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Intrasoft technologies limited
Index
Sr. No. Particulars Page No.
1 About the company 2
2 Financial Statements of company 3-7
3 Financial Analysis 8-16
4 Leverage 17-23
5 Financial Risk and Business Risk 24-28
6 Webliography 29
2
About the Company:
IntraSoft Technologies Limited is in the business of providing back ended IT Enabled Services to its
subsidiary companies.
Our E-commerce subsidiary www.123stores.com focuses on the US Online Retail market and was ranked
as the 262nd largest Internet Retailer in USA as well as the 11th fastest growing Internet Retailer in the
2016 Top 500 Internet Retailer Guide.
We sell approximately 535,000 products from over 1,740 brands on the Internet under the brand name
"123Stores". The E-Commerce Portal offers customers direct access to a vast selection of products,
superior customer service, convenience of fast delivery and low affordable prices. We have strategic
partnerships with Amazon.com & Ebay.com and others to sell its products to their customers, similar to a
shop-in-shop format.
Our E-greetings subsidiary www.123greetings.com is the world's leading online destination for human
expressions reaching 95 million visitors annually. Its offering of over 42,000 ecards across multiple
languages covers a mix of 3,000 seasonal & everyday categories. Its presence is ubiquitous with its
Mobile App, Mobile Website and Facebook App catering to users on mobile and social media
respectively. Its Connect feature is a relationship management tool enabling users to actively manage
their expressions to both personal and professional contacts. It also operates 123Greetings Studio, a
unique platform for artists, to upload and monetize their own ecards.The Company went public in 2010
and is listed on the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE).
The company management includes Arvind Kajaria - Managing Director, Sharad Kajaria - Whole Time
Director, Rupinder Singh - Independent Director, Anil Agrawal - Independent Director, Savita Agarwal -
Independent Director.
Intrasoft Technologies Ltd. Key Products/Revenue Segments include I T Enabled Services which
contributed Rs 28.43 Cr to Sales Value (96.28% of Total Sales), Other Operating Revenue which
contributed Rs 1.10 Cr to Sales Value (3.71% of Total Sales), for the year ending 31-Mar-2016.
For the quarter ended 30-Jun-2016, the company has reported a Consolidate sales of Rs. 222.17 Cr., up
19.05% from last quarter Sales of Rs. 186.62 Cr. and up 88.71% from last year same quarter Sales of Rs.
117.73 Cr. Company has reported net profit after tax of Rs. 2.65 Cr. in latest quarter.
Company has Walker Chandiok & Co. LLP as its auditors. As on 30-Sep-2016, the company has a total
of 14,731,678 shares outstanding.
3
Financial Statements of Company:
Balance Sheet: ₹ in Crores
Particulars 2016 2015 2014
EQUITIES AND LIABILITIES
SHAREHOLDER'S FUNDS
Equity Share Capital 14.73 14.73 14.73
Total Share Capital 14.73 14.73 14.73
Reserves and Surplus 103.34 64.78 62.67
Total Reserves and Surplus 103.34 64.78 62.67
Total Shareholders’ Funds 118.07 79.51 77.4
NON-CURRENT LIABILITIES
Long Term Borrowings 33.13 2.12 2.4
Deferred Tax Liabilities [Net] 1.06 0.14 0
Other Long Term Liabilities 0 0.79 0.68
Long Term Provisions 0.44 0.83 0.48
Total Non-Current Liabilities 34.63 3.88 3.56
CURRENT LIABILITIES
Short Term Borrowings 3.3 0 19
Trade Payables 32.43 12.67 4.95
Other Current Liabilities 13.99 9.74 4.89
Short Term Provisions 3.85 1.79 1.73
Total Current Liabilities 53.57 24.2 30.58
Total Capital and Liabilities 206.27 107.59 111.53
ASSETS
NON-CURRENT ASSETS
Tangible Assets 19.07 17.09 18.01
Intangible Assets 0.59 0.53 0.43
Capital Work-In-Progress 0.04 0 0.48
Intangible Assets Under Development 0 26.35 26.35
Fixed Assets 19.7 43.97 45.28
Non-Current Investments 4.96 8.96 29.13
Deferred Tax Assets [Net] 0 0 0.63
Long Term Loans and Advances 20.36 0.14 0.11
Total Non-Current Assets 45.02 53.07 75.14
CURRENT ASSETS
Current Investments 53.62 0 0
Inventories 55.3 12.13 1.3
Trade Receivables 9.01 5.95 5.12
Cash and Cash Equivalents 17.26 13.33 8.33
Short Term Loans and Advances 25.9 21.47 19.96
OtherCurrentAssets 0.16 1.63 1.67
Total Current Assets 161.24 54.52 36.39
Total Assets 206.27 107.59 111.53
4
OTHER ADDITIONAL INFORMATION
CONTINGENT LIABILITIES, COMMITMENTS
Contingent Liabilities 0.42 0.11 0.01
BONUS DETAILS
Bonus Equity Share Capital 10.31 10.31 10.31
NON-CURRENT INVESTMENTS
Non-Current Investments Quoted Market Value 4.94 4.8 9.56
Non-Current Investments Unquoted Book Value 0 3 18.13
CURRENT INVESTMENTS
Current Investments Quoted Market Value 0 0 0
Current Investments Unquoted Book Value 0 0 0
Profit and Loss Account: ₹ in Crores
