Financial statement analysis

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  • 1. Basic Financial Statement Analysis By Abhijit Singh Thakur abhijit1979s@gmail.com +91 9766 498 350 (i3 Fin, Pune)
  • 2. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 3. Financial Statement Analysis: Introduction Who uses Financial Statements To EnsureGovernment and Regulatory Bodies • Compatibility with LawTax department, Accounting • Quality of Disclosuresbody, Securities regulator. • Protect interest of ClaimholdersCreditors To Analyze • Liquidity PositionDebt holders & Credit rating Agencies • Repayment capacity • Possibility of defaultInvestors To AnalyzeRetail Investors, Buy-side and sell-side • Profitabilityanalysts. • Sustainability • growth
  • 4. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 5. Cash Flow Statement: IntroductionThe Cash Flow Statement: ConstructionNet IncomeAdd: Depreciation Cash flow from operationsAdd: (Increase) / Decrease in Accounts receivables indicates the cash the business hasAdd: (Increase) / Decrease in Inventories generated from its core operationsAdd: Increase / (Decrease) in Accounts payable and the amount of funds available forAdd: Increase / (Decrease) in Accrued Liabilities expansion and other activities.Cash Flow from Operations2 (CFO) Cash flow from Investing indicates the cash the business hasCapital Expenditures spent on expansion and investmentsInvestments in other activities like investments inCash Flow from Investing (CFI) marketable securities.Debt raisedDebt repaid Cash flow from financingEquity Capital Issued indicates the cash the business hasShare Buyback generated from raising and repaymentDividends Paid of debt and equity capital.Cash flow from Financing (CFF) 2 Using indirect method
  • 6. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 7. Cash Flow Statement: AnalysisThe Cash Flow Statement: AnalysisNet Income • Has depreciation risen considerably?Add: Depreciation • Has the firm given more credit to generate sales?Add: (Increase) / Decrease in Accounts receivables • Have inventories piled up due to lack ofAdd: (Increase) / Decrease in Inventories demand?Add: Increase / (Decrease) in Accounts payable • Can the firm get enough credit fromAdd: Increase / (Decrease) in Accrued Liabilities suppliers?Cash Flow from Operations2 (CFO) • Does the firm have internal accruals forCapital Expenditures expansion?Investments • Has it invested sufficiently for futureCash Flow from Investing (CFI) growth?Debt raised • Is the company having a healthy debtDebt repaid ratio?Equity Capital Issued • Has the it been able to repay itsShare Buyback obligations?Dividends Paid • Would it be able to raise debt in future ifCash flow from Financing (CFF) CFO falls short of Capex requirements? 2 Using indirect method
  • 8. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 9. Income Statement: Introduction Introduction to the Income StatementMeasure of ProfitabilityThe income statement measures the income and expenditures of a companyduring a given period and thus it measures profitability. It measures profitabilityat 4 levels viz. Gross, Operating, Before tax and after tax.Accumulated over a period of timeUnlike the balance sheet, the income statement measures the income andexpenditure over a given period of time, usually a quarter or an year.Is a consequence of most3 Activities undertaken by a businessThe income statement is a consequence of most of the activities a businessundertakes ranging from investments in capital, purchase of raw materials, dueto creditors and dues from customers, cash collections, tax payout, asset chargesetc. However, it is an incomplete story teller, which is completed after ananalysis of the other two statements. 3Off-balance sheet items and FCCBs may not be reflected in the Income Statement
  • 10. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 11. Income Statement: Analysis Analysis of the Income StatementSales Includes both cash and credit salesCost of Goods SoldGross Profit Includes Inventories, Wages, andSelling, General & Administration expenses expenses related to producing goodsEBITDA Marketing, advertising and salaryDepreciation & Amortization expenses.EBIT / Operating ProfitInterest Depreciation of fixed assets andProfit before tax / Pretax Income amortization of goodwill if anyTaxesProfit After Tax / Net Profit Interest expense on debt Includes taxes paid and deferred Measures the effect of inflation and price competitiveness of the company Measures the operational efficiency of the company Measures the overall internal efficiency of the company
  • 12. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 13. Balance Sheet: An introduction An Introduction to the Balance Sheet …is what company owes and owns on aAssets = Liabilities + Stockholder’s Equity particular date. Unlike the income statement, the Balance Sheet is a snapshot of a company on a particular date. Assets Cash & Cash Equivalents It gives a insight into what was used to Accounts Receivable Inventories generate sales Fixed Assets The balance sheet gives an insight into the items Goodwill and other intangibles used to generate sales i.e. Capital used. Liabilities Accounts Payable Complements the income and cash flow Accrued Liabilities statement to form a holistic story Short-Term debt The Balance sheet along with the cash flow and Long-term debt income statement gives a clear picture of how Stockholder’s equity funds are employed and how well are they utilized.
