Chapter 15. Financial Statement Analysis – Financial Accounting

Chapter 15

Financial Statement Analysis

LEARNING OBJECTIVES

After studying this chapter, you will be able to understand

  1. Meaning Of Financial Statement Analysis

  2. Types Of Financial Statement Analysis

  3. Process Of Financial Analysis

  4. Purposes And Significance Of Financial Analysis

  5. Tools Of Financial Analysis

  6. Comparative Financial Statements

    1. Comparative Balance Sheets
    2. Comparative Income Statements
  7. Common Size Statements

  8. Trend Percentage – Features, Method Of Analysis And Limitations

  9. Users Of Financial Statements

  10. Limitations Of Financial Statement Analysis

  11. Financial Statements Of A Company – Types And Formats

INTRODUCTION

 

As already said, the end product of the accounting process is the preparation of Financial Statements, viz., Profit and Loss Account and Balance Sheet. These are prepared periodically to assess the results achieved by an entity during the specific accounting period. The Income Statement depicts the net result of operations during the period where as the Balance Sheet reflects the financial position of an entity in particular. These statements communicate accounting information to its users both internal and external. The internal users are the management and the important external users are investors, creditors, suppliers, customers, lenders, employees and government and its various agencies. But mere presentation of figures in these statements would not be enough. Users of these financial statements are darely in need of more specific information relating to profitability, solvency and liquidity of such business entities. As this is an era of cut throat competition, they want to compare the performance with similar firms in the existing market. Inter-firm and intra firm comparisons have to be carried out to know the exact position of an entity.

Furthermore, to judge the earning capacity of the firm, the managerial efficiency of the firm, these financial statements need to be scrutinised and analysed further. These financial statements constitute complex data, which has to be split into simple elements and relationships have to be established between these elements. Such process of division, establishing relationship and meaningful interpretation to understand efficiency is termed as “Analysis of Financial Statements”. Analysis of financial statements is a critical examination of the various elements in the financial statements so as to understand and take apt decisions with respect to entire operations of business entities.

OBJECTIVE 1: MEANING OF FINANCIAL STATEMENT ANALYSIS

Financial statements provide information on the various aspects namely – assets, liabilities on a specified date, revenues and expenses and the net result of operations during the specified period. In order to make the information more useful, such elements which form a part of financial statements have to be analysed in a systematic manner and there of after proper interpretation, they may be communicated to its users.

Myer defines Financial Statement Analysis as, “Financial statement analysis is largely a study of relationships among the various financial factors in a business as disclosed by a single set of statements, and a study of trends of these factors, as shown in a series of statements.”

It may also be said that the analysis of financial statements is a study of relationship among various financial facts and figures as setout in financial statements, that is, Balance Sheet and Income Statement.

OBJECTIVE 2: TYPES OR CLASSIFICATION OF FINANCIAL STATEMENT ANALYSIS

Financial Analysis – various types of analysis is based on the material used, modus operandi and the objective of the analysis. These types of financial analysis are discussed briefly as follows.

2.1 Type 1 – According to the Material Used

This may further be classified into External Analysis and Internal Analysis.

External Analysis: In case, if a person may not have access to the detailed records of the company, external analysis is to be restored. One has to depend and rely on published financial statements. Persons engaged in external analysis include investors, credit agencies and governmental agencies. The role of external analysis have gained of such importance now-a-days. Such external records are reliable as governmental regulations enforce the business entities to make available needed information to the public.

Internal Analysis: This type of financial analysis is carried on by the persons who may have access to the detailed records (books of accounts and other information) of business entities. While conducting internal analysis such persons become part of the entities. For example, analysis for managerial discussions is an internal type of analysis, which is usually conducted by the employees of that business concern – naturally becomes part of that concern. At times, internal analysis is conducted by the statutory agencies.

2.2 Type 2 – According to Modus Operandi

This type of analysis may be classified into Horizontal Analysis and Vertical Analysis.

Horizontal Analysis: This is also known as “Dynamic Analysis.” In case, financial statements for a number of users are received and analysed, such analysis is referred to as “horizontal analysis.” It is based on data from year to year and not one date or period of time.

This type of financial analysis is useful for long term trend analysis and planning.

Vertical Analysis: This is also known as “Static Analysis.” Generally, it is based on data on one date or period of time. Vertical analysis is not of much use as one may not be able to analyse data in perspective.

2.3 Type 3 – According to the Objective of the Analysis

The analysis on this basis may be of two types namely Short-term Analysis and Long-term Analysis.

Short-term Analysis: This type of analysis is conducted to compute the short-term solvency, liquidity and earning capacity of the business. Shot-term analysis is usually conducted to assess whether the business entities have enough to meet their short-term (requirements) contingencies.

Long-term Analysis: This type of analysis is conducted to determine of a business. This analysis is usually carried on to assess whether the business entities will be able to earn enough to meet its long-term obligations – profit, growth, modernisation and development of the business entities. This analysis is also useful to determine the effective rate of return on its investment.

2.4 Distinction between Horizontal Analysis and Vertical Analysis

Basis of Distinction Horizontal Analysis Vertical Analysis

1. Accounting Period

It requires statements of two or more accounting periods.

It requires a statement of one period.

2. Items

It deals with same item of different periods.

It deals with different items of the same period.

3. Information

It provides information in absolute and percentage form.

It provides information in percentage of money.

4. Uses

It is used for time series analysis.

It is used for cross-section analysis.

5. Comparison

It is a part of comparison.

It is a step towards comparison.

Inter-firm and Intra-firm analysis of financial statements differs in the following aspects:

2.5 Distinction between Inter-firm and Intra-firm Analysis

Basis of Distinction Intra-firm Analysis Inter-firm Analysis

1. Number

It involves analysis of financial variables of one firm.

It analyses the financial variables of two or more firms.

2. Objective

To determine the financial status of the firm and make decisions at management level.

To make important comparisons and determine the competitive status of the firm.

3. Other names

It is also called as Time Series Analysis and Trend Analysis.

When single set of information of two firms are compared, it is termed as cross-section analysis.

4. Comparison with other firms

Comparison with other firms may not be possible.

Comparison with other firm is possible.

OBJECTIVE 3: PROCESS OF FINANCIAL STATEMENT ANALYSIS

Main functions used in the process of analysis are:

3.1 Re-arrangement

Re-classification and re-arrangement of data in financial statement is vital to get maximum information. This depends upon the purpose of analysis.

3.2 Comparison

In case of a time series analysis, it is imperative to have comparative data of the same enterprise of the past periods. In case of cross-sectional analysis, it is essential to have comparative data of the same accounting period of the similar or comparative enterprises.

3.3 Analysis

Comparative data, item are analysed with special reference to financial characteristics. (e.g., solvency, liquidity, profitability)

3.4 Interpretation

This is the concluding part. The interpretation should be precise. It should indicate the movement of various financial characteristics in the right direction.

OBJECTIVE 4: PURPOSES AND SIGNIFICANCE OF FINANCIAL ANALYSIS

Financial Analysis serves the following purposes and also that brings out the importance of such analysis.

4.1 Earning Capacity

On the basis of financial statements, the earning capacity of an enterprise may be computed. The future earning capacity may be forecasted. Investors very keenly observe this for making this investment.

