INSTITUTE-UNIVERSITY SCHOOL OF

BUSINESS
DEPARTMENT-MBA
Master of Business Administration
Financial Reporting and Analysis
BAT-601

FINANCIAL STATEMENT
ANALYSIS DISCOVER . LEARN . EMPOWER
 FINANCIAL
STATEMENT
ANALYSIS
Course Outcome
CO Title Level
Number

CO1 To impart understanding of the Basic Principles of Remember Will be covered in this
Accounting, Accounting Standards, Reading and Analyzing lecture
Balance sheets and its application in modern day business
CO2 To prepare various financial statements i.e. trading Understand
account, Profit and loss account and balance sheet, P/L
Appropriation account, cash flow statement etc.
CO3 To provide knowledge of concepts those are helpful in Understand
financial decision making

2
It is a systematic process of the critical
examination of the financial information
contained in the financial statements in order to
understand and make decisions regarding the
operations of the firm

3
Introduction of Financial Statement Analysis :

FSA is an analysis which highlights important relationships between items in the

financial statements.

FSA embraces the methods used in assessing and interpreting the results of past
performance and current financial position as they relate to particular factors of
interest in investment decisions.

It is an important means of assessing past performance and in forecasting and

planning future performance.

4
 Definition:
FSA is the use of analytical or financial tools to examine and
compare financial statements in order to make business decisions.

In other words, FSA is a way for investors and creditors to examine financial
statements and see if the business is healthy enough to invest in or loan to.

FSA takes the raw financial information from the financial statements and turns it
into usable information the can be used to make decisions.

The three types of analysis are horizontal analysis, vertical analysis, and ratio
analysis.

Each one of these tools gives decision makers a little more insight into how well the
company is performing.

5
Objectives of Analysis of Financial Statement:

It has already been pointed out above that financial statements are used by various
interested parties for their various purposes.
(a) To ascertain short-term liquidity position of an enterprise by the application of
various liquidity ratios.
(b) To evaluate the long-term solvency position by the application of various
solvency ratios;
(c) To assess the risk (both financial as well as business) involved with firm.
(d) To assess the present earning capacity of the firm for the purpose of inter-firm
comparison and thereby to assess the progress or otherwise of the firm.

6
(e) To evaluate the efficiency of the firm for proper utilization of financial
resources.

(f) To assess the intra-firm comparison among of the various components of the
firm.

(g) To see the effect of various non-economic and economic factors of the firm.

(h) To assess the working capital position of the firm.

7
Objectives of Financial Statement Analysis:

1. Assessment of Past Performance and Current Position:

Past performance is often a good indicator of future performance.

Therefore, an investor or creditor is interested in the trend of past sales, expenses, net
income, cast flow and return on investment.

These trends offer a means for judging management’s past performance and are
possible indicators of future performance.

8
2. Prediction of Net Income and Growth Prospects:

The financial statement analysis helps in predicting the earning prospects and
growth rates in the earnings which are used by investors while comparing
investment alternatives and other users interested in judging the earning
potential of business enterprises.

Investors also consider the risk or uncertainty associated with the expected
return.

9
3. Prediction of Bankruptcy and Failure:

Financial statement analysis is a significant tool in predicting the bankruptcy and

failure probability of business enterprises.

After being aware about probable failure, both managers and investors can take
preventive measures to avoid/minimise losses.

Corporate managements can effect changes in operating policy, reorganize

financial structure or even go for voluntary liquidation to shorten the length of
time losses.

10
4. Loan Decision by Financial Institutions and Banks:

Financial statement analysis is used by financial institutions, loaning agencies,

banks and others to make sound loan or credit decision.

In this way, they can make proper allocation of credit among the different
borrowers.

Financial statement analysis helps in determining credit risk, deciding terms and
conditions of loan if sanctioned, interest rate, maturity date etc.

