Financial accounting & Analysis

1. This pandemic situations has drawn the attention of a lot of individuals to actively
watch and participant in the Indian financial market. As a life-long learner, you also
decide to understand the fundamentals of certain companies listed on the stock
exchanges in India. One of your friends advised you to look in to the various techniques
of financial analysis, as one of the way of evaluating the financials of business entities.
You are done with getting an understanding about various techniques of financial
analysis. Elaborate any five of the said techniques for financial analysis.

Answer:
Financial statement analysis

The financial statements provide data of the company to the users. The financial statements
of a company record important financial data on every aspect of a business’s activities. As
such they can be evaluated on the basis of past, current, and projected performance. The
objective of financial analysis is to identify the firm’s strengths and weaknesses so that the
stakeholders can take decisions based on such inputs. In order to do this, financial analysis
provides various tools or techniques.

Need for Financial Statements Analysis

Financial statement analysis is used to identify the trends and relationships between financial
statement items. Both internal management and external users (such as analysts, creditors,
and investors) of the financial statements need to evaluate a company's profitability, liquidity,
and solvency.The most significantly used techniques of financial statement analysis are ratio
analysis, common-size statements, comparative analysis, trend analysis, percentage change
analysis and Management’s Discussion and Analysis. These techniques include various
calculations and the connection between their outcomes. In simple words, the proper analysis
and explanation of financial statement can provide a clear picture of organisation’s financial
health.

Techniques for financial analysis

Horizontal Analysis (Comparative Statements)

Horizontal analysis is an approach used to analyze financial statements by comparing specific

financial information for a certain accounting period with information from other periods.
Analysts use such an approach to analyze historical trends.
Trends or changes are measured by comparing the current year’s values against those of the
base year. The goal is to determine any increase or decline in specific values. A percentage or
an absolute comparison may be used in horizontal analysis. Horizontal technique involves
comparison of the firm’s current year figures with previous year’s figures. The amount and
the percentage of changes are computed and analysed. The change contributes to either the
good health or the bad health of the organisation. It may be done with a balance sheet as well
as with profit and loss a/c or income statement

Vertical Analysis (Common Size Statements)

Vertical analysis (also known as  common-size analysis) is a popular method of financial
statement analysis that shows each item on a statement as a percentage of a base figure within
the statement.To conduct a vertical analysis of balance sheet, the total of assets and the total
of liabilities and stockholders’ equity are generally used as base figures. All individual assets
(or groups of assets if condensed form balance sheet is used) are shown as a percentage of
total assets. The current liabilities, long term debts and equities are shown as a percentage of
the total liabilities and stockholders’ equity.
To conduct a vertical analysis of income statement, sales figure is generally used as the base
and all other components of income statement like cost of sales, gross profit, operating
expenses, income tax, and net income etc. are shown as a percentage of sales.

In a vertical analysis the percentage is computed by using the following formula:

Percentage of base = (Amount of individual item/Amount of base item) × 100

A basic vertical analysis needs an individual statement for a reporting period but comparative
statements may be prepared to increase the usefulness of the analysis.

For example, if the balance sheet total is Rs.2,50,000and the long-term debts is Rs.2,00,000,
then it shows that long-term debts constitute 80% (i.e., 2,00,000/2,50,000) of the total funds.

Ratio Analysis
A ratio represents a relationship between two numbers. An accounting ratio represents a
relationship between two accounting numbers. A ratio can be expressed in the following three
forms:
1. Proportion
2. Percentage
3. Turnover rate

Steps in ratio analysis

 Calculation of the selected such ratios.

 Comparison of the calculated ratios with the ratios of the same business concern in the
past.
 Comparison of the calculated ratios with the same type of ratios of other similar
business concern.
 Comparison of the calculated ratios with the same type of ratios of the industry to
which the business concern belongs.
 Interpretation of the ratios.

Management discussion and analysis report

Management discussion and analysis (MD&A) is a section of a public company's annual

report or quarterly filing. The MD&A addresses the company’s performance. In this section,
the company’s management and executives, also known as the C-suite, present an analysis of
the company’s performance with qualitative and quantitative measures.This report is better
known as MD & A report which is the communication medium from the management to the
shareholders of the company giving them insights into the present business conditions of the
company and its future potential. Using this report, shareholders have bird eye view of the
company’s business and other related things and accordingly they decide about the
performance of the organization.

