Ratio Analysis Rajendra K. K. Lagu
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1 Ratio Analysis Rajendra K. Lagu
2 Balance Sheet Shows the status of company s financial position. It is actually a snap shot at the instant it is prepared, what the company owns and owes. Not duration specific, such as P&L statement is. Ideally, can be calculated every day; however companies usually calculate on a quarterly basis. Shows the sources and applications of funds. Numbers by themselves are not important; ratios are.
3 Balance Sheet continued Double entry accounting system: Assets and Liabilities must balance Every transaction gets entered at two places under different heads so that accounts are balanced. Credit / Debit or Assets / Liabilities Compare the movement across the quarters or years Scope for manipulation: Asset valuation, payment realization (GAAP)
4 Balance Sheet Structure Fixed Assets Assets Land, Buildings, Vehicles, Equipment Current Assets Cash, Accounts Receivable Inventory: WIP, Finished Goods Liabilities Long Term Liabilities Equity, Term Loans, Debentures Current Liabilities Accounts Payable Short Term Loans
5 Financial Management Decisions Capital budgeting decisions Assets Liabilities Fixed Assets Long Term Liabilities Land, Buildings, Vehicles, Equipment Current Assets Cash, Accounts Receivable, Marketable Securities Inventory: WIP, Finished Goods Equity, Term Loans, Debentures Current Liabilities Accounts Payable Short Term Loans Operating gpolicy decisions Capital structure decisions
6 Assets You pay for them to acquire them and so you own them They generate revenues later in short or long term Liquidity of an asset: Length of the time it takes to generate revenue Their value generally depreciates over time They can be revalued on some events They can be tangible or intangible (goodwill, monopoly)
7 Examples of Assets Cash in bank and in hand (bank balance, physical cash) Marketable Securities (parked funds) Accounts Receivables Inventory (Work In Progress) Inventory (Finished goods) Land, Building, Plants, Offices, Vehicles Equipment (PCs, Office equipment, Test jigs) Patents, Copyrights, Trademarks Goodwill, Brand Position
8 Liabilities Money that has been made available to the firm, received from outside sources. The firm owes them to outside agents including the shareholders Liabilities can have short term, long term, or b esc ves o e, o g e,o no term repayment schedules
9 Examples of Liabilities Accounts payable py (supplier credit) Accrued corporate tax Short term loans Debentures Long term loans Equity y( (common stock + preferred stock) Retained earnings
10 Balance Sheet of a Prototype Company Frequency of P&L statement calculation Operating Cycle duration: 2 weeks, 2 months, 1 year Inventory turns and profit margins are closely linked to the operating cycle Traders, Manufacturers, Knowledge-based companies
11 A Typical Manufacturing Company Starts Operation Two promoters deposit Rs 5 lakhs in the company account as equity XYZ Private Limited Balance Sheet at April 1, 2001 Assets Liabilities Cash 5,00,000 Equity 5,00,000 Total 5,00,000 Total 5,00,000
12 A lathe is bought on cash basis Owner pays Rs 3 lakhs from the bank acount Assets Liabilities Cash 2,00,000 Equity 5,00,000 Plant ,00,000 Total 5,00,000 Total 5,00,000
13 Raw material worth Rs 80,000 bought on a 60 day credit basis No payment is done so cash position does not change Assets Liabilities Cash 2,00,000 Equity 5,00,000 Plant 3,00,000 Account Payable 80,000 Inventory 80,000 Total 5,80,000 Total 5,80,000
14 Raw material worth Rs 40,000 processed and sold for Rs 50,000 with a 30 day credit No payment is done so cash position does not change, but inventory is reduced Assets Liabilities Cash 2,00,000 Equity 5,00,000 Plant 3,00,000, Accounts Payable 80,000 Inventory 40,000 Retained Earnings 10,000 Accounts Receivable 50, Total 5,90,000 Total 5,90,000