4.2 Managerial Efficiency

The financial statement analysis is an indicator to pin point the strength and weakness of managerial efficiency. Favourable and unfavourable variations can be identified and the reasons thereof can be inferred, especially with the usage of financial ratios.

4.3 Solvency

Short-term solvency and long-term solvency of the concern can be judged. Debenture holders are interested in long-term solvency and trade credits are interested is short-term solvency.

4.4 Inter-firm Comparison

Financial statements of different concerns can be analysed and comparisons can be obtained. This comparison helps to assess its own performance as well as that of other firms. This analysis will give the desired results, if such comparison is based on ratios.

4.5 Budgets and Forecasts

Analysis of financial statements will in a great way facilitates in forecasting future financial activities. Analysis also helps in preparation of budgets.

OBJECTIVE 5: TOOLS OR TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS

Following are the tools or techniques for analysing financial statements:

5.1 Comparative Financial Statements

These are the statements in which figures for two or more periods are placed side by side along with the change in figures in absolute and percentage form. Both Balance Sheet and Profit and Loss Account are prepared in the form of Comparative Financial Statements.

5.2 Common Size Financial Statements

These statements express all figures of a financial statement as percentage of some common base. In the Profit and Loss Account, sale figure is assumed to be 100 and all figures are expressed as a percentage of sales. In the Balance Sheet, the sum of assets or liabilities is assumed to be 100, and all the figures are expressed as percentage of total.

5.3 Trend Percentages

Any year may be taken on as the base year, each item of the base year is taken as 100. On that basis the percentage for each of the items of each of the following years are calculated.

5.4 Ratio Analysis

It expresses the relationship between two variables (financial or accounting) taken from financial statements of an accounting period in the form of ratio.

5.5 Cash Flow Statement

It shows the sources from which cash was received and the purpose for which it was used. It shows the changes in cash position from one period to another.

5.6 Funds Flow Statement

It shows the sources from which Working Capital was got and the purpose for which it was used. It shows the changes in Working Capital position.

Now, each technique is explained in detail by way of illustrations as follows:

OBJECTIVE 6: COMPARATIVE FINANCIAL STATEMENTS

Comparative Financial Statements

  • is a tool of financial analysis
  • depicts change in each item of financial statement
  • depicts the changes in both absolute and percentage term
  • takes the same item in preceding accounting years as base.

These statements are prepared to show:

  • Absolute data – (rupee amount only)
  • Increase/decrease in absolute data – (in terms of money value)
  • Increase/decrease in absolute data – (in terms of percentage)
  • Comparisons – (expressed in ratios)
  • Percentage of totals

6.1 Objectives of Comparative Financial Statements

  1. It gives information about nature of changes influencing financial position and performance of a business concern.
  2. These indicate the strength and weakness about liquidity, profitability and solvency of an enterprise.
  3. These help the management in forecasting and planning.
  4. The movements of the key financial factors can be studied well.

The tools for comparison and analysis of financial statements are

  1. Comparative Balance Sheets
  2. Comparative Income (P and L A/c) statements
  3. Common Size Statement

6.2 Meaning of Comparative Balance Sheet

Comparative Balance Sheet analysis

  1. is the study of the trend of the same items;
  2. group of items and computed items;
  3. in two or more Balance Sheets;
  4. of the same business enterprise;
  5. on different dates.

6.2.1 Advantages of Comparative Balance Sheets

  1. It shows the extent to which the balance of accounts increases/decreases between two dates.
  2. Unlike a Single Balance Sheet, the Comparative Balance Sheet shows balances of accounts on different dates.
  3. In a Single Balance Sheet, the strong is on status. But in a Comparative Balance Sheet, the strong is on change.
  4. The trends in a business concern may be studied by using Comparative Balance Sheet.
  5. It shows by using effects of business operation on its assets, liabilities and capital.
  6. It is a connecting link between the Balance Sheet and the Profit and Loss Account.

6.2.2 Preparation of Comparative Balance Sheet

A Comparative Balance Sheet is prepared as per Schedule VI of the Companies Act 1956. It is prepared by providing the columns:

  1. Particulars
  2. Data of previous year’s Balance Sheet
  3. Data of current year’s Balance Sheet
  4. Absolute change, increase/decrease in data as per column (ii) and (iii)
  5. Percentage of change in data as per column (ii) and (iii)

Illustration: 1

From the following information, prepare a Comparative Balance Sheet of ABC Ltd:

Particulars March 31, 2008 Rs March 31, 2009 Rs

Equity Shares Capital

30,00,000

30,00,000

Fixed Assets

25,00,000

30,00,000

Reserves and Surplus

4,00,000

4,50,000

Investments

5,00,000

6,00,000

Long-term Loan

10,00,000

10,00,000

Current Assets

20,00,000

15,00,000

Current Liabilities

6,00,000

6,50,000

(B. Com. Madras – Modified)

Solution

 

Comparative Balance Sheet

Note:

  1. Columns have to be provided as in solution.
  2. Figures within brackets shows decrease/minus.
  3. Percentage of change is calculated taking the amount in the year 2008 as base:

Example: Fixed Assets = Change/Base × 100 = 5,00,000/25,00,000 × 100 = 20%

OBJECTIVE 7: COMPARATIVE INCOME STATEMENT – SPECIAL FEATURES
  • The P and L A/c shows the Net Profit/Loss on account of business operations during the year.
  • The Comparative P and L A/c (Income Statement) shows operating results for a number of (accounting period) years.
  • It also shows changes in data in terms of money and percentage.

The Comparative (P and L A/c) Income Statement shows:

  1. Increase/decrease in Sales (Gross)
  2. Increase/decrease in Sales (Net)
  3. Increase/decrease in Cost of Goods Sold
  4. Increase/decrease in Gross Profit
  5. Increase/decrease in Operating Profit
  6. Increase/decrease in Operating Expenses
  7. Increase/decrease in Net Operating Expenses
  8. Analysis of various Items of income
  9. Analysis of Net Profit and its percentage with sales

7.1 Objectives of Comparative Income Statements

  1. To analyse the income and expenditure for two or more years.
  2. To analyse the increase or decrease in the income and expenditure in terms of rupee and percentage.
  3. To review the business operations of the last year and its effect on current year’s operations.

7.2 Preparation of Comparative (P and L A/c) Income Statement

It is prepared by providing the columns:

  1. Particulars
  2. Data of previous year’s Income Statement
  3. Data of current year’s Income Statement
  4. Absolute change in the data as per column (ii) and (iii)
  5. Percentage of change in data as per column (ii) and (iii)

7.3 Percentage of Change is Calculated this Way

  1. Data of the previous year is taken as base.
  2. Change in Percentage = (Absolute Increase/decrease)/(Data in previous year) × 100 =…. %

For each item, it is calculated this way, as in the case of Comparative Balance Sheets.

