R.

Kannan

Module - 4
Credit Risk - Financial Statement
Analysis

Prof. R. Kannan
R.Kannan

Financial Statement Analysis

A. Purpose
- Financial statements are presented in line with the accounting principles. They
need to be restructured for analysis.
- Whether the business is growing or shrinking
- Whether the profitability is increasing or decreasing
- How well the company is capitalised – leverage and over trading.
- Ability to service the debt-Level of strength and sustainability of cash flow.
- How well the assets are utilised
- How good is the working capital management
- Status of defaults
- How good is the liquidity; can current assets cover current liabilities.
- Whether statutory liabilities are being paid regularly.
- Does the company has adequate borrowing power as per bye laws /
Memorandum and Articles of Association.
- Maximum duration of financial year is 18 months.
- Normally April-March is considered the financial year.
 Financial Statement Analysis - Contd..
R.Kannan

B. Content
– Profit and loss account - Schedules
– Balance Sheet - Schedules
– Note on accounts on accounting policies and assumptions
– Cash flow statements
– Production, Sales, Stock, exports data.
– Auditors report certifying the financial accounts, changes in accounting
policies and other observations which has an impact on profitability.
– Directors report on operating environment.
– Chairmans’ statement
– Corporate Governance report / investor information
– Cash flow statement.
R.Kannan Auditors comment on

• Correctness of accounts

• Inventory records, physical verification of inventory

• Details of loans given, terms

• Details of deposits, terms and defaults if any

• Defaults in repayment of loans / advances

• Status of payment of statutory dues (taxes, PF dues)

• Quarterly statements – Guidance forecasts

• Is the company proposing change of statutory auditors/or year end.

R.Kannan Auditors comment on- contd..

• Guarantees given by the company which may become liability

• Losses/accumulated losses-Potential sickness

• Non-adherence to accounting standards

• Overstating of income/suppression of expenses by

capitalization/non provision for losses
R.Kannan

Does the balance sheet has the following statements

- The severe difficulties faced by our customers may result in

- While there are indications of better trading conditions much will
depend on
- The cost of expansion programme will resulted in
- The company is taking a number of measures to reduce costs
- This year promises to be a challenging one.
- Your company is well placed to benefit from an economic recovery
in the long term.
- It is clear that with these developments the group requires a new
management structure.
R.Kannan CMA (Credit Monitoring arrangement) - Formats

• Banks convert all the profit and loss account, Balance sheet etc. into CMA format

developed by Tandon Committee for effective analysis of

– Source of profits

– Ability to service debt

– Liquidity

– Proper presentation of assets/liabilities

– Assessment of working capital requirement

– Diversion of short term funds for long term

– Extent of leveraging
R.Kannan

Does the balance sheet has the following statements

- The severe difficulties faced by our customers may result in

- While there are indications of better trading conditions much will
depend on
- The cost of expansion programme resulted in
- The company is taking a number of measures to reduce costs
- This year promises to be a challenging one.
- Your company is well placed to benefit from an economic recovery
in the long term.
- It is clear that with these developments the group requires a new
management structure.
 R.Kannan Profit and Loss Account
The P/L Account is restructured in the following format
Last two years actuals as per Current Projections for the
audited accounts Year following Year
Estimates
1 2 3 4
1 Gross Sales
a) Domestic Sales
b) Export Sales
c) Sub total (a+b)
d) Less Excise Duty
i. Net Sales
e) Percentage rise or
falling sales turnover as
compared to previous
year
ii. Other Operating
Income
a. Duty Draw Back
b. Cash Assistane
iii. Total (i) +(ii)
 R.Kannan
Last two years actuals as per Current Year Projections for the following
audited accounts Estimates Year

