Analysis of Financial Statement( Kaushal Mehta )

8/4/2019 Analysis of Financial Statement( Kaushal Mehta )

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A

SUMMER INTERNSHIP REPORT

ON

ANALYSIS OF FINANCIAL STATEMENT

Submitted to

L.J. Institute of Engineering and Technology

In requirement of partial fulfillment of

Masters of Business Administration (MBA)

2 year full time Program of Gujarat Technological University

Submitted on:

14th

July 2011

Submitted by:

Kaushal .R. Mehta

Enrollment number-107280592017

Batch No.: 2010-12


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Page 1

ACKNOWLEDGEMENT

The activity of going through summer training has bridged the gap between the academics and practical life for us. Many people supported us in our training and project and we take this

opportunity to acknowledge their support.

No one can complete any internship without taking the guidance and support of their guides and

well wishers. It was highly eventful session working, with Thermotech systems limited. Hence

we are thankful to them for providing us this opportunity to work with them because this is the

experience that will surely help us in our future endeavors.

We would like to express our gratitude to our company guide Mr. Kinjal Shah (Director) and

all staff members including for his help. They have been a constant source of inspiration and we

are thankful to them for pushing us to limits whenever we have fallen back in our project and

providing new insights on the problems that we have encountered. Their guidance gave us new

direction for system understanding and corporate culture.

We are thankful to Mr. Kinjal Shah for his constructive contribution and guidance towards

successful completion of the project.

We are also thankful to our faculty guides Mr. Mehul Yogi for helping us in our project and for

their suggestions on how to proceed step by step in the making of the project.

Last but not least there are so many other people whose name might not appear in the

acknowledgement but the sense of gratitude for them will always remain in our heart.

Thanks to All.


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Page 2

PREFACE

The project presented here gives an idea about how the various Financial analysis are executed atThermotech systems limited.

In today's era we find that FINANCE is becoming a recognized department. Most of the fields

are getting automated and computerized and so is FINANCE.

As a part of the course curriculum, the third semester students are required to prepare a project

report. The objective behind preparing this project is to relate the management subjects taught in

the classrooms to their practical application.

The preparation of this project report is based on facts and findings noted during the summer

internship program, information received from written and published documents and briefings by

company executives.

The material used in this project has come from a wide variety of forces. As possible the project

has been accompanied by graphs and statistical information. Clear and lucid language has been

used to make the project easily understood by the readers.

Moreover, the scope of the project is limited to the observation made during the training period

as they were not providing with their firms information. The primary data is collected by

observation and personnel interview.

My work in this project is therefore a humble attempt towards this end.

In spite of my best efforts, there may be errors of omissions and commissions which may please

be excused.


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Page 3

CCeerrttiiffiiccaattee

It is hereby certified that the work incorporated in the thesis submitted entitled ANALYSIS OF

FINANCIAL STATEMENT submitted by Mr. Kaushal Rameshkumar Mehta comprises the

result of independent and original investigation carried out me. The material which obtained (and

used) from other sources has been duly acknowledged in the thesis.

Date:

Place: Signature of the student

It is certified that the work mentioned above is carried out under my guidance.

Date:

Place: Signature of the faculty guide


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Page 4

TABLE OF CONTENTS

Sr.No. Title Page No.

EXECUTIVE SUMMARY 5Ch.1 STUDY OF INDUSTRY 6

1.1 Introduction to Indian Engineering Industry 7

1.2 Heavy Electrical Industry 8

1.3 Heavy Engineering Sector 9

1.4 Company Profile 12

1.5 Quality Policy 13

1.6 Our Vision 13

1.7 The Products 13

1.8 Major Achievements and Credentials 141.9 Corporate Profile 15

1.10 The Company Today 15

1.11 Application of Thermotech Products 15

OBJECTIVE STATEMENT 16Ch.2 RESEARCH METHODOLOGY 17

2.1 Financial Analysis 18

2.2 Elements of Financial Statement 24

2.3 Task of Financial Analyst 25

Ch.3 RATIO ANALYSIS 26

3.1 Meaning 27

3.2 Steps in Ratio Analysis 27

3.3 Relationship of Ratios 28

3.4 Importance of Ratio Analysis 29

3.5 Limitations of Ratio Analysis 30

3.6 Classification of Ratios 31

3.7 Guidelines for the use of Ratio 32

3.8 Types of the Ratio 33

Ch.4 DATA ANALYSIS AND INTERPRETATION 61

CONCLUSIONS 98 LIMITATIONS OF THE STUDY 99 REFERENCES 100


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Page 5

EXECUTIVE SUMMARY

In this report we would try and look how financial analysis is has been done with help of various

financial statements, how they function and what opportunities do they offer to the management

of the company.

Firstly we would see why is there need for financial analysis, what are the different factors that

affect the financial position of the company, we will see what are different methods of finding

companys present financial position.

Secondly we will try to compare the current years data or the current year financial position to

the previous year financial position, so that we can analyze whether company is able to improve

its financial position or not.

This report consists of various expenses and income which are taken in consideration after many

findings. Here data regarding companys finance department has been analyzed very effectively.

This project consists of various years data and also its comparison between the years with the

help of graph and interpretation.


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Analysis of Financial Statement

Summer Internship Report Page 6

Chapter 1:

Study

of

Industry


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1.1 Introduction to Indian Engineering Industry:

The Engineering sector is the largest in the overall industrial sectors in India. It is a diverse

industry with a number of segments, and can be broadly categorized into two segments, namely,

heavy engineering and light engineering. The engineering sector is relatively less fragmented at

the top, as the competencies required are high, while it is highly fragmented at the lower end

(e.g. unbranded transformers for the retail segment) and is dominated by smaller players.

The engineering industry in India manufactures a wide range of products, with heavy

engineering goods accounting for bulk of the production. Most of the leading players are

engaged in the production of heavy engineering goods and mainly produces high-value products

using high-end technology. Requirement of high level of capital investment poses as a major

entry barrier. Consequently, the small and unorganized firms have a small market presence.

The light engineering goods segment, on the other hand, uses medium to low-end technology.

Entry barrier is low on account of the comparatively lower requirement of capital and

technology. This segment is characterized by the dominance of small and unorganized players

which manufacture low-value added products. However, there are few medium and large scale

firms which manufacture high-value added products. This segment is also characterized by small

capacities and high level of competition among the players.

Which steam boilers and steam pipes are regulated by Indian Boiler Regulations?

Steam boiler:

Steam boilers under IBR means any closed vessel exceeding 22.75 liters in capacity and which is

used expressively for generating steam under pressure and includes any mounting or other fitting

attached to such vessel which is wholly or partly under pressure when the steam is shut off.

Steam pipes:

IBR steam pipe means any pipe through which steam passes from a boiler to a prime mover or

other user or both if pressure at which steam passes through such pipes exceeds 3.5 kg/cm2

above atmospheric pressure or such pipe exceeds 254 mm in internal diameter and includes in

either case any connected fitting of a steam pipe.


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1.1.1 User Segments

The major end-user industries for heavy engineering goods are power, infrastructure, steel,

cement, petrochemicals, oil & gas, refineries, fertilizers, mining, railways, automobiles, textiles,

etc. Light engineering goods are essentially used as inputs by the heavy engineering industry.