Particulars 2016 2015 2014
INCOME
Revenue From Operations [Gross] 716.88 342.91 148.4
Revenue From Operations [Net] 716.88 342.91 148.4
Other Operating Revenues 0.85 0 0
Total Operating Revenues 717.73 342.91 148.4
Other Income 3.75 4.11 4.61
Total Revenue 721.48 347.02 153.01
EXPENSES
Operating and Direct Expenses 574.44 262.49 107.73
Changes In Inventories Of FG, WIP And Stock-In Trade 0 0 0
Employee Benefit Expenses 22.79 17.82 12.13
Finance Costs 2.37 0.76 0.9
Depreciation and Amortization Expenses 1.6 1.47 4.02
Other Expenses 111.22 57.63 30.41
Total Expenses 712.42 340.17 155.19
Profit/Loss Before Exceptional, ExtraOrdinary Items And Tax 9.06 6.85 -2.18
Exceptional Items 34.41 0 0
Profit/Loss Before Tax 43.47 6.85 -2.18
Tax Expenses-Continued Operations
Current Tax 9.68 1.19 0.04
Less: MAT Credit Entitlement 8.64 1.08 0
Deferred Tax 0.92 0.77 -4.28
Tax For Earlier Years 0 0 0
Total Tax Expenses 1.96 0.88 -4.24
Profit/Loss After Tax And Before Extraordinary Items 41.51 5.96 2.06
Profit/Loss From Continuing Operations 41.51 5.96 2.06
Profit/Loss For The Period 41.51 5.96 2.06
5
Consolidated Profit/Loss After MI And Associates 41.51 5.96 2.06
OTHER ADDITIONAL INFORMATION
EARNINGS PER SHARE
Basic EPS (Rs.) 28 4 1
Diluted EPS (Rs.) 28 4 1
DIVIDEND AND DIVIDEND PERCENTAGE
Equity Share Dividend 2.95 2.95 1.47
Tax On Dividend 0.6 0.59 0.25
Trade Receivables 9.01 5.95 5.12
Cash And Cash Equivalents 17.26 13.33 8.33
Short Term Loans And Advances 25.9 21.47 19.96
OtherCurrentAssets 0.16 1.63 1.67
Total Current Assets 161.24 54.52 36.39
Total Assets 206.27 107.59 111.53
OTHER ADDITIONAL INFORMATION
CONTINGENT LIABILITIES, COMMITMENTS
Contingent Liabilities 0.42 0.11 0.01
BONUS DETAILS
Bonus Equity Share Capital 10.31 10.31 10.31
NON-CURRENT INVESTMENTS
Non-Current Investments Quoted Market Value 4.94 4.8 9.56
Non-Current Investments Unquoted Book Value 0 3 18.13
CURRENT INVESTMENTS
Current Investments Quoted Market Value 0 0 0
Current Investments Unquoted Book Value 0 0 0
Cash Flow Statement: ₹ in Cores
Particulars 2016 2015 2014
Net Profit/Loss Before Extraordinary Items and Tax 40.59 5.79 -2.23
Net Cashflow From Operating Activities -5.25 -19.98 -11.01
Net Cash Used in Investing Activities 8.28 24.68 11.48
Net Cash Used from Financing Activities -3.81 -4.25 -0.4
Net Increase/Decrease In Cash and Cash Equivalents -0.78 0.45 0.06
Cash and Cash Equivalents Begin of Year 0.94 0.49 0.43
Cash and Cash Equivalents End Of Year 0.17 0.94 0.49
6
Financial Analysis:
General Analysis of Company performance over the years:
Year 2016 2015 2014
Revenue/Sales 717.73 342.91 148.4
Net worth 118.07 79.51 77.4
Capital Employed 151.2 81.63 79.8
EBITDA 13.03 9.08 2.74
Working Capital 107.68 30.31 5.81
EBIT 11.43 7.61 -1.28
PAT 41.51 5.97 2.06
EBITDA to revenue 2% 3% 2%
PAT to Revenue 6% 2% 1%
2016 2015 2014
Revenue 721.48 347.02 153.01
EBITDA 708.45 337.94 150.27
PAT 41.51 5.97 2.06
0
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₹ I
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Profit Graph
7
Liquid Ratio
Liquidity ratios measure a company's ability to pay debt obligations and its margin of
safety through the calculation of metrics including the current ratio, quick ratio and operating
cash flow ratio.
Types of Liquid Ratio:
Current Ratio - The current ratio is a liquidity ratio that measures a company's ability to
pay short-term and long-term obligations. To gauge this ability, the current ratio considers the
current total assets of a company (both liquid and illiquid) relative to that company’s current
total liabilities. The current ratio is mainly used to give an idea of the company's ability to pay
back its liabilities (debt and accounts payable) with its assets (cash,
marketable securities, inventory, accounts receivable). As such, current ratio can be used to take
a rough measurement of a company’s financial health. The higher the current ratio, the more
capable the company is of paying its obligations, as it has a larger proportion of asset value
relative to the value of its liabilities. The current ratio is also known as the working capital ratio.
Liquid Ratio - Liquidity ratios measure a company's ability to pay debt obligations and
its margin of safety through the calculation of metrics including the current ratio, quick
ratio and operating cash flow ratio. Current liabilities are analyzed in relation to liquid assets to
evaluate the coverage of short-term debts in an emergency. Bankruptcy analysts and mortgage
originators use liquidity ratios to evaluate going concern issues, as liquidity measurement ratios
indicate cash flow positioning. Liquidity ratios are most useful when they are used in
comparative form. This analysis may be performed internally or externally.
