Ratio

Financial Statement Analysis: Ratio Analysis

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. 10

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 nonoperating 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. 15

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 18

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

Functions of Balance Sheet Measurement 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 liabilities Current assets – Inventories Quick ratio = Current liabilities Cash + Marketable securities Cash ratio = Current liabilities Current ratio =

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Solvency Ratios  Solvency ratios measure the dependence of

a firm on borrowed funds. Debt Debt-equity ratio  Equity (Net Worth) Debt Debt Debt ratio   Debt  Equity Capital employed Earnings before interest and tax Interest coverage  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 sales Inventory turnober  Average (or closing) inventory Number of days in the year (say, 360) Days of inventory holding  Inventory turnover Credit sales or net sales Debtors turnover  Average (or closing) debtors Number of days in the year (say, 360) Collection period  Debtors turnover 29

Turnover Ratios Net sales Current assets Net sales Net current assets turnover  Net current assets Net sales Fixed assets turnover  Net fixed assets Net sales Net assets turnover  Net assets or capital employed

Current assets turnover 

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Profitability Ratios  Profitability ratios measure a firm’s overall

efficiency and effectiveness in generating profit. Profit before interest and tax (PBIT) Margin  Net sales Profit after tax (PAT) Net margin  Net sales PBIT Before tax return on investment  Net assets Profit after tax Return on equity  Equity (net worth)

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Equity-related Ratios  Equity-related ratios measure the

shareholders’ return and value. Profit after tax Number of ordinary shares Dividends DPS  Number of ordinary shares DPS Dividends Payout ratio   EPS Pr ofit after tax DPS Dividend yield  Market value per share EPS 

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Equity-related Ratios EPS Earnings yield  Market value per share Market value per share P / E ratio = EPS Net worth Book value per share  Number of ordinary shares Market value per share M B value  Book value per share Market value of assets Tobin ' s q  Economic value of assets

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DuPont Analysis DuPont Analysis integrates the important ratios to analyse a firm's profitability. PBIT Sales PBIT RONA=   Net Assets Net Assets Sales PAT Sales PBIT  PAT Net Assets  ROE      Net Worth Net Assets Sales  PBIT Net Worth  ROE  Assets turnover × Margin × Leverage

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ISPAT INDUSTRIES LIMITED BALANCE SHEET AS AT 31ST MARCH, 2001 SOURCES OF FUNDS 1. Shareholders' Funds Share Capital Advances against Share Capital Reserves & Surplus 2. Loan Funds Secured Loans Unsecured Loans TOTAL APPLICATION OF FUNDS 1. Fixed Assets Gross Block Less: Depreciation Net Block Capital Work -in-Progress Pre-operative exp. etc. 2. Investments 3. Current Assets, Loans & Advances Inventories Sundry Debtors Cash & Bank Balances Loans, Advances & Deposits Less: Current Liabilities & Provisions Liabilities Provisions Net Current Assets 4. Miscellaneous Expenditure (To the extent not written off or adjusted) 5. Profit and Loss Account Debit balance TOTAL

Rs crore 2001

2000

978.07 244.3 746.77 1969.14

901.55 96.46 874.08 1872.09

4989.26 630.09 5619.35 7588.49

3582.6 1088.29 4670.89 6542.98

3470.36 704.01 2766.35 2093.31 1715.74 6575.4 130.87

1640.28 498.14 1142.14 2740.66 2231.85 6114.65 135.79

257.37 389.69 53.9 1018.31 1719.27

259.48 250.4 77.7 907.61 1495.19

1150.7 18.86 1169.56 549.71 134.37

1185.39 18.61 1204 291.19 1.35

198.14 7588.49

_ 6542.98

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ISPAT INDUSTRIES LIMITED PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH (Rs. crores) 2001 2000 INCOME Sales & Job Work (Net) Other Income TOTAL (A) EXPENDITURE Decrease in stocks Raw Materials Consumed Purchases of Finished Goods Payments to & Provisions for Employees Excise Duty Mfg., Dist., Sell. & Admin. Expenses Interest & Finance Charges Depreciation Less: Transfer from Revaluation Reserve TOTAL (B) Profit/(Loss) before Taxation (A+B) Less: Provision for Taxation Add: Provision for Taxation written back Profit/(Loss) after taxation Less: Balance brought forward from Previous Year Transfer from Debenture Redemption Reserve Transfer from Taxation Reserve Transfer from General Reserve Profit/(Loss) available for appropriation APPROPRIATIONS: Transfer to Debenture Redemption Reserve Balance carried to Balance Sheet TOTAL

