FINANCIAL STATEMENT ANALYSIS AND PERFORMANCE MEASURMENTASSIGNMENT HERO MOTO CORP FINANCIAL ANALYSIS SUBMITTED BY G.UMESH CHANDU REG.NO:13010121169 SEC: A ROLL.NO:25 1.How would corporate reports of a corporate aid investors and bankers in decision-making processes? Explain? A. Financial reporting provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decision. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. External users of financial information encompass a wide range of interests but can be classified into three general groups: 1. Credit and equity investors 2. Government, regulatory bodies, and tax authorities 3. The general public and special interest groups, labor unions, and consumer groups Each of these user groups has a particular objective in financial statement analysis; the primary users are equity investors and creditors. However, the information supplied to investors and creditors is likely to be generally useful to other user groups as well. Hence, financial accounting standards are geared to the purposes and perceptions of investors and creditors. The underlying objective of financial analysis is the comparative measurement of risk and return to make investment or credit decisions. These decisions require estimates of the future, be it a month, a year, or a decade. General-purpose financial statements, which describe the past, provide one basis for projecting future earnings and cash flows. Many of the techniques used in this analytical process are broadly applicable to all types of decision, but there are also specialized techniques concerned with specific investment interest or, in other words, risks and returns specific to one class of investors or securities. The equity investor is primarily interested in the long-term earning power of the company, its ability to grow, and, ultimately, its ability to pay dividends and increase in value. Since the equity investor bears the residual risk in an enterprise, the largest and most volatile risk, the required analysis is the most comprehensive of any user and encompasses techniques employed by all other external users. Creditors need somewhat different analytical approaches. Short-terms creditors, such as bank and trade creditors, place more emphasis on the immediate liquidity of the business because they seek an early payback of their investment. Long-term investors in bonds, such as insurance companies and pension funds, are primarily concerned with the long-term asset position and earning power of the company. They seek assurance of the payment of interest and the capability of retiring or refunding the obligation at maturity. Credit risks are usually smaller than equity risks and may be more quantifiable. 1. Briefly explain as to how MD&A section of the annual report of a corporate is useful to the analysts? A. Companies with publicly traded securities have been required since 1968 to provide a discussion of earnings in the MD&A section. In 1980, the SEC expanded the requirements to a comprehensive, broad-based discussion and analysis of the financial statement to encourage more meaning disclosure. The MD&A will discuss: Results of operations, including discussion of trends in sales and categories of expense Capital resources and liquidity, including discussion of cash flow trends Outlook based on known trends Prospective information and required discussion of significant effects of currently known trends, events, and uncertainties; for example, decline in market share or impact of inventory obsolescence. Firms may voluntarily disclose forward-looking data that anticipate trends or events. Liquidity and capital resources: Firms are expected to use cash flow statements to analyze liquidity; provide a balanced discussion of operating, financing, and investing cash flows; and discuss transactions or events with material current or expected long-term liquidity implication Extensive disclosure in interim financial statements in keeping with the obligation to periodically update MD&D disclosures. 2. How is depreciation accounting policy used to window dress the financial information of a corporate? Explain with example? A. Depreciation terms used for the systematic allocation of the capitalized cost of an asset to income over its useful life. Depreciation, the most frequently used of these terms, its represents the allocation of the cost of tangible fixed assets. There are several method of allocating depreciation. Those most commonly employed are: 1. Straightline method 2. Written down value method Suppose take an example of Asset which it cost is 1000 and its life span is 5 years and assume its sales are 500 for every Straightline method:- In straight line method the value of asset will depreciate by 200 in every year up to 5 years so that value of asset is as follows: 1 st year : - 1000, 2nd year : - 800, 3 rd