Finance and Financial Statement Analysis Sunder Ram Korivi

Finance and Financial Statement Analysis Sunder Ram Korivi National Institute of Securities Markets

Agenda • Concepts of Finance • Decisions in Finance • Financial Markets • Securities Markets • Assets, Liabilities, Income, Expenses • Capital Structure Analysis • Credit Analysis • Cash Flow Analysis

Finance is the short name for Financial Economics is a branch of Economics Youngest but one of the fastest growing branches Has been recognized through Economics Nobel awards: Harry Markowitz, James Tobin, Franco Modigliani, Merton Miller, William Sharpe, Eugene Fama, Robert Shiller, Myron Scholes, Robert Merton. • Financial Economics has four sub-components • (1) Corporate Finance, (2) Investment Theory, (3) Portfolio Theory, (4) Financial Institutions & Markets • The four compartments are inter-connected and have an intense influence on valuation. Fama-Miller framework of asset pricing; dimensions of time and risk • •

Finance Quiz • Which is the oldest bank in the world? • What is the origin of the word ‘bankrupt”? • Oldest insurer in the world? • Which is the oldest company in the world? • Did the company form of organization evolve in one step? • Did the primary market and secondary market evolve separately? • How did the bond markets evolve? • Where did the mortgage markets evolve?

The Ascent of Money by Niall Ferguson • Oldest bank - Siena : Monte de Piachi • Oldest insurer: Lloyds Coffee House on Tower Street, London • Oldest company: Dutch East India Company, VOC, Amsterdam • French Government Bond Market • Danish Pfandbrief

Markets • Financial Market • Securities Market • Capital Market • Money Market • Primary Market • Secondary Market • Commodity Market • Derivative Market

Corporate Finance • Goal • Decisions to be made

Ezra Solomon, 1952 • Goal: Shareholders’ Wealth Maximization • Decisions: • Investment Decision • Financing Decision • Dividend Decision

More questions • Why do we organize business as a firm? • Why does a firm need to grow?

How is value created? • Accounting information • Market information • Value Creation Model, with examples

Income Statement • • • Sales Other Income - Material Costs Employee Costs Other Operating Costs - Depreciation & Amortization - Interest & Financial Charges = PBT - Income Tax = PAT / S (No of Shares) = EPS

Income Statement • • Sales - Variable Costs = Contribution - Fixed Costs, including Depreciation & Amortization = EBIT - Interest & Financial Charges = PBT • Risk can come from leverage

Income Statement (Contd) • EBIT • - Interest • = PBT • - Income Tax • = PAT • / S (No. of Shaares) • = EPS • Financial leverage and taxes have an offsetting impact

EBIT-EPS Analysis • EBIT • - Interest • = EBIT – Interest • - Taxes • = (EBIT – Interest) (1 -t) • EPS = [(EBIT – Interest) (1 -t)]/S

Adjustments • • • Accruals Non-cash charges Other non-operating income Non-recurring income Maintainable expenses Segment results Related party transactions End of period adjustments (Quadrophobia); D/E not known Need to correlate with macro data; turning points.

Balance Sheet • Share Capital • Reserves & Surplus • Long Term Debt / Instruments? • Short Term Debt / Instruments? • Contingent Liabilities • Related party transactions

Balance Sheet • Fixed Assets (Net of Depreciation) • Investments: Strategic and Liquid • Current Assets: Inventories, Receivables, Pre-paids, Advances, Cash • Current Liabilities: Payables, Provisions, Statutory Dues • Net Current Assets • Deferred Revenue Expenditure • Related party transactions •

Balance Sheet Liabilities Assets • Share Capital • Reserves & Surplus • = Net Worth • Fixed Assets • Investments • Current Assets – Current Liabilities • Long Term Debt • Capital Employed • Total Assets

Cash Flow Statement • Cash from Operations • Cash for Investment Activities • Cash from Financing Activities • Opening Balance • Closing Balance Analysis: • OCF / Sales • OCF / Total Assets

Du Pont Analysis • PAT/PBIT (Financial Performance) • PBIT/Sales (Margin) • Sales/TA (Volume) • TA/Long Term Debt (Coverage) • Long Term Debt/Equity (Leverage)

Credit Perspective • Interest Coverage Ratio • Debt Service Coverage Ratio • Debt/Equity Ratio • Total Liabilities/Equity Ratio

Equity Perspective • P/E • P/B • D/E • Dividend Yield

Concluding Remarks • Due Diligence Review: Business, Financial, Technical, Legal • Look at firms as a going concern • Low P/E and Low P/B may provide ominous signals • High P/E and High P/E may signal froth