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Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
Finance for Non Finance Executives : Part 2 - analysis of financial statements
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Finance for Non Finance Executives : Part 2 - analysis of financial statements

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  • 1. Analysis of Financial StatementsMr. Kaushal Mandaliakaushalmandalia@gmail.comwww.Learningmadesimple.webs.com+919825300447(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 2. What we cover in this module Limitation of Financial Accounting Ratio Analysis(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 3. Major Limitation of Financial Accounting Forecasting and Planning Financial Accounting do not provide information about future. Decision Making Management requires daily information to take decisions, such as Make or Buy Decisions? Product modification requirement etc. Financial Accounting do not provide such information Control and Assessment Management requires information to assess performance of various persons and departments. Financial Accounting do not provide such information.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 4. Foundation for Further Analysis Goals Strategy Strategies and Formulation Policies It requires Excellent Management Management Implementation of Control to make Control Strategies sure that the Strategy matches with the Final Outcome Efficient and Effective Task Control Performance of Individual Tasks(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 5. FRAMEWORK FOR STRATEGYIMPLEMENTATION (MGMT CONTROL) Strategy Performance(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 6. Ratio Analysis Ratios Ratios are mathematical calculations that company can use to evaluate its performance. It helps to check whether firm is progressing to meet its overall strategy or not.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 7. People of Interest External Internal Security Analysis Board of Directors Shareholders Senior Management Bankers Operations, Sales, Finance, Suppliers HR, Mktg, Competitors Strategic Planners Regulators(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 8. Importance Leads to Key Strategic Tasks Helps in Forecasting Expected Financial Monitor Actual Financial Performance Performance(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 9. Key Performance Measures… Company’s Liquidity Position Company’s Ability to pay its bills on a regular basis Working Capital Management Profitability Leverage(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 10. Key Ratios Liquidity Ratio : Current Ratio, Quick Ratio, Working Capital Management Ratios : Day’s Sales Outstanding, Ageing of A/c Receivables, Inventory Turnover Ratio, Profitability Ratios : Gross Profit Margin Ratio, Return on Assets, Return on Equity, Return on Sales, Leverage Ratios : Debt Equity Ratio, Interest Coverage Ratio,(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 11. Current Ratio Current Ratio compares current assets with current liabilities Ratio below 1 Ratio above 1 Current Liabilities are higher than Current Does not necessarily means high liquidity Assets. It may be due to high level of inventories It may be possible that company is facing liquidity problems or It may be possible that company has low level of inventories to meet customer’s demand(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 12. Current Ratio How to Improve Current Ratio? Cash Management : Analyze the cash requirement properly Credit Management : Revise Credit Terms Inventory Management : What level of inventory needed (Finished goods inventory / Raw Material Inventory) Source :TATA Motors Annual Report 2009-10(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 13. Quick Ratio Inventories are not really a liquid assets Quick ratio of 0.8 is somewhat acceptable(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 14. Exceptions of Liquidity Ratio Current and Quick ratio are in comfortable range, but Bank Debts are higher than normal, the future of the company is uncertain. Current ratio is comfortable, but finished goods inventory is not something what customer wants….!!!(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 15. Working Capital Management Ratio Lets understand Working Capital first(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 16. Working Capital(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 17. Working Capital Two Concepts Gross Working Capital Total of All current assets Net Working Capital Current Assets – Current Liabilities(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 18. Importance Investment in Current Assets represents substantial portion of total investment. Investment in current assets and the level of current liabilities have to be geared quickly to change in sales.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 19. Characteristics of Current Assets Short life span Cash Balance : 1 week to 2 Cash weeks A/c Receivables : 30 – 60 Days Inventories – 1 to 60 days A/c Swift transformation into other Raw MtrlReceivables asset form Finished WIP Goods(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 20. Characteristics of Current Assets Decisions relating to WC management are repetitive and frequent Efficient Management of one component can not be undertaken without simultaneous consideration of other components. Large Finished Goods Inventory More liberal credit Liquidity Crunch Generous discount(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 21. Working Capital Trade-offs Inventory High Levels Low Levels Benefit: Cost: • Happy customers • Shortages • Few production delays (always have needed parts on • Dissatisfied customers hand) Benefit: Cost: • Low storage costs • Expensive • Less risk of obsolescence • High storage costs • Risk of obsolescence Cash High Levels Low Levels Benefit: Benefit: • Reduces risk • Reduces financing costs Cost: Cost: • Increases financing costs • Increases risk(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 22. Working Capital Trade-offs Accounts Receivable High Levels (favourable credit terms) Low Levels (unfavourable terms) Benefit: Cost: • Happy customers • Dissatisfied customers • High sales • Lower Sales Cost: Benefit: • Expensive • Less expensive • High collection costs • Increases financing costs Accounts Payable and Accruals High Levels Low Levels Benefit: Benefit: • Reduces need for external finance--using a • Happy suppliers/employees spontaneous financing source Cost: Cost: • Not using a spontaneous • Unhappy suppliers financing source(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 23. Working Capital Trade-offs Current Assets High Level Low Level Profitability Lower Higher Risk Lower Higher(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 24. Current Assets Financing Policy What mix of Long term capital and short term debt should the firm employ to support its current assets? A Capital Fluctuating CA Requirement Requirements B C Permanent CA Requirements Fixed Asset Requirement Time(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 25. Current Assets Financing Policy Strategy A Long Term Financing used to Meet Fixed Asset Requirement + Peak WC Requirement WC < Peak Level, Surplus is invested in Liquid Assets Strategy B Long Term Finance – FA + Permanent CA + Portion of WC Short Term Finance used during seasonal upswing Investment in Liquid Assets during seasonal downswing Strategy C Long Term Finance – FA + Permanent CA Short Term Finance used to meet fluctuating WC requirements(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 26. Matching Principle Maturity of Sources of Finance should match with the maturity of Assets being financed. Fixed Assets, Permanent CA = Long Term Finance Fluctuating WC = Short Term Finance Strategy C(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 27. Operating Cycle and Cash Cycle Events that influence WC Requirements in Operating Cycle Purchase of Raw Material Payment of Raw Material Manufacture of Goods Sale of Finished Goods Collection of Cash for Sales Time that elapses between the purchase of Raw Material and collection of cash for sales is refereed to as the OPERATING CYCLE Length between the payment for raw material purchase and the collection of cash for sales is referred to as CASH CYCLE.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 28. Operating Cycle and Cash Cycle Finished Goods Order Sold Cash Placed Inventory Period A/c Receivable Recd Stock Period Arrives Cash Firm Paid for Receives Mtrls. Invoice A/c Payable Cash Cycle Operating Cycle(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 29. Operating Cycle and Cash Cycle Inventory Period = Avg Inventory Annual CGS / 365 A/c Receivable Period = Avg Accounts Receivable Annual Sales / 365 Find, Inventory Period, A/c Receivable Period, A/c Payable A/c Payable Period Period, Operating Cycle and Cash Cycle = Avg Accounts Payable Annual CGS / 365(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 30. Working Capital Management Ratio Daily Sales Outstanding Avg no of days that the company is taking to collect accounts receivables from its customers. Credit Terms helps Sales Person to sell more products, extending credit gives company a competitive advantage If credit days are 30 and Daily sales outstanding (DSO) is 40 days, its acceptable.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 31. Daily Sales Outstanding CASE Give your comments ABC Ltd is having credit days = 30. Accounts receivables are 6,37,000 and Annual Revenue is 41,60,000 Find DSO, compare against credit terms and give your opinion Ans : 56 days(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 32. Ageing Schedule It classifies outstanding accounts receivables at a given point of time into different age brackets.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 33. Improving A/c Receivables Reduce A/c receivables without affecting sales is very effective way to improve cash flow Tips Be Aware that Credit is a Sales Tool Never make the extension of credit automatic. Train customers to pay fast Get the clock ticking Never apologize for asking your money(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 34. Inventory Turnover Ratio Lets understand the Importance of inventory first….(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 35. Inventory - Understanding Three Types Raw Material WIP Finished Goods Second Largest asset category for Manufacturing Company, next to plant and equipment. Decisions relating to inventories are taken primarily by executives in Production, Purchasing and Marketing Departments.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 36. Water Tank Analogy for Inventory Inventory Level Supply Rate Buffers Demand Rate from Supply Rate Inventory Level Demand Rate(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 37. Reasons to hold inventory Meet variations in customer demand: Meet unexpected demand Smooth seasonal or cyclical demand Pricing related: Temporary price discounts Hedge against price increases Take advantage of quantity discounts Process & supply surprises Internal – upsets in parts of or our own processes External – delays in incoming goods Transit(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 38. Reasons Not to hold inventory Carrying cost Financially calculable Takes up valuable factory space Especially for in-process inventory Inventory covers up “problems” … That are best exposed and solved(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 39. Inventory Hides Problems Bad Design Lengthy Poor Setups Quality Machine Inefficient Breakdown Unreliable Layout Supplier(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 40. Reduce Inventory Level to Expose Problems Bad Design Lengthy Poor Setups Quality Machine Inefficient Breakdown Unreliable Layout Supplier(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 41. Remove Sources of Problem and Repeat the Process Poor Quality Lengthy Setups Bad Design Machine Inefficient Breakdown Unreliable Layout Supplier(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 42. Inventory Turnover Ratio A Turnover of 12 times translates to one month’s inventory on hand on an average A Turnover of 25 times translates to two week’s inventory on hand on an average A Turnover of 6 times translates to two month’s inventory on hand on an average(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 