Introduction and Course

Plan

Grubman Story?

Course Objectives
To strengthen the understanding of the concepts on
Business analysis and Valuation; and its application.
To use financial statement information in business
analysis and valuation, and
To value at least one Indian firm
We will be integrating our knowledge of accounting
analysis, strategy, and finance to understand
how businesses work?
how they generate value? and
how the value generated is captured in financial statements?

Pedagogy
Pedagogy: Lectures and
Discussions, Projects and
presentations on Indian Companies;
Case analysis.
Pre-requisite: Sound understating
of accounting analysis, Financial
analysis and Strategic analysis,
Accessing data from CMIE Prowess
and basic knowledge of spreadsheet.

Topics to be Covered
Understanding the Financial Statements
Framework for Business Analysis and Valuation
Tools for Business Analysis
Strategy analysis
Accounting analysis
Financial analysis

Forecasting
Valuation theories & concepts
Valuation Applications
Equity analysis
Credit analysis

Reading & References

Text:
Business Analysis and Valuation: Text and
Cases; Palepu, Healy, Bernard; 3rd Edition;
Thomson

Reference:
Financial Statement Analysis and Security
Valuation; Penman; McGraw Hill
Investment Valuation; Damodaran; 2nd Ed;
Wiley

News Articles and Research Papers

Grading

Assignments & Quizzes 20%

Project Report & PPT 30%
Case Studies 20%
End-Term Examination 30%

Team Project
Team of four
Select an Industry and at least two companies
No more than two teams on one Industry
No group can work on same company
First come, first serve basis

Compare the two companies

Analyze the business(es) of the companies

Analyze the financial statements (3-5 years): Ratios,
common size, comparative
Develop a set of assumptions and forecast the financial
statements for minimum of next 2-3 years
Apply multiple valuation models and recommend buy
or sell

Use PROWESS
Submit a report (8-10 pages) & PPT (10-15 min)

Industry Choices

Cement
Steel
Four Wheeler
IT
Tyre
Capital Goods
Chemical

Retail
Non-ferrous Metal
Paint
FMCG
Telecom
Pharmaceuticals
Consumer Durables
No financial sector, Real Estate, Mining, Refinery

er Evaluation: Efforts and Contribution (max: 10 give reaso

CR

Framework for Business Analysis and Valuation using

Fin. Stmt
What to look at in business analysis and how to use this information in
valuation?

Agenda
Fin. Stmt: who is interested & for
what?
Information asymmetry and fin. stmt.
Business activities to fin. stmt
How business intermediaries use
these statements

Information Sources
Quantitative

Qualitative

Financial statements
Industry stats.
Economic Indicators
Regulatory filings

MDA
Letter from Chairman
Press notes
Financial press
Web site

Users of Fin. Stmt. Information

Equity Investors

Litigants

Investment analysis

Management performance evaluation

Debt Investors
Probability of default
Determination of lending rates
Covenant violations

Management
Strategic planning
Investment in operations
Evaluation of subordinates

Employees
Security and remuneration

Disputes over value in

the firm

Customers

Security of supply

Governments

Policy making
Regulation
Taxation
Government contracting

Competitors

Fin. Statements: Answer

many Qs
Security analyst
How well is the firm Im following performing? Did
the firm meet my performance expectations?
What is the value of the firms stock given my
assessment of the firms current and future
performance?

Credit analyst
What is the credit risk involved in lending a
certain amount to a firm? How well is the firm
managing its liquidity and solvency? What is the
additional risk created by the firms financing and
dividend policies?

Fin. Statements: Answer

many Qs
Corporate manager
Is my firm properly valued? Is our investor
communication programme adequate on this?
Is this firm a potential takeover target? How
much value can be created if we acquire this
firm?

Management consultant
What is the structure of the industry in which
the firm is operating? What strategies are
pursued by various players? What is the
relative performance of different firms?

How Capital Mkt Works?

Savings

Communication by
entrepreneurs to
investors may not
be credible!

Busines
s Ideas

What if half the

business Ideas
are BAD?

Role of Financial Reporting in Capital

Mkt.
Information & Incentive: Lemons Problem
Emergence of intermediaries to help
investors
Info. Intermediaries add value
Enhancing credibility of financial reports
Analyzing the information in the financial
statements

Fin. Intermediaries use these

information
To analyze investment opportunities
Supplement these information with other
sources of information

How Capital Mkt Works?

Savings

Financial
ntermediaries
VC firms
Banks
MFs
Insurance cos.