1 2 3 4
2 Cost of Sales
i. Raw materials and
other spares and
consumables used in
the process of
manufacture
a. Imported
b. Indigenous
ii. Other Spares
a. Imported
b. Indigenous
iii. Power & Fuel
iv. Direct Labour
(Factory wages &
Salaries)
v. Other Manufacturing
Expenses (Repairs &
Maint.)
vi. Depreciation
vii. Sub Total(i to vi)
R.Kannan Last two years actuals as per Current Year Projections for the following
audited accounts Estimates Year
1 2 3 4

viii. Add: Op.stock in

process
ix. Less: Cl.Stock in
Process
ix. Cost of Production
(vii+viii+ix)
x. Add: op.stock of
finished goods
xi. Less: Cl.stock of
Finished goods
xii. Sub Total (Total cost of
sales (x+xi+xii)
3 Selling, General & Admn
Exps (Including Bonus
Payments)
4 Operating Profit Before
Interest [(1(iii) – 2(xiii)-3)]
5 Interest

6 Operating Profit After

Interest & Deprn. (4-5)
R.Kannan

Last two years actuals Current Projections for the

as per audited Year following Year
accounts Estimates
1 2 3 4
7 Add: Other non
operating income
Less: Other non
operating expense
8 Profit Before Tax
9 Provision for Tax
10 Net Profit/ Loss (8-9)
11 Equity Dividend paid
(Dividend Rate)
12 Retained Profit (10-11)
13 Retained Profit/ Net
Profit (%)
R.Kannan Analysis of Financial Statements

• Cost of production to include all direct costs of manufacturing plus

depreciation.

• Cost of sales includes cost of production adjusted for finished goods

inventory.

• Raw material consumption is computed as purchases adjusted for variation in

stocks.

• Sales:

• Exclusion of inter unit transfer from sales

R.Kannan
Deferred Tax Liability/Asset

a) Cost of equipment Rs.21 lacs.

Year 2008 2009
PBILD 12 12
a) Depreciation (st line) 2 2
Profit before tax 10 10
Tax at 40% 4 4
b) Depreciation (WDV) 6 4.2
Profit before tax 6 7.8
Tax at 40% 2.4 3.1
Deferred tax liability 1.6 0.9
R.Kannan

b) The company provides for the entire voluntary retirement

Compensation in 2009 though it has to write it up over a few years
on deferred basis as per IT act (say 10 years)

PBILD 12 12

VRS 1 10
------- -------
Profit before tax 11 2
Tax at 40% 4.4 0.8

(Tax paid) (Tax payable)

R.Kannan

Deferred tax asset is Rs.3.6 lacs. These are created through unabsorbed
losses, expenditure debited but not allowed by income tax department in
that year, doubtful debt diminition in the value of investments.
CENVAT
Basic cost of raw materials 1000
Excise duty paid at 24% 240
Other expenditure 460
Profit 200
---------
Selling price 1900
Production 1000 units
Quantity of goods sold 700 units (Rs. In lacs)
Excise duty payable at 24% 319.2
(1900 x 700 x 0.24)
Less: Cenvat credit available
(700 x 1000 x 0.24) 168.0
Net excise obligation 151.2
Cost to consumer Rs. 2051.20
R.Kannan Balance sheet of a company shows its assets (what it owns) and Liabilities (what
it owes). Normally, companies present the assets and liabilities in vertical
format, as follows:

Balance Sheet – Vertical Form

Schedule Number Figures as at Figures as at the
the end of the end of the
current previous
Financial Year Financial Year

1 2 3 4

I Sources of Funds
1 Share Holders Fund

a. Capital
b. Reserves & Surplus
2 Loan Funds

a. Secured Funds
b. Unsecured Funds

Total
R.Kannan Balance Sheet – Vertical Form – Contd..

Schedule Number Figures as at Figures as at the end

the end of of the previous
the current Financial Year
Financial
Year
1 2 3 4

II Application of Funds

1 Fixed Assets

a) Gross Block
b) Less Depreciation
c) Net Block
d) Capital Work in
Progress

2 Investments
R.Kannan
Schedule Number Figures as Figures as at the end
at the end of the previous
of the Financial Year
current
Financial
Year
1 2 3 4

3 Current Assets, Loans and

advances

a) Inventories
b) Sundry Debtors
c) Cash & Bank Balances
d) Other Current Assets
e) Loans and Advances

