Revision: Company Accounts and Financial Statement Analysis >> Analysis of Financial Statements CUET (UG) Analysis of Financial Statements

• "Financial Statements are the end product of financial accounting prepared by the accounts of a business enterprise that purport to reveal the financial position of the enterprise, the result of its recent activities and an analysis of what has been done with earnings." - Smith and Ashburne
• "The Financial Statements are a summary of accounts of a business enterprise, the Balance Sheet showing the assets, liabilities and capital as on a certain date and income statement showing the results, i.e., profit or loss for the period." - John N. Myer
• "The Statements which are prepared by the business to find out profitability, efficiency, solvency, growth of business to judge the financial strength and status are called as Financial Statements."

• "Financial analysis consists in separating facts according to some definite plan, arranging them in groups according to certain circumstances and then presenting them in a convenient and easily read and understandable form.'' - Finney and Miller
• "Financial statement analysis is largely a study ofrelationships among the various financial factors in a business, as disclosed by a single set of statements and a study of the trends of these factors as shown in a series of statements." - John N. Myres

• Comparative Statements or Comparative Financial Statements mean a comparative study of individual items or components of financial statements, i.e., Balance Sheet and Statement of Profit & Loss of two or more years of the enterprise itself.
• Statement showing financial data for two or more than two years placed aside by side to facilitate comparisons are called Comparative Financial Statement.

• "Common-size Statements are accounting statements expressed in percentage of some base rather than rupees." - Kohler
• Common-size Statements are the Statements which show the relationship of different items of financial statements with some common item (base) by expressing each item as a percentage of that common base.

• "Ratio analysis is a study of relationship among various financial factors in a business'' - Myres
• The use of different types of accounting ratios to evaluate the financial performance of business is called Ratio Analysis.

Absolute Change = Current Year - Previous Year

\[\text{Quick Ratio or Liquid Ratio}=\frac{\text{Quick Assets or Liquid Assets }}{\text{Current Liabilities}}\]

1. Quick or Liquid Assets:

Quick or Liquid Assets = Current Investments + Trade Receivables (i.e., Bills Receivable and Sundry Debtors less Provision for Doubtful Debts) + Cash and Bank Balances + Short-term Loans and Advances + Other Current Assets (Except Prepaid Expenses).

                                                   Or

Quick or Liquid Assets = Current Assets - Inventories - Prepaid Expenses and Advance tax. 

2. Current Liabilities:

Current Liabilities = Short-term Borrowings + Trade Payables (Sundry Creditors + Bills Payable) + Other Current Liabilities + Short-term Provisions

\[\text{Debt to Equity Ratio}=\frac{\text{Debt/Long-Term Debt}}{\text{Equity/Shareholders'Funds}}\]

1. Debt/Long-term Debts:

Debt/Long-term Debt = Long-term Borrowings + Long-term Provisions

2. Equity/Shareholders' Funds:

Equity/Shareholders' Funds = Share Capital + Reserves and Surplus

                                                             Or

Equity/Shareholders' Funds = Non-current Assets (Tangible Assets + Intangible Assets + Non-current Investments + Long-term Loans and Advances) + Working Capital* - Non-current Liabilities (Long-term Borrowings + Long-term Provisions).

                                                            Or

Equity/Shareholders' Funds = (Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances) + Working Capital* - Non-current Liabilities (Long-term Borrowings + Long-term Provisions)

\[\text{Debt to Total Assets Ratio}=\frac{\text{Debt/Long Term Debts}}{\text{Total Assets}}\]

1. Debt/Long Term Debts

Debt/Long Term Debts = Long Term Borrowings + Long Term Provisions

2. Total Assets:

Total Assets = Non-Current assets (Property, Plant and Equipment = Intangible Assets = Non-Current Investments + Long Term Loans & Advances) + Current Assets

\[\text{Proprietary Ratio}=\frac{\text{Shareholders' Funds/Equity}}{\text{Total Assets}}\]

1. Total Assets:

Total Assets = Non-current Assets + Current Assets

                                        Or

Total Assets = Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances + Current Investments + Inventories (Including Loose tools and Spare Parts) + Trade Receivable + Cash and Bank Balances + Short-term Loans and Advances + Other current Assets

2. Equity/Shareholders' Funds:

Equity/Shareholders' Funds = Share Capital + Reserves and Surplus

                                                    Or

Equity/Shareholders' Funds = Non-current Assets + Working Capital (Current Assets - Current Liabilities) – Non-current Liabilities

                                                   Or

Equity/Shareholders' Funds = Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances + Working Capital - Non-current Liabilities (Long-term Borrowings + Long-term Provisions).

\[\text{Inventory Turnover Ratio}=\frac{\text{Cost of Revenue from Operations or Cost of Goods Sold}}{\text{Average Inventory}}=...\text{Times}.\]

1. Cost of Revenue from Operations:

Cost of Revenue from Operations = Opening Inventory + Purchases + Carriage + Wages + Other Direct Charges - Closing Inventory

                                                     Or

Cost of Revenue from Operations = Cost of Materials Consumed + Purchases of Stock-in-Trade + Changes in Inventories of Finished Goods, Work-in Progress and Stock-in-Trade + Direct Expenses.

