Application of AM, GM, HM, Median and Mode

 

Financial Analysis – A Study

 

 

1. Introduction 

New companies Act 2013 introduced with aim of easing the process of doing business in India and improvement of corporate governance and making companies more accountable. There are 29 chapters, 7 schedules and 470 sections. The Act has replaced Companies Act, 1956 (in a partial manner) after receiving the assent of the President of India on 29 August 2013. Section 2 (40) deals the definition of ‘financial statement”. This statement will provide the true and fair view of state of affairs of the company in accordance with the accounting standard notified under section 133.

Financial statement includes the statement of profit and loss, statement of balance sheet, cash flow statement, statement of changes of equity and notes to the account. Cash flow statement is not mandatory for all companies. The Company act 1956 didn’t include cash flow statement in the Definition of Financial statement. The Applicability of Cash Flow Statements governed by the Companies (Accounting Standards) Rules, 2006. Provided that the financial statement, with respect to One Person Company, small company and dormant company, may not include the cash flow statement; It means all the companies whether private or public needs to include cash flow statement in its financial statement except the One Person Company, small company and dormant company. Now we have to check the definition of One Person Company, small company and dormant company

One Person Company: As per sec 2(62) of The CA, 2013 -One Person Company” means a company which has only one person as a member;

Small company

Sec 2(85) ‘small company’’ means a company, other than a public company,—

(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than five crore rupees; and

(ii) turnover of which as per its last profit and loss account does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than twenty crore rupees: Provided that nothing in this clause shall apply to—

(A) a holding company or a subsidiary company;

(B) a company registered under section 8; or

 

(C) a company or body corporate governed by any special Act;

Dormant company

As per sec 455 of The CA, 2013 “Dormant Company” means a company

(i) Where a company is formed and registered under this Act for a future project or to hold an asset or intellectual property and has no significant accounting transaction, such a company or an inactive company may make an application to the Registrar in such manner as may be prescribed for obtaining the status of a dormant company.

Explanation.—For the purposes of this section,—

(i) “inactive company” means a company which has not been carrying on any business or operation, or has not made any significant accounting transaction during the last two financial years, or has not filed financial statements and annual returns during the last two financial years;

(ii) “significant accounting transaction” means any transaction other than—

(a) payment of fees by a company to the Registrar;

(b) payments made by it to fulfil the requirements of this Act or any other law;

(c) allotment of shares to fulfil the requirements of this Act; and

(d) payments for maintenance of its office and records.

Crux and comparison analysis:

A public company will never be a small company, therefore in case of private companies, the limit has been decreased as far as turnover is concerned earlier it was exceeds 50 crores. Now it has been decreased to 2 crores resulted in increase in the compliance of the companies. In nutshell, it is applicable to almost all the private companies as 2 crores turnover is very nominal amount. Also there is no limits of borrowing as specified in accounting standards. MCA has also put a check on paid-up share capital for the applicability of CFS (Which is 50Lacs).

There are 39 accounting standard active till the date. Accounting standard is the guidelines or set of principles for recording the business transactions in books of account. Ind As 7 deals the statement of cash flow. Ind As-1 deals the presentation of financial statement and Ind As-110 deals the consolidated financial statement.

Financial Analysis is the process of identifying the financial strength and weaknesses of the firm by properly establishing relationship between items of financial statements. A financial statement is an organized collection of data according to logical and conceptual framework. Consistent accounting procedure. Its purpose is to convey an understanding of some financial aspects of a business firm. It may show a position at a moment of time as time, as in the case of an income statement.

Financial performance refers to the act of performing financial activity. In broader sense, financial performance refers to the degree to which financial objectivities being or has been accomplished. It is the process of measuring the results of firm’s policies and operations in monetary terms. It is used to measure firms over all financial health over a given period of time.

MEANING AND DEFINATION OF FINANCIAL ANALYSIS

"Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position.

Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."

According to Lev- “financial statement analysis is an information processing system design to provide data for decision making models, such as the portfolio selection model, bank lending decision models and corporate financial models “.

