Financial Statement Analysis

(FSA)
Dr. Rachappa Shette,
Associate Professor
rachappa.s@iimk.ac.in
0495-2809422
Indian Institute of Management Kozhikode
 Synopsis of Session 1
1. Course outline of Financial Reporting & Analysis
2. Financial Statements Analysis Preview
3. Two major reasons for analysing financial
statements
4. Analysts’ process of ascertaining intrinsic value
5. Integration of Business, industry, and accounting
using Unidentified Industries case of HBS
 Course Objective
• To become an intelligent user of financial
statements for:
– Equity analysis,
– Credit analysis and
– Forensic Analysis.
 Evaluation
• Quizzes 20%
• Group Assignments 30%
• End-term examination 50%
 Prescribed Text Book

• Financial Statement Analysis. K.R.

Subramanyam and John J. Wild (SW), Tata
McGraw Hill. 10th Edition or 11th Edition
• Soft copy for online as well as offline.
 Pedagogy
• Blend of
– Lectures
– Case discussion
– Problem solving
– Group projects and presentation
 Additional Readings
• The Analysis and Use of Financial Statements.
Gerald I. White, Ashwinpaul C. Sondhi and Dov
Fried. Wiley.
• Financial Statement Analysis & Security
Valuation. Stephen H. Penman. Tata McGraw
Hill
 Business
Environment
& Strategy
Analysis
Industry Strategy
Analysis Analysis

Financial
Analysis
Prospective
Accounting Analysis
Analysis
Analysis
of Cash Risk
Profitability
flows Analysis
Analysis

Intrinsic Value
Cost of Capital Estimate
• What are the various key groups that utilises
various financial statements?
• What purpose do the various groups use the
Financial Statements?
What are the two major reasons for analysing
financial statements?
 Two major reasons for analysing financial
statements
• Determine intrinsic value
• Determine credit worthiness
 Question 1:
• What should suppliers evaluate about their
customers for credit sales?
1. Solvency
2. Profitability
3. Liquidity
4. Business Efficiency
5. Valuation
 Question 2:
• What should lenders (banker) evaluate about
their clients for their credit decision?
1. Solvency
2. Profitability
3. Liquidity
4. Business Efficiency
5. Valuation
 Question 3:
• What should an equity analysts evaluate
about a company for investment decision?
1. Solvency
2. Profitability
3. Liquidity
4. Business Efficiency
5. Valuation
 Credit Analysis
Credit worthiness: Ability to honor credit obligations

Liquidity Solvency
Ability to meet short- Ability to meet long-term
term obligations obligations
Focus: Focus:
• Current Financial • Long-term financial
conditions conditions
• Current cash flows • Long-term cash flows
• Liquidity of assets • Extended profitability
 Equity Analysis
Assessment of present as well as future

Technical Analysis Fundamental Analysis

Charting Determine value without
• Patterns in price behavior or reference to price
volume history
• Analyze and interpret
• Predict future price
– Economy
movements
– Industry
– Company
What type of process should an analyst use to
determine the intrinsic value of a specific
company?
 Business
Environment
& Strategy
Analysis
Industry Strategy
Analysis Analysis

Financial
Analysis
Prospective
Accounting Analysis
Analysis
Analysis
of Cash Risk
Profitability
flows Analysis
Analysis

Intrinsic Value
Cost of Capital Estimate
 Accounting Analysis

Process to evaluate and adjust financial statements to

better reflect economic reality

Comparability problems — across firms and across time

 Financial Analysis
Process to evaluate financial position and performance using
financial statements

Profitability analysis — Evaluate return

on investments
Common tools

Risk analysis ——— Evaluate riskiness

& creditworthiness Ratio Cash
analysis flow
Analysis of — Evaluate source & analysis
cash flows deployment of funds
Prospective Analysis
Process to forecast future payoffs

Business Environment
& Strategy Analysis

Accounting Analysis

Financial Analysis

Intrinsic Value
 Integration of Business, industry, and
accounting

• Unidentified Industries case (HBS)

 Objective of the case

The case is designed to help students

recognize the range of distinctive figures in
balance sheet and in income statement in
different industries.

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 Classification of industries
• Industries with zero inventory
• Industries with fewer collection period days
• Others.

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 Industries with zero inventory
• Advertising Agency
• Airline E, G, M, N
• Commercial Bank
• Health maintenance organization

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 Industries with zero inventory
Company Features Industry
N High AR. Commercial
High AP. Bank
High A/R Collection
Period.
E High A/R Collection Ads Agency
Period.
Low Fixed Assets.
M High Fixed Assets Airline
G HMO

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Industries with fewer collection period days
(less than 30 days)
• In case of under mentioned industries the
payment is made either by cash, debit card or
credit card where the maximum period of
collection is a week or two weeks.
– Bookstore Chain
– Retail Grocery Chain
– Fam Restaurant Cahin
H, I, B, A, K
– Online Book Seller
– Retail Drug Chain
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Industries with fewer collection period days
(less than 30 days)
Company A/R Collection Inventory Turnover F.A to T.A. Ratio
Period
H 2 days 22.3 times 81%
I 4 days 10.2 times 55%
B 7 days 2.7 times 25%
A 12 days 11.4 times 9%
K 16 days 5.7 times 41%

Fam. Restaurant Chain : Highest Inventory Turnover

-H
Online Book Seller : Lowest F.A Ratio -A
Retail Grocery Chain : High F.A. Ratio, high inventory Turnover
- I Retail Drug Chain : High inventory turnover, high F.A ratio
- k Bookstore Chain : -B

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 Other industries
• Online computer vendor
• Pharma manufacturer
• Computer software developer C, D, F, J, L
• Departmental store chain
• Electric and Gas Utility

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 Other industries
Company Inventory F.A. Ratio Inventory to A/R Net Profit to
Turnover Total Assets Collection Revenue
Period
C 79.8 times 9% 2% 36 days 6.4%
D 1.6 times 14% 5% 68 days 15.8%
F 5.2 times 4% 2% 77 days 28.5%
J 2.3 times 36% 22% 41 days 6.3%
L 19.8 times 69% 2% 40 days 6.8%

Online computer vendor : High inventory turnover due to outsourcing and lower
inventory to total assets -C
Computer software developer: High Net Profit Ratio -F
Departmental store chain : high inventory -J
Pharma manufacturer : Higher NP ratio, higher A/R collection period and lower
investment in F.A Ratio -D
Electric
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and Gas Utility : Dr.S.Rachappa
-L 41
 Real Companies
Industry Company
A Online bookseller Amazon.com
B Bookstore chain Barnes and Noble
C Online computer vendor Dell
D Pharmaceutical manufacturer Pfizer
E Advertising agency Omnicom group
F Computer software developer Microsoft
G Health maintenance org Humana
H Family restaurant chain Darden Restaurant
I Retail grocery chain Kroger
J Department store chain Federated Dept. Store
K Retail drug chain Walgreen Co
L Electric and Gas Utility Consolidated Edison
M Airline Southwest Airlines
N
12/26/2023 Commercial bank Dr.S.Rachappa Citigroup 42
 Learning from Unidentified Industries from
India Case
• An analyst should have the knowledge of
distinguished financial figures of different
industries.
• When a company’s financial figures are
different from it’s respective industry's figures,
it has to be further analyzed.

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Any questions?
 Reading:
• Chapter 1 of the course text book.