PROJECT ON UNDERSTANDING FINANCIAL STATEMENTS: ANALYSIS AND

INTERPRETATION

Submitted to:

Mr.N.K.Puri

Submitted by:

Surabhi Jain

Roll No. 85

Section A

Q1. State and explain the contents of the Annual Reports.

A1. The various components of an annual report are as follows:

1. Director’s report2. Management Discussion and Analysis3. Corporate Governance Report

This report sets out the compliance status of the Company with the requirements of corporate governance, as set out in Clause 49.

4. Financial Statements

a. Auditor’s Report

The Auditor's report is a formal opinion, or disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit or evaluation performed on a legal entity or subdivision thereof (called an “auditee”). The report is subsequently provided to a “user” (such as an individual, a group of persons, a company, a government, or even the general public, among others) as an assurance service in order for the user to make decisions based on the results of the audit.An auditor’s report is considered an essential tool when reporting financial information to users, particularly in business. Since many third-party users prefer, or even require financial information to be certified by an independent external auditor, many auditees rely on auditor reports to certify their information in order to attract investors, obtain loans, and improve public appearance. Some have even stated that financial information without an auditor’s report is “essentially worthless” for investing purposes.

b. Balance Sheet

In financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company's financial condition. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time.A company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of assets are usually listed first and are followed by the liabilities. The difference between the assets and the liabilities is known as equity or the net

assets or the net worth or capital of the company and according to the accounting equation, net worth must equal assets minus liabilities.Another way to look at the same equation is that assets equals liabilities plus owner's equity. Looking at the equation in this way shows how assets were financed: either by borrowing money (liability) or by using the owner's money (owner's equity). Balance sheets are usually presented with assets in one section and liabilities and net worth in the other section with the two sections "balancing."Records of the values of each account or line in the balance sheet are usually maintained using a system of accounting known as the double-entry bookkeeping system.A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, many businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words: businesses have assets and so they can not, even if they want to, immediately turn these into cash at the end of each period. Often, these businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. In other words businesses also have liabilities.

c. Profit and Loss Account

Profit and loss statement (P&L) Income statement, also called and Statement of Operations, is a company's financial statement that indicates how the revenue (money received from the sale of products and services before expenses are taken out, also known as the "top line") is transformed into the net income (the result after all revenues and expenses have been accounted for, also known as the "bottom line"). The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

The important thing to remember about an income statement is that it represents a period of time. This contrasts with the balance sheet, which represents a single moment in time.

d. Cash Flow Statement

In financial accounting, a cash flow statement or statement of cash flows is a financial statement that shows how changes in balance sheet and income accounts affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7) , is the International Accounting Standard that deals with cash flow statements.

People and groups interested in cash flow statements include:

Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses

Potential lenders or creditors, who want a clear picture of a company's ability to repay

Potential investors, who need to judge whether the company is financially sound Potential employees or contractors, who need to know whether the company will

be able to afford compensation

Purpose

The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement. The cash flow statement reflects a firm's liquidity or solvency.

The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation or write-offs on bad debts to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Noncash activities are usually reported in footnotes.

The cash flow statement is intended to-provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances

1. provide additional information for evaluating changes in assets, liabilities and equity

2. improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods

3. indicate the amount, timing and probability of future cash flows

The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.

e. Schedules forming part of Balance Sheet and Profit and Loss Account

4. Consolidated Financial Statements

Q2. State, briefly, five major accounting policies followed by the companies.

A2. Five major Accounting Policies of Tech Mahindra Ltd. are:

(a) Basis for preparation of accounts:

The accounts have been prepared to comply in all material aspects with applicable accounting principles in India, the Accounting Standards and the relevant provisions of the Companies Act, 1956.

(b) Use of Estimates:

The preparation of financial statements, in conformity with the generally accepted accounting principles, requires estimates and assumptions to be made that affect the reported amounts of assets and liabilities on the date of financial statements and the reported amounts of revenues and expenses during the reported year. Differences between the actual results and estimates are recognised in the year in which the results are known / materialised.

