Assalamualikum Dear Students. We already have finished the first unit of this course.

Now you
need to do self-study from the second unit as per the guidelines given below:
Having understood the concept of Management Accounting and its importance in managing the
internal affairs of the organization. It becomes imperative for us to unravel the scope/areas that
this course offers:
Financial Statement Analysis:
The term ‘financial analysis’, also known as analysis and interpretation of financial statements,
refers to the process of determining the financial strengths and weaknesses of the firm by
establishing strategic relationship between the items of the balance sheet, profit and loss
account and operative data.
Analysis: Simplification of financial data by methodical classification of the data given in the
financial statements.
Interpretation: Explaining the meaning and significance of the data so simplified
So both are complementary to each other.
Objectives and Importance of Financial Statement Analysis:
Types of Financial Statement Analysis:
ANALYSIS
1. On the basis of materials used: It includes two aspects i.e. internal analysis and external
analysis depending upon to the extent of access to the data.
2. On the basis of modus operandi: It includes horizontal analysis (of same firm for several
years) and vertical analysis (of same firm for one year but between several items)
3. On the basis of entities involved: It includes cross-sectional analysis/inter-firm analysis
and time-series analysis or intra-firm analysis or the combination of both the two.
Tools/Methods of financial Statement Analysis:
a) Comparative Statements
b) Common Size Statements
c) Trend Analysis
d) Ratio Analysis
e) Funds Flow Analysis
f) Cash Flow Analysis
g) Marginal Costing/CVP Analysis
h) Differential Costing
i) Standard Costing
j) Budgetary Analysis

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Ratio Analysis:
Defining Ratio: It is a simple arithmetical expression of the relationship of one number to
another.
Financial Ratio: It is an arithmetical expression of the relationship of one financial variable to
another.
Expression of Ratio: It can be expressed as follows
- as percentage: % (by simply multiplying the ratio by 100)
- as proportion: like 2:1
- as rate or time: say 5 times.
Classification of Ratios:

Activity Ratios or
Asset Management Long-term Solvency
Liquidity Ratios Profitability Ratios
Ratios/Efficiency Ratios/Leverage Ratios
Ratios
Inventory Turnover
Current Ratio Debt-Equity Ratio Gross Profit Ratio
Ratio

Liquid/Acid-Test/Quick Debtors Turnover Funded Debt to Total

Operating Ratio
Ratio Ratio Capitalization Ratio

Absolute/Super Quick Creditors Turnover Proprietary Ratio or Operating Profit

Ratio/Cash Ratio Ratio Equity Ratio Ratio

Interval
Average Collection
Measure/Defensive Solvency Ratio Expenses Ratio
Period
Interval Ratio

Average Payment Fixed Assets to Net Non-Operating

Period Worth Ratio Expenses Ratio

Working Capital
Fixed Assets Ratio Net Profit Ratio
Turnover Ratio
Current Assets to
Cash Profit Ratio
Proprietary Funds Ratio

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 Return on
Interest Coverage Ratio Shareholders’
Funds or Net worth

Preference Dividend Return on Equity

Coverage Ratio (ROE)

Cash Debt Service Ratio

Earnings per Share
or Debt Cash Flow
(EPS)
Ratio

Return on Capital
Employed
Dividend Per Share
(DPS)
Dividend Pay-Out
Ratio
Dividend Yield
Ratio

Price-Earnings
Ratio or P/E Ratio

Earnings Yield Ratio

Market Value to
Book Value Ratio

Note: Following points may be taken into consideration.

a) The first three liquidity ratios of a firm throw light on the ability of a firm to pay its current
liabilities. Apart from paying current liabilities, the liquidity position of a firm should also
be examined in relation to its ability to meet projected daily expenditure from the
operations. For that we have the fourth ratio i.e. Interval Measure Ratio.
b) Also the Liquidity ratios discussed so far relate to the liquidity of a firm as a whole.
Another way of examining the liquidity is to determine how quickly/rapidly certain
current assets are converted into cash. The ratios to measure this are referred to as
“turnover ratios”. These ratio may be taken as part of liquidity ratios but certain experts
have developed another group of these ratios termed as activity ratios or asset

