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Learning outcome

Comprehend the significance of Financial


Statement Analysis.

Interpret the information conveyed by financial


statements and the way it is used by investors,
creditors, regulators and manager.
Meaning of Financial Statements
Financial statements are written records that convey the financial activities and conditions
of a business or entity and consist of four major components.

Financial statements are meant to present the financial information of the entity in question
as clearly and concisely as possible for both the entity and for readers.

These usually include income statements, balance sheets, statements of retained earnings
and cash flows but may also require additional detailed disclosures depending on the
relevant accounting framework.

Financial statements are often audited by government agencies, accountants, firms, etc. to
ensure accuracy and for tax, financing or investing purposes.
Meaning of Analysis of Financial Statements

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.
Objectives:
1) To assess the real meaning and significance of financial data as disclosed in
the Financial Statement.

2) To assess the liquidity and short term solvency position of the enterprise.
3) To assess the long term solvency position of the enterprise.

4) To assess the present and future profitability of the enterprise.


5) To evaluate the operational efficiency of the enterprise.

6) To evaluate the managerial efficiency of the enterprise.


7) To assess the growth potentiality of the enterprise.

8) To evaluate the different activities of the concern.


9) To assess the financial stability of the enterprise.

10) To assess the financial as well as the business risk of the concern.
11) To assess the overall performance of the concern.
Importance of Financial Statements
1) Judging Profitability

2) Judging Liquidity

3) Judging Solvency

4) Judging the efficiency of Management

5) Inter Firm Comparisons

6) Forecasting and Budgeting


Tools of Analysis of Financial Statements

1) Comparative Statements

2) Common Size Statements


3) Trend Analysis

4) Ratio Analysis

5) Cash Flow Analysis


Comparative/ Horizontal Balance Sheet
Comparative Statements
These statements refer to the statement of profit
and loss and the balance sheet prepared by
providing columns for the figures for both the
current year as well as for the previous year and for
the changes during the year , both in absolute and
relative terms.
It helps to find out not only the balances of
accounts as on different dates and
summaries of different operational activities
of different periods, but also the extent of
their increase or decrease between these
dates.
Exhibit 4.1
Comparative Balance sheets
Live examples
Balance Sheet of HUL
Balance Sheet of ITC
Q2)
Q3)
Q4)
Q5) Management Accounting book: Debarishi
Bhattacharyya Problem
Common size Statements
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.
For example, a common size balance sheet shows the percentage of
each asset to the total assets, and that of each liability to the total
liabilities. Similarly, in the common size statement of profit and loss,
the items of expenditure are shown as a percentage of the net
revenue from operations. If such a statement is prepared for
successive periods, it shows the changes of the respective
percentages over a period of time
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.
Common Size / Vertical Balance Sheet
Q1)
Q2)
Q3)
Q4)
Q5)
Practice question for students
Prepare a common size statement.
Q3)
Comparative Income Statement
Q1)
Q2)
Common size Income Statement
Q1)
Solution:
Q2)
Solution:
Reference link:

http://www.ncert.nic.in/NCERTS/l/leac204.pdf
Q1) Which of the following statements is false?

A) When all the figures in a balance sheet are stated as percentage of the total, it is termed
as horizontal analysis.

B) Financial statements are meant to present the financial information of the entity in
question as clearly and concisely as possible for both the entity and for readers.

C) Vertical Analysis is also termed as Comparative Analysis.

D) Horizontal Analysis is also termed as Comparative Analysis

a) A and B
b) A and C
c) C only
d) D only
c) C only
Q2) Analysis of any financial Statement does not comprise _______

a) Fund Flow Analysis


b) Balance sheet
c) P&L Account
d) Trading account
a) Fund Flow Analysis
Q3) Comparison of financial statements highlights the trend of the _________ of the
business.

a) Financial position
b) Performance
c) Profitability
d) All of the above
d) D
Q4) Which of the following is not a purpose of Interpretation of accounts :

a) It is a method of penalizing the managers for poor performance.

b) It is an Art and science of translating the figures.

c) It helps to know financial strengths and weaknesses of a business.

d) It helps to know the causes for the prevailing performance of business.


a) It is a method of penalizing the managers for poor performance.