43. Profitability Ratio It indicates real achievements It focuses on Profitability achieved by the management team Revenue achieved by the business Assets invested in the business The Funds that owners have invested in the business(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 44. Explanation of Few Terms Revenue = Price X Units sold Cost of Goods Sold = Fixed Cost plus Variable Costs Gross Profit = Revenue – Cost of Goods Sold EBITDA = Earning before Interest, tax, depreciation and amortization = Gross Profit EBIT = Gross Profit – Depreciation – Amortization PBT = Profit Before Tax = EBIT – Interest PAT = Profit After Tax = PBT – Tax(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 45. Company details that helps in analyzing profitability Company’s business and products The Competitive Environment Degree of Globalization Budgets Legal and Regulatory Issues Capacity Utilization Fixed – Variable Cost mix(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 46. Gross Profit Margin Company’s business and products The Competitive Environment Degree of Globalization Budgets Legal and Regulatory Issues Capacity Utilization Fixed – Variable Cost mix Source :TATA Motors Annual Report 2009-10(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 47. Return on Equity It measures company’s ability to attract new investors Without debt, ROE and ROA (Return on Assets) will remain same. More debt = More ROE Source :TATA Motors Annual Report 2009-10(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 48. Return on Capital Employed (ROCE)= EBIT / (Total Assets – Current Liabilities) Measures overall performance of business. ROCE should always be higher than the rate at which company borrows money, otherwise increase in borrowing will reduce shareholder’s earning Source :TATA Motors Annual Report 2009-10(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 49. EPS, Dividend and Dividend Pay out Ratio PE Ratio = Price per Share / Earning per Share Earning Per Share = PAT / Outstanding Shares PAT = EBIT – Interest – Tax Dividend = PAT – Retained Earning(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 50. PE Ratio PE Ratio = Price per Share / Earning per Share Higher PE Ratio = High Price = High Demand = Higher Liquidity of Shares in Secondary Market = Good bet for short term investment OR LOW EPS Lower PE Ratio = Low Price = Low Demand of Shares = Low Liquidity of Shares in Secondary Market OR High EPS, Good bet for long term investment(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 51. Financial Leverage Ratios LEVERAGE : understanding Using DEBT as a part of Capital Structure Capital Structure, Profitability Market Capitalization Firm’s Overall Progress(C) Learning Made Simple (www.learningmadesimple.webs.com) Prepared by, Kaushal Mandalia (kaushalmandalia@gmail.com, +919825300447) (C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 52. Leverage Analysis Two Types of Leverages Operating Leverage Arises from firm’s fixed operating costs like Salaries, Depr, Insurance, Property Taxes, Advertising etc Financial Leverage Arises from firm’s fixed financing costs like Interest on Debt Operating Leverage Total Leverage Financial Leverage(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 53. Operating Leverage Finex Ltd Currently selling a product @ Rs 1000 per unit Variable Cost = Rs 500 / Unit Fixed Operating Cost = Rs 2,00,000 100% Increase in PBIT will Increase PAT, Increase Portion of Retained Earning Increase Reserves and Surplus Increase Shareholder’s Expectation for returns Increase demand of shares in anticipation of expansion Increase Price of Shares Increase Market Capitalization(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 54. Financial Leverage Finex Ltd PBIT = 50,000 Fixed Interest Expense = Rs 30,000 Tax Rate = 50% O/s shares = 10,000(C) Learning Made Simple (www.learningmadesimple.webs.com) Prepared by, Kaushal Mandalia (kaushalmandalia@gmail.com, +919825300447)
  • 55. Combine Leverage (Total Leverage) Finex Ltd Currently selling a product @ Rs 1000 per unit Variable Cost = Rs 500 / Unit Fixed Operating Cost = Rs 2,00,000 PBIT = 50,000 Fixed Interest Expense = Rs 30,000 Tax Rate = 50%, O/s shares = 10,000 250% Increase in EPS will Increase Shareholder’s Expectation for returns Increase demand of shares in anticipation of expansion and healthy growth in EPS Increase Price of Shares Increase Market Capitalization(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 56. Leverage Ratio : Debt – Equity Ratio Higher ratio indicates higher usage of Debt and / or lower usage of equity in the company. Ratio in access of 0.7 requires cautious action towards capital structure.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 57. Interest Coverage Ratio PBIT / Interest on Debt PBIT = 120 M, Interest burden = 20 M, Interest coverage ratio = 6 It means even if PBIT is dropped by 83.33% earning of the company will meet its interest obligation.(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 58. Interest Coverage Ratio PBIT / Interest on Debt Even if PBIT is dropped by 63%, earning of the company will meet its interest obligation. Limitation : It only considers interest paymentSource :TATA Motors Annual Report 2009-10(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 59. Case - Ram Electronics RAM, CEO proposes to issue Rs 10 million of debenture carrying 15% of interest and use the proceeds to buyback 500,000 equity shares (50%)(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 60. Case - Ram Electronics If the operating income is Rs 3,000,000, then leverage has no effect… afterwards, it is expected that the firm should incorporate 50% debt..(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 61. Example EBIT = 200,000 Assets = 1,000,000 Interest on Debt = 10% Tax rate = 50% Find out Return on Equity and Interest Coverage Ratio for following debt component in total assets (i) No debt, (ii) 100,000 (iii) 300,000 (iv) 500,000 (v) 700,000 (vi) 900,000(C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)
  • 62. (C) InsightHR, www.insightHR.co.in Prepared by, Kaushal Mandalia (kaushal@insightHR.co.in, +919825300447)

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