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Submitted By Syeda Tasnuba Kamrul Annual Exam Roll: 9587606 Class Roll: 3023 Registration No.: 1583161 Session: 2009-10 B.B.A. (Honours) 2nd year Supervised by Mr. Mosharaf Hossain Associate Proffesor. Mr. Akhter Hossain Lecturer.
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Preface
First of all I would like to thanks my Honorable teacher Mr. Mosharaf Hossain (Associate Proffesor), Mr. Akhter Hossain (Lecturer)for permitting me to carry out a term paper on such an important topic which is introduced to me in Financial Statement Analysis Of a Company.
I have been able to complete this term paper due to their enormous guidance and help. I would also like to thanks of all those Who have helped me to prepare this term paper.
I would like to express the importance of my term paper topic, financial statement analysis for a company is very much important because they can get many kind information which can help them to make right decision. Securities exchange players review financial statements to identify factors that may undermine a company's operating efforts. These statements enable investors to raise questions about how carefully corporate management formulates operating plans. Competitors also take a peek at corporate performance data to see how other companies are turning struggling businesses around. Business partners, such as lenders and suppliers, also appraise a firm's performance information before advancing funds or extending trade credit. I also would like to state that when I got this topic for making term paper I got afraid of it. But my teachers guided me so well so that I make it very easily. I collect information through internet website, such as wikipidea, financial statement related website and also book from which I can decorate this term paper. At last I would like to give thanks Almighty Allah and I hope this term paper creation can help me in my further life and also my job field.
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Table of contents Introduction Background of financial statement analysis Objective of financial statement analysis Conceptual Issues of financial statement analysis Database of financial statement analysis Findings of the study Brief overview of Square Pharmaceuticals Ltd. Financial statement analysis of Square Pharmaceuticals Ltd. 5.00 Conclusion 5.01 Summary of major findings 5.02 Concluding remarks
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1.00 Introduction
balance sheet. Another example is to adjust the reported numbers when the analyst suspects earnings management. 3) Financial ratio analysis should be based on regrouped and adjusted financial statements. Two types of ratio analysis are performed: 3.1) Analysis of risk and 3.2) analysis of profitability: 3.1) Analysis of risk typically aims at detecting the underlying credit risk of the firm. Risk analysis consists of liquidity and solvency analysis. Liquidity analysis aims at analyzing whether the firm has enough liquidity to meet its obligations when they should be paid. A usual technique to analyze illiquidity risk is to focus on ratios such as the current ratio and interest coverage. Cash flow analysis is also useful. Solvency analysis aims at analyzing whether the firm is financed so that it is able to recover from a loss or a period of losses. A usual technique to analyze insolvency risk is to focus on ratios such as the equity in percentage of total capital and other ratios of capital structure. Based on the risk analysis the analyzed firm could be rated, i.e. given a grade on the riskiness, a process called synthetic rating. Ratios of risk such as the current ratio, the interest coverage and the equity percentage have no theoretical benchmarks. It is therefore common to compare them with the industry average over time. If a firm has a higher equity ratio than the industry, this is considered less risky than if it is above the average. Similarly, if the equity ratio increases over time, it is a good sign in relation to insolvency risk. 3.2) Analysis of profitability refers to the analysis of return on capital, for example return on equity, ROE, defined as earnings divided by average equity. Return on equity, ROE, could be decomposed: ROE = RNOA + (RNOA - NFIR) * NFD/E, where RNOA is return on net operating assets, NFIR is the net financial interest rate, NFD is net financial debt and E is equity. In this way, the sources of ROE could be clarified. Unlike other ratios, return on capital has a theoretical benchmark, the cost of capital - also called the required return on capital. For example, the return on equity, ROE, could be compared with the required return on equity, kE, as estimated, for example, by the capital asset pricing model. If ROE < kE (or RNOA > WACC, where WACC is the weighted average cost of capital), then the firm is economically profitable at any given time over the period of ratio analysis. The firm creates values for its owners.
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Insights from financial statement analysis could be used to make forecasts and to evaluate credit risk and value the firm's equity. For example, if financial statement analysis detects increasing superior performance ROE - kE > 0 over the period of financial statement analysis, then this trend could be extrapolated into the future. But as economic theory suggests, sooner or later the competitive forces will work - and ROE will be driven toward kE. Only if the firm has a sustainable competitive advantage, ROE - kE > 0 in "steady state".
Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.
Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.
Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.
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Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a longterm bank loan or debentures) to finance expansion and other significant expenditures.
Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company.
Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.
