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Module 1: Ratio Analysis and Return on Equity

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Namaste.In last few sessions we are discussing financial statement analysis, so we discussed abouthorizontal vertical analysis then variety of ratios.In the last session we had seen how to do horizontal analysis where in we have calculatedand prepared a comparative statement.I hope it is clear to all, today we are going to go for a common size statement.I will just show comparative statement once more.So, what we are done was we have calculated the change and the percentage change for bothP and L balance sheet.And then for summarized cash flow, this was a common size P and L and common size balancesheet.Now, what we will do is what is known as vertical analysis and for vertical as the name suggestsit is vertical because to a common base we compare and calculate the figures and thenif you want we can compare the 2 years figures, but first we will compare it within the year.So, a statement which we make is known as common size statement, I had requested tomake it I had requested you to make it on your own, so this is common size ok.So, let us make common size statement please make it along with me it is very simple, sotake the print out of the given sheet that is P and L balance sheet and cash flow whichis for 2 years.Now, if you take P and L we can compare these two values, but instead of comparing actualvalues we want to first convert them into percentage.For converting into percentage we will take the base as the total revenue or sometimeswe take base as revenue from operations.So, for any individual figure let us say we want to calculate operating and direct expenseswhich is 2141, so 2141 divided by revenue from operations.So, 62 percent is the operating expenses, so total revenue if is 100 62 percent is spenton, now what we can do here is let us make it B dollar 8, so that we can drag it now.So, all the figures we have got it as a relationship of the total, you can also do it for the totaleven for the revenue items got it.Gross and net revenue is of course 1 and other figures are as a percentage to total, forbetter understanding if you like you can even converted into percentage, this looks bitbetter.So, operating expenses you can see are now 63 percent of the revenue, now same thingdo it for the; so now, are you able to see them as a common size statement the totalis 100 and every item that is safe operating expense is 63 percent in March 17 whereas,it is 57 percentage in March 16.So, you can easily see that operating expenses as a percentage have gone up.Actually, if you look at the amount they have not increased much, but because of the fallin the revenue they could not reduced their expenses like the fall in the revenue thatis why as a percentage they have gone up.So, this is one way of interpreting it, employee benefit as a percentage as slightly gone up,depreciation as a percentage as slightly gone up.So, various figures now you can get it as a percent, profit if you want to see profitbefore tax has gone down from 10 percent to 5 percent, profit after tax has gone downfrom 9 percent to 4 percent.In a way we are now calculating variety of ratios, you have seen net profit profitabilityratios which were profit upon sales.You can also calculate various expense ratios like; say operating expenses to sales to knowthe operating expense percent or employee benefit expense percent.So, all figures are now represented as a percentage and then we are able to compare them acrossthe years because, comparing absolute figures was not that much sensible although sinceit is for the same company still it was possible.But, if you want to compare with other companies in the industry it was senseless to compareit, but now we can compare it across different companies or with the industry average alsoto know our expenses versus others.This is known as a common size P and L or a common size statement of revenue, now letus do it for balance sheet.Now, balance sheet also we have got figures for 2 years, so I have pasted that formulahere.But this could be slightly wrong because we have to take total; this particular figurethat is share capital is taken to the base of what earlier we took it as a base of totalrevenue because it was in P and L.In balance sheet it will be taken as a base of total of capital and liabilities whichis same as total of assets.So, you can see here total of capital and liabilities which is 22, so here I have totake base as 22, so it is 3 percent of the total for both the yearsare you getting it, it is very simple, but it gives you lot of insights if you read carefully.Now you can see that out of 100 of total liabilities only 3 comes from share capital is it a goodor bad sign, it is good sign because you can see lot of reserves are accumulated over theperiod.So, only 3 is the money put in by the owners on that 44 percent was generated by way ofreserves, so the total shareholder’s funds where 48 percent now it is 47 percent.Because of reduction in profit there is a slight fall, long term borrowings where 32percent and now they have gone down to 21 percent total non-current liabilities haveof course, fallen in line from 33 to 24.Short term borrowings are actually going up which is a matter of concern from 0 to 7 tradepayables increased from 7 to 20 percent, although there was a fall in other current liabilities.So, overall total current liabilities which were earlier 20 percent have now become 28percent.If you look at assets tangible assets are 80 percent of the total assets is it a goodsign normally yes, because it is a shipping company they have to invest huge amounts inpurchasing the ships they have their own ships that is why this percentage is very high asmuch as 80 percent.Most other figures are very small except that cash equivalents which are around 10 percentwe have to check whether they need that much of cash maybe they have got excess cash also.And current assets in general earlier where 17 percent have become now 19 percent, butwhich mainly comprise of cash other items are very small other items of current assets.So, this is a comparative balance sheet, now this comparative balance sheet sorry thisis a common size balance sheet it can be across the industry compared.In coming case we are going to compare with other peers in the industry, but right nowis this clear to you this is a comparative balance sheet, now let us go to cash flowstatement.Now, we have got cash flow statement for 2 years, now in cash flow the denominator isgoing to be the total cash generated I think total is not given here.So, first we will have to calculate the total, this total you can take as a baseit does not become that much sensible for cash flow statement, but I am just showinghow it can be it calculated, so because there are only 3 figures.So, this is a large amount in from operations though it has come down whereas, the financingactivities it is a negative amount are you getting it.Now, let us go to the next calculation, now