Want to check on a stock(buy)? Here's how
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K.Karthik Raja
Jul 11, 2008, 2:55:06 AM7/11/08
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Want to check on a stock? Here's how
Want to buy a stock? we explained what a Profit and Loss Account is
all about and what it tells you about the company.
Now it's time to turn to the balance sheet.
Unlike the P&L account, which measures a company's performance over a
period, a balance sheet is a snapshot of the company on a particular
date.
It will tell you what the company owns (assets), what the company owes
(liabilities) and how much the company is worth in its books of
accounts (net worth).
Things you must know before buying shares
A sample balance sheet
The balance sheet is divided into two main sections: the source of
funds (from where the money has come) and its application (what it has
been used for).
2004
2003
Source of Funds
Shareholders' Funds
Capital
50
50
Reserves & Surplus
200
150
Loan Funds
Secured Loans
100
115
Unsecured Loans
30
40
Total
380
355
Application of Funds
Gross Block
150
140
Less: Depreciation
50
40
Net Block
100
100
Capital work-in-progress
20
10
Investments
100
120
Current assets, loans & advances
Inventories
80
75
Sundry Debtors
55
50
Cash and Bank balances
30
20
Other current assets
25
25
Loans and advances
20
10
Less: Current liabilities and provisions
Liabilities
40
45
Provisions
10
10
Net current assets
160
125
Total
380
355
Balance Sheet as on March 31. All figures in Rs/lakh.
5 rules when buying stocks
Sources of Funds
Capital
From where does a company get its money? Share capital is one obvious
source.
Capital is the amount that the owner has in the business. As the
business grows and makes profits, it adds to its capital.
This capital is subdivided into shares.
So if a company's capital is Rs 10 crore (Rs 100 million), that could
be divided into 1 crore (10 million) shares of Rs 10 each.
Some of the shares are held by the promoters (people who started the
business) and the rest by the investors (people like you and me or
mutual funds and other financial institutional).
Note that share capital has remained the same in the above example for
2004 and 2003, which means that the company did not raise capital
(issue fresh shares) in 2004.
Reserves
When a company makes profits, it can either hold back the profits or
distribute it as dividends to its shareholders.
Let's say a company earns a profit of Rs 1 crore. It could deploy half
the money for buying new machinery and raw materials and paying back
some of the loans. The rest can be distributed as dividend.
A company's retained profits (profits that do not go out as dividend)
is transferred to Reserves. This is why the Reserves in the balance
sheet keep on rising every year for profitable companies. If the
company makes a loss, however, reserves go down.
The company's capital and retained profits together make up
shareholders' funds in the business. This is also known as net worth.
When net worth is divided by the number of shares the company has, we
get the Net Asset Value per share.
Loans
Loans are another source of funds.
Secured loans are where the lender has a charge over the company's
assets. Loans from banks fall in this category. So if the company has
no money to pay back the loan, the bank can take away, say, the
machinery or land and sell it to regain its money.
Unsecured loans are those which do not have a specific charge over the
company's assets. Fixed deposits taken by companies are an example of
unsecured loans. If the company cannot repay the investors of fixed
deposits their money, they lose it totally and cannot claim anything
back.
What a stock split is all about
Application of Funds
This part of the balance sheet tells you how the money has been
utilised.
Gross Block
The company generally will use the bulk of its money to buy assets.
Gross block is the sum total of all the assets of a company valued at
the cost of acquisition.
Depreciation
Fixed assets are those that will be around for a long time - they
include plant and machinery, buildings, land and patents and
trademarks.
Over time the value of certain fixed assets - equipment and machinery
- dips as it is being utilised. The estimated wear and tear of the
equipment is referred to as depreciation.
Net Block
When you deduct the depreciation on those fixed assets, you get net
block.
Current assets
Current assets are those that will be utilised soon and have a shorter
life span - stocks of raw materials or finished goods (inventory),
sundry debtors (those who owe money to the company), cash balances.
Current liabilities are the sundry creditors (those to whom the
company owes money) and provisions (expenses for which the company has
set aside a sum of money, eg for income tax, dividends, rent etc, but
for which payments have not yet been made).
You will have to deduct current liabilities from current assets to
arrive at net current assets.
Capital work-in-progress
This could be some construction, installation or expansion programme
going on for which work is not yet completed.
Investments
The company also uses surplus funds to make investments - these could
be in group companies or in mutual funds or in bonds or any other
avenue.
How to make money in shares
Compare figures
The way to read the balance sheet is to compare the figures with that
of the previous year. Let's take a look at some of the changes in the
example given above.
Observation: Loans have come down.
Implication: The company repaid some loans in 2003-04.
Observation: Gross block and capital work-in-progress has increased.
Implication: The company added to plant and machinery in 2003-04 and
is continuing with capital expenditure (as shown by the capital work-
in-progress). It has funded that work by drawing down its investments.
Observation: The company's shareholders' funds, or its net worth, has
increased during the year.
Implication: Which means the company is making profits and retaining a
part of them.
Observation: Inventories and debtors have risen.
Implication: This could mean either that the company has increased its
scale of operations - sales have gone up - or it has become less
efficient with its working capital, leading to a pile-up of goods and
debtors. Perhaps it is having a tough time selling its goods.
The Director's Report in the Annual Report and the P&L account will
tell you whether the company's sales have indeed increased.
Stay informed
Reading the balance sheet will enable you to ask the right questions
about a company's performance. And, together with the Annual Report
and the P&L account, it gives a fair picture of the company's health.
Don't forget to check out the Auditor's statement and the Notes to the
Accounts. These will tell you whether an attempt has been made to
dress up the accounts to show a better picture.