Importance of management discussion and analysis report

 Management is better placed than others to provide information about an organization
The MD&A is a powerful tool for the Management to communicate how the
organization has performed and how it plans to expand in future.
 Financial and Departmental Disclosures
 The MD&A along with the financial statements offers the opportunity for an
organization to communicate the effectiveness of its resources and progress towards
its defined strategic objectives.
 Comparison between company
 The MD&A is helpful in integrating and accumulating material information about the
organization that investors are interested in.
 Apart from imparting information to investors, many organization use the MD&A to
help new directors in orienting themselves to an performance and prospects.

2. Mahesh wants to start his business and for that he decides that he will take loan for
Rupees 7 Lakhs from the Bank of Baroda. He also decides to use his saving worth 3
lakhs in the bank account to start the business. Discuss how these two transactions will
be recorded in the books of accounts by passing the relevant journal entries? How these
transactions will be reflected in the Books of accounts (that’ is in the financial
statements)? Lastly, conclude your answer by stating the applicability of which
accounting assumption/s you did the above mentioned accounting treatment/
recognition and presentation in the books of accounts.

Answer:
Introduction

Accountancy refers to a systematic knowledge of accounting. Accounting Refers to the actual

process of preparing & presenting the accounts. Book-keeping is the part of accounting & is
concerned with record keeping or maintaining of books of accounting which is often routine
& clerical in nature.

A journal may be defined as the book of original or prime entry containing a chronological
record of the transactions from which posting is done to the ledger. The transactions are
recorded first in the journal in the order in which they occur. The process of recording the
transction in journal is called journalize.

The types of subsidiary books include:

1. Purchases book
2. Sales book
3. Purchase returns book
4. Sales returns book
5. Bills receivable book
6. Bills payable book
7. Cash book and
8. Journal Proper.

The entries are made in these books straight without recording in usual journal. From the
respective books, posting is made to ledger. In fact, from the entries made in the subsidiary
books, journalizing can be done. A detailed note is given in the following paragraphs on each
of the subsidiary books.

Let us understand the format in detail:

 Date: The date on which the transaction was made.
 Particulars: The financial transactions of a business affect two accounts, i.e., Debit
(Dr.) account and Credit (Cr.) account. The name of the account to be debited is
entered in the first line and Dr is written towards the right side in the Particulars
column. In the next line, the name of other affected account is entered with the word
‘To’. After the details of the debit and credit accounts, a narration or the brief
description of the transaction is provided.
 Ledger Folio (L.F.): This column mentions the page number or folio number of the
ledger account where debit and credit accounts are posted. For example, if we make a
posting in the machinery account that is prepared at page 30 of the ledger, we shall
write 30 in the LF column against the Machinery account in the journal.
 Amount debit (Dr.): The amount of the account being debited is written under this
column. In simple words, it records the debit amount.
 Amount credit (Cr.): The amount of the account being credited is written under this
column. In simple words, it records the credit amount.

The capital introduction transaction is shown in the accounting records with the
following book entries:
Accounting for an Capital introduced in business - Journal Entry
Account Debit Credit
Cash 3,00,000
Capital 3,00,000
Total 3,00,000 3,00,000

Capital Introduction Book Entries Explained

Debit – What came into the business
Cash was deposited into the business bank account with the introduction of capital.

Credit – What went out of the business

The 3,00,000 capital represents your investment in the business and indicates ownership and
an entitlement to a share of the profits. The capital introduced, together with retained
earnings, forms the owners equity of the business.

Journal Entry for Loan Taken From a Bank

Banks and NBFCs are an integral part of an economy as they act as a support for companies
by providing them additional cash leverage in the form of loans.

Following is the journal entry for loan taken from a bank;

HDFC Bank Account Debit Debit the increase in asset
To Loan Account Credit Credit the increase in liability
*Assuming that the money was deposited directly in the firm’s bank.

Traditional Rules Applied

Bank Account (Personal) – Debit the Receiver

Loan Account (Personal) – Credit the Giver

Loan received from a bank may be payable in short-term or long-term depending on the
terms set by the bank. A short-term loan is categorized as a current liability whereas a long-
term loan is capitalized and classified as a long-term liability.