year: -600, 4 th year: - 400, 5 th year: - 200 Implications:- 3rd year Fixed asset turnover ratio= Sales/Fixed Assets = 500/600 = 0.8333 Written down value method: In written down value method asset will depreciate with a fixed percentage every year, here in this case asset value depreciate every by 20% Implication:- 3 rd Fixed asset turnover ratio: - 500/640 = 0.78125 This just one example that Window dress the financial information through depreciation accounting policies, there are so many different implication involved in it, where w.r.t Straight method it is showing FATR as .833, where through written down value it is showing as 0.78125, So through straight line method asset value is 600, whereas through written value method it is 640 ,that means total asset value in Balance sheet will be more if go for written down value, it is low through straight line ,depreciation accounting policies differ the financial information of the company. 4. Explain as how statement of shareholder’s equity of a corporate is useful to the existing and prospective investors? A. Companies generally report components of shareholder’s equity in order of preference upon liquidation. This report gives the information about the total shareholders capital through stock purchase, about the retained earnings, amount of dividends paid for the stock, and other comprehensive amount details. This shows how the company is performing (how equity is growing whether good are bad).By calculating the growth of the equity through the years we can assess the company’s performance, but the increase in the equity should be quality earnings i.e.; through the performance of the company but not through issuing of the additional shares or other financing activities. This will give information to the existing shareholders about the company growing and the guide for the investors to know about the company and to arrive at the investment decision. This statement reports he amount and changes in equity from capital transactions with owners and may include the following components: Preferred shares Common shares Additional paid-in capital Retained earnings Employee stock ownership plan etc. 5. What are managerial uses for comparative statements? Companies prepare financial statements of the company at the end of each accounting year. They are: 1 .Balance sheet 2. Income statement 3. Statement of comprehensive income 4. Statement of cash flows and 5 .Statement of stockholders equity The management and other financial analysts use these financial statements to analyze the company’s performance over the period. There are different tools available to analyze these financial results by 1 .Ratios 2. Comparative statements Comparative statements provide several advantages regarding the analysis of information about the financial statements. The company study of financial statements is the comparison of financial statement of business with the previous year financial statements. It enables the identification of weak points and applying corrective measures through analyzing balance statement and income statement. The comparative income statement provides the results of the operations of the business. It gives an idea about the progress of the business over a period of time. The Comparative balance sheet shows the different assets and liability of the firm of different dates to make comparison of balances from one date to other. Cash flow statements also give the information about the cash inflows and outflows occurred from various activities over the years. By these statements analysis we can know about the profitability, efficiency and financial soundness of the company over the years. By the comparative statements we can also calculate the percentage change in each item of the financial reports and calculate the YOY growth for the years. By this it will give a vivid picture about the company’s performance. The other way of analyzing is drawing the trend analysis based on the ratios by this we can draw the trend line which gives the performance chart of the company over the years and sometimes it is possible to predict the behavior of the company. These are also useful to compare the other company’s performance also. 6. What would the impact of off balance sheet items that would impact future financial position of corporate? A. Operating leases have been widely used over the years, although the accounting rules have been tightened to lessen the use. For example, a company can rent or lease a piece of equipment and then buy the equipment at the end of the lease period for a minimal amount of money, or it can buy the equipment outright. In both cases, a company will eventually own the equipment or building. The difference is in how a company accounts for the purchase. In an operating lease the company records only the rental expense for the