Financial statement analysis

1. Financial Statements

2. Objectives of Financial Statements Providing information for economic decisions. Providing information about financial position. Providing information about performance of an enterprise. Providing information about changes in financial position.

3. Financial Statement Analysis - Meaning It is a study of relationship among various factors in a business as disclosed by financial statements of a firm. The analysis show the trend of the factors and will help in evaluation of component parts. Analysis of Financial Statement is to obtain better insight into a firm’s position and performance.

4. Financial Statement Analysis - Objectives To judge the financial health of the firm. To evaluate the profitability of the enterprise. To gauge the debt servicing capacity of the firm. To understand the long-term and short-term solvency of the firm. To know the return of capital employed or invested.

5. Financial Statement Analysis - Types External analysis – done by outsiders. Internal analysis – done by insiders who have access to financial records. Horizontal analysis – Done for several years simultaneously. Done to find trend ratios and comparative financial statements. Vertical analysis – Study of quantitative relationship between data in the same financial statement. Common size statements and ratio analysis. Long-term - taken-up to determine if the earning capacity of the firm is sufficient to meet the targeted rate of return on investment, and is adequate for future growth and expansion of business. Short-term - to determine the liquidity position of the firm and short-term solvency of the firm.

6. Financial Statement Analysis – Methods Common size statements Comparative financial statements Trend ratios Ratio analysis Funds flow analysis Cash flow analysis Break-even and cost-volume profit analysis Value added analysis

7. Common Size Statements The figures shown in financial statements are converted to percentages so as to establish each element to the total figure of the statement. Common size Income Statement : In here, the sales figure is taken as 100% and all other figures are compared as percentage to sales. This shows the efficiency of the firm in generating revenue which leads to profitability and gives a chance to analyze the different components of cost as proportion to sales. Common Size Balance Sheet : The total of Assets side or liabilities side is taken as 100%. And all other figures on the both sides are compared with this. This statement reveals the proportion of fixed assets to current assets, composition of fixed assets and current assets, proportion of long-term funds to current liabilities and provisions, composition current liabilities and so on. It also helps in inter-firm comparison.

8. Comparative Financial Statements These are statements of financial position of a business designed to provide time perspective to the consideration of various elements of financial position embodied in such statements. Comparative financial statements reveal: Absolute date (money values or rupee amounts) Increase or decrease in absolute date in terms of money values Increase or decrease in absolute date in terms of percentages. Comparison in terms of ratios. Percentage of totals.

9. Comparative Income Statement : it shows the absolute figures of two or more periods and absolute change from one period to another. User can easily understand as they are presented side by side. Comparative Balance Sheet : Balance Sheets as on two or more different dates are used for comparing the assets, liabilities, and the net worth of the company.

10. Trend Ratios They are the index numbers of the movements of reported financial items in the financial statements which are calculated for more than one financial year. The calculation is based on statistical technique called ‘ Index numbers ’.

11. Methodology to compute Trend Ratios Trends ratios to be calculated to items that can be logically related. Trend analysis should be made at least for four consecutive years. The financial statements of one year should be selected as base statement and financial items of it should be assigned with value as 100. Trend ratios should be calculated by the formula: Absolute figure of financial statement under study = ------------------------------------------------------------------------------ X 100 Absolute figure of same item in base financial statement Tabulate the trend ratios for analysis of trend over a period.

12. Particulars 2003 2004 2005 Sales (Rs.) 50000 75000 100000 Purchases 40000 60000 72000 Expenses 5000 8000 15000 Profit 5000 7000 13000 Particulars 2003 (Rs.) 2004 (Rs.) 2005 (Rs.) Trend percentages Base 2003 2003 2004 2005 Purchases Expenses Profit Sales 40000 5000 5000 50000 60000 8000 7000 75000 72000 15000 13000 100000 100 150 180 100 160 300 100 140 260 100 150 200

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