Financial Parameters & Value Drivers

30th June 2008

Deepak Sankhla
Finance & Accounts Baroda

F&A an exciting subject

Growth & declines ( diff. Parameters ) Earnings Corporate takeovers M&A Business re-structuring Stock markets/ currencies Industry ups & downs Impact of globalization Increasing competition

F&A is a key link in the value addition chain

Informed decisions

Timely Feedback
Corrective actions Statutory Compliance Constructive team work Performance Measurement Setting up Systems

Generally Accepted Accounting Practices

Fiscal period Going concern Historical monetary unit Conservatism ( provisions ) Quantifiable items / transactions Consistency Full disclosure Materiality Accrual

Scope

Financial Statements

Financial Parameters - Ratios

Value Drivers

PMS in L&T

Budgets

?????

Financial Statements

Financial Statements
Objectives Provide Information on Performance of Business Operations

Changes in Financial Position

Profit & Loss Account

Balance Sheet
Notes to Accounts Cash Flow Statement

Balance Sheet
BALANCE SHEET ITEMS:
ASSETS: LIABILITIES:
ASSETS:
Fixed Assets Investments Current Assets e. g. cash, bank balance, inventory, debtors, etc.

What you have? How you have?

LIABILITIES:
Equity Capital Reserves & Surplus Debt or Borrowed funds Current Liabilities e.g. creditors, provision for expenses, etc.

Profit & Loss Account

PROFIT & LOSS ACCOUNT ITEMS:
INCOMES:
Sales Other Income

EXPENSES:
Manufacturing Other Indirect Expenses Interest Depreciation

PBT Less: Tax

PAT

Cash Flow
INFLO W
Advance Payments from Customers Progress Payments from Customers Sale Proceeds of Investments and Fixed Assets Equity subscription

OUTFLO W
Advances and Progress Payments to Vendors Purchase of Investments and Fixes Assets

Payment of expenses like travel advance, site expenses, insurance, power, salaries, etc.

Difference between Cash Out Flow & Cost

OUTFLOWS Vendor Advances Progress Payments (Against Bills) Nil Vendor Bills COST

Travel / Insurance/ Site Expenses

Nil

Travel / Insurance/ Site Expenses

Depreciation / Other Non Cash Charges

Ratios

Financial Parameters - Ratios

Financial Ratios are useful in assessing the financial performance and financial condition of a firm.
Liquidity Ratios Profitability Ratios Ownership Ratios Turnover Ratios

Liquidity Ratios
Liquidity Ratios show the ability of a firm to pay its short term debts as they mature.
Current Ratio = Current Assets / Current Liabilities Quick Ratio (also Acid-test Ratio) = Quick Assets / Current Liabilities where Quick Assets = Current Assets Inventory

Profitability Ratios
Profitability ratios are used to measure a firms efficiency and ability to generate profits.
Gross Profit margin = Gross Profit / Sales Net Profit Margin = Net Profit (PAT) / Sales

Ownership Ratios
Ownership ratios help to analyse the present & future investments in a firm and to compare the investments with factors such as Debt, Earnings, Dividends & Stock Price
Return on Equity or Net Worth (RONW)
= Net Profit / Avg. Equity

Earnings Per Share (EPS)

= Net Profit / No. of Shares Outstanding

Price Earnings Ratio (P/E)

= Market Price of Shares / EPS

Debt Equity Ratio

= Total Debt / Total Equity

Debt Service Coverage ratio

= (PAT + Depreciation + Non Cash Expenses + Interest on Loans) / (Interest on loans + Repayment)

Turnover Ratios

Net Working Capital (%age to Sales) =

NWC Sales (LTM)

Sundry Debtors Sundry Debtors (No of days' sales) = Avg. Sales per day (LTM)

Value Drivers

Value Drivers

What are Value Drivers?

Value Drivers represent the primary operating levers responsible for creating (or destroying) value in a business.

Link between value creation & operating decisions.

Value Drivers are at the root of business performance because they are leading indicators of performance.

Why Value Drivers?