1.2 Heavy Electrical Industry

The fortunes of the heavy electrical industry have been closely linked to the development of the

power sector in India. The heavy electrical industry has under its purview power generation,

transmission, distribution and utilization equipments. These include turbo generators, boilers,

turbines, transformers, switchgears and other allied items. These electrical equipments

(transformers, switchgears, etc) are used by almost all the sectors. Some of the major areas where

these are used include power generation projects, petrochemical complexes, chemical plants,

integrated steel plants, non-ferrous metal units, etc.

The existing installed capacity of the India heavy electrical industry is 4,500 MW of thermal,

1,345 MW of hydro and about 250 MW of gas-based power generation equipment per annum.

The industry has the capability to manufacture transmission and distribution equipment upto 400

KV AC and high voltage DC.

1. Turbines and Generator Sets

The Indian industry has established a manufacturing capacity of various kinds of turbines of

more than 7,000 MW per annum. The PSE Bharat Heavy Electricals Ltd (BHEL) has the largest

installed capacity. There are units in the private sector also which manufacture steam and hydro

turbines for power generation and industrial use. Domestic manufacturers of AC generators are

capable of manufacturing AC generator from 0.5 KVA to 25,000 KVA and above.

2. Boilers

The Indian boilers industry has the capability to manufacture boilers with super critical

parameters upto 1,000 MW unit size. BHEL is the largest manufacturer of boilers in the country,

with a market share of over 60%. It has the capability to manufacture boilers for super thermal

power plants, apart from utility boilers and industrial boilers.


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3. Transformers

The domestic transformer industry has the capability to manufacture the whole range of power

and distribution transformers. Special types of transformers required for furnaces, rectifiers,

electric tract, etc, and series and shunt reactors as well as HVDC transmission upto 500 KV are

also being manufactured in India.

4. Switchgear and Control Gear

The switchgear and control gear industry in India is a fully developed one, producing and

supplying a wide variety of switchgear and control gear items required by the industrial and

power sectors. The entire range of circuit breakers from bulk oil, minimum oil, air blast, vacuum

to SF6 are manufactured to standard specification. The range of products produced cover the

entire voltage range for 240V to 800KV, switchgear and control gear, MCBs, air circuit breakers,

switches, rewire able fuses and HRC fuses with their respective fuse bases, holders and starters.

5. Electrical Furnaces

Electrical furnaces are used in Metallurgical and engineering industries such as forging and

foundry, machine tools, automobiles, etc.

6. Shunting LocomotivesShunting locomotives for internal transport facilities are essentially used in railways, steel plants,

thermal power plants, etc.

1.3 Heavy Engineering Sector

The heavy engineering sector can be classified into two broad segments capital

goods/machinery (which is further classified as electrical machinery/equipment and non-

electrical machinery/equipment), and equipment segments.

Electrical machinery includes the following: power generation, transmission and distribution

equipments such as generators and motors, transformers and switchgears. Non-electrical

machinery includes machines/equipments used in various sectors such as material handling

equipments (earth moving machinery, excavators, cranes, etc), boilers, etc.


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1. Textile Machinery Industry

The textile machinery industry in India manufactures machinery needed for sorting, cording,

processing of yarns/ fabrics and weaving, along with the components, spares and accessories. As

per the Ministry of Heavy Industries, there are over 600 units engaged in the manufacture of

machinery and spares, and out of these, about 100 units are manufacturing complete machinery.

2. Cement Machinery Industry

The Indian cement machinery industry manufactures complete cement plants, based on dry

processing and pre-calcinations technology, for capacities up to 7500 TPD. According to the

Ministry of Heavy Industries, presently there are 18 units in the organized sector for the

manufacture of complete cement plant machinery.

3. Sugar Machinery Industry

As per the estimates of the Ministry of Heavy Industries, there are presently 27 units in the

organized sector for the manufacture of complete sugar plants and components. The industry can

manufacture sugar plants for a capacity up to 10,000 TCD (tones crushing per day). India is a net

exporter of sugar machinery.

4. Rubber Machinery IndustryThe rubber machinery industry in India manufactures inters-mixer, tyre curing presses, tyre

moulds, tyre building machines, turnet service, bias cutters, rubber injection moulding machine,

bead wires, etc. According to the Ministry of Heavy Industries, currently there are 19 units in the

organised sector for the manufacture of rubber machinery mainly required for tyre/tube industry.

5. Material Handling Equipment Industry

The Indian material handling equipment industry manufactures a range of equipments including

crushing and screening plants, coal/ore/ash handling plant and associated equipment such as

stackers, reclaimers, ship loaders/unloaders, wagon tipplers, feeders, etc. The industry caters to

the requirement of a host of core industries such as coal, cement, power, port, mining, fertilizers

and steel plants. Apart from the organsied players, there are a number of units present in the

small scale sector.


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6. Oil Field Equipment Industry

The oil field equipment manufacturing industry manufactures drilling rigs for on-shore drilling.

Offshore drilling equipments like jack-up rigs, etc are not manufactured indigenously. The

industry however manufactures offshore platforms and certain other technological structures

domestically. Bharat Heavy Electricals, Hindustan Shipyard, Mazagon Dock and Burn & Co. are

some of the leading producers. The recent couple of years have witnessed a surge in exports of

oil field equipments. However, the industry remains a net importer.

7. Mining Machinery Industry

The various type of mining equipments include Longwall mining equipments, road header, side

dischargers loader, haulage winder, ventilation fan, load haul dumper, coal cutter, conveyors,

battery locos, pumps, friction prop, etc.

8. Machine Tool Industry

The machine tool industry is regarded as the backbone of the entire industrial engineering

industry. The Indian machine tool industry manufactures almost the entire range of metal-cutting

and metal-forming machine tools. Apart from conventional machine tools and Computer

Numerically Controlled (CNC) machines, the Indian industry also offers other variants such as

special purpose machines, robotics, handling systems, and TPM-friendly machines.


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1.4 Company profile

Name : Thermotech systems limited.

Factory : Plot no 2608,Phase IV,GIDC Estate

Vatva, Ahmedabad

Dist: Ahmedabad.

Gujarat, India.

Establishment : February, 1996

M.D. : Shri Rajnibhai J. Shah

Main objective : To win total Quality satisfaction from

Customers by providing best Quality

Products with innovative technology.

Management: Limited Company.

Product: Thermic Fluid Heater & Non-IBR Steam Boiler Scope : Manufacturing, supply and services of

Thermic fluid heater and non-IBR steam

Boiler.

We introduce ourselves as a leading manufacturer of process heating equipments & turn key

industrial solutions, with manufacturing facilities in Gujarat & Marketing, service network

across India with offices in Delhi, Mumbai, Indore,Chennai, Bangalore, Hyderabad, Calcutta,

Rajasthan, etc & abroad with representative in Turkey, UAE, Srilanka, Bangladesh. We had

exported to countries like Srilanka, Bangladesh, Nepal, Kenya, Nigeria, UAE, Saudi Arabia,

New Zealand, Turkey, etc.


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1.5 QUALITY POLICY

We at Thermotech systems limited commit to provide products with value addition meeting

customer satisfaction. We shall also strive hard for continual improvement of our processes. We

shall accomplish quality objectives by establishing, implementing and maintaining effective

quality management systems which complies with the requirement of ISO 9001:2000.

1.6 OUR VISION

To be leaders in providing solutions for PROCESS HEATING & ENGINEERING through

consistent quality products & complete customer satisfaction.

1.7 THE PRODUCTS

Thermotech, an eco-energy company is one of the few companies in the world that offers

integrated solution in energy & ecosystem management. Thermotech is a solution provider for

complete process heating systems & its ancillaries.

