1. Financial statement analysis of a company

TOOLS FOR FINANCIAL STATEMENT ANALYSIS:

1. Common Size Financial Statements

2. Trend Analysis

3. Comparative Financial Statements

4. Cash Flow Statement

5. Fund Flow Statement

6. Ratio Analysis

The distinction between Vertical and Horizontal Analysis of financial data.

What is the meaning of Analysis and Interpretation?

Analysis and interpretation is all about presenting financial data which is self-explanatory and easy to understand. It helps users of accounting information in assessing the status of financial performance of the business for a time period and enables them to take proper decisions regarding the fiscal policy of the firm.

Importance of Financial Analysis?

Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analyzed. There are various methods that help in analyzing financial statements and make it useful for various accounting users.

Following reasons are essential for financial analysis of accounts

1. It is very helpful in determining the financial viability and profit earning capacity of the firm.

2. It is helpful in evaluating the business solvency in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

2. Comparative Statements & Common size statements

THE CONCEPT OF COMPARATIVE & COMMON SIZE STATEMENTS

What do you mean by Comparative Financial Statements?

These are the statements that help various users of accounting information in evaluating the financial progress of a firm in relative terms. These statements express the data in absolute figures or as percentage change and absolute change that occurs in the item of the financial statement over a period of time. The data presented in financial statements are self-explanatory and easy to understand. When items of the financial statement are treated with the same accounting policies and practices over a fixed period of time, then the comparative data derived from such statements bear meaningful comparisons.

Two common types are:

1. Comparative Income Statement

2. Comparative Balance Sheet

What do you mean by Common Size Statements?

Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet total and net sales are highlighted in percentages. The analysis based on these statements is called as Vertical Analysis.

Two types are:

1. Common Size Income Statements

2. Common Size Balance Sheet

What are the different techniques of financial analysis and explain the limitations of financial analysis?

1. Cash Flow Analysis: This analysis focuses on the inflow and outflow of cash and cash equivalents from the various activities of a business name, investing, operating and financing activities during an accounting period. This helps in analyzing cash payments and reason of receipt and the respective changes in cash balances during the accounting year.

2. Ratio Analysis: This method highlights the relationship between items of Balance Sheet and Income Statements. It is helpful in determining the efficiency, profitability and solvency of a firm. This analysis expresses the financial items as fractions, percentages or proportions. Also, it determines the qualitative relationship among different financial variables. It also serves as a source of information regarding the performance, viability and financial position of a firm.

3. Trend Analysis: This technique studies the trends in operating performance and financial position of the business over a period of many years in succession. In such a study, any particular year is considered a base year and the rest years are expressed as a percentage of the base year’s figures. It helps in identifying problems and inefficiency along with detecting the operating efficiency and financial position of the firm.

4. Comparative Statements: These statements use figures from two accounting periods that help determine financial position and profitability. It also enables to do intra and inter-firm comparisons and therefore determines the efficiency of a firm in relative terms. It uses both percentages as well as absolute terms. This analysis is known as Horizontal analysis.

5. Common size Statements: Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet total and net sales are highlighted in percentages. The analysis based on these statements is called as Vertical Analysis.

Explain the usefulness of trend percentages in interpretation of financial performance of a company.

Trend analysis is a form of analyzing financial data and it is expressed as a percentage for each year. It helps the accounting user in evaluating the financial performance of the business and also form an opinion of various tendencies by which businesses can predict future trends.

Importance of trend analysis:

1. Predicting of the trends of business which is forecasting of future trends in business.

2. Trends are expressed as percentages which is less time-consuming and easy to follow.

3. It becomes a popular financial analysis method due to trends being expressed in percentages which makes evaluating the financial performance and operating efficiency of the firm relatively simpler.

4. It presents a broader picture of the performance of company in terms of finance, viability and efficiency.

What is the importance of comparative statements? Illustrate your answer with particular reference to the comparative income statement.

Comparative statements have the following importance:

1. It presents financial data in a simple form, with year-wise data being presented in side by side fashion making the presentation neat and enabling intra and inter-firm comparisons more conclusive.

