CHAPTER 2

ANALYSIS OF FINANCIAL STATEMENTS - I

BY
PROF. SUKU THOMAS SAMUEL
DEPARTMENT OF MANAGEMENT
 FINANCIAL STATEMENT
Financial statements are written records that convey the business
activities and the financial performance of a company.
"Financial statements provide a summary of accounts of a business
enterprise"
- John N Myer

Objectives of financial statements are:

• State of a company assets and liabilities.
• Understanding of profit or loss position.
• Effectiveness of a company’s management.
 FINANCIAL STATEMENT ANALYSIS
The term Financial Statement analysis is the analysis and interpretation
of financial statements.
Process of determining financial strengths and weaknesses of the firm
by establishing strategic relationship between the values mentioned in
the statement.

– Application of a tool or techniques.

– Establishing the relationship/ impact between the figures reported in the
statement.
– Provide a better insight about the business financial condition.
– Communicate in a meaningful way to the stakeholders.
 FINANCIAL STATEMENT ANALYSIS
“Financial statement analysis is largely a study of relationship among
the various financial factors in a business as disclosed by a single set-of
statements and a study of the trend of these factors as shown in a
series of statements.”
- John N Myer

“Financial Statement Analysis is the process of evaluating the

relationship between the component parts of a financial statement to
obtain a better understanding of a firms position and performance.”
- Metcaff & Titard
 FINANCIAL STATEMENT ANALYSIS - OBJECTIVES
The objectives of Financial Statement analysis are:
• To estimate the earning capacity of the business concern.
• To find out the operating performance of a company.
• To examine efficiency of various business activities.
• To find out the financial performance of a company.
• To judge the managerial ability.
• To compare the performance of a company for different periods.
• To determine the long-term liquidity and solvency of the business
concern.
• To decide about the prospects of the business concern
 CLASSIFICATION OF
FINANCIAL STATEMENT ANALYSIS
 FINANCIAL STATEMENT ANALYSIS - CLASSIFICATION

Financial
Analysis

Modus
Entities Time Source
operandi

Cross Time Short

Long term Horizontal Vertical Internal External
sectional series term
FINANCIAL STATEMENT ANALYSIS - CLASSIFICATION

Based on Entities

Based on the organization used for the study:

1. Cross sectional analysis
• Analysis is done between two or more organizations.
• Helps in comparing the performance of the business.

2. Time series analysis

• Analysis is done for the same organization for different time intervals.
• Helps in knowing the progress of an organization.
FINANCIAL STATEMENT ANALYSIS - CLASSIFICATION
Based on Time

Based on duration for which the analysis is done:

1. Short term analysis
• When the analysis is done for less than 5 years.
• May not be conclusive in nature.

2. Long term analysis

• When the analysis is done for more than 5 years.
• Very accurate and conclusive in nature.
FINANCIAL STATEMENT ANALYSIS - CLASSIFICATION
Based on Modus operandi

Based on mode of analysis:

1. Horizontal analysis
• Study of same item across different time period
• Example: Fixed assets for 10 years

2. Vertical analysis
• Study of 2 or more financial items in the same statement
• Example: CL & CA in balance sheet
FINANCIAL STATEMENT ANALYSIS - CLASSIFICATION
Based on Source
Based on the source of information of analysis:
1. Internal analysis
• Analysis is done within the organization.
• Has access to extensive sources of information.
• Detail in nature.

