Financial Statement Analysis - Application - Share Investment

Many corporate concerns conduct finance for nonfinance programs. Financial statement analysis is one of the topics in such programs. Even though they conduct many programs, still the training people as well as company finance department personnel feel that their employees are not able to read balance sheets. The reason could be that persons involved are not clear about what they want their employees to understand.

If one is clear about what they want their employees to understand lectures and exercises can be developed that stress the relevant issues.

A simple reading of financial statements for understanding some basic issues should not be very difficult for many people with some training. If the issues are very complicated anyway most of the employees are not expected to know them.

Graham and Rao analysis, a Graham's method modified to Indian conditions as well as to make more mechanical is a method which can be explained to participants as an example of financial statement analysis.

 Graham-Rao Method

(Customized to India)

The company must have an adequate size (Rs 100 crore sales may be taken as adequate size for Indian companies) and a strong financial condition.

 

To satisfy this criterion, the current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1.

 

The company should have paid dividends and earned profits for the last 10 years. There should be a growth in earnings per share (EPS) of 10 per cent per annum over the last seven years.

 

The current price should not exceed 20 times the average EPS in the last seven years for companies with past seven-year growth higher than 20 per cent. For companies with past growth rates between 10 and 20 percent per annum, the multiplier has to be the growth rate itself.

 

The current price should also not be more than 1.5 times the book value last reported.

Applications of the Method

Based on 2008 results

I T C Ltd.

Graham-Rao Analysis: Reliance Industries Limited.

Source: Fundamental Analysis - Graham-Rao Method 

What are the important concepts covered?

Sales of an year

Current assets

Current liabilities

Ratio of Current assets to Current liabilities = Current ratio

Total Debt

Equity

Ratio of Total Debt to Equity  = Debt equity ratio

Dividend, Dividend payments over the years

Profit after tax or Earning after tax, Earning record over the years

Earning per share (EPS), Growth in EPS

Market price of a share

P/E ratio = Market price of a share/EPS

Multiplier = P/E ratio

Book Value

Market Price to Book Value ratio

 

 

Visit the knol for various methods of financial statement analysis

Analysing Financial Performance using Financial Statements

 

Original Knol - http://knol.google.com/k/narayana-rao/financial-statement-analysis/2utb2lsm2k7a/ 1197