Illustration: 2

From the following, prepare Comparative Income Statement

Particulars 2008
Rs
2009
Rs

Sales

2,00,000
3,00,000

Cost of Goods Sold

(50,000)
(60,000)

 

1,50,000
2,40,000

Indirect Expenses

(30,000)
(40,000)

 

1,20,000
2,00,000

Provision for Tax

(20,000)
(40,000)

Net Profit after Tax

1,00,000
1,60,000

(B.Com. Madras – Modified)

Solution

 

Comparative Income Statement

Notes: Workings

 

(i)

Percentage change (Sales) = Absolute Change/Base Figure* × 100 = 1,00,000/2,00,000 × 100 = 50%

(ii)

Percentage change (Cost of Goods Sold) = 10,000/50,000 × 100 = 20%

(iii)

Percentage change (Gross Profit) = 90,000/1,50,000 × 100 = 60%

(iv)

Percentage change (Indirect Expenses) = 10,000/30,000 × 100 = 33.3%

(v)

Percentage change (Net Profit) = 80,000/1,20,000 × 100 = 66.67%

(vi)

Percentage change (Provision for Tax) = 20,000/20,000 × 100 = 100%

(vii)

Percentage change (Net Profit after Tax) = 60,000/1,00,000 × 100 = 60%

*(viii)

Base Figure: Value given in column year 2008

7.4 Computation of Percentage Change

Accounting treatment of indirect expenses

Illustration: 3

Prepare Comparative Income Statement of X Ltd with the help of the following data:

Particulars 2008
Rs
2009Rs

Sales

3,00,000

6,00,000

Cost of Goods Sold

50% of Sales

70% of Sales

Indirect Expenses

10% of Gross Profit

10% of Gross Profit

Rate of Income Tax

50% of Net Before Tax

50% of Net Before Tax

B. Com. – Madras

Solution: Step I Cost of Goods Sold value has to be calculated

Sales = 2008 year = Rs 3,00,000

Cost of Goods Sold = 50% of Sales

             = 50/100 × 3,00,000 = Rs 1,50,000

2009: Cost of Goods Sold = 70% of Sales

             = 70/100 × 6,00,000 = Rs 4,20,000

Step II: Indirect Expenses to be calculated

This is computed from Gross Profit.

2008: Gross Profit = Sales − Cost of Goods Sold

             = Rs 3,00,000 − Rs 1,50,000 = Rs 1,50,000

2008: Indirect Expenses = 10% of Gross Profit

             = 10/100 × 1,50,000 = Rs 15,000

2009: Gross Profit = Rs 6,00,000 − Rs 4,20,000

             = Rs 1,80,000

2009: Indirect Expenses = 10/100 × 1,80,000 = Rs 18,000

Step III: After deducting Indirect Expenses from Gross Profit, Net Profit before Tax is computed.

50% of this has to be deducted to arrive at Net Profit after Tax.

Percentage change is calculated as in previous illustration.

 

Comparative Income Statement

OBJECTIVE 8: MEANING OF COMMON SIZE STATEMENTS
  • Common size financial statements are the item statements in which accounts of individual item of Balance Sheet/Profit and Loss A/c for two or more years.
  • Such amounts are further converted into percentage to some common base.
  • In case of Balance Sheet, total amount will be the base.
  • In case of P and L A/c, Net Sales is the base.

Illustration: 4

From the following, prepare a Common Size Income Statement

Solution

 

Common Size Income Statement

Notes: Students should note that, here, Net Sales for each year is taken as base.

For each item, with respect to Net Sales, percentage is calculated, for each year separately.

Percentage = Particular Value of Item/Net Sales × 100 = ….%

Workings

For the year 2008:

  1. Net Sales = Net Sales/Net Sales × 100 = 2,00,000/2,00,000 × 100 = 100%
  2. Cost of Goods Sold = Cost of Goods Sold/Net Sales
      = 1,50,000/2,00,000 × 100 = 75%
  3. Gross Profit = Gross Profit/Net Sales × 100
      = 50,000/2,00,000 × 100 = 25%
  4. Office and Administrative Expenses = 5,000/2,00,000 × 100 = 2.5%
  5. Selling and Distribution Expenses = 10,000/2,00,000 × 100 = 5%

Like above, for these items, percentage can be calculated for each item, taking Net Sales for 2009, i.e. Rs 3,00,000, as base. (Students can do themselves.)

8.1 Preparation of Common Size Balance Sheet

Common Size Comparative Balance Sheet

Illustration: 5

The Balance Sheet of XYZ Ltd as on March 31, 2008 and March 31, 2009 are given.

Prepare a Common Size Balance Sheet of XYZ Ltd for 2008 and 2009. You are required to comment on the changes.

Particulars 2008
Rs
2009
Rs

Shareholder’s Funds:

 
 

Share Capital

2,00,000
2,00,000

Reserves and Surplus

20,000
10,000

 

2,20,000
2,10,000

Liabilities:

 
 

Secured Loans

50,000
80,000

Unsecured Loans

1,50,000
60,000

Current Liabilities and Provisions

80,000
50,000

Capital and Liabilities

2,80,000
1,90,000

Assets:

5,00,000
4,00,000

Fixed Assets (Net)

3,00,000
2,40,000

Investments

5,000
4,000

Inventories

1,00,000
80,000

Debtors (Net)

80,000
66,000

Cash

15,000
10,000

Total Assets

5,00,000
4,00,000

(B. Com. Madras University – Modified)

8.2 Accounting Treatment of Sources and Uses of Funds in the Preparation of Common Size Statements (Balance Sheet)

Solution

  • Here, the items given in the problem have to be written in the column of Particulars under two heads: Sources of Funds and Application of Funds.
  • Then, as this is the Balance Sheet (B/S), total amount is to be taken as base.
  • For each item, percentage is calculated, with respect to “Total,” for each year. (As it is calculated in previous example, the only difference being, the base debtors here, i.e. instead of Net Sales, Total is taken as base.)

That is, Percentage = Particular item’s value/Total in B/S × 100 = …%

 

Common Size Balance Sheets of XYZ Ltd for the Year Ended March 31, 2008 and March 31, 2009

Comments: Major changes in the sources of funds.

  1. Share capital as a percentage of total liabilities was 40% in 2008 and 50% in 2009.
  2. Reserves and Surplus has declined from 4% to 2.5%.
  3. As a result, shareholder’s funds have increased from 44% to 52.5%.
  4. It means share liabilities has declined from 56% to 47.5%
  5. Written liabilities, share of secured loans increases from 10% to 20%.
  6. But share of unsecured loans and provisions has declined from 46% to 27.5%.
OBJECTIVE 9: MEANING AND COMPUTATION OF TREND PERCENTAGES

9.1 Trend Ratios

Trend ratios may be defined as index numbers of the movements of the various factors (items) in the financial statements for a number of periods. It may also be statements for a number of periods. It may also be defined as a statistical device employed in the analysis of financial statements to reveal the trend of those item over a period of time. Trend ratios reflect the nature and rate of movements in various items (financial factors). This belongs to horizontal analysis type. Trend ratios may also be depicted graphically, which facilitates easy comprehensive. Trend ratios predict the movement of financial factors (future), which in turn helps to formulate and make proper management decisions. Any device or technique is not without its own limitations. Hithherto, trends may be affected by unforeseen economic conditions and police of government. Hence, it has to be dealt with extraordinary precaution.

9.2 Steps involved in Computation of Trend Percentages

Step 1:

Statements for a number of years serve as a base.

Step 2:

Take one of the statements as the base. (Selection of statement should be done carefully. Generally, statement belonging to “normal year” of a business is to be taken as base.)

Step 3:

Each financial factor (item) in the base statement is taken as 100.