equipment rather than the full cost of buying it outright. When a company buys it outright, it records the asset (the equipment) and the liability (the purchase price). So by using the operating lease, the company is recording only rental expense, which is significantly lower than booking the entire purchase price, resulting in a cleaner balance sheet. Partnerships are another common off balance sheet financing item, and this is the way Enron hid its liabilities. When a company engages in a partnership, even if the company has a controlling interest, it does not have to show the partnership’s liabilities on its balance sheet, again resulting in a cleaner balance sheet. This is very attractive to all companies, but especially to those that are already highly levered. For a company that has high debt to equity, increasing its debt may be problematic for several reasons. This can often create liquidity for a company. For example, if a company uses an operating lease, capital is not tied up in buying the equipment since only rental expense is paid out. Exchange rate is also an off balance sheet item. 7. Compute, Analysis & interpret the performance of the firm for the fiscals 2012 & 2013 in term of following: Liquidity Ratio: The importance of adequate liquidity in the sense of the ability of a firm to meet current/short-term obligations when they become due for payment can hardly be overstressed. In fact, liquidity is a prerequisite for the survival of a firm. The short-term creditors of a firm are interested in the short-term solvency or liquidity of a firm, so that to find the liquidity of a firm they are main four ratios which illustrate about liquidity of a firm, they are 1. Current ratio 2. Quick ratio 3. Cash ratio 4. Cash flow from operation 1. Current ratio: - The current ratio of a firm measures its short-term solvency, that is, its ability to meet short-term obligation. As a measure of short-term/current financial liquidity, it indicates the rupees of current assets available for each rupee of current liability/obligation payable. The higher the current ratio, the larger is the amount of rupee available per rupee of current liability, the more is the firm’s ability to meet current obligation and greater is the safety of funds of short-term creditors Current Ratio results for Hero Moto Corp:- Current Ratio’s for Hero Moto Corp are 1.2174, 1.1127 and 0.959 in the years of 2013, 2012, 2011 respectively, by above following observations it will state that liquidity position of a company was improved by year on year, i.e. current asset are more than current liability which means that it has more assets in hands than of liabilities, So we can say that its good Implication of company as it improved in maintaining the current ratio Disadvantages involved in Current Ratio: - If we go deeper into the analysis of current ratio it not significant enough to tell the liquidity of firm because current assets include Inventory, Sometimes Inventories may or may not generate the revenue, even though we are considering as a current asset, i.e. if inventory we are having is outdated it is not possible to generate the revenue from the outdated inventory, so current ratio is not appropriate to calculate the liquidity position, to overcome this ratios are useful Quick Ratio: - The acid-test ratio is a rigorous measure of a firm’s ability to service short- term liabilities. The useful of the lies in the fact that is widely accepted as the best available test of the liquidity position of a firm Quick Asset = Current Asset-Inventories (Stock) Quick Ratio for Hero Moto Corp:- In 2013: - 1.0647 2012: - 0.957146 2011: - 0.847019 Above figure shows that quick is better compared to 2012 and 2011, this firm has better liquidity than past years, so it can easily meet the short obligations Cash Ratio: - Cash ratio is similar to quick ratio, whereas in the quick ratio we also consider the trade receivables where here cash ratio we will just take the cash and cash equivalents Cash Asset: -Quick Asset- Trade receivable Cash ratio’s for Hero Moto Corp: -0.9053, 0.8944, 0.825315 for years 2013, 2012, 2011 respectively, this means cash in hand for the firm has more in 2013, so liquidity of the firm has increased. Relation between Current, Quick, Cash ratio for Hero Moto Corp: - For 2013:- C.A = 1.2174 Q.A = 1.0647 This means Inventory portion in Current Asset is 0.1527 out of 1.2174 (C.A-Q.A), so firm has less inventory in their hand out of total current asset, it is good implication for the firm if firm have less inventory in current asset. Years 2013 2012 2011 Current Ratio 1.2174 1.1127 0.959 Quick Ratio 1.0647 0.957146 0.8477019 Cash Ratio 0.9053 0.894426 0.825315 CFO Ratio 0.6003 0.67757 0.45456277 TURNOVER RATIOS: Inventory Turnover Ratio: Years 2013 2012 2011 Inventory Turnover 32.35009 34.474 35.3219 Days Receivable 