FINANCIALSTATEMENTSANALYSISHOWDOIDO?

1
Mr. Yadav is a regular student of MBA and used to attend all the classes, particularly the financial management classes. One day as he was to travel to his home town he missed one class on the topic of financial statement analysis. As he was at his home far from the school, overmailheenquiredwithanotherfriendoftheclassMs.Nehaaboutthetopiccoveredinthe class.Sherepliedthatthefacultydiscussedaboutthebasicsofthefinancialstatementsanalysis andalsomailedthethingstaughtintheclasstoMr.Yadav,alongwiththeassignmentgivenat theendoftheclass.

ASSIGNMENT HEROHONDALIMITED
CorporateProfile2
TheHeroHondastorybeganwithasimplevisionthevisionofamobileandanempowered India, powered by Hero Honda. This vision was driven by Hero Hondas commitment to customer,qualityandexcellence,andwhiledoingso,maintainsthehigheststandardsofethics andsocietalresponsibilities.Twentyfiveyearsand25milliontwowheelerslater,HeroHondais closer to fulfilling this dream. This vision is the driving force behind everything that we do at Hero Honda. We understood that the fastest way to turn that dream into a reality is by remainingfocusedonthatvision. Thereweremanyunknownsbutwekeptfaith,andtoday,HeroHondahasbeenthelargesttwo wheelercompanyintheworldforeightconsecutiveyears.Ourgrowthhaskeptcompounding. Thecompanycrossedthetenmillionunitmilestoneovera19yearspan.Inthenewmillennium, Hero Honda has scaled this to 15 million units in just five years! In fact, during the year in review, Hero Honda sold more two wheelers than the second, third and fourth placed two wheelercompanyputtogether.WithHeroHonda,thedomestictwowheelermarketwasable
ThisdocumentispreparedbyDr.VunyaleNarender,FacultyMemberatIBSHyderabadforuseinthe classroom. 2 AnnualReportHeroHondaLimitedaccessedoverneton12thofOctober,2009.
1

toshowpositivegrowthduringtheyearinreview.WithoutHeroHonda,thedomesticmarket wouldhaveactuallyshrunk. Overthecourseoftwoandahalfdecades,andthreesuccessivejointventureagreementslater, bothpartnershavefinetunedandperfectedtheirrolesasjointventurepartners.Whatthetwo partnersdidwassomethingquitebasic.Theysimplystucktotheirrespectivestrengths.Asone oftheworld'stechnologyleadersintheautomotivesector,Hondahasbeenabletoconsistently provide technical knowhow, design specifications and R&D innovations. This has led to the developmentofworldclass,valueformoneymotorcyclesandscootersfortheIndianmarket. On its part, the Hero Group has taken on the singular and onerous responsibility of creating worldclassmanufacturingfacilitieswithrobustprocesses,buildingthesupplychain,settingup anextensivedistributionnetworksandprovidinginsightsintothemindoftheIndiancustomer. Since both partners continue to focus on their respective strengths, they have been able to complement each other. In the process, Hero Honda is recognized today as one of the most successful joint ventures in the world. It is therefore no surprise that there are more Hero Hondabikesonthiscountry'sroadsthanthetotalpopulationofsomeEuropeancountriesput together! The company's meteoric growth in the twowheeler market in India stems from an intrinsic ability to reach out and come closer to its customers, with every passing year. Hero Honda's bikesaresoldandservicedthroughanetworkofover3500customertouchpoints,comprisinga mixofdealers,servicecentersandstockistslocated acrossruralandurban India.HeroHonda hasbuilttwoworldclassmanufacturingfacilitiesatDharuheraandGurgaoninHaryana,andits thirdandmostsophisticatedplantatHaridwarhasjustcompletedafullyearofoperations.Itis difficulttoimaginethatallthishashappenedinthespanofjusttwoandahalfdecades! The best is yet to come. During the year in review, Hero Honda powered its way in a market that,forallpracticalpurposes,wasfeelingthefulleffectsoftheeconomicslowdowninIndia. Withaneconomicrecoverynowclearlyonthecards,HeroHondaisallsettorideintoanother summit. As Brijmohan Lall Munjal, the Chairman, Hero Honda Motors succinctly puts it, "We pioneered India's two wheeler industry, we've steered it through difficult times; now it is our responsibilitytosetthepaceagain.''

