Ratio

Financial Statement Analysis: Ratio Analysis

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Financial Statements Financial statements provide information

about the financial activities and position of a firm.

Important financial statements are: Balance sheet Profit & Loss statement Funds flow statement Cash flow statement

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Balance Sheet Balance sheet indicates the financial

condition of a firm at a specific point of time. It contains information about the firm’s: assets, liabilities and equity.

Assets are always equal to equity and liabilities:

Assets = Equity + Liabilities

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Assets Assets are economic resources or properties

owned by the firm. There are two types of assets:

Fixed assets Current assets

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Current Assets Current assets (liquid assets) are those which

can be converted into cash within a year in the normal course of business. Current assets include: Cash and bank balance Accounts receivable (debtors) Inventory (stocks) Advances to suppliers Prepaid expenses

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Fixed Assets

Fixed assets are long-term assets. Tangible fixed assets are physical assets like

plant. Intangible fixed assets are the firm’s rights and

claims, such as patents, copyrights, goodwill etc. Gross block represent all tangible assets at

acquisition costs. Net block is gross block net of depreciation.

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Liabilities Liability is a firm’s obligation to pay cash or

provide goods or services in the future. Two types of liabilities are: Current liabilities Long-term liabilities

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Current Liabilities Current liabilities are payable within a year in

the normal course of business. They include: Accounts payable (creditors) Outstanding expenses Advances from customers Provision for tax Provision for dividend

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Long-term Liabilities Long-term liabilities are payable after a year.

They include: Borrowings from financial institutions and banks

etc. Debentures/bonds:

Non-convertible Fully convertible Partly convertible

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Shareholders’ Funds or Equity

Share capital is owners’ contribution divided into shares. A share is a certificate acknowledging the amount of capital contributed by the shareholder.

Reserves and surplus or retained earnings are undistributed profits.

Shareholders’ funds or equity is the sum of share capital plus reserves & surplus. It is also called net worth.

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Balance Sheet Relationship

Total assets (TA) equal net fixed assets (NFA) plus current assets (CA):

TA = NFA + CA

Net current assets (NCA) is the difference between current assets (CA) and current liabilities (CL):

NCA = CA – CL

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Balance Sheet Relationship

Net assets (NA) equal net fixed assets (NFA) plus net current assets (NCA):

NA = NFA + NCA Capital employed (CE) is the sum of net

worth or equity (E) and borrowing/debt (D) and it is equivalent of net assets:

CE = Net Worth + Borrowing = E + D Capital Employed = Net Assets

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Profit & Loss Statement Profit & Loss statement provides information

about a firm’s: revenues, expenses, and profit or loss.

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Nature of Revenues Revenue is the amount received or receivable

within the accounting period from the sale of the firm’s goods or services.

Operating revenue is the one that arises from main operations of the firm, and the revenue arising from other activities is called non-operating revenue.

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Nature of Expenses Expense is the amount paid or payable within

the accounting period for generating revenue. Examples: raw material consumed, salary and wages, power and fuel, repairs and maintenance, rent, selling and marketing expenses, administrative expenses.

Expenses are expired costs and capital expenditures represent un-expired costs and appear as assets in balance sheet.

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Depreciation Depreciation is a charge for the use of fixed

assets; it is an expense. It is a non-cash expense since cash was paid at the time fixed assets were acquired. Expenditures incurred on acquiring assets are called capital expenditures. Depreciation is allocation of these expenditures over the life of assets that have helped in generating revenue.

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Methods of Depreciation Depreciation may be provided on straight line basis or written down value basis (DWV). DWV basis

is allowed for taxation in India.

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Concepts of Profit Gross profit = sales – cost of goods sold (CGS)

CGS = raw material consumed + manufacturing expenses of goods that have been sold

PBDIT = Profit before dep., interest and tax = sales – expenses, except dep., interest and tax

PBIT= Profit before interest and tax = PBDIT – DEP

PBT= Profit before tax = PBIT – Interest PAT = Profit after tax = PBT – Tax

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Functions of Income Statement Summary of revenues and expenses Measurement of profitability

Functions of Balance SheetMeasurement of liquidity

Measurement of solvency

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Relationships: B/S and P&L A/C

Net profit = Equity (end) – Equity (begin) Equity (end) = Equity (begin) + Net profit +

Equity issued – Dividend Net profit = [Equity (end) – Equity (begin)] –

[Equity issued – Dividend] Change in equity = Equity (end) – Equity

(begin) = Net profit + Equity issued – Dividend

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Economic Vs. Accounting Profit

Accounting profit is a result of the arbitrary allocation of expenditures between expenses (revenue expenditure) and assets (capital expenditure).

Economic profit is the net increase in the wealth of the firm, and it is measured in cash flow.

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Financial Analysis

Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by property establishing relationships between the item of the balance sheet and the profit and loss account.

