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Financial Accounting &


Analysis

Union Bank Staff Training College


Shankar Jaganathan
April 2, 2011
Ratio Analysis or Competitive View of Financial
Performance
Financial Accounting & Analysis
-Topics |
1. Introduction (March 6)
Course structure, methodology and evaluation
A brief history of accountancy
2. Accounting concepts, conventions & Double entry (March 12)
Accounting concepts, Conventions, Double entry accounting
3. Financial Statements (March 19)
Balance Sheet, Profit and Loss Account & Cash Flow Statements
4. Important Accounting Standards (March 26)
Need for Accounting Standards and key standards
5. Ratio Analysis or Comparative view (April 2)
Dupont Analysis, Altman Score and Equity Ratios
6. Accounting for Internal decision making (April 9)
Cost accounting and management accounting systems
7. Accounting for Equity Markets (April 13)
Share premium, EPS, Book value, Bonus issue, Stock split, US
GAAP and IFRS
8. Project Presentation (April 24)
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Accountancy: The
Sequence
|
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Bookkeeping ?  



 

 

Ratio Analysis
 

 

   

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A. Dupont Analysis

-
DuPont Model Origin |
DuPont took 23% stake in General Motors
Donaldson Brown, in the Treasury Department of
DuPont given the job of cleaning up the Finance
Brown an electrical engineer, developed the model in
1919
A Generic model to analyzes Value creation in an
industry
Useful for both intra-industry and inter-industry
comparison
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DuPont Model |
= 
  
Financial
Operating Asset Utilization
Leverage 
Leverage     
#  

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DuPont Model ±Detailed |
Generic Business Industry Level Company Specific

$ % #

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Performance in 2007 |
$m

Description Pfizer Walmart Citibank


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Debt 13,139 39,018 1,399,797
Liabilities 37,005 48,442 669,311
Minority Interest 114 2,160 -
+  % !   
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Pfizer,*

    
Walmart,*

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Citibank,*

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2008 Was An Abnormal Year
Three Routes to RoE
Using The DuPont Model
|
$m
Description Pfizer Walmart Citibank
Revenue 48,418 348,650 146,558

Net Income 8,144 11,284 21,538

Total Assets 115,268 151,191 2,182,706

Net Worth 65,010 61,573 113,598

Debt 13,139 39,018 1,399,797

Liabilities 37,005 48,442 669,311

Minority Interest 114 2,160 -

Capital & Liabilities 115,268 151,193 2,182,706

Asset Turnover ratio 0.42 2.41 0.07

Profit Margin 16.8% 3.2% 14.7%

Leverage -Quantum 1.69 2.52 17.43

=$ "- "u  Î"-u


Where is the Sweet Spot
An Exercise |
Can you individually calculate the following ratios
for your companies

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Operating Leverage: The Sources
of High Margin
|
 & 
 /(  
 
 Resource Control:
$   
& 
 

 Talent Farming
 * 
!


 Process Control

  * !


 Legal Protection:
-*  +   & 

What does DuPont model tell us? |
Ratio Operating Leverage:
Net Profit / Sales

0 *
  Inherent Competitive Advantage,
*  Entry / Exit barriers

0 *
  Brand strength, Operational efficiency,
*  Unique resource control

    Higher Operating Leverage improves ROE


High Asset Turnover: The Source |
Total Asset Turnover
 &   

Fixed Asset Turnover


 **     
+ ) 
Current Asset Turnover
 

      -




 

% of Intangible Assets /Investments
 +  # $  


What does DuPont model tell us? |
Ratio Asset Utilization
Sales/ Avg. Assets
0 *
  *  Vertical integration, Extent of
Outsourcing, Scale of Operations

0 *
  *  Technology base,
Managerial quality

    Higher utilization improves ROE

-
Financial Leverage: The Source |
Age of Industry

Nature of Assets

Equity base

Profitability track record

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What does DuPont model tell
us?
|
Ratio Financial Leverage
Avg. Assets/ Avg. Net Worth
0 *
  *  Attractiveness to Debt, Tangible asset
base, Industry maturity & predictability

0 *
  *  Risk appetite

    Higher Leverage  improve ROE,


only if Debt Cost is lower than ROCE

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|

B. Altman¶s Score


Can Financial Statements
Predict the Future?
|
Extensive Research in USA, the bankruptcy capital
Research on
 
  
 
  !!      *  
Used for
 -.   