2. External analysis
• Analysis is done by external agencies or consultancies.
• Has access to limited information
• Brief in nature.
 SOME COMMON TECHNIQUES
FINANCIAL STATEMENT ANALYSIS
 SOME COMMON TECHNIQUES
Some of the common techniques used for Financial Statement Analysis:
1. Comparative statement
i. Comparative Balance Sheet
ii. Comparative Income Statement
2. Common size statement
i. Common size Balance Sheet
ii. Common size Income Statement
3. Trend analysis
FINANCIAL STATEMENT ANALYSIS
COMPARATIVE STATEMENT
 COMPARATIVE STATEMENT
Comparative Statement are prepared to compare the financial aspects
at different time periods.
It is used for time series analysis.
It is horizontal analysis showing financial position & profitability at
different periods of time.
i. Comparative Balance Sheet
ii. Comparative Income Statement
FINANCIAL STATEMENT ANALYSIS
COMPARATIVE BALANCE STATEMENT
 COMPARATIVE BALANCE SHEET
Comparative Balance Sheet:
• Balance sheet of different time periods are taken.
• Helps to understand the changes in the assets and liabilities of the
firm.
• Easy to prepare.
• Analysis and interpretation is simple.
 COMPARATIVE BALANCE SHEET - FORMAT
Percentage
Absolute change Change
PARTICULAR Year 1 Year 2 (Year 2 –Year 1) 𝐀𝐛𝐬𝐨𝐥𝐮𝐭𝐞 𝐜𝐡𝐚𝐧𝐠𝐞
( )*100
𝐘𝐞𝐚𝐫 𝟏

ASSETS
(Y −X)
Asset 1 X Y Y–X * 100
X

Asset 2
TOTAL ASSETS
LIABILITIES
Liability 1
Liability 2
TOTAL
LIABILITIES
 COMPARATIVE BALANCE SHEET - QUESTION
The Balance Sheet of ABC Ltd is given as under. Prepare comparative balance sheet and
comment.
Particulars 31-03-2019 31-03-2020
Equity Share Capital 5,00,000 10,00,000
Preference Share Capital 1,00,000 2,00,000
General Reserves 1,00,000 2,50,000
Accounts Payables 1,00,000 2,00,000
Outstanding Expenses 50,000 50,000
Profit & Loss 2,00,000 3,00,000
TOTAL 10,50,000 20,00,000
Fixed Asset 4,00,000 10,00,000
Investments 3,00,000 1,00,000
Accounts Receivables 2,00,000 4,00,000
Inventories 1,00,000 4,00,000
Cash 50,000 1,00,000
TOTAL 10,50,000 20,00,000
 COMPARATIVE INCOME SHEET
Income statement is a combination of trading account and P/L account.
Shows the profit or loss position.

Comparative income sheet shows:

– Increase/decrease in gross profit.
– Changes in the operational profits.
– Increase or the decrease in net profit
– Changes in the factors that influence the profitability of the firm.
 COMPARATIVE INCOME SHEET - FORMAT
Absolute change Percentage Change
PARTICULAR Year 1 Year 2 (Year 2 – Year 1) (
𝐀𝐛𝐬𝐨𝐥𝐮𝐭𝐞 𝐜𝐡𝐚𝐧𝐠𝐞
)*100
𝐘𝐞𝐚𝐫 𝟏

SALES
Less: Cost of goods sold
GROSS PROFIT
Less: Operating expenses
Interest paid
Commission paid
Etc.
Add: Other incomes
NET PROFIT BEFORE TAX
Less: Tax
NET PROFIT AFTER TAX
 COMPARATIVE INCOME SHEET - QUESTION
The income statements of XYZ is given for the year ending 31st March 2019
and 2020. Rearrange the figures in a comparative form and interpret the
result.
Particulars 2019 2020
Net sales 15,70,000 18,00,000
Cost of goods sold 9,00,000 10,00,000
General and Administrative expense 1,40,000 1,44,000
Selling Expense 1,60,000 1,80,000
Interest paid 50,000 60,000
Income Tax 1,40,000 1,60,000
 COMMON SIZE STATEMENT
Common size statement:
– A form of analysis and interpretation of the financial statement.
– Takes into consideration each of the line items as a percentage of the
base amount for that accounting period.
– Expressed in the form of percentages
i. Common Size Balance Sheet
ii. Common Size Income Statement
 COMMON SIZE BALANCE SHEET
– Balance sheet items are being calculated as percentage of each asset
or liabilities in relation to the total asset or total liabilities.
– Helps comparing companies that differ in size.
 COMMON SIZE BALANCE SHEET - FORMAT