                                                     Or

Cost of Revenue from Operations = Net Revenue from Operations - Gross Profit

                                                     Or

Cost of Revenue from Operations = Revenue from Operations + Gross Loss

2. Average Inventory:

\[\text{Average Inventory}\quad=\quad\frac{\text{Opening Inventory }+\text{Closing Inventory}}{2}\]

\[\text{Trade Receivables Turnover Ratio}=\frac{\text{Credit Revenue from Operations (Credit Sales)}}{\text{Average Trade Receivables}}=.....\text{Times}.\]

1. Credit Revenue from Operations:

Credit Revenue from Operations (Credit Sales) = Revenue from Operations (Cash + Credit) – Cash Revenue from Operations

2. Average Trade Receivables:

\[\text{Average Trade Receivables}=\frac{\text{Opening Trade Receivables}+\text{Closing Trade Receivables}}{2}\]

Trade Receivable = Sundry Debtors + Bills Receivable

\[\text{Trade Payables Turnover Ratio}=\frac{\text{Net Credit Purchases}}{\text{Average Trade Payables}}=......\text{times}\]

1.Net Credit Purchases:

Net Credit Purchases = Net Purchases - Cash Purchases.

(When net credit purchases is not given, the amount of total purchases may be applied.)

2. Average Trade Payables:

\[\text{Average Trade Payables}=\frac{\text{Opening Trade Payables}+\text{Closing Trade Payables}}{2}\]

                                                        Or

\[\text{Average Trade Payables}=\frac{\text{Opening Creditors + Opening Bills Payable}+\text{Closing Creditors + Closing Bills Payable}}{2}\]

\[\text{Working Capital Turnover Ratio}=\frac{\text{Revenue from Operations (Net Sales)}}{\text{Working Capital}}=......\text{Times}\]

1. Revenue from Operations:

Revenue from Operations = Cash Revenue from Operations + Credit Revenue from Operations

2. Working Capital:

Working Capital = Current Assets - Current Liabilities

\[\text{Earning Per Share (EPS)}=\frac{\text{Net Profit after Tax and Preference Dividend}}{\text{Number of Equity Shares}}\]

• Meaning & Parts: Show a business’s profit and financial position. Include Balance Sheet, P&L A/c, Cash Flow, Equity Statement, and Notes.
• Purpose: Provide a true and fair view to help users make informed decisions.
• Features: Based on past data, in monetary terms. A balance sheet is for a date; a P&L is for a period. Must be verifiable, relevant, understandable, and comparable.
• Nature: Influenced by facts, accounting concepts, conventions, standards, and judgments.
• Legal Requirement: As per the Companies Act, 2013, companies must prepare them yearly in the prescribed format (Schedule III).

• Meaning: Study of financial data to understand profit, performance, solvency, and efficiency.
• Tools: Comparative & Common-size Statements, Cash Flow, Ratio Analysis.
• Purpose/Use: Helps assess trends, make decisions on investment, credit, dividends, and compare firms.
• Users: Management, investors, creditors, banks, govt., employees, etc.
• Limitations: Based on past data, may be biased, ignores price changes & qualitative factors, affected by window dressing.

                                                                         COMPARATIVE STATEMENT OF PROFIT & LOSS

                                                                                        for the year ended 31st March....

• Meaning: Comparative Statements present financial data of two or more years side‑by‑side to show changes in amount and percentage.
• Types: Intra‑firm comparison compares the same firm over different years, while Inter‑firm comparison compares different firms.
• Uses: They simplify financial data, show trends, identify strengths and weaknesses, help compare with industry performance, and assist in forecasting.
• Limitations: They are based on past data, affected by estimates and personal judgement, ignore qualitative factors, do not consider price level changes, and are unreliable if accounting policies differ.
• Formats: Information can be shown as absolute changes, percentage changes, ratios, averages, and through comparative Balance Sheet and Profit & Loss statements.

• Common-size statements show each financial item as a percentage of a common base.
• They are used in the Balance Sheet and Income Statement for better comparison.
• The main purpose is to compare data, analyse trends, and understand financial relationships.
• Each item is shown in actual figures and as a percentage of the base amount.
• They help in tracking changes, identifying trends, and assessing business efficiency.

• Meaning: Ratio analysis studies financial relationships to assess a business’s performance and financial position.
• Objectives: It simplifies data, identifies weak areas, checks solvency and profitability, and supports planning.
• Advantages: Helps with decision-making, shows trends, and supports comparisons across firms and over time.
• Use in Comparison: Allows inter-firm and intra-firm comparisons to evaluate business efficiency.
• Limitations: Depends on data accuracy, may ignore qualitative factors, and is affected by policies and bias.
• Important Reminder: Use ratio analysis with care, considering its limitations and verifying data before conclusions.