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Module 1: Ratio and Financial Statement Analysis

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Namaste.In last few sessions, we have been discussing about Analysis of Financial Statements.We have seen horizontal and vertical analysis and we have also discussed variety of ratios.If you remember, we had discussed that one can have any number of ratios linking anyparticular data to some other data and those relationships are much more valuable to theusers of financial statements.So, variety of stakeholders according to their requirement calculate variety of ratios.There can be also slight variations in the formulas they use although most of the ratiosto have a standard formula.So, we have discussed cases of a few companies.Today we will discuss a very important company known as TCS Limited.This is one of the largest companies in India in terms of employment.Perhaps the largest private sector employer and has a very high market capitalizationand it is one good example of a service sector company.So, let us look at their financials and try to calculate different ratios and then commenton the financial statements going for the interpretation of those ratios.We have also taken here apart from financial some other type of data because ratios douse or can be used can use variety of data apart from financial statements.Now, let us look at the TCS.This is their basic information the registered office, their address, name of the directors,name of the auditors and so on.I hope you have done it for your company as a part of the assignment.Now, this is a price and share holding data for the company; so, calculated up to May,2019.Now, this is the latest price, the percentage change in price; the number of shares numberof shares are calculated in millions then the market cap.Do you know what is market cap?No.We have not seen this ratio, but this differs to number of shares into market price.Full form is market capitalization; popularly known as m cap or market cap.This is a very good proxy for the size of the company or you can say the value of thecompany valued at stock market prices because here we are taking stock market price intonumber of shares.Then the volume, do you know what is volume referring to?Here the volume is referring to the number of shares traded.So, when you look it from a stock market angle, high volume indicates more liquidity for thecompany stocks and normally shareholders or prospective investors prefer to invest ina company which has more volumes.So, some basic data which is given we are just looking at.Then PE; we have discussed PE.Do you remember what is it?Price earning ratio according to market prices it will keep on changing.Denominator which is EPS which will change on a quarterly basis, but the numerator whichis market price keeps on changing every now and then.This is the current PE for the company.Then earning per share, percentage change for 1 month, 12 months etcetera are the changesof the market price and 52 week high or low is the low and high market price for the company.So, 273 is a high price 2730 and I think it is only showing part of it.So, I will click here and that will be visible; you can see here 2273 3273 is the highestprice and 17, 2273 is the highest price and 1712 is the lowest price.So, this is generally known as price and share holding data.It is already given, but I am just those who are more interested in stock markets, youcan easily download this data and study more about the company from stock market angle.Now, the share holding data this is a Indian company this belonging to Tata group.So, Indian promoters have 72 percentage holding.Foreign collaborators, there is no collaboration so, 0 percent.Indian Institutions and mutual fund have just 2 percent holding FIIs or Foreign InstitutionalInvestors have 16 percent holding there is no ADR or GDR.Are you aware what is ADR or GDR?This is American Depository Receipt or Global Depository Receipt.So, company can issue it shares in foreign market using these instruments, but sinceTCS has not done.This is 0 percent free float that is the stock which is freely available in the market, itis 28 percent.Shareholders percentage is 616.This is the number of shareholders and pledged promoters holding.So, whether promoters have pledged their holding and taken loan that is just 2 percent whichshows more stability for the company.If it is higher it means that promoters have taken lot of loans using their stake ok.So, this is some share holding data.Now, let us go to financials.So, we have got financial data for last 5 years.Again in that there is a equity share data.So, first of all you have got price data.You can see over last 5 years, the market prices have been this.This is the higher market prices and this is the low market price ok.Now, the average market cap this is one of the high M cap company.So, current average market cap is 5232.Number of employees I have told you, it is one of the largest employers in India in thousandsis 300 that is 3 lakhs; this 300,000 is the and the current is 395,000.So, around 4 lakh is a number of employees.Total wages or salary which is also given in rupees millions it is.So, it is 663960 millions.This is the total salary.Then bonus rights or conversions some code is given for the same.Then shares outstanding, this is the number of shares which are outstanding it is 1914.So, those shares which are issued and have not yet been cancelled these are shares outstanding.Above also we had been given number of shares data.Now, let us go to income data which is mainly extracted from their profit and loss account.So, this is the sales for last 5 years; current sales