THERMOTECHS wide range of heating solution envelops:

1. Thermic Fluid Heater : Range up to 15 M Kcal/hr

2. Hot Water Generator : Range Up to 10 M Kcal/hr

3. Air Heaters : Range up to 4 M Kcal/hr

Fuel For Above Systems: OIL / GAS / SOLID FUEL


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SOME OF OUR HIGHLIGHTED CUSTOMERS:

1. HLL

2.

PARLE

3. JINDAL

4. BIRLA

5. EMAMI

6. BAJAJ HINDUSTAN

7. HAYLEYS GROUP

8.

BOMBAY DYEING

9. DUKES

10.SHELL

1.8 MAJOR ACHIEVEMENTS & CREDENTIALS

3.5 M Kcal/hr x 4 Nos. : Dual Gas Fired Thermic Heater by GPS-DUBAI for Ukraine Gas

Treatment Plant Hazardous Zone

We had commissioned 10 M Kcal/hr Thermic Heater Coal Fired in Turkey, which is First of its

kind to be manufactured by any Indian Company other than Thermax. We had executed orders

up to 12 M Kcal/hr Thermic Fluid Heater. The customer base of more than 1300 in India &

abroad.

Thermotech has tie-up with consultants for detail engineering of specialized projects, pipeline

engineering & major structural work of complete system.


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1.9 CORPORATE PROFILE

The motivating power behind the phenomenal success of the Company since its inceptions is a

sole motto to provide a wide range of quality products maintenance free, which is manufactured

with the latest state of the art technology.

Guided by the dedicated philosophy of technical perfection, Thermotech Systems Limited has

earned nation wide high reputation for its exclusively superior quality products. Needless to say

that this well pursued motto has made the Company a distinctly outstanding entity in a highly

competitive field.

1.10 THE COMPANY TODAY

Today, the Company by its continuous quality encroachment had earned a recognition, which

ensures quality management services & hence an improved product quality. Thermotech enjoys a

wide spread satisfied client base of around 1500, also that the companys products are being

exported to neighboring countries. The entire products are very well received and commands

high rate of preference in the market.

The Company is promoted and backed up by a team of highly qualified and experienced

technocrats and professionals fully devoted to their respective field- Production, Marketing,

Administration etc., besides, it is heavily banking on its trump card, a prompt and efficient after

sales service. All these put to gather have led us to what we are today.

1.11 APPLICATION OF THERMOTECH PRODUCTS

Thermotechs products are widely used in following industries:

CHEMICALS PLYWOOD SOLAR

TEXTILE PAINT FOOD

GARMENTS RUBBER DISTILLERY

LEATHER PAPER AUTO


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OBJECTIVE STATEMENT

To learn the practical application of theory and fundamental of financial analysis

methods.

To apply the skills to interpret at particular time of period in the company for financial

analysis.

To understand day to day working of the company, how company manages each and

every activity.

To understand the management of finance department to improve companys present

position.

To bridge the gap between the real-life business and academic of the managementfundamentals.

To develop a platform to network which will be useful to further their career prospects.


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Chapter 2:

Researchmethodology


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2.1 Financial Analysis:

Financial analysis is the process of identifying the financial strengths and weaknesses of the firm

and establishing relationship between the items of the balance sheet and profit and loss account.

Financial ratio analysis is the calculation and comparison of ratios which are derived from the

information in a companys financial statements. The level and historical trends of these ratios

can be used to make inferences about a companys financial condition, its operations and

attractiveness as an investment. The information in the statements is used by following.

1) Trade creditors, to identify the firms ability to meet their claims i.e. liquidity position of

the company.

2)

Investors, to know about the present and future profitability of the company and its

financial structure.

3) Management, in every aspect of the financial analysis. It is the responsibility of the

management to maintain sound financial condition in the company.

The Financial statement of the company does not give all the information regarding the financial

operations of a firm. They provide some useful information to the extent the balance sheet

mirrors the financial position on a particular date in terms of the structure of assets, liabilities andowners equity. Profit and loss account shows the results of operation during a certain period of

time in terms of the revenues obtained and the cost incurred during the year. Financial statement

provides a summarized view of the financial position and operations of the firm. The analysis of

financial statement is an important aid to financial analysis.

The focus of financial analysis is on key figures in the financial statement and the significant

relationship that exist between them. The analysis of financial statement is a process of

evaluating relationship between component parts of financial statement to obtain a better

understanding of the firms position and performance.

2.1.1 Financial analysis can be done as per following methods:-

1) Ratio analysis

2) Common-size statements

3)

Importance and limitations of Ratio analysis


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Major Financial statements:-

1) Balance sheet

2) Profit and loss account

The process of analysis is usually done by using these two statements or with the

help of other ledgers made in the company

.

2.1.2 Balance sheet:-

In financial accounting, a balance sheet or statement of financial position is a

summary of the financial balances of a business. Assets, liabilities and ownership

equity are listed as on a specific date, such as the end of its financial year. A balance sheet is

often described as a "snapshot of a company's financial condition".

Balance sheet is the traditional basic statement of a business enterprise. It

furnishes useful financial data regarding its operation. It does not provides the information

regarding changes in firms financial position. It fails to provide following answers:

1) What have been the factors responsible for the difference in owners equity, assets and

liabilities of the firm at two dates of consecutive balance sheets?

2) What have been the premier financing and investment activities of the firm during

this period?

3) Have long term sources been adequate to finance fixed assets purchase in the

company?

4) Does the firm possess adequate working capital?

5) How much funds have been generated from operations?

A standard company balance sheet has three parts:-

1) Assets

2) Liabilities

3) Ownership equity


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1) Assets:-

Any item of economic value owned by an company, especially that which could

be converted into cash. Examples are cash, securities, accounts receivable, inventory, equipment,

real estate, property or investments. On a balance sheet, assets are equal to the sum of liabilities,

common stock, equity capital and retained earnings. From an accounting perspective, assets are

divided into the following categories:

1) Current assets ( Cash and other Liquid items)

2) Long term assets ( Land, Plant, Equipments)

3) Prepaid and differed assets( Expenditure for future costs such as Insurance, Rent,

Interest)

4) Intangible assets ( Trademark, Patents, Copyright, Goodwill)

2) Liabilities:-

An obligation that legally binds an company to settle a debt. When one is liable

for a debt, they are responsible for paying the debt or settling they may have committed. For

example, if John hits Jane's car, John is liable for the damages to Jane's vehicle because John isresponsible for the damages. In the case of a company, a liability is recorded on the balance sheet

and can include accounts payable, taxes, wages, accrued expenses, and differed revenues.

Current liabilities are debts payable within one year, while long term liabilities are debts payable

over a longer period.

3) Ownership Equity:-

Total assets minus total liabilities of an company is called Ownership Equity. It

includes share capital, reserves and surplus, profit.

Share Capital- 1) Equity share capital

2) Preference share capital

3) Net profit

4) Reserves

5) Surplus


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2.1.3 Profit and loss account:-

Profit and loss account is also known as income statement, statement of financial

performance, operating statement. Profit and loss account is a company's financial statement that

indicates how the revenue (money received from the sale of products and services before

expenses are taken out) is transformed into the net income (the result after all revenues and

expenses have been accounted for, also known as the "bottom line"). It displays the revenues

recognized for a specific period, and the cost and expenses charged against these revenues,

including write-offs (e.g., depreciation and amortization of various assets) and taxes. The

purpose of the income statement is to show managers and investors whether the company made

or lost money during the period being reported.

The important thing to remember about an income statement is that it represents a period of time.