According to john Myer, “financial statement analysis is largely a study of relationship among the various financial factors in a business as disclosed by single set of statements and a study of the trend of these factors as shown in a series of statements.

According to Kennedy and Muller, “the analysis and interpretation of financial statements reveal each and every aspect regarding the well-being financial soundness, operational efficiency and credit worthiness of the concern concerned”.

Financial statement analysis embraces the methods used in assessing and interpreting the result of past performance and current financial position as they relate to particular factors of interest in investment decisions. It is an important means of assessing past performance and in forecasting and planning future performance.

 Nature of the financial statement

v  Recorded facts: We need to first record facts in monetary form to create the statements. For this, we need to account for figures of accounts like fixed assets, cash, trade receivables, etc.

v  Accounting conventions: Accounting Standards prescribe certain conventions applicable in the process of accounting. We have to apply these conventions while preparing these statements. For example, the valuation of inventory at cost price or market price, depending on whichever is lower.

v  Postulates: Apart from conventions, even postulates play a big role in the preparation of these statements. Postulates are basically presumptions that we must make in accounting. For example, the going concern postulate presumes a business will exist for a long time. Hence, we have to treat assets on a historical cost basis.

v  Personal judgments: Even personal opinions and judgments play a big role in the preparation of these statements. Thus, we have to rely on our own estimates while calculating things like depreciation.

OBJECTIVES OF FINANCIAL ANALYSIS

The major objectives of financial statement analysis are to provide decision makers information about a business enterprise for use in decision making. Uses of financial statement information are management for evaluating the operational and financial efficiency of the enterprise as a whole or of sub units; investors for making investment decisions and portfolio decisions, lenders and creditors for determining the credit worthiness and solvency position; employee and labour unions for deciding economic status of the enterprise and making sound decisions in wage and salaries negotiations.

However, the following are generally considered to be the objectives of financial Analysis:

·          To find out the financial stability and soundness of the business enterprise.

·          To assess and evaluate the earning capacity of the business.

·          To estimate and evaluate the fixed assets, stock, etc of the concern.

·          To estimate and determine the possibilities of future growth of business.

·          To assess and evaluate the firm’s capacity and ability to repay short-term and long-term loans.

·          To evaluate the administrative efficiency of the business enterprise.

 

SIGNIFICANCE OF FINANCIAL ANALYSIS

Financial statements analysis is an attempt to determine the significance and meaning of the financial statements data, which measure the enterprise’s liquidity profitability, forecast may be made of the future earnings, solvency and other indicators to assess its operating efficiency, financial position and performance.

Financial analysis serves the following purpose:

1.        To know the operational efficiency of the business.

2.        This will enable the management to locate weak spots of the business and take necessary remedial action.

3.        Helpful in measuring the solvency of the firm in taking appropriate decisions for strengthening the short-term as well as long-term solvency of the firm.

4.        Comparison of past and present results.

5.        Financial analysis helps the managers in taking certain decisions for improving the profitability or reducing the losses of the firm.

6.        Helps in judging the solvency i.e. the capacity of the business to repay their loans.

7.        Financial statement analysis is a significance tool in predicting the bankruptcy and failure of the business enterprises.

8.        The financial analysis will help in assessing future development by making forecasts and preparing budgets.

  Types of Financial Statement:

 The primary financial statements are the statement of financial position (i.e., the balance sheet), the statement of comprehensive income (or two statements consisting of an income statement and a statement of comprehensive income), the statement of changes in equity, and the statement of cash flows.

 v  Balance Sheet: The balance sheet discloses what resources a company controls (assets) and what it owes (liabilities) at a specific point in time. Owners’ equity represents the net assets of the company; it is the owners’ residual interest in, or residual claim on, the company’s assets after deducting its liabilities. The relationship among the three parts of the balance sheet (assets, liabilities, and owners’ equity) may be shown in equation form as follows: Assets = Liabilities + Owners’ equity.

