How To Read Financial Statements Of An Indian Company?

Every shareholder will receive an annual report from the company they have invested in (you can opt for a hard copy or emailed PDF). It is also readily available on the company's official website. More often then not, an investor ignores it but these can prove to be very important to check how the company has been performing and to decide if you should remain invested in it. It is the easiest way to seek authentic information of the company's workings rather than other websites.

Some basics about financial reports

• An annual report is published for the one-year period ended 31 March of the respective year by listed companies in India. They are required to do so by law.
• Quarterly (every 3 months) results are also published.
• Any information published in the report is audited by an external auditor (you will find the auditor's report and seal towards the start of the report) and the company can be held liable for any misrepresentation in data.
• Some sections of the annual report are same across companies but no two reports are the same. Sector-wise or business related prospects will change the way the reports are presented.
• You do not need to overwhelm yourself by reading every single page. Make a judgemental differentiation between the marketing aspects of the report and its important elements.

Financial highlights

This section is a brief representation of the financial ratios related to the company based on industrial specific significance. It will be in the form of a graph or some kind of infographic for easy reading. One need not spend a significant amount of time on it and can refer the detailed figures in the sections that follow.

Management/Chairman message

The way the top management thinks about their company is essential to an investor. From the note, you can analyze if the authorities leading the company are aware of the faults and right doings of the business and not falsely exaggerating facts. The CEO or Chairman represents the company and with their view on the workings, you can decide if the company will go in the right direction in the long run or if you going to lose your money investing in it.

MDA

Management Discussion and Analysis section focuses on the trends and the conditions of the industry and the factors that will affect the company's business.

For example, an Information technology company will talk of the new advancements and the challenges that it is facing collectively along with its competition (like a change in governmental policy) and how it plans to overcome it. It will throw light on their performance in the last year along with the management's strategy for the years to come.

It will also specify any significant decisions taken and the important issues that affect the industry at large and its own business (internal aspects like a change in human resource policies). This will help you think ahead and disinvest in the firm before things go wrong.

Financial Statements

There are three important parts of a financial statement:

1. Profit and loss account
2. Balance sheet
3. Cash flow statement

Before you look into it, you should know that there are two types of statements known as a consolidated statement and a standalone statement. For example, RIL (Reliance Industries Limited) owns a major stake in Reliance Jio Infocomm Limited. This will make RIL the promoter of Jio and RIL's consolidated statement will include profit or losses made by Jio and the rest of its subsidiaries. On the other hand, Jio (it is a public listed company and needs to disclose financial results) will have its exclusive business profit or loss that will show on its own standalone financial statement.

Another thing you will notice in the financial statements is the "Note" column. To put it plainly, a statement (P&L, balance sheet) will only include collective totals and major headings but readers need a broad understanding on how they arrived at those figures. For that, the reader will have to refer the notes will be included in the following pages of the report as it includes a detailed breakup of the final sum arrived on the main statement.

1. Profit and loss account

The P&L statement (also called income statement) will include all the expenses made and revenue earned for that period. For example, the company manufactures cars, so the statement will include its expenses to get the input parts, the salaries paid to the employees, depreciation on the machines that are used to assemble the car, etc in the "expense" part. It basically includes all the costs to run the business to make the products that earn revenue.
Note that "revenue" is not "profit". Suppose you sell one cup of tea for Rs 10. That Rs 10 is your revenue but to calculate profit, you will minus the expense (say Rs 6) on fuel, milk, tea powder and sugar that you spent to make it, which will be Rs 4.

So the other part of the statement will include revenue from all the sales made (minus the taxes paid) to arrive at the "profit from operations". Operating profit is your Rs 4, but this is not your ultimate profit in the balance sheet (discussed later below), because you will use this profit to pay off your loans related to the business, dividends to shareholders, etc.

Further, you can check the associated notes to get a clear break up of any additional income like the sale of spare parts.

2. Balance sheet

The major difference between a P&L statement and balance sheet is that the P&L concerns itself with the specific period only (just one financial year in case of annual reports) while the balance sheet represents financial details from the time the company was established.

Any loans unpaid, any reserves maintained, inventories from the last year, etc are all "carried forward" to the next financial year.

The three main parts are assets, liabilities and equity. Know that Equity + Liability (on one side) = Assets (on the other side) and the totals of the two sides are equal (they tally). It is one of the basic laws of financial accounting.

Assets are all things of value, whether tangible (like machinery, inventory) or intangible (like patents) that the company owns, which may be acquired in the year or over the years. It has helped the company generate revenue or will do so in the future.
Liabilities (including equity), as the word suggests, are obligations of economic value that the company owes to others.

As per the above formula, Assets - Liabilities = Equity (shareholders' money) or the companies net worth. Additionally, with the help of the shareholders' equity and liabilities, the company can purchase assets, which is why "reserves" are on the liabilities side. To understand better, always look at the company as an individual that has taken money from you and others and has the responsibility to run the business and make your money multiply. The individual owes it to you to make good use of the money you invest into it.

3. Cash flow statements

Cash flow statement accounts for all the cash movement in and out of the business just belonging to that year. This could be better understood by knowing the difference between the P&L account and the cash flow statement.

Suppose X runs a bookstore and receives a bulk order of 100 books at Rs 10 each for the week and the buyer promises to pay for 50 books in the next year. In this case, the CF statement will show the receipt of Rs 500 but the P&L will show a revenue of Rs 1,000 (100x10).

It means that the CF statement gives a clear idea of how much cash the company actually currently holds and not how much it is yet to receive. This is important because X may not be able to make some payments like rent or loan interest payments despite making a sale.

Similarly, if he makes a rent payment in advance for the next year, this will show in the CF for the current period but not in the P&L as it only pertains to expenses associated with the year and not those of the next/previous year.

The breakup of the cash flow will be divided as cash flow from:

1. financial activities (loans, fresh capital issue, purchase of machinery)
2. operational activities (expenditure related to business workings like hiring, advertisements)
3. investing activities (acquiring another company)

The increase or decrease in the cash flow can be both good or bad depending on what the funds are flowing towards. For example, redirecting funds towards acquiring a new company or branch that will generate profit in the future is a fruitful expenditure.