## Monday, January 31, 2011

### What is the objective behind analysis of financial statements?

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## You’re interested in a Stock, so you’re reading its financial reports. Part of the test of a viable operation is having enough cash to keep the company going. The amount of money that flowsinto and out of a business during the time period being reported,The following formulas give you various tests of a company’s cash position:

·         Free cash flow shows you how much money a company earns from its operations that can actually be put in a savings account for future use.
Free cash flow = Cash provided by operating activities – Capital expenditures – Cash dividends
·         Cash return on sales looks specifically at how much cash is being generated by sales.
Cash return on sales = Cash provided by operating activities ÷ Net sales
·         Current cash debt coverage ratio lets you know whether a company has enough cash to meet its short-term needs.
Current cash debt coverage ratio = Cash provided by operating activities ÷ Average current liabilities
·         Cash flow coverage ratio finds out whether a company has enough money to cover its bills and finance growth.
Cash flow coverage ratio = Cash flows from operating activities ÷ Cash requirements

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## If a company doesn’t have cash on hand to cover its day-to-day operations, it’s probably on shaky ground. As you read the financial report, use the following formulas to find out whether a company has plenty of liquid (easily converted to cash) assets.

·         Current ratio gives you a good idea of whether a company will be able to pay any bills due over the next 12 months with assets it has on hand.
Current ratio = Current assets ÷ Current liabilities
·         Quick ratio or acid test ratio shows a company’s ability to pay its bills using only cash on hand or cash already due from accounts receivable. It doesn’t include money anticipated from the sale of inventory and the collection of the money from those sales.
Quick ratio = Quick assets ÷ Current liabilities
·         Interest coverage ratio lets you know whether a company is bringing in enough money to pay interest on whatever outstanding debt it has.
Interest coverage ratio = EBITDA ÷ Interest expense

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### Today's Bse Nse Stock picks

Nifty, Bank Nifty & M&M

NIFTY
Current: 5,604 (Feb future: 5,630),
Target: 5,475 (3-session target)

The index saw a new 2011 low and also broke below its own 200 Day Moving Average. This is not confirmed yet but the pattern suggests a drop till 5,475 in the next three sessions. A bounce could pullback till 5,750. Simplest is a short futures position, with a stop loss at 5,650. A preferred strategy is the bearspread of long 5,500p (82) and short 5,400p (55) - cost:27; Maximum return: 73. A "zero-delta" long-short strangle of long 5,500p (82) and long 5,700c (94) and short 5,400c (55) and short 5,800c (55) costs 66 with breakevens at 5,434; 5,766. It's low-risk if you wish to hold till settlement..

BANK NIFTY
Current: 10,676 (Feb futures 10,732),
Target: 10,500 (10,300, 3-session target)

The financial index broke downside targets (10,800) set on Jan 24 closing. If support at 10,600-10,625 is broken, secondary support at 10,475-10,500 will be tested. There's a good chance of a drop till 10,300 in a three-session timeframe. Keep a stop at 10, 825 and short. Add to the position between 10,550 and 10,600. Either clear at 10,500, or hold with a target of 10,300 if you can wait three sessions.

M&M
Current Price: Rs 733,
Target Price: Rs 695

The stock is at a key support of Rs 725-735 after a two-session drop from Rs 799. It if falls below Rs 725, it could till Rs 680-690. Keep a stop at Rs 745 and go short. Add to the position between Rs 715 and Rs 720. Start booking profits below Rs 695. If the Rs 745 stop is broken, be prepared for a jump back to Rs 770.

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## Thursday, January 27, 2011

### 15 Things I Look at Before Trading a Stock

15 Things I Look at Before Trading a Stock

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### How to Financial Reports for Profitability Ratios

You read financial reports to get a sense of a company’s financial position and how viable it is in the marketplace. You can test a company’s money-making prowess by using the following important formulas:

·  Price/earnings ratio compares the price of a stock to its earnings. A ratio of 10 means that for every \$1 in company earnings per share, people are willing to pay \$10 per share to buy the stock.
Price/earnings ratio = Market value per share of stock ÷ Earnings per share of stock
· Dividend payout ratio shows the amount of a company’s earnings that are paid out to investors. Use it to determine the actual cash return you get by buying and holding a share of stock.
Dividend payout ratio = Yearly dividend per share ÷ Earnings per share
·  Return on sales tests how efficiently a company is running its operations by measuring the profit produced per dollar of sales.
Return on sales = Net income before taxes ÷ Sales

·  Return on assets shows you how well a company uses its assets. A high return on assets usually means the company is managing its assets well.
Return on assets = Net income ÷ Total assets
· Return on equity measures how well a company earns money for its investors.
Return on equity = Net income ÷ Shareholders’ equity

· The gross margin gives you a picture of how much revenue is left after all the direct costs of producing and selling the product have been subtracted.
Gross margin = Gross profit ÷ Net sales or revenues

· The operating margin looks at how well a company controls costs, factoring in any expenses not directly related to the production and sales of a particular product.
Operating margin = Operating profit ÷ Net sales or revenues

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## Tuesday, January 25, 2011

### How to read Financial Annual Report

If you’re new to investing & looking at a business with an interest in investing in Bse/Nse stocks, you need to read its financial reports. Of course,  you don’t need to read everything, just the key parts. These Financial statements will help you figure profitability and liquidity ratios and get a better sense of cash flow .