ChairmansAddresstoShareholders:(AnnualReport200809) TworoadsdivergedinawoodandItooktheonelesstravelledby,andthathasmadeallthe difference.ThesememorablelinesbyRobertFrostsummarizesHeroHonda'sodysseyoverthese last25years.TheyalsocapturethespiritoftheIndianpeople,whoprovedallprepollforecasts and predictions wrong to vote in the country's most stable and durable government in two decades.Theprospectofstabilitycouldn'thavecomeatabettertimeforIndia.Asthecountry's GDPgrowthplungedfromaveryimpressive9percentto6percentduringtheyearinreview, the cultureofconsumerismthatpropelledIndiaintheprecedingfouryears, tookabackstage. Familybudgetsshrank,andinmanycompanies,paypacketsbecameslimmer. Expectedly,defaultsalsorose.Asaresult,banksbecameevenmorecautiousinofferingloans, particularlyintownswhereverylittleinformationwasavailabletomeasurethecreditworthiness of a customer. The trend among consumers to postpone purchase decisions and the banks decision to withdraw from certain areas had an impact. The share of financing, which had increasedrapidlyto5060percentofthetotalretailsalesbyearly2007,hasnowcomedownto below30percent.Thiswasamajorsetbackforthetwowheelerindustry,althoughjustlikethe precedingyear,yourcompanybucked the trend.In valueterms, both toplineandbottom line wasupindoubledigits.HeroHondaretailedmoretwowheelersinthedomesticmarketthanthe second, third and fourth placed manufacturer put together. Effectively, this helped your companyboostitsdomesticmotorcyclemarketsharebymorethanfourpercentagepointsand scootermarketsharebythreepercentagepoints. Thehealthygrowthinsalesalsoimprovedyourcompany'sbottomline.EBIDTAmarginsforthe entireyearincreasedby120basispointscomparedtothepreviousyear.Someofthesefinancial numbers are the highest in our 25year history. We are fortunate that these numbers are coincidingwithoursilverjubileeyear.Atthesametime,Iknowtheydonotrepresentapeak,but justthebeginningofaclimbtoanotherhighersummit.AsImentionedintheopening,wetook the road less travelled. When the twowheeler industry started going into a tailspin, our first strategic option was to remain rocksolid as the winds of the global crisis swept across companies, businesses and consumers based in urban India. We certainly spent some time consolidatingourbusiness.Wecontrolledcostsonawarfooting.Ofcourse,plungingcommodity prices helped bring down prices of key inputs such as steel, nickel and aluminum; this in turn