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 management or efficiency ratios as they are typically calculated to measure the activity
or efficiency of the assets held by a particular firm.
c) Debtors Turnover Ratio Vs. Average Collection Period: ACP gives a time period in which
debtors are converted into cash. Both the ratios (DTR & ACP) indicate the same thing but
in different terms. The former (DTR) expresses number of times debtors are converted
into cash in a particular financial year whereas the latter gives number of days or months
in which the debtors are converted into cash.
d) With regard to the solvency ratios, there are two set of ratios in this category. One
category measures the long-term solvency or ability of a firm to pay long-term obligations.
Another set of ratios measure the ability of a firm to serve different suppliers of funds
which include preference shareholders, equity shareholders, and debt holders.
e) The profitability ratios are calculated to measure the operating efficiency of the firm.
Besides management of the company, creditors and owners are also interested in the
profitability of the firm. Generally, two major types of profitability ratios are calculated:
1) Profitability in relation to sales
2) Profitability in relation to investment
Apart from these two categories, we also another set of ratios termed as ‘market ratios’.
These ratio are calculated to check the profitability and measure the efficiency of the
firm’s earnings in relation to financial market variables.
Additional Ratios (Not mandatory, only for understanding)
Integrated Analysis of Ratios: The ratios discussed so far measure a firm’s liquidity,
solvency, efficiency of operations and profitability independent of one another. However,
there exists interrelationship among these ratios. This aspect is highlighted by integrated
analysis of ratios. The disaggregation of ratios can reveal certain major economic and
financial aspects, which otherwise would have been ignored. For instance significant
changes in profitability measure in terms of return on assets (ROA) and return on equity
(ROE) are better understood through an analysis of its components.
Growth Ratios: These ratios measure the rate at which a firm should grow. Growth in
sales need additional investment to support incremental sales both in terms of current
assets (such as inventory and debtors) and productive capacity/long-term assets (such as
plant and machinery). The rate at which firms can grow depends upon many factors.
Included among these are investment in assets required for a given growth rate, net profit
margin, retention ration and willingness and ability to raise finances from the financial
markets.

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Solved Practical Problems on Ratio Analysis:
Liquidity Ratios:
Problem/1: The following is the Balance Sheet of Overseas Company Ltd., for the year ending
31st December, 2015.

Equity and Liabilities Amount (INR) Assets Amount (INR)

Equity Share Capital 10,00,000 Goodwill 1,00,000
Preference Share
5,00,000 Land & Building 6,50,000
Capital
8% Debentures 2,00,000 Plant & Machinery 8,00,000
Long Term Loans 1,00,000 Furniture 1,50,000
Short-Term
Bills Payable 60,000 25,000
Investments
Sundry Creditors 70,000 Bills Receivables 70,000
Bank Overdraft 30,000 Sundry Debtors 90,000
Outstanding
5,000 Stock 30,000
Expenses
Prepaid Expenses 5,000
Cash at Bank 45,000
Total 19,65,000 Total 19,65,000
Note: From the Balance Sheet, calculate first three liquidity ratios.

Solution:
a) Current Ratios = Current Assets/Current Liabilities
Current Assets= 70,000 + 90,000 + 45,000 + 25,000 + 5,000 + 30,000
Current Liabilities = 60,000 + 70,000 + 30,000 + 5,000
Current Ratio = 2,65,000/1,65,000 = 1.61:1

b) Acid-Test Ratio = Liquid Assets/Current Liabilities

Liquid Assets: To calculate liquid assets, we need to deduct stock and prepaid expenses
from the current assets.
Therefore, Liquid Assets = Current Assets – (Stock + Prepaid Expenses)
= 2,65,000 – (30,000 + 5,000)
= 2,30,000
Acid-Test Ratio = 2,30,000/1,65,000 = 1.39:1

c) Absolute Liquid Ratio = Absolute Liquid Assets/Current Liabilities

Absolute liquid assets include cash in hand, cash at bank and marketable securities or
temporary investment (convertible into cash without significant loss).
Absolute Liquid Assets = 45,000 + 25,000 = 70,000
Absolute Liquid Ratio = 70,000/1,65,000 = 0.42:1

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Problem/2: From the following information calculate interval measure/defensive-interval
ratio:
Cost of Goods Sold = ₹40,000
Administrative and Office Expenses (including depreciation) = ₹25,000
Depreciation = ₹8,000
Selling and Distribution Expenses = ₹15,000
Liquid Assets = ₹15,000

Solution:
Since Interval Measure = Liquid Assets/Average Daily Cash Operating Expenses
Where Average Daily Cash Operating Expenses = {COGS + Administrative & Office
Expenses + Selling & Distribution Expenses
(Less Depreciation and other Non-Cash
Expenses)}/No. of days in a year

