Understand this before You Choose to Invest in a Company

Understand this before You Choose to Invest in a Company

November 27, 2018 1 By Kashyap Kr Borah

When it’s about a company, we always know that they have a product. A product that they produce in the factory or office building and sell it in the market. A company always look for customers who will believe in their product as value for buying. But inside a company, there’s a lot of paperwork from producing to dispense, from marketing to vendors, from income to expense and so on. Let’s know some factors of a company, how do they maintain from Profit & Loss to Cash-flow.

Profit and Loss statement

It basically shows company Income and Expenses. You have to take this on the account during analysis because this chart can give you the overall story of a company

1. Income: The source of money the company generates its revenue from.
i.Revenue from Operations (Gross): Revenue from the core business of the company.
ii. Revenue from Operations (Net): Revenue from the core business of the company after a variety of non-operational expenses, gains, and/or losses
iii. Other Income: Income from a non-core business like rental income, bond maturity, income from equity etc.
2. Expenses: The use of money that the company has spent to generate its revenue.
i. Operating and Direct Expenses: Here we can see the numbers that have been used during the production of the core product of the company. Like the raw material, processing cost, labour cost etc. And the Operating expenses are those that have been spent on selling the product like marketing, R&D cost, Insurance etc.
ii. Employee benefit Expenses: This category holds all the related expense that is used for the benefit of its employee like salary, medical, TA-DA, PF etc.
iv. Finance Cost: Company’s interest payable sources like a loan from a bank, issuing Commercial papers etc.
v. Depreciation and Amortisation Expenses: Every Tangible and Intangible asset of the company has a degrading value Y-o-Y which is called depreciation and amortization respectively. To calculate the depreciation the below formula is used as

Where,

Cost: The buying price of the asset
Salvation value: use of a tangible asset after its lifetime period
Year of useful life: Till how long a machine can be used
And to calculate amortization (decreasing intangible assets value) straight-line method is used.
vi. Other Expenses: Expenses that have not mentioned above like power and fuel expenses, repairing expenses etc.
At the end of all the income and expenses, the term comes PBT (Profit before Tax) and PAT (Profit after Tax) from where Y-o-Y you can judge the company performance. For say, company X has the following numbers,
Revenue: 80 Lakhs rupees
Debt: 20 Lakhs @12%
Interest: 2.4 Lakhs rupees
PBT: 80 lakhs – 2.4 lakhs = 77.6 lakhs
Tax: PBT@30% = 23.28 lakhs
PAT: PBT – Tax = 54.32 lakhs

After calculating the PAT, a company decides whether to pay dividends to its shareholders or not. Because its never about the paying dividends for a company but to run the business in the future course also. And for that they need funds. An investor can enjoy the appreciation value of the shares (if the company outperform). But those company that pays dividends, are believed to be a value for investing because they are promising to outperform (but not all the time).

Cash Flow Statement

The total amount of money being transferred into and out of a business, especially as affecting liquidity. At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow.

1. Net Cash Flow from Operating Activities: It is the net cash flow into the company after the operating activities (producing a product and selling into the market). The more positive numbers than the past years are the more profitability of the company.
2. Net Cash used in Investing Activities: This one shows the net amount of shares or equity the company has issued to the public and generate money (if the number is positive) and how much shares or equity the company have bought back from the public (this one shows negative no) to increase the value of the company.
Here the more negative numbers in the segment are the more valuable complement for the company.
3. Net Cash used for Financing Activities: This one shows the net worth of the company after paying out all its debt to the out-source. The negative number shows the company net worth is increasing and the positive number shows the debt are yet to payable by the company.
4. Adjustments on Amalgamation/Merger/Demerger/Others: This one shows the company’s subsidiary accounts. Like how many other companies accounting has been or not adjusted with the parent company’s balance sheet.

From the above data, we can assume a company’s annual turn over. But from an investment perspective, we can not rely on a single data of a company. We have to look for other data also. And most importantly we have to compare each company with its peer company in the same industry.

Happy Investing.