Financial Accounting


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Financial Accounting

  2. 2. Answer -1: Ratio concepts: Current Ratio: Current Ratio = Current Assets/ Current Liabilities Current ratio is used to determine the liquidity of the company. However it is inversely proportional to profits. As Liquidity goes up, the profitability goes down if the liquidity is due to any external funds for which cost has to be paid. It is generally used to state the working capital of the company. Current ratio actually helps us to predict whether the organization is able to meet its short term fund requirements with the current availability of resources i.e. current assets. Current assets comprises of Cash, Cash equivalents, Debtors, marketable securities and Inventories. To analyze the cost of liquidity it is important to analyze the components of Current liabilities. Ex: if CR is very high for company, but the majority of current assets are due to the Sundry debtors, then the business is not in a situation to pay off the liabilities until the money is realized from the debtors. Return on Equity (ROE): ROE = (PAT – Preference Dividend) / Total Equity Capital Return on Equity states the actual profitability of the company with respect to the Equity shareholders. It states the company’s net profit available to equity shareholder’s to get the net returns on the total share holder equity. Shareholder equity is an accounting terminology which represents the General reserves & Surplus created by the retained earnings and the paid up capital. It can be also used to descript how well the company is using its resources to generate wealth for its share holders. Any company which gives a high return on equity is more likely to be on the priority charts of the prospective investors. Return on Total Assets (ROTA) ROTA= EBIT/ Total Net Assets This ratio is considered as an indicator of how effectively a company is using its assets to generate earnings before contractual obligations must be paid. The greater the company's earnings in proportion to its assets the more effectively that company is said to be using its assets. To compute ROTA, the net income figure from a company's income statement, plus interest and taxes that were paid for the year. The calculated number will give the company's EBIT. The EBIT should then be divided by the company's total net assets (total assets less depreciation) to reveal the earnings that company has generated for each unit or value of assets on its books. Earnings per Share (EPS)
  3. 3. EPS= Profit for Equity Shareholders/Outstanding Shares Earning per Share (EPS), is used to compute the earning of the shareholder on a per share basis, and is used in evaluating share price by using the Price / Equity method. EPS serves as an indicator of a company's profitability. An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal would be a quot;betterquot; company Thus the Earnings per share should also be looked together with the face value of shares. It is important that we use figures but we should not rely on any financial measure, but to use the measure the same in conjunction with statement analysis and other measures. Return on Capital Employed: ROCE = PBIT/ (Total Assets – Current Liabilities) ROCE states the profit generating capacity of the company for the investment made into company in the mode of equity capital and debts. It indicates the efficiency and profitability of a company with respect to the total earning before servicing the shareholders and the cost of debt. It shows how well a company is utilizing its capital resources in operating its business and whether the generated revenue is more than the cost of capital or not. ROCE measures the ability of the company to generate returns which is higher than the cost of capital. It should be higher otherwise any increase in debts will reduce the shareholder’s equity. Only drawback of ROCE is that even if cash flows remains same, ROCE increases as fixed assets depreciates with time. Economic value of return (EVA) EVA = NOPAT - (Cost of Capital * Capital Employed) EVA determines the total profit/loss incurred by a company after deducting the capital costs from the net profits. NOPAT is computed by taking the PBIT. It is also calculated by using direct method (reducing the COGS, expenses and taxes from Sales proceeds). To calculate EVA – WACC is the most important parameter, which determines weighted average cost of debt, preference shares and equity. Cost of equity capital is the opportunity cost of an investment. The basic reason behind calculating EVA is to make sure that shareholders are earning a return uniform with the risk taken by them. If EVA is negative irrespective of whatever the PAT is, there is no real profit made by the company and it means company is destroying the wealth of its shareholders.
