MODULE III AFM

FINANCIAL STATEMENT
ANYLYSIS
Prepared by: Prof. Indrayani Abhay Uthale.
Module III: Financial Statement Analysis

1. Relation and Comparison of Accounting data and

using financial statement information,
2. Ratio Analysis, Cash flow analysis
3. Determination of Existing and future capital
requirement
 Financial Statement Analysis: An
Introduction
Financial Statement Analysis is a method of reviewing
and analyzing a company’s accounting reports (financial
statements) in order to gauge its past, present or projected
future performance. This process of reviewing the financial
statements allows for better economic decision making.
What Are Financial Statements?
Financial statements are written records that convey the business
activities and
the financial performance of a company.
Financial statements are often audited by government agencies,
accountants, firms, etc.
to ensure accuracy and for tax, financing, or investing purposes. Financial
statements include:
- Balance sheet
- Profit and loss A/C
1. To know the Current Position
Promoters/owners want to know whether the company is heading in the right direction or
lagging in their targets, which they have planned in the past. Regular recording of financial
transactions helps them understand their financial position and helps them analyze prospects
better.
2. Eliminating Discrepancies if any
Recording of day-to-day transactions, i.e., sales and purchases, expenses or incomes, or
other statements, helps them understand where they need to improve and make quick
decisions in case of any discrepancies.
3. Future Decision Making
Quarterly statements like sales book, purchase, trading a/c or manufacturing a/c help them
execute their plans better. This provides them the opportunity to make future decisions with
reliable information. There is a new practice of preparing provisional final accounts even by
small companies. Analyzing financial statements on a short term basis helps the
organization to make efficient decisions.

4. Minimize the Chances of Fraud

This is not the main objective of analyzing transactions but the one which cannot be
neglected. Often we come across the news that the employee cheated his boss, which led to
huge losses for the company. Analyzing the statements will make sure that the employee will
be aware that the management is aware of everything happening in the company.
Importance of Financial Statement
Analysis
(i) Judging the operational efficiency of the business.
(ii) Measuring the profitability.
(iii) Measuring short-term and long-term financial
position.
(iv) Indicating the trend of achievements.
(v) Assessing the growth potential of the business.
(vi) Inter-firm comparison
Limitations of Financial Statement
Analysis
(i) Financial statement analysis ignore qualitative aspects
like quality of management, labour force and public
relations.
(ii) Financial statements are historical in nature.
(iii) Financial statements do not show price level changes
hence, affect the analysis also.
(iv) The results obtained by analysis of financial
statements may be misleading due to window dressing.
(v) Financial statements are affected by the personal
ability and bias of the analyst.
The utility of financial statements to different
parties is discussed in detail as follows:
(1) Management:
The financial statements are useful for assessing the efficiency for different cost centers. The
management is able to exercise cost control through these statements. The efficient and inefficient
spots are brought to the notice of the management. The management is able to decide the course of
action to be adopted in future.

(2) Creditors:
The trade creditors are to be paid in a short period. This liability is met out of current assets. The
creditors will be interested in current solvency of the concern. The calculation of current ratio and
liquid ratio will enable the creditors to assess the current financial position of the concern in
relation to their debts.

(3) Bankers:
The banker is interested to see that the loan amount is secure and the customer is also able to pay
the interest regularly. The banker will analyze the balance sheet to determine financial strength of
the concern and profit and loss account will also be studied to find out the earning position.
A banker has a large number of customers and it is not possible to supervise their business
activities. It is through the financial statements that a banker can keep a watch on the business
plans and performances of its customers. These statements also help the banker to determine the
amount of securities it will ask from the customers as a cover for the loans.
(4) Investors:
The investors include both short-term and long-term investors. They are interested in the
security of the principal amount of loan and regular interest payments by the concern. The
investors will study the long-term solvency of the concern with the help of financial
statements. The investors will not only analyze the present financial position but will also
study future prospects and expansion plans of the concern. The possibility of paying back
the loan amount in the face of liquidation of the concern is also taken into consideration.

