FINANCIAL ANALYSIS

AND PLANNING

CASH FLOW AND FUND FLOW STATEMENT ARE

NOT THERE IN SYLLABUS
 Financial Analysis and Planning CW Questions

Problem: 1
56
JKL Limited has the following Balance Sheets as on March 31, 2015 and March 31, 2016:
Balance Sheet
` in lakhs
March 31, 2015 March 31, 2016
Sources of Funds:
Shareholders Funds 2,377 1,472
Loan Funds 3,570 3,083
5,947 4,555
Applications of Funds:
Fixed Assets 3,466 2,900
Cash and bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other Current Assets 1,567 1,404
Less: Current Liabilities (3,937) (3,794)
5,947 4,555
The Income Statement of the JKL Ltd. for the year ended is as follows:
` in lakhs
March 31, 2015 March 31, 2016
Sales: 22,165 13,882
Less: Cost of Goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative
Expenses 1,135 752
Earnings before Interest and Tax (EBIT) 170 586
Interest Expense 113 105
Profits before Tax 57 481
Tax 23 192
Profits after Tax (PAT) 34 289

Required:
(i) Calculate for the year 2015-16
(a) Inventory turnover ratio
(b) Financial Leverage
(c) Return on Capital Employed (ROCE)
(d) Return on Equity (ROE)
(e) Average Collection period.
(ii) Give a brief comment on the Financial Position of JKL Limited

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 Financial Analysis and Planning CW Questions

Problem: 2
57
NOOR Limited provides the following information for the year ending 31st March, 2014:
Equity Share Capital ` 5,00,000
Closing Stock ` 6,00,000
Stock Turnover Ratio 5 times
Gross Profit Ratio 25%
Net Profit / Sale 20%
Net Profit / Capital 1
4
You are required to prepare:
Trading and Profit & Loss Account for the year ending 31st March, 2014.

Problem: 3

The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st
December, 2015:
Particulars 2015
I Accounting Information:
Gross Profit 15% of Sales
Net profit 8% of sales
Raw materials consumed 20% of Cost of Goods Sold
Direct wages 10% of Cost of Goods Sold
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of Cost of Goods Sold
Debt collection period 60 days
All sales are on credit -
II Financial Ratios
Fixed assets to sales 1:3
Fixed assets to Current assets 13:11
Current ratio 2:1
Long-term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4
If value of fixed assets as on 31st December, 2014 amounted to `26 lakhs, prepare a Financial Statement
of PQR Limited for the year ended 31st December, 2015 and also the Balance Sheet as on 31st
December, 2015.

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 Financial Analysis and Planning CW Questions

Problem: 4
58
From the following information, prepare a summarised Balance Sheet as at 31st March, 2002 :
Net Working Capital ` 2,40,000
Bank overdraft ` 40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus ` 1,60,000
Current ratio 2.5
Liquid ratio (Quick Ratio) 1.5

Problem: 5

X Co. has made plans for the next year. It is estimated that the company will employ total assets of
` 8,00,000; 50 per cent of the assets being financed by borrowed capital at an interest cost of 8 per
cent per year. The direct costs for the year are estimated at ` 4,80,000 and all other operating
expenses are estimated at ` 80,000. the goods will be sold to customers at 150 per cent of the direct
costs. Tax rate is assumed to be 50 per cent.
You are required to calculate: (i) net profit margin; (ii) return on assets; (iii) asset turnover and (iv)
return on owners’ equity.

Problem: 6

Following is the abridged Balance Sheet of Alpha Ltd

Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation 15,000 35,000
1,15,000
Stock 21,000
Receivable 20,000
Bank 1,000 42,000
Total 1,57,000 Total 1,57,000

With the help of the additional information furnished below, you are required to prepare Trading and
Profit & Loss Account and a Balance Sheet as at 31st March, 2013:
(i) The company went in for reorganisation of capital structure, with share capital remaining the
same as follows :
Share capital 50%
Other Shareholders’ funds 15%
5% Debentures 10%

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 Financial Analysis and Planning CW Questions

Payables 25%
59 Debentures were issued on 1st April, interest being paid annually on 31st March.
(ii) Land and Buildings remained unchanged. Additional plant and machinery has been bought and
a further ` 5,000 depreciation written off.
(The total fixed assets then constituted 60% of total gross fixed and current assets.)
(iii) Working capital ratio was 8 : 5.
(iv) Quick assets ratio was 1 : 1.
(v) The receivables (four-fifth of the quick assets) to sales ratio revealed a credit period of 2 months.
There were no cash sales.
(vi) Return on net worth was 10%
(vii) Gross profit was at the rate of 15% of selling price.
(viii) Stock turnover was eight times for the year
Ignore Taxation.

