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Financial Statements and Analysis

Financial Statements: are prepared on the basis of recorded facts. The recorded facts are those which can be expressed in monetary terms. These are the outcome of summarizing process of accounting.

“Financial statement is a collection of data organized according to logical and consistent accounting procedures.”

Types of Financial Statements:1. Position Statement OR Balance Sheet2. Income Statement OR Profit and Loss Account (P&L A/c)3. Statement of Changes in Owner’s equity OR Retained Earnings4. Statements of changes in Financial Position

Forms and Contents of Balance Sheet:(a) Horizontal or T Form or Account Form of Balance Sheet

Cash Flow Statement

Fund Flow Statement

(b) Vertical or Report Form of Balance Sheet

(a) Horizontal or T Form of Balance Sheet

LIABILITIES ASSETSParticulars Amt. Particulars Amt.

Share Capital – Equity/Preference

Reserves and Surplus- Capital and General Reserves- Share Premium Account- Profit & Loss A/c (Retained Earnings)- Other Reserves

Secured Loans- From FIs and Banks- Secured Debentures, Bonds

Unsecured Loans - Fixed Deposits- Other Loans & Advances- Unsecured Bonds etc.

Current Liabilities- Sundry Creditors- Bills Payable, Outstanding Exp.- Bank Overdraft, Dividend and Tax Payable, Short Term Advances etc.

Provisions - For Taxation- Dividend - For Contingencies etc.

-

-

-

-

-

-

Fixed Assets- Land, Building- Goodwill- Furniture, Plant and Machinery - Patent- Copy Rights- Live Stock- Trade Mark

Investments- Govt. & Trust Securities- Shares, Debentures & Bonds of Other Corporates

Current Assets- Cash in Hand & Cash at Bank - Marketable Securities, Short Term Investment- Bills receivables, sundry debtors- Inventories: Raw material, finished goods, spares & tools, work-in-progress.- Prepaid expenses, accrued interest

Loans & Advances- Advances & Loans - Preliminary Expenses, Deferred Exp.- Discount on issue of shares/bonds

-

-

-

-

xx xx

Financial Statements

Part I (B): Vertical Form of Balance SheetName of the Company ……………..Balance Sheet as at ………………..

Schedule Figures as at the Figure as at the No. end of current end of previous Financial year (Rs.) Financial Year (Rs.)I. Sources of Funds

1. Shareholder’s Funds(a) Capital(b) Reserves & Surpluses

2. Loans Funds (a) Secured Loans (b) Unsecured LoansTOTAL:

II. Application of Funds1. Fixed Assets (a) Gross Block (b) Less Depreciation (c) Net Block (d) Capital Work-in-Progress

2. Investments3. Current Assets, Loans & Advances (a) Inventories (b) Sundry Debtors (c) Cash & Bank Balances (d) Other Current Assets (e) Loans & Advances

Less: Current Liabilities & Provisions(a) Liabilities(b) Provisions

Net Current Assets4. (a) Miscellaneous Expenditure to the extent not written off or adjusted (b) Profit & Loss Account (debit)TOTAL:

M&FA – Financial Statements

EXPLANATION OF BALANCE SHEET ITEMS:

LIABILITIES

1. SHARE CAPITAL: Money collected from the promoters of the business and from general public in the form of “SHARE”. Share capital can be of two type:

(i) Equity Share Capital: Shareholders of this capital have voting right but they cannot demand dividend even if Company is in profits. Dividend decision is taken by the Management of the Company.

(ii) Preference Shares: Shareholders of these type of shares don’t have any voting right. But these shareholders are paid some fixed rate of dividend, if Company is in profit.

They are known as preference shares as they have preference over equity shares in following ways.

At the time of liquidation or winding-up of the company, these are paid before equity shareholders but after the secured loans.

They have preference over the dividend distribution also.

2. RESERVES & SURPLUS: This is created by undistributed profits or retained earnings. Reserves are created from these retained earnings for various purposes i.e. General reserves, Reserve for redemption of bonds etc., Reserve for contingencies etc.

We can classify the various items of Reserves & Surpluses as following: Share Premium Reserves (All kinds of reserves) Retained Earnings (Previous years profits) Surplus Profit (Current Year)

3. SECURED LOANS: All those loans against which security is provided to raise the loans are known as secured loans. These can be classified as following:

Loans taken from financial institutions like IDBI, ICICI and other state financial institutions and Banks etc.