This contrasts with the balance sheet, which represents a single moment in time.

Charitable organizations that are required to publish financial statements do not produce an

income statement. Instead, they produce a similar statement that reflects funding sources

compared against program expenses, administrative costs, and other operating commitments.

This statement is commonly referred to as the statement of activities. Revenues and expenses are

further categorized in the statement of activities by the donor restrictions on the funds received

and expended.The income statement can be prepared in one of two methods. The Single Step income statement

takes a simpler approach, totaling revenues and subtracting expenses to find the bottom line. The

more complex Multi-Step income statement (as the name implies) takes several steps to find the

bottom line, starting with the gross profit. It then calculates operating expenses and, when

deducted from the gross profit, yields income from operations. Adding to income from

operations is the difference of other revenues and other expenses. When combined with income

from operations, this yields income before taxes. The final step is to deduct taxes, which finally

produces the net income for the period measured.


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Usefulness of Income statement:

1) Income statements helps investors and creditors determine the past financial performance of

the enterprise.

2) Predict future performance.

3) Assess the capability of generating future cash flows through report of the income and

expenses.

Limitations of Income statement:

1) Items that might be relevant but cannot be reliably measured are not reported (e.g. Brand

recognition and Loyalty).

2) Some numbers depend on accounting methods used (e.g. Using FIFO or LIFO accounting to

measure Inventory level).

3) Some numbers depend on judgments and estimates (e.g. Depreciation expense depends on

estimated useful life and salvage value).

The expenses and incomes determined in the profit and loss account can be differentiated as

follows:

2.1.4 Operating section

Revenue - Cash inflows or other enhancements of assets of an entity during a period

from delivering or producing goods, rendering services, or other activities that constitute

the entity's ongoing major operations. It is usually presented as sales minus sales

discounts, returns, and allowances.

Expenses - Cash outflows or other using-up of assets or incurrence of liabilities during a

period from delivering or producing goods, rendering services, or carrying out other

activities that constitute the entity's ongoing major operations.

Cost of Goods Sold - Represents the direct costs attributable to goods produced and sold

by a business (manufacturing or merchandizing). It includes material, direct labor,

and overhead costs, and excludes operating costs (period costs) such as selling,

administrative, advertising or R&D, etc.


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Selling, General and Administrative expenses - Consist of the combined payroll costs.

These are usually understood as a major portion of non-production related costs, in

contrast to production costs such as direct labor.

Selling expenses - Represent expenses needed to sell products (e.g. Salaries of sales

people, commissions and travel expenses, advertising, freight, shipping, depreciation of

sales store buildings and equipment, etc.).

General and Administrative expenses - Represent expenses to manage the business.

(Salaries of officers / executives, legal and professional fees, utilities, insurance,

depreciation of office building and equipment, office rents, office supplies, etc.).

Depreciation / Amortization - The charge with respect to fixed assets / Intangible

assets that have been capitalized on the balance sheet for a specific (accounting) period. It

is a systematic and rational allocation of cost rather than the recognition of market value

decrement.

Research & Development (R&D) expenses - Represent expenses included in research

and development.

Expenses recognized in the income statement should be analyzed either by nature (raw

materials, transport costs, staffing costs, depreciation, employee benefit etc.) or

by function (cost of sales, selling, administrative, etc.).

2.1.5Non-operating section Other revenues or gains - Revenues and gains from other than primary business

activities (e.g. Rent, income from patents). It also includes unusual gains that are either

unusual or infrequent, but not both (e.g. Gain from sale of securities or gain from disposal

of fixed assets)

Other expenses or losses - Expenses or losses not related to primary business operations,(e.g. Foreign exchange loss).

Finance costs - Costs of borrowing from various creditors (e.g. Interest expenses, bank

charges).

Income tax expense - Sum of the amount of tax payable to tax authorities in the current

reporting period (Current tax liabilities/ tax payable) and the amount of deferred

tax liabilities (or assets).


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2.2 Elements of Financial statement:

Assets are probable future economic benefits obtained or controlled by a particular entity

as a result of past transactions or events. Comprehensive income is the change in equity (net assets) of an entity during a period

from transactions and other events and circumstances from non owner sources. It

includes all changes in equity during a period except those resulting from investments by

owners and distributions to owners.

Distributions to owners are decreases in net assets of a particular enterprise resulting

from transferring assets, rendering services, or incurring liabilities to owners.

Distributions to owners decrease ownership interest or equity in an enterprise.

Equity is the residual interest in the assets of an entity that remains after deducting its

liabilities. In a business entity, equity is the ownership interest.

Expenses are outflows or other uses of assets or incurring of liabilities during a period

from delivering or producing goods or rendering services, or carrying out other activities

that constitute the entity's ongoing major or central operation.

Gains are increases in equity (net assets) from peripheral or incidental transactions of an

entity and from all other transactions and other events and circumstances affecting the

entity during a period except those that result from revenues or investments by owner.

Investments by owners are increases in net assets of a particular enterprise resulting from

transfers to it from other entities of something of value to obtain or increase ownership

interest (or equity) in it.

Liabilities are probable future sacrifices of economic benefits arising from present

obligations of a particular entity to transfer assets or provide services to other entities in

the future as a result of past transactions or events.

Losses are decreases in equity (net assets) from peripheral or incidental transactions of

an entity and from all other transactions and other events and circumstances affecting the

entity during a period except those that result from expenses or distributions to owners.

Revenues are inflows or other enhancements of assets of an entity or settlement of its

liabilities (or a combination of both) during a period from delivering or producing goods,

rendering services, or other activities that constitute the entity's ongoing major or central

operation.


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2.3 Task of Financial Analyst:-

1) Select the information relevant to the decision.

2) Arrange the information in a way to highlight significant relationships

3) Interpretation and drawing of inferences and conclusions.

In short:-

1) Selection

2) Relation

3) Evaluation


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Chapter 3:

RatioAnalysis


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As if the financial statement does not gives all the information regarding the financial operation

of the firms. The ratio analysis is one of the important method of doing analysis of financial

statement.

3.1 Meaning:-

Ratio analysis is a widely used tool of financial analysis. It is defined as the

systematic use of ratio to interpret the financial statement so that the strengths and weaknesses of

a firm as well as its historical performance and current financial condition can be determined.

The term ratio defers to the numerical or quantitive relationship between two items. Ratios are

used to assess the return on investment, solvency, liquidity, resources efficiency, profitability

and capital market valuation of the company. Ratio analysis is thus a relative and more focused

analysis of financial statement. That does not mean that it can be used independently of other

tools and techniques. It leads to an expansion and further analysis of the findings recorded

through other tools. Ratio analysis is of particular significance in the following cases:

1) Trend ratios

2) Inter-firm comparison

3) Comparison of items within a single years financial statement

4)

Comparison with standards or plan1) Trend ratios involve a comparison of ratios of a firm over a time, that is, present ratios

are compared with past ratios.

2) Inter-firm comparison involving comparison of the ratio of a firm with those of others in

the same line of business.

3) Remaining both are ratios which may relate to comparison of items within a single years

financial statement of a firm and comparison with standard or plans.

3.2 Steps in Ratio Analysis

1) The first task of the financial analysis is to select the information relevant to the

decision under consideration from the statements and calculates appropriate ratios.

2) To compare the calculated ratios with the ratios of the same firm relating to the past or

with the industry ratios. It facilitates in assessing success or failure of the firm.

3) Third step is to interpretation, drawing of inferences and report writing conclusions are

drawn after comparison in the shape of report or recommended courses of action.


