B.B.A. L.L.B. (HONS.

)
SEM – 1
MINOR - I

FINANCIAL MANAGEMENT
Margie Acharya
Assistant Professor
Faculty of Law
 UNIT - 4 FINANCIAL STATEMENT ANALYSIS
TOPICS COVERED:

 Ratio Analysis

 Common Size Statements

 Basic Computation of Ratio Sums

 Break- even analysis

 Budgeting – Definition , Meaning & Purpose

 Preparation and Types of Budgets

 Analysis Cash Flow Statements

 Description & Measurement of Risk

 Risk Evaluation Approaches

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

FINANCIAL STATEMENT ANALYSIS & RATIO
ANALYSIS
 The focus of financial analysis is on key figures in the financial statements and the
significant relationship that exists between them.

 It is a process of evaluating the relationship between component parts of financial

statements to obtain a better understanding of the firm’s position and performance.

 STEPS:

1. select the information relevant to the decision under consideration

2. arrange the information in a way to highlight significant relationships.

3. interpretation and drawing of inferences and conclusions

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

RATIO ANALYSIS
 Ratio analysis is a systematic use of ratios to interpret/assess the
performance and status of the firm.

 Ratio refers to the numerical or quantitative relationship between two

items/variables

 Comparison with related facts is the base of ratio analysis

 Used to compare the risk and return relationships of firms of different sizes

 Relationship between items/variables can be expressed in form of:

1. Percentages (Ex: Net Profit is 25% of Sales)

2. Fraction ((Net Profit is 1/4th of Sales)

3. Proportion of numbers (The relationship between NP and Sales is 1:4)

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
 RATIO ANALYSIS – TYPES OF COMAPRISON
1. TREND RATIOS: Involves evaluation of financial performance over a
period of time using finanicial ratio analysis. Ex: Profitability of Firm for 5
years

2. INTERFIRM COMPARISON: involves comparison of different firms’

financial ratios at the same point of time; involves comparison of a
firm’s ratios to those of others in its industry or to industry average.

3. Comparison of items within a single year’s financial statement of a firm

4. Comparison with standards or plans.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

TYPES OF RATIOS – A VIEW

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 TYPES OF RATIOS
•Measures ability of a firm to satisfy its short-term obligations as they become due.
Liquidity Ratios •Determines company’s ability to pay off current debt obligations without raising
external capital

•Measures ability of a company to generate income (profit) relative to revenue, assets,

Profitability
operating costs, and shareholders’ equity during a specific period of time.
Ratios
•Categorised into Margin & Return Ratios

Solvency
Ratios •Measures ability of firm to meet its long term debt obligations

Turnover/
•Measures company’s efficiency and speed with which it uses its assets in generating
Efficiency/
revenue/sales
Activity Ratios

Earning Ratios •Measure earning in relation to shareholders wealth

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

LIQUIDITY RATIOS
No Ratios Meaning Formula

1 Net Working Liquidity measured by subtracting current Current Assets –

Capital liabilities from current assets Current Liabilities

2 Current Ratio Shows whether current assets are Enough Current

to cover Current Liabilties Assets/Current
Liabilities

3 Quick Ratio/Acid Firm’s ability to convert its current assets Current Assets -
Test Ratio quickly into cash in order to meet its Inventory - Prepaid
current liabilities. Expenses
/Current Liabilities

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 PROFITABILITY RATIOS
No Ratios Meaning Formula
1 Gross Profit Margin Measures the percentage of each sales rupee (Gross Profit/Sales)*100
Ratio remaining after the firm has paid for its goods.

2 Operating Profit Reflects the percentage of profit a company produces EBIT/Net sales
Margin Ratio from its operations (before subtracting tax and
interest).
3 Net Profit Margin measures the percentage of each sales rupee EAT/Net Sales
Ratio remaining after all costs and expenses including
interest and taxes have been deducted.