Less

Current Liabilities and Provisions

a) Liabilities
b) Provisions

Net Current Assets

R.Kannan

Schedule Number Figures as Figures as at the end

at the end of the previous
of the Financial Year
current
Financial
Year
4 a) Miscellaneous
expenses to the
extent not written off

b) Profit & Loss

Account

Details of each item are given in attachments called”Schedules”, and the number of the

relevant schedules is given in column 3

Restructuring the Balance Sheet

The structure of the balance sheet can be explained as follows

R.Kannan

Sources of Funds – Liabilities Uses of Funds - Assets

Long Term: Long Term:
Capital Fixed Assets
Reserves Intangible Assets
Term Loans / Borrowings Other non-current Assets
Investments

Short Term:
Short Term:
Current Liabilities
Short Term borrowings from banks Current Assets
Sundry Creditors Cash
Other Current Liabilities Inventory
Unsecured loans Sundry Debtors
Provisions Loans and advances
Other Current Assets
Miscellaneous expenditure (to the
extent not written off)
Profit & Loss A/c.
R.Kannan

Assets

– Fixed Assets

– Current Assets

– Non current assets – Advances to suppliers, Investments in

subsidiary companies, deposits with the electricity Board.

– Intangibles – Patents, unprovided bad debts, goodwill,

expenses not written off.
 R.Kannan

Liabilities
– Short term liabilities are amounts payable within a year and include even
term loan instalments
– Long term liabilities are those payable beyond one year.
– Banks use a different form and include lease finance as liability and lease
assets as company’s assets. This is because in case of the industrial assets
lease is like a term loan and the ownership and charges to borrower at the
end of the lease.
– Bills discounted/purchased are included by banks both on the asset side
(receivables/bank borrowings) and the liability side. In case of customers
default, it becomes the liability of the company.
– Banker’s exclude revaluation reserves from the liability side and reduce the
amount from the fixed assets.
– Bankers in their analysis show contingent liabilities (i.e ) those that may
become liabilities in future (Guarantees, disputed tax etc.)
R.Kannan
Analysis of Balance Sheet
Last two years actuals Current Projections for the
as per audited accounts Year following Year
Estimates

1 2 3 4

Year Ended/ Ending

Liabilities
Current Liabilities
1 Short Term Borrowings
from Banks (including
bills purchased and
discounted)
i From Applicant Bank
ii From other Banks
Sub Total A
R.Kannan

Analysis of Balance Sheet – contd..

Last two years actuals as Current Projections for the
per audited accounts Year following Year
Estimates
2 Short Term Borrowings
from others
3 Deposits (maturing within
one year)
4 Sundry Creditors (Trade)
5 Other Creditors
6 Advances / Progress
payments from
Customers/Depositors from
dealers, selling agents etc.

7 Interest and other charges

accrued but not due
8 Provision for Taxation
9 Dividend Payable
R.Kannan

Analysis of Balance Sheet – contd..

Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
10 Other statutory payables
11 a) Instalments of term loans/
deferred payments credit
due within 1 year
b) Debentures / Redeemable
prefereances shares due
within one year
c) Unsecured Loans due
within one year
d) Short term loans and
advances
12 a) Other current liabilities
due within one year such
as a Retirement Benefits /
Gratuity/ Leave
encashment / Dues to
subsidiary/Unclaimed
dividend/ Managerial
remuneration payable etc
list individually
R.Kannan

Analysis of Balance Sheet – contd..

Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
b) Lease liabilities due within
one year

Sub Total B
13 Total Current Liabilities (Total
1 to 12)
14 Debentures (Not maturing
within one year)

15 Redeemable preference shares

(not maturing within 1 year)
16 a) Term Loan
b) Foreign Currency Loans
c) Rupee Term Loans from
Banks
d) Foreign Currency loans
from banks
17 Deferred payment credits
(Exclusive of instalments
payable within 1 year)
R.Kannan
Analysis of Balance Sheet – contd..
Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
18 Unsecured Loan (Beyond 1
year)
19 a) Other Term Liabilities
b) Lease Liabilities due
beyond one year
20 Total Term Liabilities (Total of
items 14 to 19)
21 Total Outside Liabilities (Items
13 plus item 20)

NET WORTH
22 Ordinary Share Capital
23 Share Applications Money
Premium A/c & Capital Reserve
24 General Reserve
25 Investment Allowance
R.Kannan

Analysis of Balance Sheet – contd..

Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
26 a) Other Reserves/ Share
premium
b) Securities Premium a/c
c) Debentures Redemption
Res. Etc. List seperately
27 Surplus (+) or Deficit (-) in Profit
and Loss Account
28 Net Worth (Total of items 22 to
27)
29 Total Liabilities (Item 21 + Item
28)

ASSETS

CURRENT ASSETS

30 Cash and Bank Balances

31 Investment (Other than long
term investment e.g., sinking
fund, gratuity fund)
R.Kannan
Analysis of Balance Sheet – contd..
Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
i Government & Other trustee
securities
ii F/D with Banks
32 Receivables other than deferred and
export receivables (including bills
purchased and discounted by
bankers)

33 Instalments of deferred receivables

(due within 1 year)

34 Raw Materials (Including Stores &

Other items used in the process of
manufacture

i) a) Imported
b) Indigenous
ii Stock – in- Process
iii Finished Goods

iv Other Consumable Spares

R.Kannan Analysis of Balance Sheet – contd..
Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
35 Advances to suppliers of raw
materials & stores, spares,
consumables
36 Advance payment of Taxes
37 Other Current Assets

(Major Item to be specified

individually)
i. Loans / Advances
ii. Balance with Customs/
Ports
iii. Bills receivables/ Staff adv
iv. Other receivables
v. Interest Accrued
38 Total Current Assets (Total of
Item 30 to 37)
39 Gross Block (Land & Building,
Machinery Construction –in-
progress etc.)
 R.Kannan Analysis of Balance Sheet – contd..
Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
40 Less Depreciation to date

41 Net Block (Item 39 - Item 40)

Add Lease Assets (Pending Lease
payments)

Total Fixed Assets

OTHER NON CURR. ASSETS

42 Investments/ Book Debts/ Advances/

Deposits, which are not current assets
i a) Investments in subsidiary cos/
affiliates
b) Others
ii Adv to suppliers of Capital Goods/
Spares

iii Deferred receivables (other than those

maturing within 1 year)
iv Other Deposits (Under lien/ pledge etc)
R.Kannan Analysis of Balance Sheet – contd..
Last two years actuals as Current Year Projections for the
per audited accounts Estimates following Year
v Inter – corporate Loans and
Advances
43 Non – Consumable Stores and
Spares
44 a) Any other Non-Current
Assets including dues from
subsidiaries
b) Deferred Tax Assets
45 Total other Non-Current
Assets (total of 42 to 44)
46 Intangible Assets (Patents, good
will, preliminery & formation
expenses, bad / doubtful debts
not provided for, illiquid
investments, other losses not
provided for etc.)

P & L Account (Accumulated

loss)
R.Kannan Analysis of Balance Sheet – contd..
Last two years actuals as per Current Year Projections for the
audited accounts Estimates following Year
Expenditure not written off

Total Intangibles
47 Total Assets (total Item 38, 41, 45
and 46)
48 Tangible Net Worth (Item 28
minus item 46)

Adjusted Tangible Net Worth

(Item 28 minus item 46 minus
42(i) )
49 Net Working Capital (item 38
minus item 13)
50 Contingent Liabilities

i Arrears of Cumulative dividends

ii Gratuity scheme for staff

iii Other liab. Not provided for

R.Kannan

Analysis of Balance Sheet – contd..