is 1231.You can do a trend analysis because the information is made available for last 5 years.Then, other income which is not much so, you get total revenue which is currently 1267then, gross profit which is 325.The balance is of course, their cost of providing services because it is mainly a service company.Depreciation which is not much of amount which is 20000 millions since this is a manufacturingcompany their depreciation is relatively low.Interest cost you can see is very low.Why it is low?Because the debt must have been very low.We will go to balance sheet now.Then profit before tax, you can see reasonably consistent increase in profit although inthe current year the profit has stagnated.Minority interest is given in last 2 years; right now there is no minority interest.Now, what is meant by minority interest?This is the data for the whole group.So, group will have various subsidiaries and there might be some shareholders who haveshares in the subsidiary.Although our company that is TCS has majority holding there might be some small shareholdersin those subsidiary companies.Their holding or their share in the owners fund is called as minority interest whichwill come whenever any consolidated balance sheet is given.Now, currently there is no minority interest those companies might have been merged withTCS.Then prior period items, what is a prior period item?These items are last years mistakes or errors; if they are rectified in a particular yearthey are required to be separately shown as a prior period item which is not the case,so, it is 0.Extraordinary items into bracket expense.So, in most of the years it is 0 except in 1 year where it is 4898.Then tax and the last figure over here is profit after tax.So, the whole P and L will would have been very long.So, a kind of summary of P and L is given and we have been asked to calculate certainratios.So, one is a gross margin ratio, then effective tax rate and net margin ratio.Now, how will you calculate gross margin?What is a formula?Do you remember the formula?Very simple, we are trying to link gross profit to sales.So, compute the gross margin ratio.So, this is equal to gross profit divided by net sales.So, you get 0.30 you can convert it into percentage for better understanding.So, 31 percent is a gross margin or gross profit percent.So, if you compare 5 years, what do you get?It is 31, 26, 28, 27 and 26 which shows that margins are in pressure.In 2014, their margins were pretty high 31 percent; now it is only 26 percent.Gradual fall in the margin is seen.Getting it?Next is effective tax rate.Please calculate with me.So, we have got tax amount.Now, this is what percentage if you want to know it as a percentage.So, what is a formula?This tax is to be divided by what?It is charge on which amount?Actually it is charge on profit before tax.So, this shows 23 percent.In terms of percentages, it has come to 24.So, you can see in all the years it has remained stagnant; it is 24 percent.Now, what is the actual rate of tax for the companies?The maximum marginal rate is 30 percent or 33 percent including surcharge.Most of the companies do some investment and their effective rate of tax is low and theymight also get some benefits because of export or because of some investment at certain places.That is why we need to calculate effective tax rate which you can see here is 24 percent,Getting it?Next is net profit margin.Net profit margin is nothing, but net profit ratio.So, we will calculate the net profit after tax as a percentage of which figure, you willget?Net sales.Net sales or other income or total revenue.Normally here total revenue is more relevant.See, in case of gross profit we had taken it as a percentage of net sales, but for netprofit we are normally going for total revenue because net profit includes all profits includingother income, but yes if you want to calculate it as a percentage of net sales then thatcan also be done.So, it comes to 23 percent.Over the period it has also fallen from 23, it has slowly gone down and it is now 20 percent.Why there is a fall in net profit?Mainly because of fall in the gross profit.In fact, other income has increased especially from 2015 and that would have help to slightlytake up net profit ratio, otherwise all other calculations are more or less same.Are you getting me?So, we have calculates calculated some of the important profit related ratios.Now, we can also go for balance sheet and try to calculate sum of the balance sheetrelated ratios.Before that if you want to have some idea about the cost, you can be asked about calculatinghow much their how much is their cost of sales as a percentage of profits.So, can you calculate it?You can calculate you can take the gross margin and 100 minus gross margin, you will get thepercentage of their cost of sales ok.So, let us also try to calculate that ratio.You can also call it cost of providing service because it is mainly a service company.One easy way of doing, it is just finding it from the gross margin; otherwisewe can calculate the cost of sales here and then divided by net sales; cost of sales uponnet sales or one minus the gross margin either way you can get it.You can see here the cost of sales is slowly going up and that increase has put pressureon the gross margin which in turn has also brought down the net margin.Are you getting it?.Let us go to now the balance sheet data.Have a look at the balance sheet first.The current assets are slowly going up same way their current liabilities are also goingup, but at a slower rate.You can see their current liabilities are much lesser than current asset.Then net fix assets also show slow raise although the major raise was in 2015 after