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July 27, 2021

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Teaching Note

Identifying the Industry – A Short Case on Financial

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Statement Analysis
CASE SUMMARY
This short case provides income statements and balance sheets for the financial year ending
onMarch 31, 2017 for seven Indian firmsfromseven industries.Thesefirms belong to the
following industries:

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1. Airline
2. Banking
3. Information Technology Services (IT)
4. Distillery
5. Oil Exploration and Development
6. Pharmaceutical
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7. Retail

The task before the students is to evaluate the financial statements given in Exhibits 1 and 2, and
identify the appropriate industry for each firm.

TEACHING PURPOSE AND AUDIENCE

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The objective of the case is to help in teaching financial statement analysis using actual data of
Indianfirms in anengaging manner. In most cases, students generally get to analyse a known
firm using its financial statements. Here, however, they do it the other way round: tracing the
firm through its financial statements.The process is intuitive and motivates students to study
each line item andto use different tools and techniques of financial statements analysis like
common-size and ratio analysis.Thus, students learn and appreciate the fine operational
characteristics, and investment and financial decisions that reflect in the firms’ respective
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financial statements.

I have used this case several times in my second-year MBA elective course on Financial
Statement Analysis. The case can also be used in the first-year MBA or Executive MBA course
on Financial Accounting, and, in short,Accounting or Financial Statement Analysis executive
education modules. Although such a case study does exist for foreign firms, my teaching
experience suggests that students’ appreciation and engagement increases once they identify a
firm as Indigo rather than American!
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LEARNING OBJECTIVES

1. To understand how the inherent uniqueness of every industry reflects in its financial
reporting.

Prepared by Associate Professor Neerav Nagar, Indian Institute of Management Ahmedabad.

© 2019 by the Indian Institute of Management Ahmedabad.

This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.
 2 of 7 A00278

2. To learn and appreciate the fine operational characteristics, investment and financial

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decisions that reflect in the firms’ respective financial statements.

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3. To understand how the magnitude of the line items in the financial statements reflect a
firm’s business model.

ASSIGNMENT QUESTION

Evaluate the financial statements given in the exhibits and identify the appropriate industry for

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each firm.

TEACHING PLAN
Circulate the supporting spreadsheet in advance and give 15–20 minutes to the students to
accomplish the task. They can do this individually or in groups, though the latter approach is
preferred. Once they are finished, the instructor can start the discussion, which can take about

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30–40 minutes.

The discussion should first highlight the need for the preparation of common-size financial
statements for all the firms (see Exhibits TN-1 and TN-2) as the statements belong to firms of
different sizes. Once the common-size statements are ready, it becomes easierto do an inter-firm
comparison. The next step should be to compute a few ratios as there are several ratios that do
not have sales as the denominator (unlike the common-size analysis). Some of these ratios can
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be asset turnover, inventory turnover, receivable turnover, debt-to-assets, PPE-to-assets,
etc.(Instructors who prefer to skip this step can circulate the common-size financial statements
and ratios in advance.)

The next step is to divide the industries into (a) services, (b) trading and (c) others. The
industries under “services” include banking, IT andairline. The industryunder “trading”
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includesretail.Out of these, three industries—banking, IT and airline—should ideally reflect

zero inventory levels. In Exhibit TN-2, Firms A, D and F exhibit zero or minimal inventory.
Hence, the focus should be on these firms first.

Effort should first be made to identify thefirm under banking. Once this is done, the discussion
can focus on the nature of a banking firm’s business and how that should reflect in its financial
statements.This firm should be the easiest to identify as firms in this industry are highly
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leveraged,that is, the amount of deposits is high.Exhibit TN-2 suggests that Firm F has the
highest percentage of total debt (59.3%) driven by secured and unsecured loans. These are the
current, savings and fixed deposits. A bank’s advances to customers should also be high, which
can be observed in loans and advances (25.1%). Therefore, one should expect to see a high
percentage of other income (20.2%) and interest expense (64.8%; Exhibit TN-1). In addition, by
the nature of their businessbanks do not invest a lot in PPE, which reflects in their low net block
(1.6%; Exhibit TN-2). Ratios like debt-to-assets and PPE-to-assets in Exhibit TN-3 show a similar
picture. Hence, Firm F belongs to the banking industry. In this case, it is the State Bank of India.
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The next task is to identify which of the firms (A orD) belongs to theITor airline industry. The
key items where these two industries would differ are power and fuel cost, employee cost,
accounts receivable and investments in PPE. Focussing on the income statement (Exhibit TN-1),
power and fuel cost is very high (34.1%) forFirm A making it a worthy contender for being an
airline firm. Conversely, employee costs should be very high for an IT firm, which is seen with

