Understanding Basics of Financial Statements

1. Understanding Basics of Financial Statements Presented By: Vishal Thakkar ConTeTra Universal LLP

2. Objectives of the Presentation • Understanding the basic concepts and terms used in the Financial Statements. • Understanding the ratios used for analyzing the Financial Statements. • Discussing factors that drive corporate valuations.

3. Contents • Objectives of Financial Statements • Basic Accounting Concepts • Structure of Profit & Loss Statement • Structure of Balance Sheet & Cash flow Statement • Q & A

4. Objectives of Financial Statements • To provide information to stakeholders about: • Performance of the company during a given period: • Financial health of the company as on a specified date. • To furnish information useful in making decisions relating to investment and lending.

5. Basic Financial Statements • Profit and Loss Statement. • Balance Sheet. • Cash Flow Statement. • Statement of Accounting Policies and Notes to Accounts.

6. Dual Impact of Financial Transactions INCOME EXPENDITURE ASSETS LIABILITIES

7. Examples of Financial Transactions • Salary Receipt • Rent payment • Purchase of House • Taking of Housing Loan • Buying MF Units • Loan EMI

8. Personal P & L A/C (Monthly) Income Rs. Salary 15,000 Interest 1,000 Total Income 16,000 Expenditure Utilities 3,000 Groceries 3,000 Education 2,000 Maintenance 2,000 Total Exps. 10,000 Net Income 6,000 Loan EMI 3,000 Net Savings 3,000 Personal Balance Sheet Assets Rs. Lakhs House Property 11 Bank balances 2 Shares 1 Mutual Funds 1 Total assets 15 Liabilities Housing Loan 4 Personal Loan 1 Total Liabilities 5 Net wealth 10 Your own P & L & Balance Sheet

9. Fundamental Accounting Concepts • Business Entity: An Enterprise is different from the persons who own it. • Going Concern: Enterprise will continue to exist in a foreseeable future. • Accrual: Revenue and expenses are recognised as they are incurred and not as money is received or paid. • Substance over form: Substance of a transaction takes precedence over legal form.

10. Fundamental Accounting Concepts • Prudence: Recognise all known expenses and losses. Do not recognise revenue and profits unless you are sure of realisation of the same. • Capital Expenditure: Expenditure which brings into existence asset or benefit of a long term nature. e.g. Building, computers, furniture, equipment. • Revenue Expenditure: Expenses which are incurred to earn revenue and which are written off over a normal accounting period. e.g. salary, rent, stationery, electricity.

11. Profit and Loss (P&L) Account • A statement showing revenues and expenditure over a defined period of time. It shows results of business operations for a defined duration. • Profit =Total Income – Total Expenditure. • It is a measure of financial performance. • Income and Expenditure are recognized in accordance with Generally Accepted Accounting Principles (GAAP).

12. Structure of a P & L Account Revenue Cost of Material Employee Costs Selling, General & Admn (SGA) Operating Profit (EBIDTA) Depreciation Interest Tax Profit After Tax

13. Revenue • Total Revenue = Sales + other income. • Sales is usually the amount invoiced during the period for product and services. • Some of the amounts invoiced may not have been collected at the year end. • Other income would include dividend, interest etc.

14. Expenditure • Material Cost - Raw Materials and Consumables. • Employee Related Expenses (ERE) - Salary & allowances, bonus, staff welfare and benefits. • Selling, General & Administration Expenses (SGA) - Bizdev., Advertisements, Commission, Travel, Marketing office expenses, Rent, Electricity, Maintenance, Insurance, Housekeeping, Telephones, Internet link etc.

15. Depreciation • Depreciation is a charge for use of capital assets. • Non – cash charge to the P&L. • Depreciation method ensures that the original cost of an assets less its salvage value is spread over estimated useful life of an asset. • Depreciation methods: Straight Line / Reducing Balance.

16. Interest cost • Interest is an amount payable to the lenders, e.g. Banks, Financial Institution, etc. • The interest will arise in relation to • Working capital loans • Term Loans

17. Provision for Tax • Provision for tax relates to income tax payable on the company profit. • It is a notional Figure arrived at by using the provisions of Income Tax Law, but the Final tax liability is assessed by the assessing officer of the Income tax Dept and the difference is settled accordingly

18. Profit & Loss Account Revenue:100 Emp Exp 45 Selling Exp 5 G & A Exp 15 OPG Profit 35 Depreciation 10 Interest 2 PBIT 25 PBT 23 Tax 0.5 PAT 22.5

19. Dividend • Dividend: A portion of profit which is paid to the share - holders. • Lenders are paid fixed rate of interest, whereas shareholders are paid dividend depending upon the profits and the policy of the company. • The Board of the Company recommends the rate of dividend based on the profitability and policy of the Company. • In India, currently there is no tax on dividend received by the shareholder as the company pays dividend tax.

20. Retained Earnings (RE) Profit After Tax 22.5 Dividend 2.5 Retained Earnings 20

21. Profitability Ratios Operating Profit Margin or EBIDTA Margin = Operating Profit / Sales = 35 / 100 = 35% Operating Profit shows intrinsic profitability of a business.

22. Profitability Ratios PBIT Ratio = PBIT / Sales % = 25 / 100 = 25% PBIT Ratio shows profitability of a business after accounting for depreciation.

