If you want to invest for the long term and create good returns, then it is very important for you to learn about fundamental analysis.
In the long term, the share price of financially strong companies tends to increase and create good profits for investors. There are examples like Tata consultancy services (TCS) which have generated 30% returns p.a. for over 10 years.
In this blog we will learn the following:
- Annual report of a company
- Profit and loss statement
- Balance sheet statement
- Cash flow statement
Annual Report of a company
An annual report is a publication provided annually by a company to its shareholders. It provides information about its operations and financial performance.
It is published at the end of a financial year. You can find the annual report of a company on its website.
There are many sections in an annual report and going through each section is not practical. So, I will tell you the main sections which you should go through.
1. Management Statement
Sometimes also called a chairman’s statement.
Here, you would get to know what the top management person(s) is thinking about the company. What were the reasons for their past decisions and actions, and their future plans? You get to know here whether they are realistic or not, are they transparent in discussing details.
2. Management discussion & analysis (MD&A)
It is one of the most important section. In this section, you will get to know what the management thinks about their industry, past, and expected future growth in that industry sector.
You can also use this section to compare it with other companies in the same industry and find out which is the best to invest in. Here you would also get to know what risks can company face in the future, their court cases.
Here you will get to know who has which amount of holding in the company.
Financial statements of the company
According to me, this is the most important part of Fundamental analysis. This section contains profit & loss, cash flow statements, balance sheet which we will discuss briefly below.
But before that, you must understand: what is consolidated and standalone financial statements.
Consolidated statements include the numbers of the company along with its subsidiaries whereas standalone statements only include the numbers of the company.
For example, there is company A which made loss of 100cores while its subsidiary company B makes a profit of 200crores. Here if we look at the consolidated financial statements, the company made a profit of 100crores but if we look at standalone statements, it had made a loss of 100crores.
It is advisable to look through the consolidated financial statements as it gives better representation of company’s financial position.
Profit and Loss Statement
Profit and loss statements include the revenue of the company for the given period (annually or quarterly), expenses, tax and depreciation, and earning per shares (EPS).
I have attached below the profit and loss statement of TCS to make you learn how you can read it.
In the first line we can see sales turnover or net sales which is 1,31,306Cr which they must have got by providing services to its clients as it is a tech company.
Next is other income 8,082Cr which includes income that is not related to the main business of the company. It includes interest on bank deposits, insurance claims, etc.
Since TCS is a tech company, its main expenditure will be on employees. Miscellaneous expenses can be office rent, software and equipment costs, marketing costs, etc.
Here the operating profit comes out to be 37,353Cr. Next is PBDIT which means profit before depreciation, income, and tax.
Next term here is depreciation, let’s understand it. There are some assets which when brought once can provide economic benefit to the company for a period. For example, a laptop costing Rs60,000 could be useful for 4 years. So, here instead of showing a lump sum amount in that year only it can be depreciated through its period.
For example, the price of the laptop can be depreciated as Rs60,000/4 i.e Rs15,000. So here 15,000 is the depreciation. It will be included in the profit and loss statement for 4 years.
Profit before tax of the company is 41,991Cr and after deducting the taxes, the net profit comes out to be 33,260Cr.
You can see here the net profit has increased nearly 3,000Cr from the previous year which is good for the company.
Next, you can see is the profit per share. It is calculated by dividing the net profit by total outstanding shares in the market.
Balance Sheet Statement
The balance sheet statement gives us information about assets, liabilities, and shareholder’s equity. Assets include property, cars, etc. Liabilities include loans, borrowing, etc.
The equation of the balance sheet is given by assets = liabilities. For example a company took a loan of 100Cr from a bank, that amount will be its liability. They use that money to set up a factory and that factory of 100Cr will be their asset. So, here assets = liabilities = 100Cr.
I have attached below the balance sheet of Lupin. I will make you understand all the terms on it so that you can read any balance sheet after that.
The first term here is shareholder’s fund. It includes money raised from shareholders plus the profit money left after paying dividends to shareholders. But you will wonder why it comes under liability?
