Financial Statements

Financial Statements
Financial statements provide information about the financial activities and position of a firm. Important financial statements are:
Balance sheet Profit & Loss statement Funds flow statement Cash flow statement

Balance Sheet
Balance sheet indicates the financial condition of a firm at a specific point of time. It contains information about the firms: assets, liabilities and equity. Assets are always equal to equity and liabilities: Assets = Equity + Liabilities

Assets
Assets are economic resources or properties owned by the firm. There are two types of assets:
Fixed assets Current assets

Current Assets
Current assets (liquid assets) are those which can be converted into cash within a year in the normal course of business. Current assets include:
Cash and bank balance Accounts receivable (debtors) Inventory (stocks) Advances to suppliers Prepaid expenses

Fixed Assets
Fixed assets are long-term assets.
Tangible fixed assets are physical assets like plant. Intangible fixed assets are the firms rights and claims, such as patents, copyrights, goodwill etc. Gross block represent all tangible assets at acquisition costs. Net block is gross block net of depreciation.

Liabilities
Liability is a firms obligation to pay cash or provide goods or services in the future. Two types of liabilities are:
Current liabilities Long-term liabilities

Current Liabilities
Current liabilities are payable within a year in the normal course of business. They include:
Accounts payable (creditors) Outstanding expenses Advances from customers Provision for tax Provision for dividend

Long-term Liabilities
Long-term liabilities are payable after a year. They include:
Borrowings from financial institutions and banks etc. Debentures/bonds

Shareholders Funds or Equity

Share capital is owners contribution divided into shares. A share is a certificate acknowledging the amount of capital contributed by the shareholder. Reserves and surplus or retained earnings are undistributed profits. Shareholders funds or equity is the sum of share capital plus reserves & surplus. It is also called net worth.

Balance Sheet Relationship

Total assets (TA) equal net fixed assets (NFA) plus current assets (CA):
TA = NFA + CA

Net current assets (NCA) is the difference between current assets (CA) and current liabilities (CL):
NCA = CA CL

Balance Sheet Relationship

Net assets (NA) equal net fixed assets (NFA) plus net current assets (NCA):
NA = NFA + NCA

Capital employed (CE) is the sum of net worth or equity (E) and borrowing/debt (D) and it is equivalent of net assets:
CE = Net Worth + Borrowing = E + D Capital Employed = Net Assets

Functions of Balance Sheet

Measurement of liquidity Measurement of solvency

Profit & Loss Statement

Profit & Loss statement provides information about a firms:
revenues, expenses, and profit or loss.

Nature of Revenues
Revenue is the amount received or receivable within the accounting period from the sale of the firms goods or services. Operating revenue is the one that arises from main operations of the firm, and the revenue arising from other activities is called nonoperating revenue.

Nature of Expenses
Expense is the amount paid or payable within the accounting period for generating revenue.
Examples: raw material consumed, salary and wages, power and fuel, repairs and maintenance, rent, selling and marketing expenses, administrative expenses.

Expenses are expired costs and capital expenditures represent un-expired costs and appear as assets in balance sheet.

Depreciation
Depreciation is a charge for the use of fixed assets; it is an expense. It is a non-cash expense since cash was paid at the time fixed assets were acquired. Expenditures incurred on acquiring assets are called capital expenditures. Depreciation is allocation of these expenditures over the life of assets that have helped in generating revenue.

Methods of Depreciation
Depreciation may be provided on straight line basis or written down value basis (DWV). DWV basis is allowed for taxation in India.

Concepts of Profit
Gross profit = sales cost of goods sold (CGS)
CGS = raw material consumed + manufacturing expenses of goods that have been sold

PBDIT = Profit before dep., interest and tax = sales expenses, except dep., interest and tax PBIT= Profit before interest and tax = PBDIT DEP PBT= Profit before tax = PBIT Interest PAT = Profit after tax = PBT Tax

Functions of Income Statement

Summary of revenues and expenses Measurement of profitability

Standards of Financial Reporting

Full disclosure Materiality Consistency Conservatism Fairness

Accounting Principles and Concepts

Business entity concept Money measurement concept Going concern concept Cost concept Duality concept Accounting period concept Realization concept Matching concept

