Finance - Basic Session

Finance- Basic Session

AGENDA
• Introduction
• Major recruiters over the last few years
• Selection process
• Basic finance concepts:
• Primary Financial Statements
• Accounting Ratios
• Time value of money
• Roles offered

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 Finance- Basic Session

WHAT CONSTITUTES FINANCE DOMAIN?

Encompasses the entire spectrum of activities that relates to the management
of money and key economic resources by organizations.
It includes the whole range of services provided by:
§ Banks and Non-Banking Financial Companies
§ Insurance companies
§ Investment Banks
§ Asset management companies/mutual funds/wealth management divisions
§ Stock brokerage firms
§ Financial technology companies
§ Venture capital/Private equity firms
§ Asset Reconstruction / risk management cos
§ Internal Finance departments (Corporate Finance)

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 Finance- Basic Session

ROLES OFFERED
Role Insights/job descriptions Career path and opportunities
Investment banking Pitch books for M&A, company’s Major investment banks come on
financial assessments, IPO execution campus; very exciting but very
demanding role
Equity research Sector analysis, valuation of the Almost all investment banks, private
companies equity firms, hedge funds have this
division
Retail banking Product management, market research Major private banks recruit from B
schools for this role; a mix of finance,
strategy and marketing
Commercial banking Dealing with businesses and corporates, Role is a mix of finance and strategy; all
portfolio assessment & offering financial the major commercial banks offer this
products, industry analysis role
Risk roles Credit risk , market risk and operational Every financial institution has to
risk management manage risk and hence vast
Audits, credit reporting and analysis opportunities
Corporate Finance Internal finance management Includes internal finances like treasury
(funds management), project appraisal

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 Finance- Basic Session

MAJOR RECRUITERS

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 Finance- Basic Session

SELECTION PROCESS
Skill Sets Common Processes
• For roles like investment banking, equity • Resume shortlists
research, corporate banking etc., the basic A strong academic background is desirable;
understanding of valuation approaches like
DCF and multiples as well as ratio analysis is top-heavy resumes are generally preferred
required. • Tests: online/written
• For other roles, basic knowledge of Test areas like accountancy, LR, data
accounting is expected. Knowing how to
read and interpret financial statements is interpretation and general market
key. awareness
• Quantitative and analytical skills and the • Group discussions
ability to work with numbers .
• Workshops
• Following business news is a must. Do
follow a sector; identify some major Designed to educate as well as identify
companies and go through the reports, potential candidates well in advance of
recent events of those companies; read other processes
about some significant M&A deals and
IPOs • Networking events
• Good communication skills help during • Personal interviews
workshops and networking events, which In most cases, multiple rounds are
are very important and should be taken
seriously. conducted to test the technical aptitude;
HR rounds occur as well
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 Finance- Basic Session

PRIMARY FINANCIAL STATEMENTS

Basic financial statements What does it tell? Major components

Company’s operating results for the Revenues, Expenses, Net

Income Statement
period Income

Balance Sheet Assets, Liabilities,

Company’s current financial position
Shareholder’s Equity
Cash inflows and outflows
How the company obtains and use cash
Cash Flow Statement under operating, investing
during the period
and financing activities

ACCOUNTING EQUATION : Assets = Liabilities + Owner’s Equity

• It shows that all the assets that the business owns are financed by either the shareholder’s funds or
outsider’s funds
• The balance is maintained because every business transaction affects at least two of the company's
accounts. For example, when a company borrows money from a bank, the company's assets will
increase and its liabilities will increase by the same amount. Similarly, when an asset is purchased, it
can either be financed through loan (which will increase both assets and liabilities) or bought using
cash (which will increase one asset and decrease another asset).
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 Finance- Basic Session

PRIMARY FINANCIAL STATEMENTS

Income Statement Balance Sheet
Revenue from operations (Sales) Equity & Liabilities Assets
Other income Shareholder’s Fund Non Current Assets
a) Share capital a) Fixed Assets
Total income b) Reserves & Surplus b) Non Current Investments
Less: Expenses c) Long term Loans &
Advances
(-) Cost of goods sold
Non-current Liabilities Current Assets
(-) Expenses other than Depreciation, Interest & Tax a) Long term borrowing a) Current Investment
b) Long Term Provisions b) Inventories
EBITDA c) Trade Receivables
(-) Depreciation d) Cash & Cash Equivalents
e) Short Term Loans &
EBIT Current Liabilities Advances
a) Short term borrowings f) Other Current Assets
(-) Interest b) Trade Payables
c) Other Current Liabilities
PBT (Profit before Tax)
d) Short term Provisions
Tax
The income statement illustrates the profitability of a B/S is a snapshot of the company at a specific point in time
company. It begins with the revenue line and after subtracting such as the end of the quarter or year. The balance sheet
various expenses arrives at net income. The income statement shows the company’s resources (assets) and funding for those
covers a specified period like quarter or year. resources (liabilities and stockholder’s equity).