Step 4:

Trend percentage of each item in other statement (belonging to other years) is to be calculated with reference to the same item in the base statement by using the formula as:

(Absolute value of item (in Rs) in other statements)/(Absolute value of same item (in Rs) in base statement) × 100.

Illustration: 6

From the following information extracted from the Balance Sheet of Good Luck Ltd for four previous financial years, calculate the trend percentages taking 2005–2006 as the base year.

Solution

Step 1: Base year is taken as 2005–2006 (given in the question).

Step 2: First, Cash (item or factor) – in the base year is taken as 100.

Step 3:

  1. Trend percentage for 2006–07 for the item Cash

    (Absolute value 2006–07)/(Absolute value 2006–07) × 100

    = 720/600 × 100 = 120

  2. Trend percentage for 2007–2008 for the item Cash

    = 1,200/600 × 100 = 200

  3. Trend percentage for 2008–2009 for the item Cash

    = 660/600 × 100 = 110

Like this, for other items trend percentage can be calculated and tabulated as follows:

 

Trend Percentages

9.3 Limitations of Trend Ratios (Percentage)

  1. In case, if the accounting practices are not followed uniformally and with consistency every year, trend percentages cannot show true and fair results and hence cannot be relied bluntly.
  2. It ignores price level changes. To obtain better results, financial factors (items in statements) must first get adjusted for price level changes from the base year and only then trend percentage should be computed. Various factors that affect price level changes have to be carefully considered.
  3. Trend ratios have to be always read with absolute data on which they are based. In the above illustration, take the factor cash for the year 2006–07, there is a 120% change in trend ratio representing an absolute change of Rs 120 lakh. Take the other factor, building, there is a 120% change in the trend ratio representing an absolute change of Rs 1,200 lakh. Hence, without connecting absolute data, the results may be misleading.
OBJECTIVE 10: VARIOUS USERS OF FINANCIAL STATEMENTS

There are various users of financial statements, which are discussed as follows:

1. Investors: Investors – who are the real owners of the company are darely in need of financial statements in order to ascertain earnings for their investments and to assure the safety of it.

2. Lenders: There are so many types of lenders such as, debenture holders, suppliers of loans, leases and the like. Each is interested in assessing the capacity of the entity to repay debt with interest. Financial statements extend a helping hand to such users.

3. Creditors: Some creditors are eager to know the ability of the business to settle (repay) the amounts on the stipulated data.

4. Customers: Customers – in both senses – a regular suppliers of raw material to the company as well as a regular user of finished products of the company – are very much interested in knowing growth prospects of the company.

5. Employees: Employees (trade unions) use these statements for better bargaining of employments, perks, retirement benefit and so on.

6. Government and its agencies: Government, its agencies and various departments (Income Tax, Sales Tax, Excise) are interested in using these statements to formulate, operate, control and forecast policies pertaining to them.

7. Public: Now-a-days, public is interested in knowing the health of business entities. The use of financial statements cannot be underestimated as public awareness attains much significance.

OBJECTIVE 11: LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS

Not withstanding the fact that financial statement analysis is helpful in assessing the financial position and earning capacity of a business entity, it is not free from certain shortcomings which are discussed below:

1. Ignores price level changes: Financial statements are complied on the basis of historical costs. It ignores price level changes and current economic real conditions. So any results arrived on analysis of financial statement may not reflect the real factor. Even Government regulations, tax structure, inflation all play a major role. Ignoring all such factors and analysing only the past factors may not serve the real purpose for which analysis is made.

2. Not absolute: Even though financial statements are expressed in exact money terms, the net result is not associated with absolute change in value. As the result, analysis will not be meaningful.

3. Accounting methods: Unless there is consistency and continuity in adopting accounting policies and techniques adopted by business entities, in such analysis, in the absence of consistency, the results may not be comparable and that too they will be biased.

4. Skilled analysis: It will be an effective tool only if the financial statements are analysed by skilled accountants. Analysis done by unskilled men may lead to erroneous conclusions.

5. Interim reports: Generally, financial statements are interim reports and not final. True gain or loss can be computed only at the termination of business. Financial statements prepared periodically may only reflect the way in which the business moves.

6. Different interpretations: The results derived from analysis of financial statements are generally interpreted differently by the different users of financial statements. There are no standard interpretations in practice. No common procedure exists.

7. Limited Usage: The analysis of financial statement in respect of a single year usually may not be of much help, as comparison cannot be made based on the results of more than one year. To arrive at a precise and reliable conclusion, analysis must be extended over a number of years.

8. Lacks accuracy: At times, the income statement of the balance sheet are manipulated. Such manipulations affect the accuracy of figures in the final statement. The reliability of analysis is affected to a great extent, as they lack accuracy.

9. Faulty forecast: Analysis of financial statements is made on the basis of past records. Factors analysed on past events may not serve as a better indicator for future forecasting as many external factors affect the business transactions of an enterprise which are beyond its control. As such future forecast may not be perfect.

10. Different tools: There are many different tools or techniques available for the analysis of financial statements. Naturally results will vary due to the variance in technique and persons whose skill employed in analysis of financial statements.

OBJECTIVE 12: FINANCIAL STATEMENTS OF A COMPANY – TYPES AND FORMATS

Financial statements are the summarised statements of accounting data. It is prepared at the end of the accounting year. (Its preparation is discussed in detail in Chapter 5, “Accounting Process – Preparation of Final Accounts from Trial Balance”.) Usually a set of financial statements include:

  1. Balance Sheet
  2. Profit and Loss Account
  3. Schedule and Notes forming part of Balance Sheet and Profit and Loss Account

These statements are very much useful to investors, lenders, suppliers, trade creditors, customers, consumers, governments and statutory bodies and employees – which had been discussed in the chapter “Final Accounts.”

As per the Companies Act 1956, it is statutory, for the board of directors to attach Annual Report along with Financial Statements.

12.1 Contents of Annual Report

  1. A report by the board of directors, which is generally presented at the meeting of the general body of a company, is referred to as Annual Report. It contains:
    1. Report in terms of Sec. 217 of the Companies Act
    2. Director’s Responsibility Statement
    3. Report on Corporate Governance
    4. Management discussion and analysis
  2. Auditor’s Report (to shareholders)
  3. Balance Sheet
  4. Profit and Loss Account
  5. Notes to Accounts – which usually contains:
    1. Accounting policies adopted
    2. Explanatory notes explaining significant transaction and events
    3. Information disclosed in terms of Schedule VI, of the Companies Act
  6. Cash Flow Statement
  7. Segment Report (segment wise investment and results) [Note: Cash Flow Statement and Segment Report is applicable to listed companies in turnover of Rs 50 crores or companies that accept public deposits of Rs 10 crores or more.] Now we may look into each in detail.

12.2 Report of Board of Directors

Board of Directors of a company will have to prepare a report to be presented at the Annual General Meeting of shareholders of the company. The meeting has to be convened every year. Its main agenda is to approve annual accounts and other related matters of urgent importance. Director’s Report must be attached to the Balance Sheet, to be presented before the shareholders at the annual meeting. The board of directors will be required to make a report comprising important contents as stipulated by Sec. 217 of the Companies Act, 1956. Main contents of the report of board of directors are:

  1. The Statement of Affairs of the Company
  2. Provision of Reserves (Amount)
  3. Proposed Dividend (Amount)
  4. Material Changes and Commitments
  5. Foreign Exchange Earnings
  6. Matters relating to Technology
  7. Changes occurred during the accounting period
  8. Details of employee’s particulars
  9. Director’s Responsibility Statement through which accounting standards, procedure and accounting policies are explained in detail
  10. Auditor’s Report
  11. Report on corporate governance which mainly furnishes information such as the status of the members of the board of directors, position held by each of the directors – whole time, part-time, executive director, various committees, board meetings.
  12. Analysis and discussion on structure of the business enterprise.