11
Significance of Financial Analysis to different parties:

Finance Manager
Analysis of financial statements helps the finance manager in:

•Assessing the operational efficiency and managerial effectiveness of the

company.
•Analyzing the financial strengths and weaknesses and creditworthiness of
the company.
•Analyzing the current position of financial analysis,
•Assessing the types of assets owned by a business enterprise and the
liabilities which are due to the enterprise.
•Providing information about the cash position company is holding and how
much debt the company has in relation to equity.
•Studying the reasonability of stock and debtors held by the company.

12
Top Management

•Financial analysis helps the top management:

•To assess whether the resources of the firm are used in the most efficient
manner

•Whether the financial condition of the firm is sound

•To determine the success of the company’s operations

•Appraising the individual’s performance

•evaluating the system of internal control

•To investigate the future prospects of the enterprise.

13
Trade Payables:

Trade payables analyze of financial statements for:

•Appraising the ability of the company to meet its short-term obligations

•Judging the probability of firm’s continued ability to meet all its financial
obligations in the future.

•Firm’s ability to meet claims of creditors over a very short period of time.

•Evaluating the financial position and ability to pay off the concerns.

14
Lenders:
Suppliers of long-term debt are concerned with the firm’s long-term solvency and
survival. They analyze the firm’s financial statements:

•To ascertain the profitability of the company over a period of time,

•For determining a company’s ability to generate cash, to pay interest and repay
the principal amount
•To assess the relationship between various sources of funds (i.e. capital structure
relationships)
•To assess financial statements which contain information on past performances
and interpret it as a basis for forecasting future rates of return and for assessing
risk.
•For determining credit risk, deciding the terms and conditions of a loan if
sanctioned, interest rate, and maturity date etc.

15
Investors:

Investors, who have invested their money in the firm’s shares, are interested in the
firm’s earnings and future profitability. Financial statement analysis helps them
in predicting the bankruptcy and failure probability of business enterprises. After
being aware of the probable failure, investors can take preventive measures to
avoid/minimize losses.

Labour Unions:

Labour unions analyze the financial statements:

•To assess whether an enterprise can increase their pay.

•To check whether an enterprise can increase productivity or raise the prices of
products/ services to absorb a wage increase.

16
 Tools and Techniques of Financial Statement

Comparative financial statements

Common size statements

Trend analysis

Ratio analysis

Fund flow statement

Cash flow statement

17
 Types of Financial Analysis

• External analysis: Conducted by those persons who do not have access to the detailed record of the
enterprise and depend on the published reports.

• Internal analysis: Conducted by management so as to know the financial position nd operational

efficiency of the organization.

• Horizontal analysis: This analysis is made to review and analyse the financial statements for number of
years and are therefore based on the financial data based on those years.

• Vertical analysis: This is made to review and analyse the financial statements of one year only.

18
 Importance of Financial Analysis

• Judging the earning capacity or profitabilty

• Judging the managerial efficiency
• Judging the long term and short term solvency of the firm
• Inter firm comparison
• Making forecasts

19
 Limitations

• Historical analysis
• Ignores price level changes
• Qualitative aspect ignored
• Not free from bias

20
What Is Common Size Analysis?

Let's meet Jojo, who owns the Hardware Haven.

He runs a successful business and is always wondering how he is performing in

relation to his competition.

He finds comparing his results to competitors difficult because he is much

smaller than they are.

As a result, his competitors' profits are always greater, which makes him suspect
they are more successful.

He is looking for a way to compare his results with theirs in a meaningful way.

Let's see if we can help Sam with this problem.

21
 Common size, or vertical analysis, is a method of evaluating financial information
by expressing each item in a financial statement as a percentage of a base amount
for the same time period.

A company can use this analysis on its balance sheet or its income statement.

A balance sheet summarizes the company's assets, which are things that it owns that
have value; its liabilities, which are the amounts it owes to others; and its equity,
which is an owner's investment in the business.

An income statement shows the company's revenues, which is the amount of money it
made by selling its goods and services, and its expenses, which is the amount of
money it spent to earn its revenues.

