CHAPTER-1

INDUSTRY PROFILE

“A STUDY ON COMPARATIVE ANALYSIS OF FINANCIAL STATEMENTS OF

BMTC,BENGALURU

INTRODUCTION
in present situation,finance is referred as the provision of money at a time when it is
required. every interprise or industry or company whether it is a big.small or medium needs
finance to carry on its operation and achieve its targets.in fact, finance is so indispensable
that it is rightly said that it is the “life blood of on enterprise”. without adequate finance,an
enterprise cannot think of its existence. the profit making organisation engaged in the fields
of industry,trade and commerce is undertaken under the discipline of “business finance”.

MEANING OF FINANCE
finance is referred to as the provision of money at a time when it is required. finance refers
to the management of flow of money through an organation.financial management
involves managerial activities concerned with the acquisition of fund for business
purpose.the finance function deals with procurement of money taking into consideration
today`well as future needs of a business finance is required to purchase a machinery,row
materials to pay salaries and wages and also to meet day to day expenses of the business.

DEFINITIONS OF FINANCE
SIMON ANDRADE,DEFINES THE TERM FINANCES OF THE FOLLOWING WAYS:

1. “area of economic activity in which money is the basis of the varios

embodoments,whether stock market investment,real estate
indusrial,construction,agricultural development,so on.”,and
2. “area of the economy in which we study the performance of capital markets and
supply and price of financial assets”

MEANING OF BUSINESS FINANCE

business finance means the funds and creadit emplayed in the business.finance is the
foundation of a business.finance requirements are to purchase assets,goods,raw materials
and for the other flow of economic activities.let us understand in depth the meaning of
business finance.
DEFINITIONS OF BUSINESS FINANCE
according to b.o. wheeler meaning of business of business finance includes those business
activities that are concerned with the acquisition and conservation of capital funds in
meeting the financial needs and overall objectives of a business enterprise.”

function of business finance

1.financing or capital mix decision.

2.funds requirement decision.

3.investment or long term asset-mix decision.

4.dividend or profit allocation decision.

5.liquidity or short –term asset-mix decision.

FINANCIAL MANAGEMENT
Financial management focuses on ratios, equities and debts. it is useful for portfolio
management, distribution of dividend, capital raising, hedging and looking after fluctuations
in foreign currency and product cycles. financial managers are the people who will do
research and based on the research, decide what sort of capital to obtain in order to fund
the company's assets as well as maximizing the value of the firm for all the stakeholders. it
also refers to the efficient and effective management of money (funds) in such a manner as
to accomplish the objectives of the organization. it is the specialized function directly
associated with the top management. the significance of this function is not seen in the
'line' but also in the capacity of the 'staff' in overall of a company. it has been defined
differently by different experts in the field.

DEFINITION:
“Financial management is the activity concerned with planning, raising, controlling and
administering of funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of

capital and a careful selection of the source of capital in order to enable a spending unit to
move in the direction of reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining
and effectively utilizing the funds necessary for efficient operations.”- Massie
IMPORTANCE OF FINANCIAL MANAGEMENT :

 finance is the lifeblood of business and every business unit needs money to make more
money, but more money only when it is managed properly.

 financial management helps a firm in optimizing the output from given input of funds.

 financial management helps a firm in monitoring the effects employment of funds in

fixed assets as well as in current assets.

 financial management helps in profit planning, capital budgetting, controlling

invebtories and account receivables.

SCOPE OF FINANCIAL MANAGEMENT :

 Estimating the financial requirments.

 Deciding capital structure.

 Selecting a source of finance.

 Selecting a pattern of investments.

 Proper cash management.

OBJECTIVES OF FINANVCIAL MANAGEMENT:

Objectives of financial management can be classified into two:

1. Profit maximization.
 2. Wealth maximization.

1. Profit maximization:

A business firm is a profit seeking organization. Naturally the profit maximization will
be one of the most important objectives of financial management. The earnings or the
profits of a firm can increase either by increasing the output or by minimizing the cost
of the production for a given output.

2. Wealth maximization:

Wealth maximization is an appropriate objectives of an enterprise. Financial theory

assets that wealth maximization is the single substitute for a stockholder’s wealth, the
individual stockholders can use this wealth to maximizing the stock holder’s wealth,
and the firm is operating consistency towards maximizing stockholders utility.

FINANCIAL STATEMENT ANALYSIS:

Meaning :
 Financial statement analysis is an evaluative method of determining the past, current
and projected performance of a company. Several techniques are commonly used as
part of financial statement analysis including horizontal analysis,which compares two or
more years of financial data in both doller and percentage form; vertical analysis,
where each category of accounts on the balance sheet is shown as a percentage of the
total account; and ratio analysis, which calculates statistical relationships between
data.