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 +*     


Initial Research Triggered by Great Depression of 1930s
Predicting Bankruptcies
Altman¶s Z Score
|
Edward Altman¶s model in 1968
Picked 33 companies that
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Picked a paired sample of 33 solvent companies
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Most Popular Predictive Model Using Financial Statements
Reliability of Model |
One years prior to Burst Two years prior to Brust
95% accuracy 83% accuracy

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Model Validated in 30 years with 80% accuracy Levelë


Z Score Model ±The Basis |
Liquidity Ratios
 ,. + 


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*
     * 
Solvency Ratios
 = * 



*
*-
 *  *!
Profitability Ratios
 - *
*+
  2'**!  
Leverage Ratios
 &.+-.  !   *
*
 +
   !
Activity Ratios
 



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*
 %    2!!  
 2!   !  
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Picked One from the Five distinct Pools
Z Score Computed |
For Public Manufacturing Companies
Z score = 1.24 A + 1.4 B + 3.3 C + 0.6 D + .999 E
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For Private Companies
Instead of Market value of equity book value of equity used
Z¶ Score = 0.717 A +0.847 B +3.107 C +0.420 D +0.998 E
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For non-manufacturing firms
Z¶¶ Score =6.56 A +3.26 B+ 6.72 C+ 1.05D
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Multi-discriminate Analysis
Credit Rating Efficiency |

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Model Independently Validated
Manufacturing Companies In
India ± Two Extremes
|
=
"+
Tata Motors Tata Motors HUL HUL
2007-08 2008-09 2007 2009*
Altmans¶ Score
,. +  4ë è5 4 -è5 4 Îè-5 4Îè5



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Z Score 4.10 2.00 19.70 18.46

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>2.99: Safe zone; 1.8-2.99: Grey zone; <1.8: Distress zone ë-


Non-Manufacturing
Companies: Two Extremes
|
Infosys Infosys Jet Air Jet Air
2007-08 2008-09 2007-08 2008-09
Altmans Score
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Z Score 33.10 34.42 0.85 0.08
a 
0.97 0.52

>2.6: Safe zone; 1.1-2.6: Grey zone; <1.1: Distress zone ë[


Can U Calculate Altman¶s
Score for Your Company?
|

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|

C. Equity Market Valuations

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Value and Price |
Value based View Price based View

Fundamental value Technical value


Intrinsic value Extrinsic value
Absolute value Relative value
Fair value Market value
True value Traded value
Yield based or Asset based
Value in use Value in Exchange

Absolute Valuation & Relative Valuation ëÎ


Absolute and Relative valuation |
$ Absolute valuation

$ 
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$ 7  
* 
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$ Relative valuation

$ =  !
*  

$ ,   .  .  

Enterprise Valuation and


Equity Valuation
|
Enterprise valuation
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 &. *!8&.  

Equity valuation
 &.+  ) 
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Shareholder Value Creation


 
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How is Value of Share price
Determined
|
Return Based Valuation
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Asset Based Valuation
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*
 *:
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Growth Based Valuations
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Dividend based Ratios |
Dividend Yield

   **
&. 

Dividend Payout

   ** 

Dividend Growth

   ** +   **  


 

   **
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Profit based Ratios |
PAT to Sales
  
 

*

PBT to Sales
 (
* 
 ! 
 *
 *'*
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PBIT to Sales
 (
* 
 !
*!

*! 

* 
PBDIT to Sales
 (
* 
 !


!

 
 **    
* 
Gross Margin to Sales
 (
* 
     

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EVA based Ratios |
EVA = Economic Value Add

  
   



 *
'  
 

   


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Like Investment in Our House for Individual è-


Asset Based Ratios |
Book value based

 =+   *

 = 

 -.


Market Capitalization

 
+ ;,

 &.+  ,;+ 

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Growth based Ratios |
PE Ratio: Price Earnings Ratio

   


  -

  -

PEG: Price Earnings Growth Ratio

  
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The Next Class:
Presentation
|
1. What is Management Accounting? Explain this with

reference to Segment Accounting given in your Annual

Report?

2. What are the main differences between Financial

accounting and Cost Accounting?

3. Explain what is the difference between Standard Costing

and Budgetary Controls?

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