Media and the general public are also interested in financial statements for a variety of reasons.
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you need to make. There are many others as well, but well stick to the three major ones here, as follows: 1. Actual vs. Planned Performance
You did considerable business planning before you started your business (and you likely updated it for the banks, investors, or suppliers), complete with pro forma financial statements (no matter how crude).So, after your business is operating, you will need to compare your actual performance (from your financial statements) against your planned performance (from your pro forma financial statements).This financial statement analysis should be performed line item by line item. If you had fewer sales than planned you should know or find out why. If any costs were greater than planned again, you should know or find out why. Ever dollar received, and every dollar spent shows up on your financial statements, and every dollar that is different than you planned should be analyzed. This could be a good thing as you may need to change your planning. This is where it becomes important to have an advisory group where you can bounce information, and ideas, around. 2. Trend Analysis
By comparing current financial statements to previous financial statements you can see which areas of your business have changed, and by how much. Then you need to determine why the change occurred, whether positive or negative:
Are sales trending up? Are costs trending down (which ones arent)? Are profits trending up? Is your cash flow improving?
These are the types of things you will want to look at in your financial statement analysis.Like the performance analysis, you need to analyze your financial statements line item by line item
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to determine trends and don't be afraid to change your planning if you see a new trend emerging.
3. Industry Comparisons
This analysis is not only a comparison or your businesss performance to others in your industry, but also to standards set by your banker, your investor(s), your advisory group, or even yourself. These comparisons are usually made in the form of financial ratios. Here are a few of the more common financial ratio analyses:
Current Ratio This is one of the most widely used tests of financial strength, and is calculated by dividing Current Assets by Current Liabilities. This ratio is used to determine if your business is likely to be able to pay its bills. Obviously, a minimum acceptable ratio would be 1:1; otherwise your company would not be expected to pay its bills on time. A ratio of 2:1 is much more acceptable, and the higher, the better.
Quick Ratio This is sometimes called the acid test ratio because it concentrates on only the more liquid assets of your business. It is calculated by dividing the sum of Cash and Receivables by Current Liabilities. It excludes inventories or any other current asset that might have questionable liquidity. Depending on your history for collecting receivables, a satisfactory ratio is 1:1.
Working Capital Bankers especially, watch this calculation very closely as it deals more with cash flow than just a simple ratio. Working Capital equals Current Assets minus Current Liabilities. Quite often your banker will tie your loan approval amount to a minimum Working Capital requirement.
Inventory Turnover Ratio Not every business has an inventory that needs to be of concern, and if that is your situation you can ignore this ratio.This ratio tells you if your
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inventory is turning over fast enough, and is calculated by dividing Net Sales by your average Inventory (at cost).If you are concerned about your inventory, then you definitely should watch this ratio carefully when comparing it to industry guidelines.
Leverage Ratio This is another of the analyses used by bankers to determine if your business is credit worthy. It basically shows the extent your business relies on debt to keep operating. This ratio is calculated by dividing Total Liabilities by Net Worth (total assets minus total liabilities).Obviously, the higher the ratio is, the more risky it becomes to extend credit to your business.This is often the calculation a supplier to your business will make before extending credit to you.
P&L Ratios Profit and Loss (P&L) financial statements also have some important ratio calculations for your financial statement analysis:
Gross Profit Ratio This is the most common calculation on your P&Lit is simply your Gross Profit divided by Net Sales. Often, different industries will have standard guidelines that you can compare your businesss numbers to. It is also desirable to watch your trends and not let this number move too far from your target.
Net Profit Ratio This calculation is simply Net Pre-tax Profit divided by Net Sales. Other than wanting this number to be as large as possible, I usually dont pay too much attention to it because it includes too many non-operating costs (depreciation, amortization, etc.) to be of any real analysis value. (Your banker may be interested however.)