Types Formula 2016 2015 2014 Standard Comments
Current Ratio Current assets /
Current Liabilities
3.01 2.25 1.19 2:1 Except for the Yr.
2014, the CR is
satisfactory and above
par.
Liquid Ratio Quick Assets /
Current liabilities
1.98 1.75 1.15 1:1 Company is able to
maintain more of liquid
assets than liabilities
and hence it can clear
immediate dues.
8
Leverage Ratios
Companies rely on a mixture of owners' equity and debt to finance their operations. A Leverage
ratio is any one of several financial measurements that look at how much capital comes in the
form of debt (loans), or assesses the ability of a company to meet financial obligations.
Debt to Equity – Debt/Equity Ratio is a debt ratio used to measure a company's
financial leverage, calculated by dividing a company’s total liabilities by its stockholders' equity.
The D/E ratio indicates how much debt a company is using to finance its assets relative to the
amount of value represented in shareholders’ equity. This ratio can be applied to personal
financial statements as well as corporate ones, in which case it is also known as the Personal
Debt/Equity Ratio. Here, “equity” refers not to the value of stakeholders’ shares but rather to the
difference between the total value of a corporation or individual’s assets and that corporation or
individual’s liabilities.
Debt Ratio - The higher this ratio, the more leveraged the company is, implying greater financial
risk. At the same time, leverage is an important tool that companies use to grow, and many
businesses find sustainable uses for debt. Debt ratios vary widely across industries, with capital-
intensive businesses such as utilities and pipelines having much higher debt ratios than other
industries like technology.
Equity Ratio - The equity ratio is an investment leverage or solvency ratio that measures the
amount of assets that are financed by owners' investments by comparing the total equity in the
company to the total assets. The equity ratio highlights two important financial concepts of a
solvent and sustainable business. The first component shows how much of the total company
assets are owned outright by the investors. In other words, after all of the liabilities are paid off,
the investors will end up with the remaining assets.
Proprietary ratio - The proprietary ratio (also known as the equity ratio) is the proportion of
shareholders' equity to total assets, and as such provides a rough estimate of the amount of
capitalization currently used to support a business. If the ratio is high, this indicates that a
company has a sufficient amount of equity to support the functions of the business, and probably
has room in its financial structure to take on additional debt, if necessary. Conversely, a low ratio
indicates that a business may be making use of too much debt or trade payables, rather than
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equity, to support operations (which may place the company at risk of bankruptcy). Thus, the
equity ratio is a general indicator of financial stability. It should be used in conjunction with
the net profit ratio and an examination of the statement of cash flows to gain a better overview of
the financial circumstances of a business. These additional measures reveal the ability of a
business to earn a profit and generate cash flows, respectively.
Interest Coverage Ratio - The interest coverage ratio is a debt ratio and profitability ratio used to
determine how easily a company can pay interest on outstanding debt. The interest coverage ratio
may be calculated by dividing a company's earnings before interest and taxes (EBIT) during a given
period by the amount a company must pay in interest on its debts during the same period.
Essentially, the interest coverage ratio measures how many times over a company could pay its
current interest payment with its available earnings. In other words, it measures the margin of
safety a company has for paying interest during a given period, which a company needs in order
to survive future (and perhaps unforeseeable) financial hardship should it arise. A company’s
ability to meet its interest obligations is an aspect of a company’s solvency, and is thus a very
important factor in the return for shareholders.
Types Formula 2016 2015 2014 Standard Comments
Debt to Equity Debt / Net
Worth
3.4:1 20.5:1 32:1 2:1 Satisfactory
Debt Ratio Total Debt /
Capital
Employed
4.6:1 39:1 33:1 Lower the
ratio, lower
the risk
The capital employed
consists more of equity
than debt, so the risk and
debt burden involved in
business is low
Equity Ratio Shareholders’
Equity/
Capital
employed
78% 97% 97% Higher the
ratio, lower
the risk
Satisfactory
Proprietary
Ratio
Net Worth/
Total Assets
57% 74% 69% 65% More than 50% of total
assets is funded through
Equity. Hence, finance cost
is kept at minimum
Interest
Coverage
Ratio
EBIT/ Interest 4.82 10.01 -1.42 Higher the
better,
Company
can meet its
interest
obligations
Company is easily able to
meet its interest obligation
sufficiently.
10
Profitability Ratios
Profitability ratios are a class of financial metrics that are used to assess a business's ability to
generate earnings compared to its expenses and other relevant costs incurred during a specific
period of time.
Return on Equity - Return on equity (ROE) is a measure of profitability that calculates how
many dollars of profit a company generates with each dollar of shareholders' equity. ROE is more
than a measure of profit; it's a measure of efficiency. A rising ROE suggests that a company is
increasing its ability to generate profit without needing as much capital. It also indicates how well
a company's management is deploying the shareholders' capital. In other words, the higher the
ROE the better. Falling ROE is usually a problem.
Return on Capital Employed - Return on capital employed (ROCE) is a financial ratio that
measures a company's profitability and the efficiency with which its capital is employed.
“Capital Employed” as shown in the denominator is the sum of shareholders' equity and debt
liabilities; it can be simplified as (Total Assets – Current Liabilities). Instead of using capital
employed at an arbitrary point in time, analysts and investors often calculate ROCE based on
“Average Capital Employed,” which takes the average of opening and closing capital employed for
the time period.