helpedusprunemanufacturingcosts.Yetyourcompanydidnotjustgetlucky;ittookanumber of sound business decisions through the year. To give you an example, your company took a policy decision and resisted the temptation of offering discounts to stir up sales in a tepid market. However, we did not compromise on market development and customer focus; we upgradedourproducts,addedfeatures,introducednewproductsandincreasedouradvertising spends. HeroHondaalsomadeitssupplychainmorerobustwithstrongonlineconnectionsbothatthe front end as well as at the backend. Your company didn't stop at consolidation; it sought to growaswell.AsImentionedlastyear,ourobjectiveasacompanyhasbeentodevelopacross bothIndiaandBharat.Wearestronglyconvincedthatthenewgovernment'splantostrengthen inclusive programs in rural India will create job opportunities and aspiration demand. I have always believed that rural and small town India represents our future. Now, after last year's performance, I am convinced that we have to make rural India also an integral part of our present. We have here a market that has incredible depth. This makes it less susceptible to global economiccyclesandamarketwhereeverygovernmentwhichcomestopowerisguaranteedto investheavily.Althoughyourcompanyhasalwaysconcentratedonbothurbanandruralareas, we have now started adding more muscle to our rural initiatives; some of our efforts have startedpayingoff.Itgivesmegreatpersonalpleasuretoseethatoverthecourseofmylifetime, I am being able to see the gradual evolution of India's villages and small towns: from being survivorstoaspirantsandconsumers.Iremainconfidentabouttheneartermfuture.Ofcourse, therewillbechallengesahead.ButIwouldratherseethemasopportunities.Overthenext12 months,thetwowheelerenvironmentwillbecomemuchmorecompetitiveasmoreplayerstry toenterourhighervolumeexecutivesegment.Wewelcomethisemergingcompetition,sinceit willprovideuswithanopportunitytoproveourmettleonceagain.Thereisalsosomebuzzand anticipation surrounding the lowcost cars. Without doubt, these will be good for India's consumers.Nevertheless,fromtheperspectiveofourindustryandourcompany,Iamconvinced that the twowheeler segment will continue to remain the vehicle of choice by the masses in India. Fuel efficiency and maintenance costs continue to be the most important considerations for the Indian customer today. They will be the most important considerations in the medium

termaswell.TherearemorethansevenmillionnewbicycleuserseveryyearinIndia,andmost ofthemaspiretoupgradetotwowheelers.Thegrowingaspirations,expandingroadnetworks andgrowthofsatellitetownshipsacrossIndiaaresomeofthefactorsthatwillspurdemandfor twowheelers in the near and medium term. These factors will operate as the twowheeler industry's biggest insurance in the coming decades. In my preceding year's message, I talked abouthowstrongcompaniesareonesthatareabletogrowrootsamongtherocks.Theyhave thecapacitytoholdthefort,whileotherbastionsaroundthemcrumble.Championcompanies don'tjustgrowroots,theydevelopfarreachingbranches.
Yours sincerely, Sd/Brijmohan Lall 3 Chairmam

3 Assignment:
Make the necessary financial statements analysis and comment from the income statement and balance sheet on Profitability, Liquidity, Shortterm Solvency and LongTerm Solvency of the firm. For any further information required for analysis the students can access the soft copy of the annual reportoverhttp://www.herohonda.com/invest_annual_reports.htm

10/14/2009

FINANCIAL STATEMENTS ANALYSIS

FINANCIAL STATEMENTS ANALYSIS

1. HORIZONTAL AND VERTICAL ANALYSIS 2. COMMON SIZE ANALYSIS 3. 3 COMPARATIVE ANALYSIS 4. RATIO ANALYSIS 5. TREND ANALYSIS 6. ECONOMIC VALUE ADDED 7. MARKET VALUE ADDED

RATIO ANALYSIS
RATIOS
FINANCIAL RATIOS CAPITAL STRUCTURE RATIOS TURNOVER RATIOS & PROFITABILITY RATIOS

LIQUIDITY RATIOS
1) CURRENT RATIO 2) QUICK RATIO 3) ABSOLUTE QUICK RATIO 4) BASIC DEFENSIVE INTERVAL RATIO

LIQUIDITY RATIOS

LIQUIDITY RATIOS
Current Assets/ Current Current Ratio = Liabilities Current Assets = Cash, Bank, Stock, Bills Receivable, Sundry Debtors, Prepaid Expenses, Outstanding Incomes, etc. Current Liabilities = S. Crs., Bills Payable, Bank Overdraft, Outstanding Expenses, Provision for Tax, Proposed Dividend, etc.

Quick Ratio =
Quick Assets/ Quick Liabilities Quick Assets = Current Assets (Stock + Prepaid Expenses) ( p p ) Quick Liabilities = Current Liabilities Bank Over draft

10/14/2009

Absolute Quick Ratio=

Absolute Quick Assets/Current Liab.
Absolute Quick Assets = Cash + Bank + Marketable Securities or Short Term Investments. Current Liabilities = S. Crs., B/P, O/s. Expenses, Prov. For Tax, Proposed Dividend, Incomes received in advance, etc.