12.3 Auditor’s Report

As an auditor of a company, he has to express his opinion on the annual accounts, in a statement called “Auditor’s Report to the Shareholders”.

12.3.1 Contents of Auditor’s Report

  1. True and fair view on the state of Company’s affairs for Balance Sheet
  2. Profit or Loss for Profit and Loss Account
  3. The auditor has to state whether
    1. Proper books of accounts have been maintained.
    2. He has got all necessary information in preparing final accounts.
    3. The final accounts are in agreement with the books of accounts and returns.
    4. Audited by others (other than company auditors), for branches have been analysed.
    5. The accounting procedures comply with the Accounting Standards.
    6. Any adverse effects have been explicitly conveyed.
    7. Details of CESS payable to Government.
    8. Details of Disqualified Directors are specified.

It is the statutory duty of an auditor to include in his report, a statement on such matters, as may be specified.

12.4 Balance Sheet

As already said, Balance Sheet is a statement of company’s asset and liabilities on a particular date. The prescribed form of Balance Sheet is given in Part I of Schedule VI of the Companies Act, 1956. The Act has laid down two forms. They are:

  1. Horizontal Form
  2. Vertical Form

Horizontal Form of Balance Sheet of ……Ltd as on

 

Vertical Form of Balance Sheet of …. Ltd as on …

Schedule VI, Part I (S ec. 211) Horizontal Form of Balance Sheet

 

Balance Sheet of…(Here, enter the name of Company) as on …… Here, enter the date on which B/S is made of)

12.4.1 Statutory Contents of a Balance Sheet of a Company

12.4.1.1 Assets Side

The following are the assets under different headings:

  1. Fixed Assets: Assets which are used for a long time in the business to earn profit are known as Fixed Assets.
    1. Different assets should be shown separately.
    2. For every fixed asset, its original cost and the additions there to and deductions there from during the year and the total depreciation provided should be shown. The value of each asset (cost or book value) has to be explained in books of accounts.
  2. Investments:
    1. Investments are shown after fixed assets. Investments are classified into:
      1. Investment in government and trust securities
      2. Investment in shares, debentures and bonds of companies
      3. Investment in shares, debentures and bonds of subsidiary companies
      4. Investment in fixed assets
    2. Nature and mode of valuation of every investment is to be disclosed.
      Nature of investment means fixed asset or current asset.
      Mode of valuation means on cost price or market price.
    3. Total amount of quoted and unquoted investments and market value of quoted investments must also be shown in the Balance Sheet.
  3. Current Assets, Loans and Advances: Assets which are likely to be converted into cash within a year from the date of Balance Sheet are called Current Assets. These are divided into two categories. They are – Current Assets and Loans and Advances.
    1. Current Assets: They are
      1. Accrued interest on investments
      2. Stores and Spare Parts
      3. Loose Tools
      4. Stock-in-trade
      5. Work-in-Progress
      6. Sundry Debtors
        1. Debtors more than 6 months old and
        2. Other Debtors

      Less: Provision for Doubtful Debts

      Cash and Bank Balance

    2. Loans and Advances: This includes loan given to different persons, advance against purpose etc. These items are shown under separate sub-headings:
      1. Loans and advances to subsidiary company
      2. Bills of Exchange
      3. Advances recoverable in cash or in kind or for value to be received, that is, pre-paid rates, taxes etc.
      4. Balance with Customs, Port Trust (Payable on Demand).
  4. Miscellaneous Expenditure: Expenses, which are not written off to the date of Balance Sheet are called so. They are shown under the head, “Miscellaneous Expenditure” in the Balance Sheet as:
    1. Preliminary Expenses
    2. Expenses including commission, brokerage, under writing subscription of shares and debentures
    3. Discount allowed on issue of shares/debentures
    4. Interest paid out of capital during construction period of the company
    5. Development expenditure (not adjusted)
    6. Other sums, specifying nature

Profit and Loss Account:

  1. Debit balance of Profit and Loss Account is to be shown on the Assets side of the Balance Sheet.
  2. If it has General Reserve, it is shown by deducting from it.

12.4.1.2 Liabilities Side:

Two types of items are shown on the Liabilities side:

 

Type 1:

Items that are related to owner’s equity. It includes share capital, reserves and surplus.

Type 2:

Items that create the claims of creditors. It includes secured loans, unsecured loans, provisions and current liabilities.

  1. Share Capital: Under this heading, following sub-headings with details are shown:
      1. Authorised Share Capital: This refers to the total amount of share capital a company is authorised to raise, as per its memorandum of association. It is not added to the liabilities of the company.
      2. Issued Share Capital: Issued share capital is that part of authorised share capital, which the company has issued for subscription till the date of balance sheet.
        It includes a number of classes of shares (equity, preference) and their face value.
      3. Subscribed Shared Capital: This refers to that part of issued share capital, which has been subscribed (along with share value called up).
      4. Paid-up Share Capital: This refers to that part of issued share capital, which has been paid up by subscribers.
    1. Information regarding shares allotted other than cash and shares fully allotted by way of bonus shares are to be treated in the form of general reserve, profit and loss account, securities premium account which are also shown.
    2. Details of each type of shares is given (equity, preference).
    3. Amount of calls-in arrears is shown as deduction from called up or subscribed capital.
    4. Amount relating to shares forfeited is shown as Additional Paid-up Capital.
    5. Profit on re-issue of forfeited shares is transferred to Capital Reserve Account.
  2. Reserves and Surplus: It includes the following:
    1. Capital Reserves: Profits prior to incorporation, profit on acquisition of business, profit on sale of fixed assets, profit on re-issue of forfeited shares, profit on redemption of debentures.
    2. Capital Redemption Reserve Account
    3. Securities Premium Account
    4. Other Reserves (Dividend Equalisation, Special Reserve for Depreciation)
    5. Surplus: It refers to the credit balance of Profit and Loss Account after appropriations for dividend, bonus, transfer to reserves etc.
    6. Proposed additions to reserves
    7. Sinking funds
  3. Secured Loans: If any charge is created or mortgaged on all or on any of its properties by way of loan, it is called “Secured Loans.” These are depicted in the following order:
    1. Debentures
    2. Loans and advances from Banks
    3. Loans and advances from Subsidiaries
    4. Other loans and advances
  4. Unsecured Loans: If no security is provided for loans, they are called Unsecured Loans. They are:
    1. Fixed Deposits
    2. Loans and advances from Subsidiaries
    3. Short-term loans and advances from Banks
    4. Short-term loans and advances from others
    5. Other loans and advances from Banks
    6. Other loans and advances from others
  5. Current Liabilities and Provisions: These are shown in two parts. They are – Current Liabilities and Provisions.
    1. Current Liabilities: Liabilities which are repayable in a year are called Current Liabilities. They are:
      1. Bills Payable (Acceptances)
      2. Sundry Creditors
      3. Subsidiary Companies’ balances
      4. Advance Payment and Unexpired discounts
      5. Unclaimed Dividends
      6. Other liabilities
      7. Interest accrued but not due on loans
    2. Provisions: They represent any amount written or retained by way of providing for depreciation, renewal or diminution in the value of assets or retained by providing for any known liability. If any provision is more than liability, excess is treated as a reserve. Provisions are:
  6. Provision for Taxation
  7. Proposed dividends
    1. Provision for Contingencies
    2. Provision for Provident Fund
    3. Provision for insurance, pension, similar staff benefit schemes
    4. Other provisions
  8. Contingent Liabilities: These are the liabilities, the existence of which depends on future incident. This is shown in the footnote in the Balance Sheet. They are:
    1. Claims against the company which are still not accepted by the company
    2. Liability for amount uncalled on partly paid shares
    3. Arrears of fixed cumulative dividends
    4. Estimated amount of incomplete contracts
    5. Other contingent liabilities: Liability for bill discounted, disputed excise duty claim

