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to
Myers,
Financial
statement
analysis
is
largely
study
of
32
government agencies who do not have access toInternal accounting records of the
company.
2. Internal Analysis: Analysis is done on the basis of internal and unpublished
records.It is done by persons like executives and other authorized officials, who have
access to internal accountingRecords of the firm is called internal analysis.
On the basis of Modus Operandi:
1. Horizontal Analysis: Here, every item in the financial statement is analyzed over a
numberof years, order to ascertain its trend. Comparative statements and Trend
percentages arethe two tools used in this type of analysis.
2. Vertical Analysis: It refers to the study of relationship between various items in a
specificyears financial statement. Common size financial statements and financial
ratios are the twotools used in this analytical mode.
Limitations of Financial Statement Analysis
1) Financial statements do not take into account qualitative factors like credit
Worthiness, quality of human resources, reputation, etc.
2) They ignore changes in price level.
3) The assumption that past happenings may get reflected in the future may not hold
good.
4) Interpretation is based on personal judgment of the analyst, which may be biased.
5) Window dressing, which is the major drawback of financial statements will have an
impact onthe analysis.
Tools and Techniques for Analysis of Financial Statements
The following are the most important tools are used for analysis,
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RATIO ANALYSIS
Meaning of Ratio Analysis
According to accounting parlance Ratio may be defined as a numerical relationship
between two relatedaccounting figures and is calculated by dividing one by another.
Ratio analysis is a technique used for analysis and interpretation of financial statements
It helps us to analyze and understand the financial affairs and the strength and
weakness ofa firm. Extent and quality of analysis and interpretation depends on the use
of apt type of ratio and on the talent of the caliber analyst.
Importance or Uses of Ratio Analysis
Supplies required information to the interest parties like owners, crs, govt etc..
It brings to light financial strength and weakness of a firm.
suchlimitations.
Ratios ignore Changes in price level, which render the interpretation of ratios
invalid.
It is difficult to find out a proper basis for comparison.
Ratios just provide quantitative input, and its analysis and interpretation is subject
to the personal bias and competence of the analyst.
Ratios reflect the postmortem analysis of the past affairs of the firm.and the past
ratios are calculated from such statements. Hence users of such ratios while
35
Should be noted that the basic rates are same, but the way they are classified varies
withthe objective of the analysis. Generally, an organization will be analyzed for the
following:
1) Profitability: -analysis of the profit can made from point of view of amount of
sales,capital employed in the business, and the value of assets applied in business. Is
the company is earning a normal profit etc..
2) Liquidity: -test the whether the business is having enough liquid cash to meet its
payment obligation.
3) Solvency: -this measures the companies ability to meet its long term payment
obligations. Will the company have sufficient capacity to service its long-term
borrowings
4) Asset usage: -optimum utilization of assets both fixed and current, can also be found
out.
5) Capital Gearing: -this studies the proportion between the owned funds and
borrowed funds.
6) Status in the stock market :- the companys position in the stock market. The rating
of share and other securities of the firm can also be made known.
lows.