Funds and Cash Flow

Liquidity refers to resources currently available with the firm. It is reflected by the funds or cash flows rather than the stock of current assets and liabilities. Funds flow is a change in a firms net current assets while cash flow is a change in the firms cash position. Funds or cash flows occur due to changes in items in the balance sheet and profit & loss statement. Thus liquidity analysis involves measurement of changes in assets, liabilities and equity.
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Sources and Uses of Funds and Cash Flows

Sources of funds or cash flows:
funds from operations sale of fixed assets issue of share capital borrowings losses purchase of fixed assets repayment of borrowings payment of dividends
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Uses of funds are:

Funds from Operations

Funds flow from operations
+ PAT ( loss) + Depreciation + Other non-cash expenses Non-cash incomes + Loss from the sale of fixed assets Gain from the sale of fixed assets

Cash from Operations

Cash flow from operations
+ PAT ( loss) + Depreciation + Other non-cash expenses Non-cash incomes + Loss from the sale of fixed assets Gain from the sale of fixed assets + Increases in net working capital Decreases in net working capital

Uses of Funds and Cash Flow Statements

Liquidity position Capital expenditures Dividends paid Retained earnings External financing Repayment of loans Non-performing assets

Financial Statement Analysis

Financial Analysis
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm (to understand the overall business situation) by properly establishing relationships between the item of the balance sheet and the profit and loss account.

Users of Financial Analysis

Trade creditors Lenders Investors Management

Nature of Ratio Analysis

A financial ratio is a relationship between two accounting numbers. Ratios help to make a qualitative judgment about the firms financial performance.

Standard of Comparison
Time series analysis Inter-firm analysis Industry analysis Proforma financial statement analysis

Types of Financial Ratios

Liquidity ratios Solvency ratios Turnover ratios Profitability ratios Equity-related ratios

Liquidity Ratios
Liquidity ratios measure a firms ability to meet its current obligations.
Current assets Current ratio = Current liabilities Current assets Inventories Quick ratio = Current liabilities Cash + Marketable securities Cash ratio = Current liabilities

Solvency Ratios
Solvency ratios measure the dependence of a firm on borrowed funds.
Debt Debt-equity ratio ! Equity (Net Worth) Debt Debt Debt ratio ! ! Debt  Equity Capital employed Earnings before interest and tax Interest coverage ! Interest

Turnover Ratios
Turnover or activity ratios measure the firms efficiency in utilising its assets.
Cost of goods sold or net sales Inventory turnober ! Average (or closing) inventory Number of days in the year (say, 360) Days of inventory holding ! Inventory turnover Credit sales or net sales Debtors turnover ! Average (or closing) debtors Number of days in the year (say, 360) Collection period ! Debtors turnover

Turnover Ratios
Net sales Current assets turnover ! Current assets Net sales Net current assets turnover ! Net current assets Net sales Fixed assets turnover ! Net fixed assets Net sales Net assets turnover ! Net assets or capital employed

Profitability Ratios
Profitability ratios measure a firms overall efficiency and effectiveness in generating profit.
Margin ! Profit before interest and tax (PBIT) Net sales Profit after tax (PAT) Net margin ! Net sales PBIT Before tax return on investment ! Net assets Profit after tax Return on equity ! Equity (net worth)

Equity-related Ratios
Equity-related ratios measure the shareholders return and value.
Profit after tax EPS ! Number of ordinary shares Dividends DPS ! Number of ordinary shares Dividends DPS ! ! Payout ratio EPS Pr ofit after tax DPS Dividend yield ! Market value per share

Equity-related Ratios
Earnings yield P / E ratio = EPS ! Market value per share Market value per share EPS Net worth ! Book value per share Number of ordinary shares ! Market value per share Book value per share

M B value

DuPont Analysis
DuPont Analysis integrates the important ratios to analyse a firm's profitability. PBIT Sales PBIT RONA= ! v Net Assets Net Assets Sales PAT Sales PBIT PAT Net Assets ROE ! ! v v v Net Worth Net Assets Sales PBIT Net Worth ROE ! Assets turnover Margin Leverage