Last two years actuals Current Year Projections for
as per audited accounts Estimates the following Year
Corporate Guarantee

Claims not acknowledged as debt

Disputed Tax

Disputed Excise

Disputed Customs

Bills discounted

Contracts remaining to be
executed

Total Contingent Liabilities

 Liabilities - Contd…
R.Kannan

• Redeemable preference shares are not part of net worth but treated as debt
unless otherwise, they are redeemed after 12 years.
• Net worth is arrived after providing for intangibles, likely losses not provided
for such as bad debts, illiquid investments and also investment in subsidiaries
and associate companies, unsecured loans to subsidiaries/associate
companies, unsecured loans to subsidiaries/associate companies. This is
called adjusted tangible net worth (Item No.48)
• Net working capital is the portion of working capital financed by long term
loans. (Item No.49).
R.Kannan
Data to be collected for Financial Analysis

• Production and Sales

– Product wise production (quantity), sales (quantity and value), and average

realization net of duties for the last 3 years – Comment on variation from

year to year.

– Index capacity utilization, sales, price and profit and if these indices are

varying from year to year and between themselves - further analysis.

– Relationship between the dealers and the company and whether dealers

hold any equity in the company.

– How good are the industrial relations.

R.Kannan Data to be collected for Financial Analysis – Contd…

– Do the dealers also supply services / materials

– Check year wise product returns. Are they high and occur every
year
– Capacity utilization and PBILD/sales how do they compare with the
industry
– Compound growth in sales over last 3 years. Static sales is a danger
Signal
R.Kannan

2. Cost
– Compute the ratio of the cost of raw material, consumable
stores, salaries and wages selling expenses, Utilities and
administrate overheads as a percentage of cost of sales over
the years and compare with the industry norm.
– Compute repairs and maintenance as a percentage of the sum
of gross value of the plant and machinery, miscellaneous
fixed assets and civil works.
– Locate the critical cost factor in the profitability
Refinery – Crude Oil cost (80%)
Aluminum – Power (50%)
Textile - Labour, Selling expenses
Petrochemical - Interest and depreciation
FMCG - Selling expenses
How do they compare with the industry standards?
R.Kannan

• Other Income = Non operating income + extra ordinary

income
The following are not operating incomes (i.e) not to be included
for operating profit.
• Non-Operating Income
Lease rentals / rent / hire charges
Fee received for services (selectively)
Interest received (netting of interest) / dividend
Utilisation of common services by group companies
Subsidy from Government of India (Fertiliser)
Refunds / write offs – not to be routed through profit and loss
account.
Fluctuation in exchange rates
Export benefits
R.Kannan
• Modvat benefits
• Claims receivables from Government agencies (such as electricity board etc.)
• Interest on debtors / exchange gain on overdue foreign debts.
• Waiver of interest / principal not to be routed through profit & loss account
• Government concessions
Exordinary Income:
– Profit / (loss) on sale of fixed assets / investments
– Non compete fee
– Sale of brands
• Examine whether the income has been received and age of the receivable
pertaining to the income.
• Utilisation of common services for group companies is a safe way of transfer
of profit and loss between various group companies. Check the basis of
computation.
R.Kannan

• Check whether subsidy as computed and taken by the company has been
formally approved by the Government.
• There are several ways of computing export benefits. This needs to be
checked. (eg. Entitlement of benefits due the duty free import of raw
materials for exports.
• Claims from Government bodies: Usually this amount will always remain at
a particular level. If so, this will not be a part of cash flow
• Interest on debtors should not be considered unless it is acknowledged by the
other party. Exchange gain on overdue foreign debtors should be excluded
as we are unsure of its collection.
• Some companies treat the relief given by the lenders by way of waiver of
interest/principal as other income. If the waived interest has been capitalized,
then it should be written off outside profit and loss account. Under no
circumstances principal relief can be taken as other income. It has to be
directly dealt with reserves/fixed assets as the case may be and loan amount.
R.Kannan

• Interest should not be netted out. Interest payable and receivables

should be shown separately.
• If a company has a continuing provision for expenses (for
previous year) every year below the line, it indicates that the
company does not provide for all expenses in the profit and loss
account and provides them below the line later to improve the
profit.
• Usually the other income is high where there are inter dealings
between the group companies.
• There are companies like Bajaj Auto which run a large treasury
operations. Almost 35% of the company’s profit is derived from
investments. This can even be taken as an operating income of
the investment division.
R.Kannan

• There are even cases where EPCG differential custom duties

on machinery have been taken as income / deferred income
which should be ignored as modvat credits are available for all
these.