23. Profitability Ratios Net Profit (PAT) Ratio = PAT / Sales % = 22.5 / 100 = 22.5% Net Profit Ratio shows profitability of a business after accounting for all expenses including depreciation, interest & tax.

24. Industry Comparison – P&L

25. Balance Sheet • A statement of Assets and Liabilities of the Company. • A snapshot view of a business at a defined point of time. • Balance Sheet is a measure of financial resources or wealth of a company whereas Profit and Loss Account is an indicator of performance of a company, • Balance Sheet is always balanced. Assets are equal to liabilities.

26. Assets and Liabilities • Liabilities: Amounts owed by the Company to parties external to the Company – sources of funds. • Assets: Resources ownedby the company – Application of funds. • It could be presented in either a Horizontal or vertical format.

27. Balance Sheet: Horizontal Structure Liabilities Assets Equity Capital (10) & Reserves (60) Fixed Assets (70) (e.g. Land & building, Plant & machinery , Computers, DG set) Loan Funds (30) Current Assets(40) (e.g. cash, inventories, Debtors) Current Liabilities (10) (e.g. creditors, provision) Total (110) Total (110)

28. Equity Capital (10) Reserves (60) Loan Funds (30) Fixed Assets (70) Net Current Assets (30) [Current Assets (40) less: Current Liabilities (10)] Balance Sheet: Vertical Structure Liabilities (owed) Sources Assets (owned) Application

29. Fixed Assets Land Building Finished products Machinery Computers Furniture and fixtures Current Assets Cash Account receivables Raw material Motor vehicles Loans and advances Find the items in the wrong heading

30. How do they relate to each other? Profit & Loss Account Balance Sheet31 March 2018 Balance Sheet31 March 2017 Cash Flow

31. Net worth = Share Capital +Reserves = Rs. 10 +Rs. 60 = Rs. 70 Cr. OR Net worth = Total Assets – Loan Funds = Rs.100 – Rs.30 = Rs. 70 Cr Net Worth

32. Working Capital = Current Assets – Current Liabilities = Rs. 40 - Rs.10 = Rs. 30 Cr. Working Capital

33. Debt to Equity Ratio = Long Term Debt / (Equity + Reserves) = Rs. 30 / (Rs.10+60) = Rs. 30 / Rs. 70 = 0.42:1 Balance Sheet Ratios: Debt to Equity

34. Current Ratio = Current Assets / Current Liabilities = Rs. 40 / Rs.10 = 4:1 Balance Sheet Ratios: Current Ratio

35. Return on Equity = Profit After Tax / Average Equity Cap. and Reserves = Rs. 22.5 / ((Rs. 70 + Rs. 50) / 2) = Rs. 22.5 / 60 = 37.5% Mixed Ratio: Return on Equity

36. ROCE = Profit before Interest & Tax (PBIT) / Avg. Capital Employed. = Rs. 25 / ((100+70) / 2) = 29.4% Mixed Ratio: Return on Capital Employed

37. ROCE ROCE = PBIT / Average Capital employed = (PBIT / Sales) X (Sales / Avg.Capital Empl.) = Profit Margin X Capital Turnover Ratio = Operating Efficiency x Efficiency in utilising capital.

38. EPS = Profit After Tax / No. of shares outstanding = Rs. 22.5 Cr. / 1 Crore Shares = Rs. 22.5 Mixed Ratio: Earnings Per Share (EPS)

39. Fixed Asset Turnover Ratio = Sales / Avg. Fixed Assets = Rs. 100 Cr / ((70+50)/2) = 1.67 Asset Turnover Ratios

40. Asset Turnover Ratios • Inventory Turnover Ratio = Sales / Avg. Inventory • Debtors Turnover Ratio = Sales / Avg. Debtors • Capital Turnover Ratio = Sales / Avg. Capital Employed

41. Industry Comparison – Balance Sheet

42. Concept of Valuation of Equity Shares • Face Value • Book Value • Market Value

43. Face Value is par value of the share appearing on the face of share certificate = Rs. 10 per share. Book Value is the net worth divided by a no. of outstanding shares. = (Share Capital + Reserves) / No. of outstanding shares. = Rs. 70 Cr. / 1 Cr. = Rs. 70 per share. Valuation of Equity Shares: Face/Book Value

44. Valuation of Equity Shares: Market Value • Market Value (MV) of a listed share is the price of the share quoted on a recognized stock exchange.

45. Current Valuations of select Companies ** As on 05/02/2018

46. Price Earning Ratio • PE = MV / EPS 100 / 10 = 10 • PE is driven by a no. of subjective and objective factors associated with the company and the industry it belongs to: • Projected Growth of sales, profit,cash flow and EPS. • Company brand equity, management practices, corporate governance. • Market sentiment • MV = EPS x Price Earnings (PE) Ratio • EPS = PAT / No. of outstanding shares

47. Current PE Ratios of select Companies ** As on 05/02/2018

48. Market Value of a Company • Market Value of a company or Market Capitalization is the price you will pay to buy all the shares of a company at a given point of time. = No. of shares outstanding x Market value of a share. • For Example, market capitalization of Havell’s is as follows: No. of Shares = 62.51 Crs Price of a share = 501.10 per share Market Cap. = 31,323.76 Crs

49. Q & A

50. Thank you!!