ANALYSIS OF FINANCIAL STATEMENTS�� Prepared By:� Mr. Ashish A.Johory� PGT Commerce � JNV Kodagu

What are Financial Statements?�

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Financial statements are the end products of accounting process, which reveal the financial results of a specified period and financial position on a particular date. These statements include the income statement and the position statement (Balance Sheet)

Why the Financial Statements need to be prepared?

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The basic objectives of these statements is to provide information required for decision making by the management as well as the outsiders who are interested in the affairs of the undertaking.

What are the types of Financial Statements?

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1. Balance Sheet or Position Statement
2. Income statement or Statement of profit and loss
3. Notes to accounts
4. Cash Flow Statement

Who are the users of Financial Statements?

1. Internal Users:

a) Shareholders

b) Management

c) Employees

2. External Users:

a) Banks & financial institutions

b) Investors and Potential Investors

c) Creditors

d) Government and its Authorities

e) Securities and Exchange Board of India (SEBI)

Objectives of Financial Statement Analysis

Dear Students, it is very important for you to understand why do we need to study the Financial statements. The objectives of Financial Statement Analysis:

1. To provide information about economic resources and obligations of business.
2. To provide information about the earning capacity of the business.
3. To provide information about cash flows.
4. To judge effectiveness of management.
5. To provide information about the activities of business affecting the society.
6. To disclose accounting policies

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Limitations of Financial Statement Analysis

Dear students, as you know every concept has certain significance as well as limitations. Now let us go through the limitations of Financial Statement Analysis:

1. It does not reflect the current situation due to the Historical Concept.
2. Assets may not realize the stated values
3. The concepts and conventions depend upon personal judgements from time to time.
4. It provides aggregate information not detailed information i.e. Macro not Micro.

Let’s talk about the Balance Sheet……

Students, the Balance sheet of a company is also known as Position statement.

Schedule III Part 1 of Companies Act, 2013 deals with the form of Balance Sheet of a company and classified disclosure to be made therein and it applies to all the companies registered under the Companies Act, 1956.

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How does it appear?

Balance Sheet of _______________________

(as per Schedule III Part I of Companies Act, 2013)

(for the year ended ________________________

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Let’s have a look at the Income Statement now……………..

Income statement is nothing else but the Profit and Loss Account of a Company form of business in the statement form. So, dear students, don’t be scared of it as you already know how to prepare Profit and Loss Account. Let’s go through the format of an Income statement………..

Income Statement of _________________________

(as per Schedule III Part 2 of Companies Act, 2013)

(for the year ended ___________________)

Why not we understand now the different components of Balance Sheet !!!!

1. Shareholders’ Fund – As its name suggest, it is the aggregate of the owned capital of the company form of business.
2. Share Capital - Share Capital comprises of Equity Share Capital and Preference Share Capital
3. Reserves & Surplus – It consists of various types of Reserves like Securities Premium Reserve, General Reserve, Reserve Fund, Capital Reserve, Debenture Redemption Reserve, Capital Redemption Reserve and even the Surplus, i.e. Balance in Statement of Profit & Loss

4) Money received against Share Warrants: Share Warrants are actually acknowledgment of the investment made by the investors in the shares of a company which is issued on a temporary basis in lieu of the actual share certificates (now in demat form). Therefore, the money received against Share warrants is used as Shareholders’ fund in the books of the company.

5) Share application money pending allotment: Share Application Money Pending Allotment means the amount received on the application on which allotment is not yet made.

6) Long term borrowings: Basically, long term borrowings are such debts which are used for the operations of a business and specifically the purchase of Fixed Assets and are not due within a period of one year.

7) Deferred Tax Liabilities: It means such tax liability which is due for the current period but has not yet been paid and records the fact that the company will pay more tax in the future because of a transaction that took place during the current period.

8) Long term provisions: These provisions mainly include employee benefits such as gratuity, leave encashment, provident funds, etc.