4 Return on Total Asset measures the profitability of the total funds/ (EAT+Interest/Avg Total
investments of a firm. Assets)*100
4 Return on Equity return on the owners (both preference and equity (NPAT/Avg Shareholders
Ratio shareholders) investment in the firm. Equity)*100

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 TURNOVER/EFFICIENCY/ACTIVITY
RATIOS
No Ratio Meaning Formula
1 Equity Measures the proportion of a company's sales to its Net Sales/Avg.
Turnover Ratio stockholders' equity Shareholders’ Equity
2 Inventory Activity/liquidity of inventory of a firm; the speed with which Cost of Goods
Turnover Ratio inventory is sold. Sold/Average Inventory
3 Total Asset Measures the efficiency of how well a company uses assets to Net sales/Average Total
Turnover Ratio produce sales Assets
4 Debtors Measures how rapidly receivables are collected.A high ratio is Net Credit Sales/Average
Turnover Ratio indicative of shorter time-lag between credit sales and cash Debtors
collection
5 Creditors A low turnover ratio reflects liberal credit terms granted by Net Credit
Turnover Ratio suppliers, while a high ratio shows that accounts are to be Purchase/Average
settled rapidly. Creditors
FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
 SOLVENCY RATIOS
No Ratios
1 Debt to Equity Ratio
2 Debt Ratio
3 Debt to Capital Ratio
4 Debt to EBITDA
Ratio
5 Interest Coverage
Ratio/ Time interest
earned
6 Proprietary Ratio
FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
Meaning Formula
measures the ratio of longterm or total debt to 1. Total Debt/Shareholders
shareholders equity. Indicates the relative proportions Equity
of debt and equity in financing the assets of a firm 2. Long term
Debt/Shareholders Equity
Measures proportion of a company’s assets that are Total Debt/Total Assets
financed by debt.
Measures company's financial leverage, calculated by Long term Debt/Permanent
taking the company's interest-bearing debt and Capital
dividing it by total capital.
measures the amount of income generated and Debt/EBITDA
available to pay down debt before covering interest,
taxes, depreciation, and amortization expenses.
Ratio used to determine how easily a company can EBIT/Interest
pay interest on its outstanding debt
Measures the extent to which assets are financed by Proprietors Funds/Total
owners funds
Assets
 EARNING RATIOS
No Ratios
1 Earnings Per Share
2 Dividend Per Share
3 Price Earning Ratio
4 Return on Net Worth
/Return on Ordinary
Shareholders Equity
5 Dividend Payout
Ratio
FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
Meaning Formula
Measures profit available to shareholders, on every NPAT/No. of Shares
share held outstanding
Measures dividends paid to the equity shareholders Dividend Paid to
on a per share basis. Shareholders/No. of Shares
Outstanding
Measures the amount investors are willing to pay for Market Price of Share/EPS
each rupee of earnings; the higher the ratio, the larger
the investors confidence in the firm’s future.
Measure of a company’s profitability expressed in NPAT-Preference
percentage Dividend/Shareholders
Equity
Measures the proportion of dividends paid to earning 1. DPS/EPS*100
available to shareholders. 2. Total Dividend /Total Net
Profit to Equity
Shareholders
 BREAK EVEN ANALYSIS

 Volume Cost Profit Analysis is the relationship among various ingredients of profit planning,
namely Unit Sale Price, Variable Cost, Sales Volume, Sales Mix and Fixed Cost

 A break-even analysis is concerned with the study of revenues and costs in relation to sales
volume and, particularly, the determination of that volume of sales at which the firm’s revenues
and total costs will be exactly equal (or net income = zero).
 The “no-profit, no-loss” point is a break-even point or a point at which losses cease and profits
begin.
 If all costs are assumed to be variable with sales volume, the BEP would be at zero sales.
 If all costs were fixed, profits would vary disproportionately with sales and the BEP would be at a
point where total sales revenue equalled fixed costs.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 BUDGETING – MEANING & DEFINITION
 A budget is defined as a ‘comprehensive and coordinated plan, expressed in financial terms,
for the operations and resources of an enterprise for some specified period in the future.