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 Finance- Basic Session

BASIC TERMINOLOGIES

• Assets- Resources which enable a firm to generate revenues are known as Assets.
For example-land, building, machinery, etc.
• Liabilities- Refers to the amount owed by the business
• Depreciation- Reduction in the value of an asset due to usage, normal wear and tear
or obsolescence
• Capital- Amount invested in a business by the owner. Can be in the form of cash or
assets having monetary value
• Income- Profit earned during a particular period
• Expense – Amount spent to generate the revenues

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 Finance- Basic Session

PRIMARY FINANCIAL STATEMENTS

Cash flow Statement
Profit before tax XXX CASH FLOW FROM OPERATING
ACTIVITIES
Adjustments for non cash & non operating activities:
• CFOA makes adjustments &
+Depreciation & Amortization expense XXX translates net income into operating
profits earned on cash basis.
+Finance cost XXX
• Therefore, it starts with net income
-Interest Income (XXX) (taken from P/L) & adds back non
-Dividend income on investment (for non investment company) (XXX) cash expenses as they did not result
into cash outflow.
+Bad and doubtful debts XXX • Also non-operating expenses are
+/- Loss or gain on sale of fixed assets XXX added as they are shown as a
deduction from other activities
Operating profit before working capital changes XXX (non-op income subtracted).
+Increase in Current Liabilities/Decrease in Current Assets XXX • If the current assets/ working capital
increases, amount is subtracted
-Decrease in Current Liabilities/Increase in Current Assets (XXX) from operating activities as it means
Cash Generated from operations XXX more investment in business
(decrease in working capital/
-Income tax paid (XXX) increase in current liabilities means
NET CASH FROM OPERATING ACTIVITIES (A) XXX less cash requirement so added).

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PRIMARY FINANCIAL STATEMENTS

Cash flow Statement

Purchase of Fixed Assets/ Long term Investments (XXX) CASH FLOW FROM INVESTING
ACTIVITIES
Sale of Fixed Assets/ Long term Investments XXX

Dividend income on investment (for non investment XXX • It reports the change in a
company) company's cash position resulting
from purchase or sale of long term
Interest Received XXX
investments.
Rent Received XXX • It also accounts for the cash
generated from such investments
NET CASH FROM INVESTING ACTIVITIES (B) XXX
e.g.. Dividend received on
investment in equity shares.
• Negative cash flow from investing
activities means that a firm is
investing in its business. Companies
with high capital expenditures are
generally in a state of growth.

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 Finance- Basic Session

PRIMARY FINANCIAL STATEMENTS

Cash flow Statement

Proceeds from issued share capital XXX CASH FLOW FROM FINANCING
Repayment of Long Term Borrowings (XXX) ACTIVITIES
Interest paid (XXX)
• This statement focuses on how a
Dividend paid (XXX) firm raises capital and pays it back
NET CASH FROM FINANCING ACTIVITIES ( C) (XXX) to investors.
• CFFA provides important insights
about the financial health of an
NET INCREASE/(DECREASE) IN CASH AND CASH XXX organization & about its future
EQUIVALENTS (A+B+C) Op + Investing + Fin plans. Positive CFFA may indicate
(+) OPENING CASH AND CASH EQUIVALENTS XXX intentions of the organization
= CLOSING CASH & CASH EQUIVALENTS XXX about expansions & growth.
• Negative CFFA can be a sign of
improving liquidity position of the
company if the debts are repaid.

