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PARTIES INTERESTED IN FINANCIAL ANALYSIS
There are different parties interested in the financial analysis of these statements. But
their aim and objective of the analysis differ significantly. The users of the financial statements
can be divided into tow broad groups:(a) Internal users(b) External Users.Internal Users:Financial Executives:
The first party interested in the financial statement analysis is the Finance Department
of the company itself. This analysis helps the Financial Manager to have a deep insight into the
financial condition of the enterprise. Top Management: The Top Management of the concern is also interested in the analysis of financialstatements. It helps them in reaching conclusion on the following:
Is the firm in a position to meet its current obligations?
What sources of long-term finance are employed by the firm?
How efficiently does the firm use its assets?
Are the earnings of the firm adequate? etc.,
External Users:Investors:
Those who are interested in buying the shares of a company are naturally interested
in the financial statements to know how safe the investment already made is and how safe the
proposed investment will be.Creditors:
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Lenders are interested to know whether their loan, principal and interested will be paid
when due. Suppliers and other creditors are also interested to know the ability of the firm to pay
their dues in time.Workers:In our country, workers are entitled to payment of bonus which depends on the sizeof profit earned. Hence, they would like to be satisfied that the bonus being paid tothem is correct.Customers:
They are also concerned with the stability and profitability of the enterprise. They may be
interested in knowing the financial strength of the company to take further decisions relating to
purchase of goods.Government: Financial analysis helps government in knowing the role and status of industry ingeneral and companies in particular in framing Macro-Economic policies.Researches:10
The financial statements, being a mirror of business conditions, are of great interest toscholars understanding research in Accounting theory as well as business affairs andpractices.Significance of Financial Analysis:
Analysis of financial statement is carried out to measure the enterprises liquidity,
profitability, solvency and other indicators to assess its operating efficiency, financial position and
performance. Financial analysis serves the following purpose:
To know the operational efficiency of the business.
Helpful in measuring the solvency of the firm.
Helpful in comparison of past and present results.
Helps in measuring the profitability.
It is more helpful in inter-firm comparison.
Helps in judging the solvency of the undertaking. Types of analysis: Two types of analysis are undertaken to interpret the position of an enterprise. Theyare:
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Vertical Analysis
Horizontal Analysis The Companies Act, 1956 permit the companies to present the financial statementsinvertical as well as horizontal form.Vertical Analysis:11
It is the analysis of relationship as between different individual components for a given
period of time. Comparison of current assets to current liabilities or comparison of debt to equity
for one point of time is the examples of vertical analysis. It can be made in the following ways.
By preparation of common size statements of the two similar units.By preparing common size statement of different years of the same business.Horizontal Analysis:
It is the analysis of changes in different components the financial statements over
different periods with the help of a series of statements. Study of trends in debt or share capital or
their relationship over the past ten years period or study of profitability trends for a period of five
years or ten years are examples of horizontal analysis. It comprises:Comparison of the financial statements of different years of the same businessunit.
Comparison of financial statement of a particular year of different businessunits.Methods of Analysis:A financial analyst can adopt the following tools for analysis of the financialstatements.
These are also termed as Methods of Financial Analysis.
Comparative Statement Analysis.
Common-size Statement Analysis.
Trend Analysis.
Funds flow Analysis.12
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Cash flow Analysis.
Ratio Analysis.Comparative Statement Analysis:
Comparative financial statements are those statements which are designed to provide
time perspective to the consideration of various elements of financial position embodied in such
statements. In these statements figures for two or more periods are shown side by side to
facilitate comparison. Both the income statement and balance sheet can be prepared in the form
of comparative financial statements.Common-size Statement Analysis:
Common-size statement is a financial tool of studying key changes and trends in
financial position of a company. In common-size statement, each item is stated as percentage of
the total of which that item is a part, each percentage exhibits the relation of the individual item to
its respective total. Therefore, the common-size percentage method represents a type of ratio
analysis. That is why this statement is also designated as component percentage or 100
percent statement. Preparation of the common-size statement involves two steps:
State the total of the statement as 100 percent.