11.28 10.5876 10.333 Table shows the Inventory turnover which gives as in how many times in an accounting year the inventory is converted into sales. The no of days has been decreasing over the years, which mean that the company is managing the inventory in an efficient manner, as well as procuring inventory as required for the production of its finished products. So lesser the Inventory Turnover is better for the company, because total revenue is dependent on Inventory, So lesser the turnover better the total sales of firm, if we see the Inventory turnover for Hero Moto Corp days for Inventory turnover has less in 2013 compared to 2012 and 2011, i.e. firm managing the inventory well 2013 compared to last 2 years Debtors Turnover (Trade receivables): Years 2013 2012 2011 Debtors Turnover 50.71558 58.52328 81.16968 Days 7.19699 6.2368 4.496757 As tabulated, the debtors turnover ratio shows in how many days the debtors pay off their debts. The ratio is also decreasing over the years, which is a positive sign for the company as management of debtors and credit period is done in an efficient manner. Creditors Turnover: Years 2013 2012 2011 Creditors turnover 11.3103 9.089 8.2295 Credit outstanding 32.271 40.15 44.35 As shown in table 4, the creditors’ turnover ratio shows in how many days the creditors ask the company for their payment. As greater the number of days the better it is for the company. However, it should not exceed more than a year for a manufacturing company. It leads to accumulation of time liability which should be cleared as and when possible Fixed Asset Turnover: Years 2013 2012 2011 FATR 7.586205 6.1655 4.696562 This ratio gives a view of the revenue in terms of the fixed assets. It shows how many times of its fixed asset (Operating Assets) does the company generate revenue. In 2013 has better turnover, It shows that the company is utilizing its assets to the fullest. The reason can be a increase in demand or less competition from its peers. Total Asset Turnover: Years 2013 2012 2011 TATR 2.46515 2.38389 1.808452 This ratio gives a view of the revenue in terms of the fixed assets. It shows how many times of its total asset (Operating Assets) does the company generate revenue. In 2013 has better turnover, It shows that the company is utilizing its assets to the fullest. The reason can be a increase in demand or less competition from its peers. Working Capital Turnover: Years 2013 2012 2011 Working capital 26.20 48.1676 --------- As shown in table working capital ratio given an account of how much times of the working capital is the net sales. This shows the net investment in current assets and liabilities to generate revenue. Since the working capital decreased in the year 2013, 2012 the ratio shows a decrease to the working capital. Thus, low investments greater revenue. Debt-Total Capital: Years 2013 2012 2011 Debt-total 0.4807 0.566198 0.724409 The debt to total capital gives an account of how much debt constitutes to the total capital employed. 0.4807 ratios show that 48% of the total capital is debt. It is good for a company to maintain low debt to its total capital as the finance cost decreases which in turn raises profits for share holders. Debt-Equity: Years 2013 2012 2011 Debt-Equity 0.9259 1.3052 2.62856 The debt equity ratio on an average is 1.61988 over the period of 3 years. This is not so healthy for the company as debt leads to more financial leverage and fixed charges. In 2012 & 2013 the ratio decreased below one which is a positive sign for the company. Times interest Earned: Years 2013 2012 2011 Times Interest 213.2594 135.4934 128.086 This means firm has more earnings to repay back their Interest expenses, Times interest more in 2013 than past two years ,it will be good for the firm because they can raise funds easily by both shareholder’s and debt. CFO to Debt: Years 2013 2012 2011 CFO to DEBT 0.407 0.4214 0.29013 This shows how much cash flow from operations has been generated as compared to debt taken by the company. As we see that Hero Moto Corp is not doing great in generating cash from operations to meet its debt if at all it is required in an unforeseen situation Gross Profit Margin: Years 2013 2012 2011 Gross ratio 0.106913 0.122397 0.124752 The Gross profit gives the profit after deduction of all the direct expenses. Although the sales have been almost same over the years the proportional increase in direct expenses is more than increase in sales and therefore the profits slight decrease. Moreover the finance cost has also been increasing as the debt increases. Operating Profit Margin: Years 2013 2012 2011 Gross ratio 0.106913 0.122397 0.124752 The operating profit gives the profit after deduction of all the direct expenses. Although the sales have been almost same over the years the proportional increase in direct expenses is more than