• During the reverse merger of ICICI and ICICI Bank, ICICI

transferred its holding of ICICI Bank into a trust which was
then disposed off for a profit of almost Rs.1191 crores. As this
is the case of a company selling its own shares, it could also
have come as Share Premium .
R.Kannan

Raw material consumption

- Whether cost of materials is showing an increasing trend

- Whether improper valuation of closing raw material stock has led to
lower raw material consumption
- Check intra firm and raw material prices
- Check average price of raw materials with closing stock value.
- Is raw materials procured from associate companies or traders
instead of manufacturers
R.Kannan

Expenses
- Capitalisation of expenses particularly if the company is
implementing a project or expansion.

- % of expenses to sales and how they have varied over the years.

Depreciation
- Any change in the method of depreciation

Interest
- Reasonableness of interest cost as a percentage of outstanding
loans
- How the other expenses incurred for raising the loan such as fees
treated?
R.Kannan
Overall Profitability (for 3-5 years)

• Compute PBILD/Turnover, PBT/turnover and PAT/turnover and compare with

the industry norms.
• PBILD/Turnover – Indicates cooperational efficiency
• PBT/Turnover - Indicates Operational and Financial Efficiency
• PAT/ Turnover – Indicates Overall efficiency (including tax)
• Return on capital employed – Compare Industry norms
• Interest cover and debt service coverage ratio.
• Asset turnover ratio
Interest plus financial charges
• Outstanding debt
• (Capitalisation of Interest)
• Reasons for change year to year and compare
• Obtaining current working – sales
• PBILD, PBT, PAT and net cash accruals.
• Read Auditor’s notes.
R.Kannan
Fixed Assets and Work in Progress
• Break up of fixed assets: Land, Civil works, Plant and
machinery and others.
• Details of addition of fixed assets for last 5 years.
• Obtain age and status of projects under implementation -
(Abandoned/delayed/non-viable projects as CWIP). These to be
excluded from fixed assets.
• Project wise break up of capital works in progress and project
status.
• Check the percentage of miscellaneous expenses and other
intangibles capitalized in fixed assets. Does that include revenue
expenses.
• Higher ratio may indicate capitalization of revenue expenses /
losses – Increases net worth/Asset cover and reduces losses
• Has the fixed assets been revlaued - Impact
 Fixed Assets and Work in Progress – Contd..
R.Kannan

• Has the company changed depreciation method. Its impact.

• Lengthening the equipment life half way to reduce
depreciation and improve profits.
• Spic Petro – Capitalisation of carrying the cost of investment
in subsidiary (Rs.106 Crores)
• Steel – Capitalisation of FE losses on export advance (Rs.154
crores)
• Project abandoned but investment not written off.
• MRPL, Haldia, Oswal - Commercial production declared late
and Capitalisation Expenses.
R.Kannan

Intangible / Fictitous Assets capitalised

- Test is whether the asset can be converted into cash. Otherwise it

is not an asset.
- Share issue expenses – to be written off
- Discount on liability purchase
- Check valuation of for copyrights, patents, trademarks.
R.Kannan
Ratios

a) Interest and Expenses capitalised

GFA + CWIP – Assets sold / written off.

b) Interest and expenses capitalised

PBT
c) Net Fixed Assets
Loan secured through fixed asset

Eg. Spic Petro (Rs.106 crores)

Essor Steel (Rs.145 Crores)
MRPL, Haldia, Oswal
R.Kannan Investments
Long Term: Equity, preference shares and debentures to be valued at cost less
permanent diminition – No mark to market.
Short term:- Normally units. Valued at cost or market value whichever is
lower.
• Quoted, book value, market value, when last traded and volumes traded in
the last 6 months.
• Investment is subsidiaries/associate companies/market securities / others
break up.
• Return on investments – Subsidiaries/ market instruments separately.
• Investments to tangible networh.
• Investments to total assets
• Investments income to PBT
• Investment in subsidiaries to total assets
• Cost of holding investments – Investments x average interest / cost of
capital comparison with return.
• How is the overall debt equity of the group as compared to the debt to
equity of the company. Is borrowed funds diverted for investments in
subsidiary.
• Highly liquid investments may be treated as current assets.
R.Kannan

