ANALYSIS OF FINANCIAL STATEMENTS

NATURE OF FINANCIAL STATEMENT

The data exhibited by financial statements are affected by a) Recorded facts b) Accounting Concepts, Conventions & Principles c) Personal Judgment

ESSENTIAL QUALITIES OF FINANCIAL STATMENTS

1. 2. 3. 4. 5. 6.

Relevance Understandability : Reliability and Accuracy Comparability Completeness Timeliness

LIMITATIONS OF FINANCIAL STATEMENTS

1. 2. 3. 4. 5. 6. 7.

Lack of Precision Lack of Exactness Incomplete Information Interim Reports Hiding of Real Position or Window Dressing Lack of Comparability Historical Costs

ANALYSIS

Analysis To Analyse But only analyse No It means also Interpretation.

Thus, Financial Statement Analysis means Analysis, comparisons and interpretation of Financial data to achieve the desired result

TOOLS OF FINANCIAL STATEMENT ANALYSIS

1. 2. 3. 4. 5. 6.

Comparative Statements Common Size Statements Trend Analysis Ratio Analysis Fund Flow Statement Cash Flow Statement

TYPES OF FINANCIAL ANALYSIS

1. Intra-Firm Comparison 2. Inter-firm Comparison 3. Industry Average or Standard Analysis: 4. Horizontal Analysis 5. Vertical Analysis

INTERPRETATION

The Analysis is of no use without interpretation The Company has to interpret the financial statement which it has analysed. The Analysis is made to serve the following purpose 1. 2. 3. Profitability Analysis Liquidity Analysis Solvency Analysis (To know the financial structure)

INTERESTED PARTIES IN ANALYSIS OF FINANCIAL STATEMENTS

1. 2.

Management Investors (In the form of Shareholders or Debentureholders) 3. Banks and Financial Institution 4. Trade Creditors 5. Government and their Agencies 6. Employees 7. Customers 8. Public 9. Trade Association 10. Stock Exchange

1. COMPARATIVE FINANCIAL STATEMENTS

Comparative Financial Statements is a statement of Financial Position of a business designed in such a way where a comparative study is undertaken of different accounting items, to measure the performance of a Business Activity.

TYPES OF COMPARISON
There are 3 types of Comparison 1) Inter Firm Comparison 2) Intra Firm Comparison 3) Inter Period Comparison

MERITS:

1) Indicate the Direction of Financial Position 2) Reveal Nature & Trend 3) Identifying Trouble Spots

DISADVANTAGES:

1) Misleading picture, if consistency in accounting principle not followed. 2) Constant change in price level tender accounting statement useless for comparison. 3) Inter firm comparison is useless, unless all the firms are of the same age, size and follow the same principles.

4) If there exists any Abnormal Period between 2 successive accounting period then it will prove to be a pointless analysis.

2. COMMON SIZE STATEMENTS

It is a Statement in Vertical Form in which every item of the Financial Statement is reduced to a common base. This was introduced with a view to overcome the limitation of Comparative Statement. An analysis of percentage financial statements where all balance sheet items are divided by total assets and all income statement items are divided by net sales or revenues.

TYPES OF COMMON SIZE STATEMENTS.

(1)Common Size Balance Sheet (2)Common Size Income Statement:

Basket Wonders Common Size Balance Sheets

Regular (thousands of $) Assets Cash AR Inv Other CA Tot CA Net FA LT Inv Other LT Tot Assets 2005 148 283 322 10 763 349 0 111 1,223 2006 100 410 616 14 1,140 631 50 223 2,044 2007 90 394 696 15 1,195 701 50 223 2,169 Common-Size (%) 2005 12.10 23.14 26.33 0.82 62.39 28.54 0.00 9.08 100.0 2006 4.89 20.06 30.14 0.68 55.77 30.87 2.45 10.91 100.0 2007 4.15 18.17 32.09 0.69 55.09 32.32 2.31 10.28 100.0

Basket Wonders Common- Size Balance Sheets

Regular (thousands of $) Liab+Equity Note Pay Acct Pay Accr Tax Other Accr Tot CL LT Debt Equity Tot L+E 2005 290 81 13 15 399 150 674 1,223 2006 295 94 16 100 505 453 1,086 2,044 2007 290 94 16 100 500 530 1,139 2,169 Common-Size (%) 2005 23.71 6.62 1.06 1.23 32.62 12.26 55.11 100.0 2006 14.43 4.60 0.78 4.89 24.71 22.16 53.13 100.0 2007 13.37 4.33 0.74 4.61 23.05 24.44 52.51 100.0

