Question

Financial ratios are the principal tool of financial analysis. Ratios standardize the financial information of firms so comparisons can be made between firms of varying sizes. Choose two firms in the same sector; locate their current financial information both in terms of current financial statements and stock market prices. With the information, do a paper of 8-10 pages, with the following headings:

How liquid are the firms?

Are the firm's managers generating adequate operating profits on the company's assets?

How are the firms financing their assets?

Are the firm's managers providing a good return on the capital provided by the shareholders?

Are the firms’ managers creating shareholder value?

Answer 1

Common Size Analysis
Profit and Loss Statement
Common Size (%)
Particulars
15-16
Mar-17
Mar-18
Income
Sales
107.76
109.51
105.27
Excise Duty and Service Tax
7.76
9.51
5.27
Revenue from Operations
100.00
100.00
100.00
Expenditure
Cost of Goods Sold
76.59
75.54
77.13
Cost of Material Consumed
65.52
67.86
68.28
Purchase of Stock-in-Trade
1.82
2.13
2.51
Changes in Inventories
1.79
-2.00
-1.11
Other Manufacturing Expenses
7.46
7.54
7.46
Gross Profit
23.41
24.46
22.87
Other Operating Expenses
Employee Benefits Expense
1.83
1.83
1.63
Depreciation / Amortisation and Depletion Expense
3.68
3.50
3.30
Other Expenses
4.70
4.75
3.40
Operating Profit
13.19
14.37
14.54
Non-Operating Income
3.35
3.60
2.83
EBIT
16.55
17.97
17.37
Interest
1.10
1.13
1.61
PBT
15.45
16.85
15.76
Tax
3.70
3.86
4.18
Profit For the Year
11.74
12.98
11.59
Common-size analysis converts each line of financial statement data to an easily comparable amount measured as a percentage of net revenue. The company like any traditional refinery business had its largest expense in the form of the Cost of Goods sold at roughly 65% which includes the primary raw material being crude oil and other expenses incurred in manufacturing. The Gross Profit for the company has roughly stayed the same at around 23-24% indicating the company’s strong ability to maintain stable manufacturing costs despite large volatility in the global crude oil prices. Other operating expenses like employee expenses, rent and repairs, admin and selling expenses also have stayed fairly stable at around 10-11% which is a very positive
indicator as it highlights the stable and good operating efficiency of the company. Interest expense has also broadly stayed the same throughout. A point of concern is that PAT has stayed at around 11-12% which is stable but however has not improved with increasing sales. The major contributor to this has been the steady increase of all expenses with sales which has prevented PAT to increase substantially.
Balance Sheet
Common Size
ASSETS
15-16
Mar-17
Mar-18
Non-Current Assets
Property, Plant and Equipment
19.99
26.61
31.07
Capital Work-in-Progress
21.26
23.46
14.99
Intangible Assets
8.72
1.66
1.47
Intangible Assets Under Development
2.09
0.82
1.12
Financial Assets
Investments
24.61
25.71
27.84
Loans
3.55
3.24
1.69
Other Non-Current Assets
0.00
0.64
0.35
Total Non-Current Assets
80.21
90.28
71.33
Current Assets
Inventories
6.12
7.24
5.51
Financial Assets
Investments
8.61
9.49
8.63
Trade Receivables
0.76
1.00
1.69
Cash and Cash Equivalents
1.51
0.32
0.44
Loans
2.61
0.90
0.57
Other Financial Assets
0.00
0.62
0.62
Other Current Assets
0.17
0.89
1.70
Total Current Assets
19.79
19.44
20.07
Total Assets
100.00
100.00
100.00
EQUITY AND LIABILITIES
Equity
Equity Share Capital
0.71
0.59
1.03
Other Equity
51.76
52.14
49.93
Total Equity
52.47
52.73
50.95
Share Application money pending allotment
0.00
Non-Current Liabilities
Financial Liabilities
Borrowings
17.01
14.40
13.21
Provisions
0.33
0.39
0.36
Deferred Tax Liabilities (Net)
2.87
4.53
4.52
Other Non-Current Liabilities
0.00
0.00
0.08
Total Non-Current Liabilities
20.21
19.32
18.17
Current Liabilities
Financial Liabilities
Borrowings
3.17
4.13
2.47
Trade Payables
11.91
12.47
14.36
Other Financial Liabilities
11.86
8.03
7.81
Other Current Liabilities
11.98
3.09
6.08
Provisions
0.26
0.23
0.15
Total Current Liabilities
27.31
27.95
30.87
Total Liabilities