Financial statement are the outcome of summarizing process of accounting. They are
essentially interim reports presented annually and account period, more frequent a
year.

OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS:

 To assets the current profitability position and operating efficiency of the firm
and as well as of different depertments.

 To find out the relative Importance of different components of the financial

positions of the firm.

 To assets the short as well as long-term liquidity position of the firm.

LIMITATION OF THE FINANCIAL STATEMENT ANALYSIS.

1. Financial statement are essentially interim reports.

2. Accounting concepts and conventions.

3. influence of personal judgement.

4. Discloses only monetary facts.

5. Artificial views.

Financial Analysis can be classified into different categories depending upon

1. TYPES OF FINANCIAL ANAYSIS

 2. Materials used and
3. The method of operation followed in the analysis

On the basis of materials used. According to material used, financial analysis can be

classified as External analysis and internal analysis.

a. External Analysis: When the parties external to the business like creditors, investors,
etc. do analysis, the analysis is known as external analysis. This analysis is done by them
to know the credit-worthiness of the concern, its financial viability, its profitability, etc.

b. Internal analysis: The analysis conducted by the persons who have access to
the internal accounting records of a business firm. Such an analysis can,
therefore, be performed by executives and employees of the organization as well
as government agencies which have statutory power vested with them.

c. Financial analysis for managerial purpose is the internal type of analysis that can be
affected depending upon the purpose to be achieved.

On the basis of method of operation. Financial analysis can be classified as Horizontal

analysis and Vertical analysis.

a. Horizontal analysis: Horizontal analysis refers to the comparison of the financial data of
a company for several years. In this analysis the figures of various years are compared
with standard or base year. This type of analysis is otherwise called as dynamic analysis
as it extends over a number of years.
b. Vertical analysis: Vertical analysis refers to the study of relationship of the various items
in the financial statements of one accounting period. This type of analysis establishes a
quantitative relationship of the various items in the financial statements on a particular
date. For e.g. the ratio of various expenditure items in terms of sales for a particular year
can be calculated. The other name for this analysis is ‘static analysis’ as it relies upon
one year figures only.

TECHNIQUES OF FINANCIAL ANALYSIS:

The financial statements are analyzed by using various techniques. Following are the important
techniques of financial analysis which can be appropriately used by the financial analysts:

1. Comparative financial statements

2. Trend analysis.
3. Common-size financial statements.
4. Ratio analysis

Comparative Financial Statements:

The comparative statements are statements of the financial position at different periods of time.
The elements of financial position are shown in a comparative form so as to give an idea of financial
position at two or more periods. This type of financial statements is ideal for carrying out horizontal
analysis. Comparative financial statements are so designed to give them perspective to the review
and analysis of the various elements of profitability and financial position displayed in such
statements. Comparative financial statements can be prepared both for income statement and
balance sheet.

Trend analysis:

The financial statements may be analyzed by computing trends of series of information .This method
determines the direction upwards or downwards and involves the computation of the percentage
relationship that each item bears to same item in the base year. The information for a number of
years is taken up and one year generally the first year is taken as base year. The figures of base year
are taken as 100 and trend ratios for other years are calculated on the basis of base year

Common-size Financial Statements:

The common-size financial statements, balance sheet and income statement are shown in analytical
percentage. In this type of statements figures are shown as percentages of total assets, total
liabilities and total sales. The total assets are taken as 100 and different assets are expressed as
percentage of total. Similarly various liabilities are taken as a part of total liabilities. These
statements are also known as component percentage or 100 percent statements because every
individual item is stated as percentage of total 100.The short comings in the comparative statements
and the trend percentages where changes in items could not be compared with totals have been
covered up.

Ratio analysis:

It is the most widely used tool of financial analysis to judge the financial strength of a company. The
term ratio refers to the numerical or quantitative relationship between two items or variables. This
method of expressing items which are related to each other one, for the purpose of financial
analysis, referred to as financial analysis. A lot of entities like research houses, investment bankers,
financial institutions and investors make use of this analysis to judge the financial strength of any
company.

 A Ratio is an expression of the quantitative relationship between two numbers.

 A ratio is a simple arithmetical expression of the relationship of one number to another.

Classification of accounting ratios:

On the basis of origin or source of figure placed in relation with each other:

I. Balance sheet ratios or position statement ratios

II. Profit and loss account ratios or operating ratios.
III. Mixed, Combined, or Inter-statement ratios.

On the basis of nature and functions of the accounting ratios:

1. Liquidity Ratios
2. Long term solvency.
3. Turnover Ratios
4. Profitability Ratios

1. Liquidity ratios or Analysis of short term financial position:

It measures the short-term solvency or short-term financial position of a firm. These ratios are
calculated to comment upon the short-term paying capacity of a concern or the firm’s ability to
meet its current obligations.

