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TiEcon
Financial Statements and Ratio Analysis
30 September 2011
©2011 Deloitte Touche Tohmatsu India Private Limited.
Agenda
• Overview
• Ratio Analysis of ABC Limited
2
Overview of financial
statements and ratio
analysis
3
©2011 Deloitte Touche Tohmatsu India Private Limited.
What are Financial Statements
• Formal records of the financial
position (health) of a business
• Three main types:
Balance Sheet (B/S) - reports a
company’s assets, liabilities, and
ownership equity at a given point
in time
Profit and Loss (P/L) Statement
reports on a company’s income,
expenses, and profits over a
period of time
Cash Flow Statement. Reports
changes in B/S and P/L
4
Sources of funds Applications of funds
Share Capital Fixed assets
Equity Net fixed assets
Reserves
Investments
Debt
Secured loans Current assets
Unsecured loans Current liabilities
Total liabilities Total assets
Income
Operating expenditure
EBIDTA
Depreciation
EBIT
Interest
Profit Before Tax
Tax
Profit After Tax
©2011 Deloitte Touche Tohmatsu India Private Limited.
Why financial ratios
• Financial numbers/statements aren't always enough to:
Provide indications of performance of business
Convince an investor that the business is a viable proposition
• Financial ratios are tools for financial analysis used by entrepreneurs and
investors
• Entrepreneurs need to track their business in terms of:
Short term business viability/liquidity
Financial leverage
Profitability and return from their investment
5
©2011 Deloitte Touche Tohmatsu India Private Limited.
Ratios – interpreting financial data
6
Liabilities Assets
Shareholders funds Fixed Assets
Equity Gross Block - dep
Reserves & surpluses Net Fixed Assets
Borrowings Net Current Assets
Long term Current Assets
Short term -Current Liabilities
Total Funds Total Assets
Revenue
(Operating costs)
Gross profit
(Selling and Admin)
Operating Margin
EBIDTA
(Depreciation)
PBIT
(Interest)
PBT
(Tax)
PAT
Financial Leverage
Asset utilisation
Liquidity
Profitability
Ratio analysis of ABC
Limited
7
©2011 Deloitte Touche Tohmatsu India Private Limited.
ABC Limited
ABC Limited (ABC or the Company) is an engineering consultancy company providing
engineering design and supervision services.
8
Featured of business operations:
• Promoted by a team of three engineers with wide ranging industry experience in 2003
• Service oriented business with revenue coming from engineering services, supervision
and project management
• Supervision contracts with uniform/regular revenue cycle
• Largely private customers – customers are large companies with good financial
background
• Being service oriented, skilled staff constitutes main operating resources as well as
cost
• Sector witnessing growth but competition increasing at fast pace
©2011 Deloitte Touche Tohmatsu India Private Limited.
ABC’s financial statements
The Company’s Balance Sheet and Profit & Loss Account are presented below:
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Particulars 2007-08 2008-09 2009-10
Sales 4,000 4,800 5,800
Cost of sales 3,040 3,820 4,760
Gross profit 960 980 1,040
Selling expenses 320 370 430
General and admin expenses 270 300 340
EBIDTA 370 310 270
Depreciation 50 70 90
EBIT 320 240 180
Interest expense 40 40 40
Profit before tax 280 200 140
Income taxes (33%) 92 66 46
Net profit 188 134 94
Particulars 2008 2009 2010
Equity 100 100 100
Retained earnings 275 350 400
Total equity 375 450 500
Long-term debt 500 500 500
Total liabilities and equity 875 950 1,000
Gross fixed assets 1,000 1,125 1,260
Accumulated depreciation 180 250 340
Net fixed assets 820 875 920
Cash 30 40 50
Accounts receivable 275 335 400
Total current assets 305 375 450
Accounts payable 250 300 370
Total current liabilities 250 300 370
Net current assets 55 75 80
Total assets 875 950 1,000
©2011 Deloitte Touche Tohmatsu India Private Limited.
ABC’s commonsize and trend analysis
ABC’s commonsize and growth analysis of P/L account:
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Particulars 2007-08 2008-09 2009-10
Sales 100% 100% 100%
Cost of sales 76% 80% 82%
Gross profit 24% 20% 18%
Selling expenses 8% 8% 7%
General and admin expenses 7% 6% 6%
EBIDTA 9% 6% 5%
Depreciation 1% 1% 2%
EBIT 8% 5% 3%
Interest expense 1% 1% 1%
Profit before tax 7% 4% 2%
Income taxes (33%) 2% 1% 1%
Net profit 5% 3% 2%
Particulars 2008-09 2009-10
Sales 20% 21%
Cost of sales 26% 25%
Gross profit 2% 6%
Selling expenses 16% 16%
General and admin expenses 11% 13%
EBIDTA -16% -13%
Depreciation 40% 29%
EBIT -25% -25%
Interest expense 0% 0%
Profit before tax -29% -30%
Income taxes (33%) -29% -30%
Net profit -29% -30%
Commonsize Growth (y-o-y)
©2011 Deloitte Touche Tohmatsu India Private Limited.
Analysing ABC using ratios
Short term liquidity/viability
• Current Ratio (CR) - Measures a company's ability to pay short-term
obligations for its operations Current Assets
CR = = Current Liabilities
Current ratio of ABC indicates that the Company is reasonably well positioned
to meet its short term obligations.
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2008 2009 2010
1.22 1.25 1.22
©2011 Deloitte Touche Tohmatsu India Private Limited.
