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Module 1: Ratio and Financial Statement Analysis

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Namaste. In last few sessions, we are discussing Analysis of Financial Statements and in thelast session we had taken up case of TCS limited. So, TCS Limited, you all know is a leadingIndian MNC which is one of the largest private sector employer in India.And, we had discussed their market data, equity market data, then income data, balance sheetdata and cash flow. And, we had also calculated some basic ratios related to P and L and relatedto balance sheet.Now, let us go for their combined ratios. By combined what I mean is one figure is pickedup from one statement, the other one is picked from the other statement. Some of the ratiohas have also been calculated on the extra information which is provided by the companyok. So, first one, now the formulas for the ratios are pretty simple almost common sense,but let us try to calculate the important ratios and observe the trends in it.Now, first one is Exports to Sales. So, what is a formula here? We are trying to look atthe export as a percentage of total sales. So, exports are given only for first 2 yearsand we will divide it by their net sales which comes to about 3 percent. I am sorry not 3percent, it is just 0.32 percent in March 14, and was 0.5 percent and in more currentyears it in the figure has not been given. So, it is just 0 amount.The next one is net working capital to sales. Now which is the important ratio for workingcapital? We have seen that for liquidity we normally calculate current ratio, which wehave already calculated.But, here we just compare between current assets and liabilities between two balancesheet items. But if we know working capital is mainly required to finance the operations,which is required to finance the day to day business activities.So, one way to know the adequacy of working capital is to link it to the revenue whichwe generate or the sales which we generate using that working capital. So, the ratiowhich is calculated is net working capital to sales.(Refer Slide Time: 03:56)So, now the working capital figure is not given although we have been given currentassets and current liabilities. So, compute CA minus CL which will be working capitalfor the numerator and divided by sales.So, CA minus CL this is the working capital divided by shall we take total revenue ornet sales both the figures are possible, but since working capital is mainly for our ownbusiness operations, not for other income it will be more authentic to take net sales.So, it comes to 0.33 you can see gradually it is going up from 0.33, then 0.36, it wentto 0.55 and in last year it has slightly come down to 0.51. So, what does it mean that companyis now keeping more and more working capital. So, for one rupee of sales they had 0.33,now it is almost 0.5. Now is it a good sign? Not necessarily theyare from liquidity angle it is good, but they are keeping too much of too much of workingcapital. They are having slightly higher working capital than required as I said we need tocheck from audit angle the composition of their debtors, because they do not have anyinventory. So, their major current assets are the receivablesfrom customers. So, they need to be checked. Do you remember any other ratio which is similarto this ratio? We had discuss that ratio earlier, that ratio would be sales to working capital,which is known as working capital turnover ratio, which is just a transposition of thisratio though it is not required in the case, I will just try to calculate it. So, I amwriting it down here. You know that there are turnover ratios which we calculate toknow the efficiency in use of that particular asset.So, to know the efficiency in use of working capital, we can calculate working capitalturnover ratio. What is the formula sales upon working capital? So, let us take netsales and divide it by working capital. So, again in bracket, we have to take sorry thereis some confusion in bracket we have to take CA minus CL.So, you can see the working capital turnover ratio is slowly going down; it has gone downfrom 3 to 1.94. What does it show; it means the efficiency of use of working capital hasbeen falling. Actually net working capital to sales and working capital turnover ratiois showing the same thing. I have just calculated it again to make you understand that differentratios can be used actually to calculate the same thing.Now, the same thing can you calculate one more ratio for it, do you remember we havediscussed that ratio. We can express this working capital turnover ratio in terms ofnumber of sales number of days of sales, let us do that also. So, that you get even moreclarity this we will call it as working capital in terms of days the formula is already withyou. So, try to calculate it. So, working capital days we will use the transpositionnow. So, it will be 1 divided by the turnover ratio, it is 1 upon I do not know why it isnot taking 1 upon C. So, you will get the ratio into if you want to do it in terms ofnumber of days we will multiplied by 365. So, you get 121 days. So, from 121 it hasgone