Compare and contrast the financial statements of a manufacturing firm with that of a bank

Income statements are an important part of most businesses. These statements allow owners, managers and shareholders to see exactly how money is flowing into the company. There is no universal income statement format that covers all businesses; however, businesses in different industries, such as service and manufacturing, have several differences between their statements since the businesses have different types of expenses and different income sources.

Income Statements

1. Income statements record the profits and losses experienced by a business over a set period of time. Income statements can cover short periods, such as one month, or longer periods, such as a full year; a common naming syntax is to describe the time period and the ending date, as in "The Six Month Period Ending April 30, 2011." The income statement includes an accounting of all revenue made during the time period as well as any expenses involved with the production of that revenue.

Industry Differences

1. Businesses adapt their income statements to their needs based upon the industry the business is in; service industry businesses could not use the same income statement template as manufacturing industry businesses because of the significant differences in how the businesses operate and earn money. Since an income statement reflects both the total amount of money earned by a company and the cost of earning that money, those industries that have more expenses or more types of expenses must provide more information in their statements than those who have only general expenses.

Service Industry Income

1. Service providers typically have low overhead costs as a result of keeping little if any inventory and having a relatively small number of employees on staff. This results in a larger percentage of revenue converting to profit in comparison to other business types, though depending on the service, the total amount of revenue may be low. Income statements generated by a service provider focus on the amount of income brought in and the types of expenses that the business encounters. Expenses that are common to other types of businesses may be left off of the income statement if the service does not require them.

Manufacturing Industry Income

1. Manufacturing companies typically have higher amounts of revenue than other business types due to the products produced being sold to retailers, other manufacturers, and directly to consumers. Manufacturing equipment, raw materials and the number of employees required to run a manufacturing company increase the amount paid to generate this revenue, however, resulting in a smaller amount of profit in comparison to business income. Income statements for manufacturing companies are typically more robust than those for other industries since manufacturers encounter a wider range of expenses than those companies that do not require extensive equipment, maintenance, shipping services or manpower.

EduPristine >Blog >How is analysis of banking companies different from manufacturing companies?

How is analysis of banking companies different from manufacturing companies?

March 9 2015 Written By: EduPristine

Fundamental analysis – the branch of analysis that deals with the fundamentals underpinning the value of a security (be it debt or equity) largely is based on a study of the business model, financial condition & the management of that company.

The business model of a banking company is different in 2 ways as compared to the ‘manufacturing’ sector.

• It relies on a lot of judgement in decision making – While financial analysis can paint a picture of the past performance and future potential, it is the lender’s judgemental call on the borrower’s willingness & ability that is the backbone of the lending decision.
• Loss distributions are asymmetrical – When defaults happen, income (interest) stops accruing and the entire principal turns into loss. Thus, the bank faces a double whammy when loan defaults happen.

  For instance, let us consider an investment outlay of Rs.5bn in a new factory that needs to be evaluated by General Manager of a FMGC Company & a lending proposal of similar amount to be evaluated by the Corporate Banking Head of a Bank. What would be the factors they take into consideration in their decision?

Expansion proposal in Company	Lending proposal in Bank
Expected Benefits	Factors Considered
Expected demand for product (Volume Growth)	Ability to repay loan – Business &operational parameters, Financial Analysis
Estimated Price realisation	Willingness to pay – Credit history,Management quality
Expected Costs	Returns from lending – Benchmarking the rate of interest charged to other companies with similar risk profile, fees, other products that may be offered to the customer
Project parameters Construction & Machinery Cost Location Construction time Connectivity – Labour & Raw material
Regulatory considerations – RBI regulations, internal policy parameters like caps on lending to a sector/ tenor restrictions etc.
Regulatory considerations – Tax, Labour,Environmental laws	Risk factors – Expected probability of default based on ‘what if” scenario analysis Mitigants – Collateral, Covenants etc.
Techniques used	Techniques used
Capital budgeting tools like payback period, NPV etc	Ratios like Return on Equity (ROE), Return on Risk Adjusted Capital(RAROC)

As we saw, the business model of a Bank is completely different than that of a manufacturing company. Therefore, standard metrics used in company analysis like – volume & price growth, gross profit margins, debt to equity ratios etc won’t work in analysis of banks. That is to say, that, while an analyst would look at the same three factors viz. business model, financial condition & management quality, the parameters used within them differ. These are outlined below.

1. Business Overview

• Business Mix: A breakup between Retail (lending to individuals/ small businesses through the branch network) Corporate lending, Trade Finance (financing import/export) and Project Financing (Funding infrastructure). This will help in understanding tenor of assets (how long is your principal at risk), granularity (size of each loan & therefore impact if it defaults), susceptibility to currency fluctuations, etc.
• Funding Mix: Share of low cost & sticky CASA (Current & Savings accounts) versus the more fickle but relatively costlier time deposits.
• Focus: Is it a universal banking offering all services or a retail/corporate/trade focussed bank.
• Growth strategy: Retail takes longer (and hence costlier) to penetrate into but is relatively less risky. Corporate assets can be built up relatively faster.
• Efficiency: Metrics like business (loans +deposits) per employee, revenues/profits per employee are used to analyse the efficiency of business

2. Financial Analysis

Select financial indicators that are studied are provided in the table below:

• Capital Adequacy % is the minimum amount of capital that must be pumped in for every $100 of risky assets (loans given+ investments) Of this Tier I capital is from equity and equity like instruments & Tier II is by way of hybrid instruments or subordinated debt. The ability of a Bank to source equity at lowest cost and from wide variety of investors and maintain Capital adequacy well above the threshold stipulated by the regulators is a sign of its strength.
• Asset Quality: The assets (loans/investments) of a Bank are its primary revenue generators. An in depth study of the asset composition will include analysing the maturity profile, industry & geographic concentration and trends in NPA ratios.
• Earnings Quality: Sustainability is the key here – steady NII growth in $ terms and maintaining a steady NIM signal stable accruals. Fee income boosts profitability and therefore is a key metric; besides ROA & ROE ratios. Cost to Income Ratio is studied to understand what is the amount spent to earn each $ of revenue.
• Funding Quality: What is the level of dependence on term deposits (wholesale funding). While CASA is sticky it also entails cost in the form of Branch network. Another critical area of study is the Asset Liability Mismatch i.e. the time when assets mature to generate cash inflows versus the time liabilities have to be paid off. A negative mismatch (time when liabilities to be paid exceeds assets maturing) will need to be refinanced.

3. Management Quality

This is a subjective analysis comprising of understanding the Composition of the Board of Directors & Key management of the Bank, frequency of changes in top management. Attrition levels are also analysed across the Bank functions as the key assets for a Bank are its employees.

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