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 Finance is the short name for Financial Economics 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 EPS = [(EBIT – Interest) (1-t)]/S

Adjustments Accruals Non-cash charges Other non-operating income Non-recurring income Maintainable 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 Share Capital Reserves & Surplus = Net Worth Liabilities Assets Share Capital Reserves & Surplus = Net Worth Long Term Debt Capital Employed Fixed Assets Investments Current Assets – Current Liabilities 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