ANALYSIS OF FINANACIAL STATEMENTS

FINANCIAL STATEMENT ANALYSIS

Analysis of financial statement means a systematic and specialized treatment of the information found in financial statements so as to derive useful conclusions on the profitability and solvency of the business entity concerned.
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Objectives of Financial Statement Analysis

Profitability Analysis

Liquidity Analysis

Solvency Analysis

 Profitability Analysis: Users of financial statements may analyze financial statements to decide past and present profitability of the business
Liquidity Analysis: Suppliers of goods, moneylenders and financial institutions may do a liquidity analysis to find out the ability of the company to meet its obligations Solvency Analysis: It refers to analysis of long term financial position of the company. This analysis helps to test the ability of a company to repay its debts.

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

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 explanatory Notes

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 the funds came from

Balance Sheet
A balance sheet is a statement of the total assets and liabilities 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 of fixed assets, current assets and the liabilities (sometimes referred to as "Net Assets") (2) A statement showing how the Net Assets have been financed, for example through share capital and retained profits.

INCOME STATEMENT
Income statement shows all revenues and expenditure over the period and the profitability .Specific information in the income statement include, Revenue, Cost of Sales, Gross Profit, Operating Expenditures, finance costs, Depreciation. An income statement reports the organizations financial performance over a specified period of time. It summarizes all revenue earned and expenses incurred during a specified accounting period. An institution prepares an income statement so that it can determine its net profit or loss (the difference between revenue and expenses).

CASH FLOW STATEMENT

A cash flow statement shows where an institutions cash 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 (incomeearning activities). Investing activities: expenditures that have been made for resources intended to generate future income and cash flows. Financing activities: resources obtained from and resources returned to the owners, resources obtained through borrowings (short-term or longterm) as well as donor funds.

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 the organization over a number of years. It is also referred to as Time Series Analysis or Trend Analysis Inter Firm Analysis: It is a comparison of two or more organizations in terms of various financial variables. Standard Analysis: only one set of financial statements of an organization is analyzed on the basis of standard set for the firm or industry Horizontal analysis: It is a comparison of figures reported in financial statements of two or more consecutive accounting periods i.e. Analysis across years Vertical Analysis: comparing figures I the financial statements of a single period is known as Vertical Analysis
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1. COMPARATIVE FINANCIAL STATEMENTS Comparative financial statements are statements of the financial position of a business so designed as to facilitate comparison of different accounting variables for drawing useful inferences Comparative financial statements show: Absolute data for each of the periods stated Changes in absolute data in terms of rupees Changes in absolute data in percentages

a) b) c)

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Advantages
Indicates the direction of movement and the financial 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 accounting principles over a period of time is not consistent. Consistent changes in price levels render accounting statements 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 analysis would be rendered useless 15

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 the trend% 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 program which 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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Comments/derivations
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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Advantages
Indicates the direction of movement of financial 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 financial performance of a company over a period of time.
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Disadvantages
Any 1 trend by itself does not show the true picture. 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 or typical.

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