Reading a companys financial report is never the easiest thing to do, and annual reports can be especially daunting. You may be relieved to know that you don’t actually need to scour every page. The following parts best serve to give you the big picture .

1.       The Profit & Loss statement on the year passed and the Last Quarter;
2.     The Balance Sheet ;
3.     The Directors’ Report on the year passed and the future plans;
4.     Annexure to the Directors’ Report containing particulars regarding     conservation of energy etc;
5.     Auditors’ Report as per the Manufacturing and Other Companies   (Auditors’ Report) Order, 1998) along with Annexure;
6.     Schedules to Balance Sheet and Profit and Loss Account;
7.     Accounting policies adopted by the company and notes on accounts giving details   about changes if any, in method of valuation of stocks, fixed assets, method of depreciation on fixed assets, contingent liabilities, like guarantees given by the banks on behalf of the company, guarantees given by the company, quantitative details regarding performance of the year passed, foreign exchange inflow and outflow etc. and
8.     Statement of cash flows for the same period for which final accounts have been presented.

Key pointers to balance sheet and profit and loss statements:

•      A balance sheet represents the financial affairs of the company and is also referred to as “Assets and Liabilities” statement and is always as on a particular date and not for a period.
•     A profit and loss account represents the summary of financial transactions during a particular period and depicts the profit or loss for the period along with income tax paid on the profit and how the profit has been allocated (appropriated).
•    Net worth means total of share capital and reserves and surplus. This includes preference share capital unlike in Accounts preference share capital is treated as a debt. For the purpose of debt to equity ratio, the necessary adjustment has to be done by reducing preference share capital from net worth and adding it to the debt in the numerator.
•      Reserves and surplus represent the profit retained in business since inception of business.  “Surplus” indicates the figure carried forward from the profit and loss appropriation account to the balance sheet, without allocating the same to any specific reserve.  Hence, it is mostly called “unallocated surplus”.  The company wants to keep a portion of profit in the free form so that it is available during the next year for appropriation without any problem. In the absence of this arrangement during the year of inadequate profits, the company may have to write back a part of the general reserves for which approval from the board and the general members would be required.
• Secured loans represent loans taken from banks, financial institutions, debentures (either from public or through private placement), bonds etc. for which the company has mortgaged immovable fixed assets (land and building) and/or hypothecated movable fixed assets (at times even working capital assets with the explicit permission of the working capital banks)

Usually, debentures, bonds and loans for fixed assets are secured by  fixed assets, while loans from banks for working capital, i.e., current assets are secured by current assets.  These loans enjoy priority over unsecured loans for settlement of claims against the company.

Unsecured loans represent fixed deposits taken from public (if any) as per the provisions of Section 58 (A) of The Companies Act, 1956 and in accordance with the provisions of Acceptance of Deposit Rules, 1975 and loans, if any, from promoters, friends, relatives etc. for which no security has been offered.

Such unsecured loans rank second and subsequent to secured loans for settlement of claims against the company.  There are other unsecured creditors also, forming part of current liabilities, like, creditors for purchase of materials, provisions etc.

Gross block = gross fixed assets mean the cost price of the fixed assets.  Cumulative depreciation in the books is as per the provisions of The Companies Act, 1956, Schedule XIV.  It is last cumulative depreciation till last year + depreciation claimed during the current year.  Net block = net fixed assets mean the depreciated value of fixed assets.

Capital work-in-progress – This represents advances, if any, given to building contractors, value of building yet to be completed, advances, if any, given to equipment suppliers etc.  Once the equipment is received and the building is complete, the fixed assets are capitalised in the books, for claiming depreciation from that year onwards.  Till then, it is reflected in the form of capital work in progress.

Investments – Investment made in shares/bonds/units of Unit Trust of India etc. This type of investment should be ideally from the profits of the organisation and not from any other funds, which are required either for working capital or capital expenditure.  They are bifurcated in the schedule, into “quoted and traded” and “unquoted and not traded” depending upon the nature of the investment, as to whether they can be liquidiated in the secondary market or not.

Current assets – Both gross and net current assets (net of current liabilities) are given in the balance sheet.

Miscellaneous expenditure not written off can be one of the following –
Company incorporation expenses or public issue of share capital, debenture etc. together known as “preliminary expenses” written off over a period of 5 years as per provisions of Income Tax.  Misc. expense could also be other deferred revenue expense like product launch expenses.
Other income in the profit and loss account includes income from dividend on share investment made in other companies, interest on fixed deposits/debentures, sale proceeds of special import licenses, profit on sale of fixed assets and any other sundry receipts.

Provision for tax could include short provision made for the earlier years.

Provision for tax is made after making all adjustments for the following:

·        Carried forward loss, if any;
·        Book depreciation and depreciation as per income tax and
·        Concessions available to a business entity, depending upon their activity (export business, S.S.I. etc.) and location in a backward area (like Goa etc.)

As per the provisions of The Companies Act, 1956, in the event of a limited company declaring dividend, a fixed percentage of the profit after tax has to be transferred to the General Reserves of the Company and entire PAT cannot be given as dividend.

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