Operating efficiency
• Measured by the efficiency with which credit sales are collected and payment is made
• Lower collection period and higher payment days considered favourable
• Average Collection period (ACP) Accounts receivable
ACP = = Annual sales/365
ACP depends on industry and customer specific factors. In general, 30 days
and below signify favourable position. However, lower ACP may indicate
potential to increase revenue through higher credit period to customers
• Average payment period (APP) Accounts payable
APP = = Annual purchase/365
APP not very favourable as it is almost same to ACP – generally it should be
higher than ACP
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2008 2009 2010
25.09 25.47 25.17
2008 2009 2010
25.14 25.39 24.42
Analysing ABC using ratios
©2011 Deloitte Touche Tohmatsu India Private Limited.
Financial leverage
• Provides indication of loan against equity (owner’s capital) and the Company’s capability
to pay back interest on loan
• Long term debt to equity
Long term debt
DER = = Total equity
Reducing DER shows improving financial leverage
• Times Interest Earned Ratio (Interest Coverage Ratio) - Indicates the extent
of which earnings are available to meet interest payments. Earnings before interest & tax
TIE = = Interest
Significant reduction shows worsening financial position even though DER seems
reasonable/to be improving
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2008 2009 2010
1.33 1.11 1.00
2008 2009 2010
8.00 6.00 4.00
Analysing ABC using ratios
©2011 Deloitte Touche Tohmatsu India Private Limited.
Profitability and return on investment
Assesses a business's ability to generate earnings as compared to its expenses and other
relevant costs incurred during a specific period of time.
• Gross profit margin (GPM) – shows the proportion of money left after direct cost of
sales. Gross profit serves as source for paying for overheads and other costs.
Gross profit
GPM = = Sales
• EBIDTA margin – shows money left after paying for sales cost and overheads
EBIDTA
EBIDTA % = = Sales
Declining GPM and EBIDTA may be due to:
• Relatively higher growth in people cost (ABC being a service company)
• Pressure on pricing due to competition, market environment
• Ineffective management of overhead costs such as marketing and administration
costs
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2008 2009 2010
24.00% 20.42% 17.93%
2008 2009 2010
9.25% 6.46% 4.66%
Analysing ABC using ratios
©2011 Deloitte Touche Tohmatsu India Private Limited.
• Net profit margin (NPM) – shows money left after paying for all costs
Net Profit
NPM = = Sales
Mainly on account of lower EBIDTA margin since no significant change in depreciation,
interest and tax expense
• Return on Total Assets (ROA)
Total assets
ROA = = Net Profit before interest after tax
• Return on Equity (ROE)
Total equity
ROE = = Net Profit
15
2008 2009 2010
4.69% 2.79% 1.62%
2008 2009 2010
26.01% 19.07% 13.72%
2008 2009 2010
50.03% 29.78% 18.76%
Analysing ABC using ratios
©2011 Deloitte Touche Tohmatsu India Private Limited.
Some comments
• Initial analysis of ABC Limited suggests
reasonable sales management
(growing revenue, reasonable sales
credit cycle) and leverage
• However, declining profitability margins
may indicate:
Pricing pressure (competition, economic
factors)
High fixed cost
Inefficient management of overheads
Thus:
• Financial ratio analysis comes handy
in identifying ‘pain’ points
• Deeper analysis of operations and
industry may be required to identity
real issues
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2008 2009 2010
Current ratio
1.22 1.25 1.22
ACP 25.09 25.47 25.17
APP 25.14 25.39 24.42
Debt to Equity
1.33 1.11 1.00
Interest coverage
8.00 6.00 4.00
GPM 24.00% 20.42% 17.93%
EBIDTAM 9.25% 6.46% 4.66%
NPM 4.69% 2.79% 1.62%
ROA 26.01% 19.07% 13.72%
ROE 50.03% 29.78% 18.76%
©2011 Deloitte Touche Tohmatsu India Private Limited.
Some more ratios
• Apart from those discussed, there are ratios and financial metrics to gain insight into a business
• Feasibility ratios and metric generally used to assess greenfield/brownfield project: Net Present Value – captures timing of cashflow to financers
Internal Rate of Return – intrinsic rate of return at which NPV is zero
Debt service coverage ratio – indicates fund available to pay interest and principal
Payback – time period within which investments are recovered
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©2011 Deloitte Touche Tohmatsu India Private Limited.
Some more ratios
• Industry specifics Employee driven sectors
• Revenue/employee or seat; Revenue/faculty hours; Revenue/billable hours
Manufacturing • Margin (USD/bbl, USD/Kg, USD over raw material, % of raw material cost)
Banks
• Spread • NPA ratio
Hotels
• ARR: Average Room Rate • Occupancy rate • RevPAR: Average Revenue per Available Room
Telecom
• ARPU: Average Revenue per User Airlines
• RPK: Revenue Per Kilometer • Yield (Passenger Revenue/ RPKs) • RASK: Revenue per Available Seat Kilometre, CASK: Cost per Available Seat Kilometre
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©2011 Deloitte Touche Tohmatsu India Private Limited.
Important Tips
• A single ratio rarely tells enough to make a sound judgment • Comparable firms Product Locations Size Brand (s)
• Consistency in time and method of computation • Duration Generally latest 5 years….but remember Changes in regulation Changes in performance/external scenario Mergers and acquisition/divestments
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©2011 Deloitte Touche Tohmatsu India Private Limited. 20
Contact
Kalpana Jain
Senior Director
Tel: +91 (0) 124 679 2266
Email : kajain@deloitte.com
Deloitte Touche Tohmatsu India Private
Limited
Building 10, Tower B, 7th Floor,
DLF Cyber City, Gurgaon 122 022
Tel : +91 (0124) 679 2000
Fax : + 91 (0124) 679 2012
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