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Users of Financial Analysis Trade creditors Lenders Investors Management

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Nature of Ratio Analysis

A financial ratio is a relationship between two accounting numbers. Ratios help to make a qualitative judgment about the firm’s financial performance.

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Standard of Comparison Time series analysis Inter-firm analysis Industry analysis Proforma financial statement analysis

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Types of Financial Ratios Liquidity ratios Solvency ratios Turnover ratios Profitability ratios Equity-related ratios

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Liquidity Ratios Liquidity ratios measure a firm’s ability to

meet its current obligations.Current assets

Current ratio = Current liabilities

Current assets – InventoriesQuick ratio =

Current liabilitiesCash + Marketable securities

Cash ratio = Current liabilities

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Solvency Ratios Solvency ratios measure the dependence of

a firm on borrowed funds.

DebtDebt-equity ratio

Equity (Net Worth)

Debt ratio

Debt Equity employed

Earnings before interest and tax coverage

Interest

DebtDebt

Capital

Interest

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Turnover Ratios Turnover or activity ratios measure the firm’s

efficiency in utilizing its assets.

Cost of goods sold or net salesInventory turnober

Average (or closing) inventory

Number of days in the year (say, 360) of inventory holding

Inventory turnover

Credit sales or net saDebtors turnover

Days

les

Average (or closing) debtors

Number of days in the year (say, 360) period

Debtors turnoverCollection

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Turnover Ratios

Net salesCurrent assets turnover

Current assetsNet sales

current assets turnoverNet current assets

Net sales assets turnover

Net fixed assetsNet sales

assets turnoverNet assets or capital

Net

Fixed

Net

employed

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Profitability Ratios Profitability ratios measure a firm’s overall

efficiency and effectiveness in generating profit.

before interest and tax (PBIT)Margin

Net sales after tax (PAT)

marginNet sales

PBIT return on investment

Net assetsProfit after tax

on equityEquity (net worth)

Profit

ProfitNet

Before tax

Return

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Equity-related Ratios Equity-related ratios measure the

shareholders’ return and value. Profit after tax

EPSNumber of ordinary shares

DPSNumber of ordinary shares

DPS ratio

EPS Pr after tax

DPS yield

Market value per share

Dividends

DividendsPayout

ofit

Dividend

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Equity-related Ratios

EPSEarnings yield

value per share

value per shareP / E ratio =

EPSNet worth

value per shareNumber of ordinary shares

value per shareM Bvalue

Book value per share

Mar'

Market

Market

Book

Market

Tobin s q

ket value of assets

Economic value of assets

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DuPont Analysis

DuPont Analysis

integrates the important ratios to analyse a firm's profitability.

PBIT Sales PBITRONA=

Net Assets Net Assets SalesPAT Sales PBIT PAT Net Assets

ROENet Worth Net Assets Sales PBIT Net Worth

ROE Assets turnover × Margin × everageL

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ISPAT INDUSTRIES LIMITEDBALANCE SHEET AS AT 31ST MARCH, 2001 Rs crore

2001 2000SOURCES OF FUNDS1. Shareholders' Funds Share Capital 978.07 901.55 Advances against Share Capital 244.3 96.46 Reserves & Surplus 746.77 874.08

1969.14 1872.092. Loan Funds Secured Loans 4989.26 3582.6 Unsecured Loans 630.09 1088.29

5619.35 4670.89 TOTAL 7588.49 6542.98APPLICATION OF FUNDS1. Fixed Assets Gross Block 3470.36 1640.28 Less: Depreciation 704.01 498.14 Net Block 2766.35 1142.14 Capital Work -in-Progress 2093.31 2740.66 Pre-operative exp. etc. 1715.74 2231.85

6575.4 6114.652. Investments 130.87 135.793. Current Assets, Loans & Advances Inventories 257.37 259.48 Sundry Debtors 389.69 250.4 Cash & Bank Balances 53.9 77.7 Loans, Advances & Deposits 1018.31 907.61

1719.27 1495.19 Less: Current Liabilities & Provisions Liabilities 1150.7 1185.39 Provisions 18.86 18.61

1169.56 1204 Net Current Assets 549.71 291.194. Miscellaneous Expenditure 134.37 1.35 (To the extent not written off or adjusted)5. Profit and Loss Account Debit balance 198.14 _ TOTAL 7588.49 6542.98

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ISPAT INDUSTRIES LIMITEDPROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH

2001 2000INCOME Sales & Job Work (Net) 2238.89 1425.48 Other Income 25.18 11.65 TOTAL (A) 2264.07 1437.13EXPENDITURE 3.95 33.7 Decrease in stocks 3.95 33.7 Raw Materials Consumed 823.04 778.15 Purchases of Finished Goods 7.77 9.32 Payments to & Provisions for Employees 43.99 21.79 Excise Duty 269.94 118.83 Mfg., Dist., Sell. & Admin. Expenses 890.84 306.72 Interest & Finance Charges 345.96 100.13 Depreciation 206.33 79.89 Less: Transfer from Revaluation Reserve 15.32 15.32 TOTAL (B) 2576.5 1433.21 Profit/(Loss) before Taxation (A+B) 312.43 3.92 Less: Provision for Taxation 0.03 0.32 Add: Provision for Taxation written back 0.07 Profit/(Loss) after taxation 312.46 3.67 Less: Balance brought forward from Previous Year 100.52 106.59 Transfer from Debenture Redemption Reserve 8.09 Transfer from Taxation Reserve 0.73 Transfer from General Reserve 13.07 _ Profit/(Loss) available for appropriation -198.14 118.35APPROPRIATIONS: Transfer to Debenture Redemption Reserve _ 17.83 Balance carried to Balance Sheet -198.14 100.52 TOTAL -198.14 118.35

(Rs. crores)

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ISPAT INDUSTRIES LIMITEDRATIO ANALYSIS

Liquidity ratiosCurrent ratio 1.47 1.24Quick ratio 0.05 0.06Activity ratiosSales/TA 0.30 0.22Sales/FA 0.81 1.25Sales/Debtors 5.75 5.69Sales/Inventory 8.70 5.49Leverage ratiosDebt/Equity 2.85 2.50Debt/TA 0.74 0.71PBIT/Interst 1.90 1.04Profitability ratiosPBIT/Sales 29.41% 7.30%Net profit/Sales 13.96% 0.26%PBIT/TA 8.68% 1.59%Net profit/NW 15.87% 0.21%

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INFOSYSBalance Sheeet as at March 31

in Rs.2,001 2,000

SOURCES OF FUNDSSHAREHOLDERS FUNDSShare capital 330,792,085 330,755,000Reserves and surplus 13,565,599,903 8,002,273,248

Capital Employed 13,896,391,988 8,333,028,248

APPLICATION OF FUNDSFIXED ASSETSOriginal cost 6,311,444,025 2,840,305,143Less: Depreciation 2,441,315,982 1,336,520,594Net book value 3,870,128,043 1,503,784,549Add: Capital work-in-progress 1,706,504,250 569,603,505

5,576,632,293 2,073,388,054INVESTMENTS 341,154,821 138,348,469CURRENT ASSETS, LOANS AND ADVANCESSundry debtors 3,023,702,417 1,361,781,253Cash and bank balances 3,850,610,285 4,317,935,730Loans and advances 4,302,793,623 2,101,277,161

11,177,106,325 7,780,994,144Less: Current liabilities 1,349,181,176 671,506,459 Provisions 1,849,320,275 988,195,960NET CURRENT ASSETS 7,978,604,874 6,121,291,725

Net Assets 13,896,391,988 8,333,028,248

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INFOSYSProfit and Loss Account for the year ended March 31

in Rs.2001 2000

INCOMESoftware development services and products Overseas 18,740,266,421.00 8,696,980,931.00Domestic 265,392,386.00 126,256,042.00Other income 593,714,915.00 391,411,095.00

19,599,373,722.00 9,214,648,068.00

EXPENDITURESoftware development expenses 9,581,766,650.00 4,662,684,578.00Administrative and other expenses 1,775,470,971.00 694,850,282.00Provision for investments 152,898,608.00Provision for contingencies 33,300,000.00Provision for e-inventing the company 35,000,000.00

11,510,136,229.00 5,425,834,860.00

Operating profit (PBIDT) 8,089,237,493.00 3,788,813,208.00InterestDepreciation 1,128,945,152.00 532,327,389.00Profit before tax and extraordinary item 6,960,292,341.00 3,256,485,819.00Provision for tax earlier years 14,000,000.00 2,400,000.00 current year 713,100,000.00 394,600,000.00Profit after tax before extraordinary item 6,233,192,341.00 2,859,485,819.00Extraordinary item -- transfer of intellectual property right (net of tax) 54,944,000.00 -- provision no longer required 75,670,846.00Net profit after tax and extraordinary item 6,288,136,341.00 2,935,156,665.00AMOUNT AVAILABLE FOR APPROPRIATION 6,288,136,341.00 2,935,156,665.00

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INFOSYSFinancial Ratios

2001 2000Activity Ratios

Income/Assets 1.41 1.11Income/Debtors 6.48 6.77

Current RatiosCA/CL 3.49 4.69CA/Assets 0.80 0.93NCA/Assets 0.57 0.73

Profitability RatiosMarginPBDIT/Income 41.27% 41.12%PBIT/Income 35.51% 35.34%PAT/Income 31.80% 31.03%Return on InvestmentPBDIT/Assets 58.21% 45.47%PBIT/Assets 50.09% 39.08%PAT/NW 44.85% 34.32%

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Utility of Ratio Analysis

Assessment of the firm’s financial conditions and capabilities.

Diagnosis of the firm’s problems, weaknesses and strengths.

Credit analysis Security analysis Comparative analysis Time series analysis

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Cautions in Using Ratio Analysis Standards of comparisons Company differences Price level Different definition Changing situations Past data