Analysis of financial statements – Financial ratio analysis, cash flow (as per Accounting Standard 3) and funds flow statement analysis.

1. ACCOUNTING
FOR
MANAGEMENT
UNIT-III
Semester: I
Course Code: BA5103
Dr.N.Ramesh Kumar

2. Analysis of Financial Statements
Analysis of financial statements – Financial
ratio analysis, cash flow (as per Accounting
Standard 3) and funds flow statement analysis.

3. Financial statement analysis
The process of understanding the risk and
profitability of a firm (business, sub-business or
project) through analysis of reported financial
information, by using different accounting tools
and techniques

4. Objectives
• Assessment of Past Performance
• Assessment of current position
• Prediction of profitability and growth
prospects
• Prediction of bankruptcy and failure
• Assessment of the operational efficiency

5. Methods or Techniques
• Ratio Analysis
• Cash Flow Analysis
– Fund Flow Statement
– Cash Flow Statement
• Comparative Financial Statements
– Comparative Income Statement
– Comparative Balance Sheet
• Common Size Financial Statement
– Common Size Income Statement
– Common Size Balance Sheet
• Trend Analysis

6. What is Ratio Analysis?
Ratio analysis is the comparison of line items in
the financial statements of a business.
Ratio analysis is used to evaluate a number of
issues with an entity, such as its liquidity,
efficiency of operations, and profitability.

8. Definition
Ratio Analysis – Ratios are a mathematical
tool that helps in defining the relationship
between two figures.
The analysis and interpretation of financial
statements is carried out with the help of Ratio
Analysis.

9. • Highlights the area of concern
• Facilitates comparison
• Evaluation of efficiency
• Forecasting and planning
• Transparency to stakeholders
• Better decision making
• Simplicity
Objectives

10. Classification of Ratios
• Liquidity ratios
• Profitability Ratios
• Turnover Ratios
• Solvency Ratios
• Overall Profitability Ratios

11. I. LIQUIDITY RATIOS
• Current Ratio.
• Quick Ratio / Acid Test / Liquid Ratio.
• Absolute Liquid Ratio / Cash Position
Ratio.

12. Components of Current Assets and Current
Liabilities
Current Assets Current Liabilities
Cash in Hand Sundry Creditors (Accounts Payable)
Cash at Bank Bills Payable
Sundry Debtors Outstanding and Accrued Expenses
Bills Receivable Income Tax Payable
Marketable Securities
( Short-Term) Short-Term Advances
Other Short-Term
Investments Unpaid or Unclaimed Dividend
Inventories : Bank Overdraft (Short-Term period)
Stock of raw materials
Stock of work in progress
Stock of finished goods

13. Current Ratio

14. Quick Ratio
Quick Ratio establishes the relationship between
the quick assets and current liabilities. In order to
compute this ratio, the below presented formula
is used:
Quick Asset = (Current Assets - Stock and Prepaid
Expenses)

15. Absolute Liquid Ratio
• This ratio established the relationship between
the absolute liquid assets and current
liabilities.
Absolute Liquid Assets = Cash in Hand + Cash at
Bank
+ Marketable Securities

16. II. PROFITABILITY RATIOS
The term profitability means the profit earning
capacity of any business activity.
• Gross Profit Ratio.
• Operating Ratio.
• Operating Profit Ratio.
• Net Profit Ratio.
• Return on Investment
Ratio.
• Return on Capital
employed Ratio.
• Earnings Per Share Ratio.
• Dividend Payout Ratio.
• Dividend Yield Ratio.
• Price Earnings Ratio.

17. Gross Profit Ratio.
Gross Profit Ratio established the relationship
between gross profit and net sales. It is usually
indicated as percentage.
Gross Profit = Sales - Cost of Goods Sold
Net Sales = Gross Sales - Sales Return
Cost of goods sold = Opening Stock + Purchases - Closing
Stock

18. Operating Ratio
Operating Ratio is calculated to measure the
relationship between total operating expenses
and sales .
Operating Cost = Cost of goods sold +
Administrative Expenses + Selling and
Distribution Expenses
.