 Essential elements of a budget are: (i) Plan, (ii) Operations and resources, (iii) Financial terms,
(iv) Specified future period, (v) Comprehensiveness, and (vi) Coordination.

 A budget is a mechanism to plan for the firm’s operations and resources. The operations are
reflected in revenues and expenses. This means that a budget should quantify the revenues
to be realised from products/services and the expenses to be incurred on goods/services
used in generating revenues.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

PURPOSE OF BUDGETING

 Explicit Statement of Expectations

 Communication

 Coordination

 Framework for Judging Performance

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

Types of various cash flows

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 TYPES OF BUDGETS

 Operating Budget - Relates to the physical activities/operations of a firm such as sales,

production, purchasing, debtors collection and creditors payment schedules. Has Components
like Sales Budget, Production Budget , Purchase Budget, manufacturing expenses budget, etc

 Financial Budget – It is concerned with expected cash receipts/disbursements, financial position

and results of operations. Has budgets like Budgeted Income Statement, Cash Budget,
Budgeted Balance Sheet, etc

 Special Decision Budgets: Relate to inventory levels, break-even analysis, and so on.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 FLEXIBLE BUDGETS
 Estimates costs at several levels of activity. Its merit is that instead of one estimate, it contains several
estimates/plans in different assumed circumstances.

 Useful tool in real world situations, that is, unpredictable environment.

 A series of fixed budgets and any increase/decrease in the level/volume of activity must be reflected in it.

 The conceptual framework of flexible budgeting relates to: (i) Measure of volume and (ii) Cost behaviour with
change in volume. Each expense in

 Each department/segment is to be categorised into fixed, variable and mixed components.

 Are superior to fixed budgets.

 Weaknesses: Inability to: (i) Show the potential variability of various estimates used in the preparation of the
budget, and (ii) Indicate the range within which costs may be expected to vary

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

SUM ON FLEXIBLE BUDGET

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 CASH FLOW STATEMENTS - MEANING,
SOURCES AND USES
 Cash flow statement is a statement which indicates sources of cash inflows and
transactions of cash outflows of a firm during an accounting period.
 The activities/transactions which generate cash inflows are known as sources of cash and
activities which cause cash outflows are known as uses of cash.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 CASH FLOW STATEMENTS - WHY
 A balance sheet shows the financial position of the a firm as at the last day of the accounting period
and An income statement focuses on financial performance (profit or loss) due to the operating
activities of a firm during the period.
 The Institute of Chartered Accountants of India (ICAI) issued the Accounting Standard (AS-3) relating to
the preparation of cash flow statement (CFS) for accounting periods commencing on or after April 1,
2001 for enterprises (i) which have either turnover of more than Rs 50 crore in a financial year or (ii) the
shares of which are listed in stock exchange (i.e. the listed companies) in India or outside India or (iii)
enterprises which are in the process of listing their equity or debt securities as evidenced by the Board of
Directors’ resolution in this regard.
 Some of the expenses shown in income statement may be non-cash expenses (depreciation,
amortisation etc.) and some may not be paid in full (goods purchased on credit, salaries payable etc).
 Thus, the period’s profit or loss does not bear direct relationship to the cash flows associated with the
period’s operations.
 It does not evidently provide information about the investing and financing activities of the firm during
the accounting period.
 Objective of the cash-flow statement is to provide information about the cash flows associated with
operating, investing and financing activities of the firm during the accounting period.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

CASH FLOW STATEMENTS RULES

 All the increases in current assets excluding cash and decreases in current
liabilities which increase working capital decrease cash

 all decreases in current assets other than cash and increases in current
liabilities which cause a decrease in working capital increase cash.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

USES OF CASH FLOW STATEMENTS

 Indicates the extent of reliance on external resources vis-a-vis the internal

sources.
 Effect of various financing and investment decisions on future cashflows
 Enables the management to revise/review its investments,
 Operations and financing activities so as to conform to the desired financial
inflow and outflow of resources.
 Long-term lenders can use the statement as a means of estimating the
firm’s ability to service their debts

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

DIRECT METHOD CASH FLOW
STATEMENT
INDIRECT METHOD CASH FLOW
STATEMENT
FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
 MEASUREMENT OF RISK
 RISK : variability in the actual returns in relation to the estimated returns.

