Course: Financial Statement Analysis

Internal Assignment Applicable for June 2023 Examination

1) INTRODUCTION: -

Financial statements are summarised financial reports that provide information on the
operating results and financial position of companies. The information contained therein is useful
for assessing the operational efficiency and financial soundness of a company. Thus, these
statements require proper analysis and interpretation of such information for which a number of
techniques (tools) have been developed by financial experts. Financial statement analysis is the
process of assessing the financial statements of a company for decision-making purposes. To put
simply, the process of critically evaluating financial information contained in the financial
statements in order to understand and make decisions regarding the operations of a company is
called ‘Financial Statement Analysis’. There are some common tools for analyzing financial
statements.

CONCEPT: -

Comparative statements and common-size statements are two different types of

financial analyses that provide insights into a company's financial performance and position.
While both approaches offer valuable information, they differ in their focus and presentation.

Common-size statements involve expressing financial statement items as percentages of a

common base item. This technique allows for easy comparison of different items within a
financial statement and facilitates comparisons across different time periods or firms. Common-
size statements enable analysts to assess the operational and financial characteristics of companies
of varying sizes within the same industry. By converting complex financial data into a concise
format, common-size statements offer a vertical analysis that aids in intra-firm and inter-firm
comparisons. Common-size statements are designed to establish a correlation between various
financial statement items and a common base item by representing each element as a percentage
of that base. This standardized approach allows for seamless comparisons of corresponding
percentages across different years or between companies. By normalizing the data, common-size
statements enable analysts to evaluate the operational and financing characteristics of companies
operating in the same industry but of varying sizes. These statements serve as a valuable tool for
both intra-firm comparisons over multiple years and inter-firm comparisons within a given year.
Common-size statements effectively condense complex financial information into a succinct and
meaningful format, simplifying vertical analysis for better comprehension.

On the other hand, comparative statements present financial data from different time periods in a
comparative form to assess the profitability and financial position of a company. Typically,
balance sheets and profit and loss statements are prepared in a comparative format to provide
insights into the changes and trends occurring over time. Comparative statements help identify the
direction and trend of a company's financial position and operating results, making them valuable
for horizontal analysis. It is important that the same accounting principles are used when
preparing comparative statements to ensure accurate and meaningful comparisons. Any deviations
in accounting principles should be disclosed as footnotes to maintain transparency. Comparative
statements play a crucial role in gauging a company's profitability and financial standing over
different time periods. A key requirement for generating meaningful comparative figures is the
consistent application of accounting principles during the preparation of these statements. Any
deviations from standardized accounting principles are diligently disclosed as footnotes to ensure
transparency. Comparative statements provide valuable insights into the trends and trajectory of a
company's financial position and operating results. This horizontal analysis assists in tracking the
company's progress, identifying patterns, and making informed decisions. By considering the
changes and developments over time, comparative statements empower analysts to comprehend
the evolving dynamics of a company's financial performance and assist in strategic planning.

In summary, while common-size statements focus on expressing financial statement items as

percentages to facilitate comparisons within and across companies, comparative statements
emphasize the comparison of financial data over different time periods to assess trends and
changes. Both approaches provide valuable insights into a company's financial performance, but
they differ in their analytical focus and presentation format.

CONCLUSION: -

In conclusion, financial statement analysis is a crucial process for assessing a company's

operational efficiency and financial soundness. It involves the critical evaluation and
interpretation of information contained in financial statements to make informed decisions. Two
 common tools used in financial statement analysis are common-size statements and comparative
statements. Overall, both common-size statements and comparative statements offer valuable
insights into a company's financial performance, but they differ in their focus and presentation.
While common-size statements facilitate comparisons within and across companies, comparative
statements emphasize the analysis of trends and changes over different time periods. By utilizing
these tools effectively, analysts can gain a deeper understanding of a company's financial health
and make well-informed decisions for the future.

2) INTRODUCTION: -

Comparing line items in a company’s financial accounts is known as ratio analysis.

Ratio analysis is used to assess a variety of aspects of a company, including its profitability,
operational effectiveness, and liquidity. A ratio refers to a mathematical number that is calculated
as a reference to relationship of two or more numbers. It can be expressed as a fraction,
proportion or percentage. If the number is calculated by referring to two accounting numbers
derived from financial statements, it is called an accounting ratio. Ratio analysis is a quantitative
technique of gaining insight into a company’s liquidity, operational potency and profit from its
financial statements. Ratio analysis plays a pivotal role in comprehending financial statements,
enabling analysts to extract valuable insights. Through effective implementation, it facilitates the
identification of areas for business improvement and potential avenues of opportunity. Moreover,
ratio analysis offers profound understanding of profitability, liquidity, solvency, and operational
efficiency levels within the organization. Additionally, it allows for meaningful comparisons of
the company's performance against industry benchmarks, thereby enabling informed decision-
making. By leveraging this information, analysts can also make projections and estimates for the
future.

