Accounting Earnings


There are many times when we get attracted to companies with fast growth in reported sales and earnings. And when such companies also generate high ROAs and ROEs and are available at single digit P/Es (with no debt and reasonable cash in Balance sheet) it is a potential multi bagger in waiting.

The figures for the company I am talking about is as follows:

This company is available at a market cap of 400 crores and has no debt. It operates in the attractive pharma industry. It has grown at a CAGR of 40% in last 4 years (excluding 2006 low base year) and has earned wonderful returns on its asset base.

However, before we invest in this company, to get a better picture, one has to look at the cash flow statement which is as follows.

As we can see, the cash flow figures present a stark contrast to the earnings figures. The company made PBT of 128 crores in last 5 years but just made 25 crores in CFO. Please note that we are not talking about Free cash flow but Cash from operations.

This does not automatically mean that the company is cooking its books. There can be businesses with very high working capital requirements which ensure that no CFO remains post working capital investments.

It is prudent to understand the key working capital ratios in such cases to understand what is happening. The figures for that are as follows:

Cash conversion cycle = Receivable days + Inventory days – Payable days. The lower it is the better it is for a company. This effectively measures “how long does it take a company to convert its product to cash”.

As we can see the company’s receivable days shot up and is at 120-140 days now. Its inventory days, which is the number of days of inventory stored, is also very high. But the payable days, i.e. the time taken to pay its suppliers has been coming down.

So effectively the company has not been able to collect money from its customers for 120-140 days, it also is storing inventory for 140-150 days and pays its suppliers within 80-100 days. Definitely not a great picture.

Usually such companies resort to earnings management like recognizing revenues much in advance than the actual sales occurs. This is to show fast growth.

A check is to understand “how much cash the company actually collected from customers” and “how much did it actually pay suppliers”.

Cash collected from customers = Revenues – Increase in A/R

Cash paid to suppliers = COGS + Increase in Inventory – Increase in accounts payable

This should be compared to Revenues and revenue growth should more or less match cash growth. Else it may mean that the company is potentially managing earnings.

As we can see from this, in 2006-08 period the company collected far less cash from its customers compared to 2008-10 period. The company may potentially have been more aggressive in recognizing revenues. If we look at COGS though, the company has paid more to its suppliers than what is recognized as COGS. The company may have potentially been more aggressive in not recognizing expenses.

It is possible that this may be a perfectly valid company with clean books. But one must observe the CF statement and BS statement and not just the IC statement since they may potentially tell a very different picture, as it was in this case. The key is to understand the “why’s” if at all one still wants to invest in this company. Because, at the end of the day, cash is king.

The company is Bliss GVS Pharma and has been recommended by ET this Saturday to be among the fastest growing fundamentally sound companies.


13 Responses to “Accounting Earnings”

  1. 1 Mahesh

    Wonderful analysis. Complete hard core fundamentalist.

    Thank for the analysis. 🙂

  2. 3 Sajan


    One of the stocks in the list of stocks you mentioned below “Pondy Oxide”. Just so happens that I recently analysed it.

    Cash Flow from Ops is -ve for past 3 years. However, they have been paying out good dividends. So, are those dividends coming from financing activities (borrowings) ?


    • Hi Sajan, They were negative only for Mar’10 if I am not wrong.

      Am I looking at the wrong numbers? It being negative for one period would not worry me too much though yes, I would still like to evaluate it. BTW, has covered the stock. You can read up on that too.

  3. Hi Pradeep
    Good analysis,’ a cash in hand is worth two in the books’ 🙂
    I hv added your blog to my Blogroll, hope thats OK with u

  4. 7 Ajay Agarwal


    Can we check the calculation done for working cycle ratio here. I have calculated the same and arrived at the following values

    Working Cycle Ratio Receivable Days Inventory Days Creditor Days CCY

    2007-08 161.36 156.51 71.86 246.01
    2008-09 126.67 202.20 31.32 297.55
    2009-10 152.19 123.60 17.77 258.02

    Though the trend is same, values are quite different. The sample calculation is as below:

    Receivable Days =(Total Receivable/Revenue)*365
    2009-10= (70.41/168.87)*365 = 152.19

    Inventory Days=(Inventory/COGS)*365
    2009-10=(30.67/90.57)*365 =123.60

    Creditors Days= (Total Creditors/Revenue)*365
    2009-10=(8.22/168.87)*365 = 17.77

    • Hi Ajay,

      Thanks for visiting my blog.

      Answers to your queries:

      1. I used the average receivables, average inventory and average payables instead of the year end values. The reason being Balance sheet numbers are not calculated for a period but calculated as on date. So the inventory mentioned would be the inventory on 31.03.2010 and not the inventory between 01.04.2009 and 31.03.2010. Whereas Income statement nos are period to period. So the company sales is calculated from 01.04.2009 and between 31.03.2010. Hence the objective is to find out on an average what would have been the receivables throughout the year. Usually whenever B/S and I/S numbers are clubbed for any ratio, average balance sheet numbers must be used. This explanation above would change values for receivable days and inventory days and they would now match with mine.

