Financial Statements Introduction New.ppt

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1. Financial Statements
Meaning:The‘FrameworkforPreparationandPresentationofFinancialStatements’
issuedbytheInstituteofChartedAccountantofIndiadealswiththevariousaspectsof
financialstatements.Acompletesetoffinancialstatementsnormallyincludesabalance
sheet,astatementofprofitandloss(alsoknownasincomestatement’),åcashflow
statementandthosenotesandotherstatementsandexplanatorymaterialthatareanintegral
partofthefinancialstatements.
Financialstatementsdonot,however,includesuchitemsasreportsbydirectors,statements
bythechairman,discussionandanalysisbymanagementandsimilaritemsthatmaybe
includedinafinancialorannualreport.

2. Objectives of Financial Statement
(a)BasicObjectives:Theobjectiveoffinancialstatementsistoprovide
informationaboutthefinancialposition,performanceandcashflowsofan
enterprisethatisusefultoawiderangeofusersinmakingeconomicdecisions.
Usersneedtoknowthecapacityofanenterprisetopayitsemployeesand
suppliers,meetinterestpayments,repayloans,andmakedistributionstoits
owners.

3. (b)FinancialPosition:Thefinancialpositionofanenterprise
dependson…
(i)theeconomicresourcesitcontrols,
(ii)itsfinancialstructure,and
(iii)itsliquidityanditssolvency.

4. (b)FinancialPosition:Thefinancialpositionofanenterprise
dependson…
(i)theeconomicresourcesitcontrols:Informationaboutthe
economicresourcescontrolledbytheenterprise(i.e.its
assets)isusefulinpredictingthefuturecashinflows.
(ii)itsfinancialstructure,and
(iii)itsliquidityanditssolvency.

5. (b)FinancialPosition:Thefinancialpositionofanenterprise
dependson…
(i)theeconomicresourcesitcontrols,
(ii)itsfinancialstructure:Informationaboutfinancial
structureisusefulinpredictingfutureliabilitiesandcash
outflows.
(iii)itsliquidityanditssolvency.

6. (b)FinancialPosition:Thefinancialpositionofan
enterprisedependson…
(i)theeconomicresourcesitcontrols,
(ii)itsfinancialstructure,and
(iii)itsliquidityanditssolvency:Informationaboutliquid
inandsolvencyisusefulinpredictingtheabilityofthe
enterprisetomeetitsfinancialcommitmentsastheyfall
due,intheshortaswellasthelongterm.

7. (c)Performance:Informationabouttheperformanceofanenterprise,in
particularitsprofitability,isrequiredinordertoassessfuturecashflows.
Informationaboutvariabilityofperformanceisimportantinthisrespect.
Informationaboutperformanceisusefulinpredictingthecapacityofthe
enterpriseisgeneratecashflowsfromitsexistingresources.Itisalsousefulin
formingjudgementsabouttheeffectivenesswithwhichtheenterprisemight
employadditionalresources.

8. (d)CashFlows:Informationconcerningcashflowsof
anenterpriseisusefulinordertoevaluateitsinvesting,
financingandoperatingactivitiesduringthereporting
period.Thisinformationhelpstoassesstheabilityof
theenterprisetogenerateandutilizecashflows.

9. (e)StewardshipandAccountability
Financialstatementsalsoshowtheresultsofthestewardship
ofmanagement,ortheaccountabilityofmanagementforthe
resourcesentrustedtoit.Thishelpstheuserstomake
economicdecisionse.g.,whethertoholdorselftheir
investmentintheenterpriseorwhethertoreappointor
replacethemanagement.

10. (3) Components
(a)BalanceSheet:Informationaboutfinancialpositionisprimarilyprovidedinabalancesheet.
(b)P&LStatement:Informationaboutperformanceisprimarilyprovidedinastatementofprofitandloss.
(c)CashFlowStatement:Informationaboutcashflowsisprovidedinthefinancialstatementsbymeansofacash
flowstatement.
(d)NotesandSchedules:Thefinancialstatementsalsocontainnotesandsupplementaryschedulesandother
information.Forexample,theymaycontainadditionalinformationthatisrelevanttotheneedsofusersaboutthe
itemsinthebalancesheetandstatementofprofitandloss.Theymayincludedisclosuresabouttherisksand
uncertaintiesaffectingtheenterpriseandmayresourcesandobligationsnotdisclosedinthebalancesheet(suchas
mineralreserves).
Informationaboutbusinessandgeographicalsegmentsandtheeffectofchangingpricesontheenterprise
(Inflation-adjustedAccounts)mayalsobeprovidedintheformofsupplementaryinformation.