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3.3 Relationship of Ratios

Relationship of ratios can be determined as follows:

1) Percantage:

Assuming sales of the company is Rs.100000.

Net profit of the company is Rs.25000

Net profit ratio = Net profit 100

Sales

= 25000 100

100000

= 25%

2) Fraction:



Net profit ratio = Net profit

Sales

= 25000

100000

= 1 /43) Proportion of numbers:



The proportion between net profit and sales of the company is 1:4.

The rationale of ratio analysis lies in the fact that it makes related information

comparable. A single figure by itself has no meaning but when expressed in terms of a related

figure, it yields significant inferences.


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3.4 Importance of Ratio analysis:

1) Profitability: Accounting ratio help to measure the profitability of the business by

calculating the various profitability ratios. It helps the management to know about the

earning capacity of the business concern. In this way profitability ratios show the actual

performance of the business.

2) Operating efficiency: Ratio analysis helps to workout the operating efficiency of the

company with the help of various turnover ratios. All turnover ratios are worked out to

evaluate the performance of the business in utilizing the resources.

3) Helpful for forecasting purposes: Accounting ratios indicate the trend of the business.

The trend is useful for estimating future. With the help of previous years ratios,

estimates for future can be made. In this way these ratios provide the basis for preparing

budgets and also determine future line of action.

4) Short-term financial position: Ratio analysis helps to workout the short-term financial

position of the company with the help of liquidity ratios. In case short-term financial

position is not healthy efforts are made to improve it.

5) Analysis of financial statement: Ratio analysis help the outsiders just like creditors,

shareholders, debenture-holders, bankers to know about the profitability and ability of the

company to pay them interest and dividend etc.

6) Solvency: With the help of solvency ratios, solvency of the company can be measured.

These ratios show the relationship between the liabilities and assets. In case external

liabilities are more than that of the assets of the company, it shows the unsound position

of the business. In this case the business has to make it possible to repay its loans.

7) Comparative analysis of the performance: With the help of ratio analysis a company may

have comparative study of its performance to the previous years. In this way company

comes to know about its weak point and be able to improve them.

8)

Simplification of the accounting information: Accounting ratios are very useful as they

briefly summarize the result of detailed and complicated computations.

9) Inter-firm comparison: Ratio analysis helps in inter-firm comparison by providing

necessary data. An interfirm comparison indicates relative position. It provides the

relevant data for the comparison of the performance of different departments. If

comparison shows a variance, the possible reasons of variations may be identified and if

results are negative, the action may be initiated immediately to bring them in line.


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3.5 Limitations of Ratio analysis:

1) False Results: Accounting ratios are based on data drawn from accounting records. In

case that data is correct, then only the ratios will be correct. For example, valuation of

stock is based on very high price, the profits of the concern will be inflated and it will

indicate a wrong financial position. The data therefore must be absolutely correct.

2) Effect of Price Level Changes: Price level changes often make the comparison of figures

difficult over a period of time. Changes in price affects the cost of production, sales and

also the value of assets. Therefore, it is necessary to make proper adjustment for price-

level changes before any comparison.

3) Qualitative factors are ignored: Ratio analysis is a technique of quantitative analysis and

thus, ignores qualitative factors, which may be important in decision making. For

example, average collection period may be equal to standard credit period, but some

debtors may be in the list of doubtful debts, which is not disclosed by ratio analysis.

4) Effect of window-dressing: In order to cover up their bad financial position some

companies resort to window dressing. They may record the accounting data according to

the convenience to show the financial position of the company in a better way.

5) Misleading Results: In the absence of absolute data, the result may be misleading. For

example, the gross profit of two firms is 25%. Whereas the profit earned by one is just

Rs. 5,000 and sales are Rs. 20,000 and profit earned by the other one is Rs. 10,00,000 and

sales are Rs. 40,00,000. Even the profitability of the two firms is same but the magnitude

of their business is quite different.

6) Absence of standard university accepted terminology: There are no standard ratios, which

are universally accepted for comparison purposes. As such, the significance of ratio

analysis technique is reduced.

7) Costly Technique: Ratio analysis is a costly technique and can be used by big business

houses. Small business units are not able to afford it.

8) Limited Comparability: Different firms apply different accounting policies. Therefore the

ratio of one firm can not always be compared with the ratio of other firm. Some firms

may value the closing stock on LIFO basis while some other firms may value on FIFO

basis. Similarly there may be difference in providing depreciation of fixed assets or

certain of provision for doubtful debts etc.


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3.6 CLASSIFICATIONS OF RATIOS

The use of ratio analysis is not confined to financial manager only. There are different parties

interested in the ratio analysis for knowing the financial position of a firm for different purposes.Various accounting ratios can be classified as follows:

1. Traditional Ratio

2. Functional Ratio

3. Significance Ratio

1. Traditional ratio:

Balance sheet (or) position statement ratio: They deal with the relationship between two

balance sheet items, e.g. the ratio of current assets to current liabilities etc., both the items

must, however, pertain to the same balance sheet.

Profit & loss account (or) revenue statement ratios: These ratios deal with the relationship

between two profit & loss account items, e.g. the ratio of gross profit to sales etc.

Composite (or) inter statement ratios: These ratios exhibit the relation between a profit &

loss account or income statement item and a balance sheet items, e.g. stock turnover ratio,

or the ratio of total assets to sales.

2. Functional ratio:

Liquidity ratios: These ratio deals with relationship between the current assets and

liabilities of the company, e.g. the ratio of net working capital, it shows the available

balance for working capital.

Long term solvency: These ratio deals with the capacity of a company to discharge its

obligation towards long term lenders indicate its financial strength and ensure its long

term survival.

Leverage ratios: A ratio used to measure a company's mix of operating costs, giving an

idea of how changes in output will affect operating income. Fixed and variable costs are

the two types of operating costs; depending on the company and the industry, the mix

will differ.

Activity ratios: Activity ratios measure company sales per another asset account the most

common asset accounts used are accounts receivable, inventory, and total assets. Activity

ratios measure the efficiency of the company in using its resources. Since most


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companies invest heavily in accounts receivable or inventory, these accounts are used in

the denominator of the most popular activity ratios.

Profitability ratios: The profitability ratios are used to measure how well a business is

performing in terms of profit. The profitability ratios are considered to be the basic bank

financial ratios.

3. Significance ratio:

Some ratios are important than others and the firm may classify them as primary and

secondary ratios. The primary ratio is one, which is of the prime importance to a concern.

The other ratios that support the primary ratio are called secondary ratios.

3.7 Guideline for the use of Ratio

The calculation of ratios may not be a difficult task but their use is not easy.

Following guidelines or factors may be kept in mind while interpreting various ratios are

calculated:

1. Accuracy of Financial statement: The financial statement of the company should

show the true figures of the companys operations. Each and every income or

expenses should be recorded according to their accounting standards.

2. Objective or purpose of analysis: The purpose of analysis should be defined

properly so that it make the analysis more detailed and accurate for the company.

3. Selection of ratios: The selection of ratio which the company has to calculate

must be confirmed first of all. According to that analysis has been done in the

company. The selection must be done properly.

4. Use of standards: For the proper results of ratio analysis, the accounting standards

and the information taken from the financial statement should be very clear and

true.

5. Caliber of the analysis: The ratio which company is going to find must match the

criteria of the analysis in the company.


