FINANCIAL ANALYSIS It is a powerful mechanism, which helps in ascertaining the strength & weakness in the operations & financial

position of an enterprise. In short, it measures profitability & financial soundness of an enterprise. Significance of financial analysis Financial analysis diagnoses the strength & weakness of enterprise, which helps in planning for future. By understanding the past, the future course of action (objectives & policies) can be prepared to reach the goals of enterprise. Techniques of Financial analysis The Techniques/tools adopted for financial analysis are listed below Comparative financial statements Common size financial statements Trend or percentages Funds flow analysis Cash flow analysis CVP analysis Ratio analysis RATIO ANALYSIS Ratio analysis is a powerful tool adopted by financial analysts for understanding financial position & performance of the enterprise. Ratio Ratio is a mathematical statement, which express the relationship (specifically a comparison) between two quantities that may or may not involve same kind of quantities. The ratios are generally expressed following notations Fraction Percentages. Fractions: Generally fraction means a part of the whole. Mathematically fraction bar / indicates division to find quotient. This notation when used in ratios analytically gives deeper insights about the two quantities taken for the ratio. Example: 1.Very useful in comparison of two items ex: If I have two-thirds (3/4) as many notebooks as Harry, this implies a ratio of 3 to 4 (I have 3 notebooks for each 4 that Harry has). 2.Determing the optimal requirement Suppose that in an eco-system, the optimal ratio between deer and forage is 1 deer to 2 tons of forage per square mile (1/2).

3. Selection of objects from a group on some basis (part of a group) Suppose there are 23 books of varying size and content on a shelf where 14 of them are novels. We can represent this situation by the fraction 14/23. In this case, we mean by 14/23 that 14 out of the 23 books are novels. Percentage: A percentage is a way of expressing a number as a fraction of 100 (per cent meaning "per hundred"). Percentages are very useful to express how large one quantity is relative to another quantity.

Financial ratios The relationship between two accounting figures expressed mathematically is financial ratio. Financial ratios may just indicate the quantitative relationship, but is very useful to make qualitative judgement about the enterprise profitability & financial position. This ratio when compared with past ratios, projected ratios, and competitor ratios, industry ratios gives deeper insights about performance & financial position of the enterprise. Financial ratios are calculated using the basic financial statements (viz. profit & loss account and Balance sheet) information. Classification of ratios According to financial activity or function to be evaluated the ratios are classified into the following categories Profitability ratios Liquidity ratios Turnover ratios Stability ratios Valuation ratios The operating efficiency ie performance of the enterprise is ascertained using Profitability ratios, Turnover ratios. The financial position of the enterprise is ascertained using stability ratios, liquidity ratios. OPERATING EFFICIENCY(PERFORMANCE) RATIOS The operating efficiency of the enterprise is said to be good, if it able to generate good expected returns on the capital invested & able to rotate the investment in operations speedily. The operating efficiency is evaluated by using the following ratios Profitability ratios Turnover ratios.

Profitability ratios Profitability means ability to earn profits for sufficiently long period of time. Profitability Ratios show the efficiency with which business operation are carried on & how successful a company is in terms of generating returns on the Investment that it has made in the business. We evaluate the profitability of the enterprise using two types of ratios 1. Margin ratios: Evaluates profitability in relation to sales 2. Returns ratios: Evaluates profitability in relation to investment. Margin ratios Margin means Excess/deficit sales amount left after expenses is deducted. Margin ratios give us the profit margin earned on sales. It indicates the Management efficiency in conducting the normal business operations. Margin ratios are calculated using the formula Margin ratios = Margin Sales 1.Gross Profit Margin ratio Gross Profit is defined as the difference between sales and manufacturing cost of goods sold. The gross profit Margin ratio measures efficiency of production & pricing strategies. Significance It indicates the extent to which the enterprise is successful in producing products at less cost & generates more sales using effective pricing strategy. Desired Relatively higher margin is desired when compared. As a higher margin relative to industry or competitor implies higher efficiency in producing each unit of product. Formula: Gross Profit Margin = Gross Profit*** Net Sales *** Gross profit=Sales-cost of goods sold. Example: Net Sales (from Income Statement)=$ 34,922 Adjusted Gross Profit (calculated) =$ 22,635** Gross Profit Margin=(22,635/34,922 )*100=64.82% **($34,922 -12,287=22635) The Interpretation The Cisco Company makes