Based on all this knowledge, you can then make an informed decision as
to whether or not you should buy or even hold on to the company's
stock.
Want to buy a stock? we explained what a Profit and Loss Account is
all about and what it tells you about the company.
Now it's time to turn to the balance sheet.
Unlike the P&L account, which measures a company's performance over a
period, a balance sheet is a snapshot of the company on a particular
date.
It will tell you what the company owns (assets), what the company owes
(liabilities) and how much the company is worth in its books of
accounts (net worth).
Things you must know before buying shares
A sample balance sheet
The balance sheet is divided into two main sections: the source of
funds (from where the money has come) and its application (what it has
been used for).
2004
2003
Source of Funds
Shareholders' Funds
Capital
50
50
Reserves & Surplus
200
150
Loan Funds
Secured Loans
100
115
Unsecured Loans
30
40
Total
380
355
Application of Funds
Gross Block
150
140
Less: Depreciation
50
40
Net Block
100
100
Capital work-in-progress
20
10
Investments
100
120
Current assets, loans & advances
Inventories
80
75
Sundry Debtors
55
50
Cash and Bank balances
30
20
Other current assets
25
25
Loans and advances
20
10
Less: Current liabilities and provisions
Liabilities
40
45
Provisions
10
10
Net current assets
160
125
Total
380
355
Balance Sheet as on March 31. All figures in Rs/lakh.
5 rules when buying stocks
Sources of Funds
Capital
From where does a company get its money? Share capital is one obvious
source.
Capital is the amount that the owner has in the business. As the
business grows and makes profits, it adds to its capital.
This capital is subdivided into shares.
So if a company's capital is Rs 10 crore (Rs 100 million), that could
be divided into 1 crore (10 million) shares of Rs 10 each.
Some of the shares are held by the promoters (people who started the
business) and the rest by the investors (people like you and me or
mutual funds and other financial institutional).
Note that share capital has remained the same in the above example for
2004 and 2003, which means that the company did not raise capital
(issue fresh shares) in 2004.
Reserves
When a company makes profits, it can either hold back the profits or
distribute it as dividends to its shareholders.
Let's say a company earns a profit of Rs 1 crore. It could deploy half
the money for buying new machinery and raw materials and paying back
some of the loans. The rest can be distributed as dividend.
A company's retained profits (profits that do not go out as dividend)
is transferred to Reserves. This is why the Reserves in the balance
sheet keep on rising every year for profitable companies. If the
company makes a loss, however, reserves go down.
The company's capital and retained profits together make up
shareholders' funds in the business. This is also known as net worth.
When net worth is divided by the number of shares the company has, we
get the Net Asset Value per share.
Loans
Loans are another source of funds.
Secured loans are where the lender has a charge over the company's
assets. Loans from banks fall in this category. So if the company has
no money to pay back the loan, the bank can take away, say, the
machinery or land and sell it to regain its money.
Unsecured loans are those which do not have a specific charge over the
company's assets. Fixed deposits taken by companies are an example of
unsecured loans. If the company cannot repay the investors of fixed
deposits their money, they lose it totally and cannot claim anything
back.
What a stock split is all about
Application of Funds
This part of the balance sheet tells you how the money has been
utilised.
Gross Block
The company generally will use the bulk of its money to buy assets.
Gross block is the sum total of all the assets of a company valued at
the cost of acquisition.
Depreciation
Fixed assets are those that will be around for a long time - they
include plant and machinery, buildings, land and patents and
trademarks.
Over time the value of certain fixed assets - equipment and machinery
- dips as it is being utilised. The estimated wear and tear of the
equipment is referred to as depreciation.
Net Block
When you deduct the depreciation on those fixed assets, you get net
block.
Current assets
Current assets are those that will be utilised soon and have a shorter
life span - stocks of raw materials or finished goods (inventory),
sundry debtors (those who owe money to the company), cash balances.
Current liabilities are the sundry creditors (those to whom the
company owes money) and provisions (expenses for which the company has
set aside a sum of money, eg for income tax, dividends, rent etc, but
for which payments have not yet been made).
You will have to deduct current liabilities from current assets to
arrive at net current assets.
Capital work-in-progress
This could be some construction, installation or expansion programme
going on for which work is not yet completed.
Investments
The company also uses surplus funds to make investments - these could
be in group companies or in mutual funds or in bonds or any other
avenue.
How to make money in shares
Compare figures
The way to read the balance sheet is to compare the figures with that
of the previous year. Let's take a look at some of the changes in the
example given above.
Observation: Loans have come down.
Implication: The company repaid some loans in 2003-04.
Observation: Gross block and capital work-in-progress has increased.
Implication: The company added to plant and machinery in 2003-04 and
is continuing with capital expenditure (as shown by the capital work-
in-progress). It has funded that work by drawing down its investments.
Observation: The company's shareholders' funds, or its net worth, has
increased during the year.
Implication: Which means the company is making profits and retaining a
part of them.
Observation: Inventories and debtors have risen.
Implication: This could mean either that the company has increased its
scale of operations - sales have gone up - or it has become less
efficient with its working capital, leading to a pile-up of goods and
debtors. Perhaps it is having a tough time selling its goods.
The Director's Report in the Annual Report and the P&L account will
tell you whether the company's sales have indeed increased.
Stay informed
Reading the balance sheet will enable you to ask the right questions
about a company's performance. And, together with the Annual Report
and the P&L account, it gives a fair picture of the company's health.
Don't forget to check out the Auditor's statement and the Notes to the
Accounts. These will tell you whether an attempt has been made to
dress up the accounts to show a better picture.
Based on all this knowledge, you can then make an informed decision as
to whether or not you should buy or even hold on to the company's
stock.
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