Performance Measurement

Take Stock & Course Correct

Allocate & re-allocate resources

Reward Good Performers Give an account to stock holders Strategy development

Need to enforce performance accountability !

Investor profile has shifted towards large institutional investors - both Indian and Foreign Large cross border capital flows huge investments in Indian capital markets Investors with good industry knowledge and international experience

Intelligent and informed Investors with large stakes demand market based returns
Under performance is punished

Net SBU Earning (NSE)

PBIT

Tax

NSE per Person

NSE / Average Employees

ROCE Return on Capital Employed

(PBIT-TAX) ANFE

or

NSE ANFE

ANFE Average Net Funds Employed

Average Net Working Capital Average Net Fixed Assets

FCF- Free Cash Flow NSE + Depreciation Increase in NWC Increase in Capital Expenses

Free Cash Flow represents the cash that a company is able to generate after laying down the money required to maintain or expand its asset base

Concept of Economic Value Added

Economic Value Added is a financial performance method to calculate the true economic profit of a firm. It is an estimate of the amount by which earnings exceed or fall short of the required minimum rate of return for shareholders or lenders at comparable risk. Economic Value Added is the excess of ROCE (Return on Capital employed) over WACC (Weighted Average Cost of Capital)

EVA
EVA
NOPAT Capital Charge
Capital used (ANFE) Cost of Capital (WACC)

EVA

Rate of Return

Capital charge

Capital used

Efficiency

Size

EVA accounts for the Market Value that Management adds to, or subtracts from, the capital it has employed.

Growth that destroys value !

Particulars Sales Operating Costs Operating Profit before tax Tax @ 40% NOPAT Loans Shareholders equity Capital Cost of capital Now 1000 800 200 80 120 400 800 1200 10% Proposed 2000 1600 400 160 240 1000 2000 3000 10%

Capital charge
EVA (NOPAT less Capital Charge)

120
0

300
(60)

Value Drivers- Others

International Sales % of Total Sales Outstanding > 6 months % of Total Outstanding Retention % of Total Outstanding Customer Advance % of Order backlog Sundry Creditors (Days Payable)

Sundry Debtors (Days Sales)

PMS in L&T

Basic premises
Operating Divisions are profit centres Operating Divisions are accountable for their post-tax earnings Corporate performance individual departments depends on performance of

Every manager influences performance of his department and the company and it is essential to identify parameters he controls and report actual performance against such parameters

April-07

OPERATIONAL INDICATORS
This month This year Bud Act Financial year-to-date This year Last yr Act Bud Act Var

Particulars

Last yr Act

Var

Direct Order Booking - Customer - Inter-unit (Inter OD) - Intra (Inter SBU) Total Direct Sales - Customer - Inter-unit (Inter OD) - Intra (Inter SBU) Total Direct Order Backlog - Customer - Inter-unit (Inter OD) - Intra (Inter SBU) - FEV/ Other adj. in BLog. Total Details : Direct Order Booking Physical Exports Deemed Exports Direct Sales Physical Exports Deemed Exports Direct Order Backlog Physical Exports

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00

April-07

FINANCIAL PERFORMANCE
Particulars Last yr Act A1 A2 A3 A B1 B2 B C1 C2 C D E This month This year Bud Act Last yr Act Financial year-to-date This year Bud Act Var 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Var 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Customer Sales Cost of Sales Less: Inter-OD Margins Gross Margin - Customer Sales I-U Sales Cost of Sales Gross Margin - I-U Sales Intra Unit Sales Cost of Sales Gross Margin - Intra Unit Sales Closed jobs - costs booked Other Income Marketing Expenses Less : Exps recovered on projects Net Marketing Expenses (Under)/ Over Recovery of Exe. exps. PBDIT Operating Margin as % to Sales Depreciation PBIT [SBU- Pre-Tax Earnings] Tax on PBIT NOPAT [Post-tax SBU Earnings] ANFE ROCE Capital Charge on ANFE EVA

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00
F1 F

0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00 0.00 0.00

0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00

0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00

0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00 0.00 0.00 0.00 #DIV/0! 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