11. Qualitative characteristics of Financial Statements
Qualitative characteristics are the features that make the information provided in the financial
statements useful to the users. The four principles qualitative characteristics are:
(1)Understandability, (2) Relevance, (3) Reliability and (4) Comparability.
(l)Understandability: Users must be able to understand financial statements. They are
assumed to have the necessary knowledge and skill to study the should not be information
properly. Complex matters left out of financial statements if it is relevant information.
(2) Relevance: Information must be relevant to the decision making needs of all the users.
Information should help the users to evaluate past, present or future events or confirm or
correct their past evaluations. Relevance of an information depends on its nature and
materiality.

12. Qualitative characteristics of Financial Statements
Qualitative characteristics are the features that make the information provided in the financial
statements useful to the users. The four principles qualitative characteristics are:
(1)Understandability, (2) Relevance, (3) Reliability and (4) Comparability.
(3) Reliability: Information must also be reliable. Reliability of the faithful information
depends on (i) representation, (ii) substance over form, (iii) neutrality, (iv) prudence and (v)
completeness.
(4) Comparability: Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance. Users should
be of the accounting policies informed employed in the preparation of the financial
statements, any changes in those policies and the effects of such changes.

13. Analysis and Interpretation
(1)NeedforAnalysisandInterpretation:AtypicalFinancialStatementofa
companymayrunintoseveralpages.Itnormallycontainsahugemassofdata
andfigures.Acommonuserwouldbeatalosstounderstandwhichfiguresare
importantandwhatistheexactsignificanceofallthefiguresshowninthe
FinancialStatements.TheFinancialStatementsarebasicallypreparedforthe
ownersormanagersandoutsiderssuchasCreditors,Lendersorresearchershave
re-organisethefiguresappearingintheFinancialStatementsforthepurposeof
theirstudy.

14. (2) Meaning of Analysis: Analysis means to resolve something into its
elements or components. For an outside user. the details in the Financial
Statements signify only raw data or ‘raw material’.
This ‘raw material’ needs to be re-organised, processed and converted
into an easy to understand form. The process of breaking up a large
mass of raw data into manageable form is called ‘analysis’ of the
Financial Statements.

15. Financialstatementanalysisisaprocessofevaluatingtherelationshipbetween
thecomponentpartsofafinancialstatementtoobtainabetterunderstandingofa
firm’sfinancialpositionandperformance.
(3) Financial Statement Analysis

16. To Conclude….
Analysis of Profit and Loss Account, therefore, means breaking down the Profit and Loss
Account into its various components or segments i.e., Gross Sales, Net Sales, Cost of Goods
Sold, Operating Profit and so on.
This is done by converting the T-Form and statutory form of Profit and Loss Account into a
Vertical Income Statement.
Analysis of Balance Sheet means breaking down or ‘analyzing’ the Funds into Total Funds
Available and Total Funds Employed.
The Total Funds Available are further broken down into Owners’ Funds and Loan Funds.
The Total Funds employed are broken down into Fixed Assets, Investments and Working
Capital. This is done by converting the T-Form Balance Sheet into a Vertical Balance Sheet.

17. (4) Types of Financial Analysis
Adistinctionmaybedrawnbetweenvarioustypes
offinancialanalysiseitheronthebasisof‘who
doesit’oraccordingto‘howitisdone’.

18. (a) According to Who Does It…
Itisdonebytheownersormanagersoftheconcernitself.Ownersarethemainusersof
FinancialStatements.
IncaseofaLimitedCompanythemanagerswhoaredifferentfromtheowners
(shareholders)alsorelyonthestudyoftheFinancialStatementstoanalysetheincome,the
expenses,theassetsandtheliabilitiesofthecompany.Theownersorthemanagersstudythe
FinancialStatementstomakeinter-firmandinter-periodcomparisons,tostudythetrends
insales,expensesetc.,tostudytherelationshipamongvariousitemsoftheFinancial
StatementsbymeansofRatioAnalysisandtoknowthemovementofFunds(fromwhere
fundshavecomeandwherefundshavegone)throughCashFlowandFundFlowAnalysis.
1. Internal analysis

19. 2. External Analysis
(i)Investors:PotentialinvestorshavetostudytheFinancialStatementsbeforedecidinguponwhethertobuyor
notabusinessorshares.Iftheydecidetobuy,thenthepurchasepriceofthebusinessorthesharesisalsofixed
onthebasisofadetailedstudyoftheFinancialStatements.
(ii)CreditorsandLenders:CreditorsandLendersstudytheFinancialStatementsoftheborrowerbefore
advancingcreditorloan.Thereafteralso,thecreditorsandLendersstudytheFinancialStatementstofindout
whetherthebusinessissolvent(inapositiontorepaytheloan).
(iii)Government:TheamountspayablebyaconcernbywayoftaxesleviedbyGovernmentsuchasIncomeTax,
SalesTax,Excise,etc.aredeterminedonthebasisofthedataintheFinancialStatements.
(iv)Misc.Users:EmployeesstudytheFinancialStatementsbeforejoiningaconcernandduringtheperiodoftheir
employment.ResearchersinthefieldofEconomicsorAccountancyandJournalistsalsousetheFinancial
Statementsforresearchandinterpretation.

