Where financial analysis fits
Chapters 6 and 7 analysed a company through its industry, economy and internal factors. The next step is to assess the impact of those factors on the company's future profit and cash flows and, from there, on the fair value of its shares. Financial statement analysis serves several earlier parts of the framework too: the bottom-up approach to market sizing in section 6.4 needs revenue numbers from the statements; the industry KPIs of section 6.7 are mostly computed from them; the profit margins and financial position that counted as strengths or weaknesses in the SWOT of section 7.5 come from them as well. And estimating expected profits means understanding how the various financial items interact, which requires studying past statements to learn how the line items behave.
An analyst need not be a great accountant, but must be able to read and interpret financial statements. Prior knowledge of accounting is an added advantage.
The complete set of statements
In India the list of financial statements listed companies must maintain and publish, and their format, are governed by Schedule III of the Companies Act 2013 and Ind AS 1.
- 1Statement of financial position, the balance sheet: assets, liabilities and equity at the end of the reporting period.
- 2Statement of profit and loss: income, expenses and profits for the period. Ind AS 1 requires it to include other comprehensive income (OCI), gains or losses from fair value changes in assets and liabilities that are required or permitted to stay out of income and expense.
- 3Statement of changes in shareholders' equity: how the owners' funds moved through profits, dividends, share issues, buybacks and OCI. Ind AS 1 recognises this statement as part of the balance sheet.
- 4Cash flow statement: a summary of the sources and uses of cash.
- 5Detailed notes explaining the accounting policies and breaking down the information in the statements.
Companies must provide comparable information for at least one prior period, so every statement shows the current period and the previous one; longer comparatives are optional.
Standalone and consolidated
In law every company is a separate registered entity, yet one company is often owned and controlled by another: Jio Platforms is a separate company majority owned and controlled by Reliance Industries; Toyota Kirloskar Motor is majority owned by Toyota Motor Corporation of Japan. Each entity prepares its own standalone statements, but for large groups those can mislead. Toyota Motor Corporation's standalone statement shows only the Japanese entity's sales; everything sold through subsidiaries in China, India, North America or anywhere else is missing.
Companies that have invested in subsidiaries must present both consolidated and standalone statements. Consolidation treats every company controlled by the parent as part of a single group and combines their performance into one statement. Control exists when a company owns more than 50% of the voting rights or has the right to appoint a majority of the board. The company that controls is the holding or parent company; the controlled one is the subsidiary. A holding company need not own more than 50%: if it has the power to control the subsidiary's strategy and operations in a way that changes the returns and their timing, and those flows can benefit it, it is de facto in control and must consolidate under Ind AS 110.
For equity analysis, consolidated statements are generally preferred because they give a more holistic picture of group performance. There is one situation where the standalone statements matter as well: when something prevents a subsidiary from distributing dividends to the parent, such as a geography with strict capital controls or a debt covenant under which the subsidiary agreed not to pay dividends. Then the analyst must also examine the parent's standalone position to see whether it can fend for itself in a crisis.
SEBI regulations require listed companies to publish consolidated financial statements annually and standalone results quarterly. Some companies voluntarily publish consolidated numbers every quarter. Groups that do not are hard to analyse: with almost a year between annual reports, the analyst is left with dated consolidated information.
An option that says a holding company must own more than 50% to consolidate is wrong under Ind AS 110. Majority voting rights or board appointment power are the usual routes, but de facto control over strategy, operations and returns also triggers consolidation.
- Financial statement analysis feeds bottom-up market sizing, industry KPIs and SWOT financial strengths, and shows how line items interact so future profits can be estimated. An analyst need not be a great accountant but must be able to read and interpret the statements.
- Ind AS 1's complete set: balance sheet (statement of financial position), statement of profit and loss including other comprehensive income, statement of changes in shareholders' equity (recognised as part of the balance sheet), cash flow statement, and detailed notes on accounting policies and breakdowns. Comparative figures for at least one prior period are compulsory.
- Every company is a separate legal entity with its own standalone statements; groups with subsidiaries must also present consolidated statements that treat all controlled companies as one. Control comes from more than 50% of voting rights or the right to appoint a majority of the board, and under Ind AS 110 from the power to direct strategy and operations even without majority ownership.
- Equity analysts generally prefer consolidated statements for the holistic group picture, but must also read the parent's standalone position when capital controls or debt covenants can stop a subsidiary paying dividends. SEBI mandates consolidated statements annually and standalone results quarterly; quarterly consolidated numbers are voluntary, and groups that skip them leave analysts with dated information.