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IMPACT OF DIFFERENT TRANSACTIONS

Impact of different transactions on Financial Statements

1. Depreciation Rs.10
• Income statement: Depreciation is an expense so operating income (EBIT) declines by
Rs.10. Assuming a tax rate of 40%, net income declines by Rs.6.
• Cash flow statement: Net income decreased Rs.6 and depreciation increased Rs.10 so cash flow from
operations increased Rs.4. Intuitively, depreciation being an expense reduces the income and thus the
tax liability (tax now paid is less than what was paid in absence of depreciation). Also, as it a non cash
expense, it does not lead to any additional outflow of cash.
• Balance sheet: Increase in depreciation by Rs.10 decreases Net Assets by Rs.10. As the cash balance
had increased by Rs. 4, so the net decrease in assets side of balance sheet is Rs. 6. On the liabilities
side, decrease in net income reduces reserves and surplus balance by Rs. 6. Note that the balance
sheet is now balanced.
2. The inventory items that were bought for $2,000 are now sold for $5,000 on credit
• Income statement: Increase in revenue by Rs. 5000 and cost of goods sold by Rs. 2000, hence
increase in gross profit is Rs.3000.
• Cash flow statement: Since the goods are sold on credit, there is no change in cash
• Balance sheet: Inventory reduces by Rs.2000, Accounts receivables increase by Rs.5000 and Profits/
Reserves & Surplus up by Rs.3000

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LINK BETWEEN THE 3 FINANCIAL STATEMENTS

As seen from the examples, the following relationship is established:
• Net income from the income statement flows to the balance sheet (as Retained earnings in Reserves
& Surplus on Liability + SH equity side) and is the starting point to calculate cash flow from operations
(Indirect method) in cash flow statement (CFS)
• Depreciation & Amortization is deducted as an expense from EBITDA to get EBIT in income statement,
added back in CFO in CFS and is subtracted from Gross Fixed Assets to get Net Fixed Assets in B/S
Sheet. Similarly, all other non cash expenses (e.g. Bad debts) that are shown in income statement are
added back in CFS
• Capital expenditure is added to Gross Fixed Assets in B/S Sheet and is shown as cash outflow in Cash
Flow from Investing in CFS
• After all the adjustments in CFS, net cash inflow/ outflow gives the closing cash balance for B/S

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RATIO ANALYSIS

Liquidity Ratios Solvency Ratios Turnover Ratios Profitability Ratios

• Measures the • Measures the • Measure of firm’s • Assesses the

short-term enterprise’s efficiency ability of
solvency or the ability to meet • Specifies how business to
ability of the its debt and efficiently assets generate
company to pay other are being utilized earnings
short-term obligations compared to its
to generate sales
liabilities using its • Ratios include expenses during
current assets • Ratios include a period of time
Debt- Equity Inventory
• Ratios include Ratio, Financial • Ratios include
Current Ratio, Leverage & turnover, Net Profit
Quick Ratio and Interest Receivables Margin, ROE,
Cash Ratio Coverage Ratio turnover & ROCE, ROA,
Payable turnover Operating
Margin, etc.

Remember, an analysis can neverbe performed considering asingle parameterin isolation. Check for more than 1 ratio for a
meaningfulinterpretation.Also,Interpretationmust be in line with industry and historicaltrends.

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Liquidity Ratios
Parameters Current Ratio Quick Ratio Acid test ratio Cash Ratio
Formula = Current Assets/ Current Liabilities = Quick Assets/ Current Labilities = Cash and cash equivalents/
Quick Assets = Current assets - Inventories Current liabilities
- Prepaid expenses OR Cash Equivalents include demand
Cash + Marketable securities + Receivables deposits, commercial paper &
marketable securities (holding
period < 3 months)
Meaning Financial ratio used to examine the Liquidity indicator that filters the current Amount of cash and short term
ability to pay short-term liabilities ratio by measuring the amount of the equivalents a company has over
with its short-term assets most liquid current assets there are to current liabilities. The cash ratio
cover current liabilities is an effective way to determine
if a company could have
potential short-term liquidity
issues
Comments • Least Stringent. Includes all current • A more conservative or stringent • Ability to meet short-term
assets, even those which cannot be measure (also known as acid test ratio) obligations out of cash and cash
easily liquidated • Includes only those current assets which equivalents without having to
• Manufacturing industries require are readily and quickly convertible into liquidate other assets (MOST
significant working capital cash and excludes items like inventory CONSERVATIVE/ WORST CASE)
investment in inventory, trade and prepaid expenses which are not • Facilitates comparison with
debtors, cash, etc., so generally easily cash convertible industry averages and
have high current ratio • Current ratio might be misleading if a competitors in a standard
• Whereas, big companies in retail considerable portion of current asset is manner
sector (Eg: Big Bazaar) are able to illiquid
negotiate long credit periods with • However, it is debatable whether some
suppliers while offering little credit assets qualify as “quick” assets; for e.g.
to customers leading to lower receivables (particularly in construction
current ratio sector)

