How to study Annual Report of a Company

The current article seeks to describe:

• The sources for getting the annual report,
• Understanding various sections of the annual report along with their importance for an investor
• A guide to understanding the changes in the financial numbers of companies on change in accounting standards from Indian GAAP (IGAAP) to IFRS (Ind AS) and
• Answers to other important queries asked by investors like:
  • The final dividend declared by the board is unpaid but there is no liability shown in the balance sheet (Impact of Ind AS/IFRS)
  • Why are security deposits present in both the asset as well as the liability side of the balance sheet?
  • How should an investor from non-finance background understand the business/accounting language used in the annual reports?

What is an Annual Report

At the end of each financial year, every company is required by law to prepare a report for shareholders, which provides the details of the performance of the company over the year. This report is called an annual report. The annual report is the single most important source of information for an investor. The importance of an annual report to an investor is akin to alphabets for any language or a periodic table for Chemistry.

A detailed analysis of any company starts with reading its annual report. I believe that if an investor does not read annual reports of companies, she would not be able to become a successful investor.

Sources for getting the annual report

An individual investor can get annual reports of any company from multiple sources. These sources are free as well as paid sources.

Free Sources:

Free sources are sufficient for most of the requirements of any individual investor.  Some of the common sources are:

A) Company Website > Investor Section:

This is the most common source and should be the first place to look for information about any company. Many companies provide annual reports for almost 10-12 years on their website. Below is the screenshot of the investor’s section on the website of Mayur Uniquoters Ltd, which provides annual reports from 2010 onwards.

Sometimes, investors may not find the annual reports of a few companies on their websites. It may be the case with some of the small-cap and mid-cap companies, which are yet to have an investor-friendly interface. As these companies grow in size, they start investing in public relations & investor-friendly initiatives and improve significantly in the dissemination of information.

Therefore, the absence of annual reports on the website should not be seen negatively. It should be accepted merely as a phase in the company’s life cycle. There are many other public sources from where we can get the required information. Some of such sources are mentioned below.

B) Stock Exchange Websites:

Stock exchanges are an important source of information distribution for companies. Many stock exchanges around the world host much more information, financial and otherwise, about companies than mere press releases and corporate announcements. In India, the Bombay Stock Exchange (BSE www.bseindia.com) is one such stock exchange, which provides annual reports as well as the financial results of the companies listed on BSE:

As we can see above, the annual reports of MUL are available on the website of BSE. Therefore, an individual investor can get the annual reports of the companies that do not provide annual reports on their websites, from the websites of stock exchanges.

Important: Please note that nowadays, BSE provides annual reports of companies from the year 1997 onwards. Therefore, BSE may serve as a one-stop solution for investors to get the historical annual reports for companies.

C) Financial Websites:

Many financial websites also provide annual reports of companies. e.g. www.moneycontrol.com. We have provided a screenshot of the webpage providing links to annual reports for MUL on the website of Moneycontrol.

Paid Sources:

The sources mentioned above are free sources available to any investor. Free sources of financial information are sufficient for most of the requirements of individual investors. However, there are many paid sources as well that can provide annual reports to investors. Capitaline and Report Junction are some of the paid sources to get annual reports.

Which sections to focus on in the Annual Report?

The annual report provides a yearly account of the performance of a company. We should read the annual report of a company with the same vigour be it when analyzing it for investment for the first time or when monitoring it as part of our portfolio. While analyzing companies for first-time investment, I prefer reading annual reports going back as far as possible, preferably for the last 10 years or more.

The annual report contains financial as well as non-financial information about the company. Both financial and non-financial information is equally important for investors.

Non-financial information:

A) Communications from promoters and senior management:

The annual report is a yearly occasion when owners/managers communicate with the shareholders and inform them about the vision of the company, its performance during last year, its achievements, hurdles & challenges being faced, steps taken to overcome such hurdles, the status of past expansion plans & other projects undertaken by the company etc.

Many promoters take this opportunity very seriously and inform the shareholders about the company and their philosophy in such detail that their communications become a collector’s affair. Warren Buffett is one such person. His letters to shareholders of Berkshire Hathaway as part of the annual report are read by investors the world over.  I would suggest that every person who wishes to be a successful investor in the stock market should read all his letters.

The communication of a company’s management to its shareholders is a very important source for judging the status of the company as well as the industry. In fact, whenever I want to know about the status of any industry, I read the annual report of any company belonging to that industry. One reading of management’s communication and the Management Discussion & Analysis (MDA) section would give an investor an authentic brief snapshot of the industry and the company.

B) Directors’ report:

In this section, the directors as representatives of shareholders intimate them about the financial performance of the company during the last year, the status of projects under implementation, major customers, the status of conversion of new customers, and other major initiatives taken by the company.

We should analyse the current performance of the company by comparing it with the outlook presented by directors in the past years in the annual report. Special focus should be on the projects under implementation. We should check whether the company is able to finish projects on time and whether the company has abandoned projects midway. I have provided below a snapshot of the director’s report from the FY2013 annual report of MUL.

C) Management discussion & analysis (MDA):

MDA is another important section where management informs the shareholders about the business environment being faced by the company. The management informs the shareholders about the industry outlook, company outlook, opportunities, challenges, risks, updates on research & development, human resources etc. A snapshot of the MDA from the FY2013 annual report of MUL is provided:

D) Details of personnel in charge of running the company:

The annual report provides details qualifications of all the directors, and key management people responsible for the decisions of the company. It provides details of employees who are being paid in excess of Rs. 60 lakh (Rs. 6.0 million) per annum in the annexure to the director’s report and disclosures. The below screenshot provides details of the salaries of most of the directors including promoter-directors of MUL for FY2013:

We get to know about the salary being drawn by most of the promoter directors in this section. We can analyze whether the salary drawn is in line with the industry norms/profits of the company.

E) Report on corporate governance:

This section contains the details composition of the board of directors, the quorum of various committees of the board, attendance records of various directors in different meetings, details of past and upcoming annual general meetings, information on listing on various exchanges, past dividend record, proposed dividend, stock market data, distribution of shares etc. It also contains details of the registrar & transfer agent of the company. The following screenshot from the 2013 annual report of MUL shows the attendance of composition of the board and attendance of directors in the last AGM:

F) Notice of annual general meeting (AGM):

This would contain the information about the upcoming AGM as well as different decisions that require shareholders’ ascent by way of a vote. We get to know of salary hikes sought by promoter managers, plans of taking further debt, new expansion projects, entry of the next generation of leaders in board positions etc by the items listed to be voted in AGM.

Financial information:

The annual report contains almost the entire financial data that an investor needs to form her views about the company:

A) The independent auditor’s report:

The financial section starts with the report of an independent auditor in which an independent entity provides its views about the financial information presented in the annual report. Auditor’s report comments on the key items like any deviation from the accepted accounting practices, any amounts that are not paid to government authorities, any default in payments to lenders, the sufficiency of control systems to the size of the company, any frauds conducted by a company or its employees, proper utilization of funds raised by the company from lenders/IPOs etc.

Auditor’s report gives you a snapshot of the authenticity of financial information that follows in the annual report.

B) Financial Statements:

These consist of three important sections: balance sheet, profit and loss statement and cash-flow statement. Financial statements of the current year are always shown in parallel to figures of the previous year so that performance of the current year can be compared with the immediately preceding year.

