Economics and Financial

Accounting Module
By :
Mrs.Shubhangi Dixit

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DAY 10

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Day 10

• Annual Report and interrelation of financial statements

• Financial Analysis and its significance.
• Tools of Analysis of Financial Statements
• Ratio Analysis (All Conceptual)

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Annual Report

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The Components that Supplement the
Financial Statements in an Annual Report
Companies traded on an organized exchange like the BSE, the New York
Stock Exchange or The American Stock Exchange are required to provide
shareholders with an annual report which always includes financial
statements. In addition, the annual report includes the following
information:
♦ Management Discussion and Analysis - covers three aspects of a
company: liquidity, capital resources, and results of operation.
♦ Notes to Financial Statements
􀂃 Clarify information presented in the financial statements.
􀂃 Describe accounting policies or explain uncertainties and contingencies.
♦ Auditor's Report
􀂃 Auditor, a professional accountant, who conducts an independent
examination of the financial accounting data presented by a company.
􀂃 Auditor gives an unqualified opinion if the financial statements present the
financial position, results of operations, and cash flows in accordance with 5
accepted accounting standards.
How the financial statements are interrelated

• The income statement is prepared first

• The income from this statement flows to the statement of
changes in stockholder’s equity

• The stockholders equity total and common stock totals flow to

the balance sheet

• The cash from the balance sheet flows to the statement of cash
flows

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Significance of Analysis of Financial Statements

(a) Finance manager

(b) Top management
(c) Trade payables
(d) Lenders
(e) Investors
(f) Labor unions
(g) Others

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Tools of Analysis of Financial Statements

The most commonly used techniques of financial analysis are as

follows:

• 1. Comparative Statements
• 2. Common Size Statements
• 3. Trend Analysis
• 4. Ratio Analysis
• 5. Cash Flow Analysis:

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4. Ratio Analysis

• The analysis is done by establishing the relationship between

the items of the Balance sheet and Profit and Loss Account. As
a technique of financial analysis, accounting ratios measure the
comparative significance of the individual items of the income
and position statements. It is possible to assess the profitability,
solvency and efficiency of an enterprise through the technique
of ratio analysis.

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Ratio analysis

• In ratio analysis the ratios may be classified into the four

categories as follows;
• (I) Liquidity Ratios
• (II) Profitability Ratios
• (III) Activity Ratios
• (IV) Solvency Ratios

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Liquidity Ratios

"Liquidity" refers to the ability of the firm to meet its current

liabilities. The liquidity ratios, therefore, are also called 'Short-
term Solvency Ratios.' These ratios are used to assess the short-
term financial position of the concern. They indicate the firm's
ability to meet its current obligations out of current resources.
Liquidity ratios include two ratios: -
1. Current Ratio
2. Quick Ratio

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Current Ratio

• The ratio is used to assess the firm's ability to meet its short-
term liabilities on time. It is generally believe that 2:1 ratio
shows a comfortable working capital position.
• C.A = Cash & Bank Bal.+ Stock + Debtors + B.R.+P/p Exp. +
Investments readily convertible into cash + Loans and
Advances
• C.L = Creditors + B.P + Bank O.d+ Unclaimed dividend +
Prov. for Taxation + Proposed Dividend.

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Formula

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Illustration: Calulate Current Ratio from the
following information:

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Solution

Significance: It provides a measure of degree to which current assets

cover current liabilities. The excess of current assets over current
liabilities provides a measure of safety margin available against
uncertainty in realisation of current assets and flow of funds. The ratio
should be reasonable.
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Illustration 2
Calculate quick ratio from the information
given in illustration
Solution:

Significance: The ratio provides a measure of the capacity of the

business to meet its short-term obligations without any flaw.
Normally, it is advocated to be safe to have a ratio of 1:1 as
unnecessarily low ratio will be very risky and a high ratio suggests
unnecessarily deployment of resources in otherwise less profitable
short-term investments. 16
Quick Ratio

• Quick or Acid Test indicates whether the firm is in a position

to pay its C.Ls within a month or immediately.
• An ideal acid test ratio is said to be 1:1. The idea is that for
every rupee or C.Ls, there should at least be one rupee of
liquid assets.