Management Ratios. There are a couple of other ratios that interested outside parties will want to analyze:
Return on Assets This is calculated by dividing Net Pre-tax Profit by Total Assets. The ratio is supposed to indicate how efficiently you are utilizing your assets.To me, this is a useless analysis for helping you run your business. However, bankers and investors will always calculate this ratio if you dont
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Return on Investment (ROI) To a bank or investor this is the most important ratio of all. It is supposed to tell youthe business ownerif you are investing your time, and money, properly, or should you just liquidate your business and put the money into a savings account.This, of course, is pure bull concocted by non-entrepreneurs and academics who have no idea what it means to be an entrepreneur.Having said that, I do realize it can be of some value to a banker or investorthey likely want to know if they could make a better return on their money by investing or loaning it to someone other than you. So, for that purpose, it can be valuable to them.To calculate your Return on Investment, divide your Net Pre-tax Profit by your Net Worth (total assets minus total liabilities). Dont worry about needing to learn all the technicalities of financial statement analysisthere are many sources of expert help and it would not be time consuming nor costly to have your accountant or a member of your advisory board assist you until you get the hang of it.This is only a general guide to a simple financial statement analysis. Your business should be small enough at this early stage that it doesnt require much more complex analyses.Should you need more analysis however, you can always use your accountant or a member of your advisory group for assistance with more in depth financial statement analysis.The next thing you should consider, regarding your financial statements, is the auditing process, because your banker or investor(s) will likely require that. You can access the report on.
Current Liabilities
Net Working Capital Ratio Net Working Capital Net Working Capital Ratio = -------------------------Total Assets
Earnings Per Share (EPS) Net Income Earnings Per Share = --------------------------------------------Number of Common Shares Outstanding
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Interest Coverage Ratio Income Before Interest and Income Tax Expenses Interest Coverage Ratio = ------------------------------------------------------Interest Expense
Income Before Interest and Income Tax Expenses = Income Before Income Taxes + Interest Expense
--------------------
Average Total As
Profit Margin = Net Income / Sales Assets Turnover Ratio = Sales / Averages Total Assets
The company became Public & became listed in the DSE in the year 1991, since then there was no looking back. The supremacy of Square is such that the closest competitor Beximco Pharmaceuticals is not even close in comparison to the market share; the latter has only about half the market share.
Square Pharmaceuticals Limited has extended its range of services towards the highway of
global market. The company pioneered exports of medicines from Bangladesh in the year 1987 and has been exporting antibiotics and other pharmaceutical products since then. This extension in business and services has increased the credibility of Square Pharmaceuticals Limited ten folds.
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Book Value - 2007 Asset Current Asset Non current Asset Amount Liabilities Amount 3,500,845,103 785,241,612
Share holder's equity Tangible asset Intangible asset 8,291,290,984 (8942400 shares) 8,417,040,705
Total Asset
12,703,127,420
Market value - 2007 Asset Current Asset Non current Asset Amount Liabilities Amount 3,500,845,103 785,241,612
36,753,264,000
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Total Asset
41,039,350,715
The above table shows the balance sheet as it was presented in the annual report 2007 of Square Pharmaceuticals Ltd. According to this balance sheet the book value of SPL shares for the day December 31, 2007 should be Tk.941.25. But in reality the actual market price on that day was much higher than that, Tk. 4110. It is good news for a company because the market value is much higher than the book value. That good news also gives a sign that the company has goodwill in the market which can be considered as intangible asset of the company.
2006
2007
Figure 1: Comparison between Book Value and Market Value of SPL stock
Assumptions of balance sheet based on Market Value: 1. The company has other subsidiaries and uses same fixed assets such as furniture and fixture, motor vehicles etc in both companies. But two companies follows two different depreciation method which makes the value of those assets lower than actual market value. Page 17 of 30
2. The balance sheet does not incorporate any intangible assets, like goodwill. Square Pharmaceuticals Ltd is a renowned and well established company and expanded its business in international market. It has gained much reputation in both the market. 3. As shareholders of SPL are highly satisfied about their performance and there is significant differences between book value and market value of share. So there is strong confidence in shareholders mind about the efficient performance of SPL make high intangible asset. 4. The equity of the company has been severely understated. The company calculates its equity from 1991 when SPL was first listed with the Dhaka Stock Exchange. But according to the time value of money theory the value of money has increased a lot over these years.
