In previous blog “How to perform Fundamental Analysis in share market” you have seen how valuation of equity shares is done using –
Present value model
Relative value model
Moving ahead in this blog we will see how fundamental analysis can be done by going through Financial Statements.
Valuation through Financial Statement
Introduction – Financial statements are one of the important indicators and basis of all business. From which sources the company is generating income, what are its expenses, how efficient is it in using funds, debtors and creditors, assets and liabilities, profit and loss etc. These statements are presented in annual reports of the company vis-à-vis income statement, balance sheet, and cash flow statement. One can also get an overview of Indian stock market and the upcoming trends of sectors.
- Income statement
One can know income (revenues) and expenditure for a period of one year through income statement of the company. Profit generated can be arrived upon by deducting expenses from income.
Stability and future growth potential of income and expenses should be looked into while analyzing the income statement. One should analyze a company from the income generated through its core business. Income so generated will be stable and truly represent company’s efficient operations, and not through its income from other sources. Income from other sources cannot be stable.
If income is the important part of the business so are its expenses. One should look into categories of expenses made by the company and their recurrence and is it at its minimum level. They should be of necessity and not wasteful in nature.
- Cash flow statement
Cash flow in and out of the company shows the liquidity of the company. Company activities are divided under three heads – operating, investing and financing. Companies will be best placed if they can generate enough cash from operations so as to finance their investing activities. That is able to generate their own funds without depending on external sources for financing.
- Balance Sheet
To make money in Indian stock market one should minutely go through the balance sheet, profit, and loss account of peer industries in that sector. The balance sheet reflects the state of assets and liabilities of the business entity at a particular date of time (usually year-end or quarter end) and not over a period of time. It gives a snapshot of year-end and not the video of the whole year.
The income generated from assets should be more than the amount the business has to pay as liabilities than only it will make a profit.
You should try to figure out from balance sheet the nature of assets and their future income-generating capacity, and whether the debt is sustainable or not. If the debt is high and beyond the company’s capacity to repay than it is in the dangerous position. It is better to sell shares of such company, make profit or book loss earlier and exit.