The following are the ways in which Ratios can be classified:
(A) Profitability ratios: under this category we have variety of ratios analyzing the
profit earned by a business unit after taking in to consideration items like sales,
cost of sales operating and non operating expenses etc. the following are the
various types of profitability ratios:-
36
37
X 100
6. Operating profit ratio : this shows the operational efficiency of the firm and
the management efficiency in carrying out the day to day operations of the
firm. Operating ratio
7. Expenses ratio: this shows the relationship between various expenses done
in connection to business and the amount of sales: This is calculated using
the below given formula:
Particular expenses X 100
Net sales
8. E.P.S or Earnings per share : it reflects the capacity of the concern to pay
dividend to equity share holders. it is helpful in determining the market price
of the equity share. This is calculated using the below given formula:
Net profit after tax and preference dividend X 100
Number of equity shares
9. Interest cover or fixed charge cover:this ratio brings to light the relationship
between profit before interest, tax and fixed interest charges. . This is
calculated using the below given formula:
Profit before interest and tax
X 100
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rotation of stock. It refers to speed with which the raw material is converted in to finished
products and finished products in to cash or sales. This is calculated using the below
given formula:
Days or Months in a year
Stock turnover ratio
3. debtorturn over ratio : this measures the number of times the receivables are
rotated in a year in terms of sales. it also indicates the efficiency of credit collection and
credit policy of the firm. This is calculated using the below given formula:
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5. creditor turnover ratio : this indicates the number of times the payables rotate in a
year, it states the relationship between net purchases for the entire year and total
payables.This is calculated using the below given formula:
Net credit purchases
Average accounts payable
6.creditor velocity or average payment period: this ratio shows how promptly the firm
settles the dues to the creditor. The lower number of days indicates the prompt payment
schedule maintained by the firm.This is calculated using the below given formula:
Days or months in a year
Creditor turnover ratio
7.working capital turnover ratio:this measures the effective utilization of working
capital. this ratio establishes relationship between sales or cost of sales and working
capital. Working capital = current assets current liabilities. .This is calculated using the
below given formula:
Sales or cost of sales
Net working capital
8.Fixed asset turnover ratio: this determines the efficiency of utilization of fixed
assets and profitability of a business concern.the higher the ratio the more efficient the
Firm is. This is calculated using the below given formula:
.
Cost of sales
Net fixed assets
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1. Fixed asset ratio:this ratio measures the relationship between fixed assets and
long term funds. The objective is to ascertain the proportion of long term funds
invested in fixed assets.
Fixed asset ratio =
fixed assets
Long term funds
2. Debt equity ratio: :this ratio measures the long term solvency of the firm.
External equity
Internal equity
Another formula for this ratio is given by
3. Proprietary ratio: this ratio compares the owners funds to total tangible
assets.
Share holders funds
Total tangible assets
4. Capital gearing ratio: it analyses the capital structure of the company. thisratio
measures the relationship between fixed interest and dividend bearing funds and
equity share holders funds.
Long term loans + debentures + preference share capital
Equity share holders funds
From the following Balance sheet and Profit and loss account as on 31.12.1997
youare required to calculate the below given ratios :
1.
2.
3.
4.
5.
6.
7.
8.
9.
Current ratio
Quick ratio
Fixed asset ratio
Debt equity ratio
Proprietary ratio
Stock turn over ratio
Fixed asset turn over ratio
Return on capital employed
Debtor turn over ratio
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Rs
40,00,000
Assets
Building
Rs
30,00,000
18,00,000
26,00,000
6,00,000
6,00,000
96,00,000
Plant
Stock
Drs
Bank
16,00,000
29,69,000
14,20,000
6,20,000
96,00,000
Rs.
19,90,000
1,09,05,000
2,85,000
68,00,000
1,99,80,000
30,00,000
6,00,000
Particulars
By sales
By closing stock
Rs.
1,70,00,000
29,80,000
1,99,80,000
68,00,000
1,80,000
expenses
To financial expenses
To non-operaring expenses
To net profit
3,00,000
80,000
30,00,000
69,80,000
1. Current ratio :current assets
Current liabilities
=
50,00,000
26,00,000
= 1.92
43
69,80,000
20,40,000
26,00,000
= 0.78
3. Fixed asset ratio =
fixed asset
Long term funds
46,00,000
70,00,0000
= 0.66
Fixed assets = building + plant = 30,00,000 + 16,00,000 = 46,00,000
Long term funds = share capital + reserves + Profit & loss a/c + debentures
= 40, 00,0,00 +18, 00,000 + 6,00,000 + 6,00,000
= 70, 00,000
4. Debt- equity ratio = long term debt
Share holders fund
= 6, 00,000
64, 00,000
= 0.094
Long term debt = debenture = 6, 00,000
Share holder fund = share capital + reserves + Profit & loss a/c
= 40, 00,0,00 +18, 00,000 + 6, 00,000
= 64, 00,000
5. Proprietary ratio = share holders fund
Total tangible assets
44
= 64,00,000
96,00,000
= 0.67
6. Stock turn over ration = cost of sales
Average stock
Cost of sales = sales gross profit = 1,70,00,000 68,00,000
= 1,02,00,000
Average stock = opening stock + closing stock
2
19,90,000 + 29,80,000
2
= 24,85,000
Stock turn over ratio =
1,02,00,000
24,85,000
== 4.10 times.
