Value Creation



When a company is formed, it is essential for a company to maintain systematic financial relationships and cash flows which are an important part of management. The co-ordination of these relationships can prove fruitful only when company's management takes correct decision at correct time.

There are three dynamic decisions that the management of the company's emphasis on and they are:

a) Investments

b) Financing and

c) Operations.


A firm is able to run properly only when there is a proper mixture of these three in the company's working because these three dynamic decisions have a huge impact on company's financial statements which indirectly reflects its performance and position.

(Source: Techniques of Financial Analysis: A Guide to Value Creation By Erich A. Helfert)

In any company's annual report, there contains a mass of financial information which needs to be understood in order to make sense. This information includes both of quantitative as well as qualitative data. Unless this rarely contextualize data is not given some analysis, it is not possible to assess its importance as a whole.

In order to solve this problem, financial intellectuals have developed number of approaches which can be broadly classified into two parts.

a) Fundamental analysis and

b) Technical analysis.

(source: pg 188, chap ..o'regan.........)

Fundamental Analysis

Fundamental analysis analyse the information with the use of balance sheet and income statement information. It also interprets the information from industry and macro-economic data, to forecast future stock price movement. Besides the financial analysts, even the investors makes a great use of this financial tool considering past sales, earnings, cash flow, product acceptance and management performance of a company so that they can predict the future trends of a company's progress. It basically helps them to assess the valuation of a stock or a group of stocks and to determine whether they are overvalued or undervalued.

(source: financial reporting & analysis- revisine..collins..johnson, pg 5 chap 1).

It helps to understand the range of macro and micro economics within which a company operates. The user will be able to understand the information regarding the company's place within a particular industry, inflation rates, recent wages and disputes.

(source: pg 190, chap ..o'regan.........)

The commonly used fundamental screens to analyse the price to a particular number in firm's financial statement is:

a) Price-to earning

b) Price-to-book value

c) Price-to-cash

d) Price-to-dividend.

(source: financial statement analysis and security valuation, Stephen penman, chap 3, pg 81).

Example: If we want to analyse a coffee production, we have find information regarding its growth, what are its planning cycles, who are the big buyers of coffees, their plans in future and their demand in the market. This all study includes in fundamental analysis.

(source: pg 190, chap ..o'regan.........)

Technical Analysis

Technical analysis is the study of the future share price by identifying trading patterns which generally tend to be repeat cycles.

(source: pg 197, chap ..o'regan.........)

These trading patterns are identified by computer analysing data series. The price collected each day is opening price, high price or the low price, and the closing price as well as sometimes the volume traded is also recorded. These are the basic things and thus are known as the building blocks of technical analysis. A simple line charts or bar or candlestick charts are created based on the data collected and on top of this charts, a technical analysis is formed which helps to review the information based on price.

((source: Investors Chronicle, septmeber 22, 2000.)source: pg 198, chap ..o'regan.........)

It relies on price and volume movements of stocks. Technical analysis does not take into consideration the financial statement numbers.

(source: financial reporting & analysis- revisine...collins..johnson, pg 5 chap 1).

Some commonly used technical screens to identify investment strategies from indicators that related to trading are:

a) Price screens

b) Small stocks screens

c) Neglected stock screens

d) Seasonal screens.

Example: It claims that all the price affecting coffee production are shown in the price chart itself which has an impact on the demand and supply. If the supply goes up and the demand stays the same then the price will go down. This can be seen as a price drop on a price chart. This is how a technical analysis is used based on the charts and conclusion drawn from them.

((Source: http://www.learninvesting/courses/commodity105.htm) source: pg 189, chap ..o'regan.........)

Techniques used for analysing financial statements

Financial statements are very important tool for running any kind of business. They help to draw the overall working conditions of the business. They are basically a representation in the form of numbers that gives information of the company's performance. It is mainly used by investors, employees, customers and government. Financial statement reflects the position of a company in the economy. They evaluate the funding of the company and wages paid to the workers. In short we can say it is like a soul to the company which helps it to run.

Firms are generally required to publish three primary financial statements and they are:

* Balance sheet

* The Income statement and

* The Cash flow statement.

(Source: financial statement analysis and security valuation, chap 1, pg 2, chap 2, pg 32, 34)

* Balance sheets:

Balance sheet is a listing of the impact of past investments, financing decisions taken, operations carried out over a period of time. It is basically a record of these transactions that affects the current business. The analysts analyse the assets, liability and the net worth of the shareholders as it reflects a unique nature of a company and the sector where this company belongs.

* The Income Statement:

It helps to Measure Company's performance over a specific period of time generally quarterly or annually. The income statement helps to interpret information about revenues, expenses and profit which are generated by various companies' operation for that period. Income statement is best used to match the relevant revenue with the relevant cost and expenses for the period like depreciation of the assets used over more period than the current reporting period or like cost of goods purchased or manufactured previously.