 Risk refers to a set of unique outcomes for a given event which can be assigned probabilities,
while uncertainty refers to the outcomes of a given event which are too unsure to be
assigned probabilities.

 HOW TO MEASURE RISK

1. Sensitivity Analysis : Behavioural approach which uses a number of possible values for a given
variable to assess its impact on a firms returns

2. Scenario Analysis : Evaluates the impact of projects profitability of simultaneous changes in

more than one variable.

3. Simulation: Statistically based behavioural approach used in capital budgeting to get a feel
for risk by applying predetermined probability distributions and random numbers to estimate
risky outcomes.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 PRECISE MEASURES OF RISK

 Standard deviation: It is a measure of risk that indicates the degree of uncertainty or

dispersion of cash flow. The greater the standard deviation of a profitability distribution, the
greater the dispersion of outcomes around the expected value.
Formula:

 Coefficient of Variation: Standard deviation cannot be used or can be misleading in

comparing uncertainty of alternative projects if they differ in size. Hence Coefficient of
variation (V ) is a correct technique in such cases.
 Formula:

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

RISK EVALUATION APPROACHES

 Risk Adjusted Discount Rate Approach

 Certainty Equivalent Approach
 Probability Distribution Approach
 Decision Tree Approach

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 YOUTUBE VIDEOS YOU COULD LISTEN TO (Ratios):
 Accounting Basics Explained Through a Story: https://www.youtube.com/watch?v=VYNTBWBqncU

 Basic Accounting Terms: https://www.youtube.com/watch?v=1Rq8t7pOT3k

 Basic Accounting Terms | Accounts | Class 11: https://www.youtube.com/watch?v=CMu8TZbyKMU,

https://www.youtube.com/watch?v=HELhyTQwhJA

 Accounting Ratios | Ratio Analysis | Meaning : https://www.youtube.com/watch?v=-gt9GmzaMgE,

https://www.youtube.com/watch?v=fwhPLeTUiQo

 CLASS XII - ACCOUNTS | BY RACHNA MA'AM: https://www.youtube.com/watch?v=nT-0Nt8Gpjs,

https://www.youtube.com/watch?v=ImYVdqgbqAM,
https://www.youtube.com/watch?v=bVKn8sQhxfQ

 Learn Financial Ratio Analysis in 15 minutes: https://www.youtube.com/watch?v=55af7cmyczo

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 YOUTUBE VIDEOS YOU COULD LISTEN TO (Other
topics):
 :
CVP Analysis | Break Even Analysis | Meaning | Formula | Graph | Management Accounting
|BBA | B.Com: https://www.youtube.com/watch?v=wsRGHu67WXE

 Cash Flow Statement | Financial Accounting | Meaning | Objective | Format | Class 12 | BBA |
MBA: https://www.youtube.com/watch?v=6nwrfwW8n3E

 Budgetary Control | Budget Meaning Type | Budgeting | Management Accounting | BBA |

B.Com | MBA: https://www.youtube.com/watch?v=IFtqzOlYrdg

 Types Of Budget | Budget | Classification Of Budget | Budgetary Control | Management

Accounting: https://www.youtube.com/watch?v=bfyu202U5Ls

 Risk analysis in investment || Measurement of Risk || Sensitivity Analysis:

https://www.youtube.com/watch?v=LNDWruLja9I

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA