Companies, Shares, and Stock Markets

We have been talking about the financials of a company and how we can analyse their statements. Now let us try and use our knowledge to earn some moolah by investing in shares of a company in the stock market:)

A little background first. Public companies raise money for their operations by issuing shares to the general public. These shares are transferable, meaning, the original shareholder can sell her shares to anybody else who wants to own it. The market where the original and subsequent shareholders sell and buy shares of companies is called the Secondary Market. The stock markets, like BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), are examples of the secondary market.

If you take a look at a stock quote in the newspaper or the Internet, you will see something like this:

Company Name : a b b ltd.
		Open	Intra Day		52 Week	Prv Close	Volume
NSE	1647.75 108.00	1600.00	High	1662.00	4841.00	1539.75	272977.00
			Low	1585.05	950.05
		Open	Intra Day		52 Week	Prv Close	Volume
BSE	1643.65 95.65	1607.00	High	1659.00	4845.00	1548.00	60095.00
			Low	1590.00	955.00

The information is quite self explanatory. You see the name of the company followed by information about how the stock fared in the stock exchange on that particular day( or till that point in time in case of a live quote):

• The first column provides the current price of the stock on both the exchanges. This is the price that you will have to pay to buy one share of the company on that day.
• The information in green signifies an increase in price over the previous day. Any decrease would be displayed in red.
• The column titled Open displays the price quoted at the beginning of the day.
• The next column displays the lowest price and highest price quoted for the stock during the day.
• The highest and lowest prices quoted for the stock in the last 52 weeks is displayed next.
• The next column has information about the closing price of the stock on the previous day.
• The last column displays the number of shares of the company traded during the day's session.

More on stocks and prices later...

Are you a Good Retail Banker?

As a retail banking executive, how do you know if you are good at your work? Here are some indicators to prove that you are indeed good:

• Does a customer walk into the branch and ask for you?
• Is she willing to wait till you are free even if another counter is free?
• Do you remember to greet her by her name?
• Does she take your word without question?
• Does she tell her friends and relatives to meet you to open their accounts?
• Does she talk to you first whenever she needs some assistance with her accounts?
• Even if she comes to the branch to talk to somebody from another department, does she stop to say a quick Hi?

If the answer to at least five of the questions above is yes, then great going!! I would recommend your manager to put you on the fast track for promotion:)

Tips for Effective Retail Banking

Here are some tips for being a good a retail banking executive:

• Always wear a smile. How often have you been put off by that grouchy shopkeeper or bus conductor?
• Dress neatly. That does not mean that you need to dress expensively.
• Keep your desk clean. Your workplace is a reflection of yourself. An untidy desk tells the onlooker, "Look at me! Why is my master so disorganized ??"
• Talk pleasantly. But remember that people are generally suspicious of sweet-talking people.
• Try to talk the language of the customer; but only if you know it well. You better off talking sense in a language you know than conveying incorrect information while trying to talk the customer's language.
• Be quick. Remember that your customer has probably taken an hour's permission from his boss to get his work done.
• Be polite with customers who don't know much about banking transactions. If they knew as much as you do, then you might have been out of job.
• Never accept gifts and favors from customers. Accept a nice organizer from your customer and the next day he will request you pass a cheque against funds in clearing...
• Please, please, think before you "commit" a transaction on your banking software.
• Spend time on learning and self improvement. You do want a promotion, don't you?

If anybody is reading this, then please help me improve this list...

Financial Statement Analysis

Analysing the financial statements of a company is no mean task. The good news, though, is that all you really need is passing knowledge of arithmetic (the calculator can take care of that, can't it??) and a whole lot of common sense.

An important technique used by number crunchers is ratio analysis. So this post introduces you to ratio analysis. As we always do, will will stick to the simple ones.

Although ratios can be classified in many ways, they are popularly classified into four categories: Liquidity Ratios, Solvency Ratios, Performance Ratios, and Profitability Ratios.

Liquidity Ratios
These ratios test the company's liquidity. Can the company repay it's short-term obligations? Does the company have adequate liquid reserves (like cash)? The following ratios fall under this category:

Current Ratio = Current Assets / Current Liabilities
(A current ratio of 2:1 is considered ideal)

Quick Ratio = (Current Assets - Inventory) / Current Liabilities
(A quick ratio of 1:1 is considered ideal)

Solvency Ratios
These ratios measure the relative interests of the owners and creditor of the company. These ratios focus on long-term solvency.

Debt-Equity Ratio = Long-Term Debt / Shareholders' Equity
(A debt-equity ratio of 2:1 is considered ideal)

Solvency Ratio - Total Assets / Total Liabilities
(Higher the ratio, the stronger is the company's financial position)

Debt Service Coverage Ratio = EBIT / (Interest on Debt + Pre-tax Principal Repayment)
(Higher the ratio, the stronger is the company's financial position)

Performance Ratios
These ratios measure the performance of the company in terms of levels of activity and usage of facilities available.

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
(Here Average Stock = (Opening Inventory + Closing Inventory) / 2)
(An inventory turnover of 8 times is considered ideal)

Total Assets Turnover Ratio = Net Sales / Total Assets
(Total asset turnover of at least 2 times is considered ideal)

Profitability Ratios
These ratios measure the profitability of the company.

Net Profit Ratio = Net Profit / Net Sales
(The higher the ratio, more profitable is the company)

Earnings Per Share (EPS) = Profit After Tax / Number of Equity Shares
(The more the better)

Price Earnings Ratio (PE) = Market Price per Share / EPS
(The higher the better. But one must watch out for overpricing of shares)

Financial Statements: Digging out the Truth

Now that we have seen how the financial statements of a company are drawn up, let us try and learn to "read between the lines". While looking at the financials of a company, you must ask some important questions. Here are some for starters:

1. If company posts a profit, does it mean that it is really doing well?
2. How has the company suddenly posted such a huge profit this year after a dismal performance last time? Have sales really improved?
3. Is the company's debt really as low as shown in the balance sheet?
4. I see this section called Miscellaneous Expenses in the balance sheet. The problem is that this makes up for more that 15% of the assets. Is that a good thing or not?

Well, answers to these questions, and many many more such questions, are not obvious. Take a look at the questions again. Now here are a possible set of answers to them:

Accounting Profits

The profits posted by a company need not necessarily reflect the true state of affairs. Say for example, more than 40% of the net sales shown in the income statement is sold on a 90-day credit. The company will receive this money only in the future. (Even a 10-year-old will tell you that the future is unpredictable). So now you see? The profits that you see are in fact, expected profits- accounting profits, perhaps, is a better term to use here. So don't get carried away by the amount of profit unless you know that the company has sold goods on credit to people who are likely to actually pay up within time.

Sudden Spurt in Profits

The company has suddenly posted a huge profit. Wow! Sales must have improved tremendously. Three cheers to the management!!
Really??

Take a look at the income statement again. Do you see something called Non-Recurring Income? That could explain the sudden increase in profitability. Non-recurring income refers to income that is not expected to continue in future. They are one-time receipts that often do not arise out of regular business activities.

Maybe the management is actually selling off some of it's assets to maintain liquidity while you think that the company is going great guns.

Debt Off the Balance Sheet

You see that the company operates with very little debt. Just before you start believing what you see, take a look at the Notes to the balance sheet. Take a look at the section called Off-Balance Sheet Items. Off-balance sheet items could contain just about any liability that the company does not necessarily have to disclose upfront. Contingent liabilities (liabilities that might arise on the happening of a certain event in future), operating leases, letters of credit, futures, and forwards are some examples here.

So you see? These long list of liabilities don't eve appear in the balance sheet! So watch out before drawing any conclusions.

"Miscellaneous" Expenses

Miscellaneous expenses is another favourite section used by companies to keep things under wraps. This section of the balance sheet records various expenses that are incurred by the company but not written off against the profits they make. For example, the company recently issued debentures to the public at a discounted rate. The discount should ideally be written off against the profits earned. But the company can choose to carry them forward instead of adjusting them against their profits. This way, the company manages to post better profits. Unfair, isn't it?

We have discussed just four questions here. Believe me, there are hundreds of such questions to which you will not find straight forward answers.

So remember to take a nice hard look at the financials of the company before you decide whether the company is really faring well or not.

Banking : Reaching Across the Counter

Retail Banking has come of age in India. Gone are the days when customers would be given a token and asked to wait endlessly just to withdraw cash that is rightfully theirs. But this boom in the retail banking segment has come with its own share of vices.

• Each banking officer in a retail bank today is doing the work that was once shared by at least 10 people
• Banking staff have become slaves of the computer; the computer tells them what to do. There is no room for personal development and knowledge sharing.
• Banks today want to recruit inexperienced youngsters to keep their salary outgo low. The lack of experience often leads to costly mistakes.
• The managements of many private sector banks refuse to take any responsibility for mistakes made by their staff. The credit for good work however is always shared by everyone. (There have been many instances where employees have had to shell out money from their pockets when the bank fails to recover dues from a defaulting customer!!)

Having worked in a bank myself, I have seen all this and much more happen. My biggest advice to anybody working in a bank is this:

Be careful and think twice before affixing your initials on that voucher on your table.

There is one more advice (you will not see this in RBI's handbook):

Know Your Manager just as well as you Know Your Customer. Will he/she back you in case of need??

Financial Statements and Personal Finance

I am dropping the "Finance for Newbies" title from now on. Thought it was too long for prolonged usage:)

Okay, so do you think financial statements are relevant only to companies? If you do, then you must read this post. All the financial statements that I spoke about in my earlier posts are indeed relevant to individuals too. Each one of us has an income (hey kids, don't forget that pocket allowance that comes in each month!) and expenses. All of us own some assets and many of us owe money to others (read liabilities).

Just like how companies draw up their financial statements on a periodic basis to assess their financial health, individuals also can use them for regular "financial introspection".

Let's draw up a simple income statement for this young lady who works as a software developer:

Total Revenues(Net Salary)	50000
Food expenses	5000
Travel and holidays	10000
Rent and provisions	25000
Net Profit (Savings)	10000

Now let's draw up a balance sheet for her:

Assets
Fixed Assets (car, computer, microwave)	20000
Current Assets (bank balance, advance paid to the maid)	100000
Investments (in shares)	10000
Total Assets	130000
Liabilities
Retained Earnings (including 10000 from income statement)	70000
Bank Loan	60000
Total Liabilities	130000

Of course, the term liabilities is a misnomer here because unlike companies your earnings do not belong to others. You own them completely. You could see it this way: you are the sole shareholder, rather stake holder, here. Hence you are the sole beneficiary of your retained earnings.

Finally, let's draw up a cash flow statement:

Net Savings (from income statement)	10000
Less: Advance paid to maid	1000
Less: Shares purchased this month	3000
Add: Proceeds of selling old two-wheeler	5000
Total Cash Flow	11000

Easy, wasn't it? And I don't have to tell you how much simpler Microsoft has made it for us to keep a tab on our expenses. So go ahead, use Excel and start working on your very own financial statements.

Finance for Newbies- Cash Flow Statement

The Cash Flow statement, true to its name, is a statement that captures inflow and outflow of cash (and cash equivalents) during a given time period. The cash flow statement is often seen as a true reflection on a company's financial health.

A cash flow statement is different from the income statement and balance sheet in that the former does not take accrued income/expenses into consideration. Accrued income/expenses refer to income/expenses likely to arise in future. A good example of accrued income is accounts receivable: amount due from customers that the company expects to receive some time in future.

A cash flow statement typically starts with the Net Income (PAT) obtained in the income statement. To the net income:

• All non-cash expenses, like depreciation, are added.
• All non-cash income, like credit sales, are reduced.
• Capital expenditure that entailed cash outgo are reduced.
• Sale proceeds of capital goods and investments are added.
• Cash utilized to pay dividends, repay debt, and repurchase shares are reduced.
• Proceeds of shares issued and loans raised are added.

Here's what a cash flow statement would look like:

Net Income
Operating Activities
Additions

• Depreciation
• Increase in accounts payable
• Increase in taxes payable

Subtractions

• Increase in inventory

-----------------------------

Investing Activities

Additions

• Sale proceeds of machinery

Subtractions

• Purchase of equipment

-----------------------------

Financing Activities

Additions

• Debentures issued

Subtractions

• Dividend payable

=================

Cash Flow for the period

=================

Here's a link to a sample cash flow statement.

Finance for Newbies: The Balance Sheet

The Balance Sheet is a statement of what the company owns and what it owes. It is a snapshot of a company's assets and liabilities on a particular date. Note that the balance sheet, unlike the income statement, applies to a single point in time. You always have a balance sheet as of say, 31 March 2007. The income statement, on the other hand, would read as say, from 31 January 2007 to 31 March 2007.

Now, whatever the company owns are called Assets. This may include building, machinery, cash, receivables, etc.

Whatever the company owes others are called Liabilities. This includes bonds, debentures, bank loans, etc.

The other important component of the balance sheet is Shareholder's Equity which represents the total equity capital and other reserves of the company. In fact shareholders' equity can be represented as follows:

Shareholders' equity = Total assets - Total liabilities

Irrespective of the format used, here's what a balance sheet looks like:

ASSETS
---------
Current Assets (short-term, liquid assets)
Accounts Receivable (debtors)
Cash at hand and in Bank
Inventory (raw material/work-in-progress)

Fixed Assets
Plant, Machinery, Building (less depreciation)
Goodwill
Investments (long term)
Deferred taxes

LIABILITIES
----------------
Current Liabilities (short term liabilities)
Accounts Payable (creditors)
Short term Loans
Provisions for Taxes

Long Term Liabilities
Debt Securities (debentures/notes/bonds)
Bank Loans

SHAREHOLDERS' EQUITY
-------------------------------
Share Capital
Retained Earnings
Capital Reserves
Other Reserves

Here's a link to a sample balance sheet.

Finance for Newbies: The Income Statement

We all know that business sell goods and services to people for a price. In the process, they incur costs like cost of purchasing raw material, salaries to employees, etc. If the revenue earned is more than the costs incurred, the company makes a profit; if the costs are more than what is earned, the company makes a loss.

The Income statement or the Profit or Loss statement summarizes the revenues generated and costs incurred during a specific period of time. Irrespective of the format used, here's how the net profit / loss is computed in an income statement:

Net sales (total revenues)
Less Cost of goods sold ( raw material, labor, etc.)
------------------------------------------------
Gross Profit
Less Operating costs ( administrative expenses, selling expenses, etc.)
--------------------------------------------------------------------
Earning Before Depreciation, Interest, and Tax (EBDIT)
Less Depreciation
--------------------------------------------------------
Earnings Before Interest and Tax (EBIT)
Less Interest to bond holders
-----------------------------------------
Profit Before Tax (PBT)
Less Taxes
------------------------
Profit After Tax (PAT)
Less Dividend to shareholders
-----------------------------
Retained Earnings
----------------------------------
----------------------------------

Here's a link to a sample income statement.

A Blogger's Audience

Old habits die hard. As a technical writer, I am not able to contain the urge to first define my target audience; never mind the fact that this is just a blog and that I can choose to be casual and informal here.

But here are the rules I will try to abide by while writing:

• Never assume anything about your audience.


• Do not assume that your audience already knows enough to understand what you write. As a corollary, always try to give a brief description of any term you use. It does not hurt to start from the basics. Those who know the subject will safely skip those sections and move on to the more interesting ones.
• Your audience could be a young 15-year old student or an 80-year old computer enthusiast. So try and put in a bit for everybody.
• Never under-estimate your audience. They are intelligent enough to grasp a concept if explained well. Do not repeat yourself to try to explain the same concept in a hundred different ways.
• Always be a humble student yourself. Be willing to learn from mistakes and improve continuously.

There might be many more rules like these. But this is all I can think of right now. Will add to the list in future. Feel free to leave comments to help me improve this list of rules.

Finance for Newbies- An Introduction

Had I started this blog two years before, I would have introduced myself as a finance professional. But today, I introduce myself to everybody as a technical writer; better still, a writer- whose writing is not constrained by the word " technical".

Technical writing happened to me by chance, after years of pursuing finance as a subject and a profession.

I am going to start my blog with a series of articles titled Finance for Newbies. As the name suggests, I am going to try to present a few concepts in finance in a manner in which they can be easily understood by anybody who wants to be able to read the Finance section of a newspaper and not look baffled by the end of it...

My Two Cents

Am joining the bloggers' community today to put in my two cents on anything I read...