Revision: Financial Statement Analysis >> Analysis of Financial Statements Accountancy Commerce (English Medium) Class 12 CBSE

• "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.

• Cash Flow Statement is a statement that shows inflows and outflows of cash and cash equivalents under Operating, Investing and Financing Activities of a company during a particular accounting period.
• Cash Flow Statement can be defined as a “Statement which summarises sources of cash inflows and uses for cash outflows during a particular period.” 

• "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.

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

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).

\[\text{Interest Coverage Ratio}=\frac{\text{Net Profit before Interest and Tax}}{\text{Interest on Long-term Borrowings}}=.....\text{Times}.\]

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

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

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

\[\text{Price Earning (P/E) Ratio}\ =\frac{\text{Market Price of the Equity Share}}{\text{Earning Per Share (EPS)}}\]

• 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).

                                                                  FORMAT OF STATEMENT OF PROFIT AND LOSS

Name of the Company............................

Profit and loss statement for the year ended..............................

• 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.

• 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.

• A Cash Flow Statement shows cash inflows and outflows during a specific accounting period.
• It covers cash from operating, investing, and financing activities.
• It helps explain the net change in cash between two balance sheet dates.
• The statement is useful for short-term planning, liquidity analysis, and decision-making.
• It is prepared as per Accounting Standard-3 (AS-3 Revised).
• It helps assess a company’s performance, liquidity, and solvency through activity-wise analysis.
• Limitations: It ignores non-cash items, reflects only past data, and does not measure profit.

• 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.