LIQUIDITY RATIOS
CURRENT RATIO
4 3 RATIO 2 1 0 1 Series1 3.21 2 2.41 3 2.65 YEAR 1 2 3 4 5 4 1.94 5 2.5

LIQUIDITY RATIOS
QUICK RATIO
3 RATIO 2 1 0 1 Series1 2.81 2 1.94 3 2.13 YEAR 1 2 3 4 5 4 1.45 5 1.91

LEVERAGE RATIOS
DEBT-EQUITY RATIO
0.3 RATIO 0.2 0.1 0 1 Series1 0.07 2 0.09 3 0.12 YEAR 1 2 3 4 5 4 0.09 5 0.23

LEVERAGE RATIOS
INTEREST COVERAGE RATIO
150 RATIO 100 50 0 1 Series1 30.08 2 50.33 3 36.78 YEAR 1 2 3 4 5 4 79.36 5 134.85

ACTIVITY RATIOS
INVENTORY TURNOVER RATIO
10 RATIO

0 1 Series1 8.32 2 5.9 3 6.09 YEAR 1 2 3 4 5 4 5.39 5 5.36

ACTIVITY RATIOS
DEBTORS RECEIVABLE TURNOVER RATIO
6 RATIO 4 2 0 1 Series1 4.62 2 3.42 3 3.45 YEAR 1 2 3 4 5 4 3.54 5 3.67

ACTIVITY RATIOS
DEBTORS RECEIVABLE TURNOVER IN DAYS
150 DAYS 100 50 0 1 Series1 73.85 2 103.34 3 99.75 YEAR 1 2 3 4 5 4 99.62 5 97.76

ACTIVITY RATIOS
TOTAL ASSETS TURNOVER RATIO
3 RATIO 2 1 0 1 Series1 1.36 2 1.71 3 1.66 YEAR 1 2 3 4 5 4 2.49 5 1.89

ACTIVITY RATIOS
FIXED ASSETS TURNOVER RATIO
6 RATIO 4 2 0 1 Series1 3.93 2 2.71 3 2.47 YEAR 1 2 3 4 5 4 2.13 5 2.29

ACTIVITY RATIOS
CURRENT ASSETS TURNOVER RATIO
1.5 RATIO 1 0.5 0 1 Series1 0.94 2 1 3 1.03 YEAR 1 2 3 4 5 4 1.21 5 1.14

PROFITABILITY RATIOS
GROSS PROFIT MARGIN
40 30 RATIO 20 10 0 1 Series1 31.55 2 12.58 3 14.11 YEAR 1 2 3 4 5 4 19.7 5 18.72

PROFITABILITY RATIOS
NET PROFIT MARGIN
40 30 RATIO 20 10 0 1 Series1 29.01 2 13.57 3 13.2 YEAR 1 2 3 4 5 4 18.48 5 16.84

PROFITABILITY RATIOS
RETURN ON EQUITY
30 RATIO 20 10 0 1 Series1 27.6 2 9 3 11.37 YEAR 1 2 3 4 5 4 13.07 5 14.81

PROFITABILITY RATIOS
RETURN ON CAPITAL EMPLOYED
40 30 RATIO 20 10 0 1 Series1 35.94 2 12.01 3 13.55 YEAR 1 2 3 4 5 4 17.79 5 15.23

PROFITABILITY RATIOS
RETURN ON TOTAL ASSETS
40 30 RATIO 20 10 0 1 Series1 29.83 2 9.53 3 10.04 YEAR 1 2 3 4 5 4 13.67 5 12.82

PROFITABILITY RATIOS
EARNINGS PER SHARE
80 RATIO 60 40 20 0 1 Series1 70.09 2 28.26 3 33.29 YEAR 1 2 3 4 5 4 50.11 5 52.78

PROFITABILITY RATIOS
DIVIDEND PER SHARE
15 RATIO 10 5 0 1 Series1 3.75 2 3.75 3 6.25 YEAR 1 2 3 4 5 4 11.25 5 11.25

DuPont Analysis
DuPont Analysis 2011 Profit 8934 Sales 52181 Assets Sales 52181 Assets 75658 Equity 0.171212 0.689696 ROE 0.1484 DuPont Analysis 2010 Profit 8461 Sales 44011 Assets Sales 44011 Assets 65528 Equity 0.192247 0.671637 ROE 0.143053 75658 60202 1.256736

65528 59146 1.107902

INFERENCE
1. Liquidity Position is at satisfactory level. In other words short term solvency position is good. However, the current assets may be proportionately higher due to excessive inventory and debtors.