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Liquidity Ratios
Parameters Current Ratio Quick Ratio Cash Ratio
High ratio • Cushion for unforeseeable • Cushion for unforeseeable • The company is more liquid and
liabilities that may arise in liabilities that may arise in can more easily fund its debt
short-term short term • Creditors are particularly
• Too high current ratio may mean • Too high current ratio may interested in this ratio because
inventory is lying unsold, a lot of mean a lot of finance is tied up they want to make sure their
finance is tied up in current in quick assets, which could loans will be repaid
assets, which could have been have been reinvested or
reinvested or distributed to distributed to shareholders
shareholders
• Increase over a period of time
may suggest improved liquidity
of a company or a more
conservative approach to
working capital management
Low ratio • Cause of concern as company • The company is taking too • The company needs more
might have problems paying much risk by not maintaining than just its cash reserves
bills on time an appropriate buffer of liquid to pay off its current debt
• A decreasing trend may suggest resources
a deteriorating liquidity position • May be due to better credit
of a business or a leaner terms with suppliers than the
working capital cycle of a competitors
company through the adoption
of more efficient management
practices

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Debt to Equity (Solvency Ratio)

Debt/ Equity = Total Debt/ Equity

Debt = Long-term borrowings + Short-term borrowings (Interest
bearing liabilities)
Equity = Common stock + Pref share capital + Reserves and surplus
• Indicates the split between investment of debt providers and the
owners
• In general, a high debt-to-equity ratio indicate higher financial
risk. It might inhibit the firm’s ability to raise further debt for
capital requirements. However, low debt-to-equity ratios may
also indicate that a company is not taking advantage of the
increased profits that financial leverage may bring
• For example, capital intensive industries such as auto
manufacturing tend to have a debt/equity ratio above 2, while
companies in service industry usually are not particularly capital
intensive and may often have a debt/equity ratio of under 0.5
Capital-gearing Ratio:
• Includes preference share capital in debt instead of equity. In
case preference capital is zero, there will be no difference
between D/E and gearing ratios.
• More conservative approach for measuring long term solvency

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 Finance- Basic Session

Interest Coverage Ratio (Solvency Ratio)

Interest Coverage Ratio= EBIT/Interest

• The interest coverage ratio shows how many times

is the EBIT as compared to Interest cost
• A lower ICR means less earnings are available to
meet interest payments and thus greater is the
possibility of bankruptcy or default.
• A higher ratio indicates a better financial health
as it means that the company is more capable to
meeting its interest obligations from operating
earnings

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Activity Ratios

Inventory Turnover Ratio Receivables Turnover Ratio Payables Turnover Ratio

Inventory Turnover = Cost of Goods Receivables Turnover Ratio = Net Payables Turnover Ratio = Credit
Sold/ Average Inventory Credit Sales/ Average Accounts purchases/Average Accounts
Receivables Payable
Average Inventory = (Opening
inventory + Closing Inventory)/2 Average Receivables = (Opening Average Payables = (Opening
receivables + Closing receivables)/2 Payables + Closing Payables)/2
Indicates how many times a The ratio indicates the efficiency with The ratio indicates how many times
company’s stock is sold and replaced which a firm manages the credit it per period the company pays its
over a given period of time. Its issues to customers and collects on average payable amount. It also
purpose is to measure the liquidity of that credit shows how easily a company can pay
the inventory off its current suppliers and vendors
To be compared against industry Lower ratio indicates inefficiency If the turnover ratio is falling from
averages; a low turnover implies poor because receivables are a form of one period to another, this is a sign
sales and, therefore, excess inventory. interest-free credit given to customers that the company is taking longer to
A high ratio implies either strong A high ratio may imply a conservative pay off its suppliers than it was
sales or ineffective buying credit policy or that the company before. The opposite is true when the
mainly operates through cash or that it turnover ratio is increasing, which
has high proportion of high quality means that the company is paying off
customers suppliers at a faster rate
Inventory days = Number of days in a Days receivables = Number of days in a Days payables = Number of days in a
period/ Inventory Turnover period/Receivable Turnover Ratio period/Payable Turnover Ratio

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Net Profit Margin (Profitability Ratio)

Net profit margin = Net profit / Revenue from operations

• The higher the ratio, the more effective a company is
at overall cost control
• Varies across sectors and industries as factors like
depreciation, finance costs and power to charge
premium vary (e.g. Luxury & consumer staples; Capital
intensive and service business)

• Comparing the margin with industry averages lets you

gauge your company's standing versus the standings of
peer businesses. Profit margin may reveal certain
things about industry or company, e.g high margins
may be due to high consumer interest in product
segment, strong brand loyalty and low margins may be
due to increased competition in industry, raw material
costs etc.

