Financial statements are reports prepared by a company’s management to present the financial

performance and position at a point in time. A general-purpose set of financial statements usually
includes a balance sheet, income statements, statement of owner’s equity, and statement of cash
flows. These statements are prepared to give users outside of the company, like investors and
creditors, more information about the company’s financial positions. Publicly traded companies
are also required to present these statements along with others to regulatory agencies in a timely
manner.

Types of financial analysis

Financial analysis involves the review of an organization's financial information in order to
arrive at business decisions. This analysis can take several forms, with each one intended
for a different use. The types of financial analysis are:
 Horizontal analysis. This involves the side-by-side comparison of the financial results of an
organization for a number of consecutive reporting periods. The intent is to discern any
spikes or declines in the data that could be used as the basis for a more detailed e xamination
of financial results.
 Vertical analysis. This is a proportional analysis of the various expenses on the income
statement, measured as a percentage of net sales. The same analysis can be used for
the balance sheet. These proportions should be consistent over time; if not, one can
investigate further into the reasons for a percentage change.
 Short term analysis. This is a detailed review of working capital, involving the calculation
of turnover rates for accounts receivable, inventory, and accounts payable. Any differences
from the long-term average turnover rate are worth investigating further, since working
capital is a key user of cash.
 Multi-company comparison. This involves the calculation and comparison of the key
financial ratios of two organizations, usually within the same industry. The intent is to
determine the comparative financial strengths and weaknesses of the two firms, based on
their financial statements.
 Industry comparison. This is similar to the multi-company comparison, except that the
comparison is between the results of a specific business and the average results of an entire
industry. The intent is to see if there are any unusual results in comparison to the average
method of doing business.
TOOLS OR TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS
1. Comparative Statements
Comparative statements deal with the comparison of different items of the Profit and Loss Account
and Balance Sheets of two or more periods. Separate comparative statements are prepared for
Profit and Loss Account as Comparative Income Statement and for Balance Sheets.
As a rule, any financial statement can be presented in the form of comparative statement such as
comparative balance sheet, comparative profit and loss account, comparative cost of production
statement, comparative statement of working capital and the like.
2. Comparative Income Statement
Three important information are obtained from the Comparative Income Statement. They are
Gross Profit, Operating Profit and Net Profit. The changes or the improvement in the profitability
of the business concern is find out over a period of time. If the changes or improvement is not
satisfactory, the management can find out the reasons for it and some corrective action can be
taken.
3. Comparative Balance Sheet
The financial condition of the business concern can be find out by preparing comparative balance
sheet. The various items of Balance sheet for two different periods are used. The assets are
classified as current assets and fixed assets for comparison. Likewise, the liabilities are classified
as current liabilities, long term liabilities and shareholders’ net worth. The term shareholders’ net
worth includes Equity Share Capital, Preference Share Capital, Reserves and Surplus and the like.
4. Common Size Statements
A vertical presentation of financial information is followed for preparing common-size statements.
Besides, the rupee value of financial statement contents are not taken into consideration. But, only
percentage is considered for preparing common size statement.
The total assets or total liabilities or sales is taken as 100 and the balance items are compared to
the total assets, total liabilities or sales in terms of percentage. Thus, a common size statement
shows the relation of each component to the whole. Separate common size statement is prepared
for profit and loss account as Common Size Income Statement and for balance sheet as Common
Size Balance Sheet.
5. Trend Analysis
The ratios of different items for various periods are find out and then compared under this analysis.
The analysis of the ratios over a period of years gives an idea of whether the business concern is
trending upward or downward. This analysis is otherwise called as Pyramid Method.
6. Average Analysis
Whenever, the trend ratios are calculated for a business concern, such ratios are compared with
industry average. These both trends can be presented on the graph paper also in the shape of curves.
This presentation of facts in the shape of pictures makes the analysis and comparison more
comprehensive and impressive.
7. Statement of Changes in Working Capital
The extent of increase or decrease of working capital is identified by preparing the statement of
changes in working capital. The amount of net working capital is calculated by subtracting the sum
of current liabilities from the sum of current assets. It does not detail the reasons for changes in
working capital.
8. Fund Flow Analysis
Fund flow analysis deals with detailed sources and application of funds of the business concern
for a specific period. It indicates where funds come from and how they are used during the period
under review. It highlights the changes in the financial structure of the company.
9. Cash Flow Analysis
Cash flow analysis is based on the movement of cash and bank balances. In other words, the
movement of cash instead of movement of working capital would be considered in the cash flow
analysis. There are two types of cash flows. They are actual cash flows and notional cash flows.
10. Ratio Analysis
Ratio analysis is an attempt of developing meaningful relationship between individual items (or
group of items) in the balance sheet or profit and loss account. Ratio analysis is not only useful to
internal parties of business concern but also useful to external parties. Ratio analysis highlights the
liquidity, solvency, profitability and capital gearing.
11. Cost Volume Profit Analysis
This analysis discloses the prevailing relationship among sales, cost and profit. The cost is divided
into two. They are fixed cost and variable cost. There is a constant relationship between sales and
variable cost. Cost analysis enables the management for better profit planning.
A Cash Flow Statement is a statement showing changes in cash position of the firm from one
period to another. It explains the inflows (receipts) and outflows (disbursements) of cash over a
period of time. The inflows of cash may occur from sale of goods, sale of assets, receipts from
debtors, interest, dividend, rent, issue of new shares and debentures, raising of loans, short-term
borrowing, etc. The cash outflows may occur on account of purchase of goods, purchase of
assets, payment of loans loss on operations, payment of tax and dividend, etc.
A Cash Flow Statement comprises information on following 3 activities:
1. Operating Activities
2. Investing Activities
3. Financing Activities