1) Balance Sheet:

This section of financials provides details of all the assets and liabilities of a company on the last date of the financial year. Liabilities are the sources of funds, which a company has utilized to purchase all the assets it owns. The balance sheet of MUL on March 31, 2013, is shown below:

We can see the comparative position of MUL on March 31, 2013, & March 31, 2012, and observe the way the balance sheet size has increased from Rs. 15,850.16 lakh (Rs. 1.58 billion) to Rs. 21,349.20 lakhs (Rs. 2.13 billion). Almost half of the increase of Rs. 5,499.04 lakhs (Rs. 0.54 billion) has been contributed by an increase in reserves & surplus by Rs. 2,700 lakhs (Rs. 0.27 billion). This is a sign of healthy growth by a company.

2) Profit & loss (P&L) statement:

This section of financials provides details of total sales that a company has achieved in a year and all the expenses the company has incurred to achieve these sales. The balance after expenses and taxes constitutes the net profit for the shareholders. Given below is the P/L statement of MUL for FY2013:

We can see that total revenues have grown by 20% from Rs. 31,909.37 lakh (Rs. 3.19 billion) in FY2012 to Rs. 38,327.47 lakh (Rs. 3.83 billion) in FY2013. Such revenue growth is very good. On top of it, we can see that in the same period net profit has grown by 30% from Rs. 3,337.06 lakh (Rs. 0.33 billion) in FY2012 to Rs. 4,362.55 lakh (Rs. 0.44 billion) in FY2013. This higher growth in net profit is an indication of improvement in the operating efficiency of the company.

Further advised reading: How to do Financial Analysis of a Company

3) Cash-flow statement:

This section provides details of the cash that a company has generated in the last financial year from operation (cash-flow from operations or CFO). This section also includes details of cash used in making investments or received from selling investments (cash-flow from investing activities or CFI) and cash raised from financial institutions as borrowings or repaid to them during the last year (cash-flow from financing activities or CFF). Given below is the cash-flow statement of MUL for FY2013:

We can see that in FY2013, MUL generated Rs. 2,723.54 lakh (Rs. 0.27 billion) of cash from operations and raised Rs. 766.70 lakh (Rs. 0.07 billion) of cash from financing and used it for investing Rs. 3,586.26 lakh (Rs. 0.35 billion) in assets of the company. Thus, we can observe that MUL has funded most of its investments in FY2013 from its operations (aka internal accruals), which is a sign of healthy growth.

Further advised reading: Understanding Cash Flow from Operating Activities (CFO)

C) Schedules/notes to financial statements:

Schedules contain the detailed breakup of numbers shown in financial statements. They are an integral part of financial statements and are studied along with financial statements to get a better understanding of financial statements. For example, if we want to see the details of long term borrowings in the balance sheet of MUL shown above, we should refer to note/schedule no.5 of the annual report of MUL, for more details:

Thus we get to know the details of the lenders, their respective loan amounts, repayment schedules and the security offered for different loans availed by the company from its lenders.

If we want to see whether MUL has invested in a new plant/assets during the year, then we can see its details in the schedule/note on fixed assets:

We can see that the company has invested Rs. 1,493.94 lakh (Rs. 149.3 million) in the current year, which was mainly invested in building & premises and plant & equipment. It indicates that the company is probably investing in a new manufacturing unit. If we see the figures for the previous year in the last row, then we realize that last year the company had invested Rs. 1,772.80 lakh (Rs. 177.2 million) in its assets. This gives an investor an indication that the company is in the expansion phase and continuously investing in assets.

Schedules/Notes are very important and should be studied with patience and due care. The quality of schedules is an important reflection of the quality of management of the company. Warren Buffett says that if you are unable to understand the notes, it is because the CEO does not want you to understand them. A lot of information/financial jugglery is often hidden in schedules.

D) Related party disclosures:

Every company is required to disclose every transaction it enters into with its promoters and other related entities. A careful analysis of these transactions can reflect whether the promoter is using different transactions to transfer money from the company to itself. We should look at the transactions between company and promoter owned entities (POE, enterprises over which promoters are able to exercise significant influence). The presence of transactions like interest-free loans to POE, taking assets owned by POE on lease/purchase at prices higher than market value are some of the examples by which we can get a sense of promoters who are taking out funds from the company and gaining at the cost of minority shareholders.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

Thus, we can see that the annual report is one such document that can throw light on the status of the company, provide information to gauge its potential for future growth and provide insight into the character of the management of the company. It is the single most important document that every investor should read.

How much time does it take to read an annual report?

Query:

First of thank you for sharing your knowledge so freely with us sir. My respect for you has increased drastically after reading a lot of your articles and company analysis articles. I wanted to ask you:

1) On average how long does it take for you to completely read a single Annual report and make your notes for that particular year?

2) While analysing a particular company how long does it take for you to completely finish analysing that particular company mean its last 10 AR, credit reports other announcements of that company and making your notes about them?

3) Reading multiple annual reports of many is a tedious activity so do you take any breaks or do you continuously analyze a company for 7-8 hours or more at a stretch?

4) When you started reading an annual report from then till now currently has your speed increased? If yes what was your speed for reading a single annual report when you started and what is it now currently?

Thank you so much, Dr, for what you are doing for the investing community as a whole. May God bless you with great health and of course, seeing your analysis you will create a lot of wealth for yourself and your loved ones.

Author’s response:

Hi Chinmay,

Thanks for writing to us. We are happy that you found our work value-adding!

1) On average how long does it take for you to completely read a single annual report and make your notes for that particular year?

You would appreciate that annual reports come in varied sizes. We have read annual reports varying from 25 pages to 350 pages. So, obviously, the time taken will depend on the number of pages in an annual report.

It may take anywhere between 2-4 hours to read a common sized annual report of 175-250 pages if we are reading the annual report for a company for the first time.

2) While analysing a particular company how long does it take for you to completely finish analysing that particular company mean its last 10 AR, credit reports other announcements of that company and making your notes about them?

Once again, it depends on the amount of data/number of documents to be analysed. For Ashok Leyland Ltd, we had to read more than 100 documents including annual reports of the company since 2002, all available credit rating reports of the company and its subsidiaries, annual reports of the subsidiaries, numerous corporate announcements, QIP placement documents etc.

Therefore, it took us about 2 weeks to read all the documents and then write the article on Ashok Leyland Ltd. Out of this, writing the article took 3 days.

Advised reading: Analysis: Ashok Leyland Ltd

However, for a small-cap company with smaller sized annual reports, a couple of credit rating reports, 8-10 historical annual reports, it may take about 5 days to complete the analysis and write the article.

3) Reading multiple annual reports of many is a tedious activity so do you take any breaks or do you continuously analyze a company for 7-8 hours or more at a stretch?

Taking breaks is required to maintain the level of concentration/quality of work required to read the annual reports. We take breaks at will.

4) When you started reading an annual report from then till now currently has your speed increased? If yes what was your speed for reading a single annual report when you started and what is it now currently?

You would appreciate that with time and practice, every investor improves her ability to grasp more information from the annual reports in lesser time.

When we started reading annual reports, more than 10 years back, then I guess it might have taken almost a full day or more to read the average annual report sized about 70-80 pages during those time.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Related query: What should be the order of reading annual reports?

Dear Vijay

In what order do you recommend reading the ARs? The latest from older or older to the latest?