increase in sales and therefore the profits slight decrease. Moreover the finance cost has also been increasing as the debt increases Margin before interest: Years 2013 2012 2011 Gross ratio 0.106913 0.122397 0.124752 The Margin before interest gives the profit after deduction of all the direct expenses. Although the sales have been almost same over the years the proportional increase in direct expenses is more than increase in sales and therefore the profits slight decrease. Moreover the finance cost has also been increasing as the debt increases Pretax Margin: Years 2013 2012 2011 Gross ratio 0.10641 0.121494 0.12392 The profit before tax margin is less than the operating profit margin because of the impairment of assets and the divesture of Long term Investments added to operating profits. Thus it decreases and thereby more funds are available to the shareholders funds. The better the percent the better it is for the company. Net Profit Margin: Years 2013 2012 2011 Net profit Margin 0.089118 0.100858 0.099387 Although the net profit is above 8% on an average in the recent years it has gone down. This is due to increased expenses as well as increased tax expenses Return on Asset: Years 2013 2012 2011 ROA 0.263556 0.291843 0.225606 Return on capital employed is given by EBIT/Total Asset. This ratio given in account of how much the company is earning through the funds of the share holders and borrowed funds. The greater it is the better and Hero Moto Corp is giving good returns on its capital employed Return on Equity: Years 2013 2012 2011 ROE 0.4937 0.815512 0.55638 The return on share holders fund shows the profitability for the shareholders investments in the given year. The greater it is the more trust worthy the company is for the shareholders, but 2013 ROE is less than 2012 its shows less return in 2013 than 2012. Earnings per share: Years 2013 2012 2011 EPS 106.07 119.09 100.53 8. Analysis & arrived at the implication of cash flow statements from the viewpoint of shareholders & Debt holder for fiscal 2012, 2013 A. The cash flow statements help to provide answers to user to some of the important question related to the company such as the following: How many cash has been generated from normal business operating activities What have been the other premier financing activities of the firm through which cash has been raised? What happened to cash so obtained? How much cash has been spent on investment activities, say, on purchase of new plant and equipment? These issues related to cash flow statements, Cash flow are separated into three categories 1. Operating activities 2. Investing activities 3. Financing activities 1. Operating activities: - (cash from operation or CFO) measures the amount of cash generated or used by the firm as a result of its production and sales of goods and services. Although deficit or negative cash flows operations are expected in some circumstances, for most firms positive operating cash flows are essential for long-run survival. 2. Investing activities: -(CFI) reports amount of cash used to acquire asset such as plant and equipment as well as investments and entire businesses. These outlays are necessary to maintain a firm’s current operating capacity and to capacity for growth 3. Financing activities: - (CFF) contains the cash flow consequences of the firm’s capital structure decisions, including proceeds from the issuance of equity, returns to shareholders in the form of dividends and repurchase of equity. Analysis of CASH FLOW Information: Free Cash flows and valuation: An important but elusive concept often used in cash flow analysis is Free Cash flow (FCF). This concept is widely used by analysts (shareholder’s & Debtors), the basic element required to calculate FCF are available from the cash flow statement. The larger the firm’s FCF the healthier it is, because it has more cash available for growth, debt payment, and dividends. So that with respect to Shareholder’s and debtors Free Cash flows are useful to interpret the Cash flow statements. FREE CASH FLOWS (FCF) for HERO MOTO CORP: - Years 2013 2012 2011 Cash flow operations 1890.43 2359.78 2254.16 Cash flow Investing -732.94 92.79 -1322.31 Cash flow Finance -1056.27 -2458.16 -955.23 Free Cash Flow1 (FCF1) 1157.49 2452.57 931.85 Free Cash flow2 (FCF2) 1282.79 1794.73 1890.04 Whereas FCF1 = CFO-CFI FCF2 = CFO-Capital Expenditure If the free cash flows are better than it is better for debtors and shareholder’s, because this is the free cash that will be taken up by either debtor or shareholder Where as if we see the Free Cash Flow 2013 has a less free cash flows compared to 2012, this means a less cash available for shareholders and debtors compared to 2012 ,they are some many reasons why the cash flows are less in 2013, it may be more on spending more to sustain operating or for future growth.