  4. 4. The two companies Analyzed are Reliance Capital and India bulls Securities both are counted in the top most companies in the financial sector in India. In the last three years the equity markets have flared up and thus the footprints of the financial sector has seen a very high rate of growth both in real and actual numbers. In this case we are reporting to the managing director of Reliance capital with a view on comparing the data with the competitor’s data as India bulls. Business Overview: Reliance Capital – Reliance Capital is the flagship company of the ADAG group owned by Mr. Anil Ambani, The Company was stripped from the flagship group of Reliance Industries managed by the Ambani family. Since then the company has almost ventured into every financial market in India (Stock and Commodities Broking, Asset Management, Portfolio Services, Consumer Loans, Life and General Insurance Business) Company has a huge inter holding in other group companies as well as the new investment of the group for ex: ADLABS and Reliance Creative thus major proportions of PAT come from the investment income due to the exorbitant Stock Markets. India Bulls Financials: India bulls has been one of the most prominent success stories in the last decade in Indian context .The group was started by the IIM graduate Sameer Gehlaut who moulded the financial group into one of the major players of the financial sector. The company has footprints in the Broking Business as well as the Real Estate Business, in the latest venture the company has started the consumer loans business, company is also looking for venturing into Asset Management and Insurance business together with some foreign Partners. Mr. L.N Mittal, the steel tycoon holds a decent stake in the group as a whole.
  5. 5. ANALYSIS The analysis is done with respect to the Cash flow of both the companies for the year 2005, 2006 & 2007 to know about the external investment deals industry reports and news articles have also been referred to. Most of the analysis is done n the liquidity and company’s ability to manage the working Capital and service the industry components. RELIANCE CAPITAL INDIA BULLS RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007 A) (1239.00 (1985.09 Cash Flow from Operation (CFO) 418.07 ) ) 150.52 278.34 (24.68) Cash Flow from Financial activity (CFF) (371.81) 1112.85 1597.06 (21.49) 283.04 (314.30) Cash Flow from Investment activity(CFI) (66.17) 123.65 338.25 (50.30) (19.22) (40.47)  The profit component has risen by 6.5 times  The profit component has risen by 4 times  Approximately 70% of the total profits are from  Interest charge is almost 15 % of the total PAT Investments  Investments in Assets is almost 35 % of PAT  Interest cost down to 10 %  Huge increase in Short term Borrowings, almost  Trade receivables increased more than thrice 5 times of PAT. The company is doing fairly well with respect to the normal course of business and profit has increased not only in terms of real value but also in compare to the competitor’s. The company in the robust business environment has leveraged itself quite highly in compare to the past periods which has increased the cost burden on the profitability. The short term borrowings has increased 6 times, there is a positive flow from the investments side but still the trade credits has increased the liquidity requirements of the business. RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007
  6. 6. B) (1239.00 (1985.09 Cash Flow from Operation (CFO) 418.07 ) ) 150.52 278.34 (24.68) Total profit 111.20 550.57 731.45 49.11 180.29 199.82 Operating Profit 165.18 80.34 259.97 54.47 174.14 167.93 694.45 (608.09) (993.67) 254.10 632.77 343.07  CFO has turned negative to the tune of 6  Trade receivables has turned negative to the times rune of 140 %  In the current trend majority of the earning to  In the past periods the company profitability the tune of almost 70 % comes from the has been quite uniform and the margins has investment income been quite buoyant. Our companies is doing very well in terms of the business but if analyzed in depth the operating profits is similar with our competitors but the most important part is that our capital base is almost 7 times of the competitor and also the rate of profitability is not uniform and the major of PAT is dependent on the extraordinary profits due to unlocking of the value of investments in subsidiaries which is not a regular affair and thus the profitability margins are something for which we should be concerned for. RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007 Changes in working Capital - Trade receivables (1271.00 (2149.54 720.16 ) ) 81.05 (11.16) (30.18) Inventories 96.78 8.29 5.37 0.00 0.00 0.00 Trade payables (253.62 ) 6.53 24.02 74.98 225.53 (51.47) (1256.18 (2120.15 563.32 ) ) 156.03 214.37 (81.65) The trade receivables has increased four times The company’s trade Receivables changes has negatively and the overall change in the working turned negative with respect to the past periods capital structure has become quite leveraged and because of the margin books in the Broking the company requires more working capital companies which is a risky proportion. The company’s buoyant expansion growth has been funded by the debts and other external sources and the increase in trade cycle as turned negative 4 times in compare to the positive figures in 2005 but the same can be inferred that the same is due to company’s new consumer loan business and the recent broking business in which the company has just started its new venture just each of the business has opened a new venue of increase revenue for the company but together with the same the leverage over the assets has increased.
