NPTEL Course

Course Title: Security Analysis and Portfolio Management

Instructor: Dr. Chandra Sekhar Mishra

Module-5
Session-9
Financial Statement Analysis I

Outline
Financial Statements and their Content
Why Financial Statement Analysis (FSA)?
Tools for FSA

Financial Statements: Businesses are provided with funds from different financial stakeholders
like equity shareholders and lenders. Besides such major stakeholders, other stakeholders like
customers, suppliers, business partners etc. will like to know the performance of the business in
order to justify their continuity or otherwise with the business and compare such business with
other businesses. For this purpose, financial statements prepared and presented by companies are
useful for all the stakeholders. Primarily the following statements are presented by the
companies:
Balance Sheet
Income Statement
Cash flow Statement
These statements pertaining to a particular accounting year are published as part of the annual
report of companies. Abridged quarterly financial reports are also published by companies. To
ensure that the financial statements are reliable and comparable over time and across firms,
companies are required to follow generally accepted accounting principles (GAAP).
Balance Sheet: Balance sheet is statement of Assets and Liabilities & Equities at a particular
moment of time. That is why it is also known as position statement rather statement of financial
position. Assets can be defined as what a business owns and liabilities mean what a business
owes to non-owners, equities means what a business owes to owners. Assets are also known as
resources and Liabilities and Equities can be otherwise known as sources of resources.
Major Types of Assets: Broadly, assets can be classified as below (this classification is more
appropriate for non-finance companies):
Fixed Assets: These assets are meant for use over a long term period. Examples of fixed
assets can be land, buildings, plant and equipment, furniture and fixtures. These assets are
expected to generate revenue for the firm. The intention of the business should not be to
1

hold and sale such assets. For instance, buildings built by a real estate firm unless used
for own purpose cannot be considered as fixed assets. These are like inventories when
one compares with a manufacturing firm.
Investments: Companies invest surplus cash in financial assets. Companies also can
invest in other companies as strategic partner, joint venture or simply in group
companies. These investments can be in equity and/ or non-equity form.
Current Assets: These assets are meant to maintain liquidity and for day to day operations
of the business. For smooth running of companies one or more such assets are vital. The
major types of current assets are as below:
Cash and cash equivalents
Marketable securities (temporary investments)
Receivables: Dues from customers who have taken goods/ services on credit but
yet to pay.
Inventory: Raw materials, work in progress, spare parts, finished goods among
others. These assets are very important for a manufacturing company.
Loans and advances
Other current assets like prepaid expenses
Intangible Assets: Companies revenue generation might not be possible just by holding
tangible assets. Assets like patents, copyrights, licenses are also vital for several
companies. For example, for a pharmaceutical company it is very pertinent to develop
new drugs, patent those for future revenue. The business drivers of information
technology, software or knowledge based companies are intangibles and human
resources. Inadequate investment in intangibles can jeopardize the future of a company.

The following table shows the balance sheet of NATCO Pharma Ltd. for three years.
Table 10. 1
Balance Sheet of NATCO Pharma Ltd as on 31st March [in Rs. Crore]
SOURCES OF FUNDS :
2009
2008
2007
Share Capital
28.04
28.04
27.64
Reserves Total
229.86
191.16
152.5
Total Shareholders Funds
257.9
219.2
180.14
Secured Loans
120.81
88.55
64.86
Unsecured Loans
5.53
5.58
11.58
Total Debt
126.34
94.13
76.44
Current Liabilities and Provisions
Current Liabilities
107.93
85.13
79.22
Provisions
2.52
5
3.85
Total Current Liabilities
110.45
90.13
83.07
Total Liabilities
494.69
403.46
339.65
APPLICATION OF FUNDS :
Gross Block
273.07
235.31
190.64
Less : Accumulated Depreciation
71.92
61.59
53.06
Net Block
201.15
173.72
137.58
2

Capital Work in Progress

Investments
Current Assets, Loans & Advances
Inventories
Sundry Debtors
Cash and Bank
Loans and Advances
Total Current Assets
Miscellaneous Expenses not written off
Total Assets
Contingent Liabilities