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Illustration

• Calculate ‘Liquidity Ratios’ from the following information:

• Current liabilities = Rs. 50,000
• Current assets = Rs. 80,000
• Inventories = Rs. 20,000
• Advance tax = Rs. 5,000
• Prepaid expenses = Rs. 5,000

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Profitability Ratios

• The main object of all the business concerns is to earn profit.

Profit is the measurement of the efficiency of the business.
Equity shareholders of the company are mainly interested in
the profitability of the company.
• A business must be able to earn adequate profit In relation to
the capital Invested in It.

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Profitability Ratios

Profitability ratios include the following: -

1. Gross Profit Margin Ratio
2. Operating Profit Margin Ratio
3. Net Profit Margin Ratio
4. Return on Capital Employed Ratio
5. Return on Net worth Ratio
6. Earning per Share Ratio
7.Book Value per Share
8.Dividend Payout Ratio
9.Price / Earning Ratio
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Gross Profit Margin Ratio: -

• This ratio measures the margin of profit available on sales. The

higher the gross profit ratio, the better it is. No ideal standard
is fixed for this ratio; but the gross profit ratio should be
adequate enough not only to cover the operating expenses but
also to provide for depreciation, Interest on loans, dividends
and creation of reserves. The ratio is compare with earlier
years ratio and important conclusions are drawn from such
comparison.

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Following information is available for the
year 2014-15, calculate gross profit ratio:

Rs.
Revenue from Operations: Cash 25,000
: Credit 75,000
Purchases : Cash 15,000
: Credit 60,000
Carriage Inwards 2,000
Salaries 25,000
Decrease in Inventory 10,000
Return Outwards 2,000
Wages 5,000
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Solution

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Operating Ratio
• This ratio measures the proportion of an enterprise’s. Cost of
sales and operating expenses in comparison to its sales“
• Operating expenses include office expenses, administrative
expenses, selling expenses, distribution expenses, depreciation
and employee benefit expenses etc.
• Cost of operation is determined by excluding non-operating
incomes and expenses such as loss on sale of assets, interest
paid, dividend received, loss by fire, speculation gain and so
on.

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Operating Profit Margin Ratio
It is calculated to reveal operating margin. It may be computed
directly or as a residual of operating ratio.
Operating Profit Ratio = 100 – Operating Ratio
Alternatively, it is calculated as under:
Operating Profit Ratio = Operating Profit/ Revenue from
Operations × 100
Or
Where O.P. = Revenue from Operations – Operating Cost
Significance: Operating ratio is computed to express cost of
operations excluding financial charges in relation to revenue
from operations. A corollary of it is ‘Operating Profit Ratio’. It
helps to analyse the performance of business and throws light on
the operational efficiency of the business. It is very useful for 25
inter-firm as well as intra-firm comparisons. Lower operating
ratio is a very healthy sign.
Illustration

• Given the following information:

Rs.
Revenue from Operations 3,40,000
Cost of Revenue from Operations 1,20,000
Selling expenses 80,000
Administrative Expenses 40,000
Calculate Gross profit ratio and Operating ratio.

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Solution

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Net Profit Margin Ratio

• This ratio measures the rate of net profit earned on sales. It

helps in determining the overall efficiency of the business
operation. An increase in the ratio over the previous year
shows improvement in the overall efficiency of the business.
• Significance: It is a measure of net profit margin in relation to
revenue from operations. Besides revealing profitability, it is
the main variable in computation of Return on Investment. It
reflects the overall efficiency of the business, assumes great
significance from the point of view of investors.

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Earning per Share Ratio

• It measures the profit available to the holders on a per share

basis, i.e. the amount that they can get on every share held. It is
calculated by dividing the profits available to the equity
shareholders by the number of the outstanding shares. The
profits available to the ordinary shareholders are represented
by net profits after taxes and preference dividend

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EPS

As a profitability ratio, the EPS can be used to draw inferences

on the basis of

i) Its trend over a period of time,

ii) comparison of the EPS of the other firms,
iii)comparison with the industry average.