(5) Government:
The financial statements are used to assess tax liability of business enterprises. The
government studies economic situation of the country from these statements. These
statements enable the government to find out whether business is following various rules
and regulations or not. These statements also become a base for framing and amending
various laws for the regulation of business.

(6) Trade Associations:

These associations provide service and protection to the members. They may analyze the
financial statements for the purpose of providing facilities to these members. They may
develop standard ratios and design uniform system of accounts.

(7) Stock Exchange:

The stock exchanges deal in purchase and sale of securities of different companies. The
financial statements enable the stock brokers to judge the financial position of different
2. Ratio analysis
Meaning of ratio analysis:
Ratio analysis is the method or process by which the relationship of
items or groups of items in the financial statements are computed ,
determined and presented.

What is a ratio?
A ratio is one figure expressed in terms of another figure. It is a
mathematic yardstick that measures the relationship between two
figures, which are related to each other and mutually interdependent.
Ratio is expressed by dividing one figure by the other related figure.
Problem 5:You have the following information on the performance of Prosper Co., as also the
industry averages :

a) Determine the indicated ratios for Prosper Co. Balance

Sheet as on 31st December, 2018
Liabilities Rs. Assets Rs.
Equity share capital 24,00,000 Net fixed assets 12,10,000
10% debentures 4,60,000 Cash 4,40,000
Sundry creditors 3,30,000 Sundry debtors 5,50,000
Bills payable 4,40,000 Stocks 16,50,000
Other current liabilities 2,20,000

38,50,000 38,50,000
Statement of profit for the year ending 31st December, 2013.

Particulars Rs. Rs.

Sales 55,00,000
Less: cost of goods sold:
Materials 20,90,000
Wages 13,20,000
Factory overheads 6,49,000 40,59,000
Gross profit 14,41,000
Less: selling and distribution cost 5,50,000
Administrative and general expenses 6,14,000 11,64,000
Earning before interest and tax 2,77,000
Less: interest charges 46,000
Earning before tax 2,31,000
Less: tax (50%) 1,15,500
Net profit 1,15,500
 Ratios to be computed:
1) Current ratio
2) Liquid ratio/ Quick ratio
3) Net profit ratio
4) Operating ratio
5) Proprietary ratio
6) Stock turnover ratio
7) Debt collection period
8) Capital gearing ratio
9) Return on capital employed.
 :

=
1. Current ratio:

=
=2.66:1
The standard ratio is 2:1 and we got
2. Liquid ratio=

=
=
=1:1
Standard ratio is 1:1 and we got 1:1 so it is favourable.
 3. Net profit ratio =x 100

=x100

= 2.1%

4. Operating expenses=X100

=40,59,000+11,64,000 x100
55,00,000
=94.96%
5.Properitory ratio = x100

=x100
=62.34%

6. Stock turnover ratio=

=
=2.46 times
7. Debt collection period :
=x365
=x365
= 37 days

8. capital gearing ratio =

=
=
=0.19.
9. Return on capital employed x100

=x100
=9.69%

capital employed = equity share capital + debenture

= 24,00,000+4,60,000
= 28,60,000
Problem 6:
From the following information calculate following
ratios:
1. Stock working capital
2. Debt equity ratio
3. Administrative expenses ratio.
4. Selling expense ratio.
5. Gross profit ratio
6. Net operating profit ratio
7. Dividend payout ratio
8. Creditors turnover ratio
9. Debtors turnover ratio
 Stock – 50,000
 Working capital -70,000
 Debt – 2,00,000
 Equity – 5,00,000
 Sales- 5,00,000
 Administrative expenses- 10,000
 Selling expenses – 30,000
 Gross profit- 2,50,000
 Dividend per equity share-0.4
 Net profit 1,00,000
 Provision for tax-50,000
 Preferential dividend- 20,000
 No. of equity shares- 30,000
 Purchases-1,00,000
 Purchase returns – 20,000
 Debtors 4,00,000
 Creditors 20,000
 1. Stock working capital Ratio :=
=
=0.7 :1
Standard ratio is 1:1 so the SWCR is 0.7 is unsatisfactory