Working Capital

A) Inventories

i) Finished goods
- Basis of valuation (market value/cost/FIFO/FILO)
- Change in the method of valuation – its impact on profitability
- Comparison of stock holding levels (finished goods/sales) in the
industry
- Variation in holding level over the last 3 years as a percentage of
cost of goods sold.
- Compounded rate of growth of finished goods inventory versus
compounded rate of growth of sales.
- Age of finished goods/stores inventory.
- Whether any fixed assets (say real estate) transferred to stock in
trade. Its impact on profitability.
R.Kannan

- Does that the quantity, specification, product mix of sales and stock
different.
- Does closing stock valuation done at listed prices and ignores
discounts.
- What is the average selling price of products during the year and
show does it compare with the prices at which the stock is valued
(Inter firm comparison)

Raw materials
- Age of inventory
- Comparison with the industry norms/consumption - How has it
varied over the last 3 years.
- Average price for valuation versus the average purchase price
during the year.
- Stock of raw materials as months’ consumption.
R.Kannan

Process Stock
- Composition
- Stock as months’ cost of production

Stores stock
- Age of inventory
- Whether this item has been utilised in the last 3 years.
- Stores stock as months of consumption.
- Whether any part of these have been transferred from capital assets
which are financed through term loans
R.Kannan

Receivables

- Debtors (including bills) as percentage of gross sales. Comparison

year to year and industry norms.
- Debt outstanding more than 6 months – Why they have been given
(sales / expenses)
- Doubtful debts and provisions – Auditors’ comment.
- Reasons for not making provisions for debts outstanding for more
than 6 months – look at their financial.
- Have the auditors stated (notes to accounts) that debtors and
creditors are subject to confirmation.
- Break up of receivables in terms of age, purpose (sales, expenses,
retention money, export debtors, government dues, receivable from
group concerns etc.)
R.Kannan

- Rate of growth of receivables versus the growth of sales over the

last 3 years.
- Average collection period versus the official credit period.
- Bills discounted to be added to bank borrowings and receivables.
- Is the company booking interest on overdue debtors. Ignore this for
profitability.
- Is the debtors also creditors, are they the sister/associate
companies. How are their financials.
- Is the debtors represent goods sold/exported without letter of credit.
- Foreign exchange gains on debtors / to be booked only on
realisation.
- Settlement of debts through sale of / buying assets.
- Auditors notes on debtors
- Status of legal action on overdue debtors
- Receivables from associates/subsidiary companies.
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Loans/Advances

- Break up of loans/advances according to age and purpose (capital

expenditure, deposits)
- Terms of advances given to group companies
- Recoverability of advances particularly from group companies
- Advances for capital expenditure
- It should be included in the capital works in progress. Is the project
still active.

Cash & Bank balances

- Has the cash/bank balances come down sharply as compared to

last year
- Large idle cash bank balances – why satyam.
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Deferred tax asset is an asset only if the company continues to make taxable
profits and use the tax shield.

Current liabilities and Provisions

- Obligations to mature within a year
- Includes loans repayable within a year
- Break up of creditors – supplies, expenses, other purposes
- Details of creditors appearing as debtors also
- Age of creditors.
- Creditors belonging to the group companies – the reason of availing of
credit.
- Basis of gratuity provision (Cash/accrual)
- Break up into gross tax provision and advance tax paid.
- Advances from dealers/selling agents is term liability if it is refundable only
on term.
- Details of provisions and their adequacy.
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Bank Borrowings
• Status of bank borrowing, borrowing limit, limits and
overborrowings/defaults if any / invocation of guarantees
• Does the company deal with the banks outside the consortium
• Details of suits filed by bankers if any.
• Other current liability / provisions
• Details of provisions and adequacy.
• Bills – discounted / purchased
• Current ratio.
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Financial Statement Analysis