Compute the ratio of each item to the total in the statement13
There are tow types of common-size statements, viz., common-size incomeStatement andBalance Sheet.
Trend Analysis:
Trend analysis depicts behavior of the ratios over a period of time and the trends in the
operation of the enterprise. The trend figures are index figures giving a birds eye view of the
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comparative data by presenting it over a period of time. This is horizontal analysis of financial
statement, often called as Pyramid Method of Ratio Analysis a guide to yearly changes.
Under this form of analysis, generally financial ratios are studied for a specified number
of years. It is a dynamic analysis depicting the changes over a stated period. The working of trend
analysis involves the following three steps:
Selection of the base year.
Assignment of an index number of 100 to each item of the base year.
Calculation of percentage relationship that each item bears to the same item inthe base yearRatio Analysis:
Ratio Analysis is powerful tool of financial analysis. The relationship between two
accounting figures, expressed mathematically, it is known as a financial ratio. In financial
analysis, a ratio is used as a benchmark for evaluating financial position and performance of a14
firm. Ratios help to summarize large quantities of financial data and to makequalitative judgmentabout the firms financial performance.
Several ratios, calculated from the accounting data, can be grouped into various
classes according to financial activity or function to be evaluated. In view of the requirements of
the various users of ratios.We may classify them into the following categories:
Liquidity Ratios.Leverage Ratios.
Activity Ratios.
Profitability ratios.
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Financial analysis is the processes of identifying the financial strengths and weaknesses
of the firm by properly establishing relationships between the items of financial statements viz.,
Balance sheet and profit and loss account, financial analysis can be undertaken by management
of the firm or by parties outside the firm, Viz., Owners, Creditors, Investors and others.Users of Financial Analysis:
Financial analysis is the process of identifying the financial strengths and weakness of
the firm by properly establishing relationship between the items of the Balance Sheet and the
Profit and Loss Account financial analysis can be under taken by management of the firm of by
parties outside the firm viz., Owners, Creditors, Investors and others. The nature of analysis will
differ depending on the purposes of the analyst.15
Trade creditors: Trade creditors are invested in firms ability to meet the climes over very short periodof
time. Their analysis therefore, confine to the revolution of the firms liquidity position.Suppliers of long term debt:
On the other hands are concerned with the firms long term solvency and survival.
They analyze the firms profitability over time its ability to generate cash to be able to pay interest
and repay principle and the relationship between various courses of funds.Investors:
Who have invested their money in the firms shares are must be concerned about the
firms earnings. They restore more confidence in those firms. That show study growth in earnings
as such they concentrate analyzing the firms present and future profitability.Management:
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Management of the firm would be invested in every aspect of the financial analysis. It is
their over all responsibility to see that the resources of the firms are used most effectively and
efficiently and that the firms financial condition is sound.Funds Flow Analysis:
Significant technique of financial analysis is FUNDS FLOW ANALYSIS. It is designed
to highlight changes in the financial condition of a business concern between concern between
two points of time which generally conform to beginning and ending financial statement dates.16
Thus, Funds Flow Statement is a report which summarizes the
events taking between the two accounting periods. It spells out the sources from which funds
were derived and the uses to which these funds were put. This statement is essentially derived
from an analysis of which these have occurred in assets and liabilities items between two balance
sheet dates. In this statement, only the net changes are shown so that the outcome of a
transaction upon the financial condition of a business enterprise reflected more sharply.MEANING AND CONCEPT OF FUNDSFund: According to the dictionary meaning of the term Funds implies anaccumulation or
deposit of resources from which supplies are may be drawn a more or less permanent store or
supply. It is also defined as available pecuniary resources but these two meanings are abroad in
nature and apt to macro level planning and control. A number of definitions of the term fund have
been given.
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Some people call fund as cash. But it is seen in practice that the current assets are
constantly circulating through cash account in business operations and many transactions affect
flow of cash at least later or sooner.
