FA Lecture I

8/3/2019 FA Lecture I

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Financial Analysis

Lecture I

Academic Year 2011-12

Trimester II


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Basic Study Plan

(A) Textbooks1. Palepu, Healy & Bernard

Business Analysis & Valuation using financial

statements, Third Edition India Edition 20062. Charles H Gibson

Analysis of Financial Statements: India Edition

2009 (B) Financial Analysis of companies and other

tasks, in groups, as per the next slide


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The Companies/Issues for Financial Analysis

Basic background material, mostly up-to-date, e.g. B/S as of

31/03/11 is being made available to you today. You willobtain the other material from the corporate/other websites

Group 1: Ambuja Cements: Company Analysis

Group 2: DR Reddys: Company Analysis

Group 3: HCL Technologies (June 10 B/S): Company Analysis Group 4: ITC: Company Analysis

Group 5: Jyoti Structures Issue of NCDs with warrants (convertibleinto equity shares)

Group 6: Mphasis: Company Analysis

Group 7: MTNL (Mar 10 B/S): Company Analysis

Group 8: Network 18 Media & Investments: Company Analysis

Group 9: ONGC: Company Analysis

Group 10: Siemens Offer to acquire shares by Siemens AG


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The Next Class

One or two persons from each group to present(not more than 3 slides can be used) the groupsview about the company, the industry, the task

on hand and how the group will go aboutperforming the task, and the aspects that willreceive the focus of attention of the group

About the company, you may talk about the

activity(ies) that it is engaged in, its marketposition, the nature of the industry that itoperates in, etc.


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Key components of Company Analysis

which you will do

Promoters/Group

Business Strategy Analysis

Accounting Analysis Financial Analysis

Prospective Analysis & Valuation


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Promoters

The various companies in the group related,

diverse

Historical background the story so far Corporate governance track record -

reputation

Management of the companies professionally managed, family owned, etc

View of the future the game plan for growth


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Business Strategy Analysis

The purpose of business strategy analysis is:

1. to identify key profit drivers and business

risks, and

2. to assess the companys profit potential at aqualitative level.

Business strategy analysis involves analyzing:

1. a firms industry, and2. its strategy to create a sustainable

competitive advantage.


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Accounting Analysis The purpose of accounting analysis is to

evaluate the degree to which a firms accountingcaptures the underlying business reality.

By identifying places where there is accounting

flexibility, and by evaluating the appropriatenessof the firms accounting policies and estimates,analysts can assess the degree of distortion in afirms accounting numbers.

Another important step in accounting analysis isto undo any accounting distortions byrecasting a firms accounting numbers to createunbiased accounting data.


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Financial Analysis The goal of financial analysis is to use financial data to

evaluate the current and past performance of a firmand to assess its sustainability.

Second, the analysis should allow the analyst to use

financial data to explore business issues. Ratio analysis and cash flow analysis are the two most

commonly used financial tools.

Ratio analysis focuses on evaluating a firms product

market performance and financial policies. Cash flow analysis focuses on a firms liquidity and

financial flexibility.


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Prospective Analysis Prospective analysis, which focuses on

forecasting a firms future, is the final step in

business analysis.

Two commonly used techniques inprospective analysis are:

1. financial statement forecasting, and

2. valuation.


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Prospective Analysis . Contd.

While the value of a firm is a function of itsfuture cash flow performance, it is alsopossible to assess a firms value based on thefirms current book value of equity, and its

future return on equity (ROE) and growth.

Strategy analysis, accounting analysis, andfinancial analysis, the first three steps in the

framework discussed here, provide anexcellent foundation for estimating a firmsintrinsic value.


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Influence of the accounting system on

the quality of the financial statements A key aspect of financial statement analysis, involves

understanding the influence of the accounting systemon the quality of the financial statement data beingused in the analysis.

One of the fundamental features of corporatefinancial reports is that they are prepared usingaccrual rather than cash accounting. The use ofaccrual accounting lies at the center of many

important complexities in corporate financialreporting.

Because accrual accounting deals with expectations offuture cash consequences of current events, it issubjective and relies on a variety of assumptions.


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Influence of the accounting system contd.

Accounting Standards & Auditing A number of accounting conventions have evolved to ensure

that managers use their accounting flexibility to summarizetheir knowledge of the firms business activities, and not todisguise reality for self-serving purposes.

For example, the measurability and conservatismconventions are accounting responses to concerns aboutdistortions from managers potentially optimistic bias.

Both these conventions attempt to limit managers optimisticbias by imposing their own pessimistic bias.

Auditing, broadly defined as a verification of the integrity ofthe reported financial statements by someone other thanthe preparer, ensures that managers use accounting rulesand conventions consistently over time, and that theiraccounting estimates are reasonable.


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Influence of the accounting system contd.

Managers Reporting Strategy

Corporate managers can choose accounting and disclosurepolicies that make it more or less difficult for external usersof financial reports to understand the true economic pictureof their businesses.

A superior disclosure strategy will enable managers to

communicate the underlying business reality to outsideinvestors.

One important constraint on a firms disclosure strategy isthe competitive dynamics in product markets. Disclosure ofproprietary information about business strategies and their

expected economic consequences may hurt the firmscompetitive position.

Subject to this constraint, managers can use financialstatements to provide information useful to investors inassessing their firms true economic performance.


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The Context

The exact nature of the analysis depends on thecontext.

The contexts that you might examine include:

1. securities analysis,2. credit evaluation,

3. mergers and acquisitions,

4. evaluation of debt and dividend policies, and

5. assessing corporate communication strategies.

The four analytical steps discussed today areuseful in each of these contexts.

Documents

FA Lecture I