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Module 1: Ratio and Financial Statement Analysis

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Namaste. In last few sessions, we are discussing Financial Statement Analysis, particularlyin the last session we have discussed a case of TCS we are we have little bit gone beyondfinancial analysis, we have also taken other information and have calculated the ratiosfor TCS. In the current session and in the next session, we are going to take up RelianceIndustries Limited, we know it is a premier listed company. It is a biggest listed companyin India in terms of its market capitalization. So, we will try to analyze the company ondifferent basis. The type of analysis which we are doing in portfolio management parlance,this is known as fundamental analysis. There are two types of analysis one is fundamental,other is technical. In technical analysis; the price data of thecompany, the volume, the movements of prices, the charts all these things are studied whereas,in fundamental analysis the fundamentals of the company are studied which will mainlyinvolve the financial statements and other data about the company. This part of fundamentalanalysis is known as company analysis, then there is a study of industry or the sectorin which the company is operating that is known as industry analysis and the third partis known as economy analysis, where the whole of the country or whole of the economy isstudied. Now, all this three factors impact the performanceof the company. Of course, we will not be able to go into details of industry or economyanalysis, but we would try to look at how to do company analysis mainly based on theratios…So, let us now, look at the reliance, you know that the MD, CEO and the chairman isMukesh Ambani and the Company Secretary is K Sethuraman, the auditors are Chaturvediand Shah. This is some details face value of the company is rupees 10.. The price is rupees 1255, this is in May 2019;the percentage change during the week etcetera is given. The market cap is 3161428 in termsof rupees millions, the volume you can see is fairly high which shows that the companyshares are very liquid, the number of shares are 6503 millions ok.Now, let us go to the share holding pattern, again it is a Indian company. The percentageof shareholding of promoters is 45 percent. It belongs to Mukesh Ambani group. Indianinstitutions have about 12 percent foreign institutional investors 18 percent. They haveissued securities abroad that is why ADR or GDR is 3.2 percent, free float is 20 percent.What is a free float? That means, these are the shares which are freely traded in themarket which is about 20 percent. The number of shareholders are given. I think this isthe largest number for any company in India 27,90,000 the percentage of shares pledgedby promoters is 0 percent.Now, let us look at the stock market data, this is the high and low prices for last 5years. Average price is also given for last 5 years. The shares outstanding at the endof year in terms of millions is given.Ddo you see any movement in the number of shares?Yes if you look at the last 2 years there is a major rise from 2958 to 5921 and thatis because of the fresh issue of bonus shares. So, they have given bonus ESOS conversionetcetera. So, every year some slight amount of ESOSare given and this year it looks like major rise in the share because of the bonus. Averagemarket capitalization over the period is also given. The number of employees are prettyhigh in terms of thousands so, its 23000 employees and now it is 187000 employees. Now the totalsalary over a period of time is given, I think this needs a bit of correction the numberof employees. So, we will do the correction in the number of employees.Now, the net sales, the net sales data over the period you can see that right from March14 in fact, the net sales have slightly gone down and in the last year again the net saleshave increased the other income is pretty stable.The total revenue went down in first 3 years and then again it has gone up understand thatthey are in oil business. So, oil prices fluctuate their sales are also fluctuating. The grossprofits surprisingly show a pretty stable sign. The gross profit have more or less increasedin all the years except in last year they decreased a bit and again they have jumpedup to 544. Depreciation is a substantial amount. Why it is high compared to that in TCS? Mainlybecause its a manufacturing company, they have got vast amount of fixed assets.So, depreciation is 112 now it has increased to 167. Interest cost is also high and ithas gone up substantially. Profit before tax is increasing steadily, minority interestis also pretty high and this minority interest is because of the shareholding of other peoplein their subsidiaries. There is a extraordinary income in March 14, there is no extraordinaryincome in any other year taxes you can