0.00
47.27
49.05
Total Equity and Liabilities
100.00
100.00
100.00
The common size analysis of the balance sheet shows some interesting facts. It’s seen that Fixed Assets in the form of Property, Plant and Equipment and Capital Work in Progress was a major chunk of total assets around 39-41% which is expected in a company in the energy sector which is a very capital intensive industry. Another important observation is that investments contribute to about 25-27% of total assets. However, these are investments in its subsidiaries which may not be a good indicator but since the company is investing in its core operations by way of PP&E and further it is investing in its various subsidiaries to diversify its business and generate further profits from these ventures, it could be looked at as a positive sign. The company’s current assets stand at a healthy 19-20%. The company has funded over 50% of its assets from internal sources (equity) and around 20% by external borrowings with the remainder coming from the Negative Working Capital as current liabilities account are close to 27-30% of total assets of the firm.

Ratios
Profitability Ratios Particulars Numerator Denominator 2016 2017 2018
ROCE
EBIT
Total Capital Employed
11.60%
11.04%
11.80%
ROE
Net Profit
Total Equity
11.40%
10.90%
10.68%
Gross Profit Margin
Gross Profit
Net Sales
23.41%
24.46%
22.87%
Net Profit Margin
Net Profit
Net Sales
11.74%
12.98%
11.59%
EBIT Margin
EBIT
Net Sales
16.55%
17.97%
17.37%
The company has been able to generate stable profits over the period analyzed which is reflected in the profitability ratios. The ROCE and ROE which give returns for all stakeholders and equity shareholders respectively have been stable with the ROCE slightly increasing from 11.6% to 11.8% whereas the ROE has only marginally come down from about 11.4% to 10.68%. The company has been able to keep its costs in check with its increasing revenues and constant expansions. The Gross profit margin shows that the Cost of manufacturing has been stable in spite of large volatility in crude oil price. The net profit margin and the EBIT margin show the company’s efficiency in managing other operating expenses as both have been pretty stable at around 11-12% and 16-17% respectively.
Long Term Solvency Particulars Numerator Denominator 2016 2017 2018
Debt Ratio
Total Liabilities
Total Assets
0.48
0.47
0.49
Debt to Equity Ratios
Total Debt
Total Equity
0.38
0.35
0.31
Total Debt to Tangible Net Worth
Total Debt
Tangible Net Worth
0.48
0.37
0.32
Interest Coverage Ratio
EBIT
Interest Expenses
15.06
15.98
10.82
Debt Service Coverage Ratios
EBIT
Interest and Principal
0.48
0.53
0.58
The company’s long term solvency seems to be fairly good as it has an interest coverage ratio of around 15-16 times which has come down to about 10times but that is due to the company taking on more debt for expanding and growing its other subsidiaries. The company has a Debt to Equity Ratio of 0.31 which is not very high and risky, yet at the same time should allow the company to benefit out of taking leverage. The Debt Service coverage ratio which includes principal also is around 0.5 times which is a pretty good number as one should take into consideration that the principal doesn’t have to be repaid in one year but over several years and if the company’s EBIT can cover over 50% of Principal and Interest payments it is quite commendable.
Short Term Solvency Particulars Numerator Denominator 2016 2017 2018
Current Ratio
Current Assets
Current Liabilities
0.72
0.70
0.65
Quick Ratio
CA except Inventory
Current Liabilities
0.50
0.47
0.44
Cash Ratio
Cash and Cash Equivalents
Current Liabilities
0.47
0.38
0.31
The company’s short term solvency seems to be deteriorating as the Current ratio has decreased from 0.72 to 0.65 and even the quick ratio has declined from 0.5 to 0.44. However, for a company as big as Reliance these numbers may not make a huge difference. The increase is due to a large increase in other payables. It will be important to see how the activity ratios have fared before coming to a conclusion based on these few ratios.