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3.8 Types of the ratio:

3.8.1 Activity ratio:

Activity ratios measure company sales per another asset accountthe most common asset

accounts used are accounts receivable, inventory, and total assets. Activity ratios measure the

efficiency of the company in using its resources. Since most companies invest heavily in

accounts receivable or inventory, these accounts are used in the denominator of the most popular

activity ratios.

Activity ratio is the indicator of how rapidly a firm converts various accounts into cash or sales.

In general, the sooner management can convert assets into sales or cash, the more effectively thefirm is being run. Companies will typically try to turn their production into cash or sales as fast

as possible because this will generally lead to higher revenues. Such ratios are frequently used

when performing fundamental analysis on different companies. The asset turnover ratio and

inventory turnover ratio are good examples of activity ratios.

Types of activity ratios are as follows:-

1. Raw materials turnover

2. Work-in-progress turnover

3. Debtor turnover ratio

4. Fixed asset turnover ratio

5. Total asset turnover ratio

6. Working capital turnover ratio

7. Capital turnover ratio

8.

Cash conversion cycle


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1. Raw materials turnover:

Raw material turnover = __Cost of raw material used ___

Average raw material inventory

This gives basic idea about how company uses its raw material or other inventories for

generating more profit in the present competitive industrial market. The cost of material used

the important factor in this ratio.

2. Work in progress turnover:

Work in progress turnover = Cost of goods manufactured ___

Average work in progress inventory

A firm should have neither too high nor too low inventory turnover. To avoid this stock out

cost associated with a high ratio and the costs of carrying excessive inventory with a low

ratio, what is suggested is a reasonable level of this ratio. The firm would be advised to

maintain a close watch on the trend of the ratio and significant deviations on either side

should be thoroughly investigated to locate the factors responsible for it. For the purpose of

that this two ratios can be found.

3. Debtor turnover ratio:

Debtor turnover ratio = Credit sales

Average debtors + Average bills receivable

The major activity ratio is the receivables or debtors turnover ratio. Allied and closely related

to this is the average collection period. It shows how quickly receivables or debtors are

converted into cash. The debtors turnover ratio is a test of liquidity of the debtors of a firm.

The debtors turnover ratio shows the relationship between credit sales and debtors of a firm.

The approach requires two types of data:

Credit sales

Average debtors


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4. Fixed asset turnover ratio:

Fixed asset turnover ratio = _Cost of goods sold_

Average fixed assets

The fixed-asset turnover ratio measures a company's ability to generate sales from fixed-asset

investments - specifically property, plant and equipment (PP&E) - net of depreciation. A

higher fixed-asset turnover ratio shows that the company has been more effective in using the

investment in fixed assets to generate revenues.

This ratio is often used as a measure in manufacturing industries, where major purchases are

made for PP&E to help increase output. When companies make these large purchases,

prudent investors watch this ratio in following years to see how effective the investment in

the fixed assets was.

5. Total asset turnover ratio:

Total asset turnover ratio = _Cost of goods sold_

Average total assets

Total asset turnover ratio measures a firm's efficiency at using its assets in generating sales or

revenue - the higher the number the better. It also indicates pricing strategy: companies with

low profit margins tend to have high asset turnover, while those with high profit margins

have low asset turnover.

The amount of sales generated for every rupee's worth of assets. It is calculated by dividing

cost of sales in rupee by assets in rupee.


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6. Working capital turnover ratio:

Working capital turnover ratio = _Cost of goods sold_

Net working capital

A measurement comparing the depletion of working capital to the generation of sales over a

given period. This provides some useful information as to how effectively a company is

using its working capital to generate sales.

A company uses working capital (current assets - current liabilities) to fund operations and

purchase inventory. These operations and inventory are then converted into sales revenue for

the company. The working capital turnover ratio is used to analyze the relationship between

the money used to fund operations and the sales generated from these operations. In a general

sense, the higher the working capital turnover, the better because it means that the company

is generating a lot of sales compared to the money it uses to fund the sales.

7. Capital turnover ratio:

Capital turnover ratio = __ _Net sales_____Capital employed

Capital turnover ratio measures the efficiency of the capital invested in the business and how

many times capital is generated into sales.

Higher the ratio, better the efficiency of utilization of capital and it would to higher

profitability for the company in the market. It establishes a relation between sales and capital

employed in the business.


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8. Cash conversion cycle:

Cash conversion cycle = Inventory outstanding + Sales outstanding +

Payables outstanding

Cash conversion cycle expresses the length of time, in days, that it takes for a company to

convert resource inputs into cash flows. The cash conversion cycle attempts to measure the

amount of time each net input rupee is tied up in the production and sales process before it is

converted into cash through sales to customers. This metric looks at the amount of time needed

to sell inventory, the amount of time needed to collect receivables and the length of time the

company is afforded to pay its bills without incurring penalties. It is also known as "cash cycle".


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3.8.2 Capital budgeting ratio:

The act of placing restrictions on the amount of new investments or projects undertaken by a

company. This is accomplished by imposing a higher cost of capital for investment consideration

or by setting a ceiling on the specific sections of the budget. Companies may want to implement

capital rationing in situations where past returns of investment were lower than expected.

Capital budgeting ratios are useful to assist management and owners in diagnosing the financial

health of their company, ratios can also help managers make decisions about investments or

projects that the company is considering to take, such as acquisitions, or expansion.

Many formal methods are used in capital budgeting, including the techniques such as:

1.

Net present value

2. Profitability index

3. Internal rate of return

4. Modified rate of return

5. Equivalent annuity

1. Net present value:Net present value = Cash flows of the year Initial investment

The difference between the present value of cash inflows and the present value of cash

outflows. NPV is used in capital budgeting to analyze the profitability of an investment or

project. NPV analysis is sensitive to the reliability of future cash inflows that an investment

or project will yield. NPV compares the value of a rupee today to the value of that same

rupee in the future, taking inflation and returns into account. If the NPV of a prospective

project is positive, it should be accepted. However, if NPV is negative, the project should

probably be rejected because cash flows will also be negative.


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2. Profitability index:Profitability index = Present value of future cash flows

Initial investment

Profitability indexis also known as profit investment ratio (PIR) and value investment

ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for

ranking projects because it allows you to quantify the amount of value created per unit of

investment.

Rules for selection or rejection of a project:

If PI > 1 then accept the project

If PI < 1 then reject the project

A ratio of 1.0 is logically the lowest acceptable measure on the index. Any value lower than

1.0 would indicate that the project's PV is less than the initial investment. As values on the

profitability index increase, so does the financial attractiveness of the proposed project.

3. Internal rate or return:The discount rate often used in capital budgeting that makes the net present value of all cash

flows from a particular project equal to zero. Generally speaking, the higher a project's

internal rate of return, the more desirable it is to undertake the project. As such, internal rate

or return can be used to rank several prospective projects a firm is considering. Assuming all

other factors are equal among the various projects, the project with the highest internal rate or

return would probably be considered the best and undertaken first. Internal rate of return can

also be compared against prevailing rates of return in the securities market. If a firm can't

find any projects with internal rate of return greater than the returns that can be generated in

the financial markets, it may simply choose to invest its retained earnings into the market.


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4. Modified rate of return:The formula adds up the negative cash flows after discounting them to time zero using the

external cost of capital, adds up the positive cash flows including the proceeds of

reinvestment at the external reinvestment rate to the final period, and then works out what

rate of return would cause the magnitude of the discounted negative cash flows at time zero

to be equivalent to the future value of the positive cash flows at the final time period.