20. According to How It is Done?
(a) Conversion of Financial Statement: For an outside user, the details in the
Financial Statement indicates only raw data or raw material.
This ‘raw material’ needs to be re-organised, processed and converted into an easy
and understandable form. The process of breaking up a large mass of raw data into
manageable form is called ‘analysis’ of the Financial Statements.

21. According to How It is Done? (Continued…)
Analysis of Profit and Loss Account, therefore, means breaking down the Profit and Loss
Account into its various components or segments i.e., Gross Sales, Net Sales, Cost of Goods
Sold, Operating Profit and so on.
This is done by converting the T-Form and statutory form of Profit and Loss Account into a
Vertical Income Statement. Analysis of Balance Sheet means breaking down or ‘analyzing’ the
Funds into Total Funds Available and Total Funds Employed. The Total Funds Available are
further broken down into Owners’ Funds and Loan Funds. The Total Funds employed are
broken down into Fixed Assets, Investments and Working Capital. This is done by converting
the T-Form Balance Sheet into a Vertical Balance Sheet.

22. (b) Comparison of Financial Statements
The Analysis of Financial Statements may be of two types-Horizontal Analysis and Vertical
Analysis.
Horizontal analysis involves comparison of two concerns or two years in respect of the same
item. Since horizontal analysis moves over a number of years or across many concerns, it is
called ‘Dynamic Analysis’.
Comparative statements and Trend Percentages are the examples of ‘Horizontal Analysis’.
Vertical analysis, on the other hand involves finding out the relationship between two items in
respect of the same concern and in the same year. Vertical analysis is, therefore, called‘Static
Analysis’.
‘Common Size Statements’ and ‘Ratio Analysis’ are the examples of ‘Vertical Analysis’.

23. On the Basis of Method of Operation
Horizontal/Dynamic
Analysis
Comparative
Statement
Comparative
Balance Sheet
Statement
Comparative
Income
Statement
Trend Analysis
Trend Balance
Sheet
Trend Income
Statement
Vertical /Static Analysis
Common Size
Statement
Common Size
Balance Sheet
Common Size
Income
Statement
Ratio
Analysis
Balance Sheet
Ratios
Income
Statement Ratios
Composite
Ratios

24. Meaning of Interpretations
The user of the Financial Statements may, by means of the tools of analysis, obtain certain
figures such as Trend Percentage or the Net Profit Ratio. Such figures (Trend Percentages or
Ratios) have to be then interpreted. For example, the figures of sales for several years may be
interpreted with the help of Trend Percentages to warn the owner (user) that the sales are
showing a decreasing trend. Or, if the Net Profit ratio (i.e. Net Profits/Sales X 100) is 20, this
figure of 20% by itself does not indicate anything; it has to be interpreted to ascertain its
significance. The user can interpret the Ratio in Several ways.
Has the Ratio increased or decreased as compared to earlier years?
How does it compare with the average Net Profits Ratio of the Industry? and so on.
In short, the Ratio obtained by analysis has to be interpreted.

25. To Conclude….
Interpretation, means to bring out the meaning for the benefit
of a person. Interpretation is an art. It is a skill developed by
experience and practice over a number years. Interpretation
brings the significance hidden within the data or figures to the
attention of the user. Interpretation means coming to a
conclusion or forming an opinion about the significance of item.

26. Back to the Past for a Moment
You learned Conventional or T-Form of Balance Sheet
Which Appears like

27. Balance Sheet

28. Whereas, Trading and Profit & Loss Account appeared like

29. Trading Account Trading Account
for the year ended ….

30. and P & L A/c looks like
Profit and Loss Account
for the year ended...

31. Whereas as per Statutory Compliance as per Schedule III of Part I
of Companies Act 2013, Balance Sheet should be prepared as….

32. Whereas as per Statutory Compliance as per Schedule III of Part I
of Companies Act 2013, Balance Sheet should be prepared as….

33. and Statement of Profit & Loss Account

34. Whereas as per Statutory Compliance as per Schedule
III of Part I of Companies Act 2013, Statement of
Profit & Loss Account should be prepared as….
Atlas Skill Tech University
Atlas Skill Tech
University

35. But for Analysis and Interpretation we have to
follow
For Balance Sheet –Vertical Analytical Balance Sheet
Format
For Profit & Loss Account –Vertical Analytical Profit
& Loss Account Format

36. That is

37. Check Google Sheet for the Specimen
https://docs.google.com/spreadsheets/d/1kQrqetzE2xtQIeiJ9uRb6Z
saieExduWC/edit?usp=sharing&ouid=106144611718743032509&r
tpof=true&sd=true