1. Operating Activities: Operating activities include cash flows from all standard business
operations. Cash receipts from selling goods and services represent the inflows. The revenues
from interest and dividends are also included here. The operational expenditures are considered
as outflows for this section. Although interest expenses fall under this section but the dividends
are not included .Dividends are considered as a part of financing activity in financial
accounting terms.
2. Investing Activities: Investing activities include transactions with assets, marketable
securities and credit instruments. The sale of property, plant and equipment or marketable
securities is a cash inflow. Purchasing property, plant and equipment or marketable securities
are considered as cash outflows. Loans made to borrowers for long-term use is another cash
outflow. Collections from these loans, however, are cash inflows.
3. Financing Activities: Financing activities on the statement of cash flows are much more
defined in nature. The receipts come from borrowing money or issuing stock. The outflows
occur when a company repays loans, purchases treasury stock or pays dividends to
stockholders. As the case with other activities on the statement of cash flows depend on
activities rather than actual general ledger accounts.
Table of Difference between Funds Flow Statement and Cash Flow Statement
Basis of
Funds Flow Statement Cash Flow Statement
Difference
1. Basis of Funds flow statement is based on Cash flow statement is based on narrow
Analysis broader concept i.e. working concept i.e. cash, which is only one of
capital. the elements of working capital.
2. Source Funds flow statement tells about the Cash flow statement stars with the
various sources from where the opening balance of cash and reaches to
funds generated with various uses the closing balance of cash by
to which they are put. proceeding through sources and uses.
3. Usage Funds flow statement is more useful Cash flow statement is useful in
in assessing the long-range understanding the short-term phenomena
financial strategy. affecting the liquidity of the business.
 4. Schedule of In funds flow statement changes in
Changes in current assets and current liabilities
Working are shown through the schedule of
Capital changes in working capital.
5. End Result Funds flow statement shows the
causes of changes in net working
capital.
6. Principal of Funds flow statement is in
Accounting alignment with the accrual basis of
accounting.
In cash flow statement changes in current
assets and current liabilities are shown in
the cash flow statement itself.
Cash flow statement shows the causes
the changes in cash.
In cash flow statement data obtained on
accrual basis are converted into cash
basis.