Activity Ratios Particulars Numerator Denominator 2016 2017 2018
Inventory Turnover
COGS or Net sales
Average Inventory
6.37
5.37
5.65
Receivables Turnover
Total Sales
Average Receivables
66.71
44.23
27.73
Payables Turnover
COGS and Purchases
Average Payables
2.96
2.41
2.28
Fixed Asset Turnover
Total Sales
Average fixed assets
1.05
0.92
1.02
Asset turnover
net sales
Average total assets
0.51
0.44
0.47
Inventory turnover has been fairly stable at about 5-6times which is typical for a company in refining business. Receivables turnover although has declined significantly we must be cautious in interpreting the value as we have taken an underlying assumption of all sales are credit sales which may not be true. Payables turnover has remained fairly stable. Fixed asset and total asset have also remained stable at around 1 and 0.5 respectively which shows the companies efficiency in using its assets in being able to generate sales.
DuPont Analysis
Ratios
15-16
16-17
17-18
Net Profit Margin
11.74%
12.98%
11.59%
Asset Turnover
0.51
0.44
0.47
ROA
5.99%
5.71%
5.45
Ratios
15-16
16-17
17-18
Net Profit Margin
11.74%
12.98%
11.59%
Asset Turnover
0.51
0.44
0.47
Equity Multiplier
1.91
1.90
1.96
ROE
11.40%
10.90%
10.68%
The company’s NPM has remained fairly stable as has it asset turnover giving it a stable ROA. The company has used leverage effectively in giving their equity shareholders a higher yet stable return. The company has effectively managed its profitability, operational efficiency as well as financial efficiency.

Comparative Statement Analysis:
Profit and Loss Statement: Particulars Comparative
16 and 17 17 and 18
Income
Sales
11.08%
14.51%
Excise Duty and Service Tax
35.09%
2.54%
Revenue from Operations
7.33%
16.86%
Expenditure
Cost of Goods Sold
8.14%
17.41%
Cost of Material Consumed
10.99%
20.32%
Purchase of Stock-in-Trade
13.28%
9.84%
Changes in Inventories of Finished Goods, Work-in-Progress and Stock-in-Trade
-768.53%
-105.75%
Other Manufacturing Expenses
2.94%
15.26%
Gross Profit
-0.74%
10.94%
Other Operating Expenses
Employee Benefits Expense
24.35%
0.04%
Depreciation / Amortization and Depletion Expense
2.53%
40.03%
Other Expenses
-17.37%
35.96%
Operating Profit
-2.64%
0.92%
Non-Operating Income
46.42%
15.77%
EBIT
5.32%
4.27%
Interest
-12.26%
68.04%
PBT
6.27%
1.41%
Tax
-9.93%
9.16%
Profit For the Year
13.93%
-1.49%
The company has seen an increase of 11.08% in Sales in FY16-17 whereas it saw an even bigger increase of 14.51% in the last fiscal over the previous year which was mainly due to higher refining margins. BPCL’s COGS for the same period however increased by around 17.41% which was due to the high volatility in crude oil prices which is reflected in the large increase in Cost of Materials consumed in the above statement. PAT grew by about 13.93% in FY16-17 whereas it reduced by 1.49% in the last FY over the PY. This was due to the interest and depreciation paid by the company against the large borrowing taken and investment in intangible assets.
Balance sheet Statement: (in Crore ) Comparative ASSETS 16 and 17 17 and 18
Non-Current Assets
Property, Plant and Equipment
35.67%
36.76%
Capital Work-in-Progress
-9.90%
-63.95%
Investment Property
-16.67%
-35.00%
Intangible Assets
4.30%
27.55%
Intangible Assets Under Development
88.58%
-10.34%
Investments in Subsidiaries, Joint Ventures and Associates
20.00%
18.67%
Financial Assets
Investments
36.45%
-1.65%
Loans
91.32%
-18.30%
Other financial assets
146.25%
29.17%
Income Tax Assets(Net)
74.20%
219.65%
Other Non-Current Assets
-6.39%
5.81%
Total Non-Current Assets
22.43%
9.69%
Current Assets
Inventories
43.54%
5.43%
Financial Assets
Investments
3.49%
-6.81%
Trade Receivables
117.37%
8.29%
Cash and Cash Equivalents
-96.84%
39.34%
Bank Balances other than Cash and cash equivalents
-97.02%
19.34%
Loans
7.67%
0.42%
Other Financial Assets
-18.83%
38.59%
Current Tax Assets (Net)
0.00%
2.82%
Other Current Assets
3.74%
26.29%
Total Current Assets
21.44%
7.69%
Assets held for sale
0.00%
75.80%
Total Assets
22.07%
8.95%
EQUITY AND LIABILITIES
Equity
Equity Share Capital
100.00%
50.00%
Reserve and Surplus
6.34%
13.50%
Total Equity
8.58%
15.11%
Non-Current Liabilities
Financial Liabilities
Borrowings
1.54%
7.13%
Other Financial Liabilities
4.40%
-7.89%
Provisions
16.97%
0.96%
Deferred Tax Liabilities (Net)
33.56%
41.45%
Other Non-Current Liabilities
96.07%
3.69%
Total Non-Current Liabilities
7.75%
12.99%
Current Liabilities
Financial Liabilities
Borrowings
30064.27%
11.98%
Trade Payables
34.74%
15.00%
Other Financial Liabilities
13.00%
-6.15%
Other Current Liabilities
12.25%
4.78%
Provisions
110.43%
-16.55%
Current tax liabilities (Net)
-86.92%
19.53%
Total Current Liabilities
42.32%
3.00%
Total Liabilities
29.74%
6.02%
Total Equity and Liabilities
22.07%
8.95%
As mentioned earlier the company is undertaking a lot of Capex which is visible in the high growth of Property, Plant and Equipment of 35.67% and 36.76% over the last 3 years. The company is also making huge investments in Unsecured, considered goods unless otherwise stated 146.25% in FY16-17 and 29.17% in FY17-18. The company has seen a huge jump in trade receivables over the past years which may not be a very strong sign as cash on the other hand has fallen steeply in the first 2 years and grown at a very fast pace after that. The company paid a huge chunk of tax this year which explains the leap in Tax asset for the year. On the liabilities side current borrowings saw a large leap of 30064.27% in the last 2 years which was raised to fill in for trade receivables as the turnover days for receivable of the company is high. Other non-current liabilities in form nearly doubles in the last two years.
Common Size Analysis:
Profit and Loss Statement:
Common-size analysis converts each line of financial statement data to an easily comparable amount measured as a percentage of net revenue. The company like any traditional refinery business had its largest expense in the form of the Cost of Goods sold at roughly 91.96% which includes the primary raw material being crude oil and other expenses incurred in manufacturing. The Gross Profit for the company has roughly stayed the same at around 8-9% indicating the company’s strong ability to maintain stable manufacturing costs despite large volatility in the global crude oil prices. Other operating expenses like employee expenses, rent and repairs, admin Particulars Common Size
Mar-16 Mar-17 Mar-18
Income
Sales
115.65
119.70
117.29
Excise Duty and Service Tax
15.65
19.70
17.29
Revenue from Operations
100.00
100.00
100.00
Expenditure
Cost of Goods Sold
90.84
91.53
91.96
Cost of Material Consumed
32.38
33.49
34.47
Purchase of Stock-in-Trade
53.52
56.49
53.09
Changes in Inventories of Finished Goods, Work-in-Progress and Stock-in-Trade
0.44
-2.76
0.14
Other Manufacturing Expenses
4.50
4.32
4.26
Gross Profit
9.16
8.47
8.04
Other Operating Expenses
Employee Benefits Expense
1.46
1.70
1.45
Depreciation / Amortisation and Depletion Expense
0.98
0.94
1.12
Other Expenses
1.84
1.42
1.65
Operating Profit
4.87
4.42
3.82
Non-Operating Income
0.94
1.29
1.27
EBIT
5.82
5.71
5.09
Interest
0.30
0.25
0.35
PBT
5.52
5.46
4.74
Tax
1.77
1.49
1.39
Profit For the Year
3.75
3.98
3.35
and selling expenses also have stayed fairly stable at around 4-4.3% which is a very positive indicator as it highlights the stable and good operating efficiency of the company. Interest expense has also broadly stayed the same throughout. A point of concern is that PAT has stayed at around 3-4% which is stable but however has not improved with increasing sales. The major contributor to this has been the steady increase of all expenses with sales which has prevented PAT to increase substantially.