For example, the sale of goods on credit increases in accounts payable rather than in an
immediate cash flow. Similarly, certain expenses may result in a current liability since they might
not have been paid immediately. In other words, it may be said that any current assets and
current liability has its impact on working capital (as working capital is the difference of current
assets and current liabilities) rather than cash. Therefore there is another view about meaning of
fund that it means working capital.17
The term funds have been defined in a number of ways.In a Narrow Sense:
It means cash only and a funds flow statement prepared on this is called a cash flow
statement. Such a statement enumerates net effects of the various business transactions on cash
and takes into account receipts and disbursements of cash.In Broader sense:
The term Funds refers to money values in whatever from it may exist here Funds means
all means all financial resources used in business whatever in the firm of men, material, money,
machinery and others.
In a Popular Sense:
The term Funds means working capital i.e., the excess of current assets over current
liabilities. The working capital concept of funds has emerged due to fact that total resource of a
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business are invested partly in fixed assets in the form of fixed capital and partly kept in firm of
liquid of near liquid form as working capital.In any business we cannot under estimate the flow of funds from two operations. The
business runs with funds but the organization knows how much important the flow of funds is.18
The Funds Flow Statement is concerned with sources and applications of organization.Statement of changes in working capital shows the increase or decrease in workingcapital.Funds from Operation statement shows how much funds from operations.IMPORTANCE OF FUNDS FLOW ANALYSIS:
The importance of funds Flow analysis and ratio analysis in all undertakings needs noemphasis.How is it managed? What are the practices adopted? What are the problems faced?
This study is an attempt to answer the questions. This is considered to M/S. PENNACEMENT LIMITED, TADPATRI.Funds Flow Statement, Income Statement and Balance Sheet:
Funds Flow Statement is not a substitute of an income statement i.e., a Profit and Loss
Account, and a Balance Sheet. The Profit and Loss Account is a document, which indicates the
extent of success achieved by a business in earning profits.
A balance sheet is a statement of financial position or status of business on given date.
It is prepared at end of accounting period. The balance sheet depicts various resources of an
understanding and the deployment of these resources in various assets on a particular date. As it
indicates the financial condition on a particular date, it is static in nature; while funds flow
statement is a dynamic one.19
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Funds Flow Statement tells us many financial facts, which a balance sheet cannot tell.
Balance sheet does not disclose the cause for change in the assets and liabilities between two
different points of time. Again, while balance sheet is the end result of all accounting operations
for a period of time? The funds flow statement provides additional information as regard changes
in working capital derived from financial statements at two points of time. It is a tool of
management for financial analysis and helps in making decisions.1. It helps in the Analysis of Financial operations:
The financial statements reveal the net effect of various transactions on the operational
and financial position of the concern. The balance sheet gives a static view of the resource of a
business and these have been put at a certain point of time. But it does not disclose the causes
for changes in the assets and liabilities between two different points of time. The funds flow
statements explains cause for such changes and also effect these changes on the liability
position of the company. Some times concern may operate profitability and yet its cash position
may become more and worse. The funds flow statement gives a clear answer to such a situation
explaining what happened to the profits firm.2. It throws light on May perplex Questions of general interest:
Why were the net current assets lesser in spite of higher profits and vise versa?
Why more dividends could not be declared in spite of available profits?
How was it possible to distribute more dividends than the present earnings?
What happened to the profit and where it has gone?20
What happened to the proceeds of sales of fixed assets, issue of shares,debentures, etc?3. It helps in the Formation of Business of Realistic Dividend Policy:
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Sometimes a firm has sufficient profits available for distributing as dividend but yet may
not be available to distribute for cash resources. In such cases a funds flow statement helps in
the information of a realistic dividend policy.4. It helps in the proper Allocation of Resources:
The resources of a concern are always limited and it wants to make the best use of
these resources. A project funds flow statement constructed for the future helps in making
managerial decisions. The firm can plan the development of its resources and allocate them
many various applications.
