The next and the most obvious step in decoding the financial statements is understanding how to analyze the Profit and Loss or Income statements of a company. While the Balance Sheet shows the financial position of a company, an Income Statement shows the financial performance and a summary of all the transactions made in the year.
The income statement has always been the most important part of Fundamental Analysis. Prediction of future prices and determining a target price is majorly based on the income statement.
By Definition, "The income statement also called a profit and loss statement is a report made by company management that shows the revenue, expenses, and net income or loss for a period".
We shall continue our analysis from where we left it. We will study the yearly (FY 18-19) profit and loss statement of Bata India Limited in order to know how to read and analyze a profit and loss statement. We will take a similar approach as we did for the Balance Sheet, first the basics, and then the analysis.
The given statement is a comparative vertical profit and loss statement. A typical income statement has a title similar to that of a balance sheet. However, this statement follows the flow concept and hence shows the transaction "for" a period and balance sheet follows a stock concept and hence shows the items "as on" date and not for a period.
Next, it has three columns one for particulars and two for the amounts belonging to different time periods. It also has the reference section for notes related to specific items.
The income statement is broadly divided into two parts:
Revenue: This is the first part of the statement that involves incomes from its main operations as well as other sources. Other sources involve the sale of assets, interest income from
investments, and other miscellaneous incomes.
Expenses: It involves all the expenses made while running the business, including operating and non-operating expenses.
i. Operating Expenses:
It includes, the cost of materials/goods sold refers to the combined cost of purchasing and processing the sold goods. Other items include the changes made to the inventory, purchase of stocks, and the excise duty.
ii. Non-operating Expenses:
It includes expenses that aren't related to the production or procurement of goods, like the salary to employees, depreciation of assets, finance costs like the interest on loans, and other miscellaneous activities.
Lastly, the profit before the tax is calculated by subtracting all the revenues from all of its expenses. Further, the tax that is paid during the year is deducted to find the profit for the year. Other incomes and expenses that may not arise every year and are due to changes in accounting techniques and standards are then deducted or added accordingly.
Kindly note that the format for the profit and loss account remains uniform for all the companies and some items may differ due to differences in business and approach.
Now, let us look at analyzing the statement. As mentioned in the previous post that to analyze any statement one must look at least at the five-year data. Hence, I downloaded a detailed income report from screener and made some calculations in the sheet itself.
While there are changes in format from the actual statement, the numbers are accurately represented in most cases. However, since the screener is a third-party website one should always tally it with the actual report.
The first and the formest thing that we shall focus on is the trend the revenues and the profits of the company follow. Hence, I have calculated the y-o-y revenue growth and operating as well as net profit margins.
The revenue growth for Bata was praiseworthy until the FY 2016-17 when it showed degrowth. Hence, we need to ascertain whether such an event has had a long-term effect on the company. While the revenues clearly show that it took the company almost 3 financial years to get back to their normal levels. It must be fresh in our memories that 2016 was the year when the country demonetized most of its currency affecting the operations. Soon after which GST was rolled out in the next year. The company has attributed the fall in revenues to this reason. The good news is that the company has recovered from it and is growing at a faster pace and hence can be concluded that it did not have a permanent impact on the company.
Operating margin is the percentage of profits in its revenues. Operating margins also show a similar trend as seen in revenues. Kindly note that we skipped the expenses part as the operating profit margin takes into consideration any effect of expenses. While demonetization and rolling of GST were trying times for the Indian economy the operating and net profit margins of Bata India did not fell significantly. Moreover, it started rising immediately to reach normal levels. This shows that the company has proper risk management strategies in place and controlled its cost during that period. Good top-level management, strong business model, and strong market hold are a few conclusions that can be made from the above analysis.
Analyzing the non-operating items is an easier task, as they follow a trend in most cases until there are developments like expansions or raising funds, etc. When we take a look at other incomes, they have a very less contribution to the actual revenues of the company. This is seen as a good sign as it shows that the company is not majorly dependent on other non-consistent and non-operating incomes. Sudden increases in these incomes can be attributed to the realisation of investments and assets. Depreciation and amortization has also maintained their normal levels for quite a long time. An increase in such an item can indicate expansion through machines, factories, or properties. Similarly, the finance costs have also been consistent since FY 2011. An increase in such an item can be due to raising funds due to loans or debentures.
These trends in the non-operating item show that the company has managed its costs effectively and still gave a consistent y-o-y increase in its revenues and profits giving a good signal to the investor.
The scope of manipulations is the most in case of non-operating expenses. While we could not find any in this case, abnormalities found here should be researched thoroughly.
Lastly, the taxation also needs it to be analyzed, yes you read it right. The percentage of tax paid by the company shows the lobbying skills and the amount that the company is finally able to give to its shareholders. The company has maintained a tax percentage range of 29%-33% with a few outliers. While the percentage is in a good range given the corporate tax in India 30%, however, some companies manage to bring it down to 25%. Some of the reasons for that could be powerful lobbying, industry benefits, etc.
Earning per share is the most important indicator in an income statement. It is the profit divided by the total number of shares of the company. It shows what each shareholder has gained through the operations of the company in the current period. An increase in EPS increases the chances of dividends and boosts the confidence of investors in the market. EPS is analyzed in comparison to the market price of the share. Such a ratio analysis (P: E) will be done in detail in future posts. However, Bata has maintained as well boosted its EPS over the years in line with its revenue growth giving a good signal.
IMPORTANT NOTE: During this analysis, we did not take into consideration the income statements of the competitors as well as the industry levels. If the average revenue growths and profit margins are less then industry averages then that can be a red flag for the company and vice versa if the averages are more. Hence, industry analysis is also equally important.
In Conclusion, Bata has given us good signals from such an income statement, and investors can put their trust in the company when it comes to effective cost management and revenue growth. Taking this statement as the basis we predict future prices which will be explained in further posts.
Here, we end our analysis of the profit and loss statement. We follow the same strategy as we did for the balance sheet:
Look for Abnormalities
Find its reasons
Identify the trends
Thanks for staying till the end, stay tuned for more blogs!
y-o-y: year-on-year
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