Balance sheet Statement: (in Crore ) Common Size ASSETS 15-16 16-17 17-18
Non-Current Assets
Property, Plant and Equipment
30.59
34.00
42.68
Capital Work-in-Progress
16.52
12.19
4.03
Investment Property
0.00
0.00
0.00
Intangible Assets
0.20
0.17
0.20
Intangible Assets Under Development
0.29
0.44
0.36
Investments in Subsidiaries, Joint Ventures and Associates
9.45
9.29
10.12
Financial Assets
Investments
0.67
0.75
0.68
Loans
2.62
4.11
3.08
Other financial assets
0.02
0.04
0.05
Income Tax Assets(Net)
0.10
0.14
0.40
Other Non-Current Assets
2.11
1.61
1.57
Total Non-Current Assets
62.57
62.76
63.18
Current Assets
Inventories
18.30
21.52
20.83
Financial Assets
Investments
6.87
5.83
4.98
Trade Receivables
2.90
5.17
5.14
Cash and Cash Equivalents
2.28
0.06
0.08
Bank Balances other than Cash and cash equivalents
0.46
0.01
0.01
Loans
0.09
0.08
0.07
Other Financial Assets
5.40
3.59
4.57
Current Tax Assets (Net)
0.00
0.03
0.02
Other Current Assets
1.11
0.95
1.10
Total Current Assets
37.43
37.23
36.80
Assets held for sale
0.00
0.01
0.02
Total Assets
100.00
100.00
100.00
EQUITY AND LIABILITIES
Equity
Equity Share Capital
0.87
1.43
1.96
Reserve and Surplus
35.39
30.83
32.11
Total Equity
36.26
32.25
34.08
Non-Current Liabilities
Financial Liabilities
Borrowings
18.00
14.98
14.73
Other Financial Liabilities
0.08
0.08
0.08
Provisions
1.54
1.47
1.36
Deferred Tax Liabilities (Net)
3.48
3.81
4.94
Other Non-Current Liabilities
0.09
0.15
0.14
Total Non-Current Liabilities
23.19
20.47
21.23
Current Liabilities
Financial Liabilities
Borrowings
0.03
7.86
8.08
Trade Payables
11.19
12.35
13.03
Other Financial Liabilities
22.43
20.77
17.89
Other Current Liabilities
4.57
4.20
4.04
Provisions
1.14
1.97
1.51
Current tax liabilities (Net)
1.18
0.13
0.14
Total Current Liabilities
40.55
47.28
44.69
Total Liabilities
63.74
67.75
65.92
Total Equity and Liabilities
100.00
100.00
100.00
The common size analysis of the balance sheet shows some interesting facts. It’s seen that Fixed Assets in the form of Property, Plant and Equipment and Capital Work in Progress was a major chunk of total assets around 46-47% which is expected in a company in the energy sector which is a very capital intensive industry. Another important observation is that inventories contribute to about 18-21% of total assets. However, these are goods which should have been sold and contributed to the revenue generation. The company’s current assets stand at a healthy 37-37.5%. The company has funded over 30% of its assets from internal sources (equity) and around 20% by external borrowings with the remainder coming from the Negative Working Capital as current liabilities account are close to 45% of total assets of the firm.
