio indicates the efficiency with which the fixed assets are used to generate revenue. Higher the ratio better is the utilization of assets for generating sales. 2. Net worth turnover ratio = Net sales Net worth This ratio indicates the overall financial and operational efficiency of the company It is an indication about the optimum capital structure and production efficiencies of the company.

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3. Debtors Turnover ratio = Net Sales Avg. Debtors This ratio indicates the number of times the debtors are converted into cash. 4. Average debt collection period = Avg. Debtors * 360 days Sales

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5.Inventory Turnover ratio = COGS Avg. inventories This ratio shows the number of times a company’s inventory is turned into sales. 6. Avg. Inventory holding period = Avg inventories * 360 COGS

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Comparative Standards / Benchmarking Industry average Industry leader Trend over a period of time Influencing factors Production efficiencies Investment in relevant technologies Price and quality of products

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Profitability ratios 1.GP ratio = GP *100 Sales 2. Net profit ratio = PAT * 100 Sales These ratios study the profitability in relation to sales. It helps to assess the business performance starting from Gross Profit. Multi level profitability ratios helps to understand the levels at which there is pressure on margin ( profit )

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Comparative Standards / Benchmarking Trend over a period of time Industry average Industry leader / laggard WACC Influencing factors Qualitative and quantitative growth in sales Age of fixed assets ( depn ) Cost of borrowing Efficient tax planning

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Valuation ratios 1. P/E ratio = Market price of equity share EPS This ratio is the most popular ratio for valuation of a company by the investors. This ratio indicates market confidence in the company and its future prospects. 2. Book value per share ( Net Asset Value ) = Net worth No. of equity shares This ratio measure the net worth per equity share. This ratio indicates the efficiency of the company’s management in building up reserves and its prudent financial practices.

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Comparative Standards / Benchmarking Industry average Leaders & laggards in industry Trend over a period of time Influencing factors Dividend policy Size of the company Market conditions NAV

Cash flow ratios:

Cash flow ratios Relevance Large non cash expenses Rapid growth Window dressing – reality check

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1.Cash flow to net income = Cash from operations / Net income 2.Cash flow adequacy = Cash from operations / Cash paid for investment Cash paid for investment = cash paid for capital expenditure + cash paid for acquisitions The denominator can also include cash paid for dividend

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3. Cash times interest earned = Cash from operations before interest & tax Cash paid for interest

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Analysts should take the following precautions Analysis of trends over a long period of time Interpretation of observation against industry bench mark Analysis of core ratios only Inter firm comparison for variations in accounting policies In case of conglomerates comparative performance of different lines of business

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Potential red flags Unexplained change in accounting policy Unusual increase in receivables, inventory, creditors & depreciation. Increase in unusual short term financing Qualified audit opinion Change in external auditor Increase in related party transactions

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1. Which company is more successful in using leverage ? A B PBIT 18000 20000 Interest on debentures 3000 14400 Income tax 7000 2500 Debentures 20000 60000 Avg. total assets 70000 90000 Avg. shareholders equity 35000 20000

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Comment on the capital market standing of both the companies . Which company’s share would you recommend to a risk taking investor. A B EPS 3.50 6.75 DPS 2.00 3.00 Market price per share 60.00 95.00 Beta 1.30 1.50

Du Pont Analysis:

Du Pont Analysis Return on Assets = Profit margin * Asset Turnover PAT * 100 = PAT * 100 * Sales Total Assets Sales Total Assets Return on Assets indicates the overall efficiency of the business driven by profitability and efficiency in use of assets.

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ROE = Profit margin * Total Assets T.O * Equity M NPAT = NPAT * Sales * Total Assets Net worth Sales Total Assets Net worth Equity multiplier depends upon the leverage of the company. A highly levered firm will have a high equity multiplier whereas a low levered firm will have a low equity multiplier.