2. Net Profit Margin ratio: Net Profit is amount left after deducting operating expenses, interest and taxes from gross profit. The Net Profit Margin measures the overall management efficiency in production, administration, selling & pricing, financial & tax management. Significance The ratio measures the ability of firm to convert every dollar of sales into profit. Desired Relatively higher margin is desired. A higher margin relative to industry or competitor implies management is efficient in conducting the affairs of business. And the enterprise with high net Profit Margin can withstand competition and adverse conditions like rising costs/expenses, falling or declining sales prices & demand. Formula: Return on Sales or Profit Margin = Adjusted Net Profit Net Sales Example Net Sales (from Income Statement)=$ 34,922 Adjusted Net Profit (calculated) =$ 7785** Profit Margin=(7785/34,922 )*100=22.29% **(adjusted EPS should include soe , but in statement we adjusted eps excluding soe. So, we need include it. The computation of inclusion SOE is done in the following way : $ 8,374-931+342=7785) The Interpretation The Cisco Company makes $22.29 on every $1.00 of Sales

For each dollar of sales, we generated $ 22.29 of profits.

Note Above I & 2 ratios should be used jointly for more meaningful interpretation of profitability. For eg: we have the gross profit margin is increasing over years, but the net profit margin is not increasing as much as Gpmargin which clearly indicates that operating expenses relative to sales are increasing. 3.Modified Net Profit (Operating Profit) margin ratio The operating profit margin ratio is variant of net profit margin ratio. Operating profit is the amount left after deducting operating expenses from

Gross Profit. Formula: Modified Profit Margin = Adjusted Operating Profit* Net Sales * After tax Adjusted Operating Profit figure will be more appropriate. The operating margin ratio is calculated for true comparison of operating performance of enterprise. We need to ignore the effects of interest and tax effects as we may give misleading information about the operating performance when we are comparing firms with different debt ratios. Returns ratios Returns ratios gives information about the returns earned on investment. It indicates the Management efficiency in utilizing the owners capital and assets to generate returns on investment. Returns ratios are calculated using the formula Returns ratios = Equity Earnings Average Assets/equity

4. Return on Assets (ROA) The Return on Assets of a company determines its ability to utilize the Assets employed in the company efficiently and effectively to earn a good return. Significance The ratio measures the percentage of profits earned per dollar of Asset. Formula: Return on Assets = Adjusted Net Profit x 100 Average Total Assets

For more meaningful comparison of operating efficiency the below formula is used Return on Assets = Adjusted Operating Profit x 100 Average Total Assets Desired Relatively higher ratio is desired. As a higher ratio relative to industry or competitor implies good use of assets. Example

Adjusted Net Profit (calculated) =$ 7785 Total Assets (from Balance sheet) =($53,340+ 43,315)/2= 48327.5 Return on Assets = [ $7785/ $48327.5] x 100=16.11% The Interpretation: Company generates 16.11% return on the Assets that it employs in its operations.

5. Return on Equity or Net Worth (ROE) The Return on Equity of a company measures the ability of the management of the company to generate adequate returns for the capital invested by the owners of a company. Significance: The ratio depicts how well the firm has used the resources of owners & able to maximize the wealth of shareholders or owners. Formula: Return on Equity or Net Worth = Adjusted Net Profit x 100 Average Net Worth or Owners Equity*** ***Net Worth or Owners Equity = Total Assets (minus) Total Liability Desired Relatively higher ratio is desired. As a higher ratio relative to industry or competitor implies good use of shareholder funds. Example: Adjusted Net Profit (calculated) =$ 7785 Total Assets (from Balance sheet) = $ 53,340 Total Liability(from Balance sheet)= 21,850 Net Worth or Owners Equity=$ 53,340-21,850=31490 Return on Net Worth = [ $5,142 / $133,522] x 100= 24.72213% The Interpretation: Company generates a 24.7% percent return on the capital invested by the owners of the company. 6.Return on Invested Capital (ROIC) The return on invested capital is variant of ROE. ROIC measures how efficiently the capital is invested in operations. Formula: Return on invested capital = Adjusted Operating Profit * Average Net Worth or Owners Equity*** x 100

***Net Worth or Owners Equity = Total Assets (minus) Total Liability * After tax Adjusted Operating Profit figure will be more appropriate. Asset Management/Turnover Ratios

Asset management ratios measure the ability of assets to generate revenues or earnings. They compliment the liquidity ratios.
Turnover means rotation. Turnover or Activity ratios are employed to evaluate the efficiency with which the capital employed is rotated. Higher rotation depicts effective utilization of assets. It calculates the speed or rate at which assets are converted into sales. To find which part of capital is efficiently employed we calculate the following ratios 1.Fixed Assets turnover ratio The fixed assets turnover ratio measures the efficiency with which the firm has been using its fixed assets to generate sales. When compared with previous period it indicates whether the investment in fixed assets has been judicious or not. Formula: Fixed assets turnover = Net sales Average fixed assets Desired Relatively higher ratio is desired since it indicates better efficiency in fixed assets utilization. Some analysts like to compute total assets turnover. This ratio shows firms ability in generating sales from all financial resources committed to total assets.