9) Other Non current Liabilities: Basically, the liabilities which are due but not to be paid within a period of one year and are not covered under Non current Liabilities are included in Other Non Current Liabilities.

10) Trade Payables: It is a composition of Creditors for Goods and Bills Payable.

11) Short Term Borrowings: The loans taken from banks and other financial institutions for a short period of time are included in Short Term Borrowings.

12) Short term Provisions: It includes Provision for doubtful debts, Provision for tax, Proposed Dividend, Provision for discount on debtors, Provision for repairs and renewals, etc.

13) Other Current Liabilities: They include interest payable, income tax payable, Outstanding expenses, Advance incomes, etc.

14) Fixed Tangible Assets: Those assets which are having a physical appearance and have an existence for a period of more than one year like Land, Building, Furniture, Vehicles, Machinery, etc.

15) Fixed Intangible Assets: Those assets which do not have a physical appearance, however, have an existence of more than a year like Goodwill, Patents, Copyrights, Trademarks, Websites, etc.

16) Non current Investments: Those investment, the value of which is not realized within a period of one year are called Non current Investments.

17) Capital work-in-progress: It represents costs incurred on a fixed asset which is under construction at the balance sheet date.

18. Intangible Assets under development: The cost incurred on the development of an Intangible Asset is taken into the Balance Sheet under the head Fixed Assets, for example, the cost incurred on the designing of a software which is still under development.

19. Long term Loans & Advances: Loans advanced by the business which are recoverable after a period of one year.

20. Other Non Current Assets: It may include other long term assets not included in Investments, Fixed tangible or intangible assets categories.. They may include the portion of Prepaid expenses that will start expiring in more than a year after the balance sheet date.

21. Trade Receivables: It comprises of Sundry Debtors and Bills Receivables.

22. Inventories: The goods which comprise of Raw materials, Work-in-progress and Finished goods.

23. Short term loans & advances: Loans advanced by the business which are recoverable within a period of one year.

24. Short term Investments: The investments realizable during the period of one year. Also known as Marketable Securities or Current Investments.
25. Cash & Cash Equivalents: They comprise of Cash at Bank and Marketable Securities.

Let’s have a look at the elements of Income Statement now!!!!

1. Revenue from Operations : Commonly known as Sales. It is the base for the calculation of Gross profit, i.e. Gross profit = Revenue from operations – Cost of Revenue from operations.
2. Other incomes: They include income from interest on bank deposits, Income from sale of non-current assets, Revaluation gain on fixed assets, Interest charged from customers, Gain on exchange rate, Penalty from employees, customers, etc.
3. Cost of material consumed: It means the cost of raw materials that the company requires to manufacture finished goods. It is calculated as Cost of material consumed = Opening Inventory + Purchases made during the year – Closing Inventory

4) Purchase of Stock-in-trade: It refers to the purchases of finished goods that the company buys towards conducting its business during the year.

5) Changes in Inventories of Stock-in-trade, Work-in-progress and Finished goods: It refers to the cost of manufacturing incurred by the company in the past, but the goods manufactured in the past were sold in the current year. Inventory change is positive if the closing inventory is more than the opening Inventory and vice-versa.

6) Employee Benefit Expenses: It includes expenses incurred in terms of the salaries paid, contribution towards provident funds, and other employee welfare expenses.

7) Finance Cost: It refers to the interest cost and other costs that the business pays when it borrows funds.

8) Depreciation and Amortisation expenses : Depreciation refers to decrease in the value of Fixed Tangible assets due to wear and tear, obsolescence or any other accidental damage. Amortisation expenses refers to decrease in the value of Fixed Intangible Assets due to various factors like time, market competition, etc.

9) Other Expenses: They include Manufacturing expenses, Selling expenses, Administrative expenses.

10) Profit before tax: It refers to the net operating income after deducting operating expenses but before deducting taxes and interest.

11) Profit after tax: It refers to company’s operating profit after deducting its tax liability.