 v  Profit and Loss Statement: The income statement presents information on the financial results of a company’s business activities over a period of time. The income statement communicates how much revenue and other income the company generated during a period and what expenses, including losses, it incurred in connection with generating that revenue and other income. The basic equation underlying the income statement is Revenue + Other income – Expenses = Net income.The statement of comprehensive income includes all items that change owners’ equity except transactions with owners. Some of these items are included as part of net income, and some are reported as other comprehensive income (OCI).

 v  Statement of Changes of Equity: The statement of changes in equity provides information about increases or decreases in the various components of owners’ equity.

 v  Cash Flow Statement: Although the income statement and balance sheet provide measures of a company’s success, cash and cash flow are also vital to a company’s long-term success. Disclosing the sources and uses of cash helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial flexibility.

 v  Notes to the Account: The notes (also referred to as footnotes) that accompany the financial statements are an integral part of those statements and provide information that is essential to understanding the statements. Analysts should evaluate note disclosures regarding the use of alternative accounting methods, estimates, and assumptions.

     In addition to the financial statements, a company provides other sources of information that are useful to the financial analyst. As part of his or her analysis, the financial analyst should read and assess this additional information, particularly that presented in the management commentary (also called management report[ing], operating and financial review, and management’s discussion and analysis [MD&A]).

     A publicly traded company must have an independent audit performed on its annual financial statements. The auditor’s report expresses an opinion on the financial statements and provides some assurance about whether the financial statements fairly present a company’s financial position, performance, and cash flows. In addition, for US publicly traded companies, auditors must also express an opinion on the company’s internal control systems.

     Information on the economy, industry, and peer companies is useful in putting the company’s financial performance and position in perspective and in assessing the company’s future. In most cases, information from sources apart from the company are crucial to an analyst’s effectiveness.

     The financial statement analysis framework provides steps that can be followed in any financial statement analysis project. These steps are:

 articulate the purpose and context of the analysis;

 

• collect input data;

 

• process data;

 

• analyze/interpret the processed data;

 

• develop and communicate conclusions and recommendations; and

 

• follow up.

 Limitations of the financial statement (Problems encounter in the financial statement)

v  Indifferent to market values

Financial statements are a derivative of bookkeeping and accounting. While accounting, an accountant records the transaction at cost. For example, assume an asset is purchased at the beginning of a financial year at $10,000 (based on the invoice value). At the end of the year, the real market value of the asset goes down to $5000 due to a new technology introduced in the market. The balance sheet of this company would show this asset’s value @ $10,000. At the max, there would be some depreciation say @15%. The net value after depreciation also would be $8,500 ( $10,000 less $1500). Still, there is a vast difference between the balance sheet value and the market value of this asset. So, heavy reliance on historical costs makes the financial statement less reliable and more misleading.

v  Inflation

We all know that inflation is a reality. Sadly, financial statements do not consider the effects of inflation on the assets and liabilities shown in the balance sheet. In a period when the inflation rate is too high, the balance sheet misleads by showing substantially low values.

v  Specific time period

Financial statements are prepared for a specific time period normally a year. Looking at one such period could be misleading because of seasonal impact on businesses, economic ups and downs etc. It is always advisable to look at 2 to 3 periods or even more if we wish to have a true analysis of the affairs of a company. Also, these statements show financial position on a particular date where is the financial position changes every day and with every transaction.

v  Not comparable

For checking the performance of one company, it is a common practice to compare it with other similar company in the same sector. A financial statement just gives an indication and does not facilitate true comparison between the two companies. It is simply because different accounting practices followed by these companies. Although, good companies mention most of the deviations from accounting policies in their disclosures. Even after a financial statement reader takes the pain of reading the disclosure, and if he finds a difference in policies of two companies, he cannot go and prepare the financial statements based on one single policy for the sake of his comparison. We must note that it is a good practice to read disclosures along with the financial statements like income statement, balance sheet, and cash flow statement.