up to 187. So, in a year of 365 days if a particular amount is locked up in theform of working capital earlier it was 121 it has now gone up to 187 days, which is youcan understand is a very high amount; that means, almost for half the period of the yeartheir working capital is locked up. It is normally suppose you sell some item you cangive a credit for 2 months, 3 months, 4 months, which we will mean a 90 days or 120 days period,but here it is very high it is 187. So, all these 3 ratios actually were essentially sameconveying the same meaning, but in a different way. Are you getting it?Now, next one is sale to assets ratio. Now this is similar to this working capital turnover,but it refers to the total assets. So, now, the total assets are used to generate sales.So, we will take the total revenue here. Because, we are going to divide it by total assetsand we will divide it from the balance sheet we get total assets, we will divide it bythat. So, we get 1.24. So, you can see there is more or less stagnancyin this ratio although it ratio increased in 2015. It has now fallen to 1 point fallena bit, but still better than slightly less than March 14 1.19; that means, 1 rupee ofassets are converted into sale of 1.19 still norm compared to other industries it is aratio on a lower side ok. So, this is showing efficiency in utilization of total assets.Now, next is ROTA, Return On Total Assets or Return on, Assets as it has been calledhere. So, in the denominator as the name suggest, we will take the total assets, here returnsignifies profitability. So, the final profits which you earned or profit after tax dividedby total assets give you return ratio on total assets. So, take profit after tax in the numeratorand from balance sheet take total assets, we get 0.28 normally we will express it asa percentage. So, here you see that the ratio has been fallingearlier they were able to generate 28 percent return on the assets, which has now come downto 24 percent. So, more assets are getting locked up relatively giving lesser profitability.Now, from the equity shareholders angle what could be interesting to them is return onequity or return on owner’s fund. So, what is a formula return is profit. So, PAT, Propertyafter Tax divided by equity or owners funds. So, let us calculate it PAT divided by networth 0.38 let us express it as a percentage. So, 38.96 percent was return in March 14 slowlythe return has been falling. Mainly because of lower profitability they are able to generatelesser return than equity. Now, the next one similar ratio, but very important ratio isreturn on capital. Now, what is the difference in return on equityand return on capital? Return on equity is a return only on equity shareholders money,return on capital is a total capital employed. Although this company does not have much debt,but normally it is capital that is owners fund plus debt, taken together what is thelong term capital. And, what do you take in the numerator; numerator also we will notjust take PAT we will take PAT plus tax plus finance cost ok.So, I will put this in bracket return on capital is equal to we have been given profit aftertax add taxes or we could have also taken PBT directly and to this we can add interestor the finance cost, divided by in the denominator. We are going to take totallong term capital. So, we will take again put it in bracket net worth sorry it got closednet worth plus so, net worth plus long term debt.So, now you got 0.51 this is for the March 14 debtors. So, 0.51 slowly it has come downto 40 percent, sorry not 0.51 51 percent in as a percentage and it has gone down to 40percent. So, because of the falling margins the returnon the capital employed has also fallen. Why is it higher than return on equity? Because,now you are taking profit before taxes, since this company is more or less 0 debt company;there was no much effect of interest. Because of addition of taxes the return oncapital or long term capital is much better, and if you compare with return on say bank,bank might give you 8 or 9 percent return whereas, TCS is able to earn as much as 51percent return on their capital and on owners funds it is 38 percent.So, for most of the healthy companies it should be on a higher side are you getting it. So,these return ratios are very important for owners as well as for anybody who wantingto take over the company or who wants to study the company from a long term angle.Now, next is sales per share, now this is one of the hybrid ratio, this is not a financialratio per say, because denominator is number of shares, but shareholders might be interestedto know that how much sale is generated for one share. So, it is sales. So, we will takethe data of net sales and let us divide it by number of shares. They have given thisshare outstanding data e o y means at the end of the year. So, we get 417 since allthe data is in rupees million, this is also in rupees million.So, for one share I will copy it here. So, for one share they are able to generate 417millions of sales you can see there is a gradual rise. So, company is able to increase, itis revenue. Although it is profitability is in sort of pressure. Now