The modified internal rate of return is a financial measure of an investment's attractiveness. It

is used in capital budgeting to rank alternative investments of equal size. As the name

implies, MIRR is a modification of the internal rate of return (IRR) and as such aims to

resolve some problems with the IRR.

5. Equivalent annuity:

Equivalent annuity = __Net present value__

Present value factor

In finance the equivalent annuity is the cost per year of owning and operating an asset over

its entire lifespan.

Equivalent annuity is often used as a decision making tool in capital budgeting when

comparing investment projects of unequal lifespan.

Equivalent annuity is calculated by dividing the net present value of a project by the present

value of an annuity factor. Equivalently, the net present value of the project may be

multiplied by the loan repayment factor.

The use of the equivalent annuity method implies that the project will be replaced by an

identical project.


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3.8.3 Leverage ratios/Capital structure ratios:

Leverage ratio is used to measure a company's mix of operating costs, giving an idea of how

changes in output will affect operating income. Fixed and variable costs are the two types ofoperating costs; depending on the company and the industry, the mix will differ. Leverage ratio

used to calculate the financial leverage of a company to get an idea of the company's methods of

financing or to measure its ability to meet financial obligations. There are several different ratios,

but the main factors looked to include is debt, equity, assets and interest expenses.

Companies with high fixed costs, after reaching the breakeven point, see a greater increase in

operating revenue when output is increased compared to companies with high variable costs. The

reason for this is that the costs have already been incurred, so every sale after the breakeven

transfers to the operating income. On the other hand, a high variable cost company sees little

increase in operating income with additional output, because costs continue to be imputed

into the outputs. The degree of operating leverage is the ratio used to calculate this mix and its

effects on operating income.

The types of leverage ratios are as follows:

1.

Debt-equity ratio

2. Debt-asset ratio

3. Equity asset ratio

4. Interest coverage ratio

5. Dividend coverage ratio

6. Total coverage ratio

7. Cash flow coverage ratio

8.

Debt service coverage ratio9. Net asset value


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1. Debt-equity ratio:

Debt-equity ratio = Long term debt

Shareholders equity

Debt-equity ratio measures a company's financial leverage calculated by dividing its total

liabilities by stockholders' equity. It indicates what proportion of equity and debt the

company is using to finance its assets. It is also known as the Personal Debt/Equity Ratio,

this ratio can be applied to personal financial statements as well as corporate ones.

A high debt/equity ratio generally means that a company has been aggressive in financing its

growth with debt. This can result in volatile earnings as a result of the additional interest

expense.

If a lot of debt is used to finance increased operations (high debt to equity), the company

could potentially generate more earnings than it would have without this outside financing. If

this were to increase earnings by a greater amount than the debt cost (interest), then the

shareholders benefit as more earnings are being spread among the same amount of

shareholders. However, the cost of this debt financing may outweigh the return that the

company generates on the debt through investment and business activities and become toomuch for the company to handle. This can lead to bankruptcy, which would leave

shareholders with nothing. The debt/equity ratio also depends on the industry in which the

company operates. For example, capital-intensive industries such as auto manufacturing tend

to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of

under 0.5.

2. Debt-asset ratio:

Debt-asset ratio = Total liabilities

Total assets

Debt-asset ratio indicates what proportion of the companys assets is being financed through

debt.Debt-asset ratio is not a particularly exciting ratio, but it is useful one. Companies with

high ratios are placing themselves at risk, especially in an increasing interest rate market.

Creditors are bound to get worried if the company is exposed to a large amount of debt and


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may demand that the company pay some of it back. This ratio is very similar to the debt-

equity ratio.A ratio under 1 means a majority of assets are financed through equity, above 1

means they are financed more by debt. Further more you can interpret a high ratio as a

"highly debt leveraged firm".

3. Equity-asset ratio:

Equity-asset ratio = Total shareholders equity

Total assets

Equity-asset ratio is used to help determining how much shareholders would receive in the

event of a company-wide liquidation. The ratio, expressed as a percentage, is calculated by

dividing total shareholders' equity by total assets of the firm, and it represents the amount of

assets on which shareholders have a residual claim. The figures used to calculate the ratio are

taken from the company's balance sheet. The higher the ratio, the more shareholders may

receive and lower the ratio, less the shareholders of the company will get against there

holding of the numbers of equity shares.

4. Interest coverage ratio:

Interest coverage ratio = Earnings before interest and tax

Interest

Interest coverage ratio is used to determine how easily a company can pay interest on

outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings

before interest and taxes (EBIT) of one period by the company's interest expenses of the

same period.

The lower the ratio, the more the company is burdened by debt expense. When a company's

interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be

questionable. An interest coverage ratio below 1 indicates the company is not generating

sufficient revenues to satisfy interest expenses.


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5. Dividend coverage ratio:

Dividend coverage ratio = Income after tax

Dividend

Dividend coverage ratio measures a company's ability to pay off its required preferred

dividend payments. A healthy company will have a high coverage ratio, indicating that it has

little difficulty in paying off its preferred dividend requirements.

Not only does this ratio give investors an idea of a company's ability to pay off its preferred

dividend requirements, but it also gives common shareholders an idea of how likely they are

to be paid dividends. If the company has a hard time covering its preferred dividend

requirements, common shareholders are less likely to receive a dividend payment on their

holdings.

6. Total coverage ratio:

Total coverage ratio = Earnings before Interest and taxes + Lease payment

Interest + Lease payment + (Preference dividend+Installment of principal)/(1Tax rate)

While the interest coverage and preference dividend coverage ratios consider the fixed

obligations of a firm to the respective suppliers of funds, that is, creditors and preference

shareholders, the total coverage ratio has wider scope and takes into account all the fixed

obligations of a firm which are as follows:

Interest on loan

Preference dividend

Lease payments

Repayment of principal


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7. Total cashflow coverage ratio:

Total cashflow coverage ratio = EBIT + Lease payments + Depreciation +

Non cash expenses

Lease payment + Interest +

Principal Repayment + Preference dividend

(1 Tax rate) (1 Tax rate)

Total cashflow coverage ratio would be more appropriate to relate cash resources of a firm to

its various fixed financial obligations. The overall ability of a firm service outside liabilities

is truly reflected in the total cashflow coverage ratio. The higher is the coverage, the better is

the ability.

8. Debt service coverage ratio:

Debt service coverage ratio = Earnings after tax + Interest + Depreciation

Installment

In corporate finance, it is the amount of cash flow available to meet annual interest andprincipal payments on debt, including sinking fund payments.

A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1,

say 0.95, would mean that there is only enough net operating income to cover 95%

of annual debt payments. For example, in the context of personal finance, this would mean

that the borrower would have to delve into his or her personal funds every month to keep the

project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the

borrower has strong outside income.


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9. Net asset value:

Net asset value = Equity share holders funds

Number of equity shares

Net asset value measures the net worth or net asset value per equity share. It thus seeks to

assess as to what extent the value of equity share of a company contributed at par or at a

premium has grown or the value has been created for the shareholders. It is also known as

net worth per share or book value per share.

This ratio indicates the efficiency of the company management in building up a back-up of

reserves and surplus to fall back upon. Higher the ratio, higher is the capacity of a company

to raise further capital, borrowed as well as equity. It is ratio which is widely prevalent and

used for the purpose of valuations.