5. It Acts as a Future Guide:
A projected funds flow statement also acts as a guide for future to the management. The
management can come to know the various problems it ids going to face in near future for want of
funds. The firms future needs of funds can arrange to finance these needs more effectively and
avoid future problems.6. It helps in appraising the use of Working Capital:A funds flow statement helps in explaining the management has its working capitalandalso suggest way the management has used its working capital position of the firm.7. It helps knowing the Overall credit Worthiness of a firm:21
The financial institution and banks such as state financial institutions, industrial
development corporation of India, Industrial Development Bank of India etc., all ask for funds flow
statement constructed for a number of years before granting loans to know the credit worthiness
and paying capacity of firm. Hence a firm is seeking assistance from these institutions has to
know alternate but to prepare functional statement.LIMITATIONS OF FUNDS FLOW STATEMENT
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The Funds Flow Statement has a number of uses: however, it has certain limitationsalso,which are listed below.
It should remember that a Funds Flow Statement is not a substitute of an income statement or a
balance sheet. It provides only some additional information as regards chances in working
capital.
It cannot reveal continuous changes.
It is not an original statement but simply is arrangement of date given in thefinancial statements.
It is essentially historic in nature and project funds flow statement cannot beprepared with much accuracy.
Changes in cash are more important and relevant for financial managementthan the working capital.Business transactions and flow of funds:22
It may be noted at this stage of analysis that for the purpose of funds flow
statement, the items of balance sheet are classified into two broad categories viz.,Items of current
accounts and Items of non-current accounts.Current account ItemsCurrent assetsCurrent liabilitiesCash in handBills payableCash at bank (including fixed deposits)
Trade or sundry creditorsBills receivableOutstanding expences
Trade or sundry debtorsCash credit/bank overdraft
Inventory-Raw-materials, work in-progress, Finished Goods, Stores,etcShort-term loansPrepaid expensesIncome received in advanceOutstanding incomesLong-term loans (or part) which fall due forrepayment within a yearShort-term loans and advances
Temporary investments, etc
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Provision for doubtful debts and discounton debtors23
Non-current Account Items
The word fund is to denote working capital. Funds flow there fore refers to the changes in the
fund (i.e., working capital) by the transactions operational, financial and investment, though the
effect of all the transactions on the funds are considered, it should be remembered here that not
all the transactions cause the flow of funds .
Transactions Affecting Flow of Funds:Increase in current assets but not any increase in current liabilities.
Decrease in current assets but not any decrease in current liabilities.
Increase in current liabilities but not any increase in current assets.
Decrease in current liabilities but not any decrease in current assets.24
Transactions not Affecting Flow of Funds:(CHANGE IN WORKING CAPITAL)
Transactions which make conversions of one current into another currentassets.
Transactions which make conversions of one current liability intoanother current liability.
Transactions which bring increase or decrease in current assets causing a corresponding
increase or decrease in current liabilities by the same amount.
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Funds Flow Statement: The Funds Flow Statement is also known as FUNDS FLOW ANALYSIS. There areseveral names for this statement; some are
Statement of sources and applications of funds.
Statement of inflow and outflow of funds.
Statement of Fund Supplied and Applied.
Statement of Resources provided and Applied.
Where got and where gone Statement.25
Funds Flow Statement: The Funds Flow Statement is also known as FUNDS FLOW ANALYSIS. There areseveral names for this statement; some are
Statement of sources and applications of funds.Statement of inflow and outflow of funds.
Statement of Fund Supplied and Applied.
Statement of Resources provided and Applied.
Where got and where gone Statement.
various factors for inflow and outflow of working capital area shown in a statement, particularly
prepared for this purpose, which is known a Funds Flow Statement . This statement reveals
the manner in which the financial resources have been generated and deployed during the
accounting period. This statement is also considered as an important one as the two traditional
financial statements as it supplies important information for the users. In brief it may be said that
fund statement focuses on the flow of funds between the various assets and equity items during
the accounting period and on analysis basis this statement is generally called as Funds Flow Analysis.26
IMPORTANCE OF FUNDS FLOW STATEMENT:
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The balance sheet and profit and loss account failed to provide the information which is provided
by Funds Flow statement i.e., changes in financial position of an enterprise. This statement
indicates the changes in financial position of an enterprise.
This statement indicates the changes which have taken place between the twoaccounting dates.
Gives details of sources and uses of funds during given period is of great help tothe users of financial information.
It is also a very useful tool in the hands of management judging the financial andoperating performance of the company.
