# Lesson 05 FINANCIAL STATEMENT ANALYSIS

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```					UNIT-II
LESSON

5
FINANCIAL STATEMENT ANALYSIS

CONTENTS
5.0 Aims and Objectives
5.1 Introduction
5.2 Definition & Classification of Financial Statement Analysis
5.3 Comparative Financial Statements
5.4 Trend Percentage Analysis
5.5 Let us Sum up
5.6 Lesson-end Activity
5.7 Keywords
5.8 Questions for Discussion

5.0 AIMS AND OBJECTIVES
In this lesson we shall discuss about financial statement analysis. After going through
this lesson you will be able to:
(i) understand definition and classification of financial statement analysis
(ii) analyse comparative financial statements and trend percentage analysis

5.1 INTRODUCTION
The financial statements are affording many facts though they are absolute and concrete
in terms; but not in a position to interpret and analyse the stature of the enterprise. To
analyse and interpret, the financial statement analysis is being applied across the financial
statements viz Trading, Profit & Loss Account and Balance sheet.
Under the financial statement analysis, the information available are grouped together in
order to cull out the meaningful relationship which is already available among them; for
interpretation and analysis.

5.2 DEFINITION & CLASSIFICATION OF FINANCIAL
STATEMENT ANALYSIS
According to Kennedy and Muller
“ The analysis and interpretation of financial statements are an attempt to determine the
significance and meaning 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”
The entire financial statement analysis can be classified into various categories
Comparative financial statements
l
Common size financial statements
l
Accounting and Finance   l       Trend percentages
for Managers
l       Fund flow statements
l       Cash flow statements
l       Ratio analysis

:                                    Comparative financial statements

Comparative study of Profit & Loss Accounts and Balance sheets

Comparison in between financial statements                Comparison in between the financial statements of various
of two or more years                                           firms or industrial average

Intra firm comparison                                               Inter firm comparison

5.3 COMPARATIVE FINANCIAL STATEMENTS
Objectives of comparative financial statements
l
Changes taken place in the financial performance are taken into consideration for
further analysis
l
To reveal qualitative information about the firm in terms of solvency, liquidity
profitability and so on are extracted from the analysis of financial statements
l
With reference to yester financial data of the enterprise, the firm is facilitated to
undergo for the preparation of forecasting and planning.
The major part of financial statement analysis is mainly focused on the comparative
analysis.
The comparative analysis classified into four different analyses viz
Comparative Balance sheet
l
Comparative Profit and Loss account
l
l
Common Size statement

l
Trend percentage
First we will discuss the comparative Balance sheet.
The first and foremost important step is to have the following information and should
take preparatory steps
i.    While preparing the comparative statement of balance sheet, the particulars for
the financial factors are required
ii.   The second most important for the preparation of the comparative balance sheet is
yester financial data extracted from the balance sheet or balance sheets
iii. The next most important requirement to have an effective comparison with the
yester financial data is current year information extracted from the balance sheet
or balance sheet of the firms.
iv. After having been procured the financial data pertaining to various time periods
are ready for comparison; to determine or identify the level of increase or decrease
taken place in the financial position of the firms
v. To determine the level of increase or decrease in financial position, the percentage
88                             analysis to carried out in between them.
Illustration 1                                                                                  Financial Statement Analysis

From the following information, Prepare comparative Balance sheet of X Ltd.