Secured debentures OR bonds – these are the loans collected from the general public instead of taken bulk loan from banks & FIs. Security is provided against these bonds.

4. UNSECURED LOANS: These are the loans and advances against which company has not given any security. They are -

Fixed deposits (open ended) Unsecured bonds or debentures Loans from subsidiary company and Other unsecured loans etc.

M&FA – FINANCIAL STATEMENTS

5. CURRENT LIABILITIES: which are to be paid or are expected to be paid within a year or earlier also. These are -

Sundry Creditors Bills payable Advance payments Bank overdraft Dividend payable Tax payable

Outstanding / accrued expenses

6. PROVISIONS: which are provided to pay short term liabilities from the profits. These are -

Provision for tax Provision for dividends etc. (Proposed) Provision for insurance, pension or for provident fund scheme

ASSETS SIDE:1. FIXED ASSETS: are those which are used for long period. Generally investment in fixed assets are ir-reversible in nature. We can broadly classify these assets in two parts -

(i) Tangible Fixed Assets Land, Building, Furniture, Plant & Machinery, Vehicles, Live Stocks etc.

(ii) Intangible Fixed Assets Goodwill, Patent, Copyright, Brand Value, Trademark

2. INVESTMENTS : are done to obtain some returns out of surplus funds. These investments can be made under various sub-heads:

- Investments in govt. securities (gifts)- In shares and debentures of other corporates and in-real estates etc.

3. CURRENT ASSETS : are those assets or possessions which are used or utilized within a year or can be converted in to cash within a year. These are following:(In the decreasing order of liquidity)

- Cash in hand- Cash at Bank- Marketable Securities- Short-term investments- Bills Receivables- Sundry Debtors- Prepaid Expenses- Accrued Incomes- Inventories of raw material, finished goods, spares & tools, work-in-progress

4. LOANS AND ADVANCES : Short-term advances and loans given by the firm / company to others.

5. DEFERRED EXPENDITURES : Those expenses which are not debited fully to the Profit & Loss A/c of the year in which they have been incurred. These expenses are spread over a no. of years and the unwritten balance is shown in the balance sheet. These are-

- Preliminary Expenses - Discount on issue of shares / bonds etc.

M&FA – FINANCIAL STATEMENTS

Financial Statements

The Manufacturing, Trading and Profit & Loss Accounts are generally prepared in T-Form. The general forms of these accounts are given as follows:

Manufacturing AccountFor the year ending …..

Debit Credit

To opening Stock Raw Materials Partly Manufactured GoodsTo Purchase of Raw MaterialsTo Carriage InwardsTo Manufacturing WagesTo Factory RentTo Depreciation: Factory Building MachineryTo Repair to PlantTo CoalTo Salary of Works Manager

…..…..

…..…..…..…..

…..…..…..…..…..

By Cost of finished goods transferred to trading account

By Closing Stock: Raw Materials Partly Manufactured Goods

…..

…..…..

xxx xxx

Trading and Profit & Loss AccountFor the year ending …..

Debit Credit

To Opening Stock of finished goodsTo Cost of finished goods transferred from Manufacturing AccountTo Gross Profit c/d*To Gross Loss b/d*To SalariesTo Office RentTo AdvertisingTo Carriage OutwardTo Discount AllowedTo Provision for Bad and Doubtful DebtsTo Depreciation: Office Building FurnitureTo Net Profit-transferred to Capital Account

…..

…..

…..…..…..…..…..…..…..

…..

…..

…..

By SalesBy Closing Stock ofBy Finished GoodsBy Gross Loss c/d*By Gross Profit b/d*By Discount ReceivedBy Net Loss transferred to Capital Account

…..…..…..…..…..…..…..

xxx xxx

* Only one figure will be there.

Profit & Loss Appropriation A/cFor the year ending …..

Debit Credit

To Transfer to General ReserveTo Transfer to Sinking FundsTo Interim DividendsTo Proposed Dividends

…..…..…..…..

By Balance b/d(Balance of Profit from Previous Year)By Net Profit (For the Current Year)

…..