CONCEPT: -
1) LIQUIDITY RATIO: Liquidity ratios are calculated for measuring solvency of the business
in the short run, the firm’s ability to meet its current obligations. These are analysed by looking
at the amounts of current assets and current liabilities in the balance sheet.

~ The current ratio measures a company’s ability to pay short obligations or those due at
intervals one year. It tells investors and analysts whether a corporation will maximise these
assets on its record to satisfy its current debt and alternative liabilities.

~ The Quik ratio is also known as acid-test ratio. The acid-test ratio uses a firm’s record
information as indicator of whether or not it is spare short assets to hide its short liabilities.
It is a ratio expresses the relationship in between the quick assets and current liabilities.

2) SOLVENCY RATIOS: Solvency ratios are calculated to determine the ability of a business to
service its debt in the long run. Solvency ratios are usually employed by prospective lenders
once evaluating a company’s trustworthiness in addition as by potential bond investors.

~ The debt-to-equity (D/E) ratio is employed to gauge a company’s money leverage and is
calculated by dividing a company’s total liabilities by its stockholder equity. The D/E
magnitude relation is a crucial metric utilized in finance.

~ The proprietary ratio (equity ratio) is the proportion of shareholders’ equity to total assets,
and intrinsically provides a rough estimate of the amount of capitalization presently
accustomed.

~ The fixed assets ratio is employed by analysts to have insight into operational
performance. This potency ratio relation compares net sales to fixed assets.

~ A coverage ratio may be a metric to a company’s ability to service its debt and meet its
money obligations such as interest payments or dividends. The upper the coverage ratio, the
better it ought to be to create interest payments on its debt or pay dividends.

3) PROFITABILITY RATIOS: Profitability ratios are the category of economic metrics that
assess a business’s ability to get earnings relative to its revenue, operative prices, record assets,
or shareholders equity over time, exploitation knowledge from a particular purpose in time.
 Profitability ratios indicate how expeditiously an organisation generates profit and price for
shareholders.

~ Gross profit ratio indicates gross margin on products sold. It also indicates the margin
available to cover operating expenses, non-operating expenses, etc.

~ The net profit ratio measures what proportion of net profit is generated as a proportion of
revenue. It is the magnitude relation of profits to revenues for a business.

~ The operating profit ratio measures what proportion a corporation makes on sales when
paying for variable prices of production, such as wages and raw materials, before paying
interest or tax.

~ The term return on assets (ROA) ratio indicates how profitable a corporation is in respect
to its total assets. The management, analysts and investors will use ROA to work how
expeditiously a corporation uses its assets to get a profit.

~ Return on Capital Employed (ROCE) can be a money magnitude relation which will be
accustomed to assess a company’s profitableness and capital potency.

4) TURNOVER RATIOS: The turnover ratio measures the worth of a company’s sales or
revenues relative to the worth of its assets. The turnover quantitative relation will be used as an
indicator of the potency with that a corporation is exploitation its assets to get revenue. The
higher the turnover ratio, the higher are the revenues.

~ The term stock turnover ratio refers to the performance ratio that helps to confirm how
sensible an organisation is in managing its stock inventory whereas generating sales
throughout a given period of time.

~ Debtor’s turnover ratio measures how well a corporation uses and manages the credit it
extends to customers and the way quickly that short-run debt is collected.

~ A creditor’s turnover ratio is also known as liabilities turnover ratio, A creditor’s turnover
magnitude relation shows how well a company pays off its debts to suppliers in a given
accounting amount.
 CONCLUSION: -

In conclusion, ratio analysis is an invaluable tool for assessing a company's financial performance
and health. It provides a quantitative approach to understanding liquidity, profitability, solvency,
and operational efficiency. By comparing line items in financial accounts, analysts gain valuable
insights into various aspects of the business. Liquidity ratios, such as the current ratio and quick
ratio, help determine the company's ability to meet short-term obligations. Solvency ratios,
including the debt-to-equity ratio and proprietary ratio, assess the long-term debt-paying capacity.
Profitability ratios, such as gross profit ratio and net profit ratio, indicate the company's ability to
generate earnings relative to revenue and assets. Turnover ratios, like stock turnover ratio and
debtor's turnover ratio, measure the efficiency of asset utilization and credit management. These
ratios enable meaningful comparisons with industry benchmarks, aiding in informed decision-
making and identification of areas for improvement. Ratio analysis is a powerful quantitative
technique that provides deep insights into a company's financial statements, facilitating
comprehensive understanding and informed decision-making for business growth and success.

3)

A) Vertical analysis or vertical statement analysis refers to a method of analysing financial

statements wherein each line item is shown as a percentage of a base figure within the statement.
Therefore, on an income statement, line items can be stated as a percentage of gross sales, while
line items on a balance sheet can be stated as a percentage of total assets or liabilities and on a
cash flow statement each cash inflow or outflow is shown as a percentage of the total cash
inflows. Vertical statement analysis allows an analyst to easily compare financial statements of
one company with another and across industries. As a result, one can see the relative proportions
of account balances. It additionally makes it easier to compare previous periods for statistical
analysis wherein quarterly and annual figures are compared over a number of years.

