Financial Statement Analysis

Introduction
 The primary objective of financial reporting is to
provide information to present and potential investors
and creditors and others in making rational
investment and other decisions.
 Effective decision making requires evaluation of the
past performance of companies and assessment of
their future prospects.
Why Financial Statement
Analysis?
 Mere a glance of the financial accounts of a company
does not provide useful information simply because
they are raw in nature.
 The information provided in the financial statements is
not an end in itself as no meaningful conclusions can
be drawn from these statements alone.
 A proper analysis and interpretation of financial
statement can provide valuable insights into a firm’s
performance.
 It enables investors and creditors to:
◦ Evaluate past performance and financial position
◦ Predict future performance
Meaning of FSA
 The term ‘financial analysis’ also known as
‘analysis and interpretation of financial statements’,
refers to the process of determining financial
strengths and weaknesses of the firm by
establishing strategic relationship between the
items of the balance sheet, P&L A/c and other
operative data.
Concept of FSA
 It is the collective name for the tools and techniques
that are intended to provide relevant information to
decision makers.
 The purpose of financial analysis is to diagnose the
information contained in financial statements so as to
judge the profitability and financial soundness of the
firm.
 Just like a doctor examines his patient by recording his
body temperature, blood pressure, etc… before making
his conclusion regarding the illness and before giving
his treatment, a financial analyst analyses the financial
statements with various tool of analysis before
commenting up on the financial health or weakness of
an enterprise.
Types of Financial Analysis
 On the basis of material used:
◦ External Analysis
◦ Internal Analysis
 On the basis of modus operandi:
◦ Horizontal Analysis
◦ Vertical Analysis
On the basis of material Used
 External: It is carried out by outsiders of the
business – investors, credit agencies, govt
agencies, creditors etc. who does not access to
internal records of the company – depending
mainly on published accounts
 Internal: It is carried out by persons who have
access to internal records of the company –
executives, manager etc – by officers appointed by
govt or courts in legal litigations etc. under power
vested in them.
On the basis of modus
operandi
 Horizontal: data relating to more
than one-year comparison with other
years – standard or base year –
expressed as percentage changes –
Dynamic analysis.
 Vertical: quantitative relationships among various
items in statements on a particular date – inter firm
comparisons – inter department comparisons –
static analysis.
1. Horizontal Analysis:
ABC Corporation
Profit and Loss accounts
For the years ended March 31, 2018 and 2019
2018 2019 Change in Percentage
Amount Change
1,00,000 1,50,000
Net Sales 50,000 50 %
Cost of Goods Sold 0
Gross Profit 0 0 0
Selling and Administrative Expenses 0
Profit before Interest and Tax 0 0 0
Interest Expense 0
Profit before Income Tax 0 0 0
Income Tax 0
Profit after Tax 0 0 0
 ABC Corporation
Balance Sheets as at Marc h 31, 2 0X2 and 20 X1
20X2(Rs) 20X1(Rs) Amoun t Change %
Shareholders' Funds
Share Capital 0
Reserves and Surplus 0
0 0 0

Liabilities
Secured Loans 0
Unsecured Loans 0
Current Liablities 0
0 0 0
0 0 0

Assets
Fixed Assets 0
Investments 0
Current Assets:
Inventories 0
Debtors 0
Cash 0
Other Current Assets 0
0 0 0
2.Common-size financial statements
Grace Corporation
Common-size Profit and Loss accounts
For the years ended March 31, 20X2 and 20X1
20X2 (Rs) 20X1 (Rs) 20X2 (%) 20X1 (%)
Net Sales
Cost of Goods Sold
Gross Profit 0 0 0 0
Selling and Administartive
Expenses
Profit before Interest and Tax 0 0 0 0
Interest Expense
Profit before Income Tax 0 0 0 0
Income Tax
Profit after Tax 0 0 0 0
 Sample Company  

Balance Sheet (Assets)  

