Company Analysis 2: Quantitative Analysis, Introduction to Financial Statements

Quantitative Analysis

Previously, in the article 'Company analysis 1: Qualitative analysis', we have discussed an example of a coffee shop, If you have not read that article please make sure to read it and then continue with this article for best understanding. In the example, the 4th point in the checklist was to, 'Make sure the expected returns are worth risking the investment amount.'

Initially, it looks a simple statement but on deeper thinking, a lot of questions come in the mind:

1. What is the expected return?
2. How to check whether the company has the potential to meet the expected returns?
3. What is the risk involved?

These just a few of them you may have a lot more but be assured all will be cleared through the understanding of quantitative analysis. Quantitative analysis is a method of analyzing a company's past financial performance to predict possible future performance and value the company based on risk-adjusted measures. The quantitative analysis consists of three major verticals:

1. Financial Statement Analysis (Indicates Past Financial Performance)
2. Ratio Analysis (Helps for Comparison with Peers)
3. Valuation (Finds Intrinsic Value of the Company)

Financial Statements 

Profit and Loss Statement, Balance Sheet, and Cash Flow Statement are important financial statements that have the ability to indicate the company's financial health. Before going into each financial statement you should know the types of these statements as the Standalone Financial Statement and Consolidated Financial Statement.

Standalone Financial Statement vs Consolidated Financial Statement

The company under consideration may be a single company or it may have few subsidiary companies as well. 

E.g. Look at Bajaj Finserve Ltd. and Bajaj Finance Ltd. business structures. Bajaj Finance Ltd. works only in a single domain while Bajaj finserve Ltd. is a holding company that owns Bajaj Finance Ltd., Bajaj Allianz General Insurance, Bajaj Allianz Life Insurance, Bajaj Finserve limited Asset Management Company, Bajaj Allianz Financial Distribution Ltd., Bajaj Finserve Health Ltd., Bajaj Finserve Esop Trust-Balic.

There are so many such companies which work in more than one business vertical, Reliance Industries have subsidiaries like reliance retail, reliance jio, etc. (The list is really long) 

The financial statements prepared considering only the performance of a single vertical of a comapany is called a standalone financial statement while the one considering all business verticals of the subsidiaries is called a consolidated financial statement. 

I prefer consolidated statements more as it gives a true overall picture and recommends you the same. In the case of Bajaj finserve Ltd. The financial statements prepared with numbers only from Bajaj Finserve Ltd. are standalone financial statements while statements considering all subsidiary companies are consolidated statements.     

Profit & Loss Statement (P&L Statement)

The profit and loss statement is a statement indicating the financial performance of a company in a specific time period like a year or a quarter. It summaries revenues/sales, costs, expenses, and profits in that period. Analyzing company financials with P&L statements consists of comparing these statements with pervious period statements. This analysis leads to an understanding of the growth of the company.

Balance Sheet

Unlike the P&L statement balance sheet is not prepared for a period rather at a specific time. A balance sheet of a company summaries the liabilities (cash and cash equivalent that the company has to pay), assets (cash and cash equivalent that the company has in reserves or will receive), and shareholder's equity of the company on a specific date. Analyzing the balance sheet gives a fair idea of sustainability of the company. 

Cash Flow Statement

The cash flow statements are prepared for a period similar to the P&L statements. The cash flow statement tracks the money flow into and out of the company. In simple words, a cash flow statement shows the amount of cash earned from specific activities and the amount of cash spent for specific activities. Analyzing the cash flow statement gives a good idea of the company's cash positions.

Now, if you have understood the basics of financial statements we can move ahead with analyzing part in the next article. If you have any query please feel free to comment below.

And don't forget to READ TO LEARN INVESTING.