Analysis of Financial Statements.final

7/29/2019 Analysis of Financial Statements.final

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ANALYSIS OF FINANACIALSTATEMENTS

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FINANCIAL STATEMENT ANALYSIS

Analysis of financial statement means a

systematic and specialized treatment ofthe information found in financialstatements so as to derive usefulconclusions on the profitability and

solvency of the business entityconcerned.

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Objectives of

Financial StatementAnalysis

Profitability Analysis Liquidity Analysis Solvency Analysis


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Profitability Analysis: Users of financial statementsmay analyze financial statements to decide past and

present profitability of the business

Liquidity Analysis: Suppliers of goods, moneylendersand financial institutions may do a liquidity analysis

to find out the ability of the company to meet itsobligations

Solvency Analysis: It refers to analysis of long term

financial position of the company. This analysis helpsto test the ability of a company to repay its debts.

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Qualitative characteristics of Financial

Statements

Attributes that make the information provided

in the financial statements useful to users.

These attributes include

Understandability

Relevance

Materiality

Reliability Comparability


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Components of Financial Statements

Balance Sheet

Income Statement

Cash flow Statement Statement of Changes of Equity

Notes, comprising a summary of significant

accounting policies and other explanatoryNotes


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Balance Sheet

The Financial Report which shows the

Financial position of the Business entity at a

given time.

Balance sheet Equation

ASSETS= CAPITAL + LIABILITIES

Where the funds are invested= Where thefunds came from


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Balance Sheet

A balance sheet is a statement of the total assets andliabilities of an organization at a particular date -usually the last date of an accounting period.

The balance sheet is split into two parts:

(1) A statement offixed assets, current assets andthe liabilities (sometimes referred to as "NetAssets")

(2) A statement showing how the Net Assets have

been financed, for example through share capital andretained profits.


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INCOME STATEMENT

Income statement shows all revenues and expenditureover the period and the profitability .Specificinformation in the income statement include, Revenue,Cost of Sales, Gross Profit, Operating Expenditures,finance costs, Depreciation.

An income statement reports the organizationsfinancial performance over a specified period of time.It summarizes all revenue earned and expensesincurred during a specified accounting period. An

institution prepares an income statement so that it candetermine its net profit or loss (the difference betweenrevenue and expenses).


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CASH FLOW STATEMENTA cash flow statement shows where an institutionscash is coming from and how it is being used over a

period of time. A cash flow statement Classifies the cash flows into

operating, investing and financing activities.

Operating activities: services provided (income-

earning activities). Investing activities: expenditures that have been

made for resources intended to generate futureincome and cash flows.

Financing activities: resources obtained from andresources returned to the owners, resourcesobtained through borrowings (short-term or long-term) as well as donor funds.


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TYPES OF

FINANCIAL

ANALYSIS

Intra Firm

Analysis

Inter Firm

Analysis

Standard

Analysis

Horizontal

Analysis

Vertical

Analysis


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Intra Firm Analysis: Analysis of performance of theorganization over a number of years. It is also referred toas Time Series Analysis or Trend Analysis

Inter Firm Analysis: It is a comparison of two or moreorganizations in terms of various financial variables.

Standard Analysis: only one set of financial statements

of an organization is analyzed on the basis of standard setfor the firm or industry

Horizontal analysis: It is a comparison of figuresreported in financial statements of two or more

consecutive accounting periods i.e. Analysis across years

Vertical Analysis: comparing figures I the financialstatements of a single period is known as Vertical Analysis


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1. COMPARATIVE FINANCIAL STATEMENTS

Comparative financial statements are statementsof the financial position of a business so designedas to facilitate comparison of different accountingvariables for drawing useful inferences

Comparative financial statements show:

a) Absolute data for each of the periods stated

b) Changes in absolute data in terms of rupeesc) Changes in absolute data in percentages

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Advantages

Indicates the direction of movement and thefinancial position of the company.

Used to compare the position of the every

month or every quarter. Used to compare with other firms.

Presents a review of the past activites and

their effect on the financial position. Helps to determine the nature of trends of

current changes affecting the enterprise.

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Disadvantages

Loose their purpose if the application of accountingprinciples over a period of time is not consistent.

Consistent changes in price levels render accountingstatements useless for comparisons

To carry out inter firm comparison the firms need to be of

the same age, size and follow the same principle.

If the accounting period follows an abnormal period the

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2. Common-Size Statements

It is a statement which facilitates

comparison of two or more business

entities with a common base

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Advantages

It reveals the sources of funds and the

application of the total funds in the assets of a

business enterprise.

It indicates the changing proportion of the

assets, liabilities, costs etc.

It assists corporate evaluation and ranking.

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Disadvantages

Do not show variation in various item from

time to time

If it is not prepared on a consistent basis

comparative study will be misleading.

It does not establish any relationship between

items in profit and loss account with that of

items of balance sheet

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3. Trend Analysis overview

What is trend analysis?

Advantages of trend analysis

Disadvantages of trend analysis Example of trend analysis

Comments derived from trend analysis.

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What is Trend Analysis

Also termed as trend percentage.

Used for comparing financial statements over

a number of years.

At least 3 years data required.

Base year

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Trend analysis

Each base year item taken as 100.

Upward trend will be indicated by the trend %being more than 100.

Downward trend % will be indicated by thetrend% being less than 100.

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Comments/derivations

Company reliance on borrowed funds has declined

whereas the dependence on owned funds has

increased which can be revealed by 80%.

The company has gone for an expansion programwhich is reflected by addition to the Fixed assets

which has increased by 50% in the year 2003 and

70% in 2004 compared to the base year calculated

on net Fixed Assets.

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Due to increase in Fixed Assets there is also an

additional requirement of working capital in

order to mobilize the Fixed Assets which is

reflected by 24% in the year 2003 and 50%increase in the year 2004 compared to the

base year.

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Comments/derivations


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Advantages

Indicates the direction of movement offinancial performance of the company.

Indicated the increase or decrease in an

accounted item. Shows the magnitude change , hence more

effective than regular data.

An efficient method to showcase the financialperformance of a company over a period oftime.

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Disadvantages

Any 1 trend by itselfdoes notshow the truepicture.

Trend percentages without absolute data

reference tend to be absurd. Comparison of trend meaningless if

accounting practices change during the years.

The base year selected may not be normal ortypical.

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Analysis of Financial Statements.final

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