* The Cash Flow Statement:

Cash flow statement is the one which carries out both the current operating results and the changes, records made in the balance sheet. Basically it's a statement that records the cash inflow and outflow over a period of time. It is prepared by comparing the end and the beginning balance sheet and key items taken form income statement.

The following cash transactions are recorded in a cash flow statement:

a) Change in impact of cash due to changing taking place in the working capital requirements.

b) Investments in assets or paying off the liabilities in cash.

c) Change in cash for paying dividends.

d) Cash impact on issue of new shares or repurchase of shares.

(Source: techniques of financial analysis-a guide to value creation, chap 1, pg26)


From the above discussion we can see that there are massive amount of numbers including pricing, values in a company's financial statements, salary's, cash transactions included in financial statements which can confuse or scare the concerned person and if this values and numbers are analysed properly with proper techniques, the information given in the statements can become like a gold mine.

Of the two techniques we studied above, we can determine that the fundamental analysis is more useful when analysing company's financial statement. The main reason why fundamental analysis is most suitable is because fundamental analysis helps in determining the in-depth value of corporate securities by an in-depth studying of earnings, risk, growth, and competitive position which has a direct relation with company's financial statements. It is also called quantitative anlaysis.

(source: journal of accounting research, vol 3 no 2, autumn 1993, printed in USA, Fundamental Information Analysis, Baruch Lev, and S. Rama Thiagarajan)(

There are two main techniques used by fundamental analysis to carry out its operation:

1) Common size statements

2) Ratios and Percentages

Common size statements:

It helps us by means of whom financial data from one accounting period or a number of accounting periods can be expressed as a percentage or ratio of relevant figure.

* Common size statements help to relate each item to a common base.

* There are always changes in the company and thus common size statements help to identify those changes

* It helps us to evaluate the financial and economic trends and characteristics of individual firms and whole industry.

* It can be easily graphed.


Ratio is one of the most important fundamental analyses. They reduce the complex financial data into a much simpler form in order to understand them.

Uses of Ratio:

* Observation: It helps in a deep observation and makes aware of the financial data to be interpreted.

* Calculation: Also, calculation can be done in a much simpler form as it allows reduction of financial information to a common base which helps in easier comparison between two years of a company's report or between industries.

* Analysis: It involves the calculation done and evaluates them to judge the performances.

* Decision Making: Ratios also help in easy decision making as there are less of the larger number to be discuss.

(source: o'regan, chap .., pg 192-196.

Fundamental Process:

To carry out a proper fundamental analysis of the financial statements, a procedure has been outlined so that information can be interpreted feasibly. The diagram below shows the steps involved in fundamental process.

The working of a Fundamental Analysis can be explained in 5 steps as follows:

Step 1

Step 2

Step 3

Step 4

Step 5

(Source: financial statement analysis and security valuation, Stephen penman, chap 3, pg 85)


We have discussed about the fundamental analysis and technical analysis in the above part and also learned that how and in what way fundamental analysis is used for analysis financial statements. But if we look at today's scenario and from the investor's point of view, analysing company's profit and performance only through fundamental analysis is not sufficient. Fundamental analysis is very essential for the study of a company's earnings but however due to its nature of extremely time consuming, (Source: Article Let's Talk Fundamentals dated Oct 16th 2008, by Daniel Kartcher, investors also prefer technical analysis which uses past data like fundamental analysis in the form of charts, moving averages ins their decision making process.

(Source: Article Being a Technical Analyst dated dec 13th 2006 by Martin Chandra,

“To conclude, fundamental analysis is the practice of looking at a company's fundamentals, such as assets, value, profits and incomestatements, because the assumption is that the stock price will eventually reflect the true “fundamentals” of the company. Technical analysis, its opposite number, is the practice of studying a stock's past prices and trends in an attempt to determine its future prices and trends, because the assumption is that the patterns to the stock price movements can yield valuable information. One approach is company-oriented and the other is price-oriented.” So we can say that instead of a single approach a combination of both can prove useful to investors and also to the company.

(Source: Article on Investment Basics: What is Fundamental Analysis and What is Technical Analysis? Dated Jun 6th 2008 by Shawn Seah)



Introduction to Autonomy Corporation

Autonomy Corporation was founded in the year 1996. It is a technological company which was founded after research carried out in Cambridge University. It is engaged in development and distribution of software with maintenance and related services.

Vision of the Company:

"The essence of Autonomy's software lies in its ability to extract the core concepts of unstructured data. The way in which it achieves this is arguably some way ahead of any rival product."