A. CURRENT RATIO:

It is the ratio, which expresses the relationship between current assets and current liabilities.

Current Assets

Current Ratio =

Current Liabilities

Or Current assets: Current liabilities

Current Assets: Current assets include cash and other assets which can be easily converted into cash
within a short period of time generally, one year, such as marketable securities, debtors, inventories,
bills receivables, cash in hand ,cash at bank, prepaid expenses, outstanding or accrued incomes,
advances to staff and others, short term investments, work in progress.

Current Liabilities: All those obligations maturing within a year are included in current liabilities.
They include bills payable, creditors, bank overdraft, accrued expenses, short-term bank loans,
provision for income tax, dividends payable, incomes received in advance, and outstanding
expenses.

Interpretation: As conventional rules, current ratio of 2:1 or more considered satisfactory. If the
actual current ratio is less than 2:1, then the logical conclusion is that the concern does not enjoy
sufficient liquidity and there is shortage of working capital. An increase in the current ratio
represents improvement in the liquidity position of a firm while a decrease in the current ratio
indicates there has been deterioration in the liquidity position of a firm.

B. QUICK / LIQUIDITY / ACID TEST RATIO

Quick ratio is the ratio, which expresses the relationship between quick or liquid assets and quick or
liquid liabilities. An asset is said to be liquid if it can be converted into cash within a short period
without any loss of value.

Quick Assets
 Quick Ratio =

Quick Liabilities

Quick Assets: Includes all current assets excluding inventory and prepaid expenses.

Quick Liabilities: Includes all current liabilities excluding bank overdraft and cash credit.

Interpretation: The ideal quick ratio is 1:1, if the quick ratio is equal or more than the standard ratio,
it is satisfactory and concern is liquid and it can pay off its short – term liabilities out of its quickly
realizable assets.

C. ABSOLUTE LIQUID RATIO OR CASH RATIO

The absolute liquid ratio is calculated together with current ratio and acid test ratio so as to exclude
even receivables from the current assets and find out the absolute liquid assets.

Although receivables, debtors and bills receivables are generally more liquid than inventories, yet
there may be doubts regarding their realization into cash immediately or in time. Hence cash ratio is
calculated.

Absolute liquid assets

Absolute Liquid assets =

Current liabilities

Absolute liquid assets: Includes cash in hand , cash at bank and short term marketable securities.

Interpretation: The acceptable norm for this ratio is 50% or 0.5:1 or 1:2 i.e. is Re. 1 worth absolute
liquid assets are considered adequate to pay Re. 2 worth current liability in time as all the creditors
are not expected to demand cash at the same time and then cash may also realized from debtors

and inventories. 2. Long term solvency ratios or Analysis of long term financial
position

The term solvency refers to the ability of a concern to meet its long term obligations. The
long term indebtness of a firm includes debenture holders, financial institutions providing
medium and long term loans and other creditors selling goods on installment basis.
 A. DEBT- EQUITY RATIO / EXTERNAL – INTERNAL RATIO

Debt- Equity ratio is calculated to measure the relative claims of outsiders and the owners
(i.e. shareholders) against the firm’s assets. The ratio indicates the relationship between the
external equities or the outsider’s funds and the internal equities or the shareholders funds.

Total long term Debt

Debt Equity Ratios =

Shareholders Equity

Total Long Term Debt: Includes long-term loan raised.

Share Holders Equity: Includes capital, all accumulated reserves, and profits.

Interpretation: The ideal debt equity ratio is 2:1 as such, if the debt is less than two times
of equity, the logical conclusion is that the financial structure of the firm is sound and the
stake of long-term creditors is relatively less. The interpretation of this ratio depends on the
financial policy of the firm and upon the firm’s nature of business.

B. PROPRIETARY RATIO OR EQUITY RATIO

This ratio establishes the relationship between shareholders funds to total assets of the
firm.

Net worth / Shareholders funds

Proprietary Ratio =

Total assets

Net worth: Equity share capital, preference share capital, undistributed profits,

Reserves and surpluses out of this amount accumulated losses should be deducted.

Total assets: Sum total of all realizable assets.

Interpretation: As equity ratio represents the relationship of owner’s funds to total assets,
higher the ratio or the share of the shareholders in the total capital of the company, better
is the long term solvency position of the company. Ideal ratio is 0.50:1 higher the
proprietary ratio, the stronger is the financial position of the concern and Vice Versa.

C. SOLVENCY RATIO:

This ratio expresses the relationship between the total assets and total liabilities.

Total assets

Solvency Ratios =

Total liabilities

Total Assets: Fixed Assets + Current assets + Investment

Total liabilities: Long-term liabilities + Current Liabilities

Interpretation: Higher the solvency ratio of the concern the stronger is the financial
position.