 v  Intangible assets

There is seldom any company on this earth which is identifying and recording each and every intangible asset in their books of accounts. On one hand, there are missed intangible assets. And on the other hand, the expenses incurred to create those intangible assets (knowingly or unknowingly) are recorded or charged to the income statement as an expense. Such a policy will significantly diminish the valuation of a company. It is a common issue spotted in startup companies. With their hard work, they create intellectual properties but in the initial phase of their business, they generate minimal sales based on that.

v  Prone to frauds

There are many situations when the financial statement becomes a tool to commit fraud. There are a lot of agencies who base their decisions on funding, rating etc on financial statements. Another possibility of window dressing of financial statement could be by the management team itself. If the shareholders have introduced remuneration policy linked to the performance shown in the financial statements, the management team has an incentive to deliberately show higher incomes. Another possibility of financial statement manipulation can try is when majority shareholders are part of the board of directors and the management team. When these shareholders want to exit from their investment in the company, they have all the incentive to show higher profit and influence the stock market price of the company. So that they can realize the higher value of their investments.

v  Ignores non-financial matters

Successfully running a business is not limited to sales, expenses, and profits. A lot of other environmental, sociological, political factors, competitive position, contribution towards local communities etc. impact the business. These factors are ignored in the financial statements. Although big and good companies have started taking care of these factors in their annual reports, there are many companies for whom writing for reporting about these factors is just a formality.

v  Unaudited financial statements

When somebody uses unaudited financial statements, they can really be misleading without the express opinion of the auditor’s about the true and fair view of the affairs of the company. The sad part here is that some audited financial statements are also as good as unaudited financial statements due to various reasons. The reasons could be the inefficiency of auditors, when management and auditors have common interests, etc.

 v  Not futuristic

When a potential investor is looking at the financial statements of a company, what will he be interested in? If i were the investor, i would be interested in the future expected profits of the company. The simple logic behind this is that if i invest today, i would get my return on investment only when the company continue making profits and raise the levels of profit in the coming years. There is no express indication by the financial statements about the future.

v  Errors and omissions

The basic recording of transactions is carried out by the accounting executive who is normally not highly qualified. So there are always chances of errors and omissions. Such misrepresentation in the ultimate financial statements.

v  Qualitative information

Financial statements highly focus on quantitative data and thus misses out on qualitative information which is very crucial in running the show. Qualitative information could be the efficiency of management, employees, customer satisfaction, the efficiency of the supply chain, etc.

v  Not self-explanatory

Financial statements are not self-explanatory which a layman can understand. Reading, understanding and interpreting the financial statements requires expert knowledge of accounting, finance etc. Investors from other backgrounds have real difficulty in deciding whether to continue their investment in a particular company or not. They have to rely on other experts. A big investor can still manage but small investors may find it difficult to afford expert advice for their small investments.

v  Real profits hidden

Financial statements of a company do not significantly distinguish between operating and non-operating expenses and incomes. This mixes up the things. The true profitability of a business can be hidden if there is a one-time income received from non-operating activities of the company like profits from investments, etc.

v  Valuation of closing stock

Valuation of closing stock is it tool for the wicked management. It is very easy to manipulate the value of the stock. In a manufacturing concern, it is very difficult at times to determine the exact available quantity of raw material, work in progress, and finished goods. For example, in ceramic industries, the sand-water mix is stored in the ball mill. No human can go inside and measure the quantity perfectly. Such situations are used for taking unnatural benefits by tweaking the profits.

Who are the stakeholders?

 There are many users of the financial statements produced by an organization. The following list identifies the more common users and the reasons why they need this information:

 

v  Company management. The management team needs to understand the profitability, liquidity, and cash flows of the organization every month, so that it can make operational and financing decisions about the business.