the next is earningper share this refers to as you know profit available per share. So, what is a formulawhich profit will you take, operating profit, profit before tax or after tax you will takeprofit after tax. In fact, if there is a preference dividend we will deduct preference dividendalso. So, PAT or profit available to the ownersshould be in the numerator right now let us take PAT, profit after tax divided by numberof shares. So, you can see earning per share has been increasing gradually. Because company’stotal profit is going up although profitability is falling a bit total profits are rising.So, earning per share is also slowly going up.Next is cash flow per share. Now some shareholders may not be happy just by knowing the earning,they would probably be interested in knowing the cash generated per share, again we donot know whether they want total cash flow or whether they want operating cash flow pershare, probably they are looking for operating cash flow.So, let us go for this is a new formula. So, note the formula cash flow per share operatingcash generated from operating activities divided by number of shares. So, you can see thereis a good rise from 75 to 130 more or less consistent rise in the cash flow from operatingactivity per share basis, next is dividend per share. So, how much money is company distributingas a dividend, which will be received on a per share basis.So, it is simple now we will take total dividend and divide it by number of shares. I thinkhere dividend data is not available. So, you will not be able to calculate dividend pershare. Let us check once again no dividend data is not available.Now, the next one is dividend yield. Now, what do you mean by dividend yield; that means,as a percentage what return you are getting based on dividend. So, it is dividend uponwill you take number of shares no. If you take dividend upon share capital, you willget the rate of dividend declared, but they are talking about market yield.So, we will take dividend upon market price of the share or DPS upon market price sincewe do not have dividend data, we are not able to calculate dividend yield also, but it isalready given on in as a share information above I will just show you.So, they have given here dividend yield which is 0.7 percent this is the current dividendyield we do not have 5 year data, but the current yield is known to you. The next oneis book value per share. Now, this is a very interesting and a important information. So,net worth is the value which shareholders will get we divided by number of shares toknow that if the company is closed today, how much money will each shareholder get pershare basis. So, please take net worth and divide it bynumber of shares. So, from 251, you can see consistent rise to 443; that means, companyis slowly earning profits and adding reserves. So, their book value is going up.Now, price upon sales ratio this is referring to market prices. Now, I think market priceinformation is not available for all the years yeah it is there. So, average market cap isgiven, but we are not been given number of we have not been given average market price,let us check again high and low market price is given, but average is not given. So, wewill not be able to calculate price per share ratio average PE ratio that is price uponEPS, again we need average price and we divide it by earnings. So, we cannot calculate thisalso. Next is price to book value ratio again inabsence of market price we do not know, but this is a important ratio which links marketprices to book value, we have just calculated book value.Next is dividend payout. So, this is based on the dividend; dividend upon thecurrent market price sorry dividend payout is a percentage of amount which is distributedas a dividend from the profits. So, it is dividend upon profit or d p s upon e p s.So, we do not know dividend data. So, we do not know this.Now, there are 3 last ratios which are interesting, because they are related to number of employees.Average sales per employee, average wages per employee and average net profit plus peremployee, this we can calculate because we know the number of employee data.So, let us go for it. Sales divided by number of employees. So, it was 2722 in rupees millionand it has slowly increase to 3116, this is the revenue generated by one single employee.Now, let us see what employees get for it that is their wages. Now, total salaries andwages are given and divide it by number of employees. So, you may want to be employeeof TCS perhaps, because 993 million was that time and today it is 1680 million for everyemployee single employ and net profit. So, we will take net profit after taxand divide it by number of employees. So, 637 per employee and now it is 655. You cansee it is more or less kind of stagnated because profitability is under pressure although thesalaries of employees has increased quite healthily ok. So, this was an attempt to doto show you how a detail analysis is done by especially the analyst who are trying tostudy a particular company in detail. So, in next session, we will try to take anothercompany till that time study this carefully Namaste thank you.