Ratio Analysis:
Profitability ratio: Particulars Numerator Denominator 2016 2017 2018
ROCE
EBIT
Total Capital Employed
24.46%
23.79%
21.71%
ROE
Net Profit
Total Equity
25.83%
27.10%
23.19%
Gross Profit Margin
Gross Profit
Net Sales
9.16%
8.47%
8.04%
Net Profit Margin
Net Profit
Net Sales
3.75%
3.98%
3.35%
EBIT Margin
EBIT
Net Sales
5.82%
5.71%
5.09%
The company has been able to generate stable profits over the period analyzed which is reflected in the profitability ratios. The ROCE and ROE which give returns for all stakeholders and equity shareholders respectively have been declining with the ROCE reducing from 24.46% to 21.71% whereas the ROE has only marginally come down from about 25.83% to 23.19%. The company has been able to keep its costs in check with its increasing revenues and constant expansions. The Gross profit margin shows that the Cost of manufacturing has been stable in spite of large volatility in crude oil price. The net profit margin and the EBIT margin show the company’s efficiency in managing other operating expenses as both have been pretty stable at around 3-4% and 5-6% respectively.
Long term Solvency: Particulars Numerator Denominator 2016 2017 2018
Debt Ratio
Total Liabilities
Total Assets
0.6374
0.6775
0.6592
Debt to Equity Ratios
Total Debt
Total Equity
0.4974
0.7080
0.6691
Total Debt to Tangible Net Worth
Total Debt
Tangible Net Worth
0.5042
0.7217
0.6804
Interest Coverage Ratio
EBIT
Interest Expenses
19.39
23.27
14.44
Debt Service Coverage Ratios
EBIT
Interest and Principal
0.7752
0.8085
0.7717
The company’s long term solvency seems to be fairly good as it has an interest coverage ratio of around 19-23 times which has come down to about 15 times but that is due to the company taking more debt for expanding and growing its other subsidiaries. The company has a Debt to Equity Ratio of 0.66 which is not very high and risky, yet at the same time should allow the company to benefit out of taking leverage. The Debt Service coverage ratio which includes principal also is around 0.77 times which is a pretty good number as one should take into consideration that the principal doesn’t have to be repaid in one year but over several years and if the company’s EBIT can cover over 77% of Principal and Interest payments it is quite commendable.
Short term Solvency: Particulars Numerator Denominator 2016 2017 2018
Current Ratio
Current Assets
Current Liabilities
0.92
0.79
0.82
Quick Ratio
Current Assets except Inventory
Current Liabilities
0.47
0.33
0.36
Cash Ratio
Cash and Cash Equivalents
Current Liabilities
0.23
0.13
0.11
The company’s short term solvency seems to be deteriorating as the Current ratio has decreased from 0.92 to 0.82 and even the quick ratio has declined from 0.47 to 0.36. However, for a government company such as BPCL these numbers may not make a huge difference. The increase is due to a large increase in other payables. It will be important to see how the activity ratios have fared before coming to a conclusion based on these few ratios.
Activity Ratio: Particulars Numerator Denominator 2016 2017 2018
Inventory Turnover Ratios
COGS or Net sales
Average Inventory
12.41
9.35
10.41
Receivables Turnover
Total Sales
Average Receivables
86.07
42.50
45.86
Payables Turnover
COGS and Purchases
Average Payables
19.29
15.52
15.86
Fixed Asset Turnover
Total Sales
Average fixed assets
6.13
6.82
6.52
Asset turnover
net sales
Average total assets
2.50
2.20
2.36
Inventory turnover has been fairly stable at about 10-11 times which is typical for a company in refining business. Receivables turnover although has declined significantly we must be cautious in interpreting the value as we have taken an underlying assumption of all sales are credit sales which may not be true. Payables turnover has declined significantly from 20 times to 16 times, hence it has turned out to be a favorable situation. Fixed asset and total asset have also remained stable at around 6-7 respectively which shows the companies efficiency in using its assets in being able to generate sales.
DuPont Analysis: Ratios 15-16 16-17 17-18
Net Profit Margin
3.75%
3.98%
3.35%
Asset Turnover
2.50
2.20
2.36
ROA
0.09
0.09
0.08
Ratios 15-16 16-17 17-18
Net Profit Margin
3.75%
3.98%
3.35%
Asset Turnover
2.50
2.20
2.36
Equity Multiplier
2.76
3.10
2.93
ROE
0.26
0.27
0.23
The company’s NPM has remained fairly stable as has it asset turnover giving it a stable ROA. The company has used leverage effectively in giving their equity shareholders a higher yet stable return. The company has effectively managed its profitability, operational efficiency as well as financial efficiency.