cost of sales
Fixed assets
Profit before interest and tax = net profit + non operating expenses +
45
= 32,00,000
Capital employed = share capital + reserves + Profit & loss a/c + debentures
= 40, 00,0,00 +18, 00,000 + 6,00,000 + 6,00,000
= 70, 00,000
Return on capital employed =32,00,000X 100
70, 00,000
= 45.71%
9. Debtor turn over ratio = credit sales
Average debtors
= 1,70,00,000
14,20,000
= 11.97 times
10. Debt collection period = days or months in a year
Debtor turn over ratio
,
= 12 months
11.97
= 1.00 month
= 4.19 times
UNIT 6
FUNDS FLOW ANALYSIS
Definition of Fund
Fund means working capital. If current assets of company is more than current liability
of business, it is called working capital and working capitals other name is Fund.
Fund = Working capital = Current assets Current liability
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Flow of fund means movement of fund. I take the example of air; we can feel its
movement or flow of air. Same thing is happen with fund, due to the activity of business
fund is transfer from one asset to another assets. If fixed assets are converted into
current asset or fixed liability is converted into current liabilities, these are the flow of
fund. But if current assets are changed with current assets or current assets are
changed into current liabilities, then, there is no flow of fund because there is no change
working capital. Suppose, we get the money from debtor, this is not flow of fund
because, working capital is not changed. Both items of current assets and when current
assets change into current assets, there will not be change in working capital.
Flow of Fund = Fixed asset changes into current asset or current asset changes into
fixed assets
Definition of fund flow statement
Fund flow statement is a statement which shows the inflow and out flow of funds
between two dates of balance sheet. So, it is known as the statement of changes in
financial position. We all know that balance sheet shows our financial position and
inflow and outflow of fund affects it. So, in company level business, it is very necessary
to prepare fund flow statement to know what the sources are and what are applications
of fund between two dates of balance sheet. Generally, it is prepare after getting two
year balance sheet.According to Prof. Anthony, The funds flow statement describes the
sources from which additional funds were derived and the use of which these funds
were put.
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Funds flow
To facilitate fund flow analysis, accounts shown in Balance Sheet can be classified as
shown below:
Accounts shown in Balance Sheet
1. Current Accounts
a. Current Assets: Eg: Cash, Debtors, Stock,
b. Current Liabilities: Eg: Creditors, Bills, Payable, etc.,
2. Non-CurrentAccounts :
a. Fixed Assets : Eg: Machinery, Land & Building
b. Fixed Liabilities: Eg: Equity Capital, Preference Capital
Flow of fund takes place only when a transaction involves one currentAccount and one
non-current account. For example, purchase of building which is non-currentAccount,
for cash which is a current account.Transaction between two current accounts for
example, cash paid to suppliers ortwo non-current accounts like issue of shares as
consideration for purchase of building,does not result in flow of funds.Transaction taking
place between Current Accounts and Non-Current Accounts onlywill generate
funds.Thus, flow of funds can be represented as follows:
Current Accounts -------- Non-Transaction leading to flow of funds-------- Current
Accounts
Steps involved in the Preparation of Fund Flow Statement
The followingsteps areinvolved in the preparation of Fund Flow Statement:
1) Preparation of Schedule of changes in Working Capital.
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Previous
Year
Current
Year
Increase Rs.