Formula: Total assets turnover = Net sales Average Total assets 2.Capital Turnover Capital Turnover measures our ability to turn capital over into sales. We have two sources of capital viz Debt and Equity.

Formula: Capital Turnover =

Net Sales Average capital employed*** ***Capital employed =Interest Bearing Debt + Shareholders Equity

3.Working Capital turnover ratio The working capital is obtained by deducting current assets from current liabilities. The working capital turnover indicates whether or not working capital has been effectively utilized in making sales. Significance It determines how much working capital is utilized for generating sales. Formula: Working capital turnover = Net sales Average working capital Desired High ratio is desired. As high ratio means the working capital utilized is less .It is an indicates of the high operating efficiency of the enterprise. 3.Inventory turnover These ratio measures how many times did enterprise turn the inventory over during the

year?
Significance It also tells the firms efficiency in selling the product. Formula: Inventory turnover = Cost of goods sold Average inventory Desired

Higher turnover rates are desirable.As higher ratio indicates more usage of inventory
and more will be sales. Example Cost of goods sold (income statement) = 12,287 Average inventory =1322+1371/2= 1346.5 Inventory turnover=12287/2693= 9.125139 ( The Interpretation: It holds holds inventory for 360/9.125=40 days. Within 40 days the inventory is converted into sales

FINANCIAL RATIOS The financial ratios indicate the financial position of the enterprise. An enterprise is said to be financially sound, if it is in a position to carry on its business smoothly and is able meet its both short & long-term obligation without strain. In short a sound enterprise will be able to meet short-term needs with liquid assets & long term needs with long term funds (debt & equity). The financial position is ascertained by short-term & long-term solvency of the enterprise, which are measured by liquidity & stability ratios respectively. Liquidity Ratios Liquidity means amount of liquid assets possessed. Liquidity ratios are employed to ascertain short-term solvency of the company. This ratio measures the ability of a company to meet short-term obligations as when they become due. Liquidity is extremely essential for enterprise to meet its obligation. Failure to meet s will result in the total failure of the business, as it would be forced into liquidation. An optimum ratio is desired as high ratio as it indicates assets are lying idle and very low ratio as it indicates insufficient liquid assets. The ratio which are employed to ascertain the sufficiency & lack of liquidity are described below 1.Current Ratio The ratio is regarded as a test of liquidity for a company. It shows the number of times short-term liabilities are covered by current assets. If the value is greater than 1.00, it means fully covered. Significance: This ratio indicates the availability of CA for every one rupee of CL. The formula: Current Ratio = Total Current Assets Total Current Liabilities

Desired The ratio should be optimal neither two high nor too low. As too low indicates may lead to insolvency and too high indicates inefficient use of capital. The ideal ratio is 2:1. The logic is that in a worse situation, even if CA becomes half, the enterprise will still be able to meet it obligation.

Example Total Current Assets(from balance sheet)= 31,574 Total Current Liabilities (from balance sheet)=13,358 Current Ratio =31,574/13,358=2.363677 The Interpretation: Company has $2.363 of Current Assets to meet $1.00 of its Current Liability as the value is greater than 1.00, it means fully covered. 2.Quick Ratio The ratio is regarded as an acid or strongest test of liquidity for a company as inventory is eliminated from current assets. Ability to meet current obligations with most liquid assets, without selling off inventory. It shows the number of times short-term liabilities are covered by quick assets. If the value is greater than 1.00, it means fully covered. Significance: This ratio indicates the availability of most liquid assets for every one rupee of CL. The formula: Quick Ratio = Total Quick Assets*** Total Current Liabilities ***Quick Assets = Total Current Assets (minus) Inventory Desired The ratio should be optimal. The ideal ratio is 1:1 as the enterprise should have atleast funds to meet its obligations. Example Total Current Assets(from balance sheet)= 31,574 Inventory(from balance sheet)= 1,322 Quick Assets =31574-1322=30252 Total Current Liabilities (from balance sheet)=13,358 Quick Ratio =30252/13,358= 2.26471

The Interpretation: Company has $2.264 of Quick assets to meet $1.00 of its Current Liability. 3.Cash Ratio The ratio is variant of quick ratio. The ability of the company to meet its current obligations with cash and cash equivalents. Formula: Cash Ratio = Total cash Assets Total Current Liabilities Cash Assets = Total Cash +market securities(or Trade investments) Example: Total Cash (from balance sheet)= 3,728 Trade investments(from balance sheet)= 18538 Cash Assets =3728+18538=22266 Total Current Liabilities (from balance sheet)=13,358 Cash Ratio = 22,266 /13,358= 1.666866 The Interpretation: Company has $1.666 of cash to meet $1.00 of its Current Liability.