see last 2 years the taxes have increased.And the profit after tax has also increased more or less consistently; the dividend figuresare given over last some years some ok. So, profit after tax and we have taken estimatedfigures of dividend for all the years just for our calculation sake. So, this is theirincome data, now using this we can calculate certain important ratios the first one isgross margin ratio. So, what is the formula, do you remember? It is gross profit dividedby sales. So, it is 8 percent for March 14 please calculate it with me for all the years.So, it becomes 8, then 9 then 17, 15 and 13. So, you can see that in March 16, they weresorry in March yeah March 16 they were able to significantly increase their gross profitmargin. Overall they have a good margin although it is changing over a period of time theyare into several businesses, but mainly in oil refining. So, may be the changes in theoil prices could be responsible for changes in the gross margin.The next is EBDITA. Now what is a full form of EBDITA? Earning Before Depreciation InterestTax and Amortization; this is a cash operating profit. Now we have been given gross profitwhich is almost like a operating profit and we have also been given profit before tax.So, in profit before tax, let us add interest and depreciation to get EBDITA. PBT add interestadd depreciation this is the EBDITA, we will divide it by net sales.So, it is about 10 percent in March 14 over a period of time, it has increased slowlyfrom 9 to 20 and then it is more or less stagnant slightly it has gone down.Now, this is a very important figure to know the cash generated from their operating profits.Now the next one is net profit margin you all know the formula net profit upon sales.But here instead of sales we would take the total revenues. So, net profit was 5 percentwent up to 10 percent is now 8.71 percent as we know mainly because of gross margins,but it also takes into account other income and other figures.Now, let us go to balance sheet data.Now, last time we had studied TCS, but this is important and more interesting becausethis is a manufacturing company which is which has more figures because it invest in varietyof types of assets. Now you can see that their current assets which actually went down andagain have gone up current liabilities are pretty high. If you look at the ratio youwill realize that their current liabilities are much higher than current assets in March18. Inventory as a days because being a manufacturing company has to maintain lot of inventory,it has increased from 48 to 64 and again it went down to 56.Debtors are very low 8, 5, 6, 10 and 16 this is in number of days. So, you will realizethat their credit policies are very strict, they are selling almost on cash basis or witha very minimum credit, but slightly it has gone up to 16 days now.Net fixed assets they are having vast quantum of fixed assets and there is a consistentincrease in the fixed assets which is 5909 now. Share capital has been constant moreor less, but in the last year it has gone up. Free reserves are pretty high amount freereserves are high because consistently they are making good amount of profits. Net worthis also reasonably high. Long term debt being a manufacturing company it is not a zero debtcompany like TCS, they have a high long term debt although the debt equity ratio is notvery high, we will just calculate the ratio now..Total assets they are nearly doubled over a period of 5 years. Now let us calculatetwo important ratios that is debt equity and current ratio. So, you know the formula indebt equity it is debt upon equity. So, long term debt divided by net worth 0.50; eitherit can be expressed as a percent or just as a fraction this time. Let us just keep itas a fraction. So, its 0.51, signifying that for one rupee of equity 50 paise is an amountof long term debt. If you compare all the 5 years, then debt equity ratio increase thebit to 0.61 it has again gone down now till March 18.Now, current ratio you know it is current assets divided by current liabilities.It was pretty high 1.31 and now has decrease substantially to 0.59. Particularly you willsee that because of rise in the current liabilities, the current ratio is falling. Now if you rememberwe had discussed of standard ratio of 2 is to 1 reliance industry has much lesser currentratio than the standard ratio. This could be a bit of problematic as far as the liquidityis concerned although it is a very big company with a high credit rating. So, they are ableto manage even with lesser current assets. Particularly in the last years there is last2 years, there is a remarkable increase in current liabilities maybe that needs to befurther studied.Now, in the third part cash flow is given, you can see in the last year there is a significantincrease in the cash from operations, cash from investments is more or less maintainedalthough in the March 