19. Operating Profit Ratio
Operating Profit Ratio indicates the operational
efficiency of the firm and is a measure of the firm's
ability to cover the total operating expenses.
Operating Profit = Net Sales -Operating Cost
= Net Sales - (Cost of Goods Sold + Office and Administrative
Expenses + Selling and Distribution Expenses)
= Gross Profit - Operating Expenses
= Net Profit+ Non-Operating Expenses -Non-Operating
Income

20. Net Profit Ratio
Net profit Ratio is used to measure the relationship
between net profit (either before or after taxes) and
sales.

21. Return on Investment Ratio
This ratio establishes the relationship between net
profit after interest and taxes and the owner's
investment.
Shareholder's Investments = Equity Share Capital +
Preference Share Capital + Reserves and Surplus –
accumulated Losses.
Net Profit (after interest and tax)= Net Profit - Interest and
Taxes

22. Return on Capital Employed
Ratio
Return on Capital Employed Ratio measures a
relationship between profit and capital employed
Gross Capital Employed= Fixed Assets + Current
Assets

23. Earning Per Share Ratio
Earning Per Share Ratio (EPS) measures the
earning capacity of the concern from the owner's
point of view and it is helpful in determining the
price of the equity share in the market place.

24. Dividend Payout Ratio
This ratio highlights the relationship between
payment of dividend on equity share capital and the
profits available after meeting tax and preference
dividend.

25. Dividend Yield Ratio
Dividend Yield Ratio indicates the relationship is
established between dividend per share and market
value per share.

26. Price Earning Ratio
Price Earning Ratio establishes the relationship
between the market price of an equity share and the
earning per equity share.

27. III. TURNOVER RATIOS
• Stock Turnover Ratio
• Debtor's Turnover Ratio
– Debtor's Collection Period Ratio
• Creditor's Turnover Ratio
– Debt Payment Period Ratio
• Working Capital Turnover Ratio
• Fixed Assets Turnover Ratio
• Capital Turnover Ratio.

28. Stock Turnover Ratio
• This ratio is also called as Inventory Ratio or Stock
Velocity Ratio.
• This ratio is used to measure whether the investment
in stock in trade is effectively utilized or not.
• Cost of Goods Sold= Total Cost of Production + Opening
Stock of Finished Goods –Closing Stock of Finished Goods
• Total Cost of Production = Cost of Raw Material Consumed
+ Wages + Factory Cost (OR) = Sales - Gross Profit
• Average Stock= Opening Stock + Closing Stock/2

30. Debtor's Turnover Ratio
• Debtor's Turnover Ratio is also termed as Receivable
Turnover Ratio or Debtor's Velocity.
• Debtor's Velocity indicates the number of times the
receivables are turned over in business during a
particular period
• Net Credit Sales = Total Sales - (Cash Sales + Sales Return)
• Accounts Receivable = Sundry Debtors or Trade Debtors +
Bills Receivable
• Average Accounts Receivable = Opening Receivable +
Closing Receivable / 2

31. a. Debt Collection Period Ratio
This ratio indicates the efficiency of the debt collection
period and the extent to which the debt have been
converted into cash.

32. Creditor's Turnover Ratio
• Its also called as Payable Turnover Ratio or
Creditor's Velocity.
• Creditor's velocity ratio indicates the number of times
with which the payment is made to the supplier in
respect of credit purchases.
• Net Credit Purchases = Total Purchases - Cash Purchases
• Average Accounts Payable = Opening Payable + Closing
Payable / 2

33. a. Average Payment Period

34. Working Capital Turnover Ratio
• This ratio represent the firm's liquidity position. It
establishes relationship between cost of sales and
networking capital
Working Capital = Current Assets - Current
Liabilities

35. Fixed Assets Turnover Ratio
Fixed Assets Turnover Ratio is used to measure the
utilization of fixed assets. This ratio establishes the
relationship between cost of goods sold and total fixed
assets.

36. Capital Turnover Ratio
This ratio measures the efficiency of capital utilization
in the business. This ratio establishes the relationship
between cost of sales or sales and capital employed or
shareholders' fund.
Capital Employed = Shareholders' Funds + Long-Term
Loans
(or) Total Assets - Current Liabilities

37. IV. SOLVENCY RATIOS
Solvency Ratio indicates the sound financial position of
a concern to carryon its business smoothly and meet its
all obligations.
1.Debt - Equity Ratio
2.Proprietary Ratio
3.Capital Gearing Ratio
4.Debt Service Ratio or Interest Coverage Ratio