5.Accounts Payable Period An account payable period/credit period enjoyed measures speed with which the enterprise pays its own bills. Accounts payable /bills are created as the firm when the purchases are done in credit. If firm is able to pay accounts payable promptly indicates sufficiency otherwise lack in liquidity. Therefore, this ratio is considered to be test of liquidity for the enterprise.

Significance: The accounts payable period/Age of accounts payable indicates the days taken by firm to pay its bills.

Formula: Accounts payable period ratio =

360 Accounts payable Turnover***

***Accounts payable turnover =

Sales*

Average Accounts Payable**** * Sales data not available then COGS can also be used. Accounts payable = Trade creditors + Bills payable.

Desired The desired is optimal as too low indicates enterprise is not taking full advantage of available credit facilities and too high indicates enterprise inability to pay creditor thereby loosing creditworthiness. Example Cost of goods sold (income statement) = 12,287 Average Accounts Payable (calculated)= (786+880)/2= 833 Accounts Payable Turnover =12287/833= 14.7503 The Interpretation: The company takes 360/14.75 =25 days to pay its suppliers.

6.Accounts Collection Period The account collection period measures speed with which the enterprise collects its account receivables. This is a yardstick to measure effectiveness of the company's credit policies & collection efforts. Accounts Receivables/books debts are created as the firm sells goods for credit. The book debts are included in CA since they can to be converted into cash within short period of time. The book debts have to be collected efficiently otherwise this has to be converted into bad debt ultimately resulting in decline the liquidity position of the enterprise. Therefore, this ratio is considered to be test of liquidity for the enterprise. Significance: The account collection period/Age of account receivable collection indicates the days taken by firm to collect its book debts Formula: Account collection period ratio = 360 Accounts Receivable Turnover***

***Accounts Receivable Turnover =

Revenue*

Average Accounts Receivable

Accounts Receivable Turnover measures the number of times we were able to convert our receivables over into cash. Higher turnover ratios are desirable.
* Sales data not available then COGS can also be used. Desired: The desired is optimum as too high indicates enterprise is too liberal or generous granting credit or is having difficulty collecting and too low indicates enterprise has very restrictive credit & inefficient collection policy which dampens the sales & liquidity position. In general, Ideal is 3-4 months. Example Revenue (from income) = 34,922 Average Accounts Receivable (calculated)=3989+3303/2=3646 Accounts Receivable Turnover=34922/3646=9.58 The Interpretation: The company takes 360/9.58 =38 days convert its accounts receivables into cash. Operating Cycle

Operating Cycle determines the number of days the enterprise takes to generate cash from current assets.
Formula:

Operating Cycle = Number of Days in Receivables + Number of Days in Inventory. So on average, it takes us 260 days to generate cash from our current assets.

Stability ratios Stability ratios are employed to ascertain long-term solvency of the company. Evaluation of long-term solvency is done from following aspects 1. Whether the firm has used appropriate debt equity mix & used the debt option intelligently to maximize the shareholders wealth 2. Whether the firm has raised adequate resources for long-term funds requirements. 3. Whether the firms earns enough to meet interest obligation.

The ratios calculated to ascertain long-term solvency from the above aspects are listed below Leverage ratio Coverage ratio Leverage ratio Leverage means increased means for accomplishing some purpose .

Financial Leverage is a measure of how much of equity and debt are used to finance the assets to magnify the return to its owner or shareholders wealth.
Leverage ratios indicate the proportions of debt & equity in the capital structure of the enterprise. In short it indicates the debt-equity mix adopted by the enterprise to maximize shareholders wealth. The leverage ratios which judges the soundness of long-term financial policies of the enterprise are described below 1.Debt ratio The debt ratio measures the extent to which the enterprise has relied on riskier source of financing debt .In otherwords, it indicates the proportion of debt in the capital structure of the enterprise. Significance: This ratio gives the proportion of lender contribution in the capital structure. Formula Debt ratio = Total debt*** Capital employed*** ***Total debt =short-term Debt + long-term Debt ***Capital employed =Total debt +Total Equity It also gives you the owners contribution in capital structure of the enterprise. As Capital employed =Total debt +Total Equity, so (1-debt ratio) =owner contribution Desired An optimal ratio is desired as high ratio indicates increase in liability, which may lead insolvency. A low debt ratio indicates equity option is used more, but it dilutes the controlling stake also decline in returns on investment per shareholder. It is always desirable to use debt option if cost of debt is less than the rate of return on CE. 2.Debt/Equity or = Total debt*** Total assets