At December 31, 2019 and 2018  

          % of Total Assets  

  1999   1998   1999   1998  

Cash 82,000   30,000   17%   8%  

Accts. Rec. 120,000   100,000   25%   26%  

Inventory 87,000   82,000   18%   21%  

Land 101,000   90,000   21%   23%  

Equipment 110,000   100,000   23%   26%  

Accum. Depr. (17,000)   (15,000)   -4%   -4%  

Total 483,000   387,000   100%   100%  

                 
Methods of Financial Analysis
 Comparative Statements Analysis
 Common-Size Statement Analysis
 Trend Analysis
 Ratio Analysis
 Funds Flow Analysis
 Cash Flow Analysis
 Cost-Volume-Profit Analysis
Comparative Statement
Analysis
 Comparative financial statements are useful in
analyzing the changes over time.
 They carry data relating to two or more years and
facilitate the comparison of an item with previous
years and even the future figures may be projected
using time series / regression analysis.
 The two comparative statements are:
1. Balance Sheet
2. Income Statement
Illustration
 The following are the Balance Sheets of a concern
for the years 2019 and 2018. Prepare Comparative
Balance Sheet and study the financial position of the
concern. Balance Sheet
As on 31st
Liabilities 2018(Rs.) 2019
Decemeber
(Rs.) Assets 2018 (Rs.) 2019(Rs.)
Equity Share Capital 6,00,000 8,00,000 Land & Buildings 3,70,000 2,70,000
Reserves & Surplus 3,30,000 2,22,000 Plant & Machinery 4,00,000 6,00,000
Debentures 2,00l,000 3,00,000 Furniture 20,000 25,000
Long-term loans on Mortgage 1,50,000 2,00,000 Other Fixed Assets 25,000 30,000
Bills payable 50,000 45,000 Cash in hand & at Bank 20,000 80,000
Sundry Creditors 1,00,000 1,20,000 Bills Receivables 1,50,000 90,000
Other Current Liabilities 5,000 10,000 Sundry Debtors 2,00,000 2,50,000
Stock 2,50,000 3,50,000
Prepaid Expences 2,000
14,35,00 16,97,00 14,35,00 16,97,00
0 0 0 0
Guidelines for interpretation of
Comparative Balance Sheet
 The interpreter is expected to study the following
aspects:
1. Current
 Financial
See Position
the Working Capital and
in both the Liquidity
years. Position
(WC is excess of CAs over CLs)
 The increase in WC will mean improve in the current financial position of the
 business. Liquid assets like Cash in hand, cash at bank, Receivables show the
liquidity position
2. Long-term Financial
Position Study the changes in Fixed assets, long-term liabilities and capital
 Wise policy will be to finance fixed assets by raising long-term funds.

3. Profitability of the
concern The study of increase or decrease in retained earnings, various reserves and surplus,
etc.. will enable to see whether the profitability has improved or not.
 C o m p a r a t i v e B a l a n c e S he et of a C o m p a n y
for the year ending D e c e m b e r 31, 2 0 1 8 a n d 2 0 1 9

Increase/
Ye a r e n d i n g 3 1 D ec . Decrease Increase/D
2 0 1 8 ( Rs) 201 9( Rs) (Amount) ec r e as e
Rs (%)

ASSETS
Cu r r e nt Assets:
C a s h in h a n d & at 20,000 80,000 60,000 300
B a n k Bills Receivables 1,50,000 90,000 -60,000 -40
S un dr y Deb t or s 2,00,000 2,50,000 50,000 25
S t ock 2,50,000 3,50,000 1,00,000 40
Pr epaid E x p e n c e s 2,000 2,000
Tot a l Cu r r en t As set s 6,20,000 7,72,000 1,52,000 24.52
Fi xe d Assets:
L a n d & Buildings 3,70,000 2,70,000 - 1, 00, 000 -27.03
Plant & 4,00,000 6,00,000 2,00,000 50
M ach iner y 20,000 25,000 5,000 25
Furniture 25,000 30,000 5,000 20
O t her Fixed 8,15,000 9,25,000 1,10,000 13.49
A sse t s 14,35,000 16,97,000 2,62,000 18.26
Tot a l F i x ed
A sset s
Tot a l As set s
50,000 45,000 -5,000 -10
LI A BI LI TI E S & 1,00,000 1,20,000 20, 000 20
C A P I TA L 5,000 10,000 5, 000 100
Cur r ent 1,55,000 1,75,000 20,000 12.9
Liabilities: 2,00l,000 3,00,000 1,00,000 50
Bills payable 1,50,000 2,00,000 50,000 33
S un d r y Creditors 5,05,000 6,75,000 1,70,000 33.66
O t her Cur r ent Liabilities
6,00,000 8,00,000 2,00, 000 33
To t al Cur r ent Liabilities
3,30,000 2,22,000 -1,08,000 -32.73
Debe nt ur es
14,35,000 16,97,000 2,62,000 18.26
Lo ng- t er m loans o n
M o r t ga ge
 Illustration

 The Income statements of a concern are given for the year

ending 31st Dec, 2018 and 2019. Re-arrange the figures in a
comparative form and study the profitability position of the
concern.
2018 2019
Rs.(000) Rs.(000)
Net Sales 785 900
Cost of Goods Sold 450 500
Operating Expenses:
General and Admn Expenses 70 72
selling Expenses 80 90
Non-operating Expenses:
Interest paid 25 30
Income-Tax 70 80
Guidelines for Interpretation of
Income Statements
1. The amount of GP should be studied
 The increase or decrease in sales should be compared with the
increase or decrease in CGS.