 

v  Competitors. Entities competing against a business will attempt to gain access to its financial statements, in order to evaluate its financial condition. The knowledge they gain could alter their competitive strategies.

 v  Customers. When a customer is considering which supplier to select for a major contract, it wants to review their financial statements first, in order to judge the financial ability of a supplier to remain in business long enough to provide the goods or services mandated in the contract.

 v  Employees. A company may elect to provide its financial statements to employees, along with a detailed explanation of what the documents contain. This can be used to increase the level of employee involvement in and understanding of the business.

 v  Governments. A government in whose jurisdiction a company is located will request financial statements in order to determine whether the business paid the appropriate amount of taxes.

 v  Investment analysts. Outside analysts want to see financial statements in order to decide whether they should recommend the company's securities to their clients.

 v  Investors. Investors will likely require financial statements to be provided, since they are the owners of the business and want to understand the performance of their investment.

 v  Lenders. An entity loaning money to an organization will require financial statements in order to estimate the ability of the borrower to pay back all loaned funds and related interest charges.

 v  Rating agencies. A credit rating agency will need to review the financial statements in order to give a credit rating to the company as a whole or to its securities.

 v  Suppliers. Suppliers will require financial statements in order to decide whether it is safe to extend credit to a company.

 v  Unions. A union needs the financial statements in order to evaluate the ability of a business to pay compensation and benefits to the union members that it represents.

 In short, there are many possible users of financial statements, all having different reasons for wanting access to this information.

 How to read the Annual Reports?

 v  What is an Annual Report?

The annual report (AR) is a yearly publication by the company and is sent to the shareholders and other interested parties. The annual report is published by the end of the Financial Year, and all the data made available in the annual report is dated to 31st March. The AR is usually available on the company’s website (in the investors section) as a PDF document or one can contact the company to get a hard copy of the same.

Since the annual report is published by the company, whatever is mentioned in the AR is assumed to be official. Hence, any misrepresentation of facts in the annual report can be held against the company. To give you a perspective, AR contains the auditor’s certificates (signed, dated, and sealed) certifying the sanctity of the financial data included in the annual report.

 Potential investors and the present shareholders are the primary audience for the annual report.  Annual reports should provide the most pertinent information to an investor and should also communicate the company’s primary message. For an investor, the annual report must be the default option to seek information about a company. Of course there are many media websites claiming to give the financial information about the company; however the investors should avoid seeking information from such sources. Remember the information is more reliable if we get it get it directly from the annual report.

 Why would the media website misrepresent the company information you may ask? Well, they may not do it deliberately but they may be forced to do it due to other factors. For example the company may like to include ‘depreciation’ in the expense side of P&L, but the media website may like to include it under a separate header. While this would not impact the overall numbers, it does interrupt the overall sequencing of data.

 v  What to look for in an Annual Report?

The annual report has many sections that contain useful information about the company. One has to be careful while going through the annual report as there is a very thin line between the facts presented by the company and the marketing content that the company wants you to read.

 Let us briefly go through the various sections of an annual report and understand what the company is trying to communicate in the AR. For the sake of illustration,

  I have taken the Annual Report of Amara Raja Batteries Limited, belonging to Financial Year 2013-2014. As you may know Amara Raja Batteries Limited manufactures automobile and industrial batteries. You can download ARBL’s FY2014 AR from here (http://www.amararaja.co.in/annual_reports.asp)

 Please remember, the objective of this chapter is to give you a brief orientation on how to read an annual report. Running through each and every page of an AR is not practical; however, I would like to share some insights into how I would personally read through an AR, and also help you understand what kind of information is required and what information we can ignore.

For a better understanding, I would urge you to download the Annual Report of ARBL and go through it simultaneously as we progress through this chapter.

ARBL’s annual report contains the following 9 sections:

Financial Highlights

The Management Statement

Management Discussion & Analysis

10 year Financial highlights

Corporate Information

Director’s Report

Report on Corporate governance

Financial Section, and

Notice

Note, no two annual reports are the same; they are all made to suite the company’s requirement keeping in perspective the industry they operate in. However, some of the sections in the annual report are common across annual reports.

 The first section in ARBL’s AR is the Financial Highlights. Financial Highlights contains the bird’s eye view on how the financials of the company looks for the year gone by. . The information in this section can be in the form of a table or a graphical display of data. This section of the annual report generally does a multi-year comparison of the operating and business metrics.

