Module 5

Preparation of Company
Financial Statements
Presentation by
Prof. Mahesh Bendigeri
Global Business School, Hubli
9342585290 / 7892899431
Email: maheshbendigeri@gmail.com
Content
Concept of Financial
01 Statement

Meaning of Financial Statement

02 Analysis & Interpretations

Tools of Financial Statement

03 Analysis

Users of Financial Statement

04 Analysis
Concept of Financial Statement
Financial Statement are summarized financial reports which provide
the operating results and financial position of companies, and the
detailed information contained therein is useful for assessing the
operational efficiency and financial soundness of a company.

The basic financial statements are

• Income Statement, Balance Sheet, Cash Flow Statement

From point of users of accounting information, these financial

statement gives broad details of financial aspects of business.
Hence, proper analysis and interpretation is required to make informed
decision
Meaning of Financial Statement Analysis

• The process of critical evaluation of the financial information

contained in the financial statements in order to understand and
make decisions regarding the operations of the firm is called
‘Financial Statement Analysis’.
• It is basically a study of relationship among various financial facts
and figures as given in a set of financial statements, and the
interpretation thereof to gain an insight into the profitability and
operational efficiency of the firm to assess its financial health and
future prospects.
Meaning of Financial Statement Analysis

• The term ‘financial analysis’ includes both ‘analysis and

interpretation’.
• The term ‘analysis’ means simplification of financial data by
methodical classification given in the financial statements.
• ‘Interpretation’ means explaining the meaning and significance of the
data.
• These two are complimentary to each other.
• Analysis is useless without interpretation, and interpretation without
analysis is difficult or even impossible.
Significance of Financial Statement Analysis

• Financial analysis is the process of identifying the financial strengths

and weaknesses of the firm by properly establishing relationships
between the various items of the balance sheet and the statement of
profit and loss.
• Financial analysis can be undertaken by management of the firm, or
by parties outside the firm,viz., owners, trade creditors, lenders,
investors, labour unions, analysts and others.
• The nature of analysis will differ depending on the purpose of the
analyst.
• A technique frequently used by an analyst need not necessarily
serve the purpose of other analysts because of the difference in the
interests of the analysts.
The Nature of Financial Statement Analysis
Depending upon the objectives, the process of financial analysis is
described;
It can be used as a preliminary screening tool in the selection of
stocks in the secondary market.
It can be used as a forecasting tool of future financial conditions and
results.
It may be used as a process of evaluation and diagnosis of
managerial, operating or other problem areas.
It reduces reliance on intuition, guesses and thus narrows the areas
of uncertainty that is present in all decision making processes
Sources of Financial Information

• The primary source is the data provided by the firm

itself in its annual report and required disclosures.
• The market prices of securities of publicly traded
corporations available in the financial press and the
electronic media daily
Tools of Financial Statement Analysis

• Comparative Statements
• Cross Sectional Analysis
• Common Size Statements
• Trend Analysis
• Ratio Analysis
Comparative Statements

• These are the statements showing the profitability and financial

position of a firm for different periods of time in a comparative form
to give an idea about the position of two or more periods.
• Comparative figures indicate the trend and direction of financial
position and operating results. This analysis is also known as
‘horizontal analysis’.
• The financial data will be comparative only when same accounting
principles are used in preparing these statements.
• It applies to balance sheet and statement of profit and loss prepared
in a comparative form.
Example:
 Cross Sectional Analysis
Under this approach the financial ratios of a firm are compared with
the industry level or with a good player in normal business
condition , to assess whether the financial ratios are within the
limits or in par or above the limit.
This will help in analyzing the strength and weakness of the firm.
 Common Size Statement
• Common Size Statement, also known as component percentage
statement, is a financial tool for studying the key changes and trends
in the financial position and operational result of a company.
• Here, each item in the statement is stated as a percentage of the
aggregate, of which that item is a part.
• Common size analysis is of immense use for comparing enterprises
which differ substantially in size as it provides an insight into the
structure of financial statements.
• Inter-firm comparison or comparison of the company’s position with
the related industry as a whole is possible with the help of common
size statement analysis.
Example:
Common Size Balance Sheet
Trend Analysis

• It is a technique of studying the operational results and financial

position over a series of years.
• Using the previous years’ data of a business enterprise, trend
analysis can be done to observe the percentage changes over
time in the selected data.
• Two Types of Trend Analysis:
• Time Series
• Index Number Trend Series
Time Series Analysis – Year to Year Change

• A comparison of financial statements over two to three

years can be undertaken by computing the year to year
change in absolute amounts and in terms of percentage
change.
• This will help to analyze the performance of the firm over
the period of time. Ratios 2015 2016 2017

Current ratio 3.31 3.78 3.98

Quick ratio 2.04 2.16 2.34

Debt to Equity ratio 0.90 0.85 1.52

Interest coverage 3.22 2.86 1.90

Index number trend series
• When a comparison of financial statements covering more than three
years is undertaken, the year to year method of comparison may
become too cumbersome.
• To overcome this limitation, the best way to understand such longer
term trend comparisons is by means of index numbers.
• The computation of a series of index numbers requires the choice of
a base year, which is not affected by any abnormal extremities.
• That year is taken as a base year as 100.
• An important use of this method is to show how all the variables of a
particular statement are changing over a longer period of time.
Ratio Analysis

• Ratio analysis is a widely used tool of financial analysis.

• It is defined as” the systematic use of ratio to interpret the financial
statements. So that the strengths and weaknesses of a firms as well
as its historical performance and current financial condition can be
determined”.
• Applying analytical techniques to financial statements and other
relevant data to produce information useful for decision making.
Utility of Ratio Analysis
It’s a tool which enables the banker or lender to arrive at
the following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances to be or
already been provided
Quantitative answers to the questions such as;

• Are the net profits adequate?

• Are the assets being used efficiently?
• Is the firm solvent?
• Can the firm meet its current obligations?
Classification of Ratios

Profitability Liquidity Leverage

Ratios Ratios Ratios

Shareholders
Activity
Returns
Ratios
Ratios
Profitability Ratios
Liquidity Ratios
Leverage Ratios
Activity Ratios
Shareholders Return Ratios
Thank You