This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.
 3 of 7 A00278

Firm Dwithan employee cost of 52.2% of sales. Further, an airline firm would be more capital

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intensive than an IT firm. Firm A’s and D’s net block-to-assets are 25.2% and 10.8%, respectively

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(see Exhibit TN-2) suggesting, again, that Firm A is an airline firm. Finally, a majority of
anairline’s sales would be in cash making its receivables very low. Firm A exhibits lower
accounts receivable (1.1%) and higher receivable turnover (117.1 times; Exhibit TN-3) when
compared to Firm D. Hence, it is confirmed that Firm A belongs to the airline industry and Firm
D belongs to the IT industry. In this case, the airline firm is Interglobe Aviation, which operates

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the airline Indigo, and the IT firm is Infosys.

The focus should now be on the firm from the retail industry, that is, one of the firms amongB,
C, E and G. The key characteristics of retail firms are that these operate on thin margins, spend
more on customer service (high selling costs), have high inventory turnover and a major sales
portionin cash (less receivables). In Exhibit TN-1, the operating margin is lowest (3.1%) for firm
G. However, selling and administration costs are the highest (22.2%) for Firm B, though this

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number may be diluted due to the magnitude of administration costs. The inventory turnover
ratios in Exhibit TN-3 indicate that any one of Firms B orC can be identified as the retail
firm.The numbers for receivable turnover (coupled with that of operating margin) should settle
the debate in Firm G’s favour as its receivables turnover ratio is very high (78.8 times) vis-à-vis
that for Firm B (3.7 times). Firm G, that is, a typical retail firm, would get cash quickly from its
customers as it sells primarily on a cash basis. In this case, this firm is Future Retail that
operates retail chains like Big Bazaar, Fashion at Big Bazaar and eZONE.
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The instructor should nextmove to the other category of firms falling under manufacturing
(distillery and pharmaceutical), and oil exploration and development. These firms are Firms B,
C and E. It would be good to start with the identification of the oil exploration firm first, which
should be the most capital intensive among these three. The easiest way is to focus on a unique
item in the balance sheet,“Producing Properties” (see Exhibit TN-2). This asset shows the oil
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and gas fields with proven oil and gas reserves where the commercial production is yet to
commence. This item is zero in all cases except for Firm C and the magnitude is huge (42.4%;
Exhibit TN-2). The net block is just 4.1% for Firm C. Adding both the items with capital work-
in-progress will show that the most capital intensive firm (62%) is indeed Firm C. In this case,
this firm is the Oil and Natural Gas Corporation (ONGC).

The toughest and most debatable step may be to decide which one among Firms B and E is
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thedistillery(or pharmaceutical). Liquor firms would generally advertise more, leading to high
selling costs. But the available data doesnot clearly identify the selling costs. In fact, selling and
administration costs are almost similar for both these firms (around 22%; Exhibit TN-1).
Inventory turnover can be low in both industries. “The older the wine the better” puts the
distillery ahead (lower inventory turnover).However, theinventory holding periodof a
pharmaceutical firmcan be longer if it stocks a lot of those medicines that are essential for public
health.In addition, stockpiles for the government can necessitate huge inventories. There will
always be one or two students who would highlight the key difference, that is, the employee
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costs. Pharmaceutical firms spend a lot on well-trained scientists and research staff. This can be
seen in Exhibit TN-1 where the employee cost is higher (18.6%) for Firm E. This firm is Dr.
Reddy’s Laboratories, while Firm B (toughest to identify) is United Breweries.

This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.
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The identifiedlist is thus as follows:

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1. Firm A: Airline (Interglobe Aviation)
2. Firm B: Distillery (United Breweries)
3. Firm C: Oil Exploration and Development (Oil and Natural Gas Corporation)
4. Firm D: Information Technology Services (Infosys)
5. Firm E: Pharmaceutical (Dr. Reddy’s Laboratories)

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6. Firm F: Banking (State Bank of India)
7. Firm G: Retail (Future Retail)

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This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.
 5 of 7 A00278

Exhibit TN-1: Common-size Income Statement for the year ending onMarch 31, 2017

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Industry

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A B C D E F G

REVENUES:
Net Sales 100.0 100.0 100.0 100.0 100.0 100.0 100.0

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EXPENSES:
Inventory Used 0.7 18.2 1.4 0.0 25.6 0.0 73.5
Stock Adjustments –0.0 –0.4 –0.2 0.0 0.0 0.0 –2.1
Power & Fuel Cost 34.1 2.9 0.7 12.1 3.0 0.0 1.4
Employee Cost 11.0 7.4 14.9 52.2 18.6 15.1 4.5
Other Manufacturing Expenses 21.6 31.4 14.7 0.3 11.1 0.0 0.2