2. Debt equity ratio =

=
=
=2,00,000/7,00,000
= 0.28
3. Administrative expenses Ratio:

=x100

=x100
=2%

4. Selling expenses Ratio: =x100

=x100

= 6%
5. Gross profit Ratio:=
= x100
=50%
6. Net operating profit ratio =x100

= x100
=42%
Net operating profit = gross profit – (administrative expenses + selling expenses)
= 2,50,000- (10000+30000)
=2,50,000 - 40,000
=2,10,000
7. Dividend payout Ratio:=
=
= 0.4

Earning per equity shares =

=50,000-20,000/30,000
=1

Net profit after tax =1,00,000-50,000=50,000

8. Creditors turnover Ratio:=

=
=80,000/20,000
= 4 times
9.Debtors turnover Ratio=

=5,00,000/4,00,000
= 1.25 times .
CASH FLOW STATEMENT.
Definition of Cash
As per AS 3, this would include cash in hand and savings, current
account balances with banks (also referred to as demand deposits)
with banks and cash equivalents.
Cash Equivalents
Cash Equivalents are defined as, short term and highly liquid
investments that are readily convertible into cash and which are
subject to insignificant risk of changes in values
Cash flows are inflow or outflow of cash and cash equivalents. Major cash flows are listed below :
Cash Inflows
1. Issue of new shares for cash.
2. Receipt of long term loans from banks, financial institutions etc.
3. Receipt of Short-term loans from banks, financial institutions and other entities.
4. Sale of assets and investments.
5. Dividend and interest received.
6. Cash generated from operations.

Cash Outflows
1. Redemption of preference shares.
2. Purchase of fixed assets or investments.
3. Repayment of long term and short term
borrowings.
4. Decrease in deferred payment liabilities.
5. Loss from operations.
6. Payment of tax, dividend etc.
Problem 1:
Solution: cash flow from operating
activities
Particulars Rs.
A. Operating receipts in cash (INFLOW)
Cash sales 6,00,000
Collection from debtors 12,00,000
Trading commission received 3,00,000
21,00,000
B. Operating payments in cash (OUTFLOW)
Cash purchases 1,50,000
Payment to suppliers 3,00,000
Wages and salaries 1,20,000
Rent paid 30,000
Production overheads paid 90,000
Office expenses paid 60,000
Selling expenses paid 30,000
7,80,000
Cash from operating activity before tax (A-B) 13,20,000
………………..

Less: income tax paid net of refunds (3,54,000-9000) 3,45,000

Cash flow before extra- ordinary item 9,75,000
Add: extraordinary item ( insurance claims received from earthquake disasters 3,00,000
Net cash flow from operating activities 12,75,000
 Problem 2:

Solution: cash flow from investing activities

Particulars Rs.
Sale of goodwill 50,000
sale of premises 20,000
Sale of machinery 40,000
Sale of investment 40,000
1,50,000
Less: Purchase of patents 50,000
Cash flow from investing activity 1,00,000
 Problem 3

Solution: cash flow from financial activities

Particulars Rs. Rs.
Issue of equity capital (4,00,000+security prm 60000- underwing 4,40,000
commission 20,000)
Issue of debentures (2,00,000 – discount on issue of debt. 2,000) 1,98,000 6,38,000

Less : redemption of preference share capital (800000-400000) 4,00,000

14% debentures (4,00,000*14%) 56,000 4,56,000
cash flow from financial activities 1,82,000
3. Determination of Existing and future capital requirement

Capital requirements are regulatory standards for banks

that determine how much liquid capital (easily sold assets)
they must keep on hand, concerning their overall holdings.
Express as a ratio the capital requirements are based on
the weighted risk of the banks' different assets.

•Capital requirements are regulatory standards for banks that

determine how much liquid capital (easily sold assets) they must
keep on hand, concerning their overall holdings.
•Express as a ratio the capital requirements are based on the
weighted risk of the banks' different assets.