Thanks

Author’s Response:

Hi,

Thanks for writing to me!

An investor may read the latest annual report first to judge whether it is worth spending further time on the company. Once the investor has decided to analyse the company in-depth, then it is advisable to read the annual reports starting from the last year and then keep reading the annual reports of later years on a sequential basis.

Read: Understanding the Annual Report of a Company

Hope it clarifies your queries!

All the best for your investing journey!

Regards,

Dr Vijay Malik

Impact of new accounting standard (IFRS) / Ind AS on the financial statements & annual reports prepared under old accounting standards (Indian GAAP, IGAAP)

The transition of accounting standards from India GAAP (IGAAP) to IFRS (Ind AS);

How to analyse financials upon change from accounting method from Indian GAAP to IFRS (Ind AS)?

Hello Dr Vijay Malik,

I was trying to analyze and compare pre-and-post-FY2016 financial statements of a company and found many figures different. As I understand, this is because of the change in the accounting standards from previous Indian GAAP to Ind-AS. Therefore, this essentially makes them incomparable.

What is a better way to compare the last 5-7 years of financial statements since the standards, and hence figures, have changed? Even financial ratios would be incomparable.

Kindly guide.

Author’s response:

Hi,

Thanks for writing to us!

Companies provide the reconciliation of the change in financial data from GAAP to IFRS in the annual report of the year in which they have started reporting financial data as per IFRS.

For example, if a company has published its financial data as per IFRS in FY2018, then in the FY2018 annual report, it would disclose multiple tables, which will show the numbers as per GAAP in the first column, the changes after the adoption of IFRS in the next column and then the final numbers as per IFRS in the last column.

In the case of Mahanagar Gas Ltd, when an investor reads the FY2017 annual report, then from page 139 to page 143, the company has detailed the impact of Ind AS on its financials. The company has provided the reconciliation of its financial statements from earlier accounting standards (Indian GAAP) to new accounting standards (Ind AS, IFRS) including the reconciliation of the balance sheet (page 140), total equity, profit and loss statement (page 141) and total comprehensive income (page 142).

For example, see the reconciliation of the profit and loss statement of the company under IGAAP and Ind AS for FY2016:

Moreover, Mahanagar Gas Ltd has explained the impact of Ind AS on each of the items in the financial statements in the notes under the reconciliation segment. E.g. notes to reconciliation on page 142 of the FY2017 annual report:

You may read the complete analysis of Mahanagar Gas Ltd in the following article: Analysis: Mahanagar Gas Ltd

Therefore, we suggest that investors should read the annual reports in detail to understand the transition of financial data from GAAP to IFRS.

If upon reading the transition data in the annual report, an investor still has some queries, then she should contact the company directly for clarification/additional information about the reconciliation data.

Comparison of the new financial data with the past financial years will differ from case to case. An investor should first understand the transition of financial numbers from GAAP to IFRS for any year by reading the annual report in detail. After looking at the extent of the difference in the GAAP and IFRS numbers, an investor may decide whether the IFRS financial data for the company is comparable with the previous year’s GAAP data. If the differences are small, then the investor may continue to use sequential comparison. Otherwise, she may refrain from doing it.

In a nutshell, the essence is to first read the annual report to understand the transition/reconciliation of GAAP and IFRS financial numbers and then decide whether to do the comparison with past years or not.

Now let us understand the other important queries asked by investors, which prove helpful in improving the understanding of annual reports for all the investors:

How should an investor from non-finance background understand the business/accounting language used in the annual reports?

Hi Sir,

As per your recommendation, I am reading annual reports of multiple companies. However, I am facing a challenge to understand the language. Most of the companies write cooperate language, which I find difficult to understand as I am from a science background. Is there any best way to understand the annual reports?

Your suggestions are most welcome.

Regards,

Author’s response:

Hi,

Thanks for writing to us! We are happy to see that you are doing your own equity analysis and spending time and effort to understand different concepts.

The best way to learn about business language is to read many annual reports, which you are already doing. Therefore, you are on the right path. Whenever an investor comes across new terms, then she may use Google/Investopedia etc. to refer to find the descriptions of these terms. Moreover, with time and reading more annual reports, the strange terms will start becoming familiar. As a result, the time to read future annual reports will decrease drastically.

On our website, we have covered many accounting terms in our articles. Therefore, whenever you come across any new terms, then you may use the search feature of our website to see if there is already an article on that term on our website.

All the best for your investing journey!

Regards,

Dr. Vijay Malik

Related query:

More of a behavioural question. Every day, I try to read about the processes and books related to investing or blogs. But when it comes to reading the annual report or doing the fundamental analysis of any stock, I somehow lose patience or I find it very boring or I am not able to find it exciting and skip over some sections.

Would be great if you can share if you had similar experiences and how did you overcome that. How do I create the discipline in me? Looking forward to your response

Author’s Response:

Hi,

Thanks for writing to me!

Reading the annual report is not a choice but a necessity for any stock investor. An investor needs to understand this fact. If she is not reading annual reports, then knowingly or unknowingly she is hurting her development as an investor.

Regards,

How to interpret contingent liabilities

Sir, I would like to know how the contingent liability is seen by the market. I mean what is a contingent liability and does it affect the price of the stock?

Also, Sir, I would like to analyse a company based on the Free Cash Flow (FCF) it is generating for over 10 yr. period of time. I mean each yr. how much FCF it is generating.

How can we find the free cash flow of a company from Screener?

Many thanks

Author’s Response:

Thanks for writing to me!

It depends on what kind of contingent liability it is:

• Corporate guarantees given on behalf of subsidiaries should definitely be considered as debt.
• Performance guarantees given as part of contracts are a normal part of the business and are ok.

Therefore, there is no one way to deal with all contingent liabilities.

You may calculate capex by the following formula:

• NFA = Net fixed assets
• CWIP= Capital work in progress
• Dep= Depreciation
• Capex = capital expenditure

(NFA+CWIP) at Year-end = (NFA+CWIP) at the start of the year – Dep+Capex

Therefore,

Capex = (NFA+CWIP) at year-end – (NFA+CWIP) at start of year + Dep

You can calculate free cash flow (FCF) for any company as:

FCF = CFO – Capex

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Hope it helps.

Regards,

Related query: When contingent liabilities seem certain liabilities

Hello Mr. Vijay Malik. I recently bought Nitin Spinners Ltd so was checking again. I read that contingent liabilities is very high – approx. ₹250 cr. I missed this part earlier.

Read – Analysis: Nitin Spinners Limited

Also after reading about contingent liabilities, I think that all these are to be paid and decisions cannot go anyway in favour of the company. So, why do they mention these dues in contingent liabilities?

To me, these parts are looking like a debt. Is it cheating or did I read it incorrectly? I am not good at understanding this part. If you please give me a few minutes then you can dissect it easily.

(On Screener, I created a ratio “Contingent Liabilities to Sales” a few months back.)

Author’s Response: 

Contingent liabilities mean liabilities that the companies might need to pay in future; however, at this point in time, it is uncertain. Showing such liabilities under contingent is not cheating. Not disclosing it in the annual report is cheating.

Investors can read the details of these liabilities and interpret them accordingly. If investors believe that they would be crystallized for sure, as you have done in Nitin Spinner’s case, then you should add it to debt/liabilities and then analyse the company accordingly.