G 0.00 H 0.00 H1 #DIV/0! I 0.00 J 0.00 K 0.00 L 0.00

M N O

0.00 0.00

0.00 0.00

0.00 0.00

0.00

Key: H = A+B+C+D+E-F+G+I ; J = H-I ROCE , EVA, ANFE based on LTM

April-07

RESOURCE UTILISATION
This month This year Bud Act Average 12month-to-date Last yr Act Bud Act Var

Particulars

Last mth Act

Var

Working capital MMI/ GIT/ FG Work in progress Customer Outstandings - Outstanding > 6 months - % to total Outstanding - Retention included above Cash and Bank Balances Other Current Assets Gross Working Capital Customer Advances (Interest-free) - as % of Backlog Vendors Credit / (Debit) - Due for > 6 months - % to total Creditors Due to Customer Other Liabilities & Provisions - Total Current Liabilities Net Working Capital Fixed Assets - Gross (Month End) - Net (Month End) Investments 10% of Non-fund based resources Net Funds employed Key: G = A+B+D+E-F ;

A B D D1 D2 D3 E F G 0.00 0.00 0.00 H H1 I I-1 I-2 #DIV/0! #DIV/0! #DIV/0! J K L 0.00 0.00 0.00 M 0.00 0.00 0.00 N N1 N2 O P Q

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00
M = G -L ;

0.00

0.00

0.00

0.00

0.00

0.00

0.00

L = H +I+J+K ;

Q = M+N2+O+P

Particulars Turnover Ratios-as % of Sales Avg. Gross Working Capital to Sales (%) R1 Avg. Net Working Capital to Sales (%) R2 Avg. Net Funds emplyed to Sales (%) R3 Free Cash flow Net Group Earnings Add: Depreciation Less: Increase in Working Capital Increase in Fixed Assets / Invsts. Free Cash Flow Marketing Expenses: (Dom+Intl.) Personnel Related Expenses Travelling & Conveyance Sales Promotion Expenses Net Distribution Cost Other Direct Expenses Establishment Expenses Depreciation Total Execution Expenses Personnel Related Expenses Travelling & Conveyance Other Direct Expenses Establishment Expenses Depreciation Total Less : Recoveries Under/(Over) Recovery Intl. Marketing Exps (Statistical Info) Sales per person Computation of tax SBU - PBIT Tax / Fiscal Benefits Margin on Capital jobs Dividend Depreciation shield (Tax - Book) Taxable Income S

Last yr

This month This year Bud Act

Var

Financial year-to-date This year Last yr Bud Act Var

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00

0.00

0.00

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

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0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

Budgets

Types of Budgets

Revenue Budgets to fix targets for

Operational indicators
Order Booking Sales Order Backlog

Financial indicators
Earnings Capital Usage

Capital Budget
For capital expenditure proposals Allocation of resources Appraisal using
Pay-back period IRR

Manpower Budget

QUIZ
1. The advance paid to a vendor forms part of the Project cost False 2. Goods dispatched by the vendor to the project site, where job is being executed, will automatically become outstanding from the Customer False 3. Gross Margin of a Project is equal to Sales minus Cost incurred for the Project

True
4. Cost Overrun due to purchase of excess material for the project does have effect on the bottom-line of OD True 5. EVA is equal to ROCE (Capital Charge * Capital Employed). This mean that EVA will increase if we increase the Capital Employed False

6. ROCE % = (PBIT Tax) / (Average Funds Employed) *100 True 7. Capital charge = Simple Average Cost of Capital False 8. To improve EVA should the various elements of Capital Employed be reduced

True
9. Working Capital for an OD is Negative which means that the Capital is required to be invested by the Company False 10. Companies can be profitable yet destroy Shareholders Value True

11. Additions to Fixed Assets has bearing on Profits, ROCE and EVA True 12. Free Cash Flow does get reduced because of higher Working Capital vis-vis end of last year Working Capital position True 13. Material purchased at a price higher than the estimated cost affect estimated ROCE & EVA

True
14. Non-realization of money from Customer affects ROCE & EVA True 15. Advance received from the Customer is reflected as Sales False

Good Luck!!