Current ratio
1.26
1.44
1.78
1.66
1.61
Quick ratio
0.68
0.84
1.19
1.08
0.98
Cash ratio
0.059
0.055
0.140
0.196
0.042
Long-term Solvency
Total Debt
33.74%
30.07%
31.15%
29.58%
21.90%
Times interest
6.58
8.64
12.51
15.92
12.13
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earned (TIE)
Cash Coverage
6.6
8.6
12.5
15.9
12.1
Asset Management Inventory Turnover DSO (Days Sales outstanding) Total Asset turnover 13.75 13.53 14.87 15.75 14.99
2.40
2.76
2.63
2.76
3.54
0.75
0.83
0.76
0.78
0.93
14.45%
14.96%
16.45%
20.26%
17.69%
Return on Asset
10.88%
12.43%
12.54%
15.88%
16.50%
Return on Equity
16.42%
17.77%
18.21%
22.55%
21.13%
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PE ratio (Price Earning) Book Value per share Market Book Ratio 941.25 1230.08 1288.65 1289.07 1275.04 26.60 11.19 9.70 12.96 8.43
4.37
1.99
1.77
2.92
1.78
Interpretation of Ratio: From the trend it can be concluded that Squares current assets are increasing and current liabilities are decreasing. So, its liquidity position is relatively stronger compare to others. It has got an inconsistent quick ratio which means that difference between assets and inventories and also liabilities frequently fluctuates. SPLs inventory turnover ratio is also inconsistent. So it means that company management is not able to manage its inventory efficiently all the time. Its receivable turnover ratio is increasing. It means that companys management has dealt proficiency with its collection policies. The fixed asset turnover ratio is decreasing. It means that company does not use its fixed assets efficiently and intensively. The total asset turnover ratio of SPL is stable. It means that company is generating sufficient volume of business given its total investment. Its total interest turn ratio is increasing. It means that company is not able to meet its annual interest cost. The profit margin on sales is increasing. It means that company has low cost of debt and also operating expenses are going down signifying the companys efficiency.ROA is increasing. It means that companys high BEP plus low interest cost resulting from its low use of debt. Its ROE has increased more than ROA. It means that companys greater use of equity.
Financial strength and weaknesses of SPL: In this section the strengths and weaknesses for the companies have been summarized.
Square Pharmaceuticals Ltd. Page 20 of 30
Strengths: Liquidity position is relatively stronger compare to others. Company management has proven efficiency in managing its inventory. Companys management has dealt proficiency with its collection policies Company is generating sufficient volume of business given its total investment Operating expenses are going down signifying the companys efficiency.
Weaknesses: Company does not use its fixed assets efficiently and intensively. Company is not able to meet its annual interest cost. 7. Financial Planning and Growth Financial planning formulates the method by which financial goals of a company are to be achieved which has two dimensions: a time frame and a level of aggregation. To identify which factors positively contribute to the growth of the stock price of Square Pharmaceuticals Ltd. (SPL), we have analyzed the trend of different variables from the five year financial statement and detected the growth or reduction of every item. After that we have selected few components which show a growing trend and positively contribute to the growth of SPL.
Growth Rate To predict the performance of any firm in the future, it is very important to understand the growth of that company. The following table shows the companys, growth over the last seven year (2004 - 2008).
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Current Asset Retained Earning Non-current Liability Current Liability Dividend EPS
20% 22.48%
-9% 24.06%
24% 35.66%
61% 68.07%
0.3521 0.2265
The growth rates that have been shown in the chart, we can find that geometric mean of sales growth is 14.39 %. As the world economy is experiencing the recession and the impact of recession is also started affecting our economy, so it will be a highly optimistic choice if we expect that the company will grow at the rate of 14%. On the other hand, the other growth rates that have been calculated also give us the indication that we can not consider them as company growth rate given GDP growth of Bangladesh is 5.45% and world economy is in recession. Lets see what the other variables that we can consider as growth rate for the company.
Variables Growth
GDP 5.45%
Br 7%
If the Square pharmaceuticals Ltd. maintains constant retention ratio and the return is also expected to be constant in future then the company can expect to grow at 7% growth rate. Though the rate is higher than GDP growth but considering the future opportunity to have higher return and the sustainable growth rate we are taking the growth rate in between these two. At the same time, keeping a constant retention ratio will give an indication to the share holders that the company does not have any liquidity Page 22 of 30
problem and company is efficient enough in investment decision. Because at the present situation of world economy and our economy, while new investment is risky SPL is not retaining profit unnecessarily rather distributing to shareholders. It will increase shareholders confidence regarding the company and thus will increase the share price.