…..

xxx xxx

M&FA – FINANCIAL STATEMENTS ANALYSIS

Format To Find Out “NET PROFIT’ From “GROSS PROFIT”

Earning Before Interest, Depreciation & Tax - E B D I T(Depreciation) – Less - D

Earning Before Interest & Tax - E B I T__(Interest) – Less - I__

Earning Before Tax - E B T___

(Tax) – Less - T_________Earning After Tax - EAT / PAT / N.P.OR- Profit After TaxOR- Net Profit

NET PROFITLess – Dividend to preference

share holders_________ Distributable Profit___

Less – Dividend to Equity Share Holders ______________Surplus Profit_________

Add – Depreciation___________CASH PROFIT________

Tax Shield (By Depreciation): Tax Shield is the benefit obtained by a firm or company from the tax because of the existence of depreciation i.e. savings of company or firm by paying less tax due to deducting depreciation from the Gross Profit as an expense.

Net Worth:

Also known as – “Net Own Funds” OR “Owner’s Fund” etc.

Book Value: Value of a share that should be according to the financial position of the company.

Earning Per Share (EPS): Profit earned by the Company for each share

M&FA – FINANCIAL STATEMENTS ANALYSIS

Meaning & Concept of Financial Analysis:

Financial Analysis is also known as analysis and interpretation of financial statements.

ANALYSIS – means the simplification of financial data by methodical classification of the data given in the financial statement.

INTERPRETATION – means explaining the meaning and significance of simplified data (by analysis).

Share Capital + Reserves & Surplus

____Net Worth____No. of Equity Share

Net Profit After Payment of Dividend to P. Shares______No. of Equity Shares

Both analysis and interpretation are interlinked and complimentary to each other. The purpose of this analysis is to diagnose the information contained in financial

statements so as to judge the profitability and financial soundness of the firm.

Types of Financial Analysis

1. External Analysis : Done by outsiders who don’t have access to the detailed internal accounting records. These are shareholders, potential investors, creditors, govt. agencies, credit agencies, general public etc. This analysis depends on published financial statements.

2. Internal Analysis : Done by persons who have access to the internal accounting records of a business firm. These may be executives and employees of the company. Normally this is done for managerial purposes.

3. Horizontal Analysis : It is a comparison of financial data of a company for several years, presented horizontally over a no. of columns for the data of various years. Beginning point is chosen as base or standard year and the figures of other years are compared with the base or standard year.Example- Comparative and trend analysis

4. Vertical Analysis : It is the study of relationship of the various items in the financial statements of one accounting period. In this figures from one year’s financial statements are compared with a base selected from the same years statement. It is also known as “Static Analysis”.Example- Common size statement analysis and ratio analysis

M&FA – FINANCIAL STATEMENT ANALYSIS

Methods or Techniques of Financial Statement Analysis

Several methods and techniques are used for the financial analysis but generally we use the following techniques-

1. Comparative Statement Analysis

On the basis of material used

Vertical Analysis

External Analysis

Internal Analysis

Horizontal Analysis

On the basis of modus operandi

2. Trend or Trend Percentage Analysis3. Common Size Statement Analysis4. Ratio Analysis5. Funds Flow Analysis6. Cash Flow Analysis7. Cost-Volume-Profit Analysis

1. Comparative Statement Analysis: Comparative statements show financial position of different periods of time. So they give an idea of financial position at two or more periods. When figures of previous periods are given along with the figures of current period, analyst will be able to study the trends of various items like sales, profits etc. and also the trend and direction of financial position and operating results. These statements can be of two types-(a) Comparative Balance Sheet, (b) Comparative Income Statement

(a) Comparative Balance Sheet: This analysis is done on two or more balance sheets of the same company to find out the changes which help in forming an opinion about the progress of the company. Following points can be considered while analyzing the comparative balance sheet.

(i) Current Financial Position: by analyzing working capital i.e. Excess of Current Assets (CA) over Current Liabilities (CL)

Increase in W.C. will mean improvement in current financial position of the company.

(ii) Liquidity Position: by analyzing liquid assets i.e. cash etc.

(iii) Long-Term Financial Position: by analyzing changes in fixed assets long-term liabilities, capital etc.

(iv) Profitability of the Concern: By analyzing changes in retained earning and surplus.