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3.8.4 Liquidity ratio:

The importance of adequate liquidity in the sense of the ability of a firm to meet current or short

term obligations when they become due for payment can hardly be overstressed. In fact, liquidityis a prerequisite for the very survival of a firm. The short-term creditors of the firm are interested

in the short term solvency or liquidity of the firm. But liquidity implies from the viewpoint of

utilization of the funds of the firm, that funds are idle or they earn very little. A proper balance

between two contradictory requirements, that is, liquidity and profitability is required for

efficient financial management. The liquidity ratios measure the ability or a firm to meet its short

term obligations and reflect the short term financial strengths of a firm. Generally, the higher the

value of the ratio, the larger the margin of safety that the company possesses to cover short-term

debts. A company's ability to turn short-term assets into cash to cover debts is of the utmost

importance when creditors are seeking payment. Bankruptcy analysts and mortgage originators

frequently use the liquidity ratios to determine whether a company will be able to continue as a

going concern. Some analysts will calculate only the sum of cash and equivalents divided by

current liabilities because they feel that they are the most liquid assets, and would be the most

likely to be used to cover short-term debts in an emergency . The types of liquidity ratios are as

follows:

1. Current ratio

2. Quick ratio

3. Suppliers credit

4. Inventory holding period

5. Collection period allowed to customers

6. Inventory turnover ratio

7. Defensive interval ratio


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1. Current ratio:

Current ratio = Current assets

Current liabilities

Current ratio is the liquidity ratio that measures a company's ability to pay short-term

obligations. The ratio is mainly used to give an idea of the company's ability to pay back its

short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).

The higher the current ratio, the more capable the company is of paying its obligations. A ratio

under 1 suggests that the company would be unable to pay off its obligations if they came due at

that point. While this shows the company is not in good financial health, it does not necessarily

mean that it will go bankrupt - as there are many ways to access financing - but it is definitely

not a good sign. The current ratio can give a sense of the efficiency of a company's operating

cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their

receivables or have long inventory turnover can run into liquidity problems because they are

unable to alleviate their obligations. Because business operations differ in each industry, it is

always more useful to compare companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory

and prepaid as assets that can be liquidated. The components of current ratio (current assets and

current liabilities) can be used to derive working capital (difference between current assets and

current liabilities). Working capital is frequently used to derive the working capital ratio, which

is working capital as a ratio of sales.

2. Quick ratio:

Quick ratio = _Current assets Inventory

Current liabilities B.O.D

Quick ratio is an indicator of a company's short-term liquidity. The quick ratio measures a

company's ability to meet its short-term obligations with its most liquid assets. The higher the

quick ratio, the better the position of the company. The quick ratio is more conservative than the

current ratio, a more well-known liquidity measure, because it excludes inventory from current


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assets. Inventory is excluded because some companies have difficulty turning their inventory

into cash. In the event that short-term obligations need to be paid off immediately, there are

situations in which the current ratio would overestimate a company's short-term financial

strength. It is also known as the "acid-test ratio" or the "quick assets ratio".

3. Suppliers credit:

Suppliers credit = Amount payable Days in a year

Credit Purchases

This ratio measures the average credit period availed by the company from its suppliers on credit

purchases or how much leverage it possesses to settle its outstanding payables. It is also known

as Days Purchases in payables ratio. The ratio helps analysts understand the credit policy

extended to a company by its suppliers which allowed the credit to its customers. As mentioned

above, a company enjoying a longer but extending a shorter period stands to gain and a

successful company as manifest in its return on net worth will be able to attract quality suppliers

at terms favourable to it. It gives the view point for analysis to the suppliers of the company.

4. Inventory holding period:

Inventory holding period = Inventory Days in the year

Cost of goods sold

Inventory holding period is the average number of days it takes for a firm to sell a product it is

currently holding as inventory to consumers. High inventory holding period can indicate that a

firm is not properly managing its inventory or that it has a substantial amount of goods that are

proving difficult to

The higher a firms inventory holding period, the greater its exposure to obsolescence risk, the

risk that the accumulated products will lose value in a soft market. Inventory holding period is

critical in industries with rapid sales and product cycles. If a firm is unable to move inventory, it

will take an inventory write-off charge, meaning that the products were not equivalent to their

stated value on a firms balance sheet.


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5. Inventory turnover ratio:

Inventory turnover ratio = Cost of goods sold

Average inventory

Inventory turnover ratio shows how many times a company's inventory is sold and replaced over

a period. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies

either strong sales or ineffective buying. High inventory levels are unhealthy because they

represent an investment with a rate of return of zero. It also opens the company up to trouble

should prices begin to fall.

6. Collection period allowed to customers:

Collection period allowed = Amount receivables Days in the year

Credit sales

Collection period allowed to the customers measures the credit period allowed to the customers

on credit sales or how fast a company realizes its outstanding dues. It is also known as Days

Sales in Receivables Ratio.

The ratio helps analysts understand the credit period extended by a company to its customers

which the credit enjoyed from its suppliers. A company extending a shorter and enjoying a

longer periods stands to gain.

7. Defensive interval ratio:

Defensive interval ratio = _ Liquid assets _

Projected daily cash requirement

The liquidity position of a firm should also be examined in relation to its ability to meet

projected daily cash requirement from operations. The defensive interval ratio provides such a

measure of liquidity. It is ratio between quick assets or liquid asset and the projected daily cash

requirements.


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The projected daily cash operating expenditure is based on past expenditures and future plans. It

is equivalent to the cost of goods sold excluding depreciation, plus selling and administrative

expenditure and other ordinary cash expenses. Alternatively, a very rough estimate of cash

operating expenses can be obtained by subtracting the non-cash expenses like depreciation and

amortization from total expanses. Liquid assets include current assets excluding inventory and

prepaid expenses.


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3.8.5 Profitability ratio:

Every firm is most concerned with its profitability. One of the most frequently used tools of

financial ratio analysis is profitability ratios which are used to determine the company's bottomline. Profitability measures are important to company managers and owners alike. If a small

business has outside investors who have put their own money into the company, the primary

owner certainly has to show profitability to those equity investors.

Profitability ratios show a company's overall efficiency and performance. We can divide

profitability ratios into two types: margins and returns. Ratios that show margins represent the

firm's ability to translate sales dollars into profits at various stages of measurement. Ratios that

show returns represent the firm's ability to measure the overall efficiency of the firm in

generating returns for its shareholders. Profitability ratios are a class of financial metrics that are

used to assess a business's ability to generate earnings as compared to its expenses and other

relevant costs incurred during a specific period of time. For most of these ratios, having a higher

value relative to a competitor's ratio or the same ratio from a previous period is indicative that

the company is doing well. Types of profitability ratios are as follows:

1.

Gross profit margin

2. Net profit margin

3. Operating profit ratio

4. Dividend pay-out ratio

5. Earning yield

6. Dividend yield

7. Return on share holders equity

8.

Earning per share9. Price earning ratio

10.Return on capital employed

11.Return on assets

12.Expenses ratio

13.Effective tax rate

14.Return on net worth

15.Cash earning per share


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1. Gross profit ratio:

Gross profit ratio = Gross profit 100

Sales

The gross profit margin looks at cost of goods sold as a percentage of sales. This ratio looks

at how well a company controls the cost of its inventory and the manufacturing of its

products and subsequently pass on the costs to its customers. The larger the gross profit

margin, the better for the company.

When analyzing a company, gross profit is very important because it indicates how

efficiently management uses labor and supplies in the production process. More specifically,

it can be used to calculate gross profit margin.

Gross profit ratio is also known as gross margin or gross income ratio. Gross profit is acompany's residual profit after selling a product or service and deducting the cost associated

with its production and sale. Higher the ratio, higher

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Analysis of Financial Statement( Kaushal Mehta )