MODULE 2. Business Analysis

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1 MODULE 2 Business Analysis Types Of Business Analysis Comparative Statements Ratio Analysis Break Even Analysis Comparative Statements Comparative statements present the accounts of two or more consecutive years side by side, such that an absolute comparison of the financial statement position of a business enterprise can be made. The comparative statements also indicate the percentage change over the previous year. This indicates the upward or downward trend of specific accounts in the balance sheet.

2 Comparative Statement Particulars Amount Amount %change ASSETS 60,000 68, % Land and Buildings 15,000 12,000-20% Plant and Machinery 25,000 35,000 40% Stock 5,000 6,000-20% Debtors 12,000 14, % Cash and Bank balance 3,000 1, % LIABILITIES 20,000 25,000 25% Creditors 2,000 6, % Term Loan 8,000 12,000 50% Debentures 10,000 7,000 30% CAPITAL 40,000 43, % Share capital 20,000 25,000 25% Preference capital 15,000 15,000 0% Reserves 5,000 3,000-40% Ratio Analysis The relationship between two relevant accounting information is termed as a ratio. Ratios are hence relative measures and help in business enterprise evaluation across years, enterprises, and industries. Types Of Ratios Profitability Ratios Liquidity Ratios Turnover Ratios Leverage Ratios Market Measure Ratios

3 Profitability Ratios Net Profit Ratio Higher the net profit ratio better the operational performance of the company. An increase in the net profit ratio is always viewed positively. Return on Investment An improvement in the return on investment is viewed favorable by the company. When the ratio is higher than the industry standard / expected ratio, the company s profitability position will be considered good.

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5 Liquidity Ratios Current Ratio The current ratio indicates the solvency position of a company. The higher the current ratio the safer the solvency poison of the company. This confirms the ability of the company to meet its current obligation through its current assets. Caution should be exercised in deriving the implication of a very high ratio. Very high ratio then industry standards or expected figure would indicate that the company could shift funds locked up in current assets to earning assets (long term). So that future returns could be high. Acid test ratio / Quick Ratio The immediate debt paying ability is indicated by the quick ratio. A quick ratio position of 1.0 would be an adequate position for the company, here also very high ratios do not indicate profit positions, through they might indicate safe liquidity position for the company.

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8 Turnover Ratios Inventory Turnover Ratio The relationship between cost of goods sold and inventory level held by the company is measured by this ratio. This ratio is best utilized by comparing it with industry standards or expectations. A very low ratio to this standard indicates that huge inventory positions are held by the company that needs to be managed properly. A very high ratio might indicate that out-of-stock situation could be faced by the company. Debtors Turnover Ratio The collection process of the credit transaction is reflected by this ratio. An increase in the debtors turnover ratio indicates that the collection process has improve. On the other hand if the ratio has declined from that of the previous accounting duration, their indicates that the collection process has to be strengthened by the company. Creditors Turnover Ratio The payment process of the credit transactions is indicated by this ratio. The larger the payment duration than the collection duration the company has an advantage in its overall credit policy. Asset Turnover Ratio The higher the asset turnover ratio, the better is the asset utilization position of the company. This indicates that the company is able to generate more revenue for a investment in fixed assets.

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13 Leverage Ratio Debt Equity Ratio The extent of external borrowing by the company is given by the debt-equity ratio. This ratio indicates the margin of safety for the debt holders in a company. Lower the ratio higher the margin of safety for the debt holders.

14 Market Measure Ratios Book value per share The book value per share is the intrinsic value of the company. This is the historical value for the investor of a company. Higher book values then the marketed price indicates that the company is under priced by the market. Dividend Per Share Dividend Per Share payment given to the shareholders of the company. High dividend payments usually reduce the market price of a company. P/E Ratio Price Earning multiplier compares the earnings of the company to the market price. A low P/E ratio indicates under pricing by the market. Dividend yield Dividend yield is a profitability measure. Higher the dividend yield higher the cash return to the investor. This indicates immediate cash return to the shareholder from investment in the company. Market Measure Ratios Book Value Per Share: Book value / Number of Outstanding Shares Earnings Per Share: Net Earnings / Number of Outstanding Shares Dividend Per Share: Dividend Declared/ Number of Outstanding Shares Dividend Yield: P/E Multiplier: Dividend Per Share / Market Price Earnings Per Share / Market Price

15 Example Income Statement '2001 '2000 '1999 Sales Excise Net Sales Expenditure Op. Profit (PBDIT) Interest Gross Profit (PBDT) Depreciation PBT Other Income (OI) PBT + OI Tax Reported Net Profit Net Extraordinary Items Net Profit (PAT) Equity No of Share Outstanding ('000)

16 Example Balance Sheet '2001 '2000 '1999 Liabilities Equity Preference Capital Reserves and Surplus Net Worth Debt Total Liabilities Assets Net Fixed Assets Capital Working in Progress Investments Net Working Capital Miscellaneous Expenses not written off Total Assets

17 Example Ratio Analysis '2001 '2000 '1999 Operating Profit Margin (OPM %) 11.3 % 12.2% 11.5 % Net Profit Margin (NPM %) 4.3 % 4.9 % 6.8 % Sales Growth (%) 73.4 % 97.5 % -- Operating Profit Growth (%) 80.7 % % -- Net Profit Growth 117 % 124 % -- Balance Sheet Ratios Debt/ Equity (D/E) Interest/Debt RONW (%) 7.9 % 8.8 % 12.7 % Depreciation / Fixed Assets (%) 0.1 % 0.1 % 0.1 % Fixed Assets / Sales Sales/Fixed asset + working capital Share Statistics EPS (Rs) Rs 12.7 Rs 13.7 Rs 19 Cash EPS (Rs) Rs 25.3 Rs 25.5 Rs 29.7 Book Value Break Even Analysis A business is said to break even which its total sales are equal to its total costs. It is a point of no profit or no loss. Hence, contribution can be defined as sales less variable cost. Using this definition, break even point may be said to be that point at which contribution is equal to fixed cost.

18 Break Even Formula

19 Example Particulars Amount (Rs.) Sales (80,000 Rs.50) Less: Variable costs (80,000 Rs.30) Contribution margin Less: Fixed expenses Operating income Break Even Point = /(50-30) Units Break Even Point = /(50-30)* 50 Value

Ratio Analysis. A) Liquidity Ratio : - 1) Current ratio = Current asset Current Liability

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