2. The study of operational profits

 Operational profits = GP – Office &Admn expenses – Selling &
Dist Expenses

3. The study of Net Profits

 The increase or decrease in NP will give an idea about the overall
profitability of the concern.
 NP = OP – Non-operating exp + Non-operating Income

4. An opinion should be formed about profitability of

the concern whether is good or not.
 Comparative Income Statement
for the year ending December 31, 2018 and 2019

Increase/
Year ending 31 Dec. Increase/
Decrease
Decrease
(Amount) (%)
Rs
2018 (Rs) 2019 (Rs)
Net Sales 785 900 115 14.65
Less: Cost of Goods Sold 450 500 50 11.11
Gross Profit 335 400 65 19.40
Operating Expenses:
General and Admn Expenses 70 72 2 2.86
selling Expenses 80 90 10 12.50
Total Operating Expenses 150 162 12 8.00
Operating Profit 185 238 53 28.65
Less: Non-operating Expenses:
Interest paid 25 30 5 20.00
Net Profit before Tax 160 208 48 30.00
Less: Income-Tax 70 80 10 14.29
Net Profit after-tax 90 128 38 42.22
Common-Size Statement
Analysis

 Taking sales to be equal to 100, all other items in

the income statement of a year are expressed as
percentages to the sales.
 In case of balance sheet the total assets are made
equal to 100 and all other assets are expressed in
relative percentages. The same is the case with
liabilities with the total liabilities being 100.
 Common-size Balance Sheet
as on Dec.31, 2019
2018 2019
Rs % Rs %
ASSETS
Current Assets:
Cash in hand & at Bank 20,000 1.39 80,000 4.71
Bills Receivables 150,000 10.45 90,000 5.30
Sundry 200,000 13.94 250,000 14.73
Debtors Stock 250,000 17.42 350,000 20.62
Prepai - 2,000 0.12
d Expences 620,000 43.21 772,000 45.49
Total Current Assets
Fixed Assets: 370,000 25.78 270,000 15.91
Land & Buildings 400,000 27.87 600,000 35.36
Plant & 20,000 40.00 25,000 1.47
Machinery 25,000 1.74 30,000 1.77
Furniture 815,000 56.79 925,000 54.51
Other Fixed
Assets
Total Fixed
Assets
Total Assets 1,435,000 100.00 1,697,000 100.00

LIABILITIES & CAPITAL

Current Liabilities:
Bills payable 50,000 3.48 45,000 2.65
Sundry Creditors 100,000 6.97 120,000 7.07
Other Current 5,000 0.35 10,000 0.59
Liabilities 155,000 10.80 175,000 10.31
Total Current 200,000 13.94 300,000 17.68
Liabilities 150,000 10.45 200,000 11.79
Debentures 505,000 35.19 675,000 39.78
Long-term loans 600,000 41.81 800,000 47.14
on Mortgage 330,000 23.00 222,000 13.08
Total Liabilities
 Common-sIze Income Statement
for the years ending Dec. 2018 and 2019

2018 (Rs) 2019(Rs)

Rs.(000) % Rs.(000) %
Net Sales 785 100.00 900 100.00
Less: Cost of Goods Sold 450 57.32 500 55.56
Gross Profit Operating 335 42.68 400 44.44
Expenses:
General and AdmnExpenses selling 70 8.92 72 8.00
Expenses 80 10.19 90 10.00
Total Operating Expenses
150 19.11 162 18.00
Operating Profit
185 23.57 238 26.44
Less:Non-operating Expenses:
Interest paid
25 3.18 30 3.33
Net Profit before Tax
160 20.38 208 23.11
Less: Income-Tax
70 8.92 80 8.89
Trend Analysis
 It determines the direction upwards or
downwards.
 Under this analysis the values of an item in
different years is expressed in relation to the
value in one year called the base year.
 Taking the value of the item in the base year to
be equal to 100
 The values of the item in different years are
expressed as percentages to this value.
Illustration
 Calculate the trend percentages from the following
figures of X Ltd. taking 2015 as base and interpret
them:

(Rs. In Lakhs)
Year Sales Stock Profit before Tax
2015 1,881 709 321
2016 2,340 781 435
2017 2,655 816 458
2018 3,021 944 527
2019 3,768 1,154 672
Solution:

Trend Percentages
(Base Year – 2015 =
Year Sales 100)
Stock Profit before Tax
(Rs. Lakhs) Trend % (Rs. Trend % (Rs. Trend %
Lakhs) Lakhs)
2015 1,881 100.00 709 100.00 321 100.00
2016 2,340 124.40 781 110.16 435 135.51
2017 2,655 141.15 816 115.09 458 142.68
2018 3,021 160.61 944 133.15 527 164.17
2019 3,768 200.32 1,154 162.76 672 209.35