M&FA – FINANCIAL STATEMENT ANALYSIS

BALANCE SHEETAs on 31st December

Liabilities 1993Rs.

1994Rs.

Assets 1993Rs.

1994Rs.

Equity Share CapitalReserves & SurplusDebenturesLong-term loans on

6,00,0003,30,0002,00,000

8,00,0002,22,0003,00,000

Land & BuildingsPlant & MachineryFurniture & FixturesOther Fixed Assets

3,70,0004,00,000 20,000 25,000

2,70,0006,00,000 25,000 30,000

Working Capital (W.C.) = CA – CL

MortgageBills PayableSundry CreditorsOther Current Liabilities

1,50,000 50,0001,00,000

5,000

14,35,000

2,00,000 45,0001,20,000

10,000

16,97,000

Cash in hand & at bankBills ReceivablesSundry Debtors StockPrepaid Expenses

20,0001,50,0002,00,0002,50,000

14,35,000

80,000 90,0002,50,0003,50,000 2,000

16,97,000

Solution:

COMPARATIVE BALANCE SHEET OF A COMPANYFor the year ending December 31, 1993 and 1994

Assets

Current Assets:Cash in hand & at BankBills ReceivablesSundry DebtorsStockPrepaid ExpensesTotal Current Assets

Fixed Assets:Land & BuildingsPlant & MachineryFurniture & FixturesOther Fixed AssetsTotal Fixed Assets

Total Assets

Year ending 31st December Increase/Decrease

(Amounts)

Increase/Decrease

(Percentages)1993 1994

Rs.

20,0001,50,0002,00,0002,50,000

---

Rs.

80,00090,000

2,50,0003,50,000

2,000

Rs.

+60,000-60,000+50,000

+1,00,000+2,000

Rs.

+300-40+25+40

6,20,000 7,72,000 +1,52,000 +24.52

3,70,0004,00,000

20,00025,000

2,70,0006,00,000

25,00030,000

-1,00,000+2,00,000

+5,000+5,000

-27.03+50.00

25.0020.00

8,15,000 9,25,000 +1,10,000 +13.49

14,35,000 16,97,000 +2,62,000 +18.26

Financial Statements Analysis

Liabilities & CapitalCurrent Liabilities:Bills PayableSundry CreditorsOther Current Liabilities

Year ending 31st December Increase/Decrease

(Amounts)

Increase/Decrease

(Percentages)1993 1994

Rs.

50,0001,00,000

5,000

Rs.

45,0001,20,000

10,000

Rs.

-5,000+20,000+5,000

Rs.

-10+20

+100

Total Current Liabilities

DebenturesLong-term loans on MortgageTotal Liabilities

Equity Share CapitalReserve & Surpluses Total

1,55,000 1,75,000 +20,000 +12.9

2,00,0001,50,0005,05,000

3,00,0002,00,0006,75,000

+1,00,000__+50,000+1,70,000

+50___+33+33.66

6,00,0003,30,000

8,00,0002,22,000

+2,00,000-1,08,000

+33-32.73

14,35,000 16,97,000 +2,62,000 +18.26

Interpretation

(1) The comparative balance sheet of the company reveals that during 1994 there has been an increase in fixed assets of 1,10,000 i.e. 13.49% while long-term liabilities to outsiders have relatively increased by Rs. 1,50,000 and equity share capital has increased by Rs. 2 lakhs. This fact depicts that the policy of the company is to purchase fixed assets from the long-term sources of finance thereby not affecting the working capital.

(2) The current assets have increased by Rs. 1,52,000 i.e. 24.52% and cash has increased by Rs. 60,000. On the other hand, there has been an increase in inventories amounting to Rs. 1 lakh. The current liabilities have increased only by Rs. 20,000 i.e. 12.9%. This further confirms that the company has raised long-term finances even for the current assets resulting into an improvement in the liquidity position of the company.

(3) Reserves and surpluses have decreased from Rs. 3,30,000 to Rs. 2,22,000 i.e. 32.73% which shows that the company has utilized reserves and surpluses for the payment of dividends to shareholders either in cash or by the issue of bonus shares.

(4) The overall financial position of the company is satisfactory.