Regards,

Investors’ queries: Understanding the annual report of companies

How to interpret inflow and outflows in each cash flow segment (CFO, CFI and CFF)

Vijay,

Thank you for your comments.

I am having doubts with +ve & -ve numbers in CFO, CFI, and CFF as below –

# CFO:

• -ve:?
• +ve: company generated cash from operations

# CFI:

• -ve: company funding its expansion plans or investments by a mix of CFO & CFF
• +ve:?

# CFF:

• -ve: company repaid the debt
• +ve: the company took credit

Please clarify & correct me, if I am wrong in understanding.

Author’s Response:

Hi,

-ve CFO: the company is not able to generate surplus cash from operations. Possible reasons: either company is making losses &/or cash is getting stuck in working capital.

Read: Understanding Cash Flow from Operations (CFO)

+ve CFI: Company has liquidated its assets. Might be a sale of fixed assets or investments like MF etc.

CFF can be -ve due to dividend payments and +ve due to equity dilution as well.

Regards,

How to understand “Change in Inventory” expense

Hello Sir

1) I want to understand the ‘Change in inventory’ (CIN) expense in the financial statements. For example, let’s take Sanghi Industries Limited:

CIN is shown negative (₹24.22 cr) this quarter in the expenses section which means the expenses reduced and hence the Profit increased.

• Will this negative entry be included as an expense in the next quarter and which will mean a reduction in the Profits?
• Does this affect the stock price?

2) Does ‘Change in Inventory’ in negative mean that the inventory was not sold in that quarter?

Thanks

Author’s Response:

1) The raw material or goods that are purchased in a quarter may or may not be sold in the same quarter. If they are not sold in the same quarter and are available as inventory with the company; however, their purchase cost is included in the cost of goods consumed, then the value of the increase in inventory is deducted from the expenses.

Moreover, if the inventory that was already available at the start of the quarter, is sold during the quarter, then the value of the decrease in the inventory is added to expenses.

2) You are right that negative entry under inventory expense (CIN) means that the inventory was not sold in that quarter.

Regards,

Similar Query:

Sir,

I want to know what is “increase/decrease in stock in profit and loss statement” and also I want to know where to see inventories detail of companies quarter on quarter (QoQ) and whether inventories are increasing or decreasing.

Thanks in advance.

Author’s Response:

Hi,

Thanks for writing to us!

“Increase & decrease in stock” in the P&L arises in situations when the company sells a lower or higher amount of goods than what is produced from the raw material bought in a particular year.

If it sold a lesser amount of goods than the raw material it had bought, the remaining raw material/inventory leads to an “increase in stock”. As this increase in stock would be sold in future years and therefore is not an expense of the current year, therefore, the amount equal to the increase in stock is deducted from expenses of the current year.

On the other hand, if the company sells more goods in a year than the raw material it bought in that year, then it would mean that the company used some of the existing inventory to meet the sales demand in the year. The utilization of existing inventory leads to a decrease in stock. As this amount is over and above the money spent to buy raw materials in the year, it is added to expenses for the year.

Just to clarify that “Stock” means inventory.

Hope it clarifies your query.

All the best for your investing journey!

Regards

Vijay

The final dividend declared by the board is unpaid but there is no liability shown in the balance sheet (Impact of Ind AS/IFRS)

Dear Sir,

Please refer to the following sections from the annual report of a company:

In the cash flow statement, the dividend column is blank in cash flow from financing activities. Therefore, one can assume, they have not issued dividends this year.

However, in the Director’s Report, they have disclosed that the company had declared a dividend:

DIVIDEND:

Based on the Company’s performance, the Directors are pleased to recommend for approval of the members a dividend of ₹2.50 per equity share of ₹10.00 each (i.e. 25%) for the financial year 2016-17, to be paid on total equity shares of the Company. The dividend on the equity shares, if approved by the shareholders, may involve an outflow of ₹727.79 Lakh towards dividend and ₹148.16 Lakh towards dividend tax, resulting in a total outflow of ₹875.95 Lakh.

Moreover, many companies do not show any liability for dividends declared by them on the balance sheet.

Whys is it so? Please clarify.

Author’s Response:

Hi,

Thanks for writing to us! It is great that you are reading the annual reports line by line and making insightful observations. Such an effort is commendable.

A dividend outflow is shown in the cash flow statement only after the company pays the dividend amount to its shareholders by cheques/DD or by online bank transfers. Until the dividend money goes out of the company, it will not show in the cash flow statement.

Under the previous accounting standards, Indian GAAP (IGAAP), the unpaid dividend amount used to be shown as a current liability by the companies during the period between the declaration of the dividend and the actual payment to shareholders. However, since the adoption of a new accounting standard based on IFRS (Ind AS), this practice has undergone changes.

As per IndAS, unless a dividend is approved by the shareholders, it cannot be shown under liabilities. In the previous accounting standards, the companies could show dividends under liabilities on March 31, 2017, before the shareholders approved it in the AGMs in July/Sept 2018. However, now the new accounting standards direct that dividends cannot be shown as a liability unless shareholders approve it. Therefore, now we do not find any mention of the dividends declared by the board but unapproved by the shareholders, anywhere in the financial statements. Now a day, the annual reports contain information on such dividend declarations in the Directors’ Report only as a paragraph without creating any liability in the balance sheet.

Hope it answers your query.

All the best for your investing journey!

Regards,

Dr Vijay Malik

Basic and diluted earning per share (EPS)

Hello Sir

Every article by you is increasing the knowledge base of new investors. I find your articles more relevant and useful than reading a book of foreign writers (that too is mostly written in the 1960s and has reference to USA markets).

My question is whether one should take total outstanding shares for analysis or total authorized shares. If I understand right, then the warrants, if exercised, will be an addition to the total outstanding shares.

Also in the Debt to Equity ratio: is equity considered as only float equity or total outstanding equity?

Author’s Response

Hi,

Thanks for writing to us! It is nice to know that you have found the e-book useful.

1) Total outstanding shares for analysis or total authorized shares. If I understand rightly, warrants, if exercised will be an addition to the total outstanding shares.

EPS based on total outstanding shares is called Basic EPS, whereas the EPS after considering the impact of warrants etc. is called Diluted EPS. Companies report both the EPS in their financials. It is advised that diluted EPS should be preferred for analysis.

2) Also in the debt to equity ratio…equity considered is only float equity or total outstanding equity

We consider equity as “Shareholder’s Funds”, which includes equity as well as reserves and surplus.

Further Reading: Understanding The Annual Report Of A Company

Hope it answers your concerns.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Why do companies invest money in mutual funds

Sir, Looking at an annual report for 2013-2014, I found that it has ₹1.78 crores invested in equity and debt mutual funds. I find many other good and profitable companies like Control Print, Narmada Gelatins, etc. – also have investments in mutual funds and shares.

Why do these companies make such investments- just to keep their cash somewhere and gain returns?

My understanding is that the company should give out surplus amounts as a dividend or reinvest in its own business. Is it advisable to invest in companies that make investments in mutual funds and share markets?

Regards,

Author’s Response:

Hi, Thanks for writing to me!

I appreciate the important observation made by you about these companies.

I agree that ideally, a company should either reinvest or distribute its profits. However, many times, a company might not have the reinvesting opportunity immediately when the profits are generated and they might have investment plans some time down the line. Therefore, to temporary deploy the cash, they invest in alternate avenues like mutual funds.