(c) Fixed Assets including Intangible Assets:

Fixed assets are stated at cost less accumulated depreciation. Costs comprise of purchase price and attributable costs, if any.

(d) Leases:

Assets taken on lease are accounted for as fixed assets in accordance with Accounting Standard 19 on Leases, (AS-19).

(i) Finance lease:

Assets taken on finance lease are accounted for as fixed assets at fair value. Lease payments are apportioned between finance charge and reduction of outstanding liability.

(ii) Operating lease:

Assets taken on lease under which all risks and rewards of ownership are effectively retained by the lessor are classified as operating lease. Lease payments under operating leases are recognised as expenses on accrual basis in accordance with the respective lease agreements.

(e) Depreciation / Amortisation on Fixed Assets :

i) The Company computes depreciation for all fixed assets including for assets taken on lease using the straight-line method based on estimated useful lives. Depreciation is charged on a pro-

rata basis for assets purchased or sold during the year. Managements estimate of the useful life of fixed assets is as follows :

Buildings - 15 years

Computers - 3 years

Plant and machinery - 3-5 years

Furniture and fixtures - 5 years

Vehicles - 3-5 years

ii) Leasehold land is amortised over the period of lease.

iii) Leasehold improvements are amortised over the period of lease or expected period of occupancy whichever is less.

iv) Intellectual property rights are amortised over a period of seven years.

v) Assets costing upto Rs.5,000 are fully depreciated in the year of purchase.

Five major Accounting policies of Mindtree Ltd. are:

1. Basis of preparation of financial statements:

The financial statements have been prepared and presented under the historical cost convention on the accrual basis of accounting except for certain financial instruments which are measured at fair values and comply with the Accounting Standards prescribed by Companies (Accounting Standards) Rules, 2006, as amended, other pronouncements of the Institute of Chartered Accountants of India (ICAI) and the relevant provisions of the Companies Act, 1956, (theAct) to the extent applicable.

2. Use of estimates:

The preparation of financial statements in conformity with the generally accepted accounting principles in India requires management to make estimates and assumptions that affect the reported amounts of income and expenses of the period, assets and liabilities and disclosures relating to contingent liabilities as of the date of the financial statements. Actual results could differ from those estimates. Any revision to accounting estimates is recognised prospectively in future period.

3. Fixed assets:

3.1 Fixed assets are carried at cost of acquisition (including directly attributable costs such as freight, installation, etc.) or construction less accumulated depreciation. Borrowing costs directly attributable to acquisition or construction of those fixed assets, which necessarily take a substantial period of time to get ready for their intended use, are capitalised.

3.2 Leases under which the Company assumes substantially all the risks and rewards of ownership are classified as finance leases. Such assets acquired on or after April 1, 2001 are capitalised at fair value of the asset or present value of the minimum lease payments at the inception of the lease, whichever is lower. Lease payments under operating leases are recognized

as an expense in the statement of profit and loss on a straight-line basis over the lease term.

3.3 Advances paid towards the acquisition of fixed assets, outstanding at each balance sheet date and the cost of the fixed asset not ready for its intended use on such date, are disclosed under capital work-in-progress.

3.4 Depreciation is provided on the straight-line method. The rates specified under schedule XIV of the Companies Act, 1956 are considered as the minimum rates. If the managements estimate of the useful life of a fixed asset at the time of the acquisition of the asset or of the remaining useful life on a subsequent review is shorter than envisaged in the aforesaid schedule, depreciation is provided at a higher rate based on the managements estimate of the useful life/remaining useful life. Pursuant to this policy, the management has estimated the useful life as under:

Asset classification Useful life

Computer systems (including software) 2-3 years

Furniture and fixtures 5 years

Electrical installations 3 years

Office equipment 4 years

Motor vehicles 4 years

Building 30 years

3.5 Fixed assets individually costing Rs. 5,000 or less are fully depreciated in the period of purchase/ installation. Depreciation on additions and disposals during the year is provided on proportionate basis.

3.6 The cost of leasehold land is amortized over the period of the lease. Leasehold improvements and assets acquired on lease are amortized over the lease term or useful life, whichever is lower.

4. Investments:

4.1 Long-term investments are carried at cost less any other-than-temporary diminution in value, determined on the specific identification basis.