 The details that you see in the Financial Highlights section are basically an extract from the company’s financial statement. Along with the extracts, the company can also include a few financial ratios, which are calculated by the company itself. I briefly look through this section to get an overall idea, but I do not like to spend too much time on it. The reason for looking at this section briefly is that, I would anyway calculate these and many other ratios myself and while I do so, I would gain greater clarity on the company and its numbers. Needless to say, over the next few chapters we will understand how to read and understand the financial statements of the company and also how to calculate the financial ratios.

 The next two sections i.e the ‘Management Statement’ and ‘Management Discussion & Analysis’ are quite important. I spend time going through these sections. Both these sections gives you a sense on what the management of the company has to say about their business and the industry in general. As an investor or as a potential investor in the company, every word mentioned in these sections is important. In fact some of the details related to the ‘Qualitative aspects’ (as discussed in chapter 2), can be found in these two sections of the AR.

 In the ‘Management Statement’ (sometimes called the Chairman’s Message), the investor gets a perspective of how the man sitting right on top is thinking about his business. The content here is usually broad based and gives a sense on how the business is positioned. When I read through this section, I look at how realistic the management is. I am very keen to see if the company’s management has its feet on the ground. I also observe if they are transparent on discussing details on what went right and what went wrong for the business.

 One example that I explicitly remember was reading through the chairman’s message of a well established tea manufacturing company. In his message, the chairman was talking about a revenue growth of nearly 10%, however the historical revenue numbers suggested that the company’s revenue was growing at a rate of 4-5%. Clearly in this context, the growth rate of 10% seemed like a celestial move. This also indicated to me that the man on top may not really be in sync with ground reality and hence I decided not to invest in the company. Retrospectively when I look back at my decision not to invest, it was probably the right decision.

 Here is the snapshot of Amara Raja Batteries Limited; I have highlighted a small part that I think is interesting. I would encourage you to read through the entire message in the Annual Report.

Moving ahead, the next section is the ‘Management Discussion & Analysis’ or ‘MD&A’. This according to me is perhaps one of the most important sections in the whole of AR. The most standard way for any company to start this section is by talking about the macro trends in the economy. They discuss the overall economic activity of the country and the business sentiment across the corporate world. If the company has high exposure to exports, they even talk about global economic and business sentiment.

 ARBL has both exports and domestic business interest; hence they discuss both these angles in their AR. See the snapshot below:

Following this the companies usually talk about the trends in the industry and what they expect for the year ahead. This is an important section as we can understand what the company perceives as threats and opportunities in the industry. Most importantly I read through this, and also compare it with its peers to understand if the company has any advantage over its peers.

 For example, if Amara Raja Batteries limited is a company of interest to me, I would read through this part of the AR and also would read through what Exide Batteries Limited has to say in their AR.

 Remember until this point the discussion in the Management Discussion & Analysis is broad based and generic (global economy, domestic economy, and industry trends). However going forward, the company would discuss various aspects related to its business. It talks about how the business had performed across various divisions, how did it fare in comparison to the previous year etc. The company in fact gives out specific numbers in this section.

Some companies even discuss their guidelines and strategies for the year ahead across the various verticals they operate in.

 After discussing these in ‘Management Discussion & Analysis’ the annual report includes a series of other reports such as – Human Resources report, R&D report, Technology report etc. Each of these reports are important in the context of the industry the company operates in. For example, if I am reading through a manufacturing company annual report,  I would be particularly interested in the human resources report to understand if the company has any labor issues. If there are serious signs of labor issues then it could potentially lead to the factory being shut down, which is not good for the company’s shareholders.

 v  The Financial Statements

Finally, the last section of the AR contains the financial statements of the company. As you would agree, the financial statements are perhaps one of the most important aspects of an Annual Report. There are three financial statements that the company will present namely:

The Profit and Loss statement

The Balance Sheet and

The Cash flow statement

We will understand each of these statements in detail over the next few chapters. However at this stage it is important to understand that the financial statements come in two forms.