15. It was significantly negative which is a positive sign, but inmost of the years a RI has been able to make some or other investment. Financial activityrelated cash flow also has been more or less constant though there are few fluctuations,but compared to the total size. It is not very high and the net cash flow was minus160, then it became minus 220 and in the last year it is 12660.Now, let us calculate some of the combined ratios. The first one is interest coverageratio now what is a formula do you remember? We see how better the interest is covered.So, how many times they have earning to pay interest? Interest in the denominator andprofits in the numerator. So, you will take which profit in the numerator? Will you takePAT? No because we have to take profit before interest and taxes from that amount we canpay interest.So, let us calculate PBIT, we have been given PBT add interest to that we will get PBIT;this is the profit available for paying interest divided by interest. So, you get 8.28. So,there is a fair coverage although they have got lot of interest payments since their profitabilityis very high, it is covered 8 times the coverage increased now it has slightly gone down.The next one are the efficiency related ratios? We have just considered one ratio here thatis sales to fixed assets ratio. So, it shows how efficiently you are utilizing your fixedassets to generate sales. So, sales divided by fixed assets. Since this is operating relatedwe are mainly considering only net sales and not taking total revenue. So, what do yousee here? There is a serious fall in the ratio. It was 1.81 the ratio has fallen particularlyfrom March 16 and then it has become stagnant, its 0.66. If you look carefully their fixedassets have increased substantially without much increase in the sales in fact, saleswent down and now the sales are steadily rising. But its a very complex company. So, we cannotdirectly know anything, they might be constructing new fixed assets, but the current data asof available right now shows that the efficiency of utilization has somewhat gone down. Nowreturn on assets popularly known as rota r o t a where we will try to calculate how thetotal assets are used to generate profits. So, we will take PAT upon total assets. PATdivided by total assets. So, you get 0.52. So, youcan see 0.05 and if you convert it in percentage then it is more meaningful.So, 5 percent was the return it has gone down to 4.42, it is not a much of a fall, but slightfall in the return on total assets the next one is return on equity. So, equitymeans owners funds and what profits they are able to generate? So, PAT upon net worth.So, 11.32 percent was the return and now it has more or less stagnant it has become 12.29.So, if you remember TCS this return on equity is somewhat lower for reliance.Now, the next one is return on capital popularly known as ROCE or sometimes called as ROI wherewe will take the total return and in the denominator take the total funds debt plus equity. So,do you remember formula? In the numerator we will take PBT add back interest divideit by long term debt plus equity. So, 10.61 percent; in case of TCS it was almost zerodebt company very low debt, but reliance being a manufacturing company has a reasonable quantumof debt. So, you can see the return on capital is slightly lower and now over a period oftime the return has gone up to 13 percent. Keep in mind that it is interesting to studymanufacturing because you get debt plus equity and we have discussed about capital structure.If you know your capital structure there is a higher quantum of debt the return tendsto increase which is known as trading on equity. Now, you can see here that company has somewhatbeen able to improve their return on capital by going for some level of debt ok, but incase of TCS if you remember, the return on capital was much higher because of the effectof tax. Now the next is net working capital to total sales. So, working capital is CAminus CL divided by sales 0.08, you can also take it as a percentage; that means, about8 percent of the capital of the sales is the net working capital..You can see this is very interesting it has moved from 8 percent to minus 32 percent nowwhat could be the reason? Because their current liabilities have increased substantially.So, look at the current assets and liabilities, now the current liabilities are much morethan current assets. So, they are into a negative working capital scenario, that is a reasonwhy the ratio has turned negative in last 3 years.So, really interesting ratio it was 8 percent then became less than 1 percent and its negativein last 3 years. If you look at current ratio you will see it was from 1.31 to 0.59 thesame impact was in terms of sales if you look at, you can get it from this ratio gettingit? So, we will stop here in the next session.We will continue with the calculation of the remaining ratios. Namaste.