Advantages of Cash Flow Statement

1. It shows the actual cash position available with the company between the two balance sheet
dates which funds flow and profit and loss account are unable to show. So it is important to
make a cash flow report if one wants to know about the liquidity position of the company.
2. It helps the company in accurately projecting the future liquidity position of the company
enabling it arrange for any shortfall in money by arranging finance in advance and if there is
excess than it can help the company in earning extra return by deploying excess funds.
3. It acts like a filter and is used by many analyst and investors to judge whether company has
prepared the financial statements properly or not because if there is any discrepancy in the cash
position as shown by balance sheet and the cash flow statement, it means that statements are
incorrect.
Disadvantages of Cash Flow Statement
1. Since it shows only cash position, it is not possible to deduce actual profit and loss of the
company by just looking at this statement.
2. In isolation this is of no use and it requires other financial statements like balance sheet, profit
and loss etc…, and therefore limiting its use.
Advantages of Fund Flow Statements
A Funds flow statement is prepared to show changes in the assets, liabilities and equity between
two balance sheet dates, it is also called statement of sources and uses of funds. The advantages
of such a financial statement are many fold.
Some of these are:
1. Funds flow statement reveals the net result of Business operations done by the company during
the year.
2. In addition to the balance sheet, it serves as an additional reference for many interested parties
like analysts, creditors, suppliers, government to look into financial position of the company.
3. The Fund Flow Statement shows how the funds were raised from various sources and also how
those funds were deployed by a company, therefore it is a great tool for management when it
wants to know about where and from what sources funds were raised and also how those funds
got utilized into the business.
4. It reveals the causes for the changes in liabilities and assets between the two balance sheet
dates therefore providing a detailed analysis of the balance sheet of the company.
5. Funds flow statement helps the management in deciding its future course of plans and also it
acts as a control tool for the management.
6. Funds flow statement should not be looked alone rather it should be used along with balance
sheet in order judge the financial position of the company in a better way.
 Disadvantages of Fund Flow Statements

1. Funds Flow statement has to be used along with balance sheet and profit and loss account for
inference of financial strengths and weakness of a company it cannot be used alone.
2. Fund Flow Statement does not reveal the cash position of the company, and that is why
company has to prepare cash flow statement in addition to funds flow statement.
3. Funds flow statement only rearranges the data which is there in the books of account and
therefore it lacks originality. In simple words it presents the data in the financial statements in
systematic way and therefore many companies tend to avoid preparing funds flow statements.
4. Funds flow statement is basically historic in nature, that is it indicates what happened in the
past and it does not communicate anything about the future, only estimates can be made based
on the past data and therefore it cannot be used the management for taking decision related to
future.

Capital and Revenue Expenditure

The difference between capital expenditures and revenue expenditures
Capital expenditures are for fixed assets, which are expected to be productive assets for a
long period of time. Revenue expenditures are for costs that are related to
specific revenue transactions or operating periods, such as the cost of goods sold or repairs
and maintenance expense. Thus, the differences between these two types of expenditu res are
as follows:
 Timing. Capital expenditures are charged to expense gradually via depreciation, and over a
long period of time. Revenue expenditures are charged to expense in the current period, or
shortly thereafter.
 Consumption. A capital expenditure is assumed to be consumed over the useful life of the
related fixed asset. A revenue expenditure is assumed to be consumed within a very short
period of time.
 Size. A more questionable difference is that capital expenditures tend to involve larger
monetary amounts than revenue expenditures. This is because an expenditure is only classified
as a capital expenditure if it exceeds a certain threshold value; if not, it is automatically
designated as a revenue expenditure. However, certain quite large expenditures can still be
classified as revenue expenditures, as long they are directly associated with sale transactions
or are period costs.
Deferred Revenue Expenditure
Deferred Revenue Expenditure is an expenditure which is revenue in nature and incurred
during an accounting period, but its benefits are to be derived in multiple future accounting
periods.
These expenses are unusually large in amount and, essentially, the benefits are not consumed
within the same accounting period.
Part of the amount which is charged to profit and loss account in the current accounting period is
reduced from total expenditure and rest is shown in the balance sheet as an asset (fictitious
asset, i.e. it is not really an asset).
 BASIS FOR
CAPITAL RECEIPT REVENUE RECEIPT
COMPARISON

Meaning Capital Receipts are the income Revenue Receipts are the income
generated from investment and generated from the operating
financing activities of the business. activities of the business.

Nature Non-Recurring Recurring

Term Long Term Short Term

Shown in Balance Sheet Income Statement

Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual shrinkage in the book
value of fixed assets. It is based on the cost of assets consumed in a business and not on its
market value.