2. In the capital structure debt capital has increased it may be cause for inflexibility in operations.

3. Sufficient funds are available to cover fixed charges

INFERENCE
4. Inventory levels are increasing, which may cause for liquidity problem

5. Credit policy is liberal. The average number of days credit allowed to customers is almost equal to three months.

6. On the above basis it can be said that stock and debtors are high though there is a good control over debtors and credit policy. Overall Credit management of the company is at a satisfactory level.

INFERENCE
7. Fixed assets are contributing more to sales than current assets 8. Gross Profit margin and Net Profit margins has decreased substantially. There is a need for increasing the operational efficiency.

9. The company should make attempt to reduce inventory to increase the Net Profit margin.

INFERENCE
10. Return on Equity is at satisfactory level.

11. Earnings Per Share has steadily progressed

12. Dividend Per Share is constant

13. Overall the company performance is satisfactory.

Utility of Ratio Analysis

Assessment of the firms financial conditions and capabilities. Diagnosis of the firms problems, weaknesses and strengths. Credit analysis Security analysis Comparative analysis Time series analysis

Cautions in Using Ratio Analysis

Standards of comparisons Company differences Price level Different definition Changing situations Past data

INDIAN PHARMACEUTICAL INDUSTRY

OVER VIEW

IPI has been performing well with turnover rising from about Rs. 10 cr. in 1948 to a healthy Rs.1,17,000 cr. in 2010 Exports are booming at Rs. 62,500 cr. (US dollar 13.9 billion)With formulation exports at US dollar 5.8 billion and API at US dollar 8.1 billion. The country ranks 3rd world wide by volume of production and 14th by value. The industry provides employment to over 42 lakh persons directly and indirectly. Pharma sector has no cyclical factor attached to it.

STRENGTHS
India with a population of over a billion in a largely untapped market. In fact the penetration of modern medicine is less than 30 per cent in India

Per capita expenditure on health care in India is $93, while the same for countries like Brazil is $453 and Malaysia $189. The growth of middle class in the country has resulted in fast changing lifestyles in urban to some extent rural areas. This opens a huge market for lifestyle drugs, which has a very low contribution in the Indian market

STRENGTHS
India accounts for almost 16 per cent of the world population, while the total size of the industry is just 1 per cent of the global Pharma industry Indian manufacturers are one of the lowest cost producers of drugs in the world. With a scalable labor force Indian manufacturers can produce drugs at 40% to 50% of the cost to the rest of the world.

WEAKNESSES
In India Pharma companies are marred by the price regulation NPPA-National Pharmaceutical Pricing Authority Proposal to bring all essential medicines under DPCO-Drug Price Control order. The migration into a product patent based regime is likely to transform industry scenario in the long term

OPPORTUNITIES

Opening up of health insurance sector and the expected growth in per capita income are key growth drivers from long term perspective Economic growth across the population increases consciousness and thereby healthcare expenditure health

THREATS
Threats from other low cost countries like China, Israel exist Tax related problems

Dr. Reddy Laboratories Limited

OVER VIEW

Pioneering leader in chemistry skills, development process & foray into regulated markets

Creates and leverages value opportunities through strategic partnerships

Investments in R&D in 2010-11 grew by 33% to Rs. 5,060 millions. This represents 7% of overall sales, compared to 5% in 2009-10.

Dr. Reddys grew in other emerging markets as well by 12% over the previous year. The major countries include Ukraine, Venezuela, South Africa and New Zealand.

In the US prescription market, 25 of Dr. Reddys products featured among the top three ranks in terms of market share (Source: IMS Sales Volumes, March 2011)

Dr. Reddys Top-10 brands accounted for revenues of Rs. 4,317 millions (37% of Indian formulations revenue)