Problem: 7

ABC Company sells plumbing fixtures on terms of 2/10, net 30. Its financial statements over the
last 3 years are as follows:
2011 2012 2013
` ` `
Cash 30,000 20,000 5,000
Accounts receivable 2,00,000 2,60,000 2,90,000
Inventory 4,00,000 4,80,000 6,00,000
Net fixed assets 8,00,000 8,00,000 8,00,000
14,30,000 15,60,000 16,95,000
` ` `
Accounts payable 2,30,000 3,00,000 3,80,000
Accruals 2,00,000 2,10,000 2,25,000
Bank loan, short-term 1,00,000 1,00,000 1,40,000
Long-term debt 3,00,000 3,00,000 3,00,000
Common stock 1,00,000 1,00,000 1,00,000
Retained earnings 5,00,000 5,50,000 5,50,000
Sales 14,30,000 15,60,000 16,95,000
Cost of goods sold ` ` `
Net profit 40,00,000 43,00,000 38,00,000
32,00,000 36,00,000 33,00,000
3,00,000 2,00,000 1,00,000
Analyse the company’s financial condition and performance over the last 3 years. Are there any
problems?

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 Financial Analysis and Planning CW Questions

Problem: 8
60
In a meeting held at Solan towards the end of 2014, the Directors of M/s HPCL Ltd. have taken a
decision to diversify. At present HPCL Ltd. sells all finished goods from its own warehouse. The
company issued debentures on 01.01.2015 and purchased fixed assets on the same day. The purchase
prices have remained stable during the concerned period. Following information is provided to
you:
INCOME STATEMENTS
2014 (` ) 2015 (` )
Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of goods sold 2,36,000 2,98,000
Gross profit 64,000 76,000
Less: Operating Expenses
Warehousing 13,000 14,000
Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 14,000
49,000 2,000 59,000
Net Profit 15,000 17,000

BALANCE SHEET
2014 (` ) 2015 (` )
Fixed Assets (Net Block) 30,000 40,000
Receivables 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Payables 50,000 76,000
Total Current Liabilities (CL) 50,000 76,000
Working Capital (CA - CL) 70,000 1,07,000
Total Assets 1,00,000 1,47,000
Represented by
Share Capital 75,000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000
1,00,000 1,47,000

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 Financial Analysis and Planning CW Questions

You are required to calculate the following ratios for the years 2014 and 2015.
61 (i) Gross Profit Ratio
(ii) Operating Expenses to Sales Ratio.
(iii) Operating Profit Ratio
(iv) Capital Turnover Ratio
(v) Stock Turnover Ratio
(vi) Net Profit to Net Worth Ratio, and
(vii) Receivables Collection Period.
Ratio relating to capital employed should be based on the capital at the end of the year. Give the
reasons for change in the ratios for 2 years. Assume opening stock of ` 40,000 for the year 2014. Ignore
Taxation.

Problem: 9

Using the following information, complete the Balance Sheet given below:
(i) Total debt to net worth :1:2
(ii) Total assets turnover :2
(iii) Gross profit on sales : 30%
(iv) Average collection period : 40 days
(Assume 360 days in a year)
(v) Inventory turnover ratio based on :3
cost of goods sold and year-end
inventory
(vi) Acid test ratio : 0.75

Balance Sheet as on March 31, 2016

Liabilities ` Assets `
Equity Shares Capital 4,00,000 Plant and Machinery -
Reserves and Surplus 6,00,000 and other Fixed Assets
Total Debt: Current Assets: -
Current Liabilities - Inventory -
Debtors -
Cash -

Problem: 10

With the help of the following information complete the Balance Sheet of MNOP Ltd.
Equity share capital ` 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt 0.40

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 Financial Analysis and Planning CW Questions

Total debt to Equity share capital 0.60

62 Fixed assets to Equity share capital 0.60
Total assets turnover 2 Times
Inventory turnover 8 Times

Problem: 11

The assets of SONA Ltd. consist of fixed assets and current assets, while its current liabilities comprise
bank credit in the ratio of 2 : 1. You are required to prepare the Balance Sheet of the company as on 31st
March 2016 with the help of following information:
Share Capital ` 5,75,000
Working Capital (CA-CL) ` 1,50,000
Gross Margin 25%
Inventory Turnover 5 times
Average Collection Period 1.5 months
Current Ratio 1.5:1
Quick Ratio 0.8:1
Reserves & Surplus to Bank & Cash 4 times
Assume 360 days in a year

Problem: 12

Ganpati Limited has furnished the following ratios and information relating to the year ended 31st
March, 2013.
Sales ` 60,00,000
Return on net worth 25%
Rate of income tax 50%
Share capital to reserves 7:3
Current ratio 2
Net profit to sales 6.25%
Inventory turnover (based on cost of goods sold) 12
Cost of goods sold ` 18,00,000
Interest on debentures ` 60,000
Receivables ` 2,00,000
Payables ` 2,00,000

You are required to:

(a) Calculate the operating expenses for the year ended 31st March, 2013.
(b) Prepare a balance sheet as on 31st March in the following format:

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 Financial Analysis and Planning CW Questions