2. Presentation is very effective for drawing insights quickly and easily

3. It assists the management in drafting future plans and forecast trends which is achieved by analyzing the profitability and operating efficiency of a business over time.

4. Comparative analysis helps easy detection of problems. Early detection helps take corrective measures and align the business in meeting the desired target.

What do you understand by analysis and interpretation of financial statements? Discuss its importance.

Financial analysis is of great importance for the various users of accounting information. Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analyzed. There are various methods that help in analyzing financial statements and make it useful for various accounting users.

The following reasons are essential for performing financial analysis:

1. It is very helpful in determining the financial viability and profit earning capacity of the firm.

2. It is helpful in evaluating the solvency of the business in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

4. It helps management in decision making, drafting plans and also in establishing a robust and effective control mechanism.

Explain how common size statements are prepared giving an example.

Common size statements are of two types:

1. Common Size Income Statements

2. Common Size Balance Sheet

A common size statement is prepared as a columnar form for performing analysis. In such a statement each item of the available financial statement is compared to a common item. Such analysis is called as vertical analysis.

The following columns are present:

1. Particulars: It shows the various financial item under each respective heading

2. Amount Columns: Under these columns, the amount of each item is depicted along with sub-totals and the gross total of a particular year.

3. Percentage/Ratio Columns: Under these columns, the proportion of each item is shown as a percentage or ratio with reference to the common item.

It is prepared in the following two ways:

EXAMPLE

Working Note:

For example,

Numerical Questions

1. Following are the balance sheets of Alpha Ltd. as at March 31st, 2016 and 2017:

2. Following are the balance sheets of Beta Ltd. at March 31st, 2016 and 2017:

3. Prepare Comparative Income Statement from the following information:

Working Notes:

1. Calculation of Net Sales

Net Sales = Cost of Goods Sold + Gross Profit – Sales Return

or, Net Sales = Purchases + Manufacturing Expenses + Change in Inventory + Gross Profit – Sales Return

Net Sales (2016) = 80,000 + 20,000 +30,000 + 90,000 – 4,000 = ₹ 2, 16,000

Net Sales (2017) = 1, 40,000 + 50,000 – 60,000 – 30,000 – 80,000 = ₹ 92,000

2. Calculation of Finance Cost

Finance Cost = Interest on short-term loans + Interest on 10% Debentures

Finance Cost (2016) = 20,000 + 1,000 = ₹ 21,000

Finance Cost (2017) = 20,000 + 2,000 = ₹ 22,000

3. Calculation of Other Expenses

Other Expenses = Freight Outward + Carriage Outward + Loss on sale of office car

Other Expenses (2016) = 10,000 + 10,000 + 60,000 = ₹ 80,000

Other Expenses (2017) = 20,000 + 20,000 + 90,000 = ₹ 1, 30,000

4. Prepare a Comparative Income Statement from the following information:

*There is a misprint in the book, this should be 2, 00,000

Working Notes:

1. Calculation of Net Purchases and Change in Inventory

2. Calculation of Finance Cost

Finance Cost = Interest on Bank Overdraft + Interest on Debentures

Finance Cost (2016) = 5,000 + 20,000 = ₹ 25,000

Finance Cost (2017) = 0 + 20,000 = ₹ 20,000

3. Calculation of Other Expenses

Other Expenses = Carriage outward + other operating expenses

Other Expenses (2016) = 10,000 + 20,000 = ₹ 30,000

Other Expenses (2017) = 30,000 + 10,000 = ₹ 40,000

5. Prepare a Common size statement of profit and loss of Shefali Ltd. with the help of

following information:

Working Notes:

1. Calculation of expenses

Other Expenses = Indirect Expenses = % of Gross Profit

Gross Profit = Net Sales −- Revenue from Operations

For 2016, Gross Profit = ₹(6,00,000 −- 4,28,000) = ₹1,72,000

For 2017, Gross Profit = ₹(8,00,000 −- 7,28,000) = ₹72,000

2016=1,72,000×25%=₹43,000

2017=72,000×25%=₹18,000

2016=1, 72,000×25%=₹43,000

2017=72,000×25%=₹18,000

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