Profit Margin - Profit margin is part of a category of profitability ratios calculated as net
income divided by revenue, or net profits divided by sales. Net income or net profit may be
determined by subtracting all of a company’s expenses, including operating costs, material costs
(including raw materials) and tax costs, from its total revenue. Profit margins are expressed as a
percentage and, in effect, measure how much out of every dollar of sales a company actually
keeps in earnings. A 20% profit margin, then, means the company has a net income of $0.20 for
each dollar of total revenue earned.
While there are a few different kinds of profit margins, including “gross profit margin,” “operating
margin,” (or "operating profit margin") “pretax profit margin” and “net margin” (or "net profit
margin") the term “profit margin” is also often used simply to refer to net margin. The method of
calculating profit margin when the term is used in this way can be represented with the following
formula:
11
Return on Assets - Return on assets (ROA) is an indicator of how profitable a company is
relative to its total assets. ROA gives an idea as to how efficient management is at using
its assets to generate earnings. Calculated by dividing a company's annual earnings by its total
assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".
ROA tells you what earnings were generated from invested capital (assets). ROA for public
companies can vary substantially and will be highly dependent on the industry. This is why when
using ROA as a comparative measure, it is best to compare it against a company's previous ROA
numbers or the ROA of a similar company.
The assets of the company are comprised of both debt and equity. Both of these types of
financing are used to fund the operations of the company. The ROA figure gives investors an
idea of how effectively the company is converting the money it has to invest into net income.
The higher the ROA number, the better, because the company is earning more money on less
investment.
Types Formula 2016 2015 2014 Standard Comments
Return on
Equity
Profit after Tax
/ Net Worth
35% 8% 3% Higher the
better. Indicates
more efficient
use of
shareholder's
funds
Good
Return on
Capital
Employed
Profit before
Tax / Capital
Employed
29% 8% -3% Higher the
better. indicates
more efficient
use Equity +
Borrowed funds
Good
Profit Margins Profit after tax
/ Revenue
6% 2% 1% Higher profit
margin is
preferable.
Company has been able to
increase its margin up to 6
times in last 3years which
is commendable.
Return on
Assets
Profit after Tax
/ Avg. tangible
assets
- 33% 12% Higher the
better. indicates
more efficient
use of
company's
assets
Satisfactory
12
Activity Ratios
Activity ratios are financial analysis tools used to gauge the ability of a business to convert
various asset, liability and capital accounts into cash or sales. The faster a business is able to
convert its assets into cash or sales, the more efficient it runs.
Working Capital Turnover - Working capital turnover is a measurement comparing
the depletion of working capital used to fund operations and purchase inventory, which is then
converted into sales revenue for the company. The working capital turnover ratio is used to
analyze the relationship between the money that funds operations and the sales generated from
these operations.
The working capital turnover ratio measures how well a company is utilizing its working capital
for supporting a given level of sales. Because working capital is current assets minus current
liabilities, a high turnover ratio shows that management is being very efficient in using a
company’s short-term assets and liabilities for supporting sales. In contrast, a low ratio shows a
business is investing in too many accounts receivable (AR) and inventory assets for supporting
its sales. This may lead to an excessive amount of bad debts and obsolete inventory.
A high working capital turnover ratio shows a company is running smoothly and has limited
need for additional funding. Money is coming in and flowing out on a regular basis, giving the
business flexibility to spend capital on expansion or inventory. A high ratio may also give the
business a competitive edge over similar companies.
2016 2015 2014
ROE 35% 8% 3%
RoCE 29% 8% -3%
Profit Margins 6% 2% 1%
6% 2% 1%
29%
8% -3%
35%
8% 3%
Profitability Ratios
Profit Margins RoCE ROE
13
However, an extremely high ratio, typically over 80%, may indicate a business does not have
enough capital supporting its sales growth. Therefore, the company may become insolvent in the
near future. The indicator is especially strong when the accounts payable (AP) component is very
high, indicating that management cannot pay its bills as they come due. For example, gold
mining and silver mining have average working capital turnover ratios of approximately 82%.
Gold and silver mining requires ongoing capital investment for replacing, modernizing and
expanding equipment and facilities, as well as finding new reserves. An excessively high
turnover ratio may be discovered by comparing the ratio for a specific business to ratios reported
by other companies in the industry.
Fixed Assets Turnover Ration - The fixed-asset turnover ratio is, in general, used by analysts to
measure operating performance. It is a ratio of net sales to fixed assets. This ratio specifically
measures how able a company is to generate net sales from fixed-asset investments,
namely property, plant and equipment (PP&E), net of depreciation. In a general sense, a higher
fixed-asset turnoverratio indicates that a company has more effectively utilized investment
in fixed assets to generate revenue.
While a higher ratio is indicative of greater efficiency in managing fixed-asset investments, there
is not an exact number or range that dictates whether a company has been efficient at generating
revenue from such investments. For this reason, it is important for analysts and investors to
compare a company’s most recent ratio to both the historic ratios of the company and to ratio
values from peer companies and/or industry averages.
Though the fixed-asset turnover ratio is of significant importance in certain industries, an
investor or analyst must determine whether the specific company is the right type for the ratio
being used, before attaching any weight to it. Fixed assets vary drastically from one company to
the next.
14
Debtors turnover Ratio - An accounting measure used to quantify a firm's effectiveness in
extending credit and in collecting debts on that credit. The Debtors turnover ratio is an activity
ratio measuring how efficiently a firm uses its assets.