ABC XYZ
PARTICULAR
Amount % Amount %
ASSETS
𝑥 𝑦
Asset 1 X * 100 Y * 100
2,000 5,000

Asset 2
TOTAL ASSETS 2,000 100 5,000 100
LIABILITIES
Liability 1
Liability 2
TOTAL LIABILITIES
 COMMON SIZE BALANCE SHEET - QUESTION
Following are the Balance Sheets of ABC & XYZ Ltd, prepare the common size balance sheet:
Liabilities 2019 2020 Assets 2019 2020
Equity Share Capital 4,00,000 6,00,000Land and Buildings 2,70,000 1,70,000
Reserves and Surplus 3,12,000 3,54,000Plant and Machinery 3,10,000 7,86,000
Debentures 50,000 1,00,000Furniture and Fixture 9,000 18,000
Long-Term mortgage loans 1,50,000 2,55,000Other Fixed Assets 20,000 30,000
Accounts Payable 2,55,000 1,17,000Long-term Loans 46,000 59,000
Other Current Liabilities 7,000 10,000Cash in hand & at bank 1,18,000 10,000
Accounts Receivable 2,09,000 1,90,000
Inventory 1,60,000 1,30,000
Prepaid Expenses 3,000 3,000
Other Current Assets 29,000 40,000
TOTAL 11,74,000 14,36,000 TOTAL 11,74,000 14,36,000
 COMMON SIZE INCOME STATEMENT
– Financial statement that expresses all items as a percentage of total
revenues.
– Helps in the comparison of the financial expenses of against the
revenue of the company.
– Evaluation of efficiency for similar companies.
COMMON SIZE INCOME STATEMENT - FORMAT

Year 1 Year 2
PARTICULAR
Amount % Amount %
SALES x y
Less: Cost of goods sold a (a/x)*100 b (b/y)*100
GROSS PROFIT
Less: Operating expenses
Add: Other incomes
NET PROFIT BEFORE TAX
Less: Tax
NET PROFIT AFTER TAX
 COMMON SIZE INCOME STATEMENT- QUESTION
Following are the Income Statements of XYZ & ABC Ltd, prepare the comparative
income statement.
Particulars XYZ ABC
Sales 1500 1700
Miscellaneous Income 320 615
Total Income 1820 2315
Expenses
Cost of sale 1325 1510
Office Expenses 120 125
Selling expenses 130 145
Interest 125 130
Total Expenses 1700 1910
Net Profit 120 405
 TREND ANALYSIS
Trend analysis is also called as Trend percentage.
– Helps in evaluating the trend during the period of study.
– Increase is referred to as positive trend, decrease is referred to as
negative trend.
– First year of the data series is called as base year.
– Help in inter firm comparison.
– Simple and easy to calculate.
 TREND ANALYSIS - FORMAT

Particulars Year 1 Year 2 Year 3 Year 4 Year 5

Amount x a
Item 1
% 100% (a/x)*100
Amount y b
Item 2
% 100% (b/y)*100
-
 TREND ANALYSIS - QUESTION
Calculate the trend percentages from the following figures of the company ABC
Ltd.Also, interpret the result.

Year 2005 2006 2007 2008 2009 2010

Sales (₹ in lakhs) 30 40 48 56 70 90
Profit (₹ in lakhs) 5 8 10 15 20 24
 TREND ANALYSIS - QUESTION
Calculate the trend percentages from the following figures of the company
ABC Ltd.Also, interpret the result.
Particulars 2005 2006 2007 2008 2009 2010
Sales 300 340 420 480 520 600
Cost of goods sold 180 204 287 287 300 330
Office expenses 40 42 45 50 55 60
Selling expenses 20 25 30 40 50 60
Net profit/loss 60 69 89 103 115 150