Read: Understanding Annual Report of a Company

It is important to understand, how long this idle cash has been with the company. If it is many years, then I would question it. However, you should remember that one such company which kept on investing cash into other assets (like stocks etc.) is Berkshire Hathaway managed by Warren Buffett. Berkshire was a textile company, however, the return from its investment exceeded textile business returns and it became one of the best investment opportunities in the lifetime of mankind.

Hope it helps!

Regards

Why are security deposits present in both the asset as well as the liability side of the balance sheet?

Hi Dr Vijay,

I have a doubt regarding a company that I was analysing.

1) In the notes to the financial statements section, there is a note for “other long term liability” under which there is one entry called ‘security deposits’. What is this?

There is another ‘security deposit ‘ in the ‘other non-current assets’ section.

What is the difference between the two?

2) What are the trade receivables for a hospital? How can a hospital give its services to customers (patients) for credit?

Regards,

Author’s Response:

Hi,

Thanks for writing to us!

1) Security deposits in the balance sheet:

The deposits that a company has received from its customers/vendors are shown under liabilities.

The deposits that the company has paid to service providers etc. like security deposit paid to the owner of a building, which it has taken on rent for office/factory is shown under assets.

2) A hospital may have trade receivables from insurance companies if the insurance companies take some time for payment to the hospital after the claim is approved. The hospital may also have receivables if it has a tie-up with a corporate for treating its employees. The corporate employees may take treatment today and their employer may settle the bill after some time.

Further advised reading: How to do Business Analysis of Hospitals

Hope it answers your queries.

All the best for your investing journey!

How to get annual reports for a company when no public source has them?

Hi,

I rely on company websites for annual reports. I want to know how long it take normally for a company to update its website with its latest annual reports. For example, Amara Raja announced results on 24th May 2017 but still (19th June 2017) the annual report is not updated on their site. I was wondering whether this delay in the publication of the annual report is normal or if there is something unusual. The latest annual report is not available on MoneyControl or Screener yet as well.

What would be the best way to get hold of annual reports as soon as the annual results are announced?

Regards,

Related query:

Respected Vijay sir, where can we find the annual report of a company before the year 2010. In my Google search I am getting from report junction.com which is a paid service, can you please mention any sources other than that.

Author’s Response:

Hi,

Thanks for writing to me!

You may try finding the annual reports at 1) Company website, 2) BSE website 3) Moneycontrol website

Additionally, you may try google and see if the annual report has been uploaded by anybody on any other public source.

If you are not able to find the required annual report from any public source, then you may contact the company directly and ask them to send the annual report to you.

Read: How should investors contact Companies/Management for clarifications or additional information?

Companies usually send the annual reports to investors on request. We had an experience when we requested annual reports from Hitachi Japan and the company sent us hard copies of its annual reports to us by airmail. So, do not hesitate to contact the company directly to request its annual reports.

All the best for your investing journey!

Regards,

Vijay

Production quantity and sold quantity in the annual report

Vijay, I thank you for posting the business & industry analysis (BIA) concepts. It’s amazing and easy to understand. Please keep up the good work.

Please let me know where we can find the below information for the “Increase in Production Capacity and Sales Volume” section:

1. Production capacity (tonnes per annum)
2. Quantity sold (tonnes) (A)
3. Sales price per tonne (INR) (B)
4. Total sales (INR Cr. /10 Million) (A*B)

I couldn’t find it in the screener.

Related query:

Can you please show us where can we find the following information in the annual report of a company?

1. Production capacity (tonnes per annum)
2. Quantity sold (tonnes) (A)
3. Sales price per tonne (INR) (B)

Similar query:

Sir,

I find your articles very informative. I have a query regarding business and industry analysis. Not all the annual reports of companies provide data for production capacity. So in that case how does one compare sales CAGR with production capacity CAGR?

Read: How to do Business & Industry Analysis of Companies

Author’s Response:

Hi,

Thanks for writing to me!

Production capacity and quantity sold used to be disclosed in the annual reports until a few years back, I guess up to FY20012 if I am not wrong. Now companies do not have to compulsorily disclose it. However, many companies still disclose this data as part of corporate presentations, result presentations, annual reports etc.

Sometimes, an investor may get this data in credit rating reports as well.

Read: 7 Important Reasons Why Every Stock Investor should read Credit Rating Reports

Sales price per tonne is a calculated figure from Total Sales/Quantity Sold.

Hope it clarifies your query!

All the best for your investing journey!

Regards,

Vijay

How to find capacity utilization data for companies

Hello Dr. Vijay Malik,

First of all, I would like to thank you for creating such a useful pool of information and I must say your writings are very encouraging and extremely useful for a retail investor.

I am not sure if this is the right place to post my query but I found it to be a relevant place in a way so I am putting it up here. My concern is “How to get reliable information, especially on small-cap/mid-cap stocks”

I read your analysis and Q&A on Zenith Fiber although it is one year old and things might even change in a year’s time. But the key concern I thought was management not expanding the capacity. I thought I will check on the capacity utilisation levels currently and then see if they can push the existing assets to get more production or if they are maxed out and they definitely need to invest more to build up the extra capacity. The annual report (the latest available on Moneycontrol) didn’t mention anything about the existing capacity and/or future expansion plan.

Read: Analysis: Zenith Fibres Limited

When I googled this, I found a news item in Business Standard. As per this news, they were going to expand to 50% capacity in 2011. However, in the analysis details, I noticed that the capacity hasn’t changed in the last 10 years. Now, I couldn’t find any news item confirming that the above plans went up for a toss or couldn’t be executed for some reason.

It would be great if you can comment on the capacity issue of Zenith Fiber. Also, in general, if you can suggest any other source of reliable information apart from Moneycontrol, screener and company website to confirm such level of details which can really be crucial for our investment decision?

Thank you so much in advance for your time and your guidance!!!

Best Regards,

Answer:

Hi Abhishek,

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

I would not be able to go into the specific issue of Zenith’s capacity addition. However, let me tell you about the sources that can be used to assess the capacity expansion or utilization levels of a company.

1. The company’s annual reports of the period around the expected capacity addition would describe the progress and status of capacity addition plans.
2. Company website along with corporate presentations would mention about the capacity additions
3. Credit rating reports of the company around the period of capacity addition would comment on the funding plans of the company, progress of projects as per plan and cost overruns if any.
4. If none of the above sources provides the investor with the required information, then the investor should contact the company directly by calling/emailing the investor’s contact person (usually the company secretary).

Advised reading: How should investors contact Companies/Management for clarifications or additional information?

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Dr. Vijay Malik

Equity dilution and extinguishment of shares

Dear Dr. Vijay Malik,

Would like to thank you for providing clarifications to queries and for sharing your in-depth knowledge with everyone.

I have a few queries:

1. What is equity dilution and how it is going to help the company in a distress situation?
2. What is the extinguishment of shares?

Thanks,

Author’s Response:

Hi,

Thanks for writing to me! Happy new year to you and your family as well.

1) Equity dilution is raising funds by issuing additional shares. Companies may raise funds through debt or equity. When companies raise additional funds from equity, then the new shares, which are issued to raise the funds lead to a reduction/dilution in a stake of existing shareholders. This is the reason that it is called equity dilution.

Read: How to do Financial Analysis of Companies

2) Extinguishment of shares: whenever a company buys back shares, then it extinguishes/terminates/cancels these shares. This leads to a reduction in the overall number of shares of the company and as a result the earnings per share (EPS) of each remaining share increases.

Hope it answers your concerns.

All the best for your investing journey!

Regards

Unclassified shares

Sir,

I am privileged to be associated with you as I am a subscriber of your premium service “Peaceful Investing – Workshop Videos”.

I have some doubts while reading a balance sheet. These are as follows:

• What is an unclassified share?
• What is the reclassification of an unclassified share?
• Why do companies reclassify an unclassified share?
• What are the benefits to the promoter from the reclassification of unclassified shares?
• What are the benefits to the investor from the reclassification of unclassified shares?

Please help me out.

Regards,

Author’s Response:

Hi Jaywardhan,

Thanks for writing to us!

Companies have authorized capital, which they use to issue equity shares or preferred shares. Unclassified shares (US) are that part of authorized capital, for which it has not yet been decided whether they will be issued to investors as equity shares or preferred shares. Once the company decides, whether to use the US as equity shares or preferred shares, then this is called reclassification. It’s only upon reclassification of US into equity shares or preferred shares that they can be issued to other investors like an IPO or FPO or private placement.

Unclassified shares (US) provide an option to easily issue equity shares or preferred shares when the company needs to raise money as the company can do the reclassification of US and issue these shares to investors as it wants. The benefit to promoters, existing investors or the company seems the presence of choice to use the same share capital (US) for equity or preferred shares.

As per our experience, unclassified shares are not seen as a very common occurrence in companies. At the end of the day, if a company wants to raise money, then it will in any condition complete the necessary compliance procedures to issue new shares whether it has unclassified shares or not. Therefore, we do not believe that the presence or absence of unclassified shares has a huge impact on investment decisions.

All the best for your investing journey!

Regards,

Dr. Vijay Malik

Are reserves and retained earnings, the same?

I thank you very much for sparing your valuable time to reply to me.

Sir, in some of the company balance sheets, retained earnings are not mentioned. Can I consider the “Reserves” mentioned as retained earnings??

Are company reserves and retained earnings the same or different?

Author’s Response: 

Thanks for writing to me!

Reserves and retained earnings are not the same things. Retained earnings are a part of reserves, but reserves contain many other things as well. Reserves may contain retained earnings, the premium on shares issued, any increase due to revaluation of companies assets etc.

Retained earnings (RE) are the profits that are not distributed to the shareholders by dividends. You can calculate RE for any year by deducting (dividend + dividend distribution tax) from net profit. RE is effectively the part of the profit which a company invests in its own business.

Read: Understanding the Annual Report of a Company

Regards,

Does an increase in equity capital equal to money raised by the company

Hello Vijay,

Thank you for your support for beginners like me. I am getting in the right direction after going through your blog. I have a query again. Please clarify. The query is about share capital.

The Company completed its Initial Public Offering (IPO) pursuant to which 4,20,06,038 equity shares of the company of Rs.10 each were allotted at a price of Rs.47 per equity share.

As per above and the balance sheet, share capital will be 4,20,06,038 x 10 = 42,00,60,380. But the company is collecting 47 INR from the investors in that case share capital should be 4,20,06,038 x 47

What about the remaining 37 INR? Why we are multiplying with face value?

Also as per my understanding bonus and split will affect share capital, is that correct? Please confirm.

Thank you again.

Author’s Response:

Hi,

Thanks for your feedback & appreciation! We are happy that you found the articles useful!

Here are our views about your queries:

1. remaining ₹37/- is shown part of share premium account in the section “Reserves & Surplus”
2. The bonus increases the share capital as the total number of shares increases without any change in face value. The split does not have any impact on share capital as the increase in the number of shares is inversely proportional to the change in face value.

Further advised reading: Bonus Shares: Answers to Common Queries

Hope it clarifies your queries.

All the best for your investing journey!

Regards,

Vijay

Similar query:

Analysis: Avanti Feeds Limited

The difference between PAT and CFO is ₹28 cr whereas equity raised is ₹2.54cr. Can we relate these two?

Author’s Response: 

The equity raised of ₹2.54 cr. that you are referring to is the par value/face value of the incremental shares issued to investors. The actual amount raised is higher than par/face value. The difference between the actual investment value and par/face value is shown in the securities premium account as part of reserves and surplus.

Hope it clarifies.

What does demerger mean?

Dear Vijay sir,

Sir, I am invested in Sterlite Technologies Limited for the last one year. Today it announced its March quarter results. Results are promising and Sterlite Technologies Limited shows the potential for good growth in the future.

Today, it also announced the company restructuring plan, in which they are demerging Sterlite Power from Sterlite Technologies Limited.

Sir, my query is that I am not able to understand the implication of the demerger?

It will be helpful if you can guide me on this.

Thanking you,

Author’s Response:

Demerger means that some of the existing value of Sterlite Technologies Limited (parent), which is in the form of its power business (child) will be removed from it into a separate company.

The value of the power business (child), which would be removed from the shareholder of Sterlite Technologies Limited (parent) would need to be compensated. As compensation for this loss of value, the shareholders of parents are usually given shares of Child Company.

You need to analyse what is the form in which investors are being compensated by the management of Sterlite Technologies Limited for letting go of the power business and whether the amount of compensation/shares being provided is a justifiable price for the value, which is being let go in the power business.

Regards,

Importance of face value for investors

Sir, the face value of ₹10 or above is good or we can invest in companies with a face value of ₹5, ₹2 or ₹1 as well. I have noticed that all good companies like Page Industries Limited, Eicher Motors Limited or MRF Limited are with the face value of ₹10.

Author’s Response:

The face value does not make any difference in the stock analysis. An investor should be indifferent to the face value.

Regards,

Can we get receivables on trailing twelve months (TTM) basis

Hello Vijay Sir,

Is there a way to get receivable days on a trailing twelve months (TTM) basis? Where can I get it?

Author’s Response:

Hi,

You can calculate it twice a year. Once at year-end and another time after Sept quarter results, when trade receivables are disclosed in the summary balance sheet as part of results.

You would have to do it manually for Sept data.

Regards,

Vijay

Are tangible assets the same as property, plant & equipment?

Hi Vijay,

Just to clarify, some of the annual reports do not contain information on tangible assets but rather have information as property plant and equipment which seems similar.

Please let me know if net fixed assets = property plant and equipment (adjusted for accumulated depreciation)?

Author’s Response:

Hi,

Thanks for writing to me!

Every company would describe its accounting policies in a separate section. An investor should read this section to get clarity about the items included in the PPE (property, plant and equipment) section. Most of the time it is similar to fixed assets. However, there might be certain differences which the company would have detailed in its accounting policies section.

Regards,

Vijay

What do foreign exchange outflows consist of?

I was going through the annual reports of Shilpi Cables Technologies Limited; however, I could not understand one thing. Since the company exports finished products outside India, still, the foreign currency outflows are 3 times higher than inflows for the past few years (₹330 crores of foreign exchange outflows vs ₹110 crore inflow last year).

Can someone explain this to me?

Analysis: Shilpi Cables Technologies Limited

Author’s Response:

Hi,

Forex outflows would involve sum total of all the payments sent outside India including those for raw material purchases, principal & interest payment if the company has taken a loan in foreign currency, travel & consultation expenses, sales commissions etc.

You should read the annual report of the said company again to find out whether it has any other liability to be paid in a foreign currency other than raw material purchases.

Hope it clarifies your query.

Regards,

Vijay

Impact of new balance sheet presentation (FY2013) on current ratio

Hi Vijay,

Thanks a ton for this series, quite amazing and explains fundamentals quite simply. I have one query around the current ratio. I just checked a few companies from the Auto sector like Hero Motocorp, Bajaj Auto, Eicher and found that the current ratio for them is 0.8 currently. How does that impact, kindly share more insights around this.

Thanks

Author’s Response:

Hi,

Thanks for writing to me!

In recent years, due to the new companies act, the classification of balance sheet items have undergone a lot of change. Therefore, many items, which earlier did not use to be part of current liabilities, are now being included in current liabilities (esp. “other current liabilities” section).

Therefore, the current ratio needs to be seen in conjunction with the kind of item included in current assets and current liabilities.

I prefer to calculate current ratio as (Inventory + Receivables + Cash & equivalents + Current investments)/ (trade payables)

Therefore, I advise investors to calculate the current ratio on their own from the balance sheet section of the annual report and not rely on the ratio computed by financial websites like moneycontrol etc.

You should recheck the current ratios for the above companies by taking the above information from the annual reports.

Hope it would clarify your query.

Regards,

Vijay

Impact of stock splits on stock selection

Respected Vijay sir,

Can we buy fundamentally sound companies during stock splits irrespective of their margin of safety and irrespective that we already own some stock of the company?

Author’s Response:

Dear,

Thanks for writing to me!

1) Stock splits do not alter the fundamentals of the company. Therefore, stock splits are to be ignored as a factor affecting the investment decision

2) Margin of safety has to be looked into while making an investment decision.

Read: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

3) It is preferable to invest in the companies, which are already in the investor’s portfolio.

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Vijay

How to find out the usage of short-term funds for the long-term purpose by companies?

Hello Sir,

I wanted to know how we could see whether short-term resources have been used for long-term purposes. I understand the sources of both but how can I check whether one is used for the other & vice versa.

Thank you.

Author’s Response:

Hi,

Thanks for writing to us!

There are a few finer nuances in the assessment of the usage of short-term resources for long-term purposes. However, as a thumb rule, the investor may compare non-current assets (i.e. Total assets – current assets) with non-current liabilities (i.e. total liabilities – current liabilities).

If the non-current assets are greater than non-current liabilities, then it is highly likely that short-term resources (i.e. current liabilities) have been used to fund long-term assets/purposes (i.e. non-current assets).

Please note that this general rule works in most cases. However, various kinds of grouping/reclassification of items in the balance sheet may require finer details like reading notes/schedules to financial statements to have any definitive opinion.

Moreover, auditors also point out the usage of short-term resources for long-term purposes in their report in annual report.

All the best for your investing journey!

Regards

Dr Vijay Malik

An unlisted company taking over a listed company

Hi Vijay,

I am doing a detailed analysis of Gujarat Automotive Gears Limited (GAGL). Though the fundamentals and valuations were satisfactory for me, HIM Technoforge – an unlisted company is likely to acquire GAGL sooner. It seems this acquisition is a win-win situation for both companies in terms of business developments.

My concern is what will be the likely scenario if an unlisted company acquires a listed company? Will they continue in the exchange / de-list / original promoters will buy back before closing the deal?

Is it good to enter the company at this stage (If valuation permits) or wait till to see the developments without burning our fingers?

Thanks,

Author’s Response:

Thanks for writing to me!

The news of HIM taking over GAGL has been doing rounds since 2013. I do not know whether any acquisition has yet happened or not. Anyway, I do not buy stocks based on the tentative acquisition scenario. If GAGL is a good company, I would invest. If it’s not, then I would not invest.

An unlisted entity, if it takes over a listed entity, then it would acquire certain shares of promoters/controlling shareholders. Shares of listed entities would keep trading. A substantial acquisition may trigger a mandatory open offer. The company may subsequently decide to delist or remain listed. There is no set path, which companies follow.

If your analysis indicates that GAGL in itself is a good business, then you may think about investing it.

Analysis: Gujarat Automotive Gears Limited

Regards,

Dr Vijay Malik

How to find assets/land bank owned by any company?

Hi Sir,

I want to know how we can find out the amount of land bank that any company has got. People say BEML has 30,000 acres of land etc. So for any company where can we these values? I tried but couldn’t find a clear way.

Thanks in advance.

Author’s Response:

Hi,

Thanks for writing to us!

The land bank is usually present in the detailed schedules/notes to financial statements in the fixed assets section. However, the value of the land in this section is usually the purchase cost value. Many times companies revalue their land assets over time and then this section contains the revalued land price. However, companies usually do not provide the granular details of their land holdings in the annual report.

Analysts keep on tracking the land dealings of companies as reported in the media, get more details about such land holdings from the management in their personal meetings and by asking questions in the conference calls. Many times, companies provide more details about landholdings in their corporate presentations. Many times credit rating reports might include more details about landholdings.

Further advised readings: 7 Important Reasons Why Every Stock Investor Should Read Credit Rating Reports

Therefore, there is no one defined place where investors may get the details of landholdings. It is only possible by closely tracking the developments of the company and reading all the public sources/documents that an investor may get more insights into this aspect.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Are reserves & surplus and cash & bank balances the same? How should investors correlate them?

Hello Dr. Vijay Malik,

While looking at the annual report of a company, I could not tally the amount at Reserves and Surplus to Cash and Bank Balances.

The Director’s Report of the company mentions that it has transferred Rs.1,000 Lakhs to the general reserves. The company has reiterated the same on Note 4 for the Balance Sheet.

However, in the Assets section of the Balance Sheet, the “Cash and cash equivalents” does not show it. Can you please explain where the company has been moved its cash?

Was the cash, which was moved to Reserves and Surplus already spent in the year or is it moved to any other account?

I do not have any accounting background, so could not understand it.

Thanks,

Author’s Response:

Hi,

Thanks for writing to us!

We have provided an example of fund flow analysis in the following article:

Fund Flow Analysis: The Ultimate Guide

The increase in reserves and surplus is a source of funds whereas the increase in cash is the usage of funds.

If the increase in reserves is the only inflow and the company has not used this fund for any other purpose but only holding it as cash, then the investor would find that increase in reserves is equal to an increase in cash balance.

However, in real life, companies get money from many other avenues than only reserves and surplus (i.e. profits) and use it for many activities other than holding it as cash.

The fund-flow analysis may show that the company has received funds from sources like:

• Reserves (net profits – dividends paid)
• Inventory (used in creating goods for sales)
• Fixed assets (depreciation – noncash expense in P&L)
• Long-term loans & advances (recovered money back, sold long financial products)

The analysis also indicates that the company may have used the funds during the period on the following items:

• Payment of long-term debt
• Payment of short-term debt
• 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)
• Payment of trade payables to the vendors
• Providing credit to customers (trade receivables)
• Deposits in banks (cash and equivalents)
• Given as short-term loans and advances

You may notice the many sources of funds and many usages of funds. This would help you appreciate that increase in reserves is only one out of many sources of funds and cash is only one out of many usages of funds.

Hope it answers your queries.

All the best for your investing journey!

Regards,

Dr Vijay Malik

Similar Query:

Hello Sir,

Considering GAGL in management analysis (Part – 1), I am not able to differentiate between reserves & surplus and cash + investments (CI+NCI).

Is reserves & surplus notional value whereas cash + investments (CI+NCI) is actual liquid cash available with the company?

Author’s Response:

Hi,

Thanks for writing to me!

Reserve & surplus is a source of funds whereas cash & investments are the usages of funds.

For example, it might be that a company has ₹100 as reserves (e.g. from equity infusion or from profits) and is holding all this amount as cash, then both reserves and cash would be almost equal at about ₹100 cr.

In another case, if the company invests the entire ₹100 from its reserves (e.g. from equity infusion or from profits) into plant & machinery, then the reserves and fixed assets would be almost equal at about ₹100 cr and there would be nil cash.

There can be other situations apart from the above two hypothetical situations cited above.

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Dr. Vijay Malik

What should an investor interpret when a company delays the deposit of undisputed statutory dues?

Sir,

I am going through one of the older annual reports of a company. It has a comment from the auditor that the company has not been regular in depositing undisputed statutory dues including provident fund, investor education etc.

How big is a bummer an observation like this?

A line of guidance will be much helpful.

Author’s Response:

Hi,

Thanks for writing to us!

A delay/irregularity in depositing undisputed statutory dues means that the company has not deposited the taxes on time, which the company agrees that it is liable to pay. For example, the services tax collected from customers, TDS collected from vendors, income tax payable, excise/sales tax etc. An auditor needs to comment on the status of payment of statutory dues in its report of the company.

It indicates that the company might be facing a liquidity crunch.

Therefore, if the company has a lot of debt, then it might be a sign of a cash crunch in the company.

Hope it answers your queries.

All the best for your investing journey!

Regards,

Dr Vijay Malik

Understanding the impairment of intangible fixed assets for EPC contractors

Hello Dr Malik,

I wish to seek some clarity on “other intangible assets” with respect to this statement that you mentioned for KNR Constructions Ltd:

An investor would notice that the projects on whose sale price, the company has to take a loss were operational annuity projects. Therefore, the reported financial numbers in the profit & loss statement of an infrastructure/EPC player may not communicate its true financial position/money making ability for its shareholders.

However, in the FY2017 annual report (page 134), it is mentioned that the impairment “is shown under exceptional items in the statement of profit and loss.”

(1) Given this note, the profit & loss statement (P&L) does show the impairment loss. Right? Then what exactly do you mean when you say the P&L may not communicate its true financial position for its shareholders?

(2) I do not exactly understand the term “other intangible assets” in consolidated financials, especially the term “carriageway” used for intangible assets in Notes to Financial Statements (Note 3.3, page 165). Does it mean all contracts under HAM & BOT model? Therefore, P&L transactions (revenue and expenses) only include EPC-related transactions.

Regards,

Author’s Response:

Hi,

Thanks for writing to us! We are happy to see that you are doing your own equity analysis and spending time and effort to understand different concepts.

1) The impairment in the P&L will only be present for the year in which the company decides to recognize the loss/diminution of value. However, an investor would acknowledge that the diminution of value might not have happened in a single year. Many times, companies keep poorly performing projects/assets in their balance sheet at unimpaired/original value for many years before the impairment becomes so significant that it can no longer be avoided. In case, such period of delay in recognition may extent even in decades.

Therefore, an investor should keep in mind that at any point in time, there might be projects in the balance sheet shown at unimpaired value, which actually may have witnessed significant impairment in true value.

2) Most of the companies explain their usage of accounting norms in the “Significant Accounting Policies” section of the annual report. Referring to this section also may help an investor understand the conventions being followed by any company. In case, an investor needs further clarity regarding these accounting terms and conventions, then we would request her to take an opinion from a chartered accountant as only he/she may be in the best position to explain them.

All the best for your investing journey!

Regards

Dr Vijay Malik

How to find out if a company has diluted its equity in the past?

Dear Vijay,

How do we know if a company has been diluting or is diluting its equity? I mean which data point should we look at to determine if equity dilution is happening and if yes, by how much?

In your excel template, we have “Share Capital”. If it increases by 20% this year with respect to last year, does it mean equity dilution has happened and its magnitude is 20%? And similarly, reverse with buyback?

If you can provide an example, it will be helpful.

Thanks

Author’s Response:

Hi,

Thanks for writing to us!

You are right that the dilution of equity, as well as its extent, is measured by the way of an increase in share capital (paid-up share capital). The share capital of any company increases because of the following activities:

1. Issuance of new shares either by way of IPO/FPO/preferential allotment/exercise of ESOPs/warrants etc. All these actions lead to equity dilution because when these new shares are issued by the company for allotment to entities in such transactions, then the percentage shareholding of existing shareholders reduces.
2. Issuance of bonus shares. This action does not lead to dilution as all the existing shareholders get an equal proportion of new shares so the percentage shareholding of all the promoters remains the same both before and after the issuance of bonus shares.

The share capital decreases because of the buyback of shares.

Therefore, it becomes important that an investor should keep monitoring the changes in the paid-up share capital and in case there is an increase in any period, then she should check the annual report to find out if it was due to the issuance of new shares (dilution) or issuance of bonus shares (non-dilution).

In case, an investor wishes to read the case study of a company whose business has been very cash consuming and as a result, the company to resort to equity dilution multiple times in the past to survive, then she may read our analysis of IOL Chemicals and Pharmaceuticals Ltd.

Read Analysis: IOL Chemicals and Pharmaceuticals Ltd.

All the best for your investing journey!

Regards

Dr Vijay Malik

Corporate social responsibility (CSR) commitments: How to interpret non-spending on CSR by the companies?

Sir,

‘GIC Housing Finance’ in FY2017-18 did not spend even a single rupee on corporate social responsibility (CSR) activities out of the prescribed CSR amount of ₹3.8 crores. Although there is no legal compulsion to do so, however, still what can we deduce from it about the company and its management?

Thanks

Author’s response:

Hi,

Thanks for writing to us!

Many times, it happens that a company is not able to spend part/full money on CSR in a particular year. It might be a genuine case of not finding good projects to spend CSR money or it might be a lack of priority for the company to spend CSR money. However, most of the companies spend such overdue money on CSR in future years.

We believe that investors should check for similar instances in the past. In case, in the past, any company faced similar circumstances, where it could not spend money on CSR in any particular year, then what did it do? Did it spend the money in the next year?

In case, the investor notices that the company spent the CSR overdue money in the next year, then it might be a genuine case.

Investors will get most of this information in the annual reports of the company.

In case, investors find that any company is not spending money on CSR at all year after year despite being legally required to do so, then investors may write to the company directly to seek clarifications about it. Any interpretations should be made after the response from the company is received.

The following article will help investors in contacting the company for clarifications:

How should investors contact Companies/Management for clarifications or additional information?

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr Vijay Malik

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Future articles in this series would build upon the understanding of the annual report to further the discussion on financial, business & industry, management and valuation analysis of companies. We would learn in detail about the concepts and parameters of such analysis by applying it to the analysis of a sample company.

I would be happy to learn about your feedback on this series of articles and your learning from reading annual reports. You may share your inputs in the comments section below.

Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.