BASIC DEFENSIVE INTERVAL RATIO

= Quick Assets/ Projected daily cash requirements Quick Assets = Current Assets (Stock + Prepaid Expenses Projected daily cash requirements will have to be given in the problem Or otherwise we cannot compute

CAPITAL STRUCTURE RATIOS

1. DEBT-EQUITY RATIO DEBT2. PROPRIETARY RATIO
3. CAPITAL GEARING RATIO 4. FIXED ASSETS RATIO 5. INTEREST COVERAGE RATIO 6.DIVIDEND COVERAGE RATIO & 7. DEBT-SERVICE COVERAGE RATIO DEBT-

DEBTDEBT-EQUITY LONG TERM DEBT RATIO /SHAREHOLDERS EQUITY

LONG-TERM DEBT= DEBENTURES + LOANS+MORTGAGE DEBT, Etc.

SHAREHOLDERS EQUITY=

Equity + Reserves + P & L Cr. + Undistributed profits Fictitious Assets (Preliminary expenses, etc.)

PROPRIETARY NETWORTH/ RATIO= TOTAL ASSETS

NET WORTH= EQUITY+ PREF. EQUITY+ RESERVES + P & L A/C. FICTITIOUS ASSETS TOTAL ASSETS = FIXED ASSETS AND CURRENT ASSETS

FIXED FIXED CAPITAL GEARING = DIVIDEND+INTEREST FUNDS FUNDS RATIO EQUITY SHAREHOLDERS FUNDS FIXED DIVIDEND FUNDS= PREFERENCE EQUITY FIXED INTEREST FUNDS= DEBENTURES OR ANY OTHER FIXED INTEREST LOAN

10/14/2009

FIXED ASSETS FIXED ___________________ ASSETS = CAPITAL EMPLOYED RATIO

INTEREST PROFIT BEFORE COVERAGE =INTEREST & TAX FIXED INTEREST RATIO PBIT = PROFIT AFTER TAX+ TAX+ INTEREST

CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + LONG TERM DEBT

INTEREST = INTEREST ON DEBENTURE OR ANY OTHER LONG TERM LOAN

DIVIDEND PROFIT AFTER TAX COVERAGE = PREFERENCE DIVIDEND RATIO PROFIT AFTER TAX = PROFIT BEFORE INTEREST & TAX INTEREST TAX FIVIDEND PAID OR TO BE PAID ON PREFERENCE EQUITY

DEBTDEBT-SERVICE = COVERAGE RATIO

PBIT INTEREST +
PERIODICAL LOAN INSTALMENT / 1 RATE OF TAX

PBIT = PROFIT BEFORE INTERESTT AND TAX PERIODICAL LOAN INSTALMENT MAY BE FOR THE PURCHASE OF AN ASSET RATE OF TAX WILL BE GIVEN IN THE PROBLEM

TURN0VER RATIOS
INVENTORY TURNOVER RATIO DEBTOR TURNOVER RATIO CREDITOR TURNOVER RATIO INVENTORY VELOCITY DEBTOR VELOCITY CREDITOR VELOCITY FIXED ASSETS TURNOVER RATIO TOTAL ASSETS TURNOVER RATIO

INVENTORY COST OF GOODS TURNOVER = SOLD RATIO AVERAGE STOCK AVERAGE STOCK= O/STOCK+C/STOCK 2 O/STOCK + PURCHCOST OF GOODS SOLD ASES + WAGES + = DIRECT EXPENSES CLOSING STOCK No. OF DAYS IN A YEAR/ STOCK VELOCITY = S.T.R.