According to Institute of Cost and Management Accounting, London (ICMA) terminology “The
depreciation is the diminution in intrinsic value of the asset due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants of India (ICAI) defines
depreciation as “a measure of the wearing out, consumption or other loss of value of depreciable
asset arising from use, effluxion of time or obsolescence through technology and market-change.
Depreciation is allocated so as to charge fair proportion of depreciable amount in each
accounting period during the expected useful life of the asset. Depreciation includes amortization
of assets whose useful life is pre-determined”.
Causes of Depreciation:
1. Wear and Tear:
Some assets physically deteriorate due to wear and tear in use. When an asset is constantly used
for production, the asset wears out. More and more use of an asset, the greater would be the wear
and tear. Physical deterioration of an asset is caused from movement, strain, friction, erosion etc.
For instance, building, machineries, furniture, vehicles, plant etc. The wear and tear is general
but primary cause of depreciation.
2. Lapse of Time:
There are certain assets like leasehold property, patents, copy-right etc. that are acquired for a
particular period. After the expiry of the period, they are rendered useless i.e. their value ceases
to exist. Thus, their cost is written off over their legal life.
3. Obsolescence:
Appearance of new and improved machines results in discarding of old machines. Thus new
inventions, change in fashions and taste, market condition, Government policies etc. are the
causes to discard the value of an asset. But this is not the cause of depreciation and not
depreciation in real sense.
4. Exhaustion:
Some assets are of wasting nature. For instance, quarries, mines, oil-well etc. It is the reduction
in the value of natural deposits as resources have been extracted year after year. As such these
assets are known as wasting assets. The coalmine or oil well gets physically exhausted by the
removal of its contents.
5. Non-Use:
Machines which are idly lying become less and less useful with the passage of time. Certain
types of machines exposed to weather conditions, may have more depreciation from not using it
than from its use.
6. Maintenance:
A good maintenance of machine will naturally increase its life. When there is no maintenance,
there is more depreciated value. When there is good maintenance, there is longer life to the
machines. The long life of machine depends upon good and skilled maintenance.
7. Market Trend:
The market price may fluctuate in case of certain assets, for instance, investments in gilt-edged
securities. When the prices go down, the concerned asset may depreciate its value. In certain
cases, accident causes diminution in the value of assets.
Need For Depreciation:
Depreciation is provided for the assets with a view to achieve the following results:
1. To Ascertain the True Working Result:
Asset is an important tool in earning revenues. Huge amounts are spent for acquisition of assets
which are worn out in the process of earning income. Thus, the assets get depreciated in their
value, over a period of time due to many reasons explained above.
When the value of assets decreases, this loss must be brought into account; otherwise a true
working result cannot be known. Depreciation is an operating expense of a physical asset, the
same should be considered in arriving the true profit earned during each year.
ADVERTISEMENTS:
The basic need of depreciation is to ascertain the true income. If depreciation is ignored, the loss
that is occurring in respect of fixed assets will be ignored. So, depreciation should be debited to
Profit and Loss Account before profit is ascertained.
2. To Ascertain True Value of Asset:
The function of the Balance Sheet is to show the true and correct view of the state of affairs of a
business. If no depreciation is charged and when assets are shown at the original cost year after
year, Balance Sheet will not disclose the correct state of affairs of a business.
3. To Retain Funds for Replacement:
Assets used in the business need replacement after the expiry of their service. It is always not
possible to determine the useful life of assets. But, in certain cases, machine often becomes,
obsolete long before it wears out because of rapid changes in tastes and technology. It is a
permanent loss in value of the asset. When an asset is continuously used, a time will come when
the asset is to be given up and hence its replacement is essential.
Therefore, if no depreciation is charged against the profit, during the life time of the asset, it will
be very difficult to find cash to replace the asset and if replaced it may cripple resources.
Therefore, it is necessary to make provision and create funds to replace such assets, in proper
time.
4. To Reduce Tax Liability:
Depreciation is a tax deductible expense. As such, it is permitted by the prevailing taxation laws
to be deducted from profit. Consequently, the owner of a business may avail himself of this
benefit by charging depreciation to his profit and reducing his tax liability.
5. To Present True Position:
Financial position can be studied from the Balance Sheet and for the preparation of the Balance
Sheet fixed assets are required to be shown at their true value. If assets are shown in the Balance
Sheet without any charge made for their use, (that is, depreciation) then their value must have
been overstated in the Balance Sheet and will not reflect the true financial position of the
business.
Therefore, for the purpose of reflecting true financial position, it is necessary that depreciation
must be deducted from the asset and then at such reduced value may be shown in the Balance
Sheet.
BASIS FOR
SLM WDV
COMPARISON

Meaning A method of depreciation in which A method of depreciation in

the cost of the asset is spread which a fixed rate of
uniformly over the life years by depreciation is charged on the
writing off a fixed amount every book value of the asset, over its
year. useful life.

Calculation of On the original cost On the written down value of the

depreciation asset.

Annual depreciation Remains fixed during the useful Reduces every year
charge life.