Balance Sheet as on 31st March, 2013

63
Liabilities ` Assets `
Share Capital Fixed Assets
Reserve and Surplus Current Assets
15% Debentures Stock
Payables Receivable
Cash

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 Financial Analysis and Planning HW Questions

Problem: 1
64
MN Limited gives you the following information related for the year ending 31st March, 2016:
(1) Current Ratio 2.5 :1
(2) Debt-Equity Ratio 1 : 1.5
(3) Return on Total Assets (After Tax) 15%
(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7
(7) Current Market Price per Equity Share ` 16
(8) Net Working Capital ` 4,50,000
(9) Fixed Assets ` 10,00,000
(10) 60,000 Equity Shares of ` 10 each
(11) 20,000, 9% Preference Shares of ` 10 each
(12) Opening Stock ` 3,80,000

You are required to calculate:

(i) Quick Ratio
(ii) Fixed Assets Turnover Ratio
(iii) Proprietary Ratio
(iv) Earnings per Share
(v) Price-Earning Ratio.

Problem: 2

The following accounting information and financial ratios of M Limited relate to the year ended 31st
March, 2016 :
Inventory Turnover Ratio 6 Times
Creditors Turnover Ratio 10 Times
Debtors Turnover Ratio 8 Times
Current Ratio 2.4
Gross Profit Ratio 25%

Total sales ` 30,00,000; cash sales 25% of credit sales; cash purchases ` 2,30,000; working capital `
2,80,000; closing inventory is ` 80,000 more than opening inventory.
You are required to calculate:
(i) Average Inventory
(ii) Purchases
(iii) Average Debtors
(iv) Average Creditors

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 Financial Analysis and Planning HW Questions

(v) Average Payment Period

65 (vi) Average Collection Period
(vii) Current Assets
(viii) Current Liabilities.

Problem: 3

The capital structure of Beta Limited is as follows:

Equity share capital of Rs. 10 each 8,00,000
9% preference share capital of Rs. 10 each 3,00,000
11,00,000
Additional information: Profit (after tax at 35 per cent), ` 2,70,000; Depreciation, ` 60,000; Equity
dividend paid, 20 per cent; Market price of equity shares, ` 40.

You are required to compute the following, showing the necessary workings:
(a) Dividend yield on the equity shares
(b) Cover for the preference and equity dividends
(c) Earnings per shares
(d) Price-earnings ratio.

Problem: 4

Using the following data, complete the Balance Sheet given below:
Gross Profit ` 54,000
Shareholders’ Funds ` 6,00,000
Gross Profit margin 20%
Credit sales to Total sales 80%
Total Assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long-term Debt to Equity 40%

Balance Sheet

Creditors ................................ Cash ............................

Long-term debt ................................ Debtors ............................
Shareholders’ funds ............................... Inventory ............................
Fixed assets ............................

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 Financial Analysis and Planning HW Questions

Problem: 5
66
The total sales (all credit) of a firm are ` 6,40,000. It has a gross profit margin of 15 per cent and a
current ratio of 2.5. The firm’s current liabilities are ` 96,000; inventories ` 48,000 and cash ` 16,000. (a)
Determine the average inventory to be carried by the firm, if an inventory turnover of 5 times is
expected? (Assume a 360 day year). (b) Determine the average collection period if the opening
balance of debtors is intended to be of ` 80,000? (Assume a 360 day year)

Problem: 6

MNP Limited has made plans for the next year 2015 -16. It is estimated that the company will employ
total assets of ` 25,00,000; 30% of assets being financed by debt at an interest cost of 9% p.a. The direct
costs for the year are estimated at ` 15,00,000 and all other operating expenses are estimated at `
2,40,000. The sales revenue are estimated at ` 22,50,000. Tax rate is assumed to be 40%. Required to
calculate:
(i) Net profit margin (After tax);
(ii) Return on Assets (After tax);
(iii) Asset turnover; and
(iv) Return on Equity

Problem: 7

The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st
December, 2013: 2013
I. Accounting Information:
Gross Profit 15% of Sales
Net profit 8% of sales
Raw materials consumed 20% of works cost
Direct wages 10% of works cost
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of works cost
Debt collection period 60 days
All sales are on credit
II. Financial Ratios:
Fixed assets to sales 1:3
Fixed assets to Current assets 13 : 11
Current ratio 2:1
Long-term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4

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 Financial Analysis and Planning HW Questions

If value of fixed assets as on 31st December, 2012 amounted to ` 26 lakhs, prepare a

67 summarised Profit and Loss Account of the company for the year ended 31st December, 2013 and also
the Balance Sheet as on 31st December, 2013.