The debt/equity ratio is determined to ascertain the soundness of long-term financial policies ie whether the firm has used appropriate debt-equity mix to maximize the shareholders wealth. Significance: This describes the lender contribution to each pie of owners contribution The formula: Debt/Equity = Total debt / Total Equity Desired The desired ratio is optimal. But ideally 1:1 is said to be appropriate mix. Example Total debt (calculated) =6408 Total equity (from balance) =31480 Debt/Equity =6408/31480= 0.203558 The Interpretation: Here owner contribution is more & debt is less. Coverage/Adequacy ratios The coverage ratios ascertain whether sources for meeting the debt commitments (interest obligation) are adequate or not. In short the coverage ratios are used test to enterprises debt servicing capacity. 1.Interest Coverage The extra amount paid/got on the funds provided/taken is interest charges. The interest coverage ratio measures a company's ability to meet its interest obligations with income earned from the firm's primary source of business. In short, a measure of the creditworthiness of a company. Significance: It tells the whether the earnings of the enterprise is adequate to meet interest obligation. The formula: Interest Coverage = Operating Income Interest Expense or EBITDA Interest Expense

Desired A higher ratio is desired. Ideally 1.5 or greater is said to be appropriate to meet the interest obligation. Example Operating Income (calculated)= 10,325 Interest expense=377

Interest Coverage =10325/377= 27.38727 The Interpretation: 27.38 times the interest charges are covered by funds. 4.Operating expense coverage ratio This ratio assesses a firm ability to meet its regular/daily expense by liquid assets. Significance: This ratio gives the days the most liquid assets will be sufficient to finance the operations. Formula: Interval measure ratio = Quick assets Total operating expenses Variant

Interval measure ratio

Quick assets Average daily operating expenses

Desired The ratio should be high. A high ratio is desired, as the enterprise will be able to meet cash requirements for a longer time period.

2.Cash debt coverage ratio The cash debt coverage ratio measures what proportion of debt the current cash flow can retire. The formula: cash debt coverage ratio = FCF***-Dividends Total debt ***FCF(free cash flow)=CFO-NWC-CAPEX or FCF=EBIT(1-taxes)+DA- NWC-CAPEX Desired An optimal ratio is desired. Ideal is 1:1. 3. Capital adequacy ratio

The Capital adequacy ratio measures whether the firm has raised adequate longterm funds to finance the fixed assets requirements. Capital adequacy is test of enterprise capitalization. As capitalization is a process of determining the quantum of long-term funds that an enterprise required in running its business. The formula: Capital adequacy ratio = Fixed assets Long-term funds*** ***Long-term funds =Equity +Total debt Desired An optimal ratio is desired. Ideal is 0.67.

Market Value/Valuation Ratios It indicates how the equity stock of enterprise is assessed in capital market. These ratios indicate sensitivity of share price W.R. earnings & cash flows generated by the enterprise. They also indicate the expectations of investors future growth prospects of the enterprise. The valuation ratios are regarded as the most comprehensive measure to gauge the enterprises performance. Investor ratios are used in corporate finance for a variety of purposes, including assessing the effects of proposed financing (e.g. on earnings per share); valuing a target company in a takeover (e.g. using the price/earnings ratio); analysing dividend policy (e.g. using the payout ratio); Market Capitalisation Market capitalization (or MCAP) represents the aggregate value of a company or stock. In essence, it is the price one must pay to buy an entire company. It is a measure of corporate size. Formula: It is obtained by multiplying the number of shares outstanding by their current price per share. MCAP= Price * Shares Outstanding Example: Price as on 7/8/2007 = 29.69 Shares outstanding as on 7/8/2007 =6100 millions Mcap = 29.69*6100= 181109 million or 181.1 billion.

