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Financial statement analysis


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  • 1. Financial Statement AnalysisMeaning and techniquesDr. M. Kanchan
  • 2. FSA• Process of identifying the financial strengths andweakness by establishing a strategic relationshipbetween Balance sheet and P/L A/c items.• Consists of: Comparative statements, trendanalysis, schedule of changes in WorkingCapital, Funds flow and Cash flow statements, CVPanalysis and Ratio Analysis• Dr. M. Kanchan
  • 3. Classification of Ratios• 1. Traditional: B/S Ratio, P/L Ratio, Composite Ratio• 2. Functional : Liquidity, Leverage, Activity,Profitability• Significance : Primary, SecondaryDr. M. Kanchan
  • 4. Balance Sheet Ratios• a. Current Ratio• b. Liquid /Acid test /Quick Ratio• c. Debt-Equity• d. Proprietary• e. Capital Gearing• f. Capital Inventory to WC Ratio• g. Current assets: Fixed assetsDr. M. Kanchan
  • 5. P/L A/c Ratios• Gross Profit Ratio• Operating Ratio• Operating Profit Ratio• Net Profit Ratio• Expense Ratio• Interest Coverage Ratio.Dr. M. Kanchan
  • 6. Composite/Inter-statement Ratios• Stock Turnover• Debtors Turnover• Payables Turnover• Fixed Assets Turnover• Return on Equity• Return on Shareholders’ Funds• Return on Total ResourcesDr. M. Kanchan
  • 7. Functional Classification of Ratios• Liquidity• Long term solvency/Leverage• Activity• ProfitabilityDr. M. Kanchan
  • 8. Components of Current Ratio• Current Assets: Current Liabilities• Cash in hand Outstanding Expenses• Cash at Bank Bills Payable• Short term marketable securities Sundry Creditors• Short term investments Short term advances• Bills Receivables Income tax payable• Sundry Debtors Dividend Payable• Stock Bank Overdraft• Work-in- progress• Prepaid expensesDr. M. Kanchan
  • 9. Interpretation of Current Ratio• Rule of Thumb: 2 CA : 1 CLHigh Current ratio may not be favourable• There may be slow moving stock• Debt collection may not be satisfactory• Cash /Bank may be idleDr. M. Kanchan
  • 10. Important factors• Type of Business• Type of Products• Reputation of the Concern• Seasonal Influence• Type of Assets availableLimitations:• Window Dressing• UnrefinedWeighted Current RatioTime Adjusted Current Ratio• DF= 1/(1+r)n Where DF= Discount Factor, r= annual Earnings Rate beforetax, n= time taken for each current asset and liability to be converted intocash.Dr. M. Kanchan
  • 11. Quick/Acid Test/Liquid Ratio• Components:• Quick Assets Current Liabilities• current Assets-(Inventories + prepaid exp)• Cash in hand Outstanding expenses• Cash at Bank Bills Payable• Bills Receivables Sundry creditors• Sundry Debtors Short-term advances• Marketable securities Income tax payable• Temporary Investments Dividends PayableBank overdraftRule of thumb: 1 : 1Dr. M. Kanchan
  • 12. Absolute Quick/Cash Ratio• AQ Ratio= Cash in hand + at Bank +Short term securities /CLRule of thumb: 0.5 : 1Interval Measure =Quick assets/Average Daily Cash expADC exp= Cost of goods sold+Admn and sell & dist exp (less depand non-cash exp)/No. of days in a yearDr. M. Kanchan