The above mentioned items put in the order, on the Assets and Liabilities side of the Balance Sheet in the prescribed format, one can easily understand the Schedule VI, Part Sec. 211 of the Companies Act, 1956.

12.5 Profit and Loss Account

In compliance with the requirements of Part II of Schedule VI, Profit and Loss Account (comprises) is divided into three parts:

 

 

Part I

Trading Account

 

Part II

Profit and Loss Account

 

Part III

Profit and Loss Appropriation Account

Trading Account is prepared to ascertain gross profit or loss during a year.

Profit and Loss Account is prepared to ascertain net profit or loss during a year.

Profit and Loss Appropriation Account is prepared to know how the net profit has been invested.

12.5.1 Appropriation of Profits

After ascertaining the net profit, then arises the question of distribution of profit, that is, appropriation. Same portion of profit as distributed among shareholders is dividend. Some portion of profit is kept with the company and it is shown on the credit side of Profit and Loss Account. The items that are shown on the debit side:

  1. Amount transferred to General Reserve Account
  2. Amount transferred to Dividend Equalisation Reserve
  3. Amount transferred to Debentures Redemption Fund
  4. Amount of dividend distributed and proposed
  5. Balance

The Trial Balance of profit after above appropriations is carried forward to next year’s account. This part of Profit and Loss Account is known as Profit and Loss Appropriation Account. This part of the account showing appropriation of profit is also called as “Below the Line” Account. The other part is called as “Above the Line” Account.

Profit and Loss Account may also be preserved both in horizontal as well as vertical forms. But, mostly companies prefer vertical form of presentation of Profit and Loss Account. The most widely used formats are shown here for both horizontal and vertical forms of Profit and Loss Account. A generally adapted format of the Trading and Profit and Loss Account is given below:

 

Trading and Profit and Loss Account for the year ended………

12.5.2 Profit and Loss Appropriation Account

  • In case of gross loss: The balance will appear in the Credit side of the Trading A/c and consequently will be carried down to the Debit side of Profit and Loss Account.
  • In the same manner, in case of net loss, balance will appear in the Credit of P and L A/c and carried to Debit side of P and L Appropriation.

Trading and Profit and Loss Account may be prepared in a vertical form also. A format of the vertical form is given below:

 

Trading and Profit and Loss Account for the year ended …….

Particulars Rs Rs

Sales

xx

Less: Returns

 

Less: Cost of Goods Sold

 

  Opening Stock

 

  Purchases (Net)

 

  Wages

 

  Power and Fuel

 

  Job Work Charges

 

  Carriage Inwards

 

  Other Direct Expenses

 

Sub-total

 

Less: Closing Stock

 

_____
 

  Gross Profit

xxx

Less: Operating Expenses

  Office Expenses

 

  Administrative Expenses

 

  Selling and Distribution Expenses

  Operating Profit

xxx

 

_____
_____

Add: Non-operating Income

 

  Interest

 

  Profit on Sale Fixed Assets

Less: Non-operating Income

 

  Loss by Fire/Theft

  Net Profit before Interest and Tax

xxx

  Interests on Loans

 

  Interest on Debentures

  Net Profit before Tax

xx

  Provision for Tax

 

  Net Profit available for Appropriations

xx

  Proposed Dividend

  Debenture Redemption Reserve

 

  General Reserve

 

_____
_____

Profit and Loss Account

 
xxx

 

_____
_____

12.6 Notes to Accounts

This is the statement attached to the financial statements (as required in Schedule VI). This contains accounting policies adopted. This gives better insight into company’s state of affairs.

12.7 Cash Flow Statement

This is statement indicating the flow of cash (inflow and outflow) during an accounting year. This is discussed in Chapter 17 “Cash Flow Statement.”

12.8 Segment Report

  1. A business concern, may have more than one product and it may operate in different geographical areas.
  2. The ICAI has issued an Accounting Standard (AS)–1; on segment reporting, requiring certain enterprises to prepare a report disclosing information as to revenue, assets and capital expenditure for each segment (product or geographic area). This report is known as “Segment Report.”
  3. A business segment relating to products or services are a geographical segment relating to different geographical areas (economic environment) are prepared to expose risks and returns involved.
  4. Following are some of the important terms associated with Segment Report:
    1. Segment Revenue
    2. Segment Expenses
    3. Segment Results
    4. Segment Liabilities
    5. Segment Accounting Policies

Illustration: 7

The Profit and Loss Accounts of Star and Co. for the years ended March 31, 2008 and 2009 are:

Particulars 2008
Rs
2009
Rs

Net Sales

4,85,000
4,25,000

Cost of Goods Sold

2,60,000
2,45,000

Gross Profit

4,85,000
4,25,000

Operating Expenses

60,000
45,000

Net Profit

1,65,000
1,35,000

You are required to prepare a Comparative Profit and Loss Account.

Solution

 

Comparative Profit and Loss Statement

 

Comment: Results are negative, i.e. decrease in all items.

  1. Net sales declined by Rs 60,000 (absolute change) and 12.37% (percentage change).
  2. Cost of goods sold declined by Rs 15,000 (absolute change) and 5.76% (percentage change).
  3. Gross profit is declined by Rs 45,000 and 20%.
  4. Operating expenses are also declined by Rs 15,000 and 25%.
  5. Net Profit is declined by Rs 30,000 and 18.18%.

Working Notes

  1. Net sales: Change/Base × 100 = 60,000/4,85,000 × 100 = 12.37%
  2. Cost of goods sold = 15,000/2,60,000 × 100 = 5.76%
  3. Gross profit = 45,000/2,25,000 × 100 = 20%
  4. Operating expenses = 15,000/60,000 × 100 = 25%
  5. Net profit = 30,000/1,65,000 × 100 = 18.18%

Illustration: 8

From the following data, prepare a Statement of Profit in the Comparative Form:

Particulars 2008
Rs
2009
Rs

Sales

4,00,000
4,00,000

Gross Profit Ratio

30%
40%

Administrative Expenses

25,000
50,000

Income Tax

50%
50%

Solution

Step 1:

  1. Calculation of Cost of Goods Sold: For the year 2008

    Sales – Cost of Goods Sold = Gross Profit

    100% – C.G.S. = 30% (Given)

    Hence cost of goods sold: 100% – 30% = 70%

    70% of Rs 4,00,000 = Rs 2,80,000

  2. For the year 2009

    C.G.S = 100% – 40% = 60% (Given)

    60% of Rs 4,00,000 = Rs 2,40,000

Step 2:

  1. Calculation of Tax: For the year 2008

    Net Profit = Rs 95,000

    50% = Rs 47,500

  2. For the year 2009

    50% of Rs 1,10,000 = Rs 55,000

Step 3: Percentage, absolute change is to be calculated as in the previous illustration and tabulated as:

Comment:

  1. Cost of goods declined by Rs 40,000 and 14.28%.
  2. All the other items reflect a positive trend and an upward increase.

Illustration: 9

Prepare a Comparative Income Statement of Exe Ltd from the following information:

Particulars 2008 2009

Sales

Rs 2,00,000

Rs 4,00,000

Cost of Goods Sold

60% of Sales

70% of Sales

Indirect Expenses

10% of Gross Profit

 

Rate of Income Tax

50% of Net Profit before Tax

 

Solution

 

Comparative Income Statement

Comment

  1. Sales are increased by 100%.
  2. Cost of goods sold increased by 133.3%.
  3. All the other factors are increased by 50%.
  4. In general, there is a positive development but steps should be taken to decrease the cost of goods sold.

Illustration: 10

Prepare a common size Balance Sheet and pass your comments based on the results of analysis from the following extracts of balance sheets of A Ltd and B Ltd as at December 31, 2009.

Solution

Step 1: For A Ltd:

  1. Percentage for Fixed Assets:

    Fixed Assets/Total Assets × 100 = 20,00,000/(20,00,000 + 10,00,000) × 100 = 66.67%

  2. For Current Assets = (Percentage to Total Assets)

    Current Assets/Total Assets × 100 = 10,00,000/30,00,000 × 100 = 33.33%

Step 2: For B Ltd:

  1. Fixed Assets (Percentage to Total):

    32,00,000/36,00,000 × 100 = 88.88%

  2. Current Assets (Percentage):

    4,00,000/36,00,000 × 100 = 11.12%

Step 3:

 

For A Ltd (Liabilities);

For B Ltd

(i) Share Capital: 18,00,000/30,00,000 × 100 = 60%;

(i) 24,00,000/36,00,000 × 100 = 66.67%

(ii) Reserves and Surplus: 8,00,000/30,00,000 × 100 = 26.67%;

(ii) 7,00,000/36,00,000 × 100 = 19.4%

(iii) Current Liabilities: 4,00,000/30,00,000 × 100 = 13.33%;

(iii) 5,00,000/36,00,000 × 100 = 13.89%

Step 4: These results are to be represented in the tabular form as below:

 

Common Size Balance Sheet of A Ltd and B Ltd as on December 31, 2009

Comments

  1. The short-term financial position of A Ltd is better than B Ltd.
  2. Working Capital of A Ltd is positive because

    Current Assets >Current Liabilities

    33.33% >13.33%

  3. Working Capital of B Ltd is negative because

    Current Assets < Current Liabilities

    11.12% < 13.89%

  4. B Ltd’s investment in Fixed Assets is more than that of A Ltd.
  5. In total, financial position of A Ltd is better than B Ltd.

Illustration: 11

Alternative method: Preparation of Comparative Balance Sheet

Prepare Comparative Balance Sheet of ABC Ltd. from the following information.

Solution

 

Comparative Balance Sheet of ABC Ltd.
For the Years as on 2008 and 2009

Summary

  • Analysis of Financial Statement is a process of establishing relationship between the factors in final statements of the firms.
  • Techniques or tools of Financial Statement Analysis: (1) Comparative Financial Statements (2) Common Size Financial Statements (3) Trend Percentage (4) Ratio Analysis (5) Cash Flow Statement.
  • Types of Financial Statement Analysis: (1) On the basis of materials used (2) On the basis of Modus Operandi and (3) On the basis of objectives of analysis.
  • Process of Financial Statement Analysis: (1) Rearrangements of Financial Statement (2) Comparison (3) Analysis and (4) Interpretation.
  • Objectives of Financial Analysis: (1) To assess the financial stability (2) To determine solvency (3) To determine profitability (4) Inter and Intra-firm Comparison (5) To forecast and planning.
  • Uses of Financial Analysis: Analysis of security, credit, debit, general business and decision making.
  • Users or parties interested in Financial Statement Analysis: (1) Investors (2) Management (3) Employees (4) Creditors (5) Lenders (6) Government Agencies.
  • Limitations of Financial Statement Analysis: (1) Historical (2) Ignores price level changes (3) Bias (4) Manipulation (5) Not comparable (6) Lack of accuracy (7) Different Accounting policies and procedures (8) Different interpretations.
  • Financial statements of a Company registered under the Companies Act, 1956 – Format and details.

Key Terms

Annual Report: A combination of financial statements, management discussion, analysis, graphs and charts provided periodically to shareholders.

Balance Sheet: A statement showing the financial position of a business enterprise on a particular date.

Common Size Statements: Financial statements expressed in component percentages.

Financial Statement Analysis: Analysis of financial statements to assess the firms viability.

Income Statement: A consolidated account (report) of all revenues and expenses for a specific period.

Solvency: A firm’s ability to meet its financial obligation (on the maturity date) as they become due.

Time series: Comparison of firm’s financial ratios with its own previous year’s ratios.

Trend Ratios: Index numbers of the movements of the various items in the financial statements for a number of periods.

References

 

Horngreen Sundem & Elliott, “Introduction to Financial Accounting”, Pearson Education, 2004, New Delhi.

White Gerald I, “Analysis and Use of Financial Statements”, John Wilsey & Sons, 1998, New York.

Helbert E.A., “Technique of Financial Analysis”, Richard D. Irwin, Hamewood 911, 1972.

A Objective-type Questions

 

I. State whether the following statements are True or False

  1. Financial statement analysis is a study of various financial factors in the financial statements.
  2. Only income statement can be prepared in the form of Comparative Financial Statements.
  3. Common size financial statements express all figures, a financial statement as percentage of some common base.
  4. Calculation of percentage relationship that each item bears to the same item in the base year is known as Trend Percentages.
  5. Ratio Analysis expresses the relationship between income statement and position statement.
  6. Cash Flow Statement shows the changes in cash position from one period to another.
  7. Horizontal method of financial analysis is made to review and analyse the financial statements of one particular year only.
  8. Vertical method of financial analysis is made to review and analyse the financial statements of a number of years.
  9. Financial statement analysis is a historical analysis.
  10. Analysis of data for several years is known as Time Series Analysis.

Answers

 

1. True

2. False

3. True

4. True

5. False

6. True

7. False

8. False

9. True

10. True

 

II. Fill in the blanks with appropriate word(s)

  1. Balance Sheet and __________ can be prepared in the form of Comparative Financial Statements.
  2. Common size financial statements express all figures of a financial statement as __________ of some common base.
  3. Each item of the base year is taken as __________ and on that basis Trend percentages is calculated.
  4. Ratio analysis involves the calculation of __________ between two components in financial statements.
  5. Cash Flow Statement shows the sources from which cash in __________and the purposes from which it was __________.
  6. Horizontal Analysis shows the comparison of data for several years against a chosen_____ year.
  7. Vertical analysis is made to review and analyse the financial statements of ___________ accounting period.
  8. Comparison of financial variables of a firm over a period of time is known as __________ .
  9. In case if financial statements of two firms are compared, it is referred to as _______ analysis.
  10. Percentage Change = __________/ Previous year figure × 100.

Answers

  1. Profit and Loss Account (or) Income Statements
  2. Percentage
  3. 100
  4. Ratio
  5. Received; spent (or) used
  6. Base
  7. One
  8. Trend Analysis or Time Series
  9. Cross section
  10. Absolute change

B Short-type Answer Questions

  1. What is meant by Financial Statement Analysis?
  2. Name the tools (techniques) for analysis of financial statement analysis.
  3. What is meant by Comparative Financial Statement?
  4. What do you mean by Common Size Financial Statement?
  5. Explain the term: “Trend Percentages.”
  6. What is Ratio Analysis?
  7. What is meat by Cash Flow Statement?
  8. What is Cross sectional analysis?
  9. Explain: “Time Series Analysis.”
  10. What is meant by Horizontal Analysis?
  11. What is Vertical Analysis?
  12. Distinguish between horizontal analysis and vertical analysis.
  13. Distinguish between inter-firm analysis and intra-firm analysis.
  14. What are the objectives of Analysis of Financial Statements?
  15. Explain the significance of Financial Analysis.
  16. Mention any four advantages of financial statement analysis.
  17. Mention any four limitations of financial statement analysis.
  18. Who are interested in the analysis of financial statement?
  19. What is meant by Comparative Balance Sheet?
  20. What are the advantages of Comparative Balance Sheet?
  21. What are the objectives of Comparative Financial Statement?
  22. What is meant by Comparative Income Statement?
  23. What are the objectives of Comparative Income Statements?
  24. What are “Operating Expenses”? Give examples.
  25. What do you mean by “Operating Revenue”? Give few examples.
  26. Explain “Non-operating Income” with examples.
  27. Explain “Non-operating Expense” with examples.
  28. What do you mean by “Common Size Statement”?
  29. Explain the term “Trend Percentage.”

C Essay-type Questions

  1. Define Financial Statement Analysis. What are the objectives? Explain the advantages and limitations of analysis of financial statements?
  2. Explain in detail how is it useful for various parties.
  3. Explain the various financial statement analysis techniques.
  4. What is a Comparative Balance Sheet? What are its objectives and advantages? Explain the procedure to prepare Comparative Balance Sheet.
  5. What is a Comparative Income Statement? Explain the method of preparation.
  6. Explain Trend Ratio. Explain its features. What are its limitations?

D Exercises

 

1. From the following summarised balance sheets, prepare a Comparative Balance Sheet and comment upon the changes:

2. From the following summarised balance sheets, prepare a Comparative Balance Sheet and comment upon the changes in absolute figures from one period to another.

3. Prepare a Comparative Balance Sheet from the following:

Particulars 2008
Rs
2009
Rs

Assets:

1,00,000
1,20,000

Fixed Assets

80,000
1,00,000

Current Assets

1,80,000
2,20,000

Liabilities:

 
 

Share Capital

1,00,000
1,40,000

Reserves

10,000
5,000

Sundry Creditors

70,000
75,000

 

1,80,000
2,20,000

4. From the following summarised balance sheets of a company, you are required to prepare Comparative Balance Sheet with comments on changes from one period to another.

5. Prepare a Comparative Balance Sheet from:

Model: Comparative Income Statement

6. From the following information, prepare a Comparative Income Statement showing increases, decreases and percentages:

Particulars 2008
Rs
2009
Rs

Sales

1,00,000
1,60,000

Cost of Goods Sold

80,000
1,00,000

Administrative Expenses

5,000
5,000

Selling Expenses

8,000
12,000

Other income

7,000
10,000

Income Tax

10,000
16,000

7. Convert the following income statement into Comparative Income Statement:

 

Income Statement

Particulars 2008
Rs
2009
Rs

Sales

2,00,000
3,00,000

Cost of Goods Sold

80,000
1,00,000

 

1,20,000
2,00,000

Operating Expenses:

 
 

Selling and Distribution Expenses

50,000
55,000

Administrative Expenses

20,000
25,000

 

70,000
80,000

Income from Operation

50,000
1,20,000

Other Expenses

5,000
12,000

Net Income for the year

45,000
1,08,000

8. Convert the following income statement into Comparative Income Statement and in the light of the conditions in 2008, interpret the changes in 2009:

 

Income Statement

Particulars 2008
Rs
2009
Rs

Gross Sales

2,05,000
3,10,000

Sales Returns

5,000
10,000

Net Sales

2,00,000
3,00,000

Cost of Sales

60,000
90,000

 

1,40,000
2,10,000

Operating Expenses:

 
 

Sales Expenses

30,000
45,000

Administrative Expenses

10,000
15,000

Total Expenses

40,000
60,000

Income from Operations

1,00,000
1,50,000

Other income

10,000
15,000

Total Income

1,10,000
1,65,000

Other Expenses

20,000
30,000

Net Income for the year

90,000
1,35,000

9. From the following information, prepare statement of profits in comparative form:

Particulars 2008 2009

Sales

9,00,000
12,00,000

Gross Profit

30%
40%

Office and Administrative Expenses

90,000
1,20,000

Income Tax Rate

50%
50%

10. From the following data, prepare a Comparative Income Statement:

Particulars 2008
Rs
2009
Rs

Purchases

1,20,000
1,50,000

Manufacturing Expenses

12,000
15,000

Stock Adjustment

(–7,000)
(+5,000)

Total

1,25,000
1,70,000

Gross Profit

25,000
34,000

 

1,00,000
1,36,000

11. Prepare a Comparative Income Statement from the following data:

Particulars 2008 2009

Sales

Rs 8,00,000

Rs 10,00,000

Cost of Goods Sold

40% of Sales

60% of Sales

Indirect Expenses

60% of Gross Profit

40% of Gross Profit

Income Tax

50% of Net Profit before Tax

50% of Net Profit

Model: Common Size Balance Sheet

12. From the following balance sheets of Rainbow Ltd on March 31, 2009 and 2010, you are required to prepare a Common Size Balance Sheet.

 

Balance Sheets of Rainbow Ltd as at March 31

13. Prepare a Common Size Balance Sheet from the following balance sheets of Ajay Ltd & Vijay Ltd as at December 31,2009:

Model: Common Size Income Statement

14. From the following, prepare a Common Size Income Statement:

Particulars Year I
Rs
Year II
Rs

Sales

6,00,000
10,00,000

Cost of Goods Sold

4,00,000
6,00,000

Selling and Distribution Expenses

40,000
80,000

Interest on Loan

60,000
60,000

Income Tax

25,000
20,000

15. You are required to prepare a Common Size Income Statement from the following data:

Particulars Year I
Rs
Year II
Rs

Sales

16,00,000
2,00,000

Cost of Goods Sold

9,60,000
10,20,000

Administrative Expenses

1,28,0000
1,60,000

Selling and Distribution Expenses

64,000
80,000

Interest on Loan

85,000
85,000

Income Tax

42,000
40,000

 

16. From the following information extracted from the balance sheets of V.R.S. Ltd, of four previous years, you are required to compute the Trend percentage taking 2005–06 as the base year: