June 26, 2016

Understanding Fund Flow Analysis and the Quarterly Results Filings of Companies

One of the key requisites of being listed on stock exchanges is that the listed companies are required to disclose their performance on a periodic basis. This is true for publically listed companies across the world. Different countries stipulate different disclosure requirements on the companies listed in their respective stock exchanges. However, the common requirement in all the markets is to disclose information about critical developments on an ongoing basis and financial performance on a regular basis.

Most of the markets, including India, stipulate disclosure of financial performance at least once every quarter. Therefore, companies listed in Indian stock exchanges publish their financial performance at least four times in each financial year (April – March) within a prescribed timeline from the end of the stipulated period (end of the quarter):
  • April to June: within 45 days from end of June quarter
  • July to September: within 45 days from end of September quarter
  • October to December: within 45 days from end of December quarter
  • January to March: within 60 days from the end of March quarter

If due to any reason, a company is not able to disclose its results within the above mentioned timelines, then it is a red flag. The investor should be warned that the company is facing some issue and she should not ignore such delay in disclosure of results as being trivial in nature. Most of the times, delays in filing of quarterly financial performance are linked with ongoing frauds and corporate governance issues within the companies.

The example of Ricoh India Limited is pertinent here, which published its results for September 2015 quarter on May 18, 2016. The company has initiated proceedings against its senior management for possibility of perpetrating fraud.

The current article focuses on understanding the key information contained in the quarterly results published by companies and their interpretations. The articles is aimed at helping the reader to develop a framework in getting the critical information from quarterly filings within a short amount of time.

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

SEBI has stipulated the minimum level of information, which a company must disclose in its quarterly results. However, the companies are free to disclose any information over and above the minimum required.

Quarterly results of most of the companies in India, contain the following sections and information:
  • Independent auditor’s review report for the disclosed financials
  • Profit and loss statement
  • Statement of promoters’ shareholding and pledging levels
  • Balance sheet, mainly in September quarter (half year) and March quarter (full year)
  • Statement of investor complaints
  • Notes disclosing key outcomes of board meeting, status of projects under execution, dividend declaration and other critical developments about the company.

Analysis of quarterly results is a part of regular monitoring exercise of companies in one’s portfolio. Therefore, it becomes one of the key events that shareholders track to update themselves about company’s affairs.

Let’s understand in detail the key information disclosed in the quarterly result reports and their relevance & interpretation for a fundamental stock investor.

A) Timing of Disclosure of Quarterly Results:

While assessing quarterly results, one of the key parameter that every investor should track is the timing of disclosure of results:

1) If a company is not able to publish its quarterly results within the stipulated timelines (45 or 60 days, as applicable), then it is a serious issue and the investor should definitely be worried.

In case of Ricoh India Limited, the company intimated the stock exchanges on November 14, 2015, the last date for disclosure of results for September 2015 quarter, that it would not be able to publish results within the deadlines. Later on, the company disclosed that it is investigating the possibility of a fraud by the senior management of the company.

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

2) On similar lines, if a company that used to publish results promptly within a few days from the end of the quarter, delays its results, even then an investor should try to find out the reasons for such delay.

Many a times, such delay is associated with the change in management of the company, which is a frequent event for public sector undertakings (PSUs). In most of such cases, the new management takes time to clean up the books of the activities of the previous management so that it may start with a clean slate.

Other reasons for delay in declaration of results might include that the promoter/senior management/directors are not available due to certain engagements. However, the investor should analyse each case of delay in filing of the results and try to find out the possible reasons leading to the delay.

B) Independent Auditor’s Review of the Results:

Auditor’s report is a very important section of the quarterly results that contains opinion of a competent third party on the financial performance disclosed by the company. However, it is the section of quarterly results that routinely gets ignored. One of the key reason for such ignorance is that in most of the well-run companies, the auditor’s report is uneventful and a standard attachment to results, containing mundane legally conscious language.

However, auditor’s report is an all important part of the results that has many a times exposed significant misdeeds and frauds perpetrated by the management. The role of the independent auditor is paramount in the principal-agency relationship of shareholders and management.

We mentioned earlier that Ricoh India Limited delayed filing of its quarterly results for September 2015. Finally, the company published these results on May 18, 2016. The auditor’s report, which formed part of the results release, contained eye opening comments on the status of financial dealings of the company.