Methods of Financial Statement Analysis

1. External Analysis

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2) Internal Analysis

3) Horizontal Analysis

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4) Vertical Analysis

What is the difference?

What is the difference?

Tools of Financial Statement Analysis

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• Comparative Balance Sheet
• Comparative Income Statement
• Common Size Balance Sheet
• Common Size Income Statement

FORMAT OF COMPARATIVE � BALANCE SHEET

Comparative Balance Sheet(Format)

Comparative Balance Sheet(Format)

FORMAT OF COMPARATIVE INCOME STATEMENT

FORMAT OF COMMON-SIZE BALANCE SHEET

Comparative Balance Sheet(Format)

Comparative Balance Sheet(Format)

FORMAT OF COMMON SIZE INCOME STATEMENT

SUPPLEMENTARS – Let’s have some insight.....

Dear Students, while going through the content, you may be wondering about certain items like ‘Absolute change’, ‘% change’, ‘% of Totals’ and ‘% of Revenue from Operations’. Therefore, it is very important for you to understand these concepts and know how to calculate them.

Do you know what is ‘Absolute Change’?

Students, let us be very clear about the purpose of preparing a Comparative Balance Sheet or an Income Statement. You know that a company needs to adjudge its performance on a continuous basis and as it is famously said that your best competitor is you yourself. Therefore, it is always prudent for a company to analyse its performance by comparing its current operations with its previous operations, i.e. current year’s details with previous year’s details.

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Now, in case, a company wants to know about the status of acquisition of its funds and their allocation, what it needs to do? The answer is, it should carefully study its Balance Sheet, that includes ‘EQUITY & LIABILITIES’ showing the acquisition of funds and ‘ASSETS’ showing the allocation of funds. This is where the Finance Manager can take the help of a Comparative Balance Sheet and investigate what is the change in the value of company’s assets over a period of one year and what is the change in company’s owned capital i.e. Equity and Borrowed capital i.e. Non- current Liabilities and in addition to this what change has taken place in the Working capital of the business i.e. Current Assets – Current Liabilities over a period of one year. So, ‘Absolute Change’ means the difference between the Current year values and the Previous year values.

Is the ‘Absolute Change’ a same phenomenon in case of Income Statement?

Yes, absolutely, ‘absolute change’ here too means the difference between the Current year values and the Previous year values. However, in case of an Income statement the purpose behind investigating the absolute change is to find out the improvement or regression in the operational efficiency on the basis of Profits before and after tax.

Now, what is this ‘% change’?

Students, ‘% change’ is just an extension to the ‘absolute change’ or if I tell you that it is another form of adjudging the performance of the business. To calculate ‘% change’, we need to divide ‘absolute change’ with the previous year value of each variable i.e. Assets and Liabilities (including the Equity).

Throwing some light on ‘% of Totals’ ..

While preparing a Common Size Balance Sheet, we need to find out the weightage of each and every element of a Balance Sheet in terms of the total value of ‘Assets’ and ‘Equity & Liabilities’. This is what is known as ‘% of Totals’. To calculate ‘% of Totals’ you need to divide each and every asset component and Equity and Liabilities component with the total of ‘Assets’ and ‘Equity & Liabilities’ section

Finally, let me tell you what is � ‘% of Revenue from operations’

Students, while preparing a Common Size Income Statement, we need to find out the weightage of each and every Income component and Expenses component with respect to the Revenue from Operations of the business and this is known as % of Revenue from Operations. To calculate it, we need to divide each and every component of Income (including Revenue from operations) and expenses with ‘Revenue from Operations.

LET’S BE PRACTICAL !!!

Ques. From the following balance sheet of Day Dreaming Co.Ltd. for the year ending 2012 and 2013, prepare the comparative Balance sheet.

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Comparative Balance Sheet of Day Dreaming Co.Ltd.

(for the year ended 2013)

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Notes to Accounts

THANK YOU!!!!!