Debtors turnover ratio can be calculated by dividing the net value of credit sales during a given
period by the average accounts receivable during the same period. Average accounts receivable
can be calculated by adding the value of accounts receivable at the beginning of the desired
period to their value at the end of the period and dividing the sum by two.
In essence, the Debtors turnover ratio indicates the efficiency with which a firm manages the
credit it issues to customers and collects on that credit. Because accounts receivable are moneys
owed on a credit agreement without interest, by maintaining accounts receivable firms are
indirectly extending interest-free loans to their clients. As such, because of the time value of
money principle, a firm loses more money the longer it takes to collect on its credit sales.
A high Debtors turnover ratio can imply a variety of things about a company. It may suggest that
a company operates on a cash basis, for example. It may also indicate that the company’s
collection of accounts receivable is efficient, and that the company has a high proportion of
quality customers that pay off their debts quickly. A high ratio can also suggest that the company
has a conservative policy regarding its extension of credit. This can often be a good thing, as this
filters out customers who may be more likely to take a long time in paying their debts. On the
other hand, a company’s policy may be too conservative if it is too tight in extending credit,
which can drive away potential customers and give business to competitors. In this case, a
company may want to loosen policies to improve business, even though it may reduce its
Debtors turnover ratio.
A low ratio, in a similar way, can also suggest a few things about a company, such as that the
company may have poor collecting processes, a bad credit policy or none at all, or bad customers
or customers with financial difficulty. Theoretically, a low ratio can also often mean that the
company has a high amount of cash receivables for collection from its various debtors, should it
improve its collection processes. Generally, however, a low ratio implies that the company
should reassess its credit policies in order to ensure the timely collection of imparted credit that
is not earning interest for the firm.
15
Creditors Turnover Ratio - The Creditors Turnover ratio is a short-term liquidity measure used
to quantify the rate at which a company pays off its suppliers. Accounts payable turnover ratio is
calculated by taking the total purchases made from suppliers, or cost of sales, and dividing it by
the average accounts payable amount during the same period.
The Creditors Turnover ratio is a short-term liquidity measure used to quantify the rate at which
a company pays off its suppliers. Accounts payable turnover ratio is calculated by taking the total
purchases made from suppliers, or cost of sales, and dividing it by the average accounts payable
amount during the same period.
The measure shows investors how many times per period the company pays its average
payable amount. Accounts payable, also known as payables, represents short-term debt
obligations that a company must pay off. The accounts payable is listed under a company's
current liabilities on its balance sheet. Accounts payable are also part of households because
people may be subject to pay off their short-term debt provided by creditors, such as credit card
companies.
If the turnover ratio is falling from one period to another, this is a sign that the company is taking
longer to pay off its suppliers than it was in previous time periods. The opposite is true when the
turnover ratio is increasing, which means that the company is paying off suppliers at a faster rate.
Inventory Turnover Ratio - Inventory turnover is a ratio showing how many times a company's
inventory is sold and replaced over a period of time. The days in the period can then be divided
by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. It is
calculated as sales divided by average inventory.
Inventory turnover measures how fast a company is selling inventory and is generally compared
against industry averages. A low turnover implies weak sales and, therefore, excess inventory. A
high ratio implies either strong sales and/or large discounts.
The speed with which a company can sell inventory is a critical measure of business
performance. It is also one component of the calculation for return on assets (ROA); the other
component is profitability. The return a company makes on its assets is a function of how fast it
sells inventory at a profit. As such, high turnover means nothing unless the company is making a
profit on each sale.
16
Types Formula 2016 2015 2014 Standard Comments
Working
Capital
turnover
Revenue /
Capital
Employed
4.75 4.2 1.86 Higher the ratio,
efficient utilization
of funds
The company is able
to generate more funds
than it has invested.
Fixed Assets
turnover
Revenue /
Tangible Assets
39.7 19.54 - Higher the better.
indicates more
efficient use of
company's assets
Satisfactory
Debtors
turnover
365/ (Sales /
Avg.
receivables)
4 6 A fast collection
period is desirable
as it will leds to
faster collection
and reduce chances
of Bad debts
Satisfatory
Creditors
Turnover
365/ (Purchases
/ Avg.
Creditors)
N.A. N.A. N.A. A low credit T/O
shows the liberal
policy of creditors
-
Inventory
turnover
365 / (COGS /
Avg. Inventory)
N.A. N.A. N.A. A high T/O
indicates that
inventory are
moving fast and
not hold for too
long. It also affects
liquidity of firm.
-
17
Leverage
By leverage we mean, making use of such asset or source of funds like debentures for which the
company has to pay fixed cost or fixed financial charges, to generate more return. There are three
kinds of Leverage i.e. operating leverage, financial leverage, and combined leverage.
The operating leverage measures the effect of fixed cost whereas the financial leverage evaluates
the effect of interest expenses.
Combined Leverage is the combination of the two leverages. If you are searching for the
differences between operating leverage and financial leverage, then you are at the right place.
Operating Leverage:
Operating leverage is a measurement of the degree to which a firm or project incurs a
combination of fixed and variable costs. A business that makes sales providing a very high gross
margin and fewer fixed costs and variable costs has much leverage. The higher the degree of
operating leverage, the greater the potential danger from forecasting risk, where a relatively
small error in forecasting sales can be magnified into large errors in cash flow projections.