Thus Average Daily Cash Operating Expenses = 40,000+25,000+15,000-8,000/360

= ₹200
Therefore, Interval Measure = 15,000/200 = 75 Days

So, we can say that given the level of expenses that firm is incurring on daily basis, its liquid assets
will be enough for 75 days to cover them.
Activity Ratios:
Problem/3: From the following particulars extracted from the financial statements of ABC Ltd.
Compute:
a) Inventory Turnover Ratio
b) Debtors Turnover Ratio
c) Creditors Turnover Ratio

Particulars Amount (₹) Particulars Amount (₹)

Opening Stock 47,000 Sundry Debtors 42,000
Closing Stock 53,000 Cash 10,000
Sales less Returns 2,52,000 Bank 8,000
Provision for Bad Bills Receivables
2,000 15,000
Debts
Sundry Creditors 32,000 Provision for Tax 15,000
Loose Tools 4,000 Bills Payable 29,000
Purchases 1,80,000 Marketable Securities 8,000

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Solution:
Inventory Turnover Ratio = Cost of Goods Sold or Net Sales/Average Inventory
When Sales are considered
ITR = 2,52,000/(47,000+53,000/2)
= 2,52,000/50,000
= 5.04 times
When Cost of Goods Sold is considered
ITR = Purchases + Opening Stock-Closing Stock/Average Inventory
= 1,80,000+47,000-53,000/50,000
= 1,74,000/50,000
= 3.48 times
Debtors Turnover Ratio = Net Credit Annual Sales/Average Trade Debtors
Net Credit Annual Sales = Sales less Returns (as no cash sales are given)
Average Trade Debtors = Sundry Debtors + B/Rs (as no openings balances are given)
DTR = 2,52,000/42,000+15,000
= 4.421 times
Creditors Turnover Ratio = Net Credit Annual Purchases
CTR = 1,80,000/32,000+29,000
= 2.95 times
Problem/4: A trader purchases goods both on cash as well as on credit terms. The following
particulars are obtained from the books:

Particulars Amount (₹)

Total Purchases 3,00,000
Cash Purchases 30,000
Purchases Returns 51,000
Creditors at the end 1,05,000
Bills payable at the end 60,000
Reserve for discount on creditors 8,000

Note: Calculate Average Payment Period. Also take 365 days in a year.

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Solution:
Average Payment Period = Trade Creditors x No. of Working Days in a
Year/Net Annual Credit Purchases
= (1,05,000+60,000)x365/2,19,000
= 275 Days
Problem/5: A company sells goods on cash as well as on credit. The following particulars are
extracted from their books as follows:

Particulars Amount (₹)

Gross Total Sales 4,00,000
Cash Sales 80,000
Sales Returns 28,000
Debtors at the end 36,000
Bills receivables at the end 36,000
Provision for Doubtful Debts 8,000
Total Creditors at the end 25,000

Note: Calculate Average Collection Period. Also take 365 days in a year.
Solution:
Average Collection Period = Trade Debtors x No. of Working Days/Net Sales
= (36,000+8,000) x 365/4,00,000-80,000-28,000
= 44,000/292,000x365
= 55 Days
Problem/6: From the following information given below, calculate Working Capital Turnover
Ratio (WTR):

Particulars Amount (₹)

Cash 10,000
Bills receivables 5,000
Sundry Debtors 25,000
Stocks 20,000
Sundry Creditors 30,000
Cost of Sales 1,50,000

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Solution:
WTR = Cost of Sales/Net Working Capital
Net Working Capital = Current Assets – Current Liabilities
= (10,000+5,000+25,000+20,000) – (30,000)
= 60,000 – 30,000
= 30,000
Therefore, WTR = 1,50,000/30,000
= 5 times
Solvency/Leverage Ratios:
Problem/7: Pearl Ltd., gives you the following Balance Sheet for the year ending 31 st December,
2015:

Equity & Liabilities Amount (₹) Assets Amount (₹)

Equity Capital 2,00,000 Goodwill 50,000
Preference Capital 1,00,000 Plant & Machinery 2,50,000
Reserve Fund 50,000 Furniture 70,000
Dividend Equalization
60,000 Trade Investments 1,50,000
Fund
Profit & Loss A/c 40,000 Advance Tax 20,000
5% Debentures 1,50,000 Sundry Debtors 1,25,000
7% Mortgage Loan 70,000 Bills Receivables 65,000
Sundry Creditors 50,000 Cash 20,000
Bank Overdraft 30,000
Total 7,50,000 Total 7,50,000

Note: Considering the above information, calculate the following:

a) Debt-Equity Ratio
b) Funded Debt to Total Capitalization
c) Proprietory Ratio
d) Solvency Ratio
e) Fixed Assets to Net Worth Ratio
f) Fixed Assets Ratio
g) Current Assets to Proprietory Ratio