The sensitivity of share price W.R. earnings of the enterprise is determined using below mentioned ratios Price/Earnings Price/Book value or Price/Equity Price/Cash Flow Price/Free Cash Flow 1.Price/Earnings It indicates investors judgement or expectations about the future performance of the enterprise. This is considered as yardstick for market appraisal of enterprise performance Significance: It tells how much an investor is prepared to pay for a companys shares, given its current earnings per share (EPS). Formula P/E = Price / EPS

Desired A high ratio is desired. The higher the P/E ratio which indicates the higher the premium an investor is prepared to pay for the share. This occurs because the investor is extremely confident of the potential growth and earnings of the share. Example Price as on 7/8/2007=29.69 EPS (calculated)=1.246 P/E= 23.828 Interpretation Investor is willing to pay $23.83 for $1 of current earnings. 2.Price To Book A ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. For the banking and finance companies, book value is calculated as 'share capital plus reserves minus miscellaneous assets not written off. This formula then takes care of the bank's NPAs and gives a correct picture. Significance: This ratio is tells whether a stock is under or over-priced.

Formula: Price to book =price/book value per share Example Price as on 7/8/2007=29.69 Shareholders equity or book value = 31,480 Shares outstanding as on 7/8/2007 =6100 millions Book value per share=5.16 Price to book=29.69/5.16=5.75 Interpretation Investors are paying $5.75 for $1 of value of asset in book. 3.Price/Cash Flow A measure of the market's expectations of a firm's future financial health. Formula Price/Cash Flow = Share price/cash flow per share*** ***Cash flow per share=Cash Flow from operations/common shares outstanding Example Price as on 7/8/2007=29.69 Cash Flow from operations (cash flow statement)= 10,104 Shares outstanding as on 7/8/2007 =6100 millions Cash Flow per share=10104/6100=1.656 Price/Cash Flow per share =29.69/1.656=17.93 Interpretation Market Expectations of the firm is that 1 dollar of cash flow today the company will earn 17 times in future. 4.Price/Free Cash Flow A valuation metric that compares a company's market price to its level of annual free cash flow. This helpful to companies for making decision on need to maintain or expand their asset bases (capital expenditure) to either continue growing or maintain the current levels of free cash flow. Formula Price/Free Cash Flow = MCAP/Free cash flow *** ***FCF(free cash flow)=CFO-NWC-CAPEX or FCF=EBIT(1-taxes)+DA- NWC-CAPEX

Example Mcap = 29.69*6100= 181109 million Free cash flow =10104-1251=8853 Price/Free Cash Flow=181109/8853=20.46 Interpretation This means company trades at 21 times free cash flow To ascertain the growth prospects of the enterprise the following ratios are employed. 1.Yield/returns ratio This is a measure of the rate of return earned by shareholders. Yield = dividend yield + capital gains/losses yield. Dividend yield = Dividends per share / Initial price Capital gains/losses yield = Price change/Initial price The dividend yield ratio indicates the return that investors are obtaining on their investment in the form of dividends. Capital gains/losses yields indicate capital growth on their investment in the form of an increased share price. Desired Low dividends yield ratio & high Capital gains/losses yield ratio. As this means the enterprise has a superior growth prospect (so company has given less in the form dividends to use these funds for further growth). Dividend Cover This ratio measures the extent of earnings that are being paid out in the form of dividends Desired Low dividends pay out is desired. Generally, the low growth companies have higher dividend pay-outs and high growth companies have lower dividend pay-outs. 5.Enterprise Value EV is a measure of theoretical takeover price. It answers the question "what would it cost to buy this business free of its debt and other liabilities. Formula: EV=Market Cap + Total Debt Total Cash & Cash equivalents Mcap (calculated) = 181109 Total debt(calculated)=6408 Total Cash & Short Term Investments= 3728 EV=181109+6408-3728= 183789

Interpretation We can buy cisco at 183789 million.

Profit Margin x Asset Turnover x Financial Leverage = Return on Equity

APPENDIX

Adjusted EPS Total debt

Cash flow ratios

can fit into any of the above categories but typically replace earnings data with cash flow data. They are useful in situations where the investor is concerned about earnings quality.

Just as the interest coverage ratio could be expressed using cash flow rather than accounting income, other ratios can be

adjusted to represent cash flow rather than accounting income as well. Here are a few examples: Cash flow solvency = (Cash flow from operations)/(Total liabilities) Cash flow margin = (Cash flow from operations)/ (Revenue) Cash flow ROA = (Cash flow from operations)/(Average total assets) A high cash flow solvency ratio indicates that the company has plenty of cash flow to settle obligations. A low ratio could be an indication of financial distress in the future. A high cash flow margin or cash flow return on assets indicates that the company generates large amounts of cash flow relative to revenues or assets - a good sign. In addition, cash flow from operations can be compared to net income to estimate earnings quality. A higher ratio of (cash flow from operations)/(net income) typically indicates higher earnings quality. Also, the ability of the firm to invest in future growth can be determined if the ratio of (cash flow from operations)/(capital expenditures) is higher than one. This indicates the company is able to fund capital expenditures out of operating cash flows.