  7. 7. RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007 D) Free Cash Flows (1239.00 (1985.09 Cash Flow from Operation (CFO) 418.07 ) ) 150.52 278.34 (24.68) less : Purchased fixed asset (0.04) (1.45) (29.15) (16.17) (37.28) (71.70) (1240.45 (2014.24 418.03 ) ) 134.35 241.06 (96.38) The company’s free cash flow is affected by the new The company is using much of its free business venture of consumer loans thus the trade cash flows into its expansion strategy. receivables has increased highly but still the investments Almost to the tune of 45% of the total in the fixed assets is very small. Taking into account the profits of the year 2007 is invested in the market aspect the expense on the asset side to add to the asset side. The investment in fixed asset is expansion stage should be given much more importance also seeing a growth of almost 100 % with in compare to the company’s strategy of investing in respect to previous year’s investments. acquisitions. The company has to look on the investment part in the fixed asset as the competitors are investing a majority of the profits in the asset base and in real numbers are increasing by 100 % on year to year basis but as our strategy we invest in companies by acquiring over them, but still the same can be thought again. RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007 F) (1239.00 (1985.09 CFO 418.07 ) ) 150.52 278.34 (24.68) Dividend (41.89) (43.74) (59.72) (5.60) (0.99) 0.00 (1282.74 (2044.81 376.18 ) ) 144.92 277.35 (24.68) Dividend has been paid in No dividend has been paid to the equity share holders but the same has the range of 7 – 15 % been compensated with the stock dividends and other stock assets resulted in the form of the company’s de-merger RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007
  8. 8. G) Composition of CFF Proceeds from share issues (10.00) 2228.25 445.27 0.00 (45.27) 0.00 Proceeds from long term borrowings 0.00 20.08 0.00 0.00 0.00 0.00 Proceeds from short term borrowings 189.66 0.00 1211.51 0.00 536.27 810.94 Repayment of long term borrowings (509.58) (19.24) 0.00 0.00 0.00 0.00 Repayment of short term borrowings (1072.50 (1125.24 0.00 ) 0.00 (15.89) (206.97) ) Dividend paid (41.89) (43.74) (59.72) (5.60) (0.99) 0.00 (371.81) 1112.85 1597.06 (21.49) 283.04 (314.30)  The company has diluted stake in 2006  The company has increased its short term borrowings to funds  The company has borrowed short and long its expansion plans term debt to fund the companies capital  The company’s plan to enter the real estate market by buying requirements new properties  The borrowing has overall increased in the  The company hasn’t diluted any stake directly but the same company by more than 4 times. has been done by selling the stakes in the subsidiaries . Company is quenching its thirst for funds to nurture the expansion plans but the same has to be re- looked as the DER looks to be highly leveraged and it more than any business standards and also with respect to the competitor strength the business need much more focus on its core work. RELIANCE CAPITAL INDIABULLS PARTICULARS 2005 2006 2007 2005 2006 2007 I) Composition of CFI Purchase of fixed assets (0.04) (1.45) (29.15) (16.17) (37.28) (71.70) Sale of fixed assets 0.09 1.28 0.00 0.00 0.00 0.00 Purchase of investments (2585.52 (140.97) (2874.42) ) 0.00 0.00 0.00 Sale of investments 65.79 2990.84 2918.39 0.00 0.00 0.00 Loan to group / subsidiary cos. 0.00 0.00 0.00 (35.00) 0.00 0.00 Interest received 0.09 0.26 0.00 0.87 18.06 25.45 Dividend received 8.87 7.14 34.53 0.00 0.00 5.78 (66.17) 123.65 338.25 (50.30) (19.22) (40.47) Company’s turnover in investments is almost The company has increased it investment in fixed thrice than the total revenue of the company and assets by 100 % on tear to tear basis the same is used due to the recent equity market This is almost 40 % on year to year basis with turmoil where the company has respect to the company current year’s profits.