 Standalone financial statement or simply standalone numbers and

Consolidated financial statement or simply consolidated numbers

To understand the difference between standalone and consolidated numbers, we need to understand the structure of a company.

 Typically, a well established company has many subsidiaries. These companies also act as a holding company for several other well established companies. To help you understand this better, I have taken the example of CRISIL Limited’s shareholding structure. You can find the same in CRISIL’s annual report. As you may know, CRISIL is an Indian company with a major focus on corporate credit rating services.

v  As you can see in the above shareholding structure:

 Standard & Poor’s (S&P), a US based rating agency holds a 51% stake in CRISIL. Hence S&P is the ‘Holding company’ or the ‘Promoter’ of CRISIL

The balance 49% of shares of CRISIL is held by Public and other Financial institutions

However, S&P itself is 100% subsidiary of another company called ‘The McGraw-Hill Companies’

This means McGraw Hill fully owns S&P, and S&P owns 51% of CRISIL

Further, CRISIL itself fully owns (100% shareholding) another company called ‘Irevna’.

Keeping the above in perspective, think about this hypothetical situation. Assume, for the financial year 2014, CRISIL makes a loss of Rs.1000 Crs and Irevna, its 100% subsidiary makes a profit of Rs.700 Crs. What do you would be the overall profitability of CRISIL?

 Well, this is quite simple – CRISIL on its own made a loss of Rs.1000 Crs, but its subsidiary Irevna made a profit of Rs.700 Crs, hence the overall P&L of CRISIL is (Rs.1000 Crs) + Rs.700 Crs = (Rs.300 Crs).

 Thanks to its subsidiary, CRISIL’s loss is reduced to Rs.300 Crs as opposed to a massive loss of Rs.1000 Crs. Another way to look at it is, CRISIL on a standalone basis made a loss of Rs.1000 Crs, but on a consolidated basis made a loss of Rs.300 Crs.

 Hence, Standalone Financial statements represent the standalone numbers/ financials of the company itself and do not include the financials of its subsidiaries. However the consolidated numbers includes the companies (i.e.standalone financials)  and its subsidiaries financial statements.

 I personally prefer to look through the consolidated financial statements as it gives a better representation of the company’s financial position.

v  Schedules of Financial Statements

When the company reports its financial statements, they usually report the full statement in the beginning and then follow it up with a detailed explanation.

Have a look at the snapshot of one of ARBL’s financial statement (balance sheet):

 

M3-Ch3-chart8

 Each particular in the financial statement is referred to as the line item. For example the first line item in the Balance Sheet (under Equity and Liability) is the share capital (as pointed out by the green arrow). If you notice, there is a note number associated with share capital. These are called the ‘Schedules’ related to the financial statement. Looking into the above statement, ARBL states that the share capital stands at Rs.17.081 Crs (or Rs.170.81 Million). As an investor I obviously would be interested to know how ARBL arrived at Rs.17.081 Crs as their share capital. To figure this out, one needs to look into the associated schedule (note number 2).

 Of course, considering you may be new to financial statements, jargon’s like share capital make not make much sense. However the financial statements are extremely simple to understand, and over the next few chapters you will understand how to read the financial statements and make sense of it. But for now do remember that the main financial statement gives you the summary and the associated schedules give the details pertaining to each line item.

 v  Key takeaways from this chapter

The Annual Report (AR) of a company is an official communication from the company to its investors and other stakeholders

The AR is the best source to get information about the company; hence AR should be the default choice for the investor to source company related information

The AR contains many sections, with each section highlighting certain aspect of the business

The AR is also the best source to get information related to the qualitative aspects of the company

Ø  The management discussion and analysis is one of the most important sections in the AR. It has the management’s perspective on the overall economy of the country, their outlook on the industry they operate in for the year gone by (what went right and what went wrong), and what they foresee for the year ahead

Ø  The AR contains three financial statements – Profit & Loss statement, Balance Sheet, and Cash Flow statement

Ø  The standalone statement contains the financial numbers of only the company in consideration. However the consolidated numbers contains the company and its subsidiaries financial numbers.