Free cash flow

This cash flow represents the return to all providers of capital, whether debt or equity. It can be used to pay off debt, repurchase shares, pay dividends or be retained for future growth opportunities.

Price multiples are a useful way to compare the valuation of a stock over time, against comparable companies or the market as a whole. These multiples are a ratio of the stocks current market capitalization to one of its underlying accounting fundamentals such as book value (total owners equity), sales or net income. Because investors are usually more familiar with share price rather than market

capitalization (share price x shares outstanding) the accounting fundamentals are often converted to a per-share basis when using price multiples. The most common price multiples are: Price to earnings (P/E) = (Share price)/(Earnings per share). Since earnings are meant to approximate the money available to shareholders, the P/E ratio expresses how much the investor pays for each dollar of earnings. This is the most frequently used price multiple. Price to book value [P/B] = (share price)/(book value per share). This compares the value of the firm today with the capital provided to the company over time. Price to sales (P/S) = (share price)/(sales per share). This ratio can be useful for valuing cyclical companies where earnings tend to be more volatile than sales, or situations in which a firm temporarily has little or no earnings. A high multiple indicates that the market is wiling to pay a high price relative to the underlying fundamental value such as earnings. A company may trade at a high multiple becasue it has high growth prospets and future earnings are expected to be higher than past earnings. A low mulitiple indicates that that the stock is not valued highly - perhaps it has low growth prospects, high risk or is simply undervalued by the market. Value investors tend to search for companies trading at lower multiples than peer companies.
Ratios are generally grouped into the following categories: Activity ratios indicate how efficiently and effectively a company manages its operations and assets. Liquidity ratios demonstrate the firms ability to meet its immediate obligations. Solvency ratios indicate whether the firm can meet its long-term obligations. Profitability ratios illustrate whether the company can cover its costs and have money left over to reinvest in growth opportunities. Cash flow ratios can fit into any of the above categories but typically replace earnings data with cash flow data. They are useful in situations where the investor is concerned about earnings quality. Price multiples are a form of ratio that indicates whether the firm is currently valued relative to peers, the market and its own history. Ratio of Operating Cash Flow to Current Debt Obligations

The Ratio of Operating Cash Flow to Current Debt Obligations places emphasis on cash flows to meet fixed debt obligations. Current maturities of long-term debts along with notes payable comprise our current debt obligations. We can refer to the Statement of Cash Flows for operating cash flows. Therefore, the Ratio of Operating Cash Flow to Current Debt Obligations is calculated as follows: Operating Cash Flow / (Current Maturity of Long-Term Debt + Notes Payable) Ratio Analysis Ratio Analysis is the most commonly used analysis to judge the financial strength of a company. A lot of entities like research houses, investment bankers, financial institutions and investors make use of this analysis to judge the financial strength of any company. This analysis makes use of certain ratios to achieve the above-mentioned purpose. There are certain benchmarks fixed for each ratio and the actual ones are compared with these benchmarks to judge as to how sound the company is. The ratios are divided into various categories, which are mentioned below: Profitability ratios Profitability ratios speak about the profitability of the company. The various profitability ratios used in the analysis are, operating margin (operating profit divided by net sales), gross margin (gross profit divided by net sales) net profit margin (net profit divided by net sales), return on equity (net profit divided by net worth of the company) and return on investment (operating profit divided by total assets). As obvious from the name, the higher these ratios the better for the company. Solvency ratios These ratios are used to judge the long-term solvency of a firm. The most commonly used ratios are Debt Equity ratio (total debt divided by total equity), Long term debt to equity ratio (long term debt divided by equity). While the accepted norm for debt equity ratio differs from industry to industry, the usual accepted norm for D/E is 2:1. It should not be more than this. For certain industries, a higher D/E is accepted, e.g., in banking industry, a debt equity ratio of 12:1 is acceptable. Liquidity ratios These ratios are used to judge the short-term solvency of a firm. These ratios give an indication as to how liquid a firm is. The most commonly used ratios are Current ratio (all current assets divided by current liabilities) and quick ratio (current assets except inventory divided by current liabilities). The accepted norm for current ratio is 1.5:1. It should not be less than this. Turnover ratios These ratios give an indication as to how efficiently a company is utilizing its assets. The most commonly ratios are sales turnover ratio, inventory turnover ratio (average inventory divided by net sales) and asset turnover ratio (net sales divided by total assets). The higher these ratios, the better for the company.