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Operating (EBIT) Margin (Profitability Ratio)

Operating Margin = Operating Income (EBIT)/ Revenue

from operations

• A healthy operating margin is required for a company

to be able to pay for its fixed costs, such as interest on
debt, so a high margin means that a company has less
financial risk than a company with a low margin. Also, it
suggests greater potential to derive profits and more
cushion against any increase in competition or costs
• Operating Margin provides a better measure for
assessing the financial performance of a business as
compared to net profit margin ratio because it places
emphasis on only the recurring profits of a business
which are not affected by fluctuations caused by
changes in debt level, tax rates and one time gains

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Profitability Ratios

EBITDA Margin Return on Equity

EBITDA Margin = EBITDA/ Revenue from operations ROE = Profit After Tax / (Equity Share Cap
+ Reserves & Surplus)
• EBITDA margin helps in comparing the net
profitability of different companies by: RoE = Profit After Tax / (Assets - Liabilities)
• Eliminating effect of capital structuring
decisions i.e. debt/equity mix (as compared to
NI margin)
• Accounting decisions like depreciation (as
compared to EBIT margin)
• This allows people to compare and contrast
companies of different sizes in different industries.
• More suitable measure for comparing industries
with heavy investment in machineries
Operating and Depreciation

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Return on Capital Employed (Profitability Ratios)

ROCE = Earnings Before Interest and Tax (EBIT) /

Capital Employed
Capital Employed = Equity Share Cap + Pref. Share Cap +
Reserves & Surplus + Long Term Borrowings
Or
Capital Employed = Total Assets – Current Liabilities
• Return on capital employed (ROCE) is a long term
profitability ratio and measures efficiency with which
its capital is used
• ROCE should be more than the company’s cost of
capital (borrowing rate) or else the company is not
generating value for its shareholders
• ROCE calculates return for both deb and equity
holders. Thus, ROCE is especially useful when
comparing the performance of companies in capital-
intensive sectors which generally have significant debt

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DuPont Analysis

DuPont Analysis helps us in analysing Return on Equity by breaking into 3 parameters (Net Profit Margin, Asset
Turnover Ratio and Equity Multiplier). This helps us identify the stressed parameter and accordingly make
decisions to improve Return on Equity.

Revenue from
Net Profit Operations Total Assets
Return on
Equity Revenue from Total Equity
Operations Total Assets

Net Profit Asset Turnover Equity

Margin Ratio Multiplier

Operating Asset Financial

Efficiency Utilization Leverage
Efficiency

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TIME VALUE OF MONEY

Would you like $1,000 in cash today or 5 years from now?
• The basic premise of Time Value of Money lies in this question
• Now.
• Why?
• The money that is earned today can be reinvested at a certain interest rate in order to earn a certain interest rate in
the future
• There is uncertainty about the future, and hence receiving cash flows now removes uncertainty.
• Inflation and economic situation may reduce purchasing power in the future and hence, it’s better to have that
money now.
• Thus, time has a certain quantifiable monetary value associated with it.
• Time Value of Money forms the basis of intrinsic valuation methodologies, dividend discount
models, project financing decisions etc.

Question Time: Suppose you expect to receive/spend the following amounts: T1:$500, T3:-$400,
T4:$650, T5:$750. The discount rate is 5% p.a. for the first two years, 6% p.a. thereafter. What is
the expected value at hand today ?

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TIME VALUE OF MONEY

Question Time: Suppose you expect to receive/spend the following amounts: T1:$500, T3:-$400,
T4:$650, T5:$750. The discount rate is 5% p.a. for the first two years, 6% p.a. thereafter. What is
the expected value at hand today ?

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TIME VALUE OF MONEY

Compounding, Discounting and the Discount rate

• If you have invested a sum of money P in any instrument and you’re promised a rate of
return ‘r’ on it, then the amount you’ll receive after n periods is-
𝑛
𝑟
𝐴 = 𝑃 1+ --------- Here, A is also called the Future Value (FV) of the
100
investment
This is called compounding, where the effect of interest and time increases the wealth you
invest

• How is it different from simple interest then?

• A basic assumption in case of compounding is that the interest amount that you receive is
reinvested back into the investment. This is what makes it different from simple interest.

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Thank You

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