2238.89 25.18 2264.07 3.95 3.95 823.04 7.77 43.99 269.94 890.84 345.96 206.33 15.32 2576.5 312.43 0.03 312.46 100.52

1425.48 11.65 1437.13 33.7 33.7 778.15 9.32 21.79 118.83 306.72 100.13 79.89 15.32 1433.21 3.92 0.32 0.07 3.67 106.59 8.09

0.73 13.07 -198.14

_ 118.35

_ -198.14 -198.14

17.83 100.52 118.35 36

ISPAT INDUSTRIES LIMITED RATIO ANALYSIS Liquidity ratios Current ratio 1.47 1.24 Quick ratio 0.05 0.06 Activity ratios Sales/TA 0.30 0.22 Sales/FA 0.81 1.25 Sales/Debtors 5.75 5.69 Sales/Inventory 8.70 5.49 Leverage ratios Debt/Equity 2.85 2.50 Debt/TA 0.74 0.71 PBIT/Interst 1.90 1.04 Profitability ratios PBIT/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% 37

INFOSYS Balance Sheeet as at March 31 2,001 SOURCES OF FUNDS SHAREHOLDERS FUNDS Share capital Reserves and surplus Capital Employed APPLICATION OF FUNDS FIXED ASSETS Original cost Less: Depreciation Net book value Add: Capital work-in-progress INVESTMENTS CURRENT ASSETS, LOANS AND ADVANCES Sundry debtors Cash and bank balances Loans and advances Less: Current liabilities Provisions NET CURRENT ASSETS Net Assets

in Rs. 2,000

330,792,085 13,565,599,903 13,896,391,988

330,755,000 8,002,273,248 8,333,028,248

6,311,444,025 2,441,315,982 3,870,128,043 1,706,504,250 5,576,632,293 341,154,821

2,840,305,143 1,336,520,594 1,503,784,549 569,603,505 2,073,388,054 138,348,469

3,023,702,417 3,850,610,285 4,302,793,623 11,177,106,325 1,349,181,176 1,849,320,275 7,978,604,874 13,896,391,988

1,361,781,253 4,317,935,730 2,101,277,161 7,780,994,144 671,506,459 988,195,960 6,121,291,725 8,333,028,248 38

INFOSYS Profit and Loss Account for the year ended March 31 in Rs. 2001 INCOME Software development services and products Overseas Domestic Other income EXPENDITURE Software development expenses Administrative and other expenses Provision for investments Provision for contingencies Provision for e-inventing the company Operating profit (PBIDT) Interest Depreciation Profit before tax and extraordinary item Provision for tax earlier years current year Profit after tax before extraordinary item Extraordinary item -- transfer of intellectual property right (net of tax) -- provision no longer required Net profit after tax and extraordinary item AMOUNT AVAILABLE FOR APPROPRIATION

2000

18,740,266,421.00 265,392,386.00 593,714,915.00 19,599,373,722.00

8,696,980,931.00 126,256,042.00 391,411,095.00 9,214,648,068.00

9,581,766,650.00 1,775,470,971.00 152,898,608.00

4,662,684,578.00 694,850,282.00

11,510,136,229.00 8,089,237,493.00

33,300,000.00 35,000,000.00 5,425,834,860.00 3,788,813,208.00

1,128,945,152.00 6,960,292,341.00

532,327,389.00 3,256,485,819.00

14,000,000.00 713,100,000.00 6,233,192,341.00 54,944,000.00

2,400,000.00 394,600,000.00 2,859,485,819.00

6,288,136,341.00 6,288,136,341.00

75,670,846.00 2,935,156,665.00 2,935,156,665.00 39

INFOSYS Financial Ratios 2001

2000

Activity Ratios Income/Assets Income/Debtors

1.41 6.48

1.11 6.77

Current Ratios CA/CL CA/Assets NCA/Assets

3.49 0.80 0.57

4.69 0.93 0.73

41.27% 35.51% 31.80%

41.12% 35.34% 31.03%

58.21% 50.09% 44.85%

45.47% 39.08% 34.32%

Profitability Ratios Margin PBDIT/Income PBIT/Income PAT/Income Return on Investment PBDIT/Assets PBIT/Assets PAT/NW

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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

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