Value of asset Completely written off Not completely written off

Amount of Initially lower Initially higher

depreciation

Impact of repairs and Increasing trend Remains constant

depreciation on P&L
A/c

Appropriate for Assets with negligible repairs and Assets whose repairs increase, as
maintenance like leases, copyright. they get older like machinery,
vehicles etc.

BASIS FOR
JOURNAL LEDGER
COMPARISON

Meaning The book in which all the The book which enables to
transactions are recorded, as and transfer all the transactions into
when they arise is known as separate accounts is known as
Journal. Ledger.

What is it? It is a subsidiary book. It is a principal book.

 BASIS FOR
JOURNAL LEDGER
COMPARISON

Also known as Book of original entry. Book of second entry.

Record Chronological record Analytical record

Process The process of recording The process of transferring entries

transactions into Journal is known from the journal to ledger is
as Journalizing. known as Posting.

How transactions are Sequentially Account-wise

recorded?

Debit and Credit Columns Sides

Narration Must Not necessary.

Balancing Need not to be balanced. Must be balanced.

Objectives of Accounting

The basic aim of accounting is to give information to the interested parties to enable them all to
make important business decisions. The required information, particularly in the case of external
parties, is given in the basic financial statements: Profit and loss statement and the Balance sheet.

Besides the said sources of information, the internal parties, officers and other staff of the
company, can get additional information from the records of organisation. Thus the primary
objectives of accounting can be stated as :

Maintenance of Records of Business transactions

Calculation of Profit or Loss
Processing of Financial Position
Provide Information to the Parties
Maintenance of Records of Business

First record, then pay; if there is an error, trace it from the records and correct the same. Human
memory is limited and that is true. Even the most intelligent personnel cannot accurately
recollect what he might have come across in the daily operations. He need not bother of stress his
memory for no reason, if proper and quite records of all business transactions are kept
completely. Also, records can be used by different personnel for different decision-making
purposes.

Calculation of Profit or Loss

Making profit is the sole purpose of any business. The information related to the profits are
available from the profit and loss statement. Profit is calculated by taking out expenses from the
associated revenues. Profit is a measure of the performance of the organisation.

Depiction of Financial Position

A balance sheet reflects the financial position of an organisation. It is a statement of assets and
liabilities. It shows the assets owned by an organisation and depicts the liabilities against the
assets. The balance of assets minus the external liabilities shows the capital.

Provide Information to the Parties

Generation of information is not an end in itself. It is a means to facilitate the dissemination of

information among different user groups. Therefore, communication of information is the
essential function of accounting. Accounting information is communicated in the form of reports,
statements, graphs and charts to the internal and external users who need it in different decision
situations.

Internal users: The officers and staff of an enterprise need useful and timely information for
making different types of business decisions. A major objective of accounting is to provide
management with relevant and reliable information

External users: The outside users have limited authority, ability or resources to obtain
information. Unlike internal users, they have to rely on financial statements (Balance sheet,
Profit and Loss statement) as their principal source of information about an enterprise’s
economic activity.

Limitations of Accounting

Accounting records relate to the transactions that are completed, which provide fairly good
account of the transaction of the business organisation. However, for decision-making we need
the information, which relates not only to past but also about present and future. Financial
accounting makes provision for financial information but it does not provide non-financial
information such as behavioral and socio-economic. If the objective of accounting reports is to
influence the behavior through decision-making then it must provide the data concerning the
behavior and outcome of human activity to facilitate performance evaluation. Therefore, the
accounting information does not fully meet different types of information-requirements of varied
decision making situations. Accounting provides stewardship information and not decisional
information.

Branches of Accounting
1. Financial Accounting
Financial accounting involves recording and classifying business transactions, and preparing and
presenting financial statements to be used by internal and external users.
In the preparation of financial statements, strict compliance with generally accepted accounting
principles or GAAP is observed. Financial accounting is primarily concerned in processing
historical data.

2. Managerial Accounting
Managerial or management accounting focuses on providing information for use by internal
users, the management. This branch deals with the needs of the management rather than strict
compliance with generally accepted accounting principles.

Managerial accounting involves financial analysis, budgeting and forecasting, cost analysis,
evaluation of business decisions, and similar areas.

3. Cost Accounting
Sometimes considered as a subset of management accounting, cost accounting refers to the
recording, presentation, and analysis of manufacturing costs. Cost accounting is very useful in
manufacturing businesses since they have the most complicated costing process.

Cost accountants also analyze actual and standard costs to help managers determine future
courses of action regarding the company's operations.