Peter Whiting, UBS, 2007


2007 Financial Reviews

Due to new regulations and changing of business needs, there was a transformation for the company. It ripped the market benefits and hence experienced an extraordinary year. Autonomy Corporation Produced a record results in every area which helped them to become a true market leader. Some of the awards win by them are:

a) “Best Performing Software Company in Europe”

b) “Multiple product of the year Award.”

They also had record revenues when compared to 2006 annual reports, some of them are:

a) “Research and Development increased 21%”.

b) “Cash balance of $92.6million at year end and no net debt.”

c) “Net Profit (IFRS) up 60% from 2006”.

(Source: Strategic Analysis of Financial Statements: A case study approach, Module Notes by John Stittle and Bob Wearing)

In the introduction to the 2007 Autonomy Corporation accounts, Mike Lynch (chief executive) made the following comments:

‘It is my great pleasure to present to you our results from another amazing year for Autonomy. Top line revenues, operating profits, bottom line profit before tax and EPS are all up significantly, ahead of analyst consensus expectations, with strong organic growth and the ZANTAZ acquisition performing well'

Now in accordance with the statement made by Chief Executive of the Company, let us interpret the Financial Statement 2007 of Autonomy Corporation and analyse it.

Financial Statements can be analysed with the help of Ratios:

Ratio Analysis:

Ratios basically help in reduction of the financial data that helps in comparison and thus interpretation of the financial statement becomes much easier. It helps in easy observation, calculation, analysis, interpretation and decision making.

(Source: Financial Information Analysis, Philip O' Regan, chap 7, 194)

For analysing annual report 2007 of Autonomy Corporation we use the following ratios:

1) Current Ratio = Current Assets__

Current Liabilities

(Source: Financial Reporting And Analysis by Revsine.Collins.Johnson, Chap 4, pg 166)

(Year 2006) = 207370


= 2.167

(Year 2007) = 224641


= 1.494

(Analysis: The current ratio is basically a ratio of current asset and current liabilities. The short term solvency of the company is measured by current ratio. The higher the current ratio, the larger is the amount of money available per current liability.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.3, 7.4)

In the case of Autonomy Company, as we compare year 2006 and year 2007, we will find that the ability of the company's to meet their current liabilities in 2006 was better than 2007. As also from the figures of current assets and current liabilities given in the balance sheet, we can analyse that the rise in number of current liabilities is much more than rise in current assets in 2007.)

2) Debtors Turnover Ratio = Net Sales______

Average Debtors

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.7)

(Year 2006) = 250682


= 3.020

(Year 2007) = 343409


= 2.961

(Analysis: Debtors Turnover Ratio is measured by dividing the net credit sales by average debtor outstanding during the year. The main purpose for doing this ratio is to find out how fast is the receivables collected from the debtors. The higher the ratio, is the less time between the credit given and cash collected and lower the ratio, more time is taken by the company to collect the debt.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.7)

In the above ratio we can see that the ratio is higher in year 2006 than 2007 which shows that in year 2007, the clearance of the debtor's receivables is lower than that of 2006.)

3) Cash Flow From Operations Ratio = Cash flow from operations

Current Liabilities

(Source: Financial Reporting and Analysis by Revsine.Collins.Johnson, Chap 4, pg 170)

(Year 2006) = 39472


= 0.41

(Year 2007) = 82459_


= 0.54

(Analysis: The main purpose of this ratio is to show the liquidity position of the company by comparing actual cash with current liability. The higher the ratio, the better is the company's performance in terms of liquidity.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.9)

In the year 2006 in the above ratio, the liquidity position is 0.41 as compared to 2007 which is 0.54. This shows that in the year 2007, the liquidity position of the company is more than its previous year.)

4) Debt Equity Ratio = _Long Term Debt ___

Shareholders' Equity

(Source:Clyde P. Stickney and Paul R. Brown, pg 152)

(Year 2006) = 17837


= 1: 2.85

(Year 2007) = 67776


= 1: 1.18

(Analysis: The Debt equity ratio shoes us the relation between borrowed funds and owner's capital. This is the ratio that shows the outsiders funds contribution in relation with the owner's funds in the company. The higher the ratio, the larger is the funds contributed by the outsiders and vice versa. In this case if the ratio 1: (less than 1), the company is highly in debt. And if it is 1: (more than 1), the company has fairly heavy debts.

(Source:Clyde P. Stickney and Paul R. Brown, pg 153)

In this case, in both the years, the company is fairly into heavy debts but the debt of the company is more in 2007 which we can find out from the relation ratio.)

5) Interest Coverage Ratio = EBIT__


(Source: Financial Reporting and Analysis by Revsine.Collins.Johnson, Chap 4, pg 170)

(Year 2006) = 55540


= 21.25

(Year 2007) = 88649


= 36.29

(Analysis: This ratio helps us to understand the capacity of the company to pay fixed interest on the long term debt. The larger the coverage, the greater is the ability of the firm to pay fixed income. A low ratio is a signal towards danger that the firm is in excessive debt.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.13)

In the above ratio the ratio of year 2007 is higher than that of 2006 which interprets that over the spam of one year the company's capacity to pay of the fixed interest has increased).