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 Financial Analysis and Planning HW Solutions

Problem: 1
68
Workings Notes:
1. Net Working Capital = Current Assets – Current Liabilities
= 2.5 – 1=1.5
Thus Current Assets Net Working Capital  2.5

1 .5
` 4 , 50 , 000  2.5
  ` 7 , 50 , 000
1 .5
Current Liabilities = ` 7,50,000 – ` 4,50,000 = ` 3,00,000
2. Sales = Total Assets Turnover × Total Assets
= 2 x (Fixed Assets + Current Assets)
= 2 × (` 10,00,000 + ` 7,50,000) = ` 35,00,000
3. Cost of Goods Sold = 100% – 20%= 80% of Sales
= 80% of ` 35,00,000 = ` 28,00,000
4. Average Stock Cost of Good Sold

Stock Turnover Ratio
` 28, 00 , 000
  ` 4 , 00 , 000
7
Closing Stock = (Average Stock ×2) – Opening Stock
= (` 4,00,000 × 2) – ` 3,80,000 = ` 4,20,000
Quick Assets = Current Assets – Closing Stock
= ` 7,50,000 – ` 4,20,000 = ` 3,30,000
Debt 1
= , Or Proprietary fund = 1.5 Debt.
Equity (here Pr oprietary fund) 15
Total Assets = Proprietary Fund (Equity) +Debt
Or 17,50,000 = 1.5 Debt + Debt
Or Debt `17 , 50 , 000
  ` 7 , 00 , 000
2 .5
Proprietary fund = 7,00,000 × 1.5 = ` 10,50,000
`17 , 50 , 000  1.5
  ` 10, 50 , 000
2 .5
5. Profit after tax (PAT) = Total Assets × Return on Total Assets
= ` 17,50,000 × 15% = ` 2,62,500

(i) Calculation of Quick Ratio

Quick Assets ` 3, 30, 000
   1 .1 : 1
Currents Liabilities ` 3, 00, 000
(ii) Calculation of Fixed Assets Turnover Ratio
Sales ` 35, 00 , 000
Fixed Assets Turnover Ratio    3 .5
Fixed Assets ` 10 , 00 , 000
(iii) Calculation of Proprietary Ratio
Pr oprietary fund
Proprietary Ratio 
Total Assets

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 Financial Analysis and Planning HW Solutions

`10 , 50 , 000
  0 .6 : 1
69 `17 , 50 , 000
(iv)Calculation of Earnings per Equity Share (EPS)
PAT  Pr eference Share Dividend
Earnings per Equity Share (EPS) 
Number of Equity Shares
` 2 , 62 , 500  `18, 000 (9%of 2 , 00 , 000 )

60 , 000
= ` 4.075 per share
(v) Calculation of Price-Earnings Ratio (P/E Ratio)

Market Pr ice of Equity Share `16

P /E Ratio    3.926
EPS ` 4.075

Problem: 2

(i) Computation of Average Inventory

Gross Profit = 25% of ` 30, 00,000 = ` 7,50,000
Cost of goods sold (COGS) = Sales - Gross Profit = ` 30,00,000 – ` 7,50,000
= ` 22,50,000
Inventory Turnover Ratio COGS

Average Inventory
6 ` 22 , 50 , 000

Average Inventory
Average inventory = ` 3,75,000

(ii) Computation of Purchases

Purchases = COGS + (Closing Stock – Opening Stock) = ` 22,50,000 + 80,000*
Purchases = ` 23,30,000
* Increase in Stock = Closing Stock – Opening Stock = ` 80,000
(iii) Computation of Average Debtors
25
Let Credit Sales be ` 100, Cash sales   100 ` 25
100
Total Sales = 100 + 25= ` 125
Total sales is ` 125 credit sales is ` 100
` 30 , 00 , 000  100
If total sales is ` 30,00,000, then credit sales is 
125
Credit Sales = ` 24,00,000
Cash Sales = (` 30,00,000 – ` 24,00,000) = ` 6,00,000
Net Credit Sales ` 24, 00, 000
Debtors Turnover Ratio  8 8
Average debtors Average debtors
` 24 , 00 , 000
Average Debtors 
8
Average Debtors = ` 3,00,000

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 Financial Analysis and Planning HW Solutions

(iv) Computation of Average Creditors

70 Credit Purchases = Purchases – Cash Purchases
= ` 23,30,000 – ` 2,30,000 = ` 21,00,000
Creditors Turnover Ratio Credit Purchases

Average Creditors
10 21, 00 , 000

Average Creditors
Average Creditors = ` 2,10,000

(v) Computation of Average Payment Period

Average Payment Period Average Crreditors

Average Daily Cridit Purchases
` 2,10, 000 ` 2,10, 000
 
 Credit Purchases   21, 00, 000 
`
 
 365 
` 2 ,10 , 000
  365*  36.5 days
` 21, 00 , 000

Alternatively
Average Payment Period = 365/Creditors Turnover Ratio
365 *
  36.5 days
10