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Selling &Administration Expenses 20.5 22.2 19.7 5.5 22.0 4.8 14.8
Miscellaneous Expenses 0.2 4.0 8.8 0.9 1.7 25.8 4.5
Depreciation 2.5 6.1 15.7 2.2 7.6 1.3 0.2
Total Expenses 90.5 91.7 75.7 73.2 89.6 47.0 96.9
Operating Profit 9.5 8.3 24.3 26.8 10.4 53.0 3.1
Other Income 4.2 0.3 9.7 5.2 6.1 20.2 0.1
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Interest Expense 2.2 1.2 1.6 0.0 0.6 64.8 1.1
Profit Before Tax 11.5 7.3 32.5 31.9 15.9 8.5 2.0
Tax 2.7 2.8 5.5 8.5 1.9 2.3 0.0
Deferred Tax –0.0 –0.3 3.9 0.1 –0.2 0.2 0.0
Reported Net Profit 8.9 4.8 23.0 23.3 14.2 6.0 2.0
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Extraordinary Items 0.7 –0.0 0.0 0.1 0.4 –0.0 0.0

Adjusted Net Profit 8.2 4.8 23.0 23.2 13.9 6.0 2.0
Source: Prepared by the author.
Note: All units are in percentage.
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This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.
 6 of 7 A00278

Exhibit TN-2: Year-end Common-size Balance Sheet as on March 31, 2017

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Industry

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A B C D E F G

LIABILITIES AND OWNERS' EQUITY

Share Capital 2.4 0.6 2.8 1.4 0.5 0.0 1.4

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Reserves Total 22.7 52.1 79.5 83.7 70.0 6.9 35.4
Total Shareholders' Funds 25.1 52.7 82.3 85.1 70.5 7.0 36.8
Secured Loans 15.9 11.2 0.0 0.0 0.0 11.7 14.1
Unsecured Loans 1.3 2.3 0.0 0.0 14.3 47.5 3.8
Total Debt 17.3 13.4 0.0 0.0 14.3 59.3 17.9
Other Liabilities 27.2 0.2 9.0 0.1 0.6 5.7 2.7

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Current Liabilities 29.7 31.9 7.3 9.6 13.3 28.0 42.4
Provisions 0.7 1.8 1.4 5.1 1.3 0.0 0.1
Total Liabilities 100.0 100.0 100.0 100.0 100.0 100.0 100.0
ASSETS
Gross Block 31.0 82.4 5.9 20.3 52.7 2.1 8.7
Less: Accumulated Depreciation 5.8 43.4 1.8 9.6 23.3 0.6 0.7
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Net Block 25.2 39.0 4.1 10.8 29.4 1.6 8.0
Capital Work in Progress 0.2 3.1 15.5 1.6 3.3 0.0 0.2
Producing Properties 0.0 0.0 42.4 0.0 0.0 0.0 0.0
Investments and Advances 24.7 0.6 24.0 31.3 18.9 61.3 0.0
Inventories 1.1 16.9 2.9 0.0 11.0 0.0 53.8
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Accounts Receivable 1.1 29.3 2.9 13.7 26.8 0.0 3.3

Cash and Bank 30.8 0.5 4.2 24.0 0.4 6.4 2.2
Loans and Advances 5.2 6.7 1.8 9.9 6.2 25.1 27.4
Total Current Assets, Loan & Advances 38.1 53.3 11.8 47.6 44.4 31.4 86.8
Net Deferred Tax –1.1 –1.1 –9.8 0.4 0.5 0.0 0.0
Other Assets 12.9 5.1 12.0 8.4 3.6 5.7 5.1
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Total Assets 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Prepared by the author.
Note: All unitsare in percentage.
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[email protected] or 617.783.7860.
 7 of 7 A00278

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Exhibit TN-3: Selected Ratios
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Ratio
A B C D E F G
Asset Turnover (Net Sales/Total Assets) 1.2 1.1 0.3 0.7 0.6 0.1 2.6
Inventory Turnover (Net Sales/Inventories) 113.9 6.3 11.9 – 5.4 – 4.8
Receivable Turnover (Net Sales/Accounts Receivable) 117.1 3.7 12.0 5.4 2.2 – 78.8

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Debt-to-Assets (Total Debt/Total Assets) 0.2 0.1 0.0 0.0 0.1 0.6 0.2

PPE/Assets (Net Block + Capital Work in Progress +

25.4 42.1 62.0 12.3 32.7 1.6 8.2
Producing Properties)/Total Assets

Source: Prepared by the author.

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This Teaching Note is authorized for use only by Shanul Gawshinde, Other (University not listed) until Mar 2024. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860.