2. COMPARATIVE INCOME STATEMENT

The Income Statement gives the results of the operations of a business. The comparative income statement gives an idea of the progress of a business over a period of time. The changes in absolute data in money values and percentages can be determined to analyze the profitability of the business. Like comparative balance sheet, income statement also has four columns. First two columns give figures of various items for two years. Third and fourth columns are used to show increase or decrease in figures in absolute amounts and percentages respectively.

M&FA – FINANCIAL STATEMENT ANALYSIS

Guidelines for Interpretation of Income Statement:

Increase and decrease in sales should be compared with or in cost of goods sold. Profitability will improve only when increase in the cost of goods sold will be less than the increase in sales.

Operating profit will improve when either sale will improve or operating expenses will reduce or vice-versa.

Increase or decrease in net profit will show the progress of the concern. Overall profitability of the concern should also be evaluated.

Sales – Cost of goods produced (Mfg. or production cost)_________________________________________________

= GROSS PROFIT ___________________________________

Less – Operating Expenses (Office and administration expenses, selling and distribution expenses etc.)_________________________________________________OPERATING PROFIT _______________________________

Less – Non-operating Expenses (Interest on loans, loss on sale ofassets, writing off of deferred expenses payment of taxes etc.)__________________________________________________NET PROFIT_______________________________________

Example: Income statements of a firm are given for the year ending on 31st December 1993 and 1994. Re-arrange the figures in a comparative form and study the profitability position of the concern.

1993 1994 Rs. (000) Rs. (000)

Net sales 785 900Cost of goods sold 450 500Operating Expenses:General & Admin. Expenses 70 72Selling Expenses 80 90Non-Operating Expenses:Interest Paid 25 30Income-Tax 70 80

Solution:

COMPARATIVE INCOME STATEMENTFor the year ended 31st December 1993 and 1994

Decrease (-)31st December Increase (+)

Decrease (-) Rs. (‘000)

Increase (+)Decrease (-)

(Percentages)1993

Rs. (‘000)1994

Rs. (‘000)Net SalesLess: Cost of goods soldGross Profit

Operating Expenses:General & Administrative Expenses Selling ExpensesTotal Operating Expenses

Operating ProfitLess: Other deductions Interest paid

Net profit before taxLess: Income tax

Net Profit after tax

785450

900500

+115+50

+14.65+11.0

335 400 +65 +19.40

7080

7290

+2+10

+2.8+12.5

150 162 +12 +8.0

185

25

16070

90

238

30

20880

128

+53

+5

+48+10

+38

+28.65

+20

+30.0+14.3

+42.22

InterpretationThe comparative income statement given above reveals that there has been an increase in net sales of 14.65% while the cost of goods sold has increased nearly by 11% thereby resulting in an increase in the gross profit of 19.4%. Although the operating expenses have increased by 8% the increase in gross profit is sufficient to compensate for the increase in operating expenses and hence there has been an overall increase in operational profits amounting to Rs. 53,000 i.e. 28.65% in spite of an increase in financial expenses of Rs. 5,000 for interest and Rs. 10,000 for income-tax. There is an increase in net profits after tax amounting to Rs. 38,000 i.e. 42.22%. It may be concluded that there is a sufficient progress in the company and the overall profitability of the company is good.

Illustration 3. The Income Statements of Sanyasi Ltd. are given for the years 1993 and 1994. Convert them into Common-size Income Statement and interpret the changes.

Income StatementsFor the years ending 1993 and 1994

Gross SalesLess: Sales returnsNet Sales Cost of SalesGross Profit

Operating Expenses:Selling & Distribution ExpensesAdministrative ExpensesTotal Expenses

Operating Income Other Incomes

Non-Operating ExpensesNet Profit during the year

1993Rs.

7,25,00025,000

1994Rs.