(vi) Computation of Average Collection Period

Average Debtors ` 3, 00, 000
Average Collection Period   365*   365  45.625 days
Net Credit Sales ` 24, 00, 000
Alternatively
365 *
Average collection period 
Debtors Trunover Ratio
365
  45.625 days
8
* 1 year is taken as 365 days.
(vii) Computation of Current Assets
Current Ratio Current Assets(CA)
  2.4
Current liabilities(CL)
2.4 Current Liabilities = Current Assets or CL = CA/2.4
Further, Working capital = Current Assets – Current liabilities
So, ` 2,80,000 = CA-CA/2.4
` 2,80,000 = 1.4 CA/2.4 Or, 1.4 CA = ` 16,72,000
CA = = ` 4,80,000
(viii) Computation of Current Liabilities

4 , 80 , 000
Current liabilities  ` 2, 00, 000
2 .4

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 Financial Analysis and Planning HW Solutions

Problem: 3
71
a. Dividend yield on the equity shares
` ( . ` )
=
 10 = `
 100 = 5 per cent

b. Dividend coverage ratio

(i) Preference =

` , ,
= = 10 times
` , , ( .  3,00,000)

(ii) Equity =
.
` , , ` ,
= = 1.52 times
` , , ( ,  ` )
c. Earnings per equity share
` , ,
=
= ,
= ` 3.04 per share

`
d. Price-earning (P/E) ratio =
= ` .
= 13.2 times

Problem: 4

Gross Profit `54,000

Gross Profit Margin 20%

 Sales =
= `54,000 / 0.20 =`2,70,000
Credit Sales to Total Sales = 80%
 Credit Sales = `2,70,000×0.80 =`2,16,000
Total Assets Turnover = 0.3 times
 Total Assets =
`2, 70, 000
= `9, 00, 000
0.3
Sales – Gross Profit = COGS
 COGS = `2, 70,000 – 54,000 =`2, 16,000
Inventory turnover = 4 times
2,16, 000
Inventory = = `54,000
4
Average Collection Period = 20 days
 Debtors turnover =
= 360/20 = 18
`2,16, 000
 Debtors =  `12,000
18
Current ratio = 1.8

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 Financial Analysis and Planning HW Solutions

( )
1.8 =
72 ( )
1.8 Creditors = ( `12,000+ `54,000 + Cash)
1.8 Creditors = `66,000 + Cash---------(i)
Long-term Debt to Equity = 40%

Shareholders’ Funds (Equity) = `6,00,000

 Long-term Debt =`6,00,000× 40% =`2,40,000
Creditors = `9,00,000– (6,00,000 + 2,40,000) = `60,000
 Cash= (`60,000  1.8) -` 66,000 =` 42,000 [From equation (i)]

Balance Sheet
Liabilities ` Assets `
Creditors 60,000 Cash 42,000
Debtors 12,000
Long-term debt 2,40,000 Inventory 54,000
Shareholder’s Fund 6,00,000 Fixed Assets (Balancing 7,92,000
9,00,000 Figure) 9,00,000

Problem: 5

a. Inventory turnover=
Since gross profit margin is 15 per cent, the cost of goods sold should be 85 per cent ofthe sales.
Cost of goods sold = 0.85×`6,40,000 =`5,44,000
` , ,
Thus,= =5

`5, 44, 000
Average inventory= `1, 08, 000
5

b. Average collection period =  360 days

( )
Average Receivables=
Closing balance of receivables is found as follows:
` `
Current assets (2.5 of current liabilities) 2,40,000
Less: Inventories 48,000
Cash 16,000 64,000
 Receivables 1,76,000
(`1, 76, 000 `80, 000)
Average Receivables =
2
`2,56,000 ÷2 = `1,28,000

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 Financial Analysis and Planning HW Solutions

`1, 28, 000

73 Average collection period =  360  72 days
`6, 40, 000

Problem: 6

The net profit is calculated as follows:

`
Sales Revenue 22,50,000
Less: Direct Costs 15,00,000
Gross Profits 7,50,000
Less: Operating Expense 2,40,000
Earnings before Interest and tax( EBIT) 5,10,000
Less: Interest on debt [9% × 7,50,000 (i.e. 30 % of 25,00,000 )] 67,5
Earnings before Tax)(EBT) 4,42,500
Less: Taxes (@ 40%) 1,77,000
Profit after Tax (PAT) 2,65,500

(i) Net Profit Margin (After Tax)

( ) `5,10, 000  (1  0.4)
NetProfit Margin = ×100=  13.6%
`22,50, 000
(ii) Return on Assets (ROA)( After tax)
( )
ROA =

`5,10, 000(1  0.4) `3, 06, 000
 
`25, 00, 000 `25, 00, 000
= 0.1224 = 12.24 %
(iii) Asset Turnover
`22,50, 000
Asset Turnover = =  = 0.9
`25, 00, 000
Asset Turnover = 0.9
(iv) Return on Equity (ROE)
`2, 65, 000
ROE = = = 15.17%
`17,50, 000
ROE = 15.17%

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 Financial Analysis and Planning HW Solutions