Information
Intermediarie

Busines
s Ideas

Auditors
Fin. Analysts
Rating agencies
Fin. press

Financial reporting plays a critical role in the functioning of capital marke

From Business Activities to Fin. Stmt

Business
Environme
nt
Accounting
Environme
nt

Business
Activities
- Operating
- Investment
- Financing
Accounting
Systems
- To present
business
activities in
monetary
forms
Fin.
Statements

Business
Strategy

Accounting
Strategy

Financial Statements Reflect Business

Activities
Planning
Investing

Operating

Current:

Cash
Accounts Receivable
Inventories
Marketable Securities

Noncurrent:
Land, Buildings, &
Equipment

Patents

Investments

Assets

Balance
Sheet

Sales
Cost of Goods Sold
Selling Expense
Administrative Expense
Interest Expense
Income Tax Expense

Financing
Current:

Noncurrent:

Net Income

Income
statement
Cash Flow
Statement of
Cash Flows

Notes Payable
Accounts Payable
Salaries Payable
Income Tax Payable
Bonds Payable
Common Stock
Retained Earnings

Liabilities & Equity

Balance Sheet

Statement of
Shareholders
Equity

Accounting System
The quality of information is determined
by the Accounting system
Three important features:
1. Accrual accounting
2. Accounting standards & auditing
3. Managers reporting strategy

1. Accrual accounting
Fin statements are prepared on accrual
basis rather than cash basis
Revenue
Revenue recognition is governed by the
Realization principle
Revenue should be recognized when
The firm has provided all, or substantially all, the goods
or services to be delivered to the customer, and
The customer has paid cash or is expected to pay cash
with a reasonable degree of certainty

Net Income?

1. Accrual accounting
Accrual accounting is subjective & relies on
assumptions

Deals with expectation of future cash flows

Relies on a variety of assumptions
How good are the assumptions?
How is responsible for these assumptions?

2. Accounting standards & Auditing

The reporting structure are complex
Managers performance (profits) is reflected in
Accounting numbers
Managers may use their accounting discretion
(accounting conventions) to distort financial
numbers
Conservatism/ Measurability

Accounting standards (GAAP) control the degree

of distortion
May get rigid

Auditing can limit biases and improve quality of

accounting information

3. Managers reporting strategy

Managers choice of accounting & disclosure
policies affects financial statements
Regulations usually prescribe minimum
disclosure requirements
Competition hinders from superior disclosure
Do not disclose proprietary information

Quality of financial information varies across firms

and across time, hence challenging to do
business analysis

How do we get True information?

Effective financial statement analysis
How do we do this? - Use
knowledge on firms industry
firms competitive strategy

Successful analysts have at as good an

understanding of the business economics as do
firms managers
Need to understand the economic consequences
of
Investment decisions
Operating decisions
Financing decisions

Business Analysis
Financial Statements
Managers superior
information
Estimation error
Distortion from a/c choices
Other public data

Business Application
Security analysis
Credit analysis
M&A analysis
General business analysis

ANALYSIS TOOLS
Business
Strategy
Analysis

Accounting
Analysis

Financial
Analysis

Prospective
Analysis

Business strategy analysis

Identify key drivers of profit; and business
risks
Qualitative assessment of a firms profit
potential
Can a firm sustain its competitive
advantage?
Is the current profitability sustainable?
A good analysis of business enables one to
make a sound assumption in forecasting
the future performance

Accounting analysis
Evaluate the degree to which a firms
accounting captures the underlying
business reality
What kind of distortion are there and what
is the degree of distortions?
Can we re-look at the accounting
numbers and create unbiased data?
Accounting analysis helps in financial
analysis

Financial analysis
Evaluate current and past performance
and assess its sustainability
Skills required:
Systematic and efficient
Use of financial data to explore business issues

Tools:
Ratio analysis: product market performance &
financial policies
Cash flow analysis: liquidity & financial
flexibility

Prospective analysis
Forecasting a firms future
Techniques:
Financial statement forecasting and
Valuation

Business Analysis using Fin. Statements

Financial Statements
Managers superior
information
Estimation error
Distortion from a/c choices
Other public data

Business Application
Security analysis
Credit analysis
M&A analysis
General business analysis

ANALYSIS TOOLS
Business Strategy
Analysis
Generate performance
expectations through
industry analysis &
competitive strategy
analysis

Accounting
Analysis
Evaluate
accounting quality
by assessing

Financial
Analysis
Evaluate
performance
using ratios and

Prospective
Analysis
Make forecasts
and value
business

More on Qualitative Analysis