22
The formula used in common size analysis is:

Common Size Amount = Analysis Amount x 100%

Base Amount

The base amount will change depending on whether the company is completing its
analysis on the balance sheet or the income statement.

If the company completes its analysis on the balance sheet, then the base amount
will be total assets or total liabilities and owners' (or shareholders') equity.

If the income statement is used, the base amount will be net sales.

23
Applying Common Size Analysis

Let's assume that Jojo's cash balance is Rs 75,000 and his total assets are Rs
18,35,000.

If we apply common size analysis, the common size amount would be:

= (analysis amount / base amount of total assets) x 100%

= (75,000 / 1,835,000) x 100%
= 4.1%

Therefore, 4.1% of Jojo's total assets are made up of cash.

Jojo could also compare this common size amount to last year to determine changes
that occurred.

24
Let's assume that last year's cash balance was Rs 85,000 and total assets were Rs
15,95,000.

At first glance, it appears that the cash balance has only decreased by $10,000
($85,000 - $75,000).

If we apply common size analysis to last year's cash balance, we can see that cash
comprises 5.3% of Sam's total assets calculated as follows:

= (analysis amount / base amount of total assets) x 100%

= ($85,000 / $1,595,000) x 100%
= 5.3%

Common size analysis reveals that Jojo's cash balance decreased by 1.2% (5.3%
- 4.1%) of his total assets.