Operating leverage may be used for calculating a company’s breakeven point and substantially
affecting profits by changing its pricing structure. Because businesses with higher operating
leverage do not proportionately increase expenses as they increase sales, those companies may
bring in more revenue than other companies. However, businesses with high operating leverage
are also more affected by poor corporate decisions and other factors that may result in revenue
decreases.
It is essential to compare operating leverage among companies in the same industry, as some
industries have higher fixed costs than others. The concept of a high or low ratio is then more
clearly determined.
Most of a company’s costs are fixed costs that occur regardless of sales volume. As long as a
business earns a substantial profit on each sale and sustains adequate sales volume, fixed costs
are covered and profits are earned. Other company costs are variable costs incurred when sales
occur. The business earns less profit on each sale but needs a lower sales volume for covering
18
fixed costs. However, the business does not generate greater profits unless it increases its sales
volume.
For example, a software business has greater fixed costs in developers’ salaries, and lower
variable costs with software sales. Therefore, the business has high operating leverage. In
contrast, a computer consulting firm charges its clients hourly, resulting in variable consultant
wages. Therefore, the business has low operating leverage.
The following formula is used to calculate Degree of Operating Leverage (DOL):
DOL = % change in EBIT/ % change in Sales
Effects of Operating Leverage
A high operating leverage means you are in a position to increase production without investing
in additional fixed costs. As production rises, you are in effect spreading fixed costs across a
greater number of units, so the additional units have a lower ratio of fixed costs to total costs.
The degree of operating leverage -- the percent change in earnings before interest and taxes, or
EBIT, divided by the percentage change in sales -- gives you a means to gauge how earnings will
respond to sales activity. When demand for your product increases, you can easily ramp up
production by increasing variable costs; your fixed assets allow you to magnify production. You
can increase production as long as your higher variable costs don’t cause total costs to exceed
your sales revenues. However, in a recession, high operating leverage is risky, as it saddles you
with high fixed costs even when you cut production.
Financial Leverage:
Financial leverage is the degree to which a company uses fixed-income securities such as debt
and preferred equity. The more debt financing a company uses, the higher its financial leverage.
A high degree of financial leverage means high interest payments, which negatively affect the
company's bottom-line earnings per share.
Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred
equities in a company's capital structure. As a company increases debt and preferred equities,
interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A
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company should keep its optimal capital structure in mind when making financing decisions to
ensure any increases in debt and preferred equity increase the value of the company.
The utilization of such sources of funds which carry fixed financial charges in company’s
financial structure, to earn more return on investment is known as Financial Leverage. The
Degree of Financial Leverage (DFL) is used to measure the effect on Earning Per Share (EPS)
due to the change in firms operating profit i.e. EBIT.
When a company uses debt funds in its capital structure having fixed financial charges in the
form of interest, it is said that the firm employed financial leverage.
The DFL is based on interest and financial charges, if these costs are higher DFL will also be
higher which will ultimately give rise to the financial risk of the company. If Return on Capital
Employed > Return on debt, then the use of debt financing will be justified because, in this case,
the DFL will be considered favorable for the company. As the interest remains constant, a little
increase in the EBIT of the company will lead to a higher increase in the earnings of
the shareholders which is determined by the financial leverage. Hence, high DFL is suitable.
The following formula is used to calculate Degree of Financial Leverage (DFL):
DFL = % Change in EPS/ % Change in EBIT
Combined Leverage
The degree of combined, or total, leverage is defined as the percentage change in earnings per
share divided by the percentage change in sales. It is the product of the degree of financial
leverage and the degree of operating leverage. As such, it is a measure of the overall riskiness of
your business. A high combined leverage indicates high fixed costs and heavy debt. In good
times, these factors can increase profits as you increase sales. Should business falter, these same
factors mean you cannot cut total costs substantially by decreasing production, putting a strain on
cash flow and your ability to pay interest and repay debt.
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Operating leverage vs Financial Leverage
Operating leverage and financial leverage both magnify the changes that occur to earnings due to
fixed costs in a company’s capital structures. Operating leverage magnifies changes in earnings
before interest and taxes (EBIT) as a response to changes in sales when a company's operational
costs are relatively fixed. Financial leverage magnifies how earnings per share (EPS) change as a
response to changes in EBIT where the fixed cost is that of financing, specifically interest costs.
Operating leverage measures the extent to which a company or specific project requires some
aggregate of both fixed and variable costs. Fixed costs are those not altered by an increase or
decrease in the total number of goods or services a company produces. Variable costs are those
that vary in direct relationship to a company’s production -- variable costs rise when production
increases and fall when production decreases. Businesses with higher ratios of fixed costs to
variable costs are characterized as using more operating leverage, while businesses with lower
ratios of fixed costs to variable costs use less operating leverage. Utilizing a higher degree of
operating leverage increases the risk of cash flow problems resulting from errors in forecasts of
future sales.
The degree of financial leverage (DFL) measures a percentage change of earnings per share for each
unit’s change in EBIT that result from a company's changes in its capital structure. Earnings per
share become more volatile when the DFL is higher. Financial leverage magnifies earnings per
share and returns because interest is a fixed cost. When a company's revenues and profits are on
the rise, this leverage works very favorably for the company and for investors. However, when
revenues or profits are pressured or falling, the exponential effects of leverage can become
problematic.
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Comparison Chart
Basis for
comparison
Operating leverage Financial leverage
Meaning Use of such assets in the company's
operations for which it has to pay
fixed costs is known as Operating
Leverage.