Problem: 7
74
(a) Working Notes:
(i) Calculationof Sales
1
=
3
, 1
 = Sales = ` 78,00,000
3
(ii) Calculation of Current Assets
13
=
11
, 13
 = Current Assets = `22,00,000
11
(iii) Calculation of Raw Material Consumption and Direct Wages
`
Sales 78,00,000
Less: Gross Profit 11,70,000
Works Cost 66,30,000
Raw Material Consumption (20% of Works Cost) `13,26,000
Direct Wages (10% of Works Cost) `6,63,000
(iv) Calculation of Stock of Raw Materials (= 3 months usage)
3
 13, 26, 000   `3,31,500
12
(v) Calculation of Stock of Finished Goods (= 6% of Works Cost)
6
 66,30, 000   `3,97,800
100
(vi) Calculation of Current Liabilities


=2
, ,
=2 Current Liabilities= `11,00,000

(vii) Calculation of Receivables

Average collection period=
 365

, ,
 365 =60 Receivables = ` 12,82,191.78 or ` 12,82,192
(viii) Calculation of Long term Loan
2
=
1
2
= Long term loan = `22,00,000.
, , 1

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 Financial Analysis and Planning HW Solutions

(ix) Calculation of Cash Balance

75 `
Current assets 22,00,00
Less: Receivables 12,82,192
Raw materials stock 3,31,500
Finished goods stock 3,97,800 20,11,492
Cash balance 1,88,508
(x) Calculation of Net worth
Fixed Assets 26,00,000
Current Assets 22,00,000
Total Assets 48,00,000
Less: Long term Loan 22,00,000
Current Liabilities 11,00,000 33,00,000
Net worth 15,00,000
Net worth = Share capital + Reserves = 15,00,000
1 1
= Share Capital = 15, 00, 000   `3,00,000
4 5
4
Reserves and Surplus = 15, 00, 000   `12,00,000
5
Profit and Loss Account of PQR Ltd.
for the year ended 31st December, 2013
Particulars ` Particulars `
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,0
To Works (Overhead) 46,41,000
Balancing figure
To Gross Profit c/d
(15% of Sales) 11,70,000
78,00,000 78,00,000
To Selling and 5,46,000 By Gross Profit b/d 11,70,000
DistributionExpenses
(Balancing
figure)
To Net Profit (8% of Sales) 6,24,000
11,70,000 11,70,000

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 Financial Analysis and Planning HW Solutions

Balance Sheet of PQR Ltd.

76 as at 31st December, 2013
Liabilities ` Assets `
Share Capital 3,00,000 Fixed Assets 26,00,000
Reserves and Surplus 12,00,000 Current Assets:
Long term loans 22,00,000 Stock of Raw 3,31,500
Material
Current liabilities 11,00,000 Stock of Finished 3,97,800
Goods
Receivables 12,82,192
48,00,000 48,00,000

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 Financial Analysis & Planning Theory Part

77
THEORY

Question 1

Discuss any three ratios computed for investment analysis.

Answer
Three ratios computed for investment analysis are as follows:
Net Pr ofit available to equity shareholders
(i) Earnings per share 
Number of equity shares outs tan ding
Equity dividend per share  DPS   100
(ii) Dividend yield ratio 
Market price per share  MPS 
Earnings before int erest and tax  EBIT   100
(iii) Return on capital employed* 
Capital employed
* It can be pretax or post tax

Question 2

Discuss the financial ratios for evaluating company performance on operating efficiency and
liquidity position aspects.

Answer
Financial ratios for evaluating performance on operational efficiency and liquidity position aspects are
discussed as:
Operating Efficiency: Ratio analysis throws light on the degree of efficiency in the management and
utilization of its assets. The various activity ratios (such as turnover ratios) measure this kind of
operational efficiency. These ratios are employed to evaluate the efficiency with which the firm
manages and utilises its assets. These ratios usually indicate the frequency of sales with respect to its
assets. These assets may be capital assets or working capital or average inventory. In fact, the solvency
of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by use of its assets –
total as well as its components.

Liquidity Position: With the help of ratio analysis, one can draw conclusions regarding
liquidity position of a firm. The liquidity position of a firm would be satisfactory, if it is able to meet its
current obligations when they become due. Inability to pay-off short-term liabilities affects its
credibility as well as its credit rating. Continuous default on the part of the business leads to

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 Financial Analysis & Planning Theory Part

commercial bankruptcy. Eventually such commercial bankruptcy may lead to its sickness and
78 dissolution. Liquidity ratios are current ratio, liquid ratio and cash to current liability ratio.
These ratios are particularly useful in credit analysis by banks and other suppliers of short-term loans.

Question 3

Diagrammatically present the DU PONT CHART to calculate return on equity.

Answer
Du Pont Chart
There are three components in the calculation of return on equity using the traditional DuPont model-
the net profit margin, asset turnover, and the equity multiplier. By examining each input individually,
the sources of a company's return on equity can be discovered and compared to its competitors.
Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier)
Net Pr ofit Net Pr ofit Re venue Assets
Or ,   
Shareholders Equity Re venue Assets Shareholders Equity

Question 4

What do you mean by Stock Turnover ratio and Gearing ratio?