Particulars                                          31st Mar,2004      31st Mar,2005
Equit share capital                                    50,00,000         50,00,000
Fixed Assets                                           60,00,000         72,00,000
Reserves and surpluses                                 10,00,000         12,00,000
Investments                                            10,00,000         10,00,000
Long-term loans                                        30,00,000         30,00,000
Current assets                                         30,00,000         21,00,000
Current liabilities                                    10,00,000         11,00,000
The first step we have to segregate the available information into two different categories
viz Assets and Liabilities

Particulars           2004 Rs       2005 Rs          Absolute      %         %
Change Rs   Increase   Decrease
Fixed Assets             60,00,000     72,00,000        12,00,000      20          -
Investments              10,00,000     10,00,000        N.C             -          -
Current assets           30,00,000     21,00,000        (9,00,000)                30
Total Assets             1,00,00,000   1,03,00,000      3,00,000        3          -
Equity share capital     50,00,000     50,00,000        N.C             -          -
Reserves & surpluses     10,00,000     12,00,000        2,00,000       20          -
Long-term loans          30,00,000     30,00,000        N.C             -          -
Current liabilities      10,00,000     11,00,000        1,00,000       10          -
1,00,00,000   1,03,00,000      3,00,000        3          -

N. C = No change in the position during the two years
From the above table, the following are basic inferences

l
The fixed assets volume got increased 20% from the year 2004 to 2005, amounted
Rs. 12, 00, 000

l
Rs 9, 00, 000 worth of current assets decrease from the year 2004 to 2005 recorded
30%

l
The total volume of assets recorded 3% increase from the year 2004 to 2005

l
It obviously understood that 20% increase taken place on the reserves and surpluses

l
It clearly evidenced that the current liabilities of the firm increased 10% from the
year 2004 to 2005

l
The firm has not recorded any changes in the investments, equity share capital
and long-term loans
The next one in the comparative financial statement analysis is that Income statement
analysis
Comparative (Income) financial statement analysis: This analysis is being carried out in
between the income statements of the various accounting durations of the firm, with
other firms in the industry and with the industrial average.
This will facilitate the firm to know about the stature of itself regarding the financial
performance. It facilitates to understand about the changes pertaining to various financial
data which closely relevantly connected with the financial performance

l
Change in the gross sales
l        Change in the net sales                                                                                           89
Accounting and Finance   l          Change in gross profit and net profit
for Managers
l          Change in operating profit
l          Change in operating expenses
l          Change in the volume of non operating income
l          Change in the non operating expenses
The ultimate purpose of the comparative (Income) financial statement analysis is as
follows
i.         To study the income earning and expenditure spending pattern of the firm for two
or more years
ii.        To identify the changing pattern of the income and expenditure of the firms. The
preparatory steps for the preparation of the comparative financial statement
(Income) analysis
The first and foremost important step is to have the following information and should
take preparatory steps
i.         While preparing the comparative statement of Profit and Loss Account, the
particulars for the financial factors are required
ii.        The second most important for the preparation of the comparative Profit & Loss
account is yester financial data extracted from the Profit & Loss A/c or
Profit & Loss Accounts
iii.       The next most important requirement to have an effective comparison with the
yester financial data is current year information extracted from the balance sheet
of the firm or of the other firms
iv.        After having been procured the financial data pertaining to various time periods
are ready for comparison ; to determine or identify the level of increase or decrease
taken place in the operating financial performance of the firms
v.         To determine the level of increase or decrease in financial performance, the
percentage analysis to be carried out in between them.
Illustration 2
Prepare the comparative income statement from the following:

Particulars                         2004 Rs                    2005 Rs
Sales                                                    2,00,000                   2,50,000
Cost of goods sold                                       1,00,000                   1,30,000
1,00,000                   1,20,000
Operating expenses                                       10,000                       10,000
Net profit                                               90,000                     1,10,000

Comparative Income Statement

Particulars                 2004 Rs    2005 Rs          Absolute       %                 %
Change Rs     Increase          Decrease