This is because money is raised by giving a part of the ownership of the company to shareholders. Also, the shareholders have a right to company profits. However, the company chooses whether they want to give profits to shareholders as dividends or not. That’s why it comes under a liability.
The next term is equity capital. It is equal to face value multiplied by the total number of shares of the company. For example, the face value of a company is Rs10 and the total number of shares is 10Cr, so here equity capital = 100Cr.
But the company gave the shares to shareholders at Rs.100 i.e. at an extra premium amount of Rs.90. So, here the total premium amount is 90*10Cr = 900Cr.
The next term is reserves and surplus. It includes premium amount plus the profit money left after paying dividends to shareholders.
Non-current liabilities refers to the obligations that the company has to settle or pay not within 1year. Long term borrowings are the borrowings or loans that the company has to pay not within 1year.
Deferred tax liabilities are the tax that the company has to settle after 1year. Other long term liabilities include security, rent deposit, etc.
Long term provisions is the money set aside for employee benefits like PF etc or the products that the company expects to be returned or claimed under guarantee, warranty.
Current liabilities are the obligations that the company has to settle within 1year. Trade payable is the money to be paid to vendors who supply raw materials to the company. Other current liabilities include bank overdraft, dividends unclaimed, etc.
Next we go to the asset section. Non-current assets are the assets owned by the company whose benefits can be enjoyed beyond 1year.
Tangible assets are assets that have any physical form like machines, vehicles, buildings, etc. Intangible assets are assets that did not have any physical form like brand equity, trademarks, patents, copyrights, etc.
Capital work in progress includes buildings that are under construction, machines under assembly, etc. They will move to tangible assets when their construction work is done.
Non-current investments are the investments done by the company for long term perspective like mutual funds, debentures, stake in companies, etc.
Long term loans and advances are the loans given by the company to other companies, vendors, employees, etc.
Current assets are the assets that can be easily converted to cash and the company plans to use these assets before 1year. Inventories include all the finished goods manufactured by the company, raw materials in stock.
Trade receivables is the amount that the company is expected to receive from distributors, customers, etc. Cash and cash equivalent include cash in hand or the investments done with a maturity date of less than 3 months.
Cash Flow Statement
Let’s suppose there is a company which sells mobiles. They sold 5 mobiles in a day each of Rs20,000. So, the total revenue is Rs1lakh, but 2 customers bought the phone on credit means on EMI or loan. Therefore the company got total cash as Rs.60,000 only.
If we look at the profit & loss statement of this company the total revenue will be Rs.1lakh. Let’s say the company has a short term borrowing of Rs80,000 which has to be paid immediately. But the company has a total of 60,000 in cash as the two customers took the phone on credit, which we can’t see on profit and loss statement. That’s why we also have to see a cash flow statement.
Cash flow statement is a statement that shows actual cash flow i.e. inflow and outflow of cash and cash equivalents.
There are three activities on any cash flow statement:
1. Operational activity
These are the activities relating to daily core business operations like sales, marketing, manufacturing, technology upgrade, etc.
2. Investing activities
These include investments that the company makes for taking benefits in a later stage.
3. Financial activities
These include dividends that the company has to pay, debts raised, an interest that has to be paid, etc.
All the terms under these activities are self-explanatory in the cash flow statement. So, I will not go into that.
Let’s sumarise what we learnt from this blog about fundamental analysis. First, we learnt about annual report. Then, we learnt which all important things to read in an annual report briefly: Balance sheet, profit and loss statement etc.
After reading the blog, I am sure you must have understood how to read the annual report, balance sheet, profit and loss statement, cash flow statement of a company.
You should use Fundamental Analysis for long term investing. But use Technical Analysis for short term trades. If you want to know more about Technical Analysis, you can read my blog on Technical Analysis.
Ans. You can get the profit and loss statement of a company from its official website. You can also use the Money-control website to get the profit and loss statement, or simply type on google ABC company balance sheet to get it.
Ans. The balance sheet is not an account. It is a sheet published by a company that provides the value of its assets and liabilities.
I am a student currently pursuing B-tech in electrical engineering from Delhi Technological university.