4.2 Current investments are carried at the lower of cost (determined on the specific identification basis) and fair value. The comparison of cost and fair value is carried out separately in respect of each investment.

4.3 Profit or loss on sale of investments is determined on the specific identification basis.

5. Employee benefits:

5.1 Gratuity is a defined benefit scheme and is accrued based on actuarial valuations at the balance sheet date, carried out by an independent actuary. The Company has an employees gratuity fund managed by ICICI Prudential Life Insurance Company and SBI Life Insurance Company. Actuarial gains and losses are charged to the profit and loss account.

5.2 Leave encashment is a long-term employee benefit and is accrued based on actuarial valuations at the balance sheet date, carried out by an independent actuary. The Company accrues for the expected cost of short - term compensated absences in the period in which the employee renders services.

5.3 Contributions payable to the recognised provident fund, which is a defined contribution scheme, are charged to the profit and loss account.

Q3. Explain briefly what disclosure techniques these companies have adopted. How the contingent assets and contingent liabilities are disclosed in the annual reports?

A3.

Tech Mahindra Ltd.

Contingent liabilities

These, if any, are disclosed in the notes on accounts. Provision is made in the accounts if it becomes probable that any outflow of resources embodying economic benefits will be required to settle the obligation arising out of past events.

Disclosures

a. No personnel has been denied access to the Audit Committee.b. There have been no materially significant transactions, pecuniary transactions or

relationships b/w the company and directors, management, subsidiaries or related parties except those disclosed in the financial statements for the year ended 31 march 2009.

c. The company has complied with the mandatory requirements of Clause 49.

Mindtree Ltd.

Contingent liabilities

The Company creates a provision when there is a present obligation as a result of a past event that probably requires an outflow of resources and a reliable estimate can be made of the amount of the obligation. A disclosure for a contingent liability is made when there is a possible obligation or a present obligation that may, but probably will not, require an outflow of resources. When there is a possible obligation or a present obligation in respect of which the likelihood of outflow of resources is remote, no provision or disclosure is made.

Provisions for onerous contracts, i.e. contracts where the expected unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it are recognised when it is probable that an outflow of resources embodying economic benefits will be required to settle a present obligation as a result of an obligating event, based on a reliable estimate of such obligation.

a) Guarantees given by Companys bankers as at March 31, 2009 are Rs. 30,902,359 (previous year- Rs. 43,317,454).

b) Estimated amount of contracts remaining to be executed on capital account and not provided for as at March 31, 2009isRs. 78,979,164 (previousyear-Rs. 160,583,022).

c) On September 19, 2007, the Company received a notice from the Honorable High court of Karnataka to appear before the Honorable court in respect of assessment of income for A.Y 2001-02. The Assessing Officer (AO) has held that interest receipts are not eligible for deduction under section 10B of the Act even though they are business income and disallowed the same and raised a demand of Rs. 616,530. Further AO also mentioned that losses from export earnings cannot be set off against other income. The AO also rejected the claim of carry forward of business loss and unabsorbed depreciation. The order of the AO was not upheld by Income Tax Appellate Tribunal (ITAT) and the AO preferred an appeal with the Honorable High Court of Karnataka against the order of the ITAT. Management believes that the position taken by it on the matter is tenable and hence, no adjustment has been made to the financial statements for year end March 31, 2009.

d) On January 2, 2008, MindTree has received an assessment order for A.Y 2005-06 from the AO with a demand amounting to Rs. 6,479,880 on account of certain disallowances / adjustments made by income tax department. A significant portion of this amount arises from manner of adjustment of brought forward losses in arriving at the taxable profits of the Company. Management believes that the position taken by it on the matter is tenable and hence, no adjustment has been made to the financial statements for the year ended March 31, 2009. The Company has filed an appeal against the demand received. The Income-tax department has adjusted the amount of demand against the refund due for A.Y 2006-07.

e) On January 5, 2009, MindTree has received an assessment order for A.Y 2006-07 from the Assistant Commissioner of Income-tax (ACIT) with a demand amounting to Rs. 51,446,560 on account of certain disallowances / adjustments made by income tax department. A significant portion of this amount arises from manner of adjustment of brought forward losses in arriving at

the taxable profits of the Company. Management believes that the position taken by it on the matter is tenable and hence, no adjustment has been made to the financial statements for the

year ended March 31, 2009. The Company has filed an appeal against the demand received.

