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

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

3. 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

4. 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?

5. 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

6. Markets Financial Market Securities Market Capital Market Money Market
Primary Market
Secondary Market
Commodity Market
Derivative Market

7. Corporate Finance
Goal
Decisions to be made

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

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

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

11. 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

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

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

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

15. 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.

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

17. 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

18. 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

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

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

21. Credit Perspective Interest Coverage Ratio Debt Service Coverage Ratio
Debt/Equity Ratio
Total Liabilities/Equity Ratio

22. Equity Perspective
P/E
P/B
D/E
Dividend Yield

23. 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