Share capital
- Authorised and paid up share capital
- Shareholding pattern
- Book value, movement of market prices, dividend record
- Dividend rate and redemption period of preference share capital –
Does it carry conversion option on dividend default.
- If it is redeemable within 3 years, it is treated as term liability
- If it is redeemable after 12 years, it is quasi equity.
- How frequently the shares are traded – liquidity.
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Reserves

a) Capital reserves (How were they created)

• Share premium account
• Capital redemption reserve
• Revaluation reserves

b) Revenue reserves

- Revaluation reserves is not part of networth. No dividend be

declared out of capital reserves.
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Long term secured loans

- Long term; debentures, term loans, deferred payment credits,
preference shares redeemable within 3 years.
- Short term; working capital borrowings
- Movement of term loans; loans repayable within a year (current
liabilities)
- Foreign exchange loans – currency risk
- Details of interest rates, repayment schedule and security and
seniority if any for all loans along with the lenders’ names
- Ratio of interest to outstanding loans. If it is low, it is an indication of
capitalisation of interest.
- Identify the cash flows which are subject to escrow / water fall
mechanism so as to segregate the cash flow available for the
specific loan
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- Special conditions stipulated by lenders such as right to accelerate,

demand prepayment, conversion or unilaterally alter the repayment
schedule.
- Availability of borrowing power as per articles of association/ AGM
resolutions
- Details of restructured loans
- Priority of loans in terms of security particularly debentures.
- Has the overall debt increased? How this has been utilised?
- Has the short term borrowings have increased to finance rapid
growth in fixed assets. (Subhiksha, Vishal)
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Unsecured loans
- Public deposits, commercial paper, unsecured loans from
promotors, intercorporate loans and unsecured loans from banks,
institutions.
- Study the movement of unsecured loans from the promoters/interest
rate
- Deposits – 10% of net worth maximum from shareholders
- 25% of net worth maximum from public.
- Intercorporate loans
60% of share capital and free reserves or 100% of free reserves
whichever is higher
- Deposits from dealers / selling agents may be considered term
liabilities if it is refundable only on termination of leadership.
- Term of deposits – (Interest rate – maturity) the cost of deposits
gives an idea of the company’s public rating.
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Unsecured loans
- If loans have been taken from promoters then interest rates
- Is there been any default in payment

Lease
- Details of assets taken on lease, terms and lease payments within a year.

Details of contingent liabilities

- Guarantees given on behalf of subsidiaries and others – working of
beneficiaries
- Bills discounted
- Loan assignments
- Disputes (income tax, excise) – Pharma
- Export obligation
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Details of contingent liabilities

- Claims against the company
- Patent disputes
- Pledged shares
- Status of legal disputes
- FCCB/Optionally convertible instruments (If not converted becomes
debt);
- If market prices come down and company does not do well would
become debt instruments.
- Legal claims (Pharma)
- Ratio of contingent liabilities to networth.
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Notes
Assets to be excluded from current assets
- Receivables overdue for a long time
- Payments shown as advance made in protest towards contingent
liabilities of sales tax/excise
- Investment in subsidiaries
- Unconnected investments
- Deposits in government bodies for telephone, power
- Slow moving inventories (write off)
- Long term deposits
- Stores/spares not used for more than 12 months.
- Deposits with associate companies
- Disputed receivables
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1) Cross Holding should be netted out

2) Debt exceeding free reserves and shares requires AGM approval.
Debt excludes short term loans, cash credit, bills discounting and
those payable on due.
Advances from customers (car booking)
- Current liability to the extent of not invested in approved securities.
- Deposits from dealers selling agents – term liabilities if it is
refundable only on termination of dealership.
- Status of default in meeting obligation.
- Trading in raw materials – Net out trading amount from both
purchase and sales.
- View has to be taken on disputed liablities
- Goodwill-excess of valuations over book value
- Net worth should exclude revaluation of assets.
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- Financial statistics – Historical perspective but not a predictive tool

under changing condition
- High nil rates affect capital goods
- Socio-cultural – soft drink – fruit juices.