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Introduction to Fundamental Analysis

Introduction to Fundamental Analysis

by Brands HelpL!ne

Introduction to Fundamental Analysis (FA) is a comprehensive study of business. When an investor wants to invest in a business for the long term (3-5 years), it is important to understand the business from various perspectives. Fundamental analysis examines economic, financial, qualitative and quantitative factors associated with a stock. It conjointly studies the economic information, performance of its peers, company’s financial statements etc.

Interpreting financial statements

Interpreting monetary statements is vital to know the monetary health of a corporation. The 3 major monetary statements area unit the Profit & Loss Account (P&L), Balance Sheet and Cash Flow statement.

P&L Account

P&L account reflects the operational performance of the corporate in a very given year. The operational performance shows the company’s financial gain, expense, and hence its profitability can be derived from this statement. P&L accounts area unit necessary for each company and area unit discharged quarterly.

How does it look like?

Proforma of Profit and Loss Account (P&L)

Proforma of Profit and Loss Account (P&L)

Revenue from Sale

This is the total value of items sold by the company. Revenue is recognized when an item is shipped and not necessarily when cash is received in lieu of the item.

Other Income

Any other form of income of the company including interest income on the cash that it holds in banks, investment returns on mutual funds, dividend income from subsidiaries etc is recorded here.

Cost of Goods Sold

The cost of all materials consumed and of the workers concerned in producing so as to supply the products that were sold-out throughout the amount.

Sales, General and Administrative Expenses

These embrace the value of maintenance of plant and instrumentality, cost of maintaining a head office and regional offices, employee costs, marketing and advertising expenses etc.

Other Expenses

These embrace transportation prices, power and fuel, loss on foreign currency movements, impairment losses on assets and businesses, restructuring charges like cost of laying off workers etc.

Earnings before Interest, Tax, Depreciation and Amortization (EBITDA)

This is the best measure of the profitability of the company’s operations. This is the best approximation of the surplus cash generated by the business before the debt holders are paid their interest and taxes are paid to the government.

Depreciation & Amortization

When a business purchases plant, equipment, machines that it intends to use over a long period of time, it does not show the expenses in one period only. Rather it spreads out the cost over the life of such equipment and shows the annual cost in each year’s P&L. This is called depreciation. It is not a money expense within the amount during which it’s recognized within the P&L. Amortization is similar to depreciation in concept but refers to intangible assets like the cost of advertising and brand acquisition costs.

Earnings before Interest and Tax (EBIT)

This is earnings before interest due to debt holders and taxes if any of the profits.

Finance Cost

This is the interest payment on money that the company has borrowed.

Earnings before Tax (EBT)

The company pays tax to the government at the applicable tax rate on its earnings.

Profit before Tax (PBT)

This is the company’s tax liability if a company has made a profit at EBT level.

Profit after Tax (PAT)

This is the company’s tax liability if a company has made a profit at EBT level.

Earnings per Share (EPS)

This is the PAT divided by the quantity of shares issued by the corporate. This is the profit made per share that accrues to the share/stockholder.

Balance Sheet

Balance Sheet could be a outline of what a corporation owns and what it owes to external parties. In different words, it shows what are the sources of its funds or liabilities (stock, debt, accumulated profits) and what uses have these funds been put to (assets created). In short, it is a statement of assets and liabilities.

How did it look like?

Proforma of the Balance Sheet

Proforma of Balance Sheet 
ParticularsYear End
LIABILITIES 
Share Capitalxxx
Reserves and Surplusxxx
Total Reservesxxx
Shareholder’s Funds (A)xxx
Long Term Liabilitiesxxx
Long-Term Borrowingsxxx
Short Term Borrowingsxxx
Total Long term Liabilities (B)xxx
Current Liabilitiesxxx
Trade Payablesxxx
Short Term Borrowingsxxx
Other Current Liabilitiesxxx
Total Current Liabilities (C)xxx
Total Liabilities (A+B+C)xxx
ASSETSxxx
Long Term Assetsxxx
Plant & Machineryxxx
Goodwillxxx
Total Long Term Assets (D) 
Non Current Investments 
Long Term Loans & Advancesxxx
Total Non-Current Assets (E)xxx
Current Assets Loans & Advancesxxx
Current Assets Loans & Advancesxxx
Currents Investmentsxxx
Inventoriesxxx
Cash and Bankxxx
Short Term Loans and Advancesxxx
Total Current Assets (F)xxx
Total Assets (D+E+F)xxx

Liabilities and Assets side must balance

The plus and Liability sides of the record should balance i.e. Assets = Liabilities always.

