This document discusses the analysis of financial statements. It covers the meaning and nature of financial statements, their essential qualities and limitations. It also discusses various tools and techniques used for financial statement analysis, including comparative statements, common size statements, trend analysis, ratio analysis, and cash flow statements. The document provides examples of different types of ratios and how they can be used by various stakeholders like management, investors, creditors for analysis.

1. ANALYSIS OF FINANCIAL
STATEMENTS
Prof. M .B. Thakoor

2. SYNOPSIS
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MEANING OF FINANCIAL STATEMENT
NATURE OF FINANCIAL STATEMENT
ESSENTIAL QUALITIES OF FINANCIAL
STATEMENT
LIMITATION OF FINANCIAL
STATEMENT
FINANCIAL STATEMENT ANALYSIS
TOOLS & TECHNIQUES OF ANALYSIS
TYPES OF COMPARISON
INTERPRETATION

3. NATURE OF FINANCIAL
STATEMENT
• The data exhibited by financial statements
are affected by
• a) Recorded facts
• b) Accounting Concepts,
Conventions & Principles
• c) Personal Judgment

4. Accounting Principles
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Accounting concepts
Accounting Conventions
a) Entity Concept
a)
Disclosure
b) Going Concern Concept
b)
Materiality
c) Accounting period concept
c)
Consistency
d) Money Measurement Concept
d)
Conservatism
e) Cost Concept
f)
Cost Attach Concept
g) Dual Aspect Concept
h) Accrual concept
i)
Periodic Matching of cost and
Revenue Concept
j)
Realisation Concept
k) Verifiable Objective Evidence Concept

5. ESSENTIAL QUALITIES OF
FINANCIAL STATMENTS
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Relevance
Understandability :
Reliability and Accuracy
Comparability
Completeness
Timeliness

6. LIMITATIONS OF FINANCIAL
STATEMENTS
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Lack of Precision
Lack of Exactness
Incomplete Information
Interim Reports
Hiding of Real Position or Window Dressing
Lack of Comparability
Historical Costs

7. 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”

8. TOOLS OF FINANCIAL
STATEMENT ANALYSIS
• 1. Comparative Statements
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Common Size Statements
Trend Analysis
Ratio Analysis
Fund Flow Statement
Cash Flow Statement

9. Types of Financial
Analysis
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Intra-Firm Comparison
Inter-firm Comparison
Industry Average or Standard
Analysis :
• 4. Horizontal Analysis
• 5. Vertical Analysis

10. 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
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• 1. Profitability Analysis
• 2. Liquidity Analysis
• 3. Solvency Analysis (To know the financial structure)

11. Interested Parties in Analysis of
Financial Statements
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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

12. 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.

13. Types of Comparison
• There are 3 types of Comparison
1) Inter Firm Comparison
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2) Intra Firm Comparison
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3) Inter Period Comparison
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14. Merits:
• 1) Indicate the Direction of
Financial
Position
• 2) Reveal Nature & Trend:
• 3) Identifying Trouble Spots:
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15. Disadvantages:
• 1) Misleading picture, if consistency in accounting principle
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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.

16. 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.

17. Types of common size
statements.
• (1)Common Size Balance Sheet
• (2)Common Size Income Statement:

18. Advantages of Common Size
Statement
• 1) It reveals Sources and Application of Funds
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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.

19. Disadvantages of Common
Size Statement
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(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.
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(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

20. 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.

21. Advantages:
• (1) Trend % indicate the increase or decrease
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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

22. Limitations:
• (1) It will give a misleading picture if consistency in
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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 %.

23. 4. Ratio Analysis
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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.

24. REVENUE STATEMENT
RATIOS
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Gross Profit Ratio
Net Profit Ratio
Operating Net Profit Ratio
Operating Ratio
Operating Expenses Ratio
Stock Turnover Ratio
Stock Holding Period

25. COMBINED RATIOS
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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

26. COMBINED RATIOS
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Debt : Service Coverage Ratio
Debit Collection period
Debtor Turnover Ratio
Creditor Payment Period
Creditor Turnover Ratio
Preference Dividend Cover
Equity Dividend Cover

27. BASED ON FUNCTIONS
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SOLVENCY RATIOS
Short Term Solvency
Current Ratio
Quick Ratio / Liquid Ratio / Acid Test
Ratio
Super Quick Ratio
Stock : Working Capital Ratio.

28. Long Term Solvency /
Leverage Ratio /
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Capital Gearing
Debt : Equity Ratio
Proprietary Ratio
Long Term Borrowing: Total Assets
( 1 – Net Worth )/ Total
Assets
• Fixed Asset : Net worth

29. ACTIVITY RATIO /
TURNOVER RATIOS
• Stock Turn Over Ratio
Stock Holding Period
Debt Collection Period
Debtor Turnover Ratio
Creditor Payment Period
Creditor Turnover Ratio

30. PROFITABILITY RATIO
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In relation to sales
Gross Profit Ratio
Net Profit Ratio
Operating Net Profit Ratio
Operating Ratio
Operating Expenses Ratio.

31. In relation to capital
employed
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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

32. COVERAGE RATIOS
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Interest Coverage Ratio
Preference Dividend Cover
Equity Dividend Cover
Debt Service Coverage Ratio

33. USER BASED
CLASSIFICATION
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FOR SHORT TERM CREDITORS
(1)
Current Ratio
(2)
Quick / Liquid Ratio / Acid Test Ratio
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Super Quick Ratio
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Stock : Working Capital Ratio
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Stock Turnover Ratio
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Stock Holding Period
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Creditor Payment Period
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Creditor Turnover Ratio

34. FOR LONG TERM
CREDITORS
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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

35. FOR SHARE HOLDERS
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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

36. FOR MANAGEMENT
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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

37. FOR MANAGEMENT
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Gross Profit Ratio
Net Profit Ratio
Operating Net Profit Ratio
Operating Ratio
Proprietary Ratio
Fixed Asset : Net Worth
Long Term Borrowing : Total Assets