Sales                 2,00,000   2,50,000              50,000     25                 -
(-)Cost of goods sold              1,00,000   1,30,000              30,000     30                 -
1,00,000   1,20,000              20,000     20                 -
(-)Operating expenses              10,000     10,000                 N.C        -                 -
90                                      Net profit                90,000     1,10,000              20,000    22.22
From the above table, the following inferences can be had:                                                  Financial Statement Analysis

l       The firm has registered 25% increase in sales from the year 2004 to 2005
l       Cost of goods sold raised 30% from the year 2004 to 2005
l       There is no change in the level of operating expenses
l       The firm has got 22. 22% increase in the level of net profits from the year 2004 to
2005
Illustration 3
From the following information, prepare a comparative income statement:
Particulars                             2001 Rs                  2002 Rs
Sales                                                  10,00,000                 8,00,000
Cost of goods sold                                      6,00,000                 4,00,000
Other Income                                            40,000                   20,000
Income tax                                              1,20,000                 1,40,000

Comparative Income Statement

Particulars             2001 Rs       2002Rs          Absolute       %                %
Change Rs    Increase        Decrease
Sales                         10,00,000     8,00,000         (2,00,000)      -                20
(–)Cost of goods sold         6,00,000      4,00,000         (2,00,000)      -               33.33
4,00,000      4,00,000                         -                 -
(–) Administration            2,00,000      1,40,000          (60,000)       -                30
Expenses
Operating Income              2,00,000      2,60,000           60,000       30                 -
(+)other income               40,000        20,000            (20,000)       -                50
Total Net Income Before       2,40,000      2,80,000           40,000        -               16.66
tax
Income tax                    1,20,000       1,40,000            20,000    16.66               -
Net Income after the tax      1,20,000       1,40,000            20,000    16.66               -
For this problem, the inferences could be enlisted according to the comparative statement
analysis on Profit & Loss Accounts of two different year viz 2001 and 2002.
The next important tool of financial statement analysis is a common size statement
analysis which known as predominant tool in intra firm analysis in studying the share of
each component.
The components are translated into percentage for analysis and interpretations. For
profit and loss account, Net sales is considered as a base for the computation of a share
of each financial factor available.
For Balance sheet, total volume of assets and liabilities are taken into consideration for
the computation of a share of each financial factor available under the heading of assets
and liabilities.
Illustration 4
Prepare the common size statement analysis for the firm ABC ltd
Liabilities        1990Rs            1991Rs               Assets      1990Rs           1991 Rs
Share capital           2,00,000          3,00,000        Fixed assets     2,25,000         4,00,000
Reserves and            1,00,000          2,00,000        Stock            1,29,000         2,00,000
surpluses
Bank overdraft             60,000         2,00,000        Quick assets      46,000          2,00,000
Quick liabilities          40,000         1,00,000

4,00,000          8,00,000                         4,00,000         8.,00,000                              91
Accounting and Finance
for Managers
Common size statement analysis of the Balance sheet of the firm ABC Ltd.

Particulars                     Amount                    % of Balance sheet total
Assets                      1990 Rs       1991 Rs               1990             1991
Fixed assets                2,25,000      4,00,000              56.25             50
Stock                       1,29,000      2,00,000              32.25             25
Quick assets                46,000        2,00,000               11.5             25
Total                       4,00,000      8,00,000               100             100
Liabilities
Share capital               2,00,000       3,00,000                50                    37.5
Reserves and surpluses      1,00,000       2,00,000               25                      25
Bank overdraft              60,000         2,00,000               15                      25
Quick liabilities           40,000         1,00,000                10                    12.5
4,00,000       8,00,000               100                    100

The above illustration highlights the share of every component in the balance sheet out
of the total volume of assets and liabilities.
This will certainly facilitate the firm to easily understand not only the share of every
component but also facilitates to have a meaningful and relevant comparison with various
time horizons.
From the following table, prepare the common size statement analysis:

2000 Rs.                       2001 Rs.
Sales                                                 20,00,000                     24,00,000
Miscellaneous Income                                     20,000                        16,000
20,20,000                     24.16,000
Materials consumed                                    11,00,000                     12,96,000
Wages                                                  3,00,000                      4,08,000
Factory expenses                                       2,00,000                      2,16,000
Office expenses                                          90,000                      1,00,000
Interest                                               1,00,000                      1,20,000
Depreciation                                           1,40,000                      1,50,000
Profit                                                   90,000                      1,26,000
20,20,000                     24,16,000