      2. Creditor days: Though the numerator would now be average, the denominator you have used is different in this case. The denominator is not revenues but purchases. Creditor days are calculated on “purchases” and not on “revenues” i.e. “how many days of purchases do you owe to the people from whom you purchased” is what we are trying to answer. Also, Purchases is not equal to COGS. Purchases = COGS + Increase in inventory between the 2 years. (You are trying to understand how much the company purchased in the year and not how much the company used for manufacturing whatever it sold. The latter is COGS). So denominator is 90.57+30.67-38.69 which is 82.55.

      I hope I have clarified the queries. If you feel anything is wrong/unclear in my explanation, please get back.


  5. 9 Ajay Agarwal

    Thanks for the reply Pradeep.

    I got your point of using average value rather than year end value. So this average is a simple average (last year value + this year value)/2 ?

    If so, for the benefit of all I am putting how the values are arrived at for the year
    2008-09 and 2009-10 as below. I see that the Debtor 2008-09 does not match your
    calculation and the creditors values matches closely with your calculation. Please review.

    Debtors 2008-09 = ( (46.15+45.27)/2 ) *365/132.95 = 125.5 days

    Debtors 2009-10 = ( (70.41 + 46.15 )/2) * 365/168.87 = 126 days

    1st value does not matches your calculation which is 137
    2nd matches with your calculation.

    Inventory calculation with the avg taken similarly matches with your calculation.

    Creditors 2008-09 = ( (24.19 + 24.11)/2 ) * 365/ (69.84 +19.56) = 98.6 days

    Creditors 2009-10 = ( (11.67 + 24.19 )/2 ) * 365/82.55 = 79.28 days

    ( 82 as per your calculation )

    I have also calculated ROE & ROA values as below

    ROA = Net Profit / Total Assets = Net Profit / Total F. Assets + Total C. Assets

    2008-09 = (37.47/126.89) *100 = 29.53%
    2009-10 = (41.72/158.73)*100 = 26.28%

    FinancialLeverage =Total Assets/ShareHolder Equity
    2008-09 = 126.89/97.52 = 1.3
    2009-10 = 158.73/133.21 =1.19

    ROE = ROA * Financial Lev
    2008-09 = 29.53 * 1.3 =38.39
    2009-10 = 26.28*1.19 = 31.27

    Correct me where ever I am wrong.

    Thanks and Regards

    • Hi Ajay,

      I took the numbers from here since I was not planning to dig too deep. Here the sundry debtors is 54 against the 45.27 which you have used above. Guess MC screwed up on that (and hence I screwed up by not using nos from AR!). I checked the AR and it is the number which you have used and your calculation is correct.

      Regarding ROA and ROE nos, again using the average asset and equity values would help. All B/S nos must be average when calculating returns. Just noticed that I have not done that!! (now that is something, I highlight the correct way to calculate above and have not done it myself for ROA/ROE calculations).

      Will edit my post. Thanks!

      • Edited. However why does your total assets/equity nos are not matching with mine. I took from the AR.

        TA 2009-10: 140.84 crores and TA 2008-09: 100.47 crores and average would be around 120 crores for first year.

        Any corrections?

  6. 12 Ajay Agarwal

    Hi Pradeep

    For Total Assets I have used sum of Fixed Assets and Current Assets so it does not include the liabilities so it is not equal to the sources of funds.


  7. 13 Ajay Agarwal

    Hi Pradeep

    I have done some more analysis of this company. According to my analysis the issue with the company’s is more around its business than the financial. The company Annual reports are awfully short of any information. Here I am sharing my analysis and some questions which we need to answer to evaluate if this is a worthy investment:

    1) Company is a bulk drug manufacturer therefore it does not appear to have a economic moat.
    Q) However OPM for last 3 years are >=30%. So is there any product differentiation or is the company a low cost producer?

    2) Today’s contraceptive appears to have an edge over pills and condoms used to prevent parenthood. Pills have side effect and males are loathe to using condoms for obvious reason. In such a case Today can steal market share. But a long term investment cannot be made on a single product success. What about other products?
    Q) How much is the share of Today contraceptive in the company’s sale?

    3)On the financial front, company is a debt free company and is generating positive operating cash flow and some free cash flow. Its other parameters e.g. ROA, D/E, leverage and valuations are also good.

    Q) What is the capex plan and company plans to grow?
    In the last two year reports do not see any significant addition in plants, machinery etc, is the company done with the capex plan?

    4) The receivable days for the company is 125 days for last two years, appears that the credit policy of the company is 4 month.

    Q) Is the company offering generous credit to increase market share? It appears so How ever we need to check industry average

    Q) Can the company afford this? Because the company is a nearly debt free company, its cost of capital should be less and hence it can afford the generous credit.

    5)Large chunk of the company’s long term asset is under the account name Brands

    Q) What is this account? Is it brand value of the company therefore an intangible assets or some kind of tangible assets. If it is a intangible account company’s asset base can be very small.

    6) Given the size of company the company’s appears to be fairly prices at a P/E of 10. I think we need more answers on the business side to decide if this is a cheap stock or not.

    The problem is company Annual reports are awfully short of any information and net also does not throw much information. So I think this stock is not on investment radar.

    Anyone who can add more information here or can criticize the analysis is most welcome.


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