34.41
20.8

18.11
20.8

20.14
18.46

64.67
47.68
20.09
105.89
238.33
0
494.69
39.5

55.33
35.72
19.92
79.86
190.83
0
403.46
54.06

49.31
32.14
24.09
57.93
163.47
0
339.65
24.43

Major Types of Liabilities

Current Liabilities and Provisions: Current liabilities are short term liabilities to be paid
within a short period typically a year. These liabilities usually occur as a result of regular
operations of a business. The major types of current liabilities are:
Creditors: for supplies of inputs
Accounts/ Notes payable: Part of creditors but where the promissory notes have
been provided by the company.
Accrued liabilities: The expenses that have been incurred, but not paid in cash.
Income Tax payable: Due for the income tax assessed by the company, but yet to
be paid in cash.
Debt/ Loan: These are long term sources of finance with interest commitment. Although
theoretically, debts can be perpetual, those are required to be paid within a particular
period of time. The debts or loans can be classified in different ways like:
Short term and long term
Secured and unsecured
Debentures and bonds: these are debt instruments which can be subscribed by investors
small, large, or institutional. These instruments can be listed and traded in capital market.
Preference share capital: Holders of these shares have preference over equity holders with
respect to receipt of dividend and at the time of liquidation of the firm. Otherwise, these
instruments carry a coupon known as dividend like interest in case of bonds and
debentures.
Equity Capital: these are the contribution of owner investors which consist of the
following:
Paid-up capital
Reserves and surplus
Securities premium
General Reserve
Profit and Loss A/c balance
Capital Reserve

Income Statement: The income statement also known as profit and loss account essentially
shows the income and expenses of a particular firm during a particular accounting period. It is a
summary of different types of incomes and expenses and shows the profit or loss made during
the particular accounting period. The major components of income statement are:
Income
Sales
Other income
Expenses
Operating expenses
Financial expenses
Tax provision
Net profit
Appropriation of net profit
Transfer to reserves
Distribution of profit as dividend
Table 10.2 provides an abridged version of the income statement of Natco Pharma Ltd.
Table 10. 2
Natco Pharma Ltd.
Income Statement for the period: [in Rs. Crore]
2008-09 2007-08 2006-07
INCOME :
Sales Turnover
273.79
235.91
193.23
Excise Duty
4.1
6.87
8.45
Net Sales
269.69
229.04
184.78
Other Income
11.5
18.39
18.21
Stock Adjustments
7.1
4.05
6.25
Total Income
288.29
251.48
209.24
EXPENDITURE :
Raw Materials
96.6
91.93
79.32
Power & Fuel Cost
15.24
11.02
10.13
Employee Cost
35.68
29.28
25.06
Other Manufacturing Expenses
17.03
14.14
11.19
Selling and Administration Expenses
40.63
29.21
23.99
Miscellaneous Expenses
4.3
3.04
5.55
Total Expenditure
209.48
178.62
155.24
Operating Profit (PBDIT)
78.81
72.86
54.00
Interest
15.05
9.73
6.61
PBDT
63.76
63.13
47.39
Depreciation
10.35
8.59
7.61
Profit Before Tax
53.41
54.54
39.78
4

Tax
Reported Net Profit
Extraordinary Items
Adjusted Net Profit
P & L Balance brought forward
Appropriations
P & L Balance carried down
Dividend

10.67
42.74
0.06
42.68
81.97
7.1
117.61
3.5

14.49
40.05
-0.38
40.43
49.43
7.51
81.97
3.43

9.32
30.46
8.69
21.77
25.84
6.87
49.43
3.4

Cash flow Statement: Cash is considered as life blood of a business. Cash flow statement of a
company provides the inflow and outflow of cash during a particular period. Several questions
which are not answered by balance sheet and income statement can possibly be answered by
looking at the cash flow statement. The cash flow statement classifies the cash flow into three
parts:
Cash flow from operating activities: The profit adjusted for depreciation, gains and/or
losses on sale of non-current assets, tax paid, and working capital changes. For a running
organization this is supposed to be the most vital source of cash flow.
Cash flow from investment activities: Purchases of non-current assets and proceeds on
the sale of non-current assets.
Cash flow from financing activities: Proceeds on the issue of equity/preference shares
and loans/debentures and the redemption of redeemable preference shares and
loan/debentures. Payment of interest and dividend are considered as application of cash
in this category.
Sources of Financial Information
Annual Reports of Companies
Secondary databases/ information services
Stock exchanges
Periodicals and Newspapers
Websites companies and other investment advisory firms.
Financial Statement Analysis (FSA):
Why FSA?
o Helps evaluate past performance and financial position
o Facilitates prediction of future performance
o Helps in estimating risk, cost of capital and capitalization rate
o Helps in estimating appropriate valuation multiples
Tools of FSA
Trend Analysis: Comparison of major financial figures over a time period and observing a
trend in the same;
Comparative Statements:
Comparison of financial performance between current year and previous year
5

Comparison with other companies in the same industry/ sector

Common Size Statements: A financial statement presented by representing each item as a
percentage to the total amount of which it is a part.
Common size balance sheet: Constructed by showing each item of asset as a
percentage of total assets, similarly each item of liability and owners equity is shown
as a percentage of total liabilities and owners equity.
Common size income statement: Here one can show the net sales as 100% and each
of the components of expenses and profits as a percentage of net sales.
Ratio Analysis: Ratio is a relationship between two items taken from one or more financial
statement or market data. The items are expected to be related to justify the calculation. One
can measure and comment on the profitability, solvency, efficiency and market standing of
the company by using financial ratios. Ratio analysis is discussed in detail in the subsequent
lecture, i.e. lecture # 10.

