How to read balance sheet and Profit and Loss of an Organisation: by Anid_007

Let us discuss the important factors that reveals the Fundamental strength of an organisation.

(to be updated gradually)

The equity market is propelled by 3 factors mainly

1. Political Environment and Macroeconomic policies: Govt at time to time may declare policies which may benefit or ruin a particular type of industry.

For example Govt allows sugar import , then our domestic sugar industry will be in the loosing side and you
will see the share price of Sugar companies going down. On the other hand if Govt allows exemption of tax on textile export, you may see Price of textile shares going up.

Instability of Central Govt , can impact the whole equity market adversely.

Another Important economic factor is Global Economy trend. If FIIs has invested heavily in Domestic market,
then you have take cue from Global share market to determine the trend.

2. Industry Trend:

You will see that in a country, a particular segment of industry is doing very well. For example the companies in Oil n Gas and Energy Sector or the Telecom sector doing great business in a particular year and coming times.

3. The Management efficiency and Corporate Policy:

You may notice two company of similar strength and in same sector (say telecom) are performing in different way. The performance of an organization is totally dependent on the corporate policies and the decision making policy of an organization. This is the most important factor in determining the value of share of a company.

So when you are determined about purchasing shares in a particular sector, you take care of point 1 & 2 and when it comes to zeroing in a particular company you take care of Point 3.

How you choose a good company from a particular sector?

This is the most time consuming and difficult job. Suppose you saw that Govt policies and Industry trend are
supportive in Energy Sector. Now you may have 10-15 companies in this sector.How you choose the one which will give you best return?

It has been a common tendency in Newbie in equity market to buy Small value scrip, thinking that the price will double or triple and give more return than a scrip of an higher value of an already established company But it may not be true always.

Its true that when a sector is booming , even the small cap in that segment tends to rally, but that may not happen always and remember dirty traders has lot of control on such scrip manipulating the prices and trapping you.

You must see the Balance Sheet and The Income sheet (Profit and
Loss) of an organization to determine the prospect of the organization.

The balance sheet shows what
Company has as asset and what other
owe to the company and also on the other hand it shows what are the liabilities
and what is company owes to others.

The asset of a company may further
be divided into 3 areas: Fixed Assets (buildings, land, automobiles etc),
Investments ( Over time company might have invested in other company, bonds,
given loan to others) and current asset( Cash is Bank, Finished goods in
warehouse, etc)

On the other hand Liabilities are
of 3 kinds.

Short term liability: The
loan company should pay off very soon, affecting its immediate income

Long Term Liability: The
Company may pay off the loan after a long time.

Shareholders’ Equity: This is the amount that belongs to share
holders. This is also equal to Share Capital of a company + reserve and
surplus.

You may find certain terms in
balance sheets which are very important:

·
Current Asset

·
Current Liabilities

·
Current Raito

·
Total Asset

·
Sales to asset

·
Return on Asset

Current ratio is the ratio of
current asset and current liability. A gradual increase in this factor in
yearly comparison of balance sheets is
good sign for a company.

To be continued.........

Now let’s see the important factors in Income sheet or Profit and
Loss Sheetà

This shows the information about
company’s income, sales, net profit/loss on quarterly and yearly basis.

The income sheet shows the current
uptrend or downslide in a company compared to last quarter/ year.

There are certain terms in the
income sheet which are self-explanatory, e.g

·
Net Sales,

·
other income,

·
Capital Expenditure

·
Operating Profit

·
PBDIT ( Profit before deducting income tax),

·
Earnings Per Share,

·
Book Value,

·
P/E ratio,

·
Depreciation.

I will explain some of them, which
may not be clear to beginners, but has immense valueà

Earnings per share: it is also termed as EPS. You should see from
Quarterly Result if the EPS is steadily increasing or stable or decreasing. An
gradual increasing EPS is healthy sign and such shares are for MT or LT
investment. One thing you may note, that a company is doing very good but in a
certain quarter the EPS is decreased. In
that case check if the company has issued bonus share (you can check if the number of shares is increased). Naturally the EPS [= Total Earning/ Number of
share ] has gone down. So total earning is a more clear indicator than EPS.

Depreciation: As an industry works, with time its machinery ,
equipment becomes older or obsolete, which needs replacement and incur costs.
This is known as Depreciation. This is the amount which is deducted from total profit before depreciation before taxation.

Some time companies show greater
profit by showing less depreciation in income sheet. You can add the two
factors ‘Profit before depreciation’ and ‘Depreciation’ to get the
total Cash flow which is a much better indicator.

P/E Ratio: Never forget to
check this parameter before investing in a share. It is known as Price to Earnings Ratio. You get a P/E
of a company by dividing Market Value of a share by Earning per share.

Say for a company be EPS is 5 and
Market value of the scrip is 70.

So P/E is 70/5 = 14

Share with very slow PE < 5 tends
to indicate very less interest of buyers. Share with PE >20 is something
always in demand.

Share with PE 11 to 15 are
considered as Good Buy. Exception
exists although.

Share with very High PE say 40 to 130 are very unstable, may crash
heavily when market crash. But this is not a rule of thumb; there are various
other factors to be checked before deciding only on PE. At times you may see
Analyst are Suggesting you to enter a stock even if the PE is very high, cause
they feel, the share may reach further highs.

Book
Value: The book value is the net
worth of the company’s Equity Share Capital + Reserves divided by Number of share outstanding. If you
further divide Market Price by Book
Value and see if the ratio is greater than 1. If yes then you must note
that investor s are valuing the company in a higher price, then what the
company itself feels what it will earn if it go for liquidation and forced to
sell all its assets and pay off the lenders.

Capital Expenditure: It includes the costs for new acquisition,
expansion plan and also the depreciation cost.

Generally you will find that
Capital Expenditure exceeds the depreciation cost, capital expenditure includes
various other expenses. But at certain consecutive quarter if you see that
Capital Exp is matching the depreciation cost then you must ask these question
to yourselfà

Has the company stopped expansion
plan?

Is the market is losing faith in
its product, hence no new investment?

If it happens for 4-6 consecutive
quarters, then it may be time to quit the share. Of course you can not expect a
company always to expand.

PBDIT and Net Profit: If you deduct Net profit from PBDIT (Profit before deducting tax) you will
find the tax paid. If net sales is more less stable and tax paid is decreasing,
that’s good sign, as a better tax planning by a company is always good for its
investor.

To be Continued....

Hello Anid,

Its good to see that you are also sharing such good information with us. I see that it is almost a month now, that u havent posted anything here...

Please take some time to post info abt decoding the b/s ..

looking forward to see more from u...

Thanks
Mohammed

Joined : 29 Feb 2008 Posts : 9

Nice to read this topic Anid.This Ravi from US.I am reading from you since Oct 2007.Great job and keep going.I was in India fron Jan 20 to Feb 19th.When the market crashes Jan 21st,22nd I didn't aware of it.Result my portaflio is almost 52% down and didn't average it after that.Waiting to market stablize little bit.

This forum is better than the Blog.

Ravi

Thanks for all the nice words. Dont worry, market will recover. Have patience

Yes .I will continue posting here...give me sometime...the project in which I am working now in my workplace is in crucial stage. So Very busy these days.