8,15,00015,000

7,00,0005,95,000

8,00,0006,15,000

1,05,000 1,85,000

23,00012,700

24,00012,500

35,700 36,500

69,3001,200

1,48,5008,050

70,5001,750

1,56,5501,940

68,750 1,54,610

Solution:COMMON-SIZE INCOME STATEMENT

For the year ending 1993 and 19941993 1994

Net SalesLess: Cost of Sales Gross Profit

Operating Expenses:Selling & Distribution ExpensesAdministration Expenses Total Expenses

Operating Income Other Incomes

Total Income Less: Non-Operating Expenses

Net profit during the year

Rs.7,00,0005,95,000

%100.0085.00

Rs.8,00,0006,15,000

%100.0076.87

1,05,000 15.00 1,85,000 23.13

23,00012,700

3.291.81

24,00012,500

3.001.56

35,700 5.10 36,500 4.56

69,3001,200

70,5001,750

68,750

9.900.17

10.070.25

9.82

1,48,5008,050

1,56,5501,940

1,54,610

18.561.00

19.560.24

19.32

2. Trend Analysis: In this analysis is done by computing trends of series of information. This method determines the direction upwards or downwards.

The information for a no. of years is taken up and one year, generally the first year, is taken as a base year. Base year’s figures are compared with other years to find a trend. Base year is considered as 100% (trend percentage).

Example: Figures of ‘X’ ltd from 1996 are following:

Year Sales Stock G.P. (Figures in Rs. Lacs)1996 1881 709 3211997 2340 781 4351998 2655 816 4581999 3021 944 5272000 3768 1154 672

Solution: TREND PERCENTAGES (Base Year – 1996 = 100) (Rs. In Lacs)Year Sales (%) Stock (%) Gross Profit (%)

19961997199819992000

18812340265530213768

100124141161200

7097818169441154

100110115133162

321435458527672

100136143164209

Interpretation: Sale is increased in all the years and has grown to twice of 1996 in year 2000.

Stock is also growing every year but increase was more between 1999 and 2000. Profit is also growing substantially. It has doubled from 1996 to 2000. Increase

was more in 1997 but max in 2000. Overall performance of firm is good. It’s sales & profits are doubled in just five

years. Increase of profit is more than increase in sales that shows control over cost.

3. Common-Size Statements: Common size balance sheet and income statements are shown in analytical percentages. The figures are shown as percentages of total assets and total sales and total liabilities.

The total assets are taken as 100 and different assets are shown as percentage of the total assets and same way in the liabilities.

Similarly in income statements all the components are shown as percentage of sales.

(i) Common Size Balance Sheet: In this all the assets and all the liabilities are expressed in percentages of total of assets and liabilities.

The total figure of assets Rs. 2,00,000 is taken as 100 and all other assets are expressed as a percentage of total assets. The relation of each asset to total assets is expressed in the statement. The relation of each liability to total liabilities is similarly expressed.

The common-size balance sheet can be used to compare companies of differing size. The comparison of figures in different periods is not useful because total figures may be affected by a number of factors. It is not possible to establish standard norms for various assets. The trends of figures from year to year may not be studied and even they may not give proper results.

Illustration 6. The Balance Sheets of S & Co. and K & Co. are given as follows:

BALANCE SHEETSAs on Dec. 31, 1994

Liabilities S & Co. K & Co. Rs. Rs.

Preference Share Capital 1,20,000 1,60,000Equity Share Capital 1,50,000 4,00,000Reserve & Surpluses 14,000 18,000Long-term Loans 1,15,000 1,30,000Bills Payable 2,000 ---Sundry Creditors 12,000 4,000Outstanding Expenses 15,000 6,000Proposed Dividend __10,000 90,000

4,38,000 8,08,000Land and Building 80,000 1,23,000Plant and Machinery 3,34,000 6,00,000Temporary Investment 1,000 40,000Inventories 10,000 25,000Book-Debts 4,000 8,000Prepaid Expenses 1,000 2,000Cash and Bank Balances 8,000 10,000

4,38,000 8,08,000

Compare the financial position of two companies with the help of common size balance sheet.

Solution

COMMON-SIZE BALANCE SHEETAs on Dec. 31, 1994

Assets

Fixed AssetsLand & BuildingPlant & MachineryTotal Fixed Assets Current AssetsTemporary Investments InventoriesBook DebtsPrepaid ExpensesCash & Bank BalanceTotal Current Assets Total Assets Share Capital & Reserves Preference Share CapitalEquity Share CapitalReserves & SurplusesTotal Capital & ReservesLong-term Loans Current Liabilities Bills PayableSundry CreditorsOutstanding ExpensesProposed Dividend

Total of Liability Side

S & Co. K & Co.Amount

Rs.