Answer
Stock Turnover Ratio and Gearing Ratio
Stock Turnover Ratio helps to find out if there is too much inventory build-up. An increasing
stock turnover figure or one which is much larger than the "average" for an industry may indicate poor
stock management. The formula for the Stock Turnover Ratio is as follows:
Cost of Sales Turnover
Stock Turnover Ratio  or
Average inventory Average inventory
Gearing Ratio indicates how much of the business is funded by borrowing. In theory, the higher the
level of borrowing (gearing), the higher are the risks to a business, since the payment of
interest and repayment of debts are not "optional" in the same way as dividends. However, gearing can
be a financially sound part of a business's capital structure particularly if the business has strong,
predictable cash flows. The formula for the Gearing Ratio is as follows:
Borrowings  all long term debts including normal overdraft 
Gearing Ratio 
Net Assets or Shareholders ' funds

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 Financial Analysis & Planning Theory Part

Question 5
79
Discuss the composition of Return on Equity (ROE) using the DuPont model.

Answer
Composition of Return on Equity using the DuPont Model: There are three components in the
calculation of return on equity using the traditional DuPont model- the net profit margin, asset
turnover, and the equity multiplier. By examining each input individually, the sources of a company's
return on equity can be discovered and compared to its competitors.
a. Net Profit Margin: The net profit margin is simply the after-tax profit a company generates for each
rupee of revenue.
Net profit margin = Net Income ÷ Revenue
Net profit margin is a safety cushion; the lower the margin, lesser the room for error.
b. Asset Turnover: The asset turnover ratio is a measure of how effectively a company converts
its assets into sales. It is calculated as follows:
Asset Turnover = Revenue ÷ Assets
The asset turnover ratio tends to be inversely related to the net profit margin; i.e., the
higher the net profit margin, the lower the asset turnover.
c. Equity Multiplier: It is possible for a company with terrible sales and margins to take on excessive
debt and artificially increase its return on equity. The equity multiplier, a measure of financial
leverage, allows the investor to see what portion of the return on equity is the result of debt. The
equity multiplier is calculated as follows:
Equity Multiplier = Assets ÷ Shareholders’ Equity.

Calculation of Return on Equity

To calculate the return on equity using the DuPont model, simply multiply the three components (net
profit margin, asset turnover, and equity multiplier.)
Return on Equity = Net profit margin× Asset turnover × Equity multiplier

Question 6

Explain briefly the limitations of Financial ratios.

Answer
Limitations of Financial Ratios
The limitations of financial ratios are listed below:
a. Diversified product lines: Many businesses operate a large number of divisions in quite different
industries. In such cases, ratios calculated on the basis of aggregate data cannot be used for inter-
firm comparisons.

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 Financial Analysis & Planning Theory Part

b. Financial data are badly distorted by inflation: Historical cost values may be substantially
80 different from true values. Such distortions of financial data are also carried in the financial ratios.
c. Seasonal factors may also influence financial data.
d. To give a good shape to the popularly used financial ratios (like current ratio, debt- equity ratios,
etc.): The business may make some year-end adjustments. Such window dressing can change the
character of financial ratios which would be different had there been no such change
e. Differences in accounting policies and accounting period: It can make the accounting data of two
firms non-comparable as also the accounting ratios.
f. There is no standard set of ratios against which a firm’s ratios can be compared:
Sometimes a firm’s ratios are compared with the industry average. But if a firm desires to be above
the average, then industry average becomes a low standard. On the other hand, for a below
average firm, industry averages become too high a standard to achieve.

Question 7

Explain the important ratios that would be used in each of the following situations:
(i) A bank is approached by a company for a loan of ` 50 lakhs for working capital purposes.
(ii) A long term creditor interested in determining whether his claim is adequately secured.
(iii) A shareholder who is examining his portfolio and who is to decide whether he should hold or sell
his holding in the company.
(iv) A finance manager interested to know the effectiveness with which a firm uses its available
resources.

Answer
Important Ratios used in different situations
(i) Liquidity Ratios- Here Liquidity or short-term solvency ratios would be used by the bank to check
the ability of the company to pay its short-term liabilities. A bank may use Current ratio and
Quick ratio to judge short terms solvency of the firm.
(ii) Capital Structure/Leverage Ratios- Here the long-term creditor would use the capital
structure/leverage ratios to ensure the long term stability and structure of the firm. A long term
creditors interested in the determining whether his claim is adequately secured may use Debt-
service coverage and interest coverage ratio.
(iii) Profitability Ratios- The shareholder would use the profitability ratios to measure the
profitability or the operational efficiency of the firm to see the final results of business
operations. A shareholder may use return on equity, earning per share and dividend per share.
(iv) Activity Ratios- The finance manager would use these ratios to evaluate the efficiency with which
the firm manages and utilises its assets. Some important ratios are (a) Capital turnover ratio
(b) Current and fixed assets turnover ratio (c) Stock, Debtors and Creditors turnover ratio.

