Financial Statement Analysis

Financial Statements
• Primary Goal of Management is to
maximise the value of the firm. Value
depends on stream of future cashflows
generated by the firm.
• How can manager decide which actions
are likely to increase cashflows?
• How can an investor estimate future
cashflows?
• Who are all stakeholders interested in
wellbeing of the firm?
 Financial Statements

• What is the financial position of the

firm at a given point in time?
• How has a firm performed financially
over a given period of time ?
• What have been the sources and uses
of cash over a given period of time?
 “THE SCORECARDS”
• BALANCE SHEET – a statement of position at a
point in time
– Shows SOURCES OF FUNDS and USES OF FUNDS
• PROFIT & LOSS ACCOUNT – a statement that
measures the income and expenditure for the year
– Measures the results of OPERATIONS
• CASH FLOW STATEMENT – puts operations on
a cash basis
– Gives sources and uses of cash
 Structure of financial statements – Schedule VI
Income statement
I. Revenue From Operations
II. Other Income : Interest, Dividend, Sale of Assets
III. Total Revenue
IV. Expenses:
a. Cost of material consumed
b. Purchase of stock in trade
c. Change in inventory
d. Employee benefit expense
e. Financial costs
f. Depreciation and amortization
g. Other expenses
V. Total Expenses
 Structure of financial statements – Schedule VI
Income statement
VI. Profit before exceptional and extraordinary
items and tax = Total Revenue – Total Expenses
VII. Less Exceptional Items,
VIII. Profit before Extra ordinary items and Tax
IX. Less Extra ordinary items
X. Profit before tax
XI. Less Tax expense
XII. Profit(Loss) For the Period
XIII. Earnings per share
 Structure of financial statements – Schedule VI
Balance sheet
I. Equity and Liabilities
(1) Shareholder's Funds (Share capital, & reserves)
(2) Share application money pending allotment
(3) Non-Current Liabilities (Long term borrowings,
provisions, deferred tax liabilities)
(4) Current Liabilities (short term borrowings, trade
payables, short term provisions, other current
liabilities)
II. Assets
(1) Non-current assets (Fixed assets – tangible and
intangible, Non current investments, long term loans
and advances, deferred tax assets)
(2) Current assets (current investments, inventories,
trade receivables, cash, cash equivalents, short term
 Deferred Tax
• XYZ Co. produces drill machines. The company
XYZ assumes that the probability of a drill machine
being sent for warranty repairs is 2%. If XYZ’s
revenue for financial year 2017 is Rs.10,00,000,
then the discrepancy arises in the income
statement and the tax authority statement.
• Revenue – Warranty Exp. = Taxable income
• Tax authority statement
• Revenue = Taxable income
 Linkage between the Financial Statements
PROFIT & LOSS ACCOUNT BALANCE SHEET
Income Liabilities Assets
Revenues from operations
Other Income Equity Capital Fixed Assets
Reserves & Surplus
Expenses
Material Loan Funds Investments
Employee benefit Exp Current Liabilities Current Assets
Finance costs Cash
Other expenses
Depreciation
Profit before Exceptional and
Extraordinary Items and Tax CASH FLOW STATEMENT
Less Exceptional & Extra ordinary OPENING CASH BALANCE
Expenses Operating
Less Tax Investment
Profit After Tax Financing
Less Dividend
Closing Cash Balance
Retained Profit
 CASH FLOW STATEMENT
• A statement of changes in financial position on cash
basis, commonly known as the cash flow statement,
summarizes the causes of changes in cash position
between dates of the two balance sheets.

• It indicates the sources and uses of cash.

• This statement analyzes changes in noncurrent

accounts as well as current accounts (other than
cash) to determine the flow of cash.

10
 Sources of Cash
The profitable operations of the firm,
Decrease in assets (except cash),
Increase in liabilities (including debentures or bonds),
Sale proceeds from an ordinary or preference share issue
Uses of Cash
• The loss from operations
• Increase in assets (except cash)
• Decrease in liabilities
• Redemption of redeemable preference shares
• Cash dividends
11
 NET CASH FLOW

When we looked at the profit and loss account, the emphasis

was on profit after tax (also called the bottom line). In
finance, however, the focus is on cash flow.
A firm’s cash flow generally differs from its profit after tax
because some of the revenues/expenses shown on its profit
and loss account may not have received/paid in cash during
the year. The relationship between net cash flow and profit
after tax is as follows:

Net cash flow = Profit after tax – Non cash revenues

+ Non cash expenses
 NET CASH FLOW
An example of non cash revenue is accrued interest
income that has not yet been received. It increases the
bottom line but is not matched by a cash inflow during the
accounting period – the cash inflow would occur in a
subsequent period. An example of a non cash expense is
depreciation.
In practice, analysts define the net cash flow as:
Net cash flow = Profit after tax+ Depreciation+
Amortisation
However, note that the above expression will not reflect
net cash flow accurately if there are significant noncash items
beyond depreciation and amortisation.
 Cashflow Statement
• Operating Activities involve Producing and
selling goods and services
• Cash Inflows : Monies received from
customers for sales of goods
• Cash outflow : Payments to suppliers for
material, Employees and labours, to the
government for taxes
Cashflow Statement : Investing Activities

• Investing Activities involve acquiring and

disposing fixed assets, buying and selling of
securities and disbursing and collecting loans
• Cash Inflows : Receipt from sale of asset,
recovery of loans, collection of dividends and
interest
• Cash outflow : Payments for the purchase of
assets and disbursement of loans
 CORPORATE INCOME TAX
• A company’s taxable income is determined by taking
into account its revenues, expenses, and deductions on
account of various incentives and reliefs. The taxable
income is subject to a tax rate of 30 percent for domestic
companies and 40 percent for foreign companies.
• While computing the taxable income, among other
things, bear in mind the provisions relating to the following
-
depreciation, interest expense, dividend payment,
dividend income, unabsorbed business loss and
depreciation, exemptions and deductions, minimum
alternate tax, and
advance tax.
 CORPORATE INCOME TAX

1. Depreciation is charged on blocks of assets which

represent a group of assets within the broad class
of assets such as buildings, plant, machinery, and
furniture, for which a common rate of
depreciation is applicable.
2. While interest on borrowings is a tax-deductible
expense, dividend on share capital is not.
3. Unabsorbed business loss of any year can be
carried forward and set off against income under
the head of business of subsequent years.
 FREE CASH FLOW

Free cash flow is the cash flow available for

distribution to investors (lenders and
shareholders) after the firm has made
investments in fixed assets and working capital to
support its operations.