ANALYSIS

OF
ACCOUNTS

CHAPTER 26
Analysis of published accounts will tell you
– Whether a business is performing better than
previous year
– Performing better than other business or not ANALYSIS OF
ACCOUNTS

– Check the case study given pg.no311

Meaning of liquidity:
Is the ability of the business to pay back its short
term debts. Profitability
Profitability is the measurement of the profit and liquidity
made relative to either the value of sales
achieved or the capital invested in the business.
Meaning of capital employed:
Is shareholders equity plus noncurrent liabilities
and is the total long term and permanent capital
invested in a business.
Getting exact analysis is possible through comparing two
figures from the accounts . This is called ratio analysis.
RATIO
Some ratios are used to measure and compare profitability ANALYSIS
(or performance) and liquidity of a business.
They are called -
Profitability ratio
LIQUIDITY: IS THE ABILITY OF A
And BUSINESS TO PAY BACK ITS SHORT
TERM DEBTS.
Liquidity ratio
CAPITAL EMPLOYED: IS
SHAREHOLDERS EQUITY PLUS NON
CURRENT LABILITIES AND IS THE
TOTAL LONG TERM AND
TERMANENT CAPITAL INVESTED IN A
BUSINESS.
Profitability is the measurement of the profit made
relative to either:
– The value of sales achieved
– The capital invested in the business.
It is important to:
Investor while deciding which business to invest
Managers to understand success of the business.
– RETURN ON CAPITAL EMPLOYED(ROCE)
NET PROFIT
------------------------------------- X 100
CAPITAL EMPLOYED
PROFITABILITY
CALCULATE: ROCE RATIOS
NET PROFIT=280 MILLION 1. RETURN ON CAPITAL
CAPITAL EMPLOYED=1065 MILLION EMPLOYED

2. GROSS PROFIT MARGIN

3. NET PROFIT MARGIN

Ans : 26.3%
It means return on capital employed in the business of
26.3%
Higher the result ,the more successful are the
managers are in earning profit.
GROSS PROFIT MARGIN(%)

GROSS PROFIT GROSS PROFIT

------------------------------------------------------X100 MARGIN
SALES REVENUE

Gross profit : $400 million

Revenue : $1300 million
Calculate ..
It means the average gross profit made by the company on each $
worth of goods sold.
NET PROFIT MARGIN (%)

NET PROFIT
NET PROFIT
-------------------------------------------X100
MARGIN(%)
SALES REVENUE

Revenue $1300
Net profit: $280 m
It means the net profit made by the company on each $
worth of sales.
ABS COMPUTING LIMITED-2017 $m
ACCOUNTING SUMMARY

REVENUE 1200
CALCULATE
GROSS PROFIT 450
RETURN ON CAPITAL
NET PROFIT 220 EMPLOYED
GROSS PROFIT
CAPITAL EMPLOYED 965
MARGIN
NET PROFIT MARGIN
 Year 1 Year 2

Sales revenue 80000 120000

Income
Cost of sales 20000 30000

Gross profit 60000 90000

statement of
expenses 40000 65000
Salmah’s cafe
Do you think Salmah
Net profit 20000 25000 should be pleased with
the profitability of her
café in the first two
years of trading?
– Do the activity 26.1
– Page no 314
Liquidity ratios

– If a business cannot pay its suppliers for materials that

are important to production or if the business cannot
repay an overdraft when required to ,it is said to be
illiquid.
CURRENT RATIO :
CURRENT ASSETS
-----------------------------------
CURRENT LIABILITIES
LIQUIDITY
CASE STUDY: CA-125M RATIO
;CL-100M
CURRENT RATIO
CALCULATE CURRENT RATIO
ACID TEST OR LIQUID
This result means that the business could pay off all of its short term
debts from current assets or not. RATIO
If the result is lower than 1 means business has real cash flow problem.
Really safe ratio is 1.5 to 2
If it is more than 2 means too much working capital is tied up in current
asset.
The current ratio is useful but it assumes that all current assets
could be turned into cash quickly. This is not always the case. It
might be very difficult to sell all inventories in a short period of
time. For this reason second liquidity ratio is been used.
ACID TEST OR LIQUID RATIO: ACID TEST OR
CURENT ASSETS – INVENTORIES LIQUID RATIO
-------------------------------------------
CURRENT LIABILITIES
CALCULATE: CA-125M,CL-100M,INVENTORIES-50M
It will show that business could pay off its short term
Debts from its most liquid assets.
If the result is less than one business has to improve its
liquidity position by selling some of its inventory for cash.
– CALCULATE 26.2
– PAGE NO 316
USER OF ACCOUNT WHAT THEY USE THE ACCOUNT FOR
MANAGERS -TO KEEP CONTROL OVER PERFORMANCE
OF EACH PRODUCT OR DIVISION AND
TAKE DECISION ACCORDINGLY
-TO COMPARE PROFIT PERFORMANCE
AND LIQUIDITY WITH OTHER YEARS OR
OTHER BUSINESS WHY AND HOW
SHAREHOLDERS -PROFIT AND LOSS
-HIGHER PROFITABILITY RATIO ACCOUNTS
ENCOURAGE S.H TO BUY MORE SHARES
-LIQUIDITY RATIO WILL HELP THEM TO ARE USED
UNDERSTAND THE COMPANIES CASH OR
LIQUIDITY PROBLEMS
-BALACE SHEET WILL HELP TO
UNDERSTAND THE WORTH OF THE
BUSINESS
CREDITORS -STATEMENT OF FINANCIAL POSITION
WILL HELP TO UNDERSTAND TOTAL
VALUE OF DEBT AND CASH POSITION

-LIQUIDITY RATIO WILL HELP THEM

TO UNDERSTAND THE COMPANIES
ABILITY TO PAY BACK TO THE
CREDITORS

BANKS -IF IT IS ILLIQUID BANK WILL NOT

LEND MORE
GOVT. TO CHECK THE PROFIT TAX

WORKER AND TRADE UNION -TO ACESS FUTURE OF THE COMPANY

-TO UNDERSTAND POSSIBILITY OF PAY
RISE

OTHER BUSINESS -TO BID TO TAKE OVER

- TO COMPARE THE PROFITABILITY
AND PERFORMANCE IN THE SAME
INDUSTRY
– EXTERNAL USERS ARE HAVING ONLY PUBLISHED DATA
– RATIOS ARE BASED ON PAST ACCOUNTING DATA SO NOT ENSURE
THE PERFORMANCE OF COMPANY IN FUTURE
– ACCOUNTING DATA WILL BE AFFECTED BY INFLATION ,COMPARISON LIMITATION OF
BETWEEN YEARs MAY BE MISLEADING USING ACCOUNTS
– DIFFERENT COMPANY USE DIFFERENT ACCOUNTING METHODS AND RATIO
WICH WILL MAKE COMPARISON DIFFICULT. ANALYSIS
 y si s
i o a n al
Ra t
– Prepare a mind map of all the ratios useful
to compare business performance with
other businesses and previous year
MCQ
MCQ
MCQ
MCQ
MCQ