38. Debt Equity Ratio
This ratio is calculated to ascertain the firm's
obligations to creditors in relation to funds invested by
the owners. The ideal Debt Equity Ratio is 1: 1.
(OR)

39. • External Equities = Debenture + Sundry Creditors +
Bills Payable + Provision for taxation + Outstanding
Creditors
• Internal Equities = Preference Share Capital + Equity
Share Capital + Capital Reserve + Profit and Loss a/c

40. Proprietary Ratio
Proprietary Ratio is also known as Capital Ratio or Net
Worth to Total Asset Ratio.
Shareholders' Fund= Preference Share Capital + Equity Share
Capital + All Reserves and Surplus
Total Assets = Tangible Assets + Non-Tangible Assets + Current
Assets (or) All Assets including Goodwill

41. Capital Gearing Ratio
The term capital gearing refers to describe the
relationship between fixed interest and/or fixed dividend
bearing securities and the equity shareholders' fund
Equity Share Capital = Equity Share Capital + Reserves and
Surplus
Fixed Interest Bearing Funds = Debentures + Preference Share
Capital + Other Long-Term Loans

42. Debt Service Ratio
This ratio establishes the relationship between the
amount of net profit before deduction of interest and tax
and the fixed interest charges

44. MEANING & CONCEPT OF FUND
Funds are amounts of money that are available
to be spent, especially money that is given to an
organization or person for a particular purpose.
These different interpretations of the concept of
fund are:
• Cash and bank
• Working Capital

45. MEANING OF FLOW OF FUND
• Flow of Fund means the inward and outward
movement of a Fund of an enterprise.
• Flow of Fund means movement of or changes
in the Working Capital (i.e., current) items.

46. • A Fund Flow Statement is a summarized
statement of the movement of Fund (i.e.,
Working Capital) from different activities of a
concern during an accounting period.
• It is prepared to locate the various sources of
Fund inflows into the business and also to
identify the various purposes of Fund
outflows from the business, during two
consecutive Balance Sheet dates
WHAT IS FUND FLOW STATEMENT

47. Importance
• Analyses Financial Statements
• Rational Dividend Policy
• Proper Allocation of Resources
• Guide to Future Course of Action
• Proper Managing of Working Capital
• Guide to Investors
• Evaluation of Performance

48. Limitations
• Historical Nature
• Structural Changes Not Disclosed
• Not Foolproof
• Ignores Non-Fund Items
• Not Relevant

50. Preparation of Fund Flow Statement
• Statement of Changes in Working Capital
• Fund From Operations
• Fund Flow Statement.

51. Statement of Changes in Working
Capital
• It is also termed as Statement of Changes in Working
Capital.
• Before preparation of fund flow statement, it is
essential to prepare first the schedule of changes in
working capital and fund from operations.
• Statement of changes in working capital is prepared
on the basis of items in current assets and current
liabilities of between two balance sheets.

52. Rules for preparing WC statement
• Increase in CA Increases WC
• Decrease in CA Decreases WC
• Increase in CL Decreases WC
• Decrease in CL Increases WC

53. Schedule of Changes in WC
Particulars
Previous
Rs.
Current Year
Rs.
Effect on Working
Capital
Increase Decrease
Current Assets :
Cash in Hand
Cash at Bank
Sundry Debtors
Bills Receivable
Short-Term Investments
Stock
Prepaid Expenses
Outstanding Incomes
Total Current Assets (A) ***** *****

54. Current Liabilities :
Sundry Creditors
Bills Payable
Bank Overdraft
Outstanding Expenses
Short-Term Loans
Total Current Liabilities (B) ***** *****
Working Capital
(A -B)
***** ***** ***** *****
Net Increase /Decrease
In Working Capital
*******
--------- -------- *******
Total ******* ****** ****** ******

55. FUND FROM OPERATIONS
• Fund from Operation is to be determined on
the basis of Profit and Loss Account.
• The operating profit revealed by Profit and
Loss Account represents the excess of sales
revenue over cost of goods sold.

