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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.