3. Take Britannia Industries Ltd as a case. In the context of its financial statements and
annual report answer the following
a. It’s a largely acceptable practice among the corporate entities to pay dividend to its
shareholders. Take Britannia Industries Ltd as a case. Discuss and differentiate the
types of dividend the company paid for the financial year 2020-2021. Also, mention your
understanding about what could be the accounting treatment of Dividend in the books
of Britannia Industries Ltd.
b. Discuss and share your understanding on any three profitability ratios which you feel
relevant to assess the profitability of the company.

A) Answer:
Dividend

Dividends are payments made by a corporation to its shareholder members on a regular

(usually quarterly) basis–these are essentially the shareholder’s portion of a company’s
profits. A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives
a dividend in proportion to their shareholding; owning more shares results in greater
dividends for the shareholder. When it is time to make dividend payments, corporations
always pay preferred stock owners first, and then common stock dividends are allocated after
all preferred dividends are paid in full. In the United States, dividends are usually declared
quarterly by the corporation’s board of directors.
A firm’s dividend policy has the effect of dividing its net earnings into two parts: retained
earnings and dividends. The retained earnings provide funds to finance the firm’s long-term
growth. It is the most significant source of financing a firm’s investments in practice.
Dividends are paid in cash. Thus, the distribution of earnings uses the available cash of the
firm. A firm which intends to pay dividends and also needs funds to finance its investment
opportunities will have to use external sources of financing, such as the issue of debt or
equity.

Types of dividends paid by Britannia Industries for the financial year 2020-21
Interim dividend: An interim dividend is typically one of two dividends given out by a
company that is providing shareholders with income on a semi-annual basis. The interim
dividend is usually paid out ahead of a firm's annual general meeting and the release of the
final version of its financial statements.

Special dividend: A special dividend is a non-recurring distribution of company assets,

usually in the form of cash, to share holder. A special dividend is usually larger compared to
normal dividends paid out by the company and often tied to a specific event like an asset sale
or other windfall event. Special dividends are also referred to as extra dividends.

Final dividend: Final dividend is the amount declared by the board of directors to be payable
as dividend to the shareholders of the company after the financial statements are prepared and
issued by the company for the relevant financial year and is commonly announced in the
annual general meeting of the company.

B) Answer

The ratio analysis is one of the most powerful tools of financial analysis. Ratio analysis is a
quantitative method of gaining insight into a company's liquidity, operational efficiency, and
profitability by studying its financial statements such as the balance sheet and income
statement

Profitability Ratios
Profitability ratios are designed to provide answers to the following questions:
 Is the profit earned by the firm adequate?
 What rate of return does it represent?
 What is the rate of profit for various divisions and segments of the firm?
 What was the amount paid in dividends?
 What is the rate of return to equity-holders?

Gross profit ratio: Gross profit margin is typically the first profitability ratio calculated by
businesses. It measures how much sales income a company has left over after it covers the
cost of goods sold (COGS). This figure is known as a company’s gross profit margin. 

Gross Profit ÷ Revenue (aka Net Sales) = Gross Profit Margin %

Return Ratios: Return ratios show whether a business generates a profit for its owners or
shareholders. Two of the most common return ratios that businesses calculate are return on
assets (ROA) and return on equity (ROE). 

Net profit ratio: As a small business owner, the profitability measurement that may matter
most to you is your company’s net profit margin ratio. It reveals how much of the money
your company earns makes its way to the bottom line.

Specifically, net profit margin shows the percentage of profit your company keeps from its
sales revenue after all expenses (operating and non-operating) are paid.
Here is the formula you can use to calculate your company’s net profit margin. Check your
income statement for the initial figures you need to plug into the equation.

Net Income ÷ Revenue (aka Net Sales) = Net Profit Margin %

Return on investment: Return on investment ratio used to evaluate the competence of an

investment or to compare the competence of different investments. To calculate ROI, the
return expected from an investment is divided by the cost of the investment.

Return on investment = Return from Investment Cost of Investment/ Cost of investment

ROI serves as a return ratio, allowing a business owner to calculate how efficiently the
company uses its total asset base to generate sales. Total assets include all current assets such
as cash, inventory, and accounts receivable in addition to fixed assets such as the plant
buildings and equipment.