15 Customer pays up after 20 days Payment deposited in bank so cash position changes Assets Liabilities Cash 2,50,000 Equity 5,00,000 Plant 3,00,000, Accounts Payable 80,000 Inventory 40,000 Retained Earnings 10,000 Accounts Receivable 00, Total 5,90,000 Total 5,90,000
16 Supplier credit period is over and raw material is paid for after 60 days Payment done from bank so cash balance reduces Assets Liabilities Cash 1,70,000 Equity 5,00,000 Plant 3,00,000, Accounts Payable 00,000 Inventory 40,000 Retained Earnings 10,000 Accounts Receivable 00, Total 5,10,000 Total 5,10,000
17 A new promoter buys 10,000 shares of Rs 10 face value at a premium of Rs 20 Payment done to bank so cash balance increases Assets Liabilities Cash 4,70,000 Equity 6,00,000 Plant 3,00,000 Accounts Payable 00,000 Inventory 40,000 Retained Earnings 10,000 Accounts Receivable 00,000 Share Premium a/c 2,00,000 Total 8,10,000, Total 8,10,000,
18 Profit & Loss Account (Income Statement) Sales Revenues 4,00,000 Other Revenues 1,00,000 Total Revenues 5,00, % Cost of Goods Sold 2,00, % Gross Profit 3,00, % Operating Expenses 1,50, % PBITD 1,50,000, 30 % Interest + Tax + Depreciation 25,000 5 % Net Profit 1,25, %
19 Cash Flow / Funds Flow Statement Differences in successive balance sheets Sources of Funds Net profit Issue of new share capital Sale of fixed assets New loans Use of Funds Payment of dividends Purchase of fixed assets Repayment of loans
20 Ratio Analysis Compare the performance of the company for three successive years The absolute numbers change so compare ratios Compare two companies of fdiffering i size but tfrom the same industry, e.g, Infosys and Mastek Calculate industry-wide numbers (net profit margins for automobile companies)
21 Liquidity Ratios Measure a firm s ability to meet its short term obligations Show trends early and so corrective actions can be taken in the working capital management Current Ratio: Current Assets / Current Liabilities i Acid Test Ratio or Quick Ratio: (Current Assets Inventory) / Current Liability (Cash or cash equivalent) / Current Liability A firm is solvent if its assets are greater than outside liabilities. A firm is liquid if its current assets are greater than its current liabilities
22 Gearing Ratios Leverage of a firm: Proportion of its long term liabilities i that are debts Long term liabilities = Debts + Equity Debt/Equity ratio Loan Capital / Share holder s funds Gears, Leverage: Mechanical Engg terms
23 Asset Utilization Ratios Return on Total Investment: management s skill in exploiting the funds made available ROI = PBT / (Shareholders funds + Long term loans) Return on Shareholders Equity ROE = PBT / (Shareholders h funds) Sales / Total Capital Employed
24 Profitability Ratios Net Profit Margin = NP / Sales Gross Profit Margin = GP / Sales
25 Market Value related Ratios EPS (Earning Per Share) : NP / Total outstanding shares P/E : Market Price / Earning Per Share Revenue Multiple: Revenues / Assets Market to Book: Market Value / Book Value
26 Limitations of Financial Statements They are backward looking: Accrued results of the past year / quarter Company s value depends on its future profitability which depends on many factors not reflected in the balance sheet, which are nonmonetary Nature and innovativeness of it products Technology landscape (product obsolescence) Competitors Economic conditions (recession / boom), government policies Staff and management morale
27 Balance Sheet of Three IT Companies at (in Rs Cr) ( Company Infosys Wipro Satyam Equity Share premium Retained earnings Net Worth Debt Capital employed Fixed Assets Account receivable Cash & bank balance
28 Profit and Loss Statement of Three IT Companies for 12 Months Ending (in Rs Cr) Company Infosys Wipro Satyam Sales Other income Total income Cost of material Comm + traveling cost Employee cost Total cost of sales PBIDT PAT Prior year PAT y adjusted
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