Common size statements Profit & Loss Account

Particulars               2000 Rs.        % Percentage           2001 Rs.        Percentage
%
Sales                          20,00,000                 100            24,00,000            100
Miscellaneous Income              20,000                   .9              16,000             .67
20,20,000               100.9            24.16,000         100.67
Materials consumed             11,00,000               54.46            12,96,000          53.64
Wages                           3,00,000               14.85             4,08,000          16.82
Factory expenses                2,00,000                9.90             2,16,000           8.92
Office expenses                   90,000                4.47             1,00,000           4.95
Interest                        1,00,000                4.95             1,20,000           4.92
Depreciation                    1,40,000                6.94             1,50,000           6.21
Profit                            90,000                4.47             1,26,000           5.21
20,20,000               100.9            24,16,000         100.67

92
Financial Statement Analysis

(1)   Financial statement analysis is to
(a)      Inter firm comparison only

(b)      Intra firm comparison only

(c)      Industrial average comparison

(d)      (a), (b) & (c)
(2) Intra firm analysis is

(a)      With in a year

(b)      In between the years

(c)      Comparison with the projected

(d)      (a), (b) & (c)
Comparative financial statement analysis is into
(3)
Comparison of Income& Position statements
(a)
(b)      Common size statements
Trend percentage analysis
(c)
(d)      (a), (b) & (c)
Main objectives of the Financial statements analysis are
(4)
To study the changes in the financial performance
(a)
To study the liquidity, solvency of the firm
(b)
To undergo financial planning based upon the yester financial performance
(c)
(d)      (a), (b) & (c)

5.4 TREND PERCENTAGE ANALYSIS
The next important tools of analysis is trend percentage which plays significant role in
analyzing the financial stature of the enterprise through base years’ performance ratio
computation. This not only reveals the trend movement of the financial performance of
the enterprise but also highlights the strengths and weaknesses of the enterprise
The following ratio is being used to compute the trend percentage

Current year
                   100
Base year

This trend ratio is being computed for every component for many number of years
which not only facilitates comparison but also guides the firm to understand the trend
path of the firm.

5.5 LET US SUM UP
Under the financial statement analysis, the information available are grouped together in
order to cull out the meaningful relationship which is already available among them; for
interpretation and analysis. To reveal qualitative information about the firm in terms of
93
Accounting and Finance   solvency, liquidity profitability and so on are extracted from the analysis of financial
for Managers
statements. Comparative (Income) financial statement analysis is being carried out in
between the income statements of the various accounting durations of the firm, with
other firms in the industry and with the industrial average. After having been procured
the financial data pertaining to various time periods are ready for comparison ; to determine
or identify the level of increase or decrease taken place in the operating financial
performance of the firms.

5.6 LESSON-END ACTIVITY
In financial statement analysis, what is the basic objective of observing trends in data
and ratios? Suggest some other standards of comparison.

5.7 KEYWORDS
Balance Sheet
Financial Statement
Financial data
Assets
Firm

5.8 QUESTIONS FOR DISCUSSION
1.     Write elaborative note on the financial statement analysis.
Elucidate the common size statement analysis.
2.
List out the objectives of the financial statement analysis.
3.
Explain the steps involved in the process of comparative statement of balance
4.
sheet.
Write brief note on the trend analysis.
5.

V. K. Goyal, “Financial Accounting”, Excel Books, New Delhi.
Khan and Jain, “Management Accounting”.
S. N. Maheswari, “Management Accounting”.
S. Bhat, “Financial Management”, Excel Books, New Delhi.
Prasanna Chandra, “Financial Management – Theory and Practice”, Tata McGraw
Hill, New Delhi (1994).
I. M. Pandey, “Financial Management”, Vikas Publishing, New Delhi.
Nitin Balwani, “Accounting & Finance for Managers”, Excel Books, New Delhi.

94

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