56. Particulars
Amount
Rs.
Particulars Amount
Rs.
To Depreciation on Fixed Assets *** By Opening Balance of P & L A/c ***
To Loss on Sale of Fixed Assets *** By Profit on Sale of Fixed Assets ***
To Loss on Sale Investments *** By Excess provision written back ***
To Goodwill written off *** By Dividend received on investment ***
To Discount on shares written off *** By Revaluation of fixed assets ***
To Transfer to reserve *** By Fund From Operations (Bal. Fig.) ***
To Preliminary expenses written
off
***
To Provision for Tax ***
To Proposed Dividend ***
To Closing Balance of P & L a/c ***
* * * * * *
Calculation of Fund from Operations

57. FUND FLOW STATEMENT
A fund flow statement is a statement prepared to
analyse the reasons for changes in the financial
position of a company between two balance
sheets.
It portrays the inflow and outflow of funds

58. Account Form
Sources of Funds
Amount
Rs.
Application of Funds
Amount
Rs.
Fund From Operations Fund Lost in Operations
Issue of Share Capital Redemption of Shares
Issue of Debentures Redemption of Debenture
Long-Term Loans Purchase of Fixed Assets
Sale of Fixed Assets
Repayment of Long-Term
Loans
Sale of Investments Non-Trading Expenditure
Non-Trading Incomes Payment of Tax
Decrease in Working
Capital
Payment of Dividend
Increase in Working Capital
Total Inflow * * * Total Outflow ***

60. Meaning
• A cash flow statement is a statement of
changes in the financial position of a firm on
cash basis.
• It reveals the net effects of all business
transactions of a firm during a period on cash
and explains the reasons of changes in cash
position between two balance sheet dates

61. Objectives
• To Help the Management in Making Future
Financial Policies
• Helpful in Declaring Dividends etc.
• Cash Flow Statement is Different than Cash
Budget
• Helpful in devising the cash requirement
• Helpful in finding reasons for the difference
• Helpful in predicting sickness of the business

62. Importance
• Short-term financial Planning
• Helpful in preparing Cash Budget
• Measurement of Liquidity
• Dividend Decisions
• Prediction of Sickness
• Future Guide

63. Advantages
• Evaluation of Cash Position
• Planning and Control
• Performance Evaluation
• Framing Long-term Planning
• Capital Budgeting Decision
• Liquidity Position

64. Limitations
• Ignores Non-cash transactions
• Ignores the accrual concept
• Historical in Nature
• Not a Substitute for an Income Statement
• Not suitable for judging Liquidity of the
enterprise

65. Classification
• Business Activities Accounting Standard-
3 (Revised) requires that the changes resulting in
inflows and outflows of cash and cash equivalents
will be classified into following three activities:
Cash flow from operating activities.
Cash flow from investing activities.
Cash flow from financing activities.

66. • Cash flow from operating activities:
Operating activities are the principal revenue-producing
activities of the enterprise and other activities that are not
investing or financing activities.
• Cash flow from investing activities: Investing
activities are the acquisition and disposal of long-term
assets and other investments not included in cash
equivalents.
• Cash flow from financing activities:
Financing activities are activities that result in changes in
the size and composition of the owners’ capital and
borrowings of the enterprise.

71. A3 Format of Cash Flow Statement
Particulars Amount(Rs) Amount (Rs)
Cash Flows from Operating Activities:
Net Profit as per P&L a/c ( Difference) xxxxx
ADD: : Items to be Added
Depreciation on Building, Machinery, Plant xxxxx
Depreciation on Machinery sold xxxxx
Increase In provision for doubtful debts xxxxx
Dividend Paid xxxxx
Transfer to Reserves xxxxx
Good Will written off xxxxx
Preliminary Expenses written off xxxxx
other Tangible Assets written off xxxxx
Loss on sale of disposable fixed asset xxxxx xxxxx
xxxxx
LESS: Items to be Deducted
Profit on sale of Investment xxxxx
Profit on Sale of fixed assets xxxxx
Interest Income xxxxx
Dividend Received xxxxx
Rent Received xxxxx xxxxx
Operating Profit before Working Capital Changes Xxxxx

72. ADD: Items to be Added
Decreased in Current Assets xxxxx
Increased in Current Liabilities xxxxx
xxxxx
LESS: Items to be Deducted
Increased in Current Assets xxxxx
Decreased in Current Liabilities xxxxx xxxxx
Cash Generated from Operating Activities xxxxx
LESS: Income Tax Paid xxxxx
Net Cash Flow from Operating Activities (Total-A) xxxxx