6) Gross Profit Margin = Gross Profit x 100


(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.15)

(Year 2006) = 219093 x 100


= 87.398%

(Year 2007) = 291347 x 100


= 84.839%

(Analysis: It is calculated by dividing gross profit by sales. A gross margin helps to understand a margin beyond which a fall in sales price can become intolerable for the company. A higher gross profit margin to sales is a good sign for the company and it shows low cost of production. A relatively low margin is definitely a danger sign and the factors responsible should be analysed immediately.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.15)

In the above two years margin we can see that both years gross margin are high but the gross margin of year 2006 is higher than that of year 2007 which shows that in one year the company's gross margin have actually decline by approximatly3%)

7) Operating Profit Margin Ratio = EBIT____ x 100

Net Sales

(Source: Revine.Collins.Johnson, pg 161)

(Year 2006) = 55540 x 100


= 22.1%

(Year 2007) = 88649_ x 100


= 25.81%

(Analysis: It shows the relation between net profits and the sales of the company. This ratio shows the ability of a company to operate the business with success not only to recover the sales amount but also the other services and operating costs along with borrowed funds. A high net profit is the higher returns to owner.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.16)

Thus in the above net profit ratio we can see that there was a rise in the percentage of ratio when compared to previous year.)

8) Return on Capital Employed = ____Profit_______ x 100

Capital Employed

(Source: Financial Reporting and Analysis by Revsine.Collins.Johnson, Chap 4, pg 172)

(Year 2006) = 55540_ x 100


= 9.42%

(Year 2007) = 88649__ x 100


= 8.3%

(Analysis: It mainly measures a Company's Performance in using capital that is provided by shareholders to generate earnings.

(Source: Financial Reporting and Analysis by Revsine.Collins.Johnson, Chap 4, pg 172)

The higher the ratio the more efficiently is the company using the capital employed. It provides a test of profitability in relation with long term funds.

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.18)

So in the above analysis as we compare the ROCE of year 2006 and 2007, we will find that the ROCE of year 2006 i.e. 9.42 % is higher than that of 2007 which is 8.3% which shows that the shareholders funds were more efficiently used in the year 2006.

9) Asset Turnover Ratio= ____Sales_______ x 100

Capital Employed

(Source: Financial Management by MY Khan and P K Jain, chap7, pg 7.19)

Asset Turnover Ratio

(Year 2006) = 250682 x 100


= 42.52%

(Year 2007) = 343409_ x 100


= 32.21%

(Analysis: Asset Turnover Ratio shows us how effectively the use of assets by the company is. This ratio helps us to understand the use of assets during sales in relation with per capital employed. The higher the Ratio, the better is the use of it. In the above interpretation we can see that in the year 2006, the percentage of Asset Turnover was 42.52% as compared to 32.21 in the year 2007 which shows that in year 2006, the assets utilization was more than year 2007. But it also shows that for the maintenance of such high utilization more of capital is also needed. So this contradicts ratio and thus sometimes asset turnover proves to be misleading.)

10) Earnings Per Share = __Net Income - Preferred Stock Dividends________________

Weighted Average Number of Common Shares Outstanding

(Source: Clyde P. Stickney and Paul R. Brown, pg 160)

(Year 2006) = 0.21

(Year 2007) = 0.31 (Given in the Company's Income Statement)

(Analysis: Sometimes valuing the firm as a whole is a difficult process during merger negotiations, during buyouts. So for valuation it is better to value individual common shares. Knowing company's total earnings for this purpose is required. This is done with the help of earnings per share.

(Source: Revsine.Collins.Johnson, Chap 4, pg 752)

Earnings per share are the money that shareholders earn per share. Higher earnings per share show higher profitability to the company. So in the Autonomy Corporation the EPS for year 2006 was 0.21 which increased to 0.31 in the year 2007. But higher EPS not always shows higher profits, it can because of retained earnings or increase in equity capital.


According to the analysis done above and various interpretations made, I do not agree with the Chief Executive Officer of Autonomy Corporation about his optimistic assessment of the company's financial performance. There are many areas where 2006 was better than 2007 like gross profit margin, debt equity ratio, asset turnover ratio which contradicts his statement. Though there was a tremendous increase in company's well being due to ZANTAZ acquisition like Research and Development, renegotiation with Banks for its loans but this was not seen in every area of company's financial statement as that we can see it from the ratios done.

To conclude, according to me some part of financial performance do indicate that this can be continued further but only when the default areas are sorted out with more efficiently.

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