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Price / Earning Ratio

The ratio is computed as –

P/E Ratio = Market Price of a share/earnings per share
For example, if the EPS of X Ltd. is Rs. 10 and market price is
Rs. 100, the price earning ratio will be 10 (100/10). It reflects
investors expectation about the growth in the firm’s earnings and
reasonableness of the market price of its shares. P/E Ratio vary
from industry to industry and company to company in the same
industry depending upon investors perception of their future.

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Illustration

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Illustration
From the following details, calcualte EPS and P/E Ratioif
market price of the share is Rs 34 and the net profit after tax is
Rs. 1,50,000 and the tax is Rs. 50,000.

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Solution

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Activity Ratios

These ratios are calculated on the basis of 'cost of sales' or

‘sales’; therefore, these ratios are also called as 'Turnover Ratios'.
Turnover indicates the speed or number of times the capital
employed has been rotated in the process of doing business. In
other words, these ratios indicate how efficiently the capital is
being used to obtain sales; how efficiently the fixed assets are
being used to obtain sales; and how efficiently the working
capital and stock is being used to obtain sales. Higher turnover
ratios indicate the better use of capital or resources and in turn
lead to higher profitability.

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Activity Ratios

Turnover ratios include the following

1. Inventory Turnover Ratio
2. Debtors Turnover Ratio
3. Trade Payable Turnover Ratio
4. Net Assets or Capital Employed Turnover Ratio

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Solvency Ratios

• These ratios are calculated to assess the ability of the firms to

meet its long-term liabilities as and when they become due.
Long term creditors including debenture holders are primarily
interested to know whether the company has ability to pay
regularly interest due to them and to repay the principal
amount when it becomes due. Solvency ratios disclose the
firm’s ability to meet the interest costs regularly and long-term
indebtedness at maturity.

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Solvency Ratios

• The persons who have advanced money to the business on

long-term basis are interested in safety of their periodic
payment of interest as well as the repayment of principal
amount at the end of the loan period. Solvency ratios are
calculated to determine the ability of the business to service its
debt in the long run. The following ratios are normally
computed for evaluating solvency of the business.
• 1. Debt-Equity Ratio
• 2. Interest Coverage Ratio

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Debt- Equity Ratio

• A higher ratio means that outside creditors has a larger claim

than the owners of the business. The company with high debt
position will have to accept stricter conditions from the lenders
while borrowing money. If this ratio is lower, it is not
profitable from the viewpoint of equity shareholders, as benefit
of trading on equity is not availed of and the rate of equity
dividend will be comparatively lower.

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Debt- Equity Ratio

• External Equities = All Long term liabilities+ Current

Liabilities
• Internal Liabilities= Equity share+ Preference share + Reserves
& Surplus + P & L A/c- Intangible or Fictitious Assets

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Illustration: From the following B.S.,
Calculate debt equity ratio:

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Debt equity ratio

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TAXATION

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Tax Structure in India

• Tax Structure

Indirect Tax =
Direct Tax GST (Except
customs)

Income Tax
Intra- state Inter State

IGST
CGST SGST (State) (Central)
(Central) 44
MODEL of GST

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 GST

• The goods and services tax (GST) is a value-added tax levied on

most goods and services sold for domestic consumption.
The GST is paid by consumers, but it is remitted to the
government by the businesses selling the goods and services. In
effect, GST provides revenue for the government.
• In simple words, Goods and Service Tax (GST) is an indirect
tax levied on the supply of goods and services. This law has
replaced many indirect tax laws that previously existed in
India. ... Under the GST regime, the tax is levied at every point
of sale.
• The responsibility to pay GST is on the seller.
However, GST being an indirect tax, the burden of tax can be
shifted and the seller thus collects it from the buyer/customer 46
and remits it to the Government.
History