Xxxxxx
Xxxx
Current Assets:
Cash
Xxx
50
Decrease Rs.
Bank
Xxx
Xxxxxx
Bills Receivable
Xxx
Xxxxxx
Xxxx
Debtors
Xxx
Xxxxxx
xxxxx
Xxxxx
Xxxxxxx
Xxxxxx
Xxxxxx
Bank Overdraft
Xxxxxxx
Xxxxxxx
Xxxxx
Xxxxxxx
TotalCurrent liabilities.
xxxxxx
Xxxxxxxx
Net Working
xxxxx
Xxxxx
Current liabilities
Capital (CA-CL)
Net Increase or
decrease
Total
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xxxx
current year
2.Decrease in Current asset
--------
Decrease
Increase
----------
Increase
--------
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for examples: Refund oftax, profit on sale of asset, Dividend received, Loss on sale of
asset, etcThe balancing figure in the Adjusted Profit and Loss A/c is either, Funds
fromFunds from operation or Loss from operation.
Following is the format for Adjusted Profit and Loss A/c:
Dr
Particulars
Cr
Particulars
To Depreciation
Amount
Xxx
By Net Profit of last year
Amount
Xxxx
Xxxx
Xxxxx
To Transfer to reserves
Xxxx
Xxxxxxx
Xxxxx
Xxxxxx
Xxxxx
asset
Xxxx
non-current item)
To Loss on sale of asset
Xxxx
Xxxxxx
xxxxxx
By Dividend received
Xxxxxx
Xxxxxxx
xxxxxx
funds on another along with the data generated in the above three steps. Following is
the format of Fund Flow Statement:
Fund Flow Statement as on ..
Sources of Funds
Amount
Application of Funds
Rs.
Amount
Rs.
Xxx
Xxxxx
Issue of shares/debentures
Xxxxx
Xxxxxx
Xxxxx
Debenture
Xxxxxx
Xxxxx
Xxxxx
xxxxx
Payment of tax
Xxxxx
Payment of dividend
Xxxxx
xxxxx
Balance Sheet
particular date
It is the end-result of accounting operations
Companies Act makes preparation of
Flow Statement
It is a statement showing of changes in
andliabilities
Analysis of Balance Sheet reveals the
andLiabilities
Funds
Importance or uses of Fund Flow Statement
1) It brings to light how and from what sources funds were raised and utilized.
2) It shows the consequences of business operations, thus enabling management to
take remedial measures.
3) It depicts the reasons for changes in working capital.
4) It helps in working capital management.
5) Sources of funds reveal how the firm has funded its development projects in the
past, whether and to what extent from internal and external sources.
6) Analysis of Application of funds reveals how the resources were used in the
past. This can act as a guide while planning future funds deployment.
7) It gives a general idea about the overall financial management of the business.
8) Acts as a guideline for efficient use of scarce resources.
9) Helps banks and financial situations to assess the credit worthiness and repaying
capacity of the firm.
10) Aids management in formulating financial policies in areas like dividend declaration,
creating reserves, etc.
Limitations of Fund Flow Statement
1) It is not original in nature and is only a re-arrangement of data given in financial
55
statements.
2) When both aspects of a transaction involve current account, they are ignored in
this statement.
3) When both aspects of a transaction involve non-current account, they are not
considered in this statement.
4) It depicts the past position and not the future.
5) It is not a ideal tool for financial analysis.
6) Changes in cash position are more important that working capital.
Cash Flow Statement
Cash flow statements report a companys inflows and outflows of cash. This is important because
a company needs to have enough cash on hand to pay its expenses and purchase assets. While an
income statement can tell you whether a company made a profit, a cash flow statement can tell
you whether the company generated cash. The purpose of the Cash flow statements is to
highlight the major activities that directly and indirectly impact cash flows and hence affect the
overall cash balance. A Cash Flow Statement is one which is prepared from income statement
and balance sheet, showing sources and uses of cash. It reveals the inflow and outflow of cash
during a particular period, and explains reasons for changes in cash position between two
balance sheet dates.