Disclosures

a. The company had compied with all requirements on matters related to capital market since listing.

b. The company had complied with all requirements prescribed by SEBI and other statutory authorities on all matters relating to capital from the period april 1 2008 to march 31 2009.

c. Compliance with mandatory and non mandatory requirements under clause 49 of the

listing agreement.

Q4. Calculate the two ratios under each of the following categories of the two companies and state your viewpoint on their comparative position:

A3. Ratios are defined and calculated below:

a. Liquidity Ratios

In finance, the Acid-test or quick ratio or liquid ratio measures the ability of a company to use its near cash or quick assets to immediately extinguish or retire its current liabilities. Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values.

Generally, the acid test ratio should be 1:1 or better, however this varies widely by industry.Notice that very often Acid test refers instead of Quick ratio to Cash ratio:

They can also be termed as :

Current ratio

Acid-test ratio (Quick ratio)

Tech Mahindra Ltd.

Current Assets = Inventories + Sundry Debtors + Cash and bank balance + Loans and advances + Fixed Deposits

= 1.3 + 854.50 + 494.40 + 302.20 + 1.70(in Rs Cr.)

= 1654.10 (in Rs Cr.)

Current liabilities = Sundry Creditors + Provisions

= 671.90 + 199.0 (in Rs Cr.)

= 870.90 (in Rs Cr.)

Current ratio = 1654.10 / 870.90 = 1.90

Quick ratio = 1637.29 / 870.90 = 1.88

Mindtree Ltd.

Current Assets = Inventories + Sundry Debtors + Cash and bank balance + Loans and advances + Fixed Deposits

= 0.00 + 214.99 + 17.69 + 137.6 + 11.13 (in Rs Cr.)

= 381.41 (in Rs Cr.)

Current liabilities = Sundry Creditors + Provisions

= 249.88 + 16.43 (in Rs Cr.)

= 266.31 (in Rs Cr.)

Current ratio = 381.41 / 266.31 = 1.43

Quick ratio = 367.50 / 266.31 = 1.38

The current ratio of Tech Mahindra Ltd. is near to 2 which is satisfactory but the current ratio of Mindtree Ltd. is 1.43 which is much lesser than 2 but greater than 1 which shows that the current creditors are financing the day to day operations in entirety but the firm has no margin and any loss of current assets would mean loss to current creditors.

The quick ratio of both the firms is greater than 1:1 which is good enough but Tech Mahindra with a higher quick ratio can repay the debts more quickly.

b. Profitability Ratios

Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.

1) Gross margin, Gross profit margin or Gross Profit Rate

OR

2) Operating margin, Operating Income Margin, Operating profit margin or Return on sales (ROS)

Note: Operating income is the difference between operating revenues and operating expenses, but it is also sometimes used as a synonym for EBIT and operating profit. This is true if the firm has no non-operating income. (Earnings before interest and taxes / Sales)

3) Profit margin, net margin or net profit margin

4) Return on equity (ROE)

5) Return on investment (ROI ratio or Du Pont ratio)

6) Return on assets (ROA)

7) Return on assets Du Pont (ROA Du Pont)

8) Return on Equity Du Pont (ROE Du Pont)

9) Return on net assets (RONA)

10) Return on capital (ROC)

11) Risk adjusted return on capital (RAROC)

OR

12) Return on capital employed (ROCE)

Note: this is somewhat similar to (ROI), which calculates Net Income per Owner's Equity

13) Cash flow return on investment (CFROI)

14) Efficiency ratio

Tech Mahindra Ltd.

Gross Profit Ratio = (gross profit / net sales) * 100

Gross Profit = Net sales – Cost of goods sold (all manufacturing expenses included)

Gross Profit = 4296.10 – 3107.5 = 1188.6

Gross Profit Ratio = (1188.6 / 4296.10) * 100 = 28%

Net Profit Ratio = (net profit / net sales) * 100

= (986.6 / 4357.8) * 100 = 23%

Mindtree Ltd.