References:
Reilly and Brown (2006), Investment Analysis and Portfolio Management, 8e, Thomson
(Cengage) Learning, New Delhi
Bodieet al (2009), Investments, 8e, Tata McGraw Hill, New Delhi
Prasanna Chandra (2008), Investment Analysis and Portfolio Management, 3e, Tata
McGraw Hill, New Delhi
Ramachandran and Kakani (2008), Financial Accounting for Management, 2e, Tata
McGraw Hill, New Delhi
Narayanaswamy (2011), Financial Accounting: A Managerial Perspective, 4e, Prentice
Hall India, New Delhi

Questions and Answers

Q.1: What is the purpose of financial statement analysis (FSA) and what are the major
techniques of FSA?
Ans.: Financial statement analysis (FSA) is the analysis of major financial statements like
Income Statement, Balance Sheet and Cash flow statement to measure the strength and weakness
of a business entity depending upon the requirement of an user of financial statement.
Essentially, FSA helps in
Evaluating past performance and financial position
Predicting future performance
Estimating risk, cost of capital and capitalization rate
Estimating appropriate valuation multiples
The major techniques of financial statement analysis are:
Trend Analysis
Comparative analysis (comparison with prior year performance/ comparison with peer
group companies)
Common size statement
Ratio analysis with focus on:
o Profitability
o Efficiency
o Liquidity
o Solvency
o Capital market standing
Q.2: Prepare common size income statement and balance sheet of ABC Limited with the help of
the following tables.
ABC limited
Income Statement

Net Sales
Expenditure:
Raw Materials
Power & Fuel Cost
Employee Cost
Other Manufacturing Expenses
Selling and Administration
Expenses
Total Expenditure
Operating Profit (PBDIT)
Interest
PBDT

2008-09
(Rs. Crore)
350

2009-10
(Rs. Crore)
410

120
80
40
17
11

130
95
50
24
14

268
82
10
72

313
97
10
87
7

Depreciation
Profit Before Tax
Tax
Reported Net Profit

24
48
14.4
33.6

28
59
17.7
41.3

Balance Sheet
SOURCES OF FUNDS :
Share Capital (Face Value: Rs.10)
Reserves Total
Total Shareholders Funds
Secured Loans
Unsecured Loans
Total Debt
Current Liabilities and Provisions
Current Liabilities
Provisions
Total Current Liabilities
Total Liabilities
APPLICATION OF FUNDS :
Gross Block
Less : Accumulated Depreciation
Net Block
Capital Work in Progress
Investments
Current Assets, Loans & Advances
Inventories
Sundry Debtors
Cash and Bank
Loans and Advances
Total Current Assets
Total Assets

2008-09
(Rs. Crore)
40
95
135
90
35
125

2009-10
(Rs. Crore)
40
135
140
85
41
126

45
30
75
335

56
48
104
370

90
22
68
12
70

110
29
81
14
78

75
56
38
28
197
335

57
87
30
37
211
370

Ans.:
Common Size Income Statement of ABC Limited
Net Sales
Expenditure:
Raw Materials

100.00

100.00

34.29

31.71
8

Power & Fuel Cost

Employee Cost
Other Manufacturing Expenses
Selling and Administration Expenses
Total Expenditure
Operating Profit (PBDIT)
Interest
PBDT
Depreciation
Profit Before Tax
Tax
Reported Net Profit

22.86
11.43
4.86
3.14
76.57
23.43
2.86
20.57
6.86
13.71
4.11
9.60

23.17
12.20
5.85
3.41
76.34
23.66
2.44
21.22
6.83
14.39
4.32
10.07

Common Size Balance Sheet

SOURCES OF FUNDS :
Share Capital
Reserves Total
Total Shareholders Funds
Secured Loans
Unsecured Loans
Total Debt
Current Liabilities and Provisions
Current Liabilities
Provisions
Total Current Liabilities
Total Liabilities
APPLICATION OF FUNDS :
Gross Block
Less : Accumulated Depreciation
Net Block
Capital Work in Progress
Investments
Current Assets, Loans & Advances
Inventories
Sundry Debtors
Cash and Bank
Loans and Advances
Total Current Assets
Total Assets

2008-09
11.94
28.36
40.30
26.87
10.45
37.31

2009-10
10.81
36.49
37.84
22.97
11.08
34.05

13.43
8.96
22.39
100.00

15.14
12.97
28.11
100.00

26.87
6.57
20.30
3.58
20.90

29.73
7.84
21.89
3.78
21.08

22.39
16.72
11.34
8.36
58.81
100.00

15.41
23.51
8.11
10.00
57.03
100.00