Importance or uses of Cash Flow Statement
1. It indicates the reasons for low cash balance despite huge profits or huge cash balance inspite
of low profits.
2.By comparing the actual cash flow statement with that of the projected one, it helps
management in identifying the variation, and thus provide a basis for remedial measures.
3. It reveals the liquidity position of the firm, by indicating the source of cash and its uses.
4.Provides a basis for effective cash management by matching cash receipts and payments.
5. It is an essential tool for short term planning.
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6. It helps in taking loans from banks by indicating the repayment capacity of the firm through
cash flow statement.
7. A projected cash flow statement aids in planning for the investment of surplus or meeting the
deficit.
8. It explains the reasons for changes in cash position between two balance sheet
dates.
Distinction between Cash Flow and Fund Flow Statements
Cash Flow Statement
cash position.
payments.
working capital
cash balance.
Improved cash position
capital position.
cash position.
Rs.
58
Rs.
Rs.
Application of Cash
Issue of shares
Purchase of assets
Loan taken
Sale of assets
Dividend paid
59
Rs.
Rs.
Xxxx
Issue of shares
Xxxx
Loan taken
Xxxx
Sale of assets
Xxxxx
Xxxxx
Total sources of cash
Rs.
Xxxxxx (A)
Xxxx
Purchase of assets
Xxxx
Xxxx
Xxxx
Dividend paid
xxxx
Total application of cash
1.1.2000
31.12.2000
10,000
30,000
35,000
80,000
40,000
35,000
2,30,000
7,000
50,000
25,000
55,000
10,000
60,000
2,47,000
40,000
25,000
40,000
1,25,000
44,000
----50,000
1,53,000
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Xxxxx(B)
Xxxxx C=A-B
2,30,000
2,47,000
Duing the year machine costing Rs.10,000(accumulated depreciationRs.3000) was sold for
Rs.5,000. The balance of provision for depreciation against machinery as on 1.1.2000 was
Rs.25,000 and on 31.12.2000 Rs.40,000. Net perfit for the year 2000 amounted to Rs.45,000.
Prepare cash flow statement.
Solution:
Inflow of cash
Cash balance 1.1.2000
Sales of machine
Loan from party
Cash from operation
Rs
20,000
5,000
10,000
59,000
84,000
Rs
10,000
25,000
25,000
17,000
7,000
84,000
Workings:MACHINERY ACCOUNT
Particulars
To balance b/d
To balance c/d
Rs
1,05,000
10,000
1,05,000
Particulars
By machinery disposal
Rs
95,000
1,05,000
Rs
3,000
40,000
43,000
Particulars
1.1.2000 By Balance b/d
31.12.2000 By p&L a/c (bal.fig)
Rs
25,000
18,000
43,000
Rs
10,000
5,000
2,000
10,000
Particulars
Provision for depreciation
Rs
10,000
10,000
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RS.
45,000
18,000
2,000
65,000
10,000
4,000
79,000
20,000
59,000
Example
From the following balance sheet prepare a cash flow statement:
BALANCE SHEET
Liability
Equity share capital
General Reserve
P&La/c
Creditors
Outstanding expenses
Provision for Tax
Provision for bad debt
1985
20,000
2,800
3,200
1,600
240
3,200
80
31,120
1986
20,000
3,600
2,600
1,080
160
3,600
120
31,160
Asset
Goodwill
Land
Building
Investments
Stock
B/R
Bank
1985
2,400
8,000
7,400
2,000
6,000
4,000
1,320
31,120
Additional Information:
1. Piece of land is sold for Rs.800
2. Depreciate building by Rs.1,400
3. Provision for tax has been made for Rs.3,800 during the year.
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1986
2,400
7,200
7,200
2,200
4,680
4,440
3,040
31,160
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