Basket Wonders Common- Size Income Statements

Regular (thousands of $) 2005 Net Sales COGS Gross Profit Adm. EBIT Int Exp EBT EAT Cash Div 1,235 849 386 180 206 20 186 112 50 2006 2,106 1,501 605 383 222 51 171 103 50 2007 2,211 1,599 612 402 210 59 151 91 50 Common-Size (%) 2005 100.0 68.7 31.3 14.6 16.7 1.6 15.1 9.1 4.0 2006 100.0 71.3 28.7 18.2 10.5 2.4 8.1 4.9 2.4 2007 100.0 72.3 27.7 18.2 9.5 2.7 6.8 4.1 2.3

ADVANTAGES OF COMMON SIZE STATEMENT

1) It reveals Sources and Application of Funds in a nutshell which help in taking decision. (2) If common size statements of 2 or more years are compared it indicate the changing proportion of various components of Assets, Liabilities, Cost, Net Sale & Profit. (3) When Inter Firm Comparison is made with the help of Common size statement it helps in doing corporate evaluation and Ranking.

DISADVANTAGES OF COMMON SIZE STATEMENT

(1) No Established Standard Proportion: Common Size Statements are regarded as useless as there is no established standard proportion of an asset to the total asset or an item of expense to the net sales.

(2) Consistency Required:If Financial Statement of a Particular business organization are not prepared year after year on a consistent basis comparative study of common size statement will be misleading

3. TREND ANALYSIS

Trend Analysis is a statement in vertical form where the earliest year is taken as base year and the value of all the items in the financial statements will be related to the base year in terms of % where value of each item in base year will be considered as 100. Trend % analysis move in one directions either upward or downward progression or regression.

Basket Wonders Indexed Balance Sheets

Regular (thousands of $) Assets Cash AR Inv Other CA Tot CA Net FA LT Inv Other LT Tot Assets 2005 148 283 322 10 763 349 0 111 1,223 2006 100 410 616 14 1,140 631 50 223 2,044 2007 90 394 696 15 1,195 701 50 223 2,169 2005 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Indexed (%) 2006 67.6 144.9 191.3 140.0 149.4 180.8 inf. 200.9 167.1 2007 60.8 139.2 216.1 150.0 156.6 200.9 inf. 200.9 177.4

Basket Wonders Indexed Balance Sheets

Regular (thousands of $) Liab+Equity Note Pay Acct Pay Accr Tax Other Accr Tot CL LT Debt Equity Tot L+E 2005 290 81 13 15 399 150 674 1,223 2006 295 94 16 100 505 453 1,086 2,044 2007 290 94 16 100 2005 100.0 100.0 100.0 100.0 Indexed (%) 2006 101.7 116.0 123.1 666.7 126.6 302.0 161.1 167.1 2007 100.0 116.0 123.1 666.7 125.3 353.3 169.0 177.4

500 100.0 530 100.0 1,139 100.0 2,169 100.0

Basket Wonders Indexed Income Statements

Regular (thousands of $) 2005 Net Sales COGS Gross Profit Adm. EBIT Int Exp 1,235 849 386 180 206 20 2006 2,106 1,501 605 383 222 51 200 7 2,211 1,599 612 402 210 59 2005 100.0 100.0 100.0 100.0 100.0 100.0 Indexed (%) 2006 170.5 176.8 156.7 212.8 107.8 255.0 2007 179.0 188.3 158.5 223.3 101.9 295.0

EBT
EAT Cash Div

186
112 50

171
103 50

151
91 50

100.0
100.0 100.0

91.9
92.0 100.0

81.2
81.3 100.0

ADVANTAGES:

(1) Trend % indicate the increase or decrease with the magnitude of change in % which is more effective than absolute data. Ex. If we say profit increases by Rs. 50,000/- it will be meaningless unless we find by what % the profit has increased. (2) Facilitate efficient comparative study of financial performance

LIMITATIONS:

It will give a misleading picture if consistency in accounting principle is not followed. Constant change in price level render accounting statement useless for comparison. During inflationary period the data over a period of time become incomparable, unless the absolute rupee data is adjusted. There is always the danger of selecting the base year which may not be representative, normal & typical.

Trend % should be studied in relation with Absolute figure otherwise it give misleading picture. For ex. No. of student where 2, the next year they increased to 4. Now trend % show 100% increase but absolutely we get clear picture than trend %.

CASE:

REQUIRED :
a. Use horizontal analysis to determine which expense item increased by the highest percentage from 2008 to 2009. b. Use vertical analysis to determine whether the inventory balance is a higher percentage of total assets in 2008 or 2009.