73. II: Cash Flow from Investing Activities
ADD: Items to be Added
Sale of Investment xxxxx
Sale of Fixed Assets xxxxx
Sale of Intangible assets xxxxx
Interest Received xxxxx
Dividend Received xxxxx xxxxx
LESS: Items to be Deducted
Purchase of Fixed Assets xxxxx
Rent Received xxxxx
Purchase of Investment xxxxx
Purchase of intangible Assets xxxxx xxxxx
Net Cash Flow from Investing Activities (Total-B) xxxxx

74. III. Cash Flow from Financing Activities
ADD: Items to be Added
Issue of Equity Shares xxxxx
Issue of Preference Shares xxxxx
Issue of debentures/ Bonds xxxxx
Long Term Borrowings/ Loans xxxxx xxxxx
LESS: Items to be Deducted
Redemption of Shares xxxxx
Redemption of Debentures xxxxx
Final Dividend Paid xxxxx
Interim Dividend Paid xxxxx
Interest paid xxxxx
Repayment of Loans xxxxx xxxxx
Net Cash Flow from Investing Activities (Total-C) xxxxx

75. Net Increase/ Decrease in Cash and Cash Equivalent
(A+B+C)
xxxxx
ADD: Cash Equivalent at the Beginning of the Year
Cash at Bank/ Overdraft xxxxx
Cash in Hand xxxxx
Short term Deposits xxxxx
Marketable Securities xxxxx xxxxx
xxxxx
LESS: Cash Equivalent at the End of the Year
Cash at Bank/ Overdraft xxxxx
Cash in Hand xxxxx
Short term Deposits xxxxx
Marketable Securities xxxxx xxxxx
0

76. Common Size Statements
• Common size statements are the statement in
which data of financial statements are
presented in the form of percentage.
• The figures are shown as percentages of total
assets, total liabilities and total sales.
• The total assets are taken as 100 and different
assets are expressed as a percentage of the
total.

77. Types of Common-Size Statements
• Common-Size Balance Sheet: In the Common
Size Balance Sheet the total balance (total assets or
total liability) is taken as 100% and each element of
Balance sheet is represented as a fraction of the
respective total.
• A statement in which balance sheet items are
expressed as the ratio of each asset to total assets and
the ratio of each liability is expressed as a ratio of
total liabilities is called common-size balance sheet

78. Format of Common Size Balance Sheet

80. Common Size Income Statement
• The items in income statement can be shown
as percentages of sales to show the relation of
each item to sales.
• A significant relationship can be established
between items of income statement and
volume of sales.
• The increase in sales will certainly increase
selling expenses and not administrative or
financial expenses.

81. Particulars Pervious Year Percentage
Current
Year
Percentage
Net Sales xxx 100 xxx 100
Less: Cost of Goods Sold xxx xxx xxx xxx
Gross Profit (A) xxx xxx xxx xxx
Less: Opeating Expenses:
General Expensres xxx xxx xxx xxx
Administrative Expenses xxx xxx xxx xxx
Selling & Distribution Expenses xxx xxx xxx xxx
Total Operating Expenses (B) xxx xxx xxx xxx
Operating Profit (C=A-B) xxx xxx xxx xxx
Add: Non Operating Income
Divend Received xxx xxx xxx xxx
Rent Received xxx xxx xxx xxx
Total Non Operating Income (D) xxx xxx xxx xxx
EBIT (E=C+D) xxx xxx xxx xxx
Less: Non Operating Expeneses
Interest Paid xxx xxx xxx xxx
Income Tax Paid xxx xxx xxx xxx
Total Non Operating Expeneses (F) xxx xxx xxx xxx
Net Profit After Tax (E-F) xxx xxx xxx xxx

82. Comparative Statements
• The comparative statements are the statements of
the financial position and performance of two or
more periods represented in comparative form
in adjacent columns in a single report.
• In comparative statement we can compare each
elements of financial statement very easily and
find increase/decrease in the elements in
absolute terms and in terms of percentage.

83. Types of Comparative Statements
• Comparative Balance Sheets, and
• Comparative Income Statements

84. Comparative Balance Sheets
Comparative balance sheet analyses the assets
and liabilities of business for the current year
and also compares the increase or decrease in
them in relative as well as absolute parameters.

85. Format of Comparative Balance Sheet

87. Comparative Income Statement
Income statements provide the details about the
results of the operations of the business, and
comparative income statements provide the
progress made by the business over a period of a
few years.

88. Format of Comparative Income Statement