that itis more or less stagnant.Then free reserves sorry share capital.Share capital is more or less same although it has been reduced now in terms of rupeesmillions.Then the free reserves- free reserves are steadily going up net worth also is steadilygoing up the company has been in profit for a very long time that is why they are ableto build up their free reserves.What is a net worth?Net worth is nothing, but the owners fund.The net worth also has been slowly increasing and as you know share capital plus free reservesgive us the net worth.Then you get long term although net worth may not be exactly that amount because therecould be some other reserves also in some cases.See this is not the full balance sheet we have just been given some extracted and importantfigures.Now, long term debt it is very low it is just 1273 and now it is 540.So, company is mainly relying on the owner’s fund.They hardly have any debt and whatever little debt they have that also they are slowly repaying.Total assets, this is the figure of their total assets which has been steadily risingespecially if you see last year March this is I think March 17.There was a major increase in the total assets ok.Now, let us try to calculate these two ratios; debt to equity ratio and current ratio.Now, what is the formula of debt to equity?Normally we take long term debt as a percentage or of or divided by net worth or we can alsosay borrowed fund upon owners’ fund.If you go for a percentage it will be 0 percent I will just increase the decimal it becomes0.26 percent which is very low.Sometimes it is calculated as number of times, but since this amount is so small that numberof times will be just 0.2.Now, is it good to have such a low debt equity ratio if you remember we had discussed aboutdebt equity ratio of 1, 2, 3, 4 also sometimes; that means, debt was much more than the debtby than the equity maybe 2 times or 3 times.Now, is it good to have low debt equity?Answer is yes.We have discussed that higher debt equity leads to un stability whereas, a lower debtequity is a stable position; that means, from risk perspective lower debt equity is alwaysgood, but it may impact profitability adversely.But, what happens is in case of companies like IT companies, they do not require veryhigh quantity of capital.For a manufacturing or for an infrastructure company there is a need of a huge capital.So, they can justify more debt equity ratio their income streams are also more stable.But, for a IT company or for a service sector company their main capital is human capitalor their main capital is their brain.It is not in the tangible form so, does not need too much of fixed asset, so, does notneed too much of capital.So, they do not have normally have high level of debt equity ratio.So, it is good that they have low debt equity ratio.In fact, they have further brought it down.There are companies like Infosys which most of zero debt company because they are completelyfinanced by equity.Now, this was about their long term stability.Now, let us look at their liquidity for which we will calculate current ratio.Now, what is the formula of current ratio?Do you remember?It is current assets divided by current liabilities.So, please calculate along with me CA divided by CL.So, you get 2.73.Normally, it is not calculated as a percentage.So, we will drag it over a period of time it has consistently increased.So, from 2.73 now it is 4.55.Of course, in the last year it had come down a bit.So, is it a good sign?Normally yes because we have discuss that debt equity ratio of 2 is to 1 is consideredas standard although that standard can change from company to company.So, here we see that company has much higher debt equity ratio than the minimum requiredwhich is a positive sign from liquidity angle.Although one can raise a question as to why current assets are though that high comparedto current liability?For further analysis we may require more data like their aging schedule or like their debtlike their debtors collection period, to see whether their collection period is too high.But, as of now based on available data this is a good sign as for as liquidity is concerned.Now, next are cash flow related information.So, all the three types of cash flows are given; cash from operations, investments andfinancial activity.So, you can see here cash from operations is consistently rising, although in the lastyear it has become somewhat stagnant.Cash from investments was negative; high quantum negative.Last year also it was negative in the current year it is positive.Now, it is a good sign that it is it a good sign that it is positive now?Not necessarily, although normally we feel positive is good, but if investment side cashflow is positive it means that there is no much of fresh investment.So, having a negative cash flow from investment is in fact, good.Of course, just by one year we cannot conclude because over 4 year period they have got anegative cash flow there.Cash from financing activity has been most years negative because they have been payinggood amount as a dividend and do not have a to really raise a much of the funds sincethey are getting good amount of cash flows from operations.So, overall you can see that net cash flow was has been maintained well.In fact, it was much higher positive figure in 2016, then negative figure one year andagain it has become positive.So, overall their cash flow position looks fine.So, we have just have a look at all the three statements.Now, in the coming session we are going to continue with calculation of various ratios.So, I will request you all to sit with that sheet and try to calculate the ratios alongwith me.Till that time let us break.Namaste.