Amount (Rs '000) Percentage

ASSETS
Current Assets 950 28.03%
Accounts Receivable 250 7.39%
Supplies 150 4.43%
Salaries Payable 150 4.43%
Cash 550 16.24%
Prepaid Insurance 300 8.85%
Non-Current Assets 1500 44.28%
Equipment 1500 44.28%
TOTAL ASSETS 2450 100.00%

LIABILITIES
Current Liabilities 740 30.20%
Unearned Revenue 200 8.16%
Accounts Payable 540 22.04%
TOTAL LIABILITIES 740 30.20%

STOCKHOLDER'S
EQUITY
Common Stock 1000 40.82%
Retained Earnings 860 35.10%
TOTAL 1860 75.92%
STOCKHOLDER'S
EQUITY
TOTAL LIABILITIES 2450 100.00%
AND STOCKHOLDER'S
EQUITY

A Vertical Form Balance Sheet is a financial statement that presents a company's financial
position in a specific format. It is widely used by businesses to provide a snapshot of their assets,
liabilities, and equity at a given point in time. The vertical format arranges the components of the
balance sheet in a columnar structure, making it easier to analyze the relationship between various
items. The structure of a Vertical Form Balance Sheet typically consists of three main sections:
assets, liabilities, and equity. The assets section lists all the resources owned by the company,
such as cash, accounts receivable, inventory, and fixed assets. Liabilities represent the company's
obligations and debts, including accounts payable, loans, and accrued expenses. The equity
section reflects the residual interest in the company after deducting liabilities from assets and
 encompasses items like common stock, retained earnings, and additional paid-in capital. The
Vertical Form Balance Sheet provides a concise overview of a company's financial health and
helps stakeholders assess its solvency, liquidity, and overall stability. By analyzing the
relationships between different elements within each section, financial analysts can gain insights
into the company's ability to meet its short-term and long-term obligations, evaluate its leverage,
and assess the composition of its capital structure. In conclusion, the Vertical Form Balance Sheet
is a vital tool for understanding a company's financial position. It organizes financial information
in a clear and structured manner, allowing stakeholders to make informed decisions based on the
company's assets, liabilities, and equity.

B) The current ratio is a financial metric used to evaluate a company's short-term liquidity and
ability to meet its immediate financial obligations. It measures the relationship between a
company's current assets and its current liabilities.

The formula for calculating the current ratio is:

Current Ratio = Current Assets / Current Liabilities

The current assets include cash, accounts receivable, supplies, and prepaid insurance, while the
current liabilities include accounts payable, salaries payable, and unearned revenue.

The significance of the current ratio lies in assessing a company's short-term financial health. A
ratio greater than 1 indicates that a company has more current assets than current liabilities,
suggesting it has sufficient resources to cover its short-term obligations. A current ratio of less
than 1 implies that the company may face difficulties in meeting its immediate financial
obligations.

i) Liquidity Assessment: The current ratio provides insight into a company's liquidity position,
indicating its ability to pay off short-term debts and fulfill operational needs. A higher current
ratio is generally desirable, as it suggests a stronger ability to meet obligations.
ii) Comparison: The current ratio can be used to compare a company's liquidity position with
industry peers or historical performance. It helps investors and analysts evaluate a company's
efficiency in managing its short-term assets and liabilities.
iii) Trend Analysis: Monitoring the current ratio over time can reveal the company's changing
liquidity position. A declining current ratio may indicate worsening financial health, while an
increasing ratio could signify improved liquidity.
iv) Limitations: Although the current ratio provides valuable information about short-term
liquidity, it does not consider the quality of assets or the timing of liabilities. It is important to
conduct a comprehensive analysis of a company's financial statements and other financial ratios
to gain a deeper understanding of its financial condition.

By calculating and interpreting the current ratio, investors and analysts can make more
informed decisions regarding a company's ability to meet its short-term obligations and manage
liquidity effectively. In conclusion, the current ratio serves as a critical financial metric for
evaluating a company's short-term liquidity and its capability to meet immediate financial
obligations. By examining the relationship between current assets and current liabilities, this ratio
offers valuable insights into a company's liquidity position, providing investors with an
understanding of its ability to fulfill short-term financial commitments. The current ratio not only
assists in assessing a company's liquidity health but also facilitates comparisons with industry
peers and historical performance. Monitoring the trend of the current ratio over time can reveal
changes in a company's liquidity position, shedding light on potential financial strengths or
weaknesses. By comprehending and accurately interpreting the current ratio, investors and
analysts can make well-informed decisions about a company's liquidity position, allowing them to
evaluate its ability to manage short-term obligations effectively.