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

Therefore, it becomes paramount that investors should always read the auditor’s report in detail, whenever they read the financial results of any company.

C) Profit and Loss Statement:

Profit & loss statement (P&L) is the permanent feature of all the quarterly results and many a times investors limit their reading of quarterly results to the P&L only. However, it is advised that investors should pay equal attention to all the sections of the quarterly results to effectively monitor their stock holdings.

The P&L statement in the quarterly results contains:
  • the financial performance for the 3 months ending in the current quarter (e.g. March 2016 quarter),
  • performance of preceding 3 months (December 2015 quarter),
  • performance of respective quarter in the previous financial year (March 2015 quarter),
  • year to date (YTD) performance of current year (6M-FY2016, 9M-FY2016 or FY2016 as the case may be),
  • YTD performance of previous year (6M-FY2015, 9M-FY2015 or FY2015 as the case may be) and
  • the performance of previous full financial year (FY2015 in this case).

In case of companies having subsidiaries, joint ventures etc. the performance at both standalone as well as consolidated level are disclosed. Let’s see the P&L disclosed by Ambika Cotton Mills Limited in its March 2016 quarterly results:

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited
*Disclosure: I own shares of Ambika Cotton Mills in my portfolio.

There are different set of analysis inputs that an investor can get from the P&L statement contained in the quarterly results. These analysis points usually include:

Year to date (YTD) performance:

It compares the YTD performance of the company until the reported quarter (6 months, 9 months or full year as the case may be) with the performance in the same period in the previous financial year.

The investor can assess the performance of the company on parameters like:
  • Sales growth: compare sales income to assess growth or decline in sales income
  • Profitability margins: compare the profitability margins/proportion of expenses as a ratio of sales income:
    • operating profit margin (OPM),
    • net profit margin (NPM),
    • cost of material consumed as a ratio of sales,
    • power & fuel as a ratio of sales
    • employee expenses
    • finance costs etc.

All these parameters highlight the improvement or deterioration of financial performance of the company during the periods under comparison. The investor should specially focus on the item, which shows sudden high increase or decrease over the comparative periods.

Quarterly performance:

1) Year on year (YoY) performance: 

It compares the performance of the company during the reported quarter (March 2016) with the performance in the respective quarter in the previous financial year (March 2015). The key parameters of performance evaluation are the same as has been discussed above.

The YoY performance rules out the impact of seasonality in the business of the company. It provides an opportunity to understand the current performance of the company with the performance in the last year under similar seasonal parameters.

2) Quarter on Quarter (QoQ) performance: 

It compares the performance of the company during the reported quarter (March 2016) with the performance in the preceding quarter (December 2015). The key evaluation parameters remain the same as per the above discussion.

I advise the investors to focus more on the year till date (YTD) performance and not get a lot worried about the quarterly performances.

Even in quarterly performance evaluation, it is advised that investors should give more weightage to YoY performance than QoQ performance. As mentioned above YoY performance is assumed to rule out the impact of seasonality in the business performance evaluation.

QoQ performance evaluation is of least importance among the three scenarios discussed above (YTD, YoY and QoQ).

I believe that changing the views about a company after each quarterly results, is to fundamental investing what intra-day trading is to technical investing:

It is all but natural that the performance of humans as well as companies never stays the same over time and we suffer from periods of exuberance and distress. It is difficult to repeat exactly the same performance for humans and companies in two attempts (only machines/robots seem to be capable of doing it). In this light, we expect the company’s performance to fluctuate from one period to another and it should be accepted as a norm.

We should be worried if the company keeps on improving/maintaining its performance like a clockwork performance. Because such performance is usually associated with managed financials where the company adjusts/cooks its books to show desired financial performance.

D) Segmental Results:

The quarterly results also contain a section on the financial performance of different segments of the companies and provide their performance data in the form of:
  • Segmental revenue
  • Intra company/group dealings of different segments
  • Segmental net profits
  • Segmental capital employed, which can be used to assess the return on capital employed for particular segment.

As discussed above in the quarterly P&L analysis section, while doing segmental analysis as well, it is advised that an investor should focus on the year till date (YTD) performance the most, next on the year on year (YoY) performance and least on the quarter on quarter (QoQ) performance.

E) Balance Sheet (B/S):

Most of the companies listed on stock exchanges in India disclose their summary balance sheet in their September (half yearly) and March (full year) quarterly results. The summary balance sheet contains only a snapshot of assets and liabilities at the date of end of the quarter without providing detailed notes/schedules, which are included in the annual report.

Even though the balance sheet is only a summary, nevertheless, it provides great insights into the status of the company’s financial position at the reporting date. An investor can get a rough estimate of change in leverage, progress of projects under execution, movement of cash & funds etc. from the summary balance sheet.

I advise investors to mandatorily conduct the funds flow analysis whenever they analyse the balance sheet.

Funds Flow Assessment:

Movement of funds in the company’s balance sheet can be assessed by doing a comparative assessment of different sections of the balance sheet. An investor should compare the values of every section at the reporting date of current year and the previous year and calculate the change in their values.

1) Equities and Liabilities:

In the liabilities section, any increase in an item means that the company has received funds (inflow), which need to be paid to external parties like:
  • shareholders (equity and reserves),
  • lenders (long term debt, short term debt etc),
  • vendors (trade payables),
  • customers (advances from customers usually part of other current liabilities)
  • employees (leaves, gratuity etc. as part of short term provisions)

Similarly, a decrease in any item in the liability section means that the funds have gone out (outflow) from the company to third parties to satisfy the existing liability.

2) Assets:

In the assets section, any increase in an items means that the company has spent funds (outflow) to purchase assets, which would generate cash/funds inflow in future like:
  • Fixed assets (purchase of plant and machinery)
  • Long term loans & advances/Non-current investments (investments in long term financial products, JVs, subsidiaries etc.)
  • Current Investments (investments in short term financial products)
  • Inventory (raw material)
  • Trade receivables (payment due from customers)
  • Cash & equivalents (bank balance)
  • Short term loans & advances (loans to related parties, vendors etc.)

Similarly, a decrease in any item in the assets section means that the funds have come into the company (inflow) from third parties by way of sale of assets or collection of dues from third parties.

This contrasting interpretation of directional change (increase/decrease) in items in liabilities and assets sections and their impact on funds statement (inflow/outflow) becomes confusing for many investors. Therefore, it is essential that the reader spend extra care while interpreting the funds flow analysis.

To understand further, let’s do the fund-flow analysis on the summary balance sheet of Ambika Cotton Mills Limited, which it disclosed with March 31, 2016 results:

To simplify the matter, all the items depicting funds inflow have been shown in “Green” and all the items leading to funds outflow are shown as “Red

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

The fund-flow analysis depicts that Ambika Cotton Mills Limited, has received funds of about ₹75.6 crores from:
  • reserves (net profits – dividends paid): ₹33.8 crores
  • inventory (used in creating goods for sales): ₹20 crores
  • fixed assets (depreciation – non cash expense in P&L): ₹14.8 crores
  • long term loans & advances (recovered money back, sold long financial products): ₹7 crores

The analysis also indicates that these funds have been used by the company in the period under analysis (March 2015 to March 2016) in the following manner:
  • payment of long term debt: ₹3.7 crores
  • payment of short term debt: ₹26 crores
  • payment of other current liabilities (primarily current maturity of long term debt and customer advances that are recognized as sales and therefore removed from balance sheet liabilities: see the section below): ₹13 crores
  • payment of trade payables to the vendors: ₹4 crores
  • providing credit to customers (trade receivables): ₹12.5 crores
  • deposits in banks (cash and equivalents): ₹2 crores
  • given as short term loans and advances: ₹2 crores
Other current liabilities section of the FY2015 annual report of Ambika Cotton Mills Limited, showing current maturity of long term debt and other items in the composition of other current liabilities section: 

The fund flow analysis for Ambika Cotton Mills Limited indicates that during FY2016, the primary sources of funds for Ambika Cotton Mills have been profits (reserves) and liquidation of inventory, which it has used to repay debt (short term, long term and current maturity of long term debt) and providing credit to customers.

This pattern of funds flow indicate normal operations of a healthy profitable company where the management is using the funds generated from the company into company operations.

Fund flow analysis has the potential of highlighting and early stage identification of cases where management uses funds generated from the company (profits/reserves and debt) for its own benefits in form of loans and advances to group companies/promoter entities.

The case of Gujarat Automotive Gears Limited (GAGL) is a pertinent example of funds diversion by the promoter/management, in which the majority shareholder/promoter/management took out the profits of GAGL and made it take debt, which GAGL did not need for its operations and used these funds to give loans to themselves. Promoters of GAGL (HIM Teknoforge Limited) in turn benefited at the cost of GAGL shareholders.

You may read the detailed analysis of GAGL in which the funds diversion was identified by way of funds flow analysis in the following article:

The analysis would also indicate:
  • whether the debt position of the company is improving or deteriorating by observing increasing or decreasing debt levels
  • whether the receivables position of the company is changing for better or worse by noticing increase or decrease in trade receivables when compared with sales performance
  • Status of project progress:
  • In case capital work in progress (CWIP) is increasing, it would mean that the work on project under implementation is progressing
  • In case CWIP has decreased and net fixed assets (NFA) has increased, it would mean that most probably the under construction project has been completed and has been transferred from CWIP to NFA

Thus an investor can get multiple useful information points from the cursory overview of summary balance sheet disclosed with quarterly results.

F) Notes to the Quarterly Results:

Quarterly results published by the companies usually contain a short section of notes, which contains a few bullet points indicating:
  • the key outcomes of the board meeting
  • declaration of dividend, if any
  • status of progress of projects under implementation
  • other critical developments related to the company
  • other disclosures

These notes are a critical piece of communication from the company to its shareholders and serve as a direct source of assessment of critical issues affecting the company and shareholders.

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

An investor should also read the notes in the quarterly results filed by Ricoh India Limited for September 2015 quarter disclosed on May 18, 2016, which can be downloaded from here. These notes are an eye opener for every investor.

G) Promoters’ Shareholding and Pledging Details:

This section contains critical information about changing promoters’ shareholding and the level of pledge that they have created, if any:
  • Increase in promoters’ shareholding is seen as a positive indicator that shows faith of promoters in the company and vice versa.
  • Increase in pledge of shareholding by promoters is seen as a negative indicator as it indicates deteriorating financial position of the promoters. It also indicates that the promoters are reducing their interest in the company in an indirect manner by monetizing their shareholding by taking loans against it.
  • Decrease in pledge along with decrease in promoter shareholding is the worst sign as it indicates that the promoter is not able to repay the debt raised against the shares and the lenders have invoked the pledge. It means that the lenders have sold the shares and used the money to settle their debt.
  • Decrease in pledge with stable or increasing shareholding is seen as a positive sign, as it indicates improving liquidity position of the promoters and their interest in the business/company.

A simple guide to understand and interpret key information from quarterly results of companies, Ricoh india Limited, Ambika Cotton Mills Limited

However, this segment of the quarterly results disclosure is a duplication of information, which the companies have already declared as part of shareholding pattern disclosures. Shareholding pattern disclosures are to be done by companies within 21 days from the end of the quarter whereas the quarterly results are to be disclosed within 45-60 days after the end of the quarter.

Therefore, if an investor has been following the company closely and have already analysed the shareholding pattern filing previously, then she may ignore this section. Otherwise, she may get critical information about promoters’ liquidity position and their interest in the company.

With this we have come to an end to the current articles, which focuses on the importance of analysing quarterly results disclosures of a company. To summarize, an investor should focus on the following key aspects while studying the quarterly results:
  1. Timing of results disclosure: delay in results disclosure should not be taken lightly
  2. Independent auditor’s review report: should be read for all the key comments
  3. Profit & loss account: focus more on the year till date (YTD) performance, next on the year on year (YoY) performance and least on the quarter on quarter (QoQ) performance
  4. Balance sheet: mandatorily do the funds flow analysis
  5. Shareholding pattern: analyse the change in promoters’ shareholding and pledge levels
  6. Notes to the results: read all the points in the notes carefully to understand developments related to key aspects of company’s developments.

Please share whether you consider quarterly results analysis as a relevant parameter in stock analysis and monitoring. Please also share the key aspects of the quarterly results disclosure that you focus on while analysis. You may share your inputs in the comments section below.

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The views and opinions expressed or implied herein are my own and do not reflect those of my employer, who shall not be liable for any action that may result as a consequence of my views and opinions.

Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I own stocks of Ambika Cotton Mills Limited out of the companies discussed above. I have disclosed stocks in my portfolio on a dedicated page (My Portfolio). I request you to see the list of stocks I own, because it is assumed that my views can be biased when I opine about any stock which I own and therefore, have a financial interest.