10/14/2009

DEBTOR TURNOVER = NET CREDIT SALES AVERAGE DEBTORS RATIO

CREDIT SALES = TOTAL SALESCASH SALES

CREDITOR NET CR. PURCHASES TURNOVER = AVERAGE CREDITORS RATIO CR. PURCHASES= TOTAL PURCHASES CASH PURCHASES CREDITOR = No OF DAYS IN A YEAR VELOCITY CREDITOR TURNOVER RATIO

AVERAGE Drs. = O/Drs+C/Drs./2 DEBTOR = No. of days in a year VELOCITY Debtor Turnover Ratio

FIXED ASSETS TURNTURN-OVER = RATIO

SALES FIXED ASSETS

TOTAL ASSETS TURNOVER RATIO = SALES / TOTAL ASSETS TOTAL ASSETS = FIXED ASSETS + CURENT ASSETS Note: Fictitious assets like preliminary expenses should be excluded while computing total assets.

SALES = TOTAL SALES FIXED ASSETS= ALL FIXED ASSETS AND MAY INCLUDE GOODWILL IF IT IS CONSIDERED AS FIXED ASSET THOUGH IT IS AN INTANGIBLE ASSET

PROFITABILITY RATIOS
GENERAL PROFITABILITY RATIOS: 1. GROSS PROFIT RATIO 2. NET PROFIT RATIO 3. OPERATING PROFIT RATIO 4. OPERATING COST RATIO

GROSS GROSS PROFIT x 100 PROFIT = SALES RATIO

GROSS PROFIT = SALES COST OF GOODS SOLD

COST OF GOODS SOLE = OPENING STOCK + PURCHASES + WAGES +

DIRECT EXPENSES CLOSING STOCK

SALES = CASH SALES + CREDIT SALES

10/14/2009

NET PROFIT = RATIO

NET PROFIT SALES

X 100

OPERATING PROFIT RATIO =

OPERATING PROFIT

X 100 X

SALES

NET PROFIT = SALES COST OF GOODS SOLD OPERATING EXPENSES SELLING EXPENSES ADMINISTRATIVE EXPENSES GENERAL EXPENSES

Operating Profit = Sales Cost of g goods sold operating expenses p g p (including depreciation) & admn. , general, selling & distribution expenses

OPERATING = COST RATIO

OPERATING COST
X100

SALES

RETURN ON CAPITAL EMPLOYED =

PROFIT BEFORE INTEREST & TAX CAPITAL EMPLOYED

Operating Cost = Cost of Goods sold + Operating Expenses + Administration, General Selling & Distbution Expenses

CAPITAL EMPLOYED = Long Term Debt + Shareholders Equity Where Shareholders equity = Ordinary Equity + Reserves & Surplus + Retained earnings/Profit & Loss Account (Cr.) Balance + Preference Equity.

Return On Capital Employed is otherwise known as Return on Investment

PROFIT AFTER TAX RETURN ON = NET WORTH NET WORTH

RETURN ON = EQUITY Equity shareholders funds

PROFIT AFTER TAX Pref. Dividend

Return On Net Worth is also known as Return on Shareholders Equity

Shareholders Equity = Equity shareholders funds + Preference Equity

Equity Shareholders Funds = Ordinary Shareholders Equity +Reserves & Surplus + +R S l Retained Earnings + Profit & Loss A/c. Cr. balance

10/14/2009

RETURN ON TOTAL = ASSETS

PROFIT AFTER TAX

TOTAL ASSETS

EARNINGS PER SHARE

PROFIT AFTER TAX PREF. DIVIDEND No. OF SHARES No. of Shares = Equity capital/ called up capital

DIVIDENDS PER SHARE

DIVIDENDS DECLARED AND PAID NUMBER OF SHARES

DIVIDEND PAYOUT RATIO

DIVIDEND PER SHARE EARNINGS PER SHARE

PRICE EARNINGS RATIO

BOOK VALUE OF SHARE

NET WORTH NUMBER OF SHARES

MARKET VALUE PER SHARE EARNINGS PER SHARE MARKET VALUE PER SHARE = EARNINGS PER SHARE x PRICE EARNINGS MULTIPLE i.e. ratio.