• Though GST was formally introduced by Arun Jaitley in 2017, the

concept of GST for India was conceived back in 1999 under the
leadership of Atal Bihari Vajpayee was heading the NDA government
and also had the blessings of the Congress Government during their
regime.
• The first state to ratify the constitution amendment bill which cleared
the way to bring GST Act in India is Assam on 12 August, 2016,
followed by Bihar on 16 August, 2017. While, the first state to
pass State GST Bill is Telangana on April 17, 2017 followed by
Bihar.
• On 12 August 2016, Assam became the first state to ratify the bill,
when the Assam Legislative Assembly unanimously approved
it. State Legislatures that ratified the amendment are listed below:
Assam (12 August 2016) 47
GST Implementation in India

• India’s biggest tax reform is now a reality. A comprehensive

dual Goods and Services Tax (GST) has replaced the complex
multiple indirect tax structure from 1 July 2017.
• The concept of GST was visualized for the first time in 1999.
On 8 August 2016, the Constitutional Amendment Bill for roll
out of GST was passed by the Parliament, followed by
ratification of the bill by more than 15 states and enactment of
the bill in early September.

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Benefits of GST

• GST is a consumption based tax/levy. It is based on the

“Destination principle.” GST is applied on goods and services at
the place where final/actual consumption happens. GST is
collected on value-added goods and services at each stage of sale
or purchase in the supply chain.
• Reduction in multiplicity of Indirect taxes
• GST proposed to be a simpler and rational tax structure with
improved administration (common administration) with updated and
enhanced IT/technological framework
• Common base for levy of GST (as against cascading)
• Reduced cascading effect due to cross tax credit mechanism
under GST
• Previously retention of VAT input tax credit for inter state stock 49
transfers / non availability of Cenvat Credit to Traders
Goods and Services Tax is levied on each
of these stages which makes it a multi-
stage tax.

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There are 3 taxes applicable under this system: CGST, SGST & IGST.
CGST: Collected by the Central Government on an intra-state sale (Eg: transaction happening within Maharashtra)
SGST: Collected by the State Government on an intra-state sale (Eg: transaction happening within Maharashtra)
IGST: Collected by the Central Government for inter-state sale (Eg: Maharashtra to Tamil Nadu)
In most cases, the tax structure under the new regime will be as follows:

Transaction New Regime Old Regime

Sale within the State CGST + SGST VAT + Central Revenue will be
Excise/Service tax shared equally
between the Centre
and the State

Sale to another State IGST Central Sales Tax + There will only be
Excise/Service Tax one type of tax
(central) in case of
inter-state sales. The
Centre will then
share the IGST
revenue based on the
destination of goods.

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Illustration: 

• Let us assume that a dealer in Gujarat had sold the goods to a

dealer in Punjab worth Rs. 50,000. The tax rate is 18%
comprising of only IGST.
• In such case, the dealer has to charge Rs. 9,000 as IGST. This
revenue will go to the Central Government.
• The same dealer sells goods to a consumer in Gujarat worth
Rs. 50,000. The GST rate on the good is 12%. This rate
comprises of  CGST at 6% and SGST at 6%.
• The dealer has to collect Rs. 6,000 as Goods and Service Tax.
Rs. 3,000 will go to the Central Government and Rs. 3,000 will
go to the Gujarat government as the sale is within the state. 52
Income Tax Slab for FY 2019-20 (AY 2020-21)

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Income Tax Slab for FY 2018-19 (AY-
2019-20)

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Corporate Tax

• India’s statutory rate for corporate tax is 22 per cent now, down
from 30 per cent.
• For the current year, KPMG data shows that the statutory tax
rate in Myanmar is 25 per cent, in Malaysia, it is 24 per cent,
in Indonesia and Korea 25 per cent and Sri Lanka 28 per cent.
Even Chinese companies cough up more – they pay a tax of 25
per cent and Brazil 34 per cent.
• The global average corporate tax rate is 23.79 now, and the
Asian average is 21.09 per cent.

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