(Growth Rate = 7%) Current Assets Fixed Assets Total Assets Current Liabilities Noncurrent Liabilities Total Liabilities 5,165,019,887 5,037,453,530 4,913,602,697 4,793,359,170 4,531,145,872 4,286,086,715 785,241,612 785,241,612 785,241,612 785,241,612 785,241,612 785,241,612 4,379,778,275 4,252,211,918 4,128,361,085 4,008,117,558 3,745,904,260 3,500,845,103 15,892,414,507 15,429,528,648 14,980,124,901 14,543,810,583 13,592,346,339 12,703,127,420 10,372,928,552 10,070,804,420 9,777,480,019 9,492,699,048 8,871,681,353 8,291,290,984 5,519,485,955 5,358,724,228 5,202,644,882 5,051,111,536 4,720,664,987 4,411,836,436
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Common Stock Reserves Retained Earnings brought forward Retained Earnings Total Equity Total Liabilities and Equity Excess Fund 2,815,460,802 1,982,426,555 1,216,060,078 511,645,457 247,171,719 0 18,707,875,309 17,411,955,203 16,196,184,979 15,055,456,040 13,839,518,058 12,703,127,420 13,542,855,422 12,374,501,673 11,282,582,282 10,262,096,870 9,308,372,186 8,417,040,705 1,168,353,749 1,091,919,391 1,020,485,412 953,724,684 891,331,481 1,235,703,093 8,236,983,236 7,145,063,845 6,124,578,433 5,170,853,749 4,279,522,268 3,043,819,175 2,929,705,000 1,207,813,437 2,929,705,000 1,207,813,437 2,929,705,000 1,207,813,437 2,929,705,000 1,207,813,437 2,929,705,000 1,207,813,437 2,929,705,000 1,207,813,437
The above table shows the pro forma balance sheets for the coming 5 years. There are some assumptions are made in preparing the pro forma income statement and balance sheet. Initially all assets, including fixed assets, accounts payable vary directly with sales. Long term debt and common stock wont vary with sales as management decision is to keep a constant long term debt and common stock. As the company decided to maintain a constant retention rate, the company will pay dividend every year at the same rate. The balance sheets indicate the company has excess fund, which can be financed distributed to payoff long term debt and reduce the obligations of interest expenses. Page 24 of 30
Plug Variables
The pro forma statements from the above section indicate the firm will have excess fund if it will grow at 7% rate. The company can decrease its long term debts by the extra fund, thus will decrease the debt equity ratio. As the company decided to maintain a constant retention rate, it ends up with extra fund at the end of the year. In the current recession of economy, it will be risky to do any new investment. So, the company can payoff its debt which will give an encouraging signal to the shareholders. The table below lists the change is capital structure of the company.
The above table shows that the debt/equity ratio of the companys capital structure will go down from the current 26.80% to 19%.
Scenario Analysis
In this case study, the growth rate of 7% has been selected as the constant growth rate and the pro forma statement has been generated based on this growth rate. For scenario analysis, both optimistic and pessimistic scenarios are being considered.
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Growth Rate Income Statement Sales COGS Gross Profit Operating Expenses Operations Profit/(Loss) Other Income Other Cost Depreciation EBIT Tax Net Income Dividend Retained Earnings
12.00%
10.00%
7.00%
5.00%
3.00%
1,895,573,107
1,861,723,587
1,810,949,307
1,777,099,787
1,743,250,268
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Fixed Assets
9,286,245,902 14,227,502,71
Total Assets Current Liabilities Non-current Liabilities Total Liabilities Common Stock Reserves Retained Earnings Total Equity Total Liabilities
0 3,920,946,515
9,936,226,817
9,832,678,453
9,677,355,907
9,573,807,543
9,470,259,179
4,291,275,894
4,140,761,709
3,914,990,433
3,764,476,248
3,613,962,064
30%
29.48%
28.68%
28.14%
27.61%
In the above scenario analysis, we have taken the 7% growth rate in normal situation. If we want to be optimistic enough to predict that the economy will have a high growth and the company will also able to grow at 10% to 12%. On the other hand, the situation can also be worse enough to have a growth lower than the normal and the company may face a growth of 5% or even 3%. In that case the good news for Page 27 of 30
the company is that if the company will have to grow at 5% then company doesnt have to face any loss as the rate is much closer to GDP growth rate. After analyzing the scenario of different situation we can say that the projected growth rate is appropriate for the company which will help the company to operate in the market even if the situation is worse. It gives a positive indication towards the company and increases the shareholders confidence to invest in the companys share.
production of the next year would go down compared to industry due to cost savings in inventories.
5.02Concluding Remarks:
From the total financial statement analysis, we can summarize that for the last year 2007, even though Square Pharmaceuticals Ltd. deteriorated in all the ratios, but still holding the better position compared to Beximco Pharmaceuticals Ltd (the best alternative forgone) and this has been reflected through the increment in share price and in P/E and M/B ratios. The firm gained the trust of the investors. Square Pharmaceuticals Ltd might have a good news that is not reflected in other ratios but investors know. Therefore we can come to the conclusion that Square Pharmaceutical Ltd is a better company to invest on. So that is the financial statement analysis on Square Pharmaceuticals Ltd. Bangladesh.
Thank you
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