Here is Sam's common size analysis for his balance sheet: 25

26
27
28
29
30
31
 14-Mar 15-Mar 16-Mar 17-Mar 18-Mar
EQUITIES AND LIABILITIES
SHAREHOLDER'S FUNDS
Equity Share Capital 113.6 113.6 113.6 113.6 113.6
Total Share Capital 113.6 113.6 113.6 113.6 113.6
Revaluation Reserves 315.37 315.37 315.37 0 0
Reserves and Surplus -4,603.83 -6,753.78 -5,639.41 -6,618.76 -7,252.73
Total Reserves and Surplus -4,288.46 -6,438.41 -5,324.04 -6,618.76 -7,252.73
Total Shareholders Funds -4,174.86 -6,324.81 -5,210.44 -6,505.16 -7,139.13
NON-CURRENT LIABILITIES
Long Term Borrowings 6,546.07 6,607.30 6,210.33 6,967.85 5,085.56
Other Long Term Liabilities 365 1,148.41 903.53 66.01 39.2
Long Term Provisions 249.96 273.55 375.22 419.03 464.3
Total Non-Current Liabilities 7,161.03 8,029.26 7,489.08 7,452.89 5,589.06
CURRENT LIABILITIES
Short Term Borrowings 2,167.93 3,644.29 3,021.06 252.52 209.56
Trade Payables 5,228.27 5,787.90 6,120.03 4,873.00 6,713.80
Other Current Liabilities 6,578.37 5,886.19 5,841.59 6,773.87 7,532.26
Short Term Provisions 149.33 74.37 36.54 35.19 49.54
Total Current Liabilities 14,123.90 15,392.75 15,019.22 11,934.58 14,505.16
Total Capital And Liabilities 17,110.07 17,097.20 17,297.86 12,882.31 12,955.0932
ASSETS 2014 2015 2016 2017 2018
NON-CURRENT ASSETS
Tangible Assets 9,619.14 9,221.58 8,777.58 4,860.89 3,589.30
Intangible Assets 25.5 12.77 29.05 35.89 19.5
Capital Work-In-Progress 0 0 4.1 709.3 24.74
Intangible Assets Under Development 0 19.42 0 0 0
Fixed Assets 9,644.64 9,253.77 8,810.73 5,606.08 3,633.54
Non-Current Investments 665.74 669.65 679.39 748.97 837.46
Long Term Loans And Advances 1,225.64 1,408.26 1,386.07 119.57 93.13
Other Non-Current Assets 0 0 38.23 944.03 1,091.28
Total Non-Current Assets 12,708.41 11,331.68 10,914.42 7,418.65 5,655.41
CURRENT ASSETS
Current Investments 0 0 500 534 0
Inventories 859.36 963.5 1,064.10 506.12 487.64
Trade Receivables 1,287.18 1,391.14 1,627.66 1,334.84 1,280.78
Cash And Cash Equivalents 1,206.48 2,162.84 1,488.13 1,542.18 1,365.40
Short Term Loans And Advances 1,048.64 1,248.04 1,677.55 7.12 31.26
OtherCurrentAssets 0 0 26 1,539.40 4,134.60
Total Current Assets 4,401.66 5,765.52 6,383.44 5,463.66 7,299.68
Total Assets 17,110.07 17,097.20 17,297.86 12,882.31 12,955.09
33
 14-Mar 15-Mar 16-Mar 17-Mar 18-Mar
INCOME
Revenue From Operations [Gross] 18,175.43 19,976.54 21,332.58 20,877.06 23,453.85
Less: Excise/Sevice Tax/Other Levies 558.79 595.81 760.36 0 0
Revenue From Operations [Net] 17,616.64 19,380.73 20,572.22 20,877.06 23,453.85
Other Operating Revenues 1,419.20 1,584.87 1,634.74 1,815.52 1,056.84
Total Operating Revenues 19,035.84 20,965.60 22,206.96 22,692.58 24,510.69
Other Income 409.46 696.05 699.1 1,482.48 666.78
Total Revenue 19,445.30 21,661.65 22,906.06 24,175.06 25,177.47
EXPENSES
Aircraft Fuel Expenses 8,125.27 7,365.56 5,403.37 5,935.93 7,419.79
Aircraft Lease Rentals 1,954.92 2,172.51 2,285.72 2,430.81 2,456.84
Employee Benefit Expenses 2,077.84 2,419.07 2,532.33 3,084.21 3,174.22
Finance Costs 1,083.60 920.47 884.98 858.68 848.94
Depreciation And Amortisation Expenses 877.78 765.31 996.24 671.55 621.14
Other Expenses 8,737.29 9,366.86 9,749.49 9,748.61 11,381.48
Total Expenses 22,856.70 23,009.78 21,852.13 22,729.79 25,902.41
Profit/Loss Before Exceptional, ExtraOrdinary
-3,411.40 -1,348.13 1,053.93 1,445.27 -724.94
Items And Tax
Exceptional Items -717.39 -753.22 148.02 0 0
Profit/Loss Before Tax -4,128.79 -2,101.35 1,201.95 1,445.27 -724.94
Tax Expenses-Continued Operations
Current Tax 0 0 0.01 0 0
Tax For Earlier Years -0.12 0.01 0 -0.2 0
Total Tax Expenses -0.12 0.01 0.01 -0.2 0
Profit/Loss After Tax And Before ExtraOrdinary
-4,128.67 -2,101.36 1,201.94 1,445.47 -724.94
Items
Profit/Loss From Continuing Operations -4,128.67 -2,101.36 1,201.94 1,445.47 -724.94
Profit/Loss For The Period -4,128.67 -2,101.36 1,201.94 1,445.47 -724.94 34
Comparative Statements Analysis:

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.

It usually applies to the two important financial statements, namely,

balance sheet and statement of profit and loss prepared in a
comparative form.

35
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.

The financial data will be comparative only when same accounting

principles are used in preparing these statements.

Comparative figures indicate the trend and direction of financial

position and operating results.

This analysis is also known as ‘horizontal analysis’.

36
The following steps may be followed to prepare the comparative
statements:

Step 1 : List out absolute figures in rupees relating to two points of time

Step 2 : Find out change in absolute figures by subtracting the first year
from the second year (Col.3) and indicate the change as increase (+) or
decrease (–) and put it in column 4.

Step 3 : Preferably, also calculate the percentage change as follows and

put it in column 5.

37
38
39
40
41
42
 Financial Ratio Analysis

Financial ratios are mathematical comparisons of financial statement accounts or

categories.