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 Financial Analysis & Planning Summary

81
SUMMARY

1. Financial Analysis and Planning

Financial Analysis and Planning is carried out for the purpose of obtaining material and
relevant information necessary for ascertaining the financial strengths and weaknesses of an
enterprise and is necessary to analyze the data depicted in the financial statements. The main
tools are Ratio Analysis and Cash Flow and Funds Flow Analysis.

2. Ratio Analysis
Ratio analysis is based on the fact that a single accounting figure by itself may not
communicate any meaningful information but when expressed as a relative to some other figure,
it may definitely provide some significant information. Ratio analysis is comparison of different
numbers from the balance sheet, income statement, and cash flow statement against the
figures of previous years, other companies, the industry, or even the economy in general for the
purpose of financial analysis.

3. Importance of Ratio Analysis

The importance of ratio analysis lies in the fact that it presents facts on a comparative basis and
enables drawing of inferences regarding the performance of a firm. It is relevant in assessing
the performance of a firm in respect of following aspects:
 Liquidity Position
 Long-term Solvency
 Operating Efficiency
 Overall Profitability
 Inter-firm Comparison
 Financial Ratios for Supporting Budgeting.

4. Cash Flow Statement

Cash flow statement is a statement which discloses the changes in cash position between the two
periods. Along with changes in the cash position the cash flow statement also outlines the
reasons for such inflows or outflows of cash which in turn helps to analyze the functioning
of a business.

5. Classification of Cash Flow Activities

The cash flow statement should report cash flows during the period classified into following
categories:

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 Financial Analysis & Planning Summary

 Operating Activities: These are the principal revenue-producing activities of the enterprise
82 and other activities that are not investing or financing activities.
 Investing Activities: These activities relate to the acquisition and disposal of long-term assets
and other investments not included in cash equivalents. Cash equivalents are short term highly
liquid investments that are readily convertible into known amounts of cash and which are
subject to an insignificant risk of changes in value.
 Financing Activities: These are activities that result in changes in the size and composition of
the owners’ capital (including preference share capital in the case of a company) and
borrowings of the enterprise.

6. Procedure in Preparation of Cash Flow Statement

 Calculation of net increase or decrease in cash and cash equivalents: The difference
between cash and cash equivalents for the period may be computed by comparing these
accounts given in the comparative balance sheets. The results will be cash receipts and
payments during the period responsible for the increase or decrease in cash and cash
equivalent items.
 Calculation of the net cash provided or used by operating activities: It is by the
analysis of Profit and Loss Account, Comparative Balance Sheet and selected additional
information.
 Calculation of the net cash provided or used by investing and financing activities: All other
changes in the Balance sheet items must be analysed taking into account the additional
information and effect on cash may be grouped under the investing and financing
activities.
 Final Preparation of a Cash Flow Statement: It may be prepared by classifying all cash
inflows and outflows in terms of operating, investing and financing activities. The net cash
flow provided or used in each of these three activities may be highlighted. Ensure that
the aggregate of net cash flows from operating, investing and financing activities is equal to
net increase or decrease in cash and cash equivalents.

7. Reporting of Cash Flow from Operating Activities

There are two methods of converting net profit into net cash flows from operating activities-
 Direct Method: actual cash receipts (for a period) from operating revenues and actual cash
payments (for a period) for operating expenses are arranged and presented in the cash flow
statement. The difference between cash receipts and cash payments is the net cash flow from
operating activities.
 Indirect Method: In this method the net profit (loss) is used as the base then adjusted for items
that affected net profit but did not affect cash.

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 Financial Analysis & Planning Summary

8. Funds Flow Statement

83 It ascertains the changes in financial position of a firm between two accounting periods. It
analyses the reasons for change in financial position between two balance sheets. It shows the
inflow and outflow of funds i.e., sources and application of funds during a particular period.
 Sources of Funds
a. Long term fund raised by issue of shares, debentures or sale of fixed assets and
b. Fund generated from operations which may be taken as a gross before payment of
dividend and taxes or net after payment of dividend and taxes.
 Applications of Funds
a. Investment in Fixed Assets
b. Repayment of Capital

9. Funds Flow Statement vs. Cash Flow Statement

Cash flow statement Funds flow statement
(i) It ascertains the changes in (i) It ascertains the changes in
balance of cash in hand and bank. financial position between two
accounting periods.
(ii) It analyses the reasons for (ii) It analyses the reasons for
changes in balance of cash in hand change in financial position
and bank. between two balance sheets.
(iii) It shows the inflows and (iii) It reveals the sources and
outflows of cash. application of funds.
(iv) It is an important tool for short (iv) It helps to test whether
term analysis. working capital has been
effectively used or not.
(v) The two significant areas of
analysis are cash generating
efficiency and free cash flow.

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