Gross profit = 1012.57 – 745.29 = 267.28

Gross Profit ratio = 267.28 / 1012.57 = 26%

Net Profit Ratio = 30.01 / 1012.57 = 3%

The Gross Profit Ratio is almost the same for both the firms so they both are doing good business.

The Net Profit ratio is very high for Tech Mahindra Ltd. as compared to Mindtree Ltd. This shows that Tech Mahindra is getting much higher returns on sales but a low return on sales may not particularly mean that the company’s profitability is low as the return on investment may be really high.

c. Activity Ratios

Activity ratios measure the effectiveness of the firms use of resources.

1) Average collection period

2) Degree of Operating Leverage (DOL)

3) DSO Ratio

4) Average payment period

5) Asset turnover

6) Inventory turnover ratio

7) Receivables Turnover Ratio

8) Inventory conversion ratio

9) Inventory conversion period

10) Receivables conversion period

11) Payables conversion period

Cash Conversion CycleInventory Conversion Period + Receivables Conversion Period - Payables Conversion Period

Tech Mahindra Ltd.

Asset Turnover ratio = 4357.80 / 889.35 = 4.9

Inventory Turnover ratio = 3152.5 / 0.93 = 3352.13

Mindtree Ltd.

Asset Turnover ratio = 1012.57 / 389.45 = 2.6

Inventory Turnover ratio = NA

Higher Asset Turnover ratio of Tech Mahindra Ltd. shows that it is utilizing the available financial resources at its disposal in a better way.

d. Capital Structure Ratio

The capital structure ratio shows the percent of long term financing represented by long term debt. A capital structure ratio over 50% indicates that a company may be near their borrowing limit (often 65%).

Formula to calculate capital structure ratio: 

Capital Structure Ratio = long term debt / (shareholders equity + long term debt).

Q5. Explain and calculate the following for the two companies :

a) Earning Per shareb) Price Earning Ratioc) Book Value per share

A4. A) Earnings Per Share

Earnings per share (EPS) are the earnings returned on the initial investment amount.

Calculating EPS

The EPS formula does not include preferred dividends for categories outside of continued operations and net income. Earnings per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS. Remember that preferred stock rights have precedence over common stock. If preferred dividends total $100,000, then that is money not available to distribute to each share of common stock.

Earnings Per Share (Basic Formula)

Earnings Per Share (Net Income Formula)

Earnings Per Share (Continuing Operations Formula)

Only preferred dividends actually declared in the current year are subtracted. The exception is when preferred shares are cumulative, in which case annual dividends are deducted regardless of whether they have been declared or not. Dividends in arrears are not relevant when calculating EPS. EPR = N.P A.T OR P.D divided by number of equity share.

Tech Mahindra Ltd.

Earnings Per Share = 9866000000 / 121733634 = 81.05

Mindtree Ltd.

Earnings Per Share = 523011713 / 37784844 = 7.9

B) Price Earnings Ratio

The P/E ratio (price-to-earnings ratio) of a stock (also called its "P/E", "PER", "earnings multiple," or simply "multiple") is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share.It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. The P/E ratio has units of years, which can be interpreted as "number of years of earnings to pay back purchase price", ignoring the time value of money. In other words, P/E ratio shows current investor demand for a company share.

There are various P/E ratios, all defined as:

Tech Mahindra Ltd.

P/E ratio = 952.40 / 81.05 = 1.18

Mindtree Ltd.

P/E ratio = 514.4 / 7.9 = 65.11

C) Book Value Per Share

=

Stockholders Equity - Preferred Stock

Average Outstanding Shares

Somewhat similar to the earnings per share, but it relates the stockholder's equity to the number of shares outstanding, giving the shares a raw value.

Comparing the market value to the book value can indicate whether or not the stock in overvalued or undervalued.

Tech Mahindra Ltd.

Book Value Per Share = 121.7 / 0.79 = 154.51

Mindtree Ltd.

Book Value Per Share = 38 / 0.27 = 139.58