Finance For Non-Finance Managers

Final Accounts
` Final Accounts are prepared at the end of the year to find out results of the business during the year in terms of Profit or Loss ` And the financial Position of the business at the year end in terms of Assets and liabilities. ` In preparing final accounts the accounting principle of showing all the Revenue Expenditure and receipts in the Trading or Profit and Loss Account where as the Capital Expenditure and receipts in the Balance sheets is as followed.

Profit and Loss Account

It is the Account prepared to find out net profit or loss of the business during the period. This is Nominal Account in Nature. Hence All the other expenses and losses should be debited where as all the other incomes and gains should be credited to Profit & loss account. The balance of Profit & Loss Account will be considered as Net Profit(Credit Balance) or Net Loss (Debit balance) and will be transferred to Capital Account.

Balance Sheet
` Balance sheet of an entity represents the position at a particular point of time .i.e, Assets and liabilities of a concern on a given data. ` It is a statement not an account prepared by considering all real accounts and personal accounts. ` Its shows the true and fair view of the concern. ` Assets = Liability + Equity.

Balance sheet

Conti

` Since it is not feasible to draw up a balance sheet after each every transaction, it is usually prepared at the end of a specific period, usually a year. ` This period is referred to as the Accounting period, Fiscal Year or Financial year. ` Managers can easily make decisions by analyzing profit and loss obtained in the balance sheet.

Items Of Balance sheet

Assets Current assets Intangible assets Liabilities Current assets Contingent liabilities

Assets
` It is a probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events. ` Assets are classifies as: 1. Long term Assets or Fixed Assets 2. Short term Assets or Current Assets.

Long-term Assets Or Fixed Assets

Long term assets are those which are held for, with objective of use in the business. A tangible long-lived asset. Usually having a life more than one year. Includes items such as land, buildings, plant and machinery, motor vehicles, furniture and fittings etc.,

Short term Assets or Current Assets

All those held by a firm with the objective of conversion into cash with in the operating cycle or an accounting period. Usually includes items such as cash, accounts receivables, inventory, and prepayments etc.. Apart from fixed and current assets, may be classified into tangible and intangible assets.

Intangible Assets
Any long-term assets useful to the business and having no physical characteristics. Covers items such as Goodwill, patents, and copyrights.

Liabilities
Probable future sacrifice of economic benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. In the balance sheet, all the claims against the assets of the entity, other than the owner(s) claims are liabilities.

Long term Liabilities

Long-term liabilities are usually for more than one year. They cover almost all the liabilities not included in the current liabilities and provisions. These liabilities are secured or unsecured. Usually include items such as Share capital, Debentures and Bonds, Capital reserves, reserves and surpluses.

Short-term Liabilities Currents Liabilities

All those claims against the assets of the firm that are to be met out of cash or other currents assets, within an accounting period or within the operating cycle. Usually include items such as accounts payable, tax or other claims payable, and accrued or outstanding expenses.

Contingent liabilities
` A liability which materialises only on the happening of a future event. ` Example: A liability which may arise out of a pending lawsuit. ` Such items are not listed as liabilities in the body of the balance sheet. ` However, in order to give a fair view of all known facts about the affairs of the firm, contingent liabilities are disclosed as FOOTNOTES to the balance sheet.

How to analyze, What to interpret?? What to analyze, How to interpret??

This can be done, if one is clear with DO s FINANCIAL and DONT s of

STATEMENTS.

Profit & Loss Account.

Convey :
Trading Performance. Primary & Secondary Sources.

Profit & Loss Account.

Does not Convey : Future Performance. Net Income.

Balance Sheet
Convey : Assets and Claims against those Assets. Liquidity. Owner s Claims Residual.

Balance Sheet
Does not Convey :
Process of making Profits. Specific Claims. True and Fair Worth of the Business.

DEFINITION Ratio analysis refers to methods of calculating and interpreting financial ratios to assess a firm s performance. WHY IS RATIO ANALYSIS USEFUL? Provide details for financial planning. Put details into perspective. Manage expectations(creditors and investors).

TYPES OF RATIO COMPARISIONS

1.Cross-sectional analysis 2.Time series analysis 3.Combined(mixed)

1.Cross-sectional analysis
Compares different firms financial ratios at the same time.

2.Time series analysis

Evaluate a firm s financial performance over time.

3.Combined/mixed
Uses both cross-sectional and time series analysis.

TYPES OF FINANCIAL RATIOS

1.Liquidity Ratios 2.Activity Ratios 3.Leverage Ratios 4.Profitability Ratios Note : when commenting on the performance of a firm, be sure to Organize your ideas by these four types of ratios Compare these ratios of the firm over time Compare with the industry averages

LIQUIDITY RATIOS
Definition: Liquidity measures a firm s ability to satisfy its short-term obligations as they come due.
Types of ratios used for analyzing liquidity

1.Current ratio 2.Quick ratio(acid test ratio)

Current ratio=current assets/current liabilities

Current assets=inventory + debtors + cash & bank + receivables + short term loans + marketable investments Current liabilities=creditors + outstanding expenses + short term loans + bank overdraft/cash credit + provision for taxation + proposed dividend