D. FIXED ASSETS TO NET WORTH

This ratio expresses the relationship between fixed assets and net worth.

Net fixed assets

Fixed assets to Net worth ratios =

Net worth

Net Fixed Assets: Fixed assets – Depreciation

Net worth: Owners funds

Interpretation: Ideal ratio is 2/3 or 67% that the fixed assets should not constitute more
than 2/3 or 67% of the proprietors funds, it indicates that the proprietors funds are mostly
sunk in the fixed assets and the current assets are mostly financial out of loaned funds. This
indicates financial weakness of the concern and greater risks for the creditors.

E. CURRENT ASSETS TO NET WORTH

A current asset to net worth ratio is the ratio between current assets and net worth.

Current assets

Current assets to net worth ratio =

Net worth

This ratio indicates the proportion of current assets financed by the owners.

Interpretation: there is no standard or ideal current asset to net worth ratio.

If this ratio is high the financial strength of the concern is good, and if this ratio is low, the
financial position of the concern is weak.

F. FIXED ASSETS RATIOS:

Fixed assets ratio is the ratio between fixed assets and capital employed

Fixed assets

Fixed assets ratio =

Capital Employed

Capital Employed: Sum of owners fund, long-term loan, and debentures

Or

Sum of fixed assets, trade investment, And Net Working Capital

Interpretation: The ratio indicates the extent to which the total assets are financed by long
term funds of the firm. This ratio should not be more than one. The ideal ratio is 0.67; this
would mean that not only all the fixed assets but also a part of working capital is financial by
long-term funds. This is desirable because a part of the working capital, popularly known as
“core working capital”, should be met out of long-term funds.

G. CURRENT LIABILITIES TO NET WORTH:

A current liability to net worth ratio is the ratio between current liabilities and net worth.

Current liabilities

Current liabilities to net worth ratio =

Net worth

Interpretation: the desirable level set for this ratio is 1/3 or 33.333 so, if the actual ratio is
very high it would mean that the liability base of the concern will not provide an adequate
cover for long term creditors. That means it would be difficult for the concern to obtain
long-term funds.

3. TURNOVER RATIOS;

A. FIXED ASSETS TURNOVER RATIO:

Fixed assets turnover ratio is the ratio between fixed assets and turnover or sales.

Net sales

Fixed assets turnover ratio =

Fixed assets

Fixed assets mean Net fixed assets i.e., fixed assets less depreciation.
Interpretation: The standard or ideal fixed assets turnover ratio is 5 times. Therefore, a
fixed assets turnover ratio of 5 times or more indicate better utilization of fixed assets. On
the other hand, fixed assets turnover ratio of less than 5 times is an indication of under
utilization of fixed assets.

In this context, it may be noted that a very high fixed assets turnover ratio means over
trading, which is not good for the business.

B. WORKING CAPITAL TURNOVER RATIO:

This is the ratio between sales and working capital

Net sales

Working capital turnover ratio =

Working capital

Working capital = current assets – current liabilities

Interpretation: Higher the working capital turns over indicates the efficiency and low ratio
indicates the inefficiency of the management in the utilization of working capital

4. PROFITABLITY RATIOS:

Profitability ratios reveal the total effect of the business transaction on the profit position of
the enterprise and indicate how far the enterprise has been successful in its aim.

A. GROSS PROFIT RATIO:

Gross profit ratio is the ratio, which expresses the relationship between gross profit to sales
and is usually represented as a percentage.

Gross profit
 Gross profit Ratio = X 100

Sales

Gross profit = Sales - cost of goods sold

Interpretation: The rate of the gross profit must be sufficient to cover all operating
expenses and non – operating expenses and also leave sufficient amount of profit for the
owners.

B. NET PROFIT RATIO:

Net profit ratio is the ratio, which expresses the relationship between net profit and sales.

Net profit

Net profit Ratio = X 100

Sales

Net profit: means profit left after meeting all expenses. In other words, it is the excess of
total revenue over total expenses. In short it means the final profit available for the owners.
It indicates the efficiency of the management in manufacturing, selling, administrative and
other activities of the firm.

Interpretation: A high net profit ratio indicates that the profitability of the concern is good.

C. OPERATING RATIO
Operating Ratio establishes the relationship between operating costs on the one
hand and the sales in the other.

Operating Cost

Operating Ratio =

Net sales
Interpretation: Operating Ratio indicates the percentage of net sales consumed by
Operating cost. Higher the Operating cost, the less favorable it is. lower the
operating cost it is favorable for the company.

D. NET PROFIT TO NET WORTH RATIO

Net profit to net worth ratio is the relationship between net profits and the net worth or
proprietors fund.

Net profit

Net profit to net worth ratio =

Net worth