Successfully reported this slideshow.
You’ve unlocked unlimited downloads on SlideShare!
LIMITATIONS OF FINANCIAL STATEMENTS• 1. Lack of Precision• 2. Lack of Exactness• 3. Incomplete Information• 4. Interim Reports• 5. Hiding of Real Position or Window Dressing• 6. Lack of Comparability• 7. Historical Costs
Analysis• Analysis – To Analyse – to cut into pieces• 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. Comparative Statements• 2. Common Size Statements• 3. Trend Analysis• 4. Ratio Analysis• 5. Fund Flow Statement• 6. 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. Profitability Analysis• 2. Liquidity Analysis• 3. Solvency Analysis (To know the financial structure)
Interested Parties in Analysis of Financial Statements• 1. Management• 2. 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.
Types of common size statements.• (1)Common Size Balance Sheet• (2)Common Size Income Statement:
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.
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:• (1) It will give a misleading picture if consistency in accounting principle is not followed.• (2) Constant change in price level render accounting statement useless for comparison.• (3) During inflationary period the data over a period of time become incomparable, unless the absolute rupee data is adjusted.• (4) There is always the danger of selecting the base year which may not be representative, normal & typical.• (5) 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 %.
4. Ratio Analysis• TRADITIONAL CLASSIFICATION• BALANCE SHEET RATIOS• (1) Current Ratio• (2) Quick Ratio / Liquid Ratio / Acid Test Ratio.• (3) Super Quick Ratio• (4) Stock to work Capital Ratio (5) Capital Gearing Ratio• (6) Debt Equity Ratio• (7) Proprietary Ratio• (8) Long Term Borrowing : Total Asset• (9) Fixed Assets : Net Worth.
REVENUE STATEMENT RATIOS• Gross Profit Ratio• Net Profit Ratio• Operating Net Profit Ratio• Operating Ratio• Operating Expenses Ratio• Stock Turnover Ratio• Stock Holding Period
COMBINED RATIOS• Return on Investment (ROI) or Return on Capital Employed (ROCE)• Return on Proprietor / Shareholder fund• Return on Equity shareholder fund• Earning per share• Dividend per share• Dividend Payout Ratio• Price Earning Ratio• Interest Coverage Ratio
BASED ON FUNCTIONS• SOLVENCY RATIOS• Short Term Solvency• Current Ratio• Quick Ratio / Liquid Ratio / Acid Test Ratio• Super Quick Ratio• Stock : Working Capital Ratio.
Long Term Solvency / Leverage Ratio /• Capital Gearing• Debt : Equity Ratio• Proprietary Ratio• Long Term Borrowing: Total Assets• ( 1 – Net Worth )/ Total Assets• Fixed Asset : Net worth
ACTIVITY RATIO / TURNOVER RATIOS• Stock Turn Over Ratio Stock Holding Period Debt Collection Period Debtor Turnover Ratio Creditor Payment Period Creditor Turnover Ratio
PROFITABILITY RATIO• In relation to sales• Gross Profit Ratio• Net Profit Ratio• Operating Net Profit Ratio• Operating Ratio• Operating Expenses Ratio.
In relation to capital employed• Return on Interest (ROI) or Return on Capital Employed (ROLE)• Return on Proprietor / Shareholder funds• Return on Equity Shareholder Fund• Earning per Share• Dividend per Share• Dividend Payout Ratio• Price Earning Ratio
USER BASED CLASSIFICATION• FOR SHORT TERM CREDITORS• (1) Current Ratio• (2) Quick / Liquid Ratio / Acid Test Ratio• (3) Super Quick Ratio• (4) Stock : Working Capital Ratio• (5) Stock Turnover Ratio• (6) Stock Holding Period• (7) Creditor Payment Period (8) Creditor Turnover Ratio
FOR LONG TERM CREDITORS• Capital Gearing Ratio• Debit : Equity Ratio• Proprietary Ratio• Long Term Borrowing : Total Asset Ratio• Fixed Asset : Net worth• Interest Coverage Ratio• Debt Service Coverage Ratio
FOR SHARE HOLDERS• Return on Investment (ROI) or Return on Capital Employed (ROCE)• Return on Proprietary / Shareholder fund• Return on Equity Shareholder fund• Earning per share• Dividend per share• Dividend payout Ratio• Price Earning Ratio• Preference Dividend Cover• Equity Dividend Cover
FOR MANAGEMENT• Return on Investment (ROI) or Return on Capital Employed (ROCE)• Debtor Turnover Ratio• Debtor Collection Period• Creditor Payment period• Creditor Turnover Ratio• Stock Turnover Ratio• Stock Holding Period
FOR MANAGEMENT• Gross Profit Ratio• Net Profit Ratio• Operating Net Profit Ratio• Operating Ratio• Proprietary Ratio• Fixed Asset : Net Worth• Long Term Borrowing : Total Assets