It also indicates the working capital position which helps the management intaking policy decisions regarding dividend etc.,
Funds Flow statement helps in answering questions like where the profits have gone? Why there
is imbalance existing between liquidity position and profitability position of the enterprise? Why is
the concern financially solid in spite of losses?
It helps management to take policy decisions to decide about the financingpolicies and capital expenditure programmed for future.27
DIFFERENCE BETWEENFUNDS FLOW STATEMENT AND BALANCESHEETFUNDS FLOW STATEMENT
BALANCE SHEET1.It is a statement of changes in1. It is a statement of financialFinancial position and hence isposition on a particular dateDynamic in natureand hence static in nature.2.It shows the sources and2. It depicts the assets andApplications of funds in a
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funds liabilities at aParticular period of time.Particular point of time.3.It is a tool of management for3. It is not of much help toFinancial analysis and helps in
management in makingMaking decisions.Decisions.4.Usually, schedule of changes in4. No such schedule of Working capital has to be preparedchanges in workingBefore preparing funds flowcapital is required ratherStatement.Profit & loss account isPrepared.28
DIFFERENCE BETWEENFUNDS FLOW & CAH FLOW STATEMENTFUNDS FLOW STATEMENTCASH FLOW STATEMENT1. It is based on a wider concept1.It is based on a narrowerof Funds, i.e., working capital.concept of funds i.e., Cash.2. It is based on accrual basis of 2. It is based on cash basis of Accounting.Accounting.
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3. Schedule of changes in3. Schedule of changes inworking capital is requiredworking capital is notto be prepared.required to be prepared.
4. Funds Flow Analysis reveals4. It is prepared by taking thethe sources and applicationsopening balance of cash,of funds the net differenceadding to this all the inflowsbetween sources and applicationof cash and deducting theof funds represents net increaseoutflows of cash from theor decrease in working capital.total, difference representsClosing balance of cash.5. It is useful for long term planning.5. It is more useful for shortterm analysis and cash29
Planning.PROCEDURE FOR PREPARING A FUNDS FLOW STATEMENT
Funds Flow statement is a method by which we study changes in the financial position of
a business enterprise between beginning and ending financial statements dates. Hence, the
funds flow statement is prepared by comparing two balance sheets and worth the help of such
other information derived form the accounts as may be needed.Broadly speaking, the preparation of funds flow statement consists of two parts:
Statement of Schedule of Changes in Working Capital
Statement of sources and Application of Funds1. Statement of Changes in Working Capital:
Working Capital means the excess of current assets over current liabilities. Statement
of Changes in Working Capital Is prepared to show the changes in the working capital between
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the two balance sheet dates. This statement is prepared with the help of Current Assets and
Liabilities derived with the help of Current Assets and Current Liabilities derived from the two
balance sheets as:
Working Capital = Current Assets Current Liabilities.
An increase in Current Assets increase Working Capital
A decrease in Current Assets decrease Working Capital
An increase in Current Liabilities decrease Working Capital
A decrease in current Liabilities increase Working Capital30
The changes in all current assets and liabilities are merged into one figure only either
an increase or decrease in working capital over the period for which funds statements has been
prepared. If the working capital at the end of the period is more than the working capital at the
beginning thereof, the difference is expressed as Increase in working capital. On the other hand,
if the working capital at the end of the period is less than that at the commencement, the
difference is called Decrease in Working Capital2. Funds Flow Statement:
Funds flow statement is a final statement. It shows the amount used in a particular
period of time i.e., Application of Funds and the how much amount comes into the organization
in a particular period. Finally those application and sources are balanced.31
1) Schedule of changes in Working capital:32
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33PARTICULARS
PREVI
OUS
YEAR
CURR
ENT
YEAREFFECT ONWORKING CAPITALINCREASEDECREASECURRENT ASSETS
Inventories
Sundry Debtors
Cash &Bank
Loans& Advances Total Current Assets(a)CURRENTLIABILITIESCurrent LiabilitiesProvisions
Total current
liabilities(b)****************
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**********
**--**-**--****-********************************Working Capital (a-b)Net increase or decresein working capital************
****
**********
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