Use of debt in a company's capital
structure for which it has to pay
interest expenses is known as
Financial Leverage.
Measures Effect of Fixed operating costs. Effect of Interest expenses
Relates Sales and EBIT EBIT and EPS
Ascertained by Company's Cost Structure Company's Capital Structure
Preferable Low High, only when ROCE is higher
Formula DOL = Contribution / EBIT DFL = EBIT / EBT
Risk It gives rise to business risk It give rise to Financial risk
Key Differences Between Operating Leverage and Financial Leverage
The following are the major differences between operating leverage and financial leverage:
1. Employment of fixed cost bearing assets in the company’s operations is known as
Operating Leverage. Employment of fixed financial charges bearing funds in a
company’s capital structure is known as Financial Leverage.
2. The Operating Leverage measures the effect of fixed operating costs, whereas Financial
Leverage measures the effect of interest expenses.
3. Operating Leverage Influences Sales and EBIT but Financial Leverage affects EBIT and
EPS.
4. Operating Leverage arises due to the company’s cost structure. Conversely, the capital
structure of the company is responsible for Financial Leverage.
5. Low operating leverage is preferred because higher DOL will cause high BEP and low
profits. On the other hand, High DFL is best because a slight rise in EBIT will cause a
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greater rise in shareholder earnings, only when the ROCE is greater than the after-tax
cost of debt.
6. Operating Leverage creates business risk while Financial Leverage is the reason for
financial risk.
While the performance of financial analysis, Leverage, is used to measure the risk-return relation
for alternative capital structure plans. It magnifies the changes in financial variables like sales,
costs, EBIT, EBT, EPS, etc. The firms which use debt content in its capital structure are regarded
as Levered Firms, but the company with no debt content in its capital structure is known as
Unlevered firms. The multiplication of DOL and DFL will make DCL i.e. Degree of Combined
Leverage.
The effects of Financial Leverage on company:
The level of financial leverage of a certain company is determined by getting the total value of
debt and the equity and the ratio of debt. Leverage is commonly described as the use of borrowed
money to make an investment and return on that investment. It is riskier for a company to have a
high ration of financial leverage. It has also been noticed that on the outcome of financial
leverage: if the level or point of financial leverage is high, the more rise is anticipated profit on
company is equity. Thus, financial leverage is used in various circumstances as a means of
altering the cash flow and financial position of a company. There are four positions which show
a relationship with the level of financial leverage. First, is the relation of equity and debt, for
instance, the rate of capital. Another is the influences on business production and cycle of
financial leverage. Then the company is industry and branch whole financial leverage level. And
also, the correlation between the current financial leverage ratio of the company and the middle
leverage level. Lastly, the conformity of company ís mission and philosophy with the situation
connected to the relation of financial leverage. The outcome of the financial leverage can also be
utilized to boost income and growth however; it is much common for business industries in the
phase of the young and teens. Financial leverage ratio is relative to variability of profit and
contrary to stability. Company ís profits with high rate leverage level differ with the same
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condition as with the company ís profits with lesser leverage level. Another factor that affects
leverage ratio is the company is flexibility, its dynamics and openness that concerns on the
changes and development of technology, possibilities and industry. Companies having high
leverage levels has lower flexible procedure because of the fact that they are more accountable
for all the creditors and sometimes must fill some restrictions and agreements on their
investments and capital use. Companies with high leverage level usually become less successful
due to situation of transforming environment and the need of taking uncertain decisions. Because
of this, they might not able to apply or utilize growth opportunities or expansion of business. One
more risk of using financial leverage as a tool to increase revenue is the reality that the change
between profits and company is debt remains positive. If the company ís profit relative amount to
equity is higher, the debt exceeds the amount of the profit then the effect of leverage is gone and
the debt remains. It is therefore that the level of financial leverage must have a good
understanding of financial or business management. To determine the return rate upon return of
leverage simply calculate the difference among the rate of interest on assets and debts, then
multiply the difference to the relative amount of liability or debt to the equity and add up the
anticipated return on assets. Industries that are growing fast allocate only little level of than those
stably growing company. In most cases, the effects of financial leverage are used to improve the
company is financial condition and earnings but it should not be accepted as a principle rather it
requires comprehensive analysis of the present condition of the environment.
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Financial Risk and Business Risk
Financial risk refers to a company's ability to manage its debt and financial leverage, while
business risk refers to the company's ability to generate sufficient revenue to cover its
operational expenses. An alternate way of viewing the difference is to see financial risk as the
risk that a company may default on its debt payments, and business risk as the risk that the
company will be unable to function as a profitable enterprise.
The risk is the possibility of loss or danger. The equity shareholders have to go through with two
types of risk, i.e. Business Risk, and Financial Risk. The former is the risk related to the
business of the entity while the latter is the risk due to the use of debt funds. However, if there
will be no risk there will be no profit and the higher the risk, the more will be the chances of
getting high returns. In this article, we have compiled the substantial differences between
business risk and financial risk considering various parameters
Financial Risk
A company's financial risk is related to the company's use of financial leverage and debt
financing, rather than the operational risk of making the company a profitable enterprise.
Financial risk is concerned with a company's ability to generate sufficient cash flow to be able to
make interest payments on financing or meet other debt-related obligations. Obviously, a
company with a relatively higher level of debt financing carries a higher level of financial risk,
since there is a greater possibility of the company not being able to meet its financial obligations
and becoming insolvent.