80,0003,34,000

%

18.2676.26

AmountRs.

1,23,0006,00,000

%

15.2274.62

4,14,000 94.52 7,23,000 89.48

1,00010,0004,0001,0008,000

0.232.280.910.231.83

40,00025,0008,0002,000

10,000

4.953.080.990.251.25

24,000 5.48 85,000 10.524,38,000 100.00 8,08,000 100.00

1,20,0001,50,000

14,000

27.3934.253.19

1,60,0004,00,000

18,000

19.8049.502.23

2,84,000 64.83 5,78,000 71.531,15,000 26.25 1,30,000 16.09

2,00012,00015,00010,000

0.462.743.442.28

---4,0006,000

90,000

---0.490.7411.15

39,000 8.92 1,00,000 12.384,38,000 100.00 8,08,000 100.00

Comments:(1) An analysis of pattern of financing of both the companies shows that K & Co. is more traditionally financed as compared to S & Co. The former company has depended more on its own funds as is shown by balance sheet. Out of total investments, 71.53% of the funds are proprietor’s funds and outsiders’ funds account only for 28.47%. In S& Co. proprietors’ funds are 64.83% while outsiders’ share is 35.17% which shows that this company has depended more upon outsiders funds. In the present day economic world, generally, companies depend more on outsiders’ funds. In this context both the companies have good financial planning but K & Co. is more financed on traditional lines.

(2) Both the companies are suffering from inadequacy of working capital. The percentage of current liabilities is more than the percentage of current assets in both the companies. The first company is suffering more from working capital position than the second company because current liabilities are more than current assets by 3.44% and this percentage is 1.86% in the case of second company.

(3) A close look at the balance sheets shows that investments in fixed assets have been financed from working capital in both the companies. In S & Co. fixed assets account for 94.52% of total assets while long-term funds account for 91.08% of total funds. In K & Co. fixed assets account for 89.48% whereas long-term funds account for 87.62% of total funds instead of using long-term funds for working capital purposes the companies have used working capital for purchasing fixed assets.

(4) Both the companies face working capital problem and immediate steps should be taken to issue more capital or raise long-term loans to raise working capital position.

(ii) COMMON SIZE INCOME STATEMENT:The items in income statement can be shown as percentages of sales to show the relation of each item to sales. A significant relationship can be established between items of income statement and volume of sales. The increase in sales will certainly increase selling expenses and not administrative or financial expenses. In case the volume of sales increases to a considerable extent, administrative and financial expenses may go up. In case the sales are declining, the selling expenses should be reduced at once. So, a relationship is established between sales and other items in income statement and this relationship is helpful in evaluating operational activities of the enterprise.

Illustration 7. Following are the Income Statements of a company for the years ending Dec. 31, 1993 and 1994:

1993 1994 (Rs. in ‘000) (Rs. in ‘000)

Sales 500 700Miscellaneous Income 20 15

520 715Expenses:

Cost of Sales 325 510Office Expenses 20 25Selling Expenses 30 45Interest 25 30

400 610Net Profit 120 105

520 715

Solution:

COMMON-SIZE INCOME STATEMENTFor the years ending Dec. 1993 and 1994

1993 1994

SalesLess: Cost of Sales Gross Profit

Operating Expenses:Office ExpensesSelling ExpensesTotal Operating Expenses

Operating Profit Miscellaneous Income

Total Income Less: Non-Operating Expenses:Interest

Net Profit

Rs. (‘000)500325

%100.0065.00

Rs. (‘000)700510

%100.0072.86

175 35.00 190 27.14

2030

4.006.00

2545

3.586.42

50 10.00 70 10.00

12520

145

25

120

25.004.00

29.00

5.00

24.00

12015

135

30

105

17.142.14

19.28

4.28

15.00

Interpretation

(1) The sales and gross profit has increased in absolute figures in 1994 as compared to 1993 but the percentage of gross profit to sales has gone down in 1994.

(2) The increase in cost of sales as a percentage of sales has brought the profitability from 35 to 27.14%.

(3) Operating expenses have remained the same in both the years but non-operating expenses have decreased as a percentage in 1994. A slight decrease in non-operating expenses in the latter year could not help to improve profits.

(4) Net profits have decreased both in absolute figures and as a percentage in 1994 as compared to 1993.

(5) The overall profitability has decreased in 1994 and the reason is arise in cost of sales. The company should take immediate steps to control its cost of sales, otherwise the company will be in trouble.

Illustration 8. The following are the Balance Sheets of X Ltd. and Y Ltd. for the year ending 31st of December, 1994.

Liabilities

Equity Share CapitalPreference Share CapitalReserves & SurplusLoans Bills PayableSundry CreditorsOutstanding ExpensesDividend Declared

X Ltd.Rs.

2,50,0001,20,000

50,0003,50,000

25,00018,0008,5902,000

Y Ltd.Rs.

1,70,00080,00070,000

2,79,00014,0008,0004,5007,500

Assets

Land & BuildingPlant & MachineryInvestment(Temporary)Book-DebtsPrepaid ExpensesCash & Bank

X Ltd.Rs.

3,50,0002,70,000

72,000

47,50035,40048,690

Y Ltd.Rs.

2,75,0003,00,000

12,000

25,000---

21,000

8,23,590 6,33,000 8,23,590 6,33,000

Present the data in such a way that proper analysis is possible. Do your own. Give your interpretations also.

Limitations of Financial Analysis: Though financial analysis is a powerful tool of determining financial position (strengths & weaknesses) of a firm, but this analysis is based on the information available in the financial statements.

Thus this analysis suffers from inherent limitations of financial statements.

The financial analysts have to be careful about the impact of price level changes, window-dressing of financial statements, changes in accounting policies, personal judgements etc.

Some of the important limitations of financial analysis are, however, summed up as under:1) It is only a study of interim reports.2) This analysis is based upon only monetary information and non-monetary factors are ignored.3) It does not consider changes in price level.4) Changes in accounting procedure may often make financial analysis misleading.5) Analysts have to make interpretations and draw his own conclusions. Different people may interpret the same analysis in different ways.6) Sometimes accounting concepts and conventions cause a serious limitation to financial analysis.

RATIO ANALYSIS: A ratio is a simple arithmetical expression of the relationship of one no. to another.

A financial ratio is a relationship between two accounting figures expressed mathematically.

A ratio can be expressed in percentages by multiplying the ratio by 100. A ratio of 5000 can be expressed as:

1000(i) 5:1, or (ii) 5, or (iii) 5/1, or (iv) 5 to 1, or (v) 500%In all these cases the inference is that first figure (500) is five times than that of the second.

RATIO – ANALYSIS

NATURE OF RATIO ANALYSIS: Ratio analysis is a technique of analysis and interpretation of financial statements.

It is a process which helps in making certain decisions. Only calculation of ratios does not serve purpose if it is not analyzed and

interpreted properly. Selection of appropriate data and relevant ratios is also very important.

Use and Significance of Ratio Analysis: It is important for different persons, for different purposes.

A) Utility for Managers1. Helps in decision making2. Helps in financial forecasting & planning3. Helps in communicating4. Helps in communicating5. Helps in co-ordination6. Helps in control

B) Utility to Shareholders / Investors C) Utility to CreditorsD) Utility to EmployeesE) Utility to GovernmentF) Tax-Audit Requirements

Limitations of Ratio Analysis: Limited use of single ratio Lack of adequate standards Inherent limitations of accounting Change of accounting procedures Window-dressing of financial statements Personal judgement Price-Level changes

Classification of Ratios: Can be broadly classified under four categories:

(1) Liquidity Ratios (2) Activity Ratios (3) Leverage or Long-Term (4) Profitability Solvency Ratios Ratios

a) Current Ratio a) Debtor’s Turnover a) Debt-Equity Ratio (i) In relation to salesa) Gross Profit Ratio/GPM

b) Liquid or Quick b) Creditor’s b) Debt to total b) Operating Profit Ratio/NPM or Acid-test Ratio T/o Ratio Capital Ratio c) Net-Profit Ratio/NPM

c) Absolute Liquid c) Inventory c) Interest Coverage Ratio (ii) In relation to investments Ratio T/o Ratio ROI a) Return on Network

b) Return on Equityd) Working Capital d) Equity Ratio c) Return on Capi. Empl. T/o Ratio d) EPS

e) Solvency Ratio e) P/E Ratio