FINANCIAL STATEMENT ANALYSIS SWARNAM S SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I FINANCIAL STATEMENT Financial Statement are known as Trading, Profit & Loss Account and Balance Sheet It is compulsory for a concern to prepare the financial statements according to the Companies Act 1956 Necessity for Assessment of Tax It is useful for creditors, owners and general public But it wont be sufficient for the financial planning and decision making SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

FINANCIAL STATEMENT ANALYSIS Financial Statement Analysis is concerned with the process of determining financial strength and weakness It establishes relationship between various accounts in the financial statements DEFINITION: “Financial Statement Analysis is a process of evaluating the relationship between component parts of a financial statement to obtain a better understanding of a firm’s position and performance” SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I DEFINITION “The analysis and interpretation of financial statements are an attempt to determine the meaning and significance of financial statement data so that the forecast may be made of the prospects for future earnings, ability to pay interest and debt maturities and profitability and sound dividend policy” SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Analysis and Interpretation Classification of data given in the financial statements Explaining the meaning and significance of relationship between various factors Comparison of these relationships. SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS To find out the operating performance of a company (expense ratios, sales performance) To find out the financial performance of a company (financial health) To compare performance with different periods To find the find out the solvency and liquidity position To compare the performance with other companies in the industry SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

ADVANTAGES OR USES OF FINANCIAL STATEMENT ANALYSIS Advantages to the owners – strength, weakness and profit Advantages to the investors Advantages to the management (movement and utilisation of funds) Advantages to the suppliers (It helps to decide quantum of credit) SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

DISADVANTAGES OF FINANCIAL STATEMENTS Financial statement are only interim reports. Items are based on personal judgement (example: method of depreciation) Non-monetary factors are excluded Ignores the changes in price level It is records of past events only SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

TYPES OF FINANCIAL STATEMENT ANALYSIS 1. According to Material Used Internal Analysis -- Analysis by the owners, management and employees -- Carried out to find the strength and weakness of the company -- To find the growth rate of the company -- To carry out the future actions SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. External Analysis -- Analysis done by the external parties by investors, financial analysts, lenders, and general public -- The purpose is to know the financial and operating performance -- To know about the credit worthiness -- To know about the safety of their investment SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. 2. According to Modus Operandi Horizontal Analysis -- Analysis of financial statements for different periods is called horizontal analysis -- It explains whether there is a growth over a period of years -- This analysis may be conducted for two years or any number of years SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. Vertical Analysis: -- Analysis of Financial Statements for one period only -- It analysis the relationship of various items in the profit and loss account and balance sheet -- Example: Current Assets and Current Liabilities, Working Capital etc.. SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. On basis of Period -- Long-Term Period: To evaluate the long-term solvency, profitability, financial health, earning capacity, debt servicing etc.. -- Short-Term Period: To determine the liquidity position of the firm SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Procedure for Financial Statement Analysis The purpose for which the analysis is conducted is determined well in advance On the basis of the purpose the items should be identified If the analysis is carried out for income statement, the items should be clearly arranged on basis of sales If the analysis is carried out for balance sheet, the items should be classified as fixed assets and current assets for asset side and current liabilities, debt and equity for liability side SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. After classification of the items in the Income statements and Balance sheet increase or decrease of each items for one period to another should be calculated Comparison on basis of percentage of sales for income statement and total assets and liabilities for balance sheet Interpretation after the analysis to provide information for managerial decision making SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Methods of Financial Statement Analysis Comparative Balance Sheet Comparative Income Statement Common-size Statements Cash Flow Analysis Trend Analysis Fund Flow Analysis Ratio Analysis SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Comparative Balance Sheet The comparative balance sheet shows the value of assets and liabilities of two different dates In this statement, assets are separately analyzed as current assets and fixed assets The liabilities are analyzed as current liabilities, Debts (long term loans) and Equity (Share Capital and Reserves) SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Procedure for Preparation of Comparative Balance Sheet The statement should prepared with five columns The first column is for particulars Second and third column for periods Fourth Column for Increase or Decrease of items Fifth Column for the percentage increase or decrease SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. When assets is taken for Analysis, it should be separated as current assets and fixed assets. The values should be recorded in the second and third column and increase or decrease in the fourth column and percentage in fifth column Then liabilities side should be analyzed should be classified as current liabilities, debts and equity. The values should be recorded respective columns After analysis, interpretation should be given SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Comparative Income Statement As income statement shows operating results of a business Its compares the sales, profit and other expenses of two different period It has five columns The first column is for particulars Second and third column for periods Fourth Column for Increase or Decrease of items Fifth Column for the percentage increase or decrease SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Procedure for calculation of Comparative Income Statement First of all, analysis about the gross profit should be made Next increase or decrease in operating profit should be analyzed. The operating profit is the differences between gross profit and operating expenses. The operating expenses are selling , administrative and distribution expenses After analysis of Gross profit, operating profit should be analyzed. Operating profit is calculated by adjusting operating expenses SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. Net profit is calculated by adjusting non-operating expenses and non-operating income with operating profit Non-operating expenses like interest, loss on sale of fixed assets, write off goodwill and preliminary expenses , payment of tax etc.. should be deducted with operating profit The non-operating income like dividend received, interest received, profit on sale of fixed assets should be added with operating profit SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

SWARNAM S/ MBA/ ACCOUNTS/ UNIT I Contd.. The increase or decrease should be identified After preparing the analysis, the interpretation about the analysis should be stated clearly for further action of management SWARNAM S/ MBA/ ACCOUNTS/ UNIT I

Common Size Statements The statement which reports the figures as a percentage of some common base are called common size statements Common Size statements are prepared by common size income statement and common-size balance sheet Sales is taken as the common base for common size income statement In common size balance sheet, total assets or liabilities are taken as the common base SWARNAM S/ MBA/ ACCOUNTS/ UNIT I