Liabilities

Shareholder Funds/Stocks

This represents the worth of the holding of stock/shareholders within the company from associate accounting purpose of read. It is conjointly observed as internet price or internet value. This is the add of paid capital and preserved earnings. Paid-up capital is the value of shares bought by shareholders in a primary sale. Retained earnings area unit the additive profits created by the corporate since beginning less the dividends paid since beginning.

Long term debt

Long term debt is the borrowings that the company owes for a period exceeding one year or more.

Short term debt

Short term debt is the debt incurred by a company that is due within one year.

Trade Payables

These are purchases that a company is yet to pay in cash to its suppliers. A higher amount is better as it reflects the company’s credibility to get a longer credit period from its suppliers.

Other Current Liabilities

These include the portion of long term debt that is due for repayment in the next year, advances from customers for goods/services that the company has to provide in future and payments due to suppliers for plant, property and equipment.

Assets

Long term assets

These embrace property, plants and instrumentality, article of furniture and fixtures, code packages, vehicles, craft etc. that the company owns for its business. It also includes plants and types of equipment under construction (capital work in progress) and intangible assets like brands etc.Non-current investments

These ar investments in stocks/shares of subsidiary and associate firms. Subsidiaries ar firms wherever the publically listed company has > five hundredth economic stake whereas associates ar firms wherever it’s < five hundredth economic stake.

Long term loans and advances

These ar loans given to subsidiaries and associates to assist them fund their assets.

Cash

This includes cash and investments in liquid funds that can be immediately converted into cash.

Current Investments

These embrace money endowed in instruments with but one year maturity which may be simply sold  to lift money.

Trade Receivables

This represents value of items that the company has sold but not received payment for.

Inventories

These embrace raw materials that the corporate uses to supply the ultimate product, semi-finished product and finished products waiting to be sold. Lower the number the higher, indicating efficient procurement strategy and no risk of obsolescence of its products.

Short term loans and advances

These are loans given to subsidiaries and associates that are due to be repaid in less than one year.

Other Current Assets

These include interest and dividend due to be received within the next one year.

Cash Flow Statement

This gives a outline of abundant|what proportion|what quantity} money came into the corporate during a specific amount and the way much the corporate has spent within the same amount.

ParticularsYear End
Profit Before Taxxxx
Changes In working Capitalxxx
Interest Paidxxx
Tax Paidxxx
Cash From Operating Activities (A)xxx
Purchase of Plantxxx
Short Term Borrowingsxxx
Total Long term Liabilities (B)xxx
Cash Flow from Investing Activities (B)xxx
Dividend Paid 
Cash from Financing Activities (C) 
Net Cash Inflow / Outflowxxx
Total Current Liabilities (C)xxx
Free Cash Flow (FCFF) [Operating Cash Flow- Capex]xxx

Cash from Operating Activities

This represents the net of all cash inflows and outflows as a result of selling the company’s products in the market. This is found out by adding non-cash expenses like depreciation and amortization to the company’s PAT then adjusting for changes in current assets and current liabilities over the period of the cash flow statement. If current assets increase, cash flows decrease and vice versa. If current liabilities increase, cash flows increase and vice versa.

Operating cash flow= PAT + D&A -/+ Change in Current Assets Change in Current Liabilities

Cash from Investing Activities

These embrace money spent on acquisition of property, plant and equipment, or acquisition of business. It conjointly includes surplus money that the corporate invests and redeems from liquid funds.

Cash from Financing Activities

These embrace any money generated from commerce of stock/shares to existing or new shareholders, any addition of debt, any repayments, and dividend payments.

Free cash flow to Equity (FCFE)

This is the money obtainable to stock/shareholders once meeting all expenses and debt connected obligations. This is the foremost vital metric to grasp the health of the business. This is calculated as:

FCFE= PAT + Depreciation – Capital Expenditure –/+ Change in current assets Change in current liabilities.

Free cash flow to the company (FCFF)

This includes the income obtainable to the equity holders and debt holders within the company. This is calculated as:

FCFF= EBIT * (1 – tax rate) + Depreciation – Capital Expenditure –/+ Change in current assets Change in current liabilities.

Key Takeaways

•           Fundamental Analysis (FA) is a comprehensive study of a business. It examines the economic, monetary and qualitative factors associated with a stock/ business.

•           P&L account reflects the operating performance of the company in a given year.

•           Balance sheet gives a summary of what a company owns and what it owes to external parties.

•           Cash flow statement gives a summary of how much cash came into the company in a specific period and how much the company spent in the same period

Check out Types of stocks to get better understanding

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