Valuation Ratios Valuation ratios give an indication as to whether the stock is underpriced or overpriced at any point of time. The most commonly used ratios are Price to Earnings (P/E) ratio and price to book value (PBV) ratio. But care has to be taken while interpreting these ratios. While P/E ratio of a company should be compared with the industry P/E and the P/E of the competitors, it is the PBV that can distort. While a lower PBV usually means a lower valuation, there can be a case where a low PBV can be because of a very huge capital base of the company. In such a case, the stock might be overvalued but the PBV will indicate that the stock is undervalued. On the other extreme, a higher PBV usually means overvalued stock but that can also be because the company has a very small capital base. So care has to taken while interpreting these ratios. Coverage ratios These ratios give an indication about the repayment capabilities of a company. The most commonly used coverage ratios are Interest coverage ratio (Interest outstanding divided by earnings before interest and taxes) and debt service coverage ratio (earnings before interest and taxes plus all non cash charges divided by interest outstanding plus the term loan repayment installment). The acceptable norm for DSCR is 2:1.

funds flow vs Cash flow statement The funds flow statement is a report on the movement of funds or working capital. It is a summary of a firms inflow and outflow of funds. It tells us from where funds have come and where funds have gone. Cash flow statement or statement of cash flows is a financial statement that shows how changes in balance sheet and income accounts affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
Funds Flow Statement vs Cash Flow Statement

The cash flow statement is different from the fund flow statement in its approach. The difference between the two can be summarized as follows: 1. The fund flow statement is based on the concept of working capital, whereas the cash flow statement is based on cash which is only one of the elements of working capital. 2. The fund flow statement provides the details of funds movements, whereas cash flow statement provides the details of cash movements. 3. Fund flow statement considers the movement of the funds as defined in terms of net working capital, whereas the cash flow statement considers only the actual movement of funds. 4. In fund flow statement, net increase or decrease in working capital is recorded while in cash flow statement; individual item involving cash is taken into account. 5. Funds flow statement is started with the opening cash balance and closed with the closing cash balance records only cash transactions, whereas cash flow statement is started with the opening cash balance and closed with ht closing cash balance while there a no opening or closing balances in Funds Flow Statement.

Funds Flow Statements preparation Funds flow statement, also referred to as the statement of changes in financial position or the statement of sources and uses of funds, gives a clear picture of the movement of funds in a certain period. A simple funds flow statement can be arrived at by comparing the balance sheets at the stating of the period with the balance sheet at the ending of the period. The term fund refers to net working capital.
Process of Preparing a Fund Flow Statement

Funds Flow Statements is prepared in two parts - The first one is sources of Funds and the other is Uses of Funds or Application of funds. The difference of these two parts is change in working capital. When sources of funds exceed the application of funds, it is increase in working capital and when application of funds exceeds the sources, it is decrease in working capital. Funds Flow Statement presents those items only which affect the working capital. If any transaction does not affect the working capital at all i.e., if it results in increase or decrease in both current assets and current liabilities (such as payment to creditors) or it affects only fixed assets and fixed liabilities (such as conversion of debentures into shares, or shares into stocks or vice versa, issue of bonus shares, purchase of fixed assets like building or machinery by issue of shares or debentures etc.), it is not to be shown in funds Flow Statement. A fund flow statement is a summary of a firms inflow and outflow of funds. In other words, fund flow is a statement which analyzes the inflow and outflow of funds of an organization or firm in a particular period.
Limitations Of Fund Flow Statement

The fund flow statement suffers from the following limitations: 1. The fund flow statement is prepared with the help of balance sheet and profit and loss account of the current period and these statements are based on historical cost. So a realistic comparison of profitability and the funds position is not possible as the current cost is not considered for the purpose of preparation of fund flow statement. 2. The cash position of the firm is not revealed by fund flow statement. To know the cash position a cash flow statement has to be prepared. 3. The various activities are not classified as operating activities, investing activities and financing activities while preparing fund flow statement.
Uses Of Fund Flow Statement

1. The users of fund flow statement, such as investors, creditors, bankers, government, etc., can understand the managerial decisions regarding dividend distribution, utilization of funds and earning capacity with the help of fund flow statement. 2. The quantum of working capital is revealed by the schedule of working capital changes, which is a part of fund flow statement. 3. The fund flow statement is the best and first source for judging the repaying capacity of an enterprise. 4. The management will be able to detect surplus/shortage of fund balance. 5. The fund from operation is not mentioned in the profit and loss account and balance sheet but it is separately calculated for the purpose of fund flow statement.