  • 14. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 15. Balance Sheet: Analysis Table of ContentsAssetsCash & Cash Equivalents Is the firm holding too much or too less Cash?Accounts Receivable Has Accounts receivable increased suddenly?Inventories Have inventories increased disproportionately to Sales?Fixed Assets Has the company invested sufficiently in Fixed Assets for futureGoodwill and other intangibles growth? Has it used its Assets efficiently? Has Accounts receivable increased suddenly?LiabilitiesAccounts Payable Have short-term liabilities fallen or increased drastically vis-à-visAccrued Liabilities sales?Short-Term debtLong-term debt Does it include contingent liabilities like convertible bonds or FCCBs? What would be the cost for incremental borrowings forStockholder’s equity future Capex?
  • 16. Table of ContentsFinancial Statement Analysis: An IntroductionCash Flow Statement: An IntroductionCash Flow Statement : AnalysisIncome Statement: An IntroductionIncome Statement : AnalysisBalance Sheet: An IntroductionBalance Sheet: AnalysisFinancial Statement Integration & Forecasting
  • 17. Financial Statement Integration Sales Cost of Goods SoldNet Profit Selling, General & Administration expensesAdd: Depreciation Depreciation & AmortizationAdd: (Increase) / Decrease in Accounts receivables InterestAdd: (Increase) / Decrease in Inventories TaxesAdd: Increase / (Decrease) in Accounts payable Profit After Tax / Net ProfitAdd: Increase / (Decrease) in Accrued Liabilities[1] Cash Flow from Operations (CFO) AssetsCapital Expenditures Cash & Cash EquivalentsInvestments Accounts Receivable[2] Cash Flow from Investing (CFI) Inventories Fixed AssetsDebt raised Goodwill and other intangiblesDebt repaidEquity Capital Issued LiabilitiesShare Buyback Accounts PayableDividends Paid Accrued Liabilities[3] Cash flow from Financing (CFF) Short-Term debt Long-term debtNet Cash [1] +[2] +[3] Stockholder’s equity
  • 18. Financial Statement Forecasting Guidelines for Financial Forecasting│ First PrinciplesTop-Down Vs Bottom-upTop-down approach also known as E-I-C approach Key drivers forecastingFocuses on demand and its effect on company Key drivers like Sales, Cost offundamentals for key drivers. However, other parameters Goods Sold and Capitalare bottom-up, usually as a percentage of sales Expenditure are forecasted using macro-economic indicators and industry/company specific factors like availability of funds etc.Bottom-up approach Key drivers forecastingFocuses on historical growth and company Key drivers like Sales, Cost offundamentals alone. This gives a myopic picture of the Goods Sold and Capitalcompany and misrepresents true value. Expenditure are forecasted using Historical trends like CAGR, Moving average, time series analysis and regression.
  • 19. Reference Books ▬ The Analysis and Use of Financial Statements Ashwinpaul Sondhi, Gerald White and Dov Fried ▬ International Financial Statement Analysis Robinson, Greuning, Henry and Broihahn ▬ Financial Theory and corporate Policy Thomas Copeland, Fred Weston and Kuldeep Shastri