Ideal current ratio= 2:1

Quick Ratio=Quick assets/Quick liabilities

Quick assets=current assets inventory RBD prepaid expenses Quick liabilities=current liabilities bank overdraft cash credit
SIGNIFICANCE:

Ability to meet immediate liabilities Ideal quick ratio=1:1

Activity Ratios(expressed in no. of times)

Definition:

Activity ratios measure the firm s effectiveness at managing accounts receivables , inventory , accounts payable ,fixed assets and total assets
Four ratios

1.Average age of inventory 2.Average collection period 3.Average payment period 4.Fixed assets turnover

Average age of inventory= (no . of days/months *average stock) cost of goods sold
Average stock=(opening stock + closing stock) 2 Cost of goods sold=opening stock + purchases + direct expenses closing stock

Significance : Indicates the number of days

normally the stock are holding

Average collection period = no . of days /months*average debtors credit sales

Credit sales = total sales cash sales sales returns Indicates the no . Of days normally the debtors are paying

Average payment period = no . Of days/months * average creditors credit purchases Credit purchases = total purchases cash purchases purchase returns Indicates the no .of days normally paying to creditors Fixed assets turnover ratio = turnover fixed assets Fixed assets = net fixed assets after providing depreciation
Ability to generate sales per rupee of fixed assets

LEVERAGE RATIOS(expressed in a:b form) DEFINITION: Amount of debt used in an attempt to maximize shareholders wealth Debt equity ratio = debt/equity Debt = long term borrowed funds i.e, debentures , long term loans Equity = equity share capital + preference share capital + reserves & surplus Indicates relationship between debt and equity ideal ratio = 2:1

Coverage ratio (expressed in no .of times) Assess the firm s ability to service the source of financing Interest coverage ratio= earnings before interest & tax interest on long term borrowings Indicates ability to meet interest obligation of the current year ideal ratio = 6 to 7 times

PROFITABILITY RATIOS(expressed in %) Concerning with evaluating a firm s earnings with respect to a given level of sales/assets/owners investment or share value Return on total assets = earnings/net assets Net assets = total assets fictitious assets It indicates whether assets are being utilized properly or not. In other words it indicates net income per rupee of average fixed assets

Return on equity = earnings after tax net worth Net worth = net fixed assets + net working capital external liabilities Indicates profitability of equity funds invested in the business

Earnings per share(EPS) =

earnings available to equity shareholders number of equity shares

Price earnings(P/E) ratio =

market price of share earnings per share

INVESTMENT PROCESS
1. Set Investment Policy 2. Security Analysis(Fundamental and Technical analysis) 3. Portfolio Construction 4. Portfolio Revision 5. Portfolio Performance Evaluation

FUNDAMENTAL ANALYSIS
Fundamental analysis is a method used to determine the value of a stock by analyzing the financial data that is 'fundamental' to the company.

Analysis of fundamental analysis

Understanding the Macro-economic environment and developments. Analyzing the prospects of the industry to which the firm belongs. Assessing the projected performance of the company.

Macro Economic Analysis

Growth rate of gross domestic product Industrial growth rate Agriculture and monsoons Savings and investments Government budget and deficit Price level and inflation Interest rates Balance of payments, forex reserves, exchange rate Infrastructural facilities and arrangements

Industry analysis
The objective of this analysis is to assess the prospects of various industrial groups which helps in suggesting which industries have a brighter future than others and which industries are plagued with problems that are likely to persist for a while.

Three parts of industry analysis

Industry life cycle analysis Study of the structure and characteristics of an industry Profit potential of industries : Porter model

Industry life cycle analysis

Pioneering stage Rapid growth stage Maturity and stabilization stage Decline stage

Study of the structure and characteristics of an industry

Structure of the industry and nature of competition Nature and prospects of demand Cost, efficiency, and profitability Technology and research

Profit potential of industries : Porter Model

Threat to new entrants Rivalry among existing firms Pressure from substitute products Bargaining power of buyers Bargaining power of suppliers

Company Analysis

a) Study of Financials (Quantitative Factors) b) Study of other factors (Qualitative Factors)

Quantitative Factors
Earnings and Dividend Level ROE = Equity Earnings/Equity EPS = Equity Earnings/No. of outstanding shares DPR = Equity dividends/Equity earnings DPS = EPS * DPR

Risk Exposure Beta Required Return = Risk - free return + Beta[Market Risk Premium] Volatility of return on equity = Range of return on equity over n years Average return on equity over n years

 Valuation Multiple Price to Earnings Ratio = Earnings per share for year n Price Per share at the end/beginning or year n

Qualitative Factors
Sizing up the present situation of prospects Availability and cost of inputs Order position Regulatory framework Technological and production capabilites Marketing and distribution Finance and Accounting Human Resources and Personnel Evaluation of management

Estimation of Intrinsic Value

Steps: 1. Estimate the expected earnings per share 2. Establish PE ratio 3. Develop a value anchor and a value range

EPS =

PAT No. of outstanding shares

Constant growth dividend model PE ratio = Dividend payout ratio Required return - Expected growth on equity rate in dividends

Tool for judging undervaluation and overvaluation

Undervalued High Promises of growth

EPS
Dividend of Cows Low Overvalued

High

Low

Duration(1/Dividend Yield)

Thank You