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  1. Why financial results of a firm are key to investing decision

Why financial results of a firm are key to investing decision

Once you have a reasonable understanding of the company’s financials, you would need to check the risks that the company is facing at present or likely to face in the coming quarters

By: | Updated: July 28, 2015 9:00 AM
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The corporate earnings statement is an important document through which the company communicates with the outside world. (Express Photo for representation only)

As per clause 41 of the listing agreement, it is mandatory for listed companies to submit an audited or unaudited quarterly financial statement to bourses where their stocks are listed. The financial statement needs to be submitted within 45 days of the end of each quarter. The company must also publish the result in at least one English daily newspaper and in one newspaper of the region where the company is registered.

Relevance of report
The earnings statement is an important document through which the company communicates with the outside world. It is important not only for the current but also for the prospective shareholders. Many investors are not able to effectively understand the quarterly reports. Though these reports are prepared by companies on a prescribed format, it is responsibility of the investors to understand the information. To understand the report, investors must read between the lines for an informed decision making.

Format of the report
The format consists of detailed information of the quarter, the preceding quarter, corresponding quarter last year, year-to-date figures, comparative figures for the last year and numbers for the previous year. The company will report the consolidated results (if it has any subsidiaries) as well standalone results. As per accounting standard (AS) 17, if a company is dealing in more than one geography or segment, it must provide segment-wise information. Though the structure is similar for all companies, there might be a small variation between manufacturing and service companies. Banking and insurance companies are governed by different acts and their formats vary to a greater extent with that of manufacturing and service companies.

What to look at in quarterly reports
Quarterly earnings can be interpreted and reviewed in different ways. Some would focus on the current performance and some would look at the business and financial risks that the company is exposed to. Some prefer to compare the current quarter with that of the previous quarter. It is essential to review methodically to understand what the company is trying to communicate. One must try to get answers for the these questions on the financial performance of the company: How has the company performed in the current quarter compared with the previous quarter?

Whether topline has improved or deteriorated? Whether cost of sales is increasing or decreasing? Whether EPS is improving quarter-on-quarter? Also check for the profit retained, generally this is the amount which will be used for the future growth of the company.

Focus on the risk factors
Once you have a reasonable understanding of the company’s financials, you would need to check the risks that the company is facing at present or likely to face in the coming quarters. Just check whether the company has any contingent liabilities, pending lawsuits. Generally, it is difficult to assess the monetary impact of these items, just make a rough computation of potential financial impact on the value of the company. These items are important especially for pharma companies in India.

Obtaining required information and understanding the financial health of the company is not  rocket science. Assess the company in which you have invested or proposed to invest and try to obtain answers for the questions raised above. But the caveat is that quarterly results need to be reviewed keeping in mind other fundamentals of the company.

The writer is associate professor of finance and accounting in IIM Shillong

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