is it visible, so here we have taken of financialstatements of 5 leading shipping companies in India we were just talking about comparisonacross the industry peers.Now, this is for shipping corporation of India the company which we were discussing, thenthere is Gujarat Pipavav, GE shipping, Reliance Naval, and Shreyas shipping.So, now, all the figures are given you can see shipping corporation is a industry leaderthey have much more turnover than other companies other companies are relatively small, butwe would try to calculate their profitability now as a percentage.If you look at their profits, profit after tax you will see that the reported net profitof shipping companies shipping corporation is only 135 versus relatively much higherprofits for GE shipping whereas Reliance naval has a huge loss, but absolute figures aredifficult to compare because the base is different.So, what we will do now is we will convert each of these figures into percentage thenit will make much better understanding for us.So, all the figures we will divided by the sales turnover.And, let us converted into percentages I will also copy the headingand I will hide now the actual figures instead of looking at the actual figures it becomesfar better and sensible to compare it as a common size statements.Now, let us see one by one, so here we see that the net sales and if you take differentitems raw material anyway is negligible, but you have a high raw material for I think oneof the figures is not compared.So, here now we are taking all the 5 figures as common size statements and I think theybecome much better comparable.So, let us take raw material, raw material cost is negligible, but for reliance navaltheir nature of business is different.So, they have got significant raw material cost they also are spending large quantumin other manufacturing expenses.Whereas, for shipping corporation the major amount is in other manufacturing instead ofother expenses, but there can be slide different way of classifying it.Now, if you go to profits you will realize that operating profit is 22 percent for ShippingCorporation, but for other peers like Gujarat Pipavav and for GE shipping it is much higher61 percent and 43 percent.It is only 4 percent for reliance and 14 percent for Shreyas shipping, if we go for PBDIT thatis cash profit or Profit Before Depreciation Interest and Tax.Again we get a similar figure, interest expenses are very high for Reliance 110 percent ofthe revenue that is why at PBDT Profit Before Depreciation and Tax Reliance becomes minus97 percent while for others the figures are more or less same.Then the depreciation is 16 percent, but very high for Reliance because they have got verycostly ships and interest burden is also very high on them, you can see here Reliance hasacquired very high cost ships at paying high level of interest.Now, the profit before tax only 5 percent, but very good profit both for Gujarat Pipavavand GE shipping and for Reliance Naval it is significant negative.Of course you should keep in mind that though all 5 are shipping companies, nature of operationslightly differ because some are operating some pores like; Gujarat Pipavav, so theyare making more profits.Now, profit before tax these are the figures, profit after tax again the two companies GujaratPipavav and GE shipping are showing very good profitability and the calculation has beendone right up to p ratio and book value is it clear, this is how comparative statementhelps us to compare the balance sheets and P and L.We will also do it for balance sheet, see different companies are different way of financingthat can be compared and understood from balance sheet analysis.Now, as you know for balance sheet every figure will be compared with the total of assetsand liabilities, we have already done for GE shipping sorry for a shipping corporationwhich now we will also do it for all other peers.Let ushide the actual figures I think will unhide it, because for some time also see the actualfigure then we will go to the percentages.So, you can see the share capital for Shreyas is very small for others is more or less inthe range though for GE it is less it is only 150 crore.If you compare reserves Shipping Corporation has huge reserves as well as GE shipping haslarge reserves, in Reliance the reserves are very less company is continuously earninglosses.See I am not referring to Reliance industries is this Reliance Naval this is a Anil Ambanigroup company.In net worth net worth is very high for shipping corporation pretty high for GE for other companiesit is comparatively less.Secured loans are very high for shipping corporation 0 0 for I think this is Gujarat Pipavav.These shows different way of financing it is a equity finance company you can see nodebt whereas, for GE shipping they have a reasonable quantum of debt, for Reliance thedebt is very high.On a capital of something like 1000 100 of net worth they have 8 times that as a debtand anyway Shreyas is relatively small less debt.You can also look at their gross block, gross block is very high for Shipping Corporationbecause, they own lot of ships somewhat less for GE and other companies have lesser.So, you can understand that other companies are more efficient in utilizing there assetwhich is mainly the ship.Now, I think we will hide the figures and go for comparison with percentage.Let us convert it into percentage terms.So now, you can see this is a shipping corporation they have only 4 percent of the total as sharecapital because they have got substantial reserves, Gujarat Pipavav has even higherreserves, but they have no debt.So, it is mainly financed by share capital plus reserves, now their net worth is 100percent of the total for shipping corporation its 63 of net worth versus 33 of secured loans,for GE shipping it is 53 versus 43.So, if you remember we had discussed about debt equity ratio, debt equity ratio willbe 37 by 60 by 63 for Gujarat Pipavav it is 0, for GE shipping it is 43 by 53, for Relianceit is 88 by 8 because of huge debt and for the last company it is that is Shreyas itis 39 is to 64.Now, if you go to the gross block you will realize that very high gross block 146 percentfor GE shipping, but their ships are relatively older that is why they have lot of accumulateddepreciation net block is 105.Now, if you look at total fixed assets I think it is same amount more or less because onlyReliance Naval has some capital work in progress; total current assets are 20 percent more orless in the same range.Current liabilities are very high for Shipping Corporation maybe because of the loans whichthey have to repay now.And the total the miscellaneous expenses anyway are 0, net current assets are more or lesssame for all the companies, in case of reliance you can see that because of huge losses continuouslytheir net worth is relatively low.So, comparative balance sheet can be compared across industry peer and it helps us for betteranalysis.So, we will continue the analysis of few more companies in coming sessions till now Namaste.Thank you.