Some of the factors that may affect a company's financial risk are interest rate changes and the
overall percentage of its debt financing. Companies with greater amounts of equity financing are
in a better position to handle their debt burden. One of the primary financial risk ratios that
analysts and investors consider to determine a company's financial soundness is the debt/equity
ratio, which measures the relative percentage of debt and equity financing.
Foreign currency exchange rate risk is a part of the overall financial risk for companies that do a
substantial amount of business in foreign countries.
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Definition of Financial Risk
Financial Risk is the uncertainty arising due to the use of debt finance in the capital structure of
the company. The capital structure of the company can be made up of equity capital or
preference capital or debt capital or the combination of any. The firm, whose capital structure
contains debt finance are known as Levered firms whereas Unlevered firms are the firms whose
capital structure is debt free.
Now, you may wonder that debt capital is one of the cheapest sources of funds, then how will it
become a risk for shareholders? Because at the time of winding up of the company the creditors
are given priority over the shareholders and they will be repaid first. So in this way the risk arises
that the company will not be able to fulfill the financial obligations of the shareholders due to
debt financing. Moreover, financial risk does not end up here as it is a myriad of risks which are
given as under:
Market Risk: Risk arising due to the fluctuations in the financial assets.
Exchange Rate Risk: The risk arising out of the variations in the currency rates.
Credit Risk: The risk emerging because of non-payment of debt by a borrower.
Liquidity Risk: The risk originating as a result of a financial instrument is not traded
quickly in the market.
Business Risk
Business risk refers to the basic viability of a business, the question of whether a company will
be able to make sufficient sales and generate sufficient revenues to cover its operational expenses
and turn a profit. While financial risk is concerned with the costs of financing, business risk is
concerned with all the other expenses a business must cover to remain operational and
functioning. These expenses include salaries, production costs, facility rent, and office
and administrative expenses.
The level of a company's business risk is influenced by factors such as its cost of goods, profit
margins, competition, and the overall level of demand for the products or services that it sells.
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Business risk is often categorized into systematic risk and unsystematic risk. Systematic risk
refers to the general level of risk associated with any business enterprise, the basic risk resulting
from fluctuating economic, political and market conditions. Systematic risk is an inherent
business risk that companies usually have little control over, other than their ability to anticipate
and react to changing conditions.
Unsystematic risk, however, refers to the risks related to the specific business in which a
company is engaged. A company can reduce its level of unsystematic risk through good
management decisions regarding costs, expenses, investments and marketing. Operating
leverage and free cash flow are metrics that investors use to assess a company’s operational and
management of financial resources.
Business Risk is the probability of earning a comparatively low profit or even suffer losses
because of changes in the market conditions, customer demands, government regulations and
economic environment of business. Due to such risk, the firm will not generate enough profit to
meet out its day to day expenses. The risk is unavoidable in nature.
Every business organization operates in an economic environment. The economic environment
includes both micro and macro environment. The changes in the factors of the two environments
directly influence the business, and the risk arises. Some of those factors changes in customer
tastes and preferences, inflation, change in the policies of the government, natural calamities,
strikes, etc. The business risk is divided into various categories:
Compliance Risk: The risk arising due to the change in government laws.
Operational Risk: The risk originating due to the machinery break down, process
failure, lockouts by workers, etc.
Reputation Risk: The risk emerging as a result of any misleading advertisement, lawsuit,
criticism of bad products or services, etc.
Financial Risk: The risk arising due to the use of debt capital.
Strategic Risk: Every business organization works on a strategy, but due to the failure of
strategy the risk arises.
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Key Differences Between Business Risk and Financial Risk
The following are the major differences between business risk and financial risk:
1. The uncertainty caused due to insufficient profits in the business due to which the firm is
not able to pay out expenses in time is known as Business Risk. Financial Risk is the risk
originating due to the use of debt funds by the entity.
2. Business Risk can be evaluated by fluctuations in Earnings Before Interest and Tax. On
the other hand, Financial Risk can be checked with the help of leverage multiplier and
Debt to Asset Ratio.
3. Business Risk is linked with the economic environment of business. Conversely,
Financial Risk associated with the use of debt financing.
4. Business Risk cannot be reduced while Financial Risk can be avoided if the debt capital
is not used at all.
5. Business Risk can be disclosed by the difference in net operating income and net cash
flows. In contrast to Financial Risk, which can be disclosed by the difference in the return
of equity shareholders.
Risk and Return are closely interrelated as you have heard many times that if you do not bear
risk you will not get any profit. Business Risk is a comparatively bigger term than Financial
Risk; even financial risk is a part of the business risk. Financial Risk can be ignored, but
Business Risk cannot be avoided. The former is easily reflected in EBIT while the latter can be
shown in EPS of the company.
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Comparison Chart:
Basis for comparison Business Risk Financial Risk
Meaning The risk of insufficient profit, to
meet out the expenses is known
as Business Risk.
Financial Risk is the risk arising due
to the use of debt financing in the
capital structure.
Evaluation Variability is EBIT Leverage Multiplier and Debt to asset
ratio.
Connected with Economic environment Use of debt capital
Minimization The risk cannot be minimized. If the firm does not use debt funds,
there will be no risk.
Types Compliance risk, operational
risk, reputation risk, financial
risk, strategic risk etc.
Credit risk, Market risk, Liquidity
risk, exchange rate risk, etc.
Disclosed by Difference in net operating
income and net cash flows.
Difference in the return of equity
shareholders.
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