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Illustration 2009 2008 Sales 121000 110000 PAT 15396 13545 Avg. Total Assets 74800 66094 Analyse ROA using Du Pont framework

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2009 2008 Net income 973 1841 Sales 26996 24006 T. Assets 37039 34621 Equity 9781 9063 Analyse the ROE using Du Pont Framework

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2. The numbers below are for Iffy Co. and Model Co. Explain the reason of low return on equity. Iffy Model Cash 120 900 Receivables 600 4500 Inventory 480 6000 Property, plant & equipment 3440 15000 Total liabilities 3190 18150 Shareholders equity 1450 8250 Sales 10000 75000 COGS 9200 66750 Wage expenses 700 5250 Net income 100 3000

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Below is the data extracted from Doyle co. 2009 2008 Sales 211200 177600 Total Assets 201600 168000 Shareholders equity 52800 48000 Net income 17280 11520 Cash from operations 23040 31200 Cash paid for capital exp. 21360 15840 Cash paid for acquisitions 6000 480 Cash paid for interest 3600 2640 Taxes paid 9840 9600 In which year did the company perform better. Explain. Which questions would you ask the management before you invest in the said company

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The following is the incomplete set of financial statements of Arogya Co. Income Statement for the y.e 31.03.09 Net sales 33000 COGS ? Gross Profit 9000 PBIT ? Interest ? PBT ? IT ? PAT 35000

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Balance Sheet as on 31.03.09 Shareholders fund Share capital 28000 Reserves & Surplus ? Liabilities Secured loans 21000 Unsecured loans 17000 Current liabilities ? Assets Fixed Assets ? Investments 2400 Inventories ? Debtors ? Cash 1500 Other Current Assets 600

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a) Profit margin 7% b) Current ratio 1.3 c) Debt equity 1.5 d) Inventory turnover 2 times e) Avg. debt collection period 73 days (365 days) Interest coverage is 8 times Return on assets is 3.5

Predicting financial distress:

Predicting financial distress Beaver and Altman employed statistical techniques to predict financial distress. Five financial ratios were able to discriminate between bankrupt and non bankrupt companies.

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Manufacturing companies Z = 1.2X1 + 1.4 X2 + 3.3X3 + 0.6X4 + 1.0 X5 Pvt. Manufacturing companies Z1 = 0.717X1 + 0.847X2 + 3.107X3 + 0.42X4A + 0.998 X5 General use Z2 = 6.56X1 + 3.26X2 + 6.72X3 + 1.05 X4A

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X1 = Working capital to total assets X2= Retained earnings to total assets X3= EBIT to total assets X4= Market value of equity to book value of total liabilities X4A = Net worth to Total liabilities X5 = Sales to total assets

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Scores Safe Grey Bankrupt Z > 2.99 1.81-2.99 <1.81 Z1 > 2.90 1.23 – 2.90 < 1.23 Z2 > 2.60 1.10 – 2.60 < 1.10

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Illustration Determine impact of the transactions listed on the following ratios : Current ratio Asset turnover ratio Debt Equity ratio Debtors turnover ratio Quick ratio Inventory ratio Return on equity Return on capital employed Profit margin Debt service coverage ratio

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1.Received dividend from an associate 2.Made down payment for purchase of machinery 3.Sold investments for cash 4.Received payment from customer 5.Issued convertible debentures for cash 6. Accrued income tax 7.Paid advance to a supplier of materials 8.Exchanged equipment for a motorcar 9.Sold machinery for a loss 10.Retired a fully depreciated plant form use.

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Calculate cash flows from operating activities, investing activities and financing activities. Rs. lacs Issue of shares 10.00 Dividend received 0.25 Dividend paid 0.50 NPAT 12.00 Depreciation 1.00 Goodwill w/off 1.00 Increase in Drs 3.00 Increase in Crs 3.00 Repayment of loan 5.00 Purchase of fixed assets 6.00 Sale of investments 0.55 Tax 2.50 Capital advances paid 1.75 Interest paid on loans 0.25 Impairment loss on fixed assets 1.35 Interest received on ICDs 0.45