Reading the numbers

The financial section of an offer document is audited, restated, comprehensive and prepared by people who want you to buy. All four of those are simultaneously true, and reading it well means knowing which parts are constrained and which are chosen.

Restated financials

The accounts in an offer document are restated — recast onto a consistent accounting basis across the years shown, with the effects of later changes in policy pushed back through the earlier years.

This is a genuine service. It means the three years are comparable to each other, which the originally published accounts often were not.

It also means the earlier years as shown here are not what was reported at the time. If you want to know what the company told the world in the past, the restated table is not that record, and the differences are disclosed in the reconciliation.

What is constrained, and what is chosen

The audited statements are constrained: revenue, profit, assets, liabilities, cash flows, all on a defined basis with an auditor's name attached.

The key performance indicators are chosen. A company presents the metrics it considers relevant — active users, gross merchandise value, order volumes, stores, contribution margin, adjusted EBITDA. These can be real and useful, and they are selected by the seller, defined by the seller, and often have no standard definition at all.

Two habits are worth forming.

Read the definition, not the name. A company's "adjusted EBITDA" is whatever its own definition says it excludes. The definition is printed; it is usually the part nobody reads.

Notice what was dropped. A metric that appeared in the draft and is absent from the RHP, or one that was headlined two years ago and is now a footnote, is normally moving in the wrong direction.

Where profit hides

Three specific places to look, in a company being sold:

Cash flow against profit. A business reporting rising profit and falling operating cash flow is collecting less than it is billing. That gap is where the most expensive surprises live.

Related party transactions. A section that lists dealings with entities connected to the promoters — sales, purchases, loans, guarantees, rent. It is disclosed precisely because the terms may not be arm's length, and a business with substantial revenue from related parties has revenue whose durability depends on a relationship rather than a market.

Litigation and contingent liabilities. Outstanding cases against the company, its promoters and its directors, with amounts where quantifiable. A contingent liability is a cost that is not on the balance sheet because it has not crystallised — it is real, sized and deliberately outside the numbers you were reading a page earlier.

The risk factors, and how to read them

Every offer document has a long risk factors section, and it has a reputation for being boilerplate. It partly is. But it is written by lawyers who expect it to be read back to them in a dispute, which makes it the one section with a strong incentive towards candour.

The way to read it is to sort as you go.

Generic risks — policy may change, the economy may slow, competition may increase, we depend on key personnel. True of every company. Skip.

Specific risks — with a number, a name or a date in them. Customer concentration. A regulatory approval not yet received. A dependence on one plant, one supplier, one geography. A promoter case. A qualified audit opinion. These are the disclosures that exist because something is actually there.

Two patterns deserve particular attention. A risk factor stating that the company has had negative cash flows or losses in recent years will say so plainly, often with the figures. And a risk factor about the promoters' pledged shares or litigation connects directly to chapter 6 of the equity subject.

The useful output of an hour in this section is a short list of the specific ones. If that list is empty, either the business is unusually clean or you were skimming.

The pricing parameters

The offer document must also justify the price, and SEBI names the parameters:

The Parameters include EPS, PE multiple, return on net worth and comparison of these parameters with peer group companies.

That comparison is the subject of chapter 9, because the choice of peer group is the most consequential decision in the whole section — and it is made by the seller.

The order to read in

1. The reservation table on the cover — which route, from chapter 6.
2. Objects of the offer — chapter 5.
3. Risk factors, sorting generic from specific.
4. Restated financials: revenue, profit, operating cash flow, three years side by side.
5. The KPI definitions.
6. Related party transactions.
7. Litigation and contingent liabilities.
8. Basis for the issue price — chapter 9.

The point

Restated financials are comparable but are not what was reported at the time. The audited numbers are constrained; the KPIs are chosen, so read their definitions. In the risk factors, keep only the ones with a number, a name or a date in them.