Financial Analysis
What the exam tests
Financial analysis questions test whether you can convert reported statements into a credit view: normalised earnings, cash flow adequacy, leverage and coverage. Expect ratio computation, trend analysis and adjustment of accounting distortions.
Core rules and concepts
- Profit is not cash. Start from EBITDA, adjust for working capital, tax and capex to get cash flow available for debt service (CFADS).
- Leverage: debt/equity, net debt/EBITDA, and total outside liabilities/tangible net worth. Coverage: interest coverage ratio (EBITDA/interest) and DSCR (CFADS/debt service).
- Quality of earnings: one-off gains, related-party sales, capitalised interest, receivable aging, inventory build-up and contingent liabilities.
- DuPont: ROE = net margin × asset turnover × equity multiplier; use it to see whether leverage or operations drives returns.
- Projections should tie to capacity, tariff, demand and working-capital cycle, not a flat growth rate.
Worked example
EBITDA ₹240 crore; depreciation ₹50 crore; interest ₹60 crore; principal repayable ₹40 crore; tax ₹35 crore; capex ₹50 crore; working-capital increase ₹20 crore. CFADS = 240 − 35 − 50 − 20 = ₹135 crore. DSCR = 135/(60+40) = 1.35. ICR = 240/60 = 4.0. Net debt/EBITDA, using net debt ₹450 crore, = 1.9x. The project services debt but has thin headroom; a 10% EBITDA fall gives DSCR 1.23, so covenant headroom matters.
Traps
Do not use PAT as CFADS; it is after depreciation and interest. Do not mix ICR and DSCR. Do not ignore lease liabilities, guarantees or capitalised interest. Do not compare ratios across sectors without adjusting for regulation and asset intensity.