These relationships between the financial statement accounts help investors,

creditors, and internal company management understand how well a business is
performing and of areas needing improvement

Ratios are easy to understand and simple to compute.

They can also be used to compare different companies in different industries.

Since a ratio is simply a mathematically comparison based on proportions, big and

small companies can be use ratios to compare their financial information.

43
Ratios allow us to compare companies across industries, big and small, to
identify their strengths and weaknesses.

Financial ratios are often divided up into following categories:

•Liquidity,

•Solvency,

•Efficiency,

•Profitability,

44
A- Liquidity Ratios

Liquidity ratios analyze the ability of a company to pay off both its current
liabilities as they become due as well as their long-term liabilities as they become
current.
In other words, these ratios show the cash levels of a company and the ability to
turn other assets into cash to pay off liabilities and other current obligations.

Liquidity is not only a measure of how much cash a business has.

It is also a measure of how easy it will be for the company to raise enough cash or
convert assets into cash.

Assets like accounts receivable, trading securities, and inventory are relatively
easy for many companies to convert into cash in the short term.

45
1- Current ratio
2- Quick ratio.
3- Acid test ratio
4- Working capital ratio

The current ratio is a liquidity and efficiency ratio that measures a firm’s ability
to pay off its short-term liabilities with its current assets.

The current ratio is an important measure of liquidity because short-term

liabilities are due within the next year.

Current ratio = Current assets

Current liabilities

46
2- The quick ratio or acid test ratio is a liquidity ratio that measures the ability
of a company to pay its current liabilities when they come due with only quick
assets.

Quick assets are current assets that can be converted to cash within 90 days or
in the short-term.

Cash, cash equivalents, short-term investments or marketable securities, and

current accounts receivable are considered quick assets.

Quick ratio= Quick assets/ CL

Quick assets= CA- (Stock + P/P Exp.)

47
48
49
50
51
B- Solvency ratios,

SR also called leverage ratios, measure a company’s ability to sustain operations

indefinitely by comparing debt levels with equity, assets, and earnings.

Solvency ratios identify going concern issues and a firm’s ability to pay its bills in
the long term.

Many people confuse solvency ratios with liquidity ratios. Although they both
measure the ability of a company to pay off its obligations, solvency ratios focus
more on the long-term sustainability of a company instead of the current liability
payments.

52
1- Debt equity ratio.
2- Interest coverage.
3- debt ratio.
4- Equity ratio.

1-The debt to equity ratio is a financial, liquidity ratio that compares a

company’s total debt to total equity.

The debt to equity ratio shows the percentage of company financing that comes
from creditors and investors.
A higher debt to equity ratio indicates that more creditor financing (bank loans)
is used than investor financing (shareholders).

Debt to equity = Total debt

Total Equity

53
2- The Equity ratio:

It measures the amount of assets that are financed by owners’ investments by

comparing the total equity in the company to the total assets.

The equity ratio highlights how much of the total company assets are owned
outright by the investors.

In other words, after all of the liabilities are paid off, the investors will end up
with the remaining assets.

Equity ratio= Total Equity

Total Assets

54
3- Debt ratio :
It shows a company’s ability to pay off its liabilities with its assets.
In other words, this shows how many assets the company must sell in order to
pay off all of its liabilities.

This ratio measures the financial leverage of a company.

Companies with higher levels of liabilities compared with assets are considered
highly leveraged and more risky for lenders.

Debt Ratio= Total Debt

Total Assets

55
4- Interest Coverage ratio:

This ratio shows the consistency of firm result to cover the interest charges on
debt.

It is also known as Debt service ratio or Fixed charge coverage ratio.

Interest coverage ratio= EBIT OR PBIT

Fixed interest charges

56
 C- Profitability ratios:

This ratio compare income statement accounts and categories to show a company’s ability
to generate profits from its operations.

Profitability ratios focus on a company’s return on investment in inventory and other

assets.

These ratios basically show how well companies can achieve profits from their operations.

Investors and creditors can use profitability ratios to judge a company’s return on investment
based on its relative level of resources and assets.

In other words, profitability ratios can be used to judge whether companies are making
enough operational profit from their assets.

In this sense, profitability ratios relate to efficiency ratios because they show how well
companies are using their assets to generate profits.
57
1- Gross margin/Profit ratio :

This ratio measures how profitable a company sells its inventory or merchandise.

This is the pure profit from the sale of inventory that can go to paying operating
expenses.

Gross margin Vs Profit margin.

Gross margin ratio only considers the cost of goods sold in its calculation. Profit
margin ratio on the other hand considers other expenses.

Gross Margin/ Profit ratio= Gross profit/ Sales

58
2- The profit margin ratio:

It is also called the return on sales ratio.

Gross profit ratio, is a profitability ratio that measures the amount of net
income earned with each rupee of sales generated by comparing the net income
and net sales of a company.

In other words, the profit margin ratio shows what percentage of sales are left
over after all expenses are paid by the business.

Profit Margin ratio = Net Income

Net sales

59
3- The return on assets ratio: (ROA)

It is also called the return on total assets.

It is a profitability ratio that measures the net income produced by total assets
during a period by comparing net income to the average total assets.

In other words, the return on assets ratio or ROA measures how efficiently a
company can manage its assets to produce profits during a period.

ROA= Net Income

Average Total Assets

60
4- Return on capital employed :

ROCE is a profitability ratio that measures how efficiently a company can

generate profits from its capital employed by comparing net operating profit to
capital employed.

In other words, return on capital employed shows investors how much rupee in
profits each rupee of capital employed generates.

ROCE= EBIT
Capital Employed

61
5- The return on equity ratio :

It measures the ability of a firm to generate profits from its shareholders

investments in the company.

In other words, the return on equity ratio shows how much profit each rupee of
common stockholders’ equity generates.

This is an important measurement for potential investors because they want to

see how efficiently a company will use their money to generate net income.

ROE = Net Income

Share holder equity

62
D-Efficiency ratios :

It is also called activity/turnover ratios measure how well companies utilize

their assets to generate income.

Efficiency ratios often look at the time it takes companies to collect cash from
customer or the time it takes companies to convert inventory into cash—in
other words, make sales.

These ratios are used by management to help improve the company as well as
outside investors and creditors looking at the operations of profitability of the
company.

63
1-Accounts receivable turnover:

It is an efficiency ratio or activity ratio that measures how many times a

business can turn its accounts receivable into cash during a period.

In other words, the accounts receivable turnover ratio measures how many
times a business can collect its average accounts receivable during the year.

ART = Net credit sales

Average account receivable

64
2- The asset turnover ratio :

It is an efficiency ratio that measures a company’s ability to generate sales from

its assets by comparing net sales with average total assets.

In other words, this ratio shows how efficiently a company can use its assets to
generate sales.

Assets Turn over ratio = Net sales

Average total assets

65
3-The total asset turnover ratio:

It is an efficiency ratio that measures a company’s ability to generate sales

from its assets by comparing net sales with average total assets.

In other words, this ratio shows how efficiently a company can use its assets to
generate sales.

Total Assets turnover = Net sales

Total assets

66
4- Debtors turnover ratio=
Net credit sales/ Average accounts receivable

5- Creditors turnover ratio=

Net credit purchase / Average accounts payable

6- Capital turnover ratio =

Sales/ Capital employed

7- Working capital turnover ratio =

Net sales / Working capital

67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
Assessment Pattern

85
 References

• Reference book- Maheshwari S.N, Accounting for Management, Vikas Publishing House, New Delhi,2010
• Reference Website: https://www.investopedia.com/terms/f/financial-statement-analysis.asp
• Reference Journal for advance study: Journal of Accountancy (JOA)

86
THANK YOU

For queries
Email: reepu.usb@cumail.in