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 Solution:
a) Debt-Equity Ratio = Outsiders’ Funds/Shareholders’ Funds
Outsiders’ Funds = ₹1,50,000+₹70,000+₹50,000+₹30,000 = ₹3,00,000
Shareholders’ Funds = ₹2,00,000+₹1,00,000+₹50,000+₹60,000+₹40,000 =
₹4,50,000
Thus D/E Ratio = ₹3,00,000/₹4,50,000 = 0.67 times

b) Funded Debt to Total Capitalization = Funded Debt/ Total Capitalization

Funded Debt = ₹1,50,000+₹70,000 = ₹2,20,000
Total Capitalization =
₹2,00,000₹1,00,000+₹50,000+₹60,000+₹40,000+₹1,50,000+₹70,000
= ₹6,70,000
Thus Funded Debt to Total Capitalization = ₹2,20,000/₹6,70,000
= 0.33 times
c) Proprietory Ratio or Equity Ratio = Shareholders’ Funds/Total Assets
= ₹4,50,000/₹7,50,000
= 0.6 times
Note: Some say deduct intangible assets while calculating total assets for this ratio while some
say consider them. Also, deduct any miscellaneous expenditure (like preliminary expenses) from
assets. Here we have included intangible assets (goodwill) in total assets.
d) Solvency Ratio = Total Liabilities to Outsiders/Total Assets
= ₹3,00,000/₹7,50,000
= 0.4 times
Alternatively, Solvency Ratio = 1.0 – Proprietory Ratio = 1.0 – 0.6 = 0.4
e) Fixed Assets to Net Worth Ratio = Fixed Assets (after Dep.)/Shareholders’
Funds
Net Worth is equivalent to Shareholders’ Funds.
Fixed Assets = 50,000+2,50,000+70,000 = ₹3,70,000
Fixed Assets to Net Worth Ratio = ₹3,70,000/₹4,50,000
= 0.82 times
f) Fixed Assets Ratio = Fixed Assets (after Dep.)/Total L.T.Funds
Total L.T.Funds = Shareholders’ Funds + Long-Term Debt
= ₹4,50,000+₹2,20,000 = ₹6,70,000
Thus Fixed Assets Ratio = ₹3,70,000/₹6,70,000
= 0.55 times
g) Current Assets to Proprietory Funds Ration = Current Assets/S.F’s
Current Assets =
20,000+1,25,000+65,000+20,000 = ₹2,30,000

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 = ₹2,30,000/₹4,50,000
= 0.51 times
Problem/8: The net profit (after taxes) of a firm is ₹75,000 and its fixed interest charges on
long-term borrowings are ₹10,000. The rate of income tax is 50%. Calculate interest coverage
ratio.
Solution:
Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT)/Fixed Interest
Charge on Long-Term Debt
= (75,000+75,000+10,000)/10,000
= 16 times
Problem/8: Consider the following information:
EBIT = ₹3,00,000
12% Debentures = ₹2,00,000
Loan from Bank = ₹2,50,000 @5% p.a.
15% Preference Share Capital = ₹3,00,000
Tax Rate = 35%

Calculate Dividend Coverage Ratio for preference shareholders

Solution:

Dividend Coverage Ratio = Net Profit After Interest and Tax or EAT/Preference
Dividend
EAT = EBIT – Interest – Tax
= ₹3,00,000 - ₹24,000 = ₹2,76,000
= ₹2,76,000 - ₹96,600
= ₹1,79,400
Preference Dividend = 15% of ₹3,00,000 = ₹45,000
Thus Div. Coverage Ratio = ₹1,79,400/₹45,000
= 3.99 or 4 times approx.
(It means our earnings after paying taxes are four
times to pay dividend to preference shareholders)

Problem/9: From the following information, calculate cash to debt service ratio:
Earnings after Tax = ₹22,500

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Fixed Interest Charge = ₹2,000
Depreciation Charged = ₹3,000
Tax Rate = 50%
Sinking Fund Appropriation = 7.5% of outstanding Debentures
10% Debentures = ₹20,000

Solution:

��
Debt Cash Flow Coverage Ratio = ���
�

=
, , ( ) , (�� � ) , (� .)
, (� � � )
, (� )

, ,
, ,
= ,
= 10 times

Profitability Ratios (In relation to Sales):

Problem/10: The following is the Trading and Profit & Loss Account of a concern for the year
ending 31st December, 2015:
Particulars Amount (₹) Particulars Amount (₹)
To Opening Stock 76,250 By Sales 5,00,000
To Purchases 3,15,250 By Closing Stock 98,500
To Factory Expenses 7,000
To Gross Profit c/d 2,00,000
5,98,500 5,98,500
To Administrative By Gross Profit b/d
1,01,000 2,00,000
Expenses
To Selling & By Non-Operating
12,000 6,000
Distribution Expenses Income
To Non-Operating
9,000
Expenses
To Net Profit 84,000
2,06,000 2,06,000

Note: You are required to calculate:

a) Expenses Ratios
b) Gross Profit Ratio
c) Operating Ratio
d) Operating Profit Ratio

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 e) Net Profit Ratio

Solution:

1. Expenses Rations: There are several expenses and their relationship with sales makes
them different expenses ratio which can be calculated as below:

a) Factory Expenses Ratio = Factory Expenses/Sales x 100

= 7,000/5,00,000 x 100
= 1.4%

b) Administrative Expenses Ratio = Administrative Expenses/Sales x 100

= 1,01,000/5,00,000 x 100
= 20.2%

c) Selling & Dist. Expenses Ratio = Selling & Dist. Expenses/Sales x 100
= 12,000/5,00,000 x 100
= 2.4%

d) Non-Operating Expenses Ratio = Non-Operating Expenses/Sales x 100

= 9,000/5,00,000 x 100
= 1.8%

2. Gross Profit Ratio = Gross Profit/Sales x 100

= 2,00,000/5,00,000 x 100
= 40%

3. Operating Ratio = Operating Expenses/Sales x 100

Operating Expenses = Cost of Goods Sold + Administrative

Expenses+ Selling & Dist. Expenses
= 4,13,000/5,00,000 x 100
= 82.6%

4. Operating Profit Ratio = Operating Profit/Sales x 100

Operating Profit = Gross Profit – Operating Expenses

= 2,00,000 – 1,01,000 – 12,000
= 87,000
= 87,000/5,00,000 x 100
= 17.4%

5. Net Profit Ratio = Net Profit/Sales x 100

= 84,000/5,00,000 x 100

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 = 16.8%
Note: The books of accounts are usually prepared on the basis of the accrual system. So the profit
figure which we get is not the total amount of cash available with us. So, in order to know the
cash position or the profit amount which is purely cash only, we may use another ratio called
‘Cash Profit Ratio’. To Calculate this type of ratio we add back certain non-cash items (like
depreciation) and somehow make it cash in nature. Though there may be other items that need
to be considered to make this figure fully cash in nature which may call for the abandoning the
accrual system of accounting and start following the cash system of accounting. But for the sake
of calculating this ration we only adjust net profit figure for non-cash items.

Profitability Ratios (In relation to Investment):

Problem/11: Following information is extracted from the books of accounts of XYZ Ltd.
Particulars Amount (₹) Amount (₹)
Issued & Subscribed Capital
2000 equity shares of ₹100 each 2,00,000
1,000 8% Preference shares of ₹100 each 1,00,000
3,00,000
Reserves & Surplus:
Revenue Reserve 30,000
Capital Reserve 50,000
Reserves for Contingencies 20,000
1,00,000
Net Profit Before Interest & Tax (EBIT) 1,50,000
Interest Charge 30,000
Tax @ 50%

Note: You are required to calculate:

a) Return on Shareholders’ Funds
b) Return on Equity (ROE)
c) Earnings Per Share (EPS)

Solution:

a) Return on Shareholders’ Funds or Net Worth = Net Profit after Interest &
Tax (PAT)/Shareholders’ Funds
X100
PAT = EBIT – Interest – Tax
= 1,50,000 – 30,000 – {50% of
(1,50,000-30,000)}
= 1,20,000 – 60,000
= 60,000

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Shareholders’ Funds = Equity Share Cap. + Preference Share
Capital + Reserves & Surplus – Past
Accumulated Losses
=
2,00,000+1,00,000+30,000+50,000+
20,000
= 4,00,000
RSF’s = 60,000/4,00,000 x 100
= 15%

Return on Equity (ROE) = Net Profit after Interest, Tax &

Preference Dividend/Equity Share Cap x
100

Preference Dividend = 8% of ₹1,00,000

= ₹8,000
ROE = 60,000-8,000/2,00,000 x 100
= 26%

Earnings per Share (EPS) = Net Profit after Interest, Tax &
Preference Dividend or Earnings Available
to Equity Shareholders/ No. of Equity
Shares
= 52,000/2,000
= ₹26

Problem/12: The Following are the summarized profit & Loss Account and Balance Sheet of
S.N. Ltd., for the year ending March, 2016.
Particulars Amount (₹) Particulars Amount (₹)
To Opening Stock 99,500 By Sales 8,50,000
To Purchases 5,45,250 By Closing Stock 1,49,000
To Wages 14,250
To Gross Profit c/d 3,40,000
9,99,000 9,99,000
To Operating Exp. By Gross Profit b/d 3,40,000
Admin. Exp. 1,50,000 By Interest 3,000
Selling Exp. By Profit on Sale of
30,000 6,000
Investment
Finance Charge 15,000
To Non-Op. Exp.:
Loss on sale of assets 4,000
To Net Profit 1,50,000
3,49,000 3,49,000

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 Balance Sheet
Capital & Liabilities Amount (₹) Assets Amount (₹)
Share Capital 2,00,000 Buildings 1,50,000
Reserves 90,000 Machinery 80,000
Profit & Loss A/c 60,000 Stock 1,49,000
Current Liabilities 1,30,000 Debtors 71,000
Cash 30,000
4,80,000 4,80,000

Note: You are required to calculate return on net capital employed.

Solution:

Return on Net Capital Employed = Adjusted Net Profit/Net Capital Employed x 100

Adjusted Net Profit = Net Profit + Non-Operating Expenses - Non-

Operating Incomes
₹1,50,000+₹4,000+₹15,000-₹3,000-₹6,000
= ₹1,60,000

Net Capital Employed = Total Assets – Current Liabilities

= ₹4,80,000-₹1,30,000 = ₹3,50,000

= 1,60,000/3,50,000
= 45.71%
Market Ratio:

Problem/13: The following information is given about a limited company:

Profit after Tax @60% ₹3,00,000

Market price of equity share ₹50
Depreciation ₹40,000
Equity dividend paid @ 20%
Equity Capital of ₹10 shares each: ₹4,00,000
9% Preference Share Capital ₹2,00,000

Required: Calculate Dividend Per Share (DPS); Dividend Pay-out Ratio (D/P Ratio); Dividend yield
Ratio (D/Y Ratio); Price-Earnings Ratio (P/E Ratio); Earnings Yield Ratio (E/Y Ratio) & Market Value
to Book Value Ratio (MV/BV Ratio).

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Solution:

Dividend per Share = Amount of Dividend Distributed/No. of Equity Shares

Amount of Dividend Distributed = 20% of Equity Share Capital

= 20/100 x 4,00,000
= ₹80,000
No. of Equity Shares = ₹4,00,000 share capital of ₹10 each
= 40,000 shares

Thus, DPS = 80,000/40,000

= ₹2

Dividend Pay-Out Ratio = Dividend per Share/Earnings per Share

Earnings per Share = Earnings Available to Equity Shareholders/No. of

equity shares
Earnings available to
Equity shareholders = Profit after Tax – Preference Dividend
= ₹3,00,000 – 9% of ₹2,00,000
= ₹3,00,000 - ₹18,000
= ₹2,82,000
= ₹2,82,000/40,000
= ₹7.05
Thus, D/P Ratio = 2/7.05
= 0.28 or 27% approx.
Check: Dividend Declared = ₹80,000
Total Earnings available to
Equity shareholders = ₹2,82,000
Therefore, D/P Ratio = 80,000/2,82,000 x 100 = 27% approx.

Dividend Yield = DPS/MPPS (Market Price per Share) x 100

= 2/50 x 100
= 4%

Price-Earnings Ratio = MPPS/EPS

= 50/7.05
= 7.09 times

Earnings Yield Ratio = EPS/MPPS

[It tells us what percentage the
Company is making on the basis
of its after-tax income and the
Price you pay for it]

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 = 7.05/50
= 0.141 or 14.1%

Market Value to Book Value Ratio = MPPS/BVPS

= 50/10
= 5 times

Note: For further understanding on financial statement analysis and ratio analysis, visit the
following URL:

http://www.accountingtools.com/financial-statement-analysis

CASH FLOW STATEMENT (Cash Flow Analysis):

Introduction:

As a person concerned with business and more specifically finance, one has to manage various
aspects and affairs of the concern. Among the various aspects include the management of cash.
A firm requires cash to make payments to its suppliers, to pay for daily operating expenses and
to pay for salaries, wages, interest, and dividend etc.
Also, a company may be profitable enough yet it becomes difficult for it to pay taxes and
dividends. This may be because (i) although huge profits have been earned yet cash may not have
been received or (ii) even if cash has been received, it may have drained out for some other
purpose. Thus this movement of cash is of vital importance to the management. Also, financial
statements B/S and P&L A/c don’t reveal too much as to how much cash has come into the
business and how much cash has gone out of the business and the reasons for its movement
thereof.
For all this a comprehensive cash planning and analysis needs to be carried out. To facilitate the
same a statement called ‘Cash Flow Statement’ is prepared.
In June, 1995, the Sebi amended clause 32 of listing agreement requiring every listed company
to give along with the B/S and P&L A/c, a cash flow statement, prepared in the prescribed format,
showing separately cash flows from operating activities, investing activities and financing
activities.
Meaning of Cash Flow Statement (CFS):
Cash Flow Statement is a statement which describes the inflows (sources) and outflows (uses) of
cash and cash equivalents in an enterprise during a specific period of time or more technically
between tow balance sheets.
For the purpose of CFS, cash includes the following:

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 a) Cash: Cash in hand and demand deposits with the bank.
b) Cash Equivalents: These are short-term highly liquid investments that are readily
convertible into known amount of cash and which are subject to an insignificant risk of
changes in value.

Classification of Cash Flows:

It is pertinent to mention that AS-3 shall act a guiding principle in the preparation and
presentation of CFS.
As such, it divides the cash flows into three main categories:
1. Cash Flow from Operating Activities (OAs):
These are the activities which are the main activities for which business has been set up
and are termed as principle revenue generating activities and also other activities that are
not investing or financing activities.
Example: Receipts from sale of goods or rendering of services
Payment made to suppliers etc.

2. Cash Flow from Investing Activities (IAs):

These activities involve the acquisition and disposal of long-term assets and other
investments not included in cash and cash equivalents.
Example: Payment made for the purchase of Fixed Assets
Receipt from the sale proceeds of Fixed Assets etc.

3. Cash Flow from Financing Activities (FAs):

These are the activities that result in changes in the size and composition of the owner’s
capital (including preference share capital in the case of a company) and borrowing of the
enterprise.
Example: Receipts from the issue and raising of shares and debentures
Payment of interest on debt and dividend on shares etc.

Preparation of Cash Flow Statement:

Following are the sequential steps involved in the preparation of CFS:

1. Calculate Net Cash Flow from Operating Activities using either ‘Direct Method or
Indirect Method’.
2. Calculate Net Cash Flows from Investing Activities
3. Calculate Net Cash Flows from Financing Activities

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 4. Make an aggregate of net Cash Flows from all the three activities and add Cash and
Cash Equivalents at the beginning and the final figure of Cash and Cash Equivalents
should be equal to the closing balance of cash, reported in the current B/S, which we
call Cash and Cash Equivalents at the end.

Direct Method of CFS:

Under this method, cash receipts (inflow) from operating revenues and cash payments (outflows)
for operating expenses are calculated to arrive at cash flow from OAs. The difference between
the two is either cash generated/provided from/by OAs ir cash used/lost in OAs.

Note: Under direct method, there’s no need to make adjustments for depreciation, amortization
of fictitious and intangible assets and various other non-fund/non-operating items because
operating cash receipts and cash payments are reported directly on the CFS.

Indirect Method of CFS:

Under this method, the net cash flow from OAs is determined by adjusting net profit or loss for

a) Non-cash items such as depreciation, provisions, deferred taxes, and unrealized gains
from forex activities.
b) Change during the period in inventories or operating receivables and payables:
(Working Capital Changes)
c) All other items for which the cash effects are investing or financing cash flows.

FORMAT of CFS:

CASH FLOW STATEMENT

(For the year ended……………………)

Particulars Details (₹) Amount (₹)

A) Cash Flow from Operating Activities:
Either
Cash receipts from customers xxx
Cash paid to suppliers & for expenses (xxx)
Cash generated from operations xxx
Income Tax (xxx)

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 Cash flow before extra-ordinary items xxx
Extra-ordinary items xxx
Net cash from (used in) OAs xxx
OR
Net Profit before Tax & Extra-ordinary items xxx
Adjustment for Non-cash/Non-Operating Items
Add: Non-Cash/Non-Operating items which
have already been debited to P&L A/c
a) Depreciation x
b) Transfer to reserves & provision x
c) Goodwill written-off x
d) Preliminary expenses written-off x
e) Other intangible assets written-off such
as discount on issue of x
shares/debentures
f) Loss on sale or disposal of fixed assets x
g) Loss on sale of investments x
h) Foreign exchange losses x
xxx
Less: Non-Cash/Non-Operating items which
xxx
have already been credited to P&L A/c
a) Gain on sale of Fas x
b) Profit on Sale of Fas x
c) Income from Interest or dividend on
x
investments.
d) Appreciation (in FAs) like land x
e) Reserves written back x
f) Forex exchange gains x xxx
Operating Profit before Working Capital
xxx
Changes
Adjustment for changes in Working Capital
Add: Decrease in Current Assets (except C&CEs)
e.g. Trade debtors x
B/R x
Increase in Current Liabilities (except B/O)
e.g. Creditors x
B/P x

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 Less: Increase in Current Assets (except C&CEs) x
Decrease in Current Liabilities (except B/O) x xxx
Cash generated from (used in operations before
xxx
tax)
Less: Income Tax paid (xxx)
Cash flow from OAs before EOIs* xxx
Add/Less: EOIs, if any. xxx
Net Cash Flow from (used in ) OAs xxx

B) Cash Flow from Investing Activities: x

Net Cash Flow from (used in) IAs xxx

C) Cash Flow from Financing Activities: x

Net cash flow from (used in) FAs xxx
Net Increase/decrease in C&CEs** xxx
Add: C&CEs at the beginning x
C&CEs at the end xxx
*Extra-ordinary items
**Cash and Cash Equivalents

Practical Problems on Cash Flow Statement:

Direct Method:

Problem/1: MINTEX LTD., provides you the following information for the year ending 31 st,
March, 2014:

a) Sales for the year amounted to ₹2,00,000, out of which 60% is for cash.
b) Cost of goods sold was 50% of total sales.
c) All inventory is purchased on credit.
d) Collection from debtors amounted to ₹60,000
e) Payments to creditors of inventory totalled ₹45,000
f) Depreciation during the year on machinery amounted to ₹5,000
g) Goodwill written of during the year ₹3,000
h) Total salary for the period amounted to ₹6,000, out of which ₹1,000 was outstanding.
i) Office expenses paid in cash ₹8,000, outstanding office expenses ₹2,000
j) Land was purchased for ₹2,50,000 and the consideration was discharged by the allotment
to vendors of zero percent convertible debentures

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 k) Fully paid equity shares of the face value of ₹2,00,000 were issued at a premium of 10%.
l) A machine was sold for ₹15,000. The book value of the machine was ₹12,000.
m) Another machine having book value of ₹4,000 was scrapped and was treated as ordinary
business loss.
n) A vehicle was purchased for cash at a cost of ₹1,50,000.
o) Dividends paid during the period amounted to ₹40,000.
p) Income Tax paid ₹10,000.
q) Cash in hand and at bank as on 31st, March, 2013 totalled ₹25,000.

Note: You are required to prepare a Cash Flow Statement using Direct Method.

Solution:

Cash Flow Statement

(For the year ended 31st, March, 2016)
Particulars Details (₹) Amount (₹)
A) Cash Flows from Operating Activities:
Cash receipts from customers (1,20,000 + 60,000) 1,80,000
Cash paid to suppliers and employees (45,000 + 6,000 +
(58,000)
8,000)
Cash generated from operations 1,22,000
Income Tax paid (10,000)
Net Cash from Operating Activities 1,12,000
B) Cash Flow from Investing Activities:
Sale of machine 15,000
Purchase of vehicle (1,50,000)
Net Cash used in Investing Activities (1,35,000)
C) Cash Flow from Financing Activities:
Proceeds from issue of share capital (including premium) 2,20,000
Dividends paid (40,000)
Net Cash from Financing Activities 1,80,000
Net increase in Cash and Cash Equivalents (A+B+C) 1,57,000
Cash and Cash Equivalents at the beginning of the period 25,000
Cash and Cash Equivalents at the end of the period 1,82,000
Note: Land was purchased for ₹2,50,000 by issuing at par, zero percent convertible dentures.
This is a non-cash transaction, thus it finds no place in cash flow statement.

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 Indirect Method:

Problem/2: From the following balance sheet of Alpha Ltd., make out Cash Flow Statement.
Capital & Liabilities 2006 2007 Assets 2006 2007
(₹) (₹) (₹) (₹)
Equity Share Capital 3,00,000 4,00,000 Goodwill 1,00,000 80,000
8% Redeemable Preference Land & Building
1,50,000 1,00,000 2,00,000 1,70,000
Share Capital
Capital Reserve 20,000 Plant & Machinery 80,000 2,00,000
General Reserve 40,000 50,000 Investments 20,000 30,000
Profit & Loss A/c 30,000 48,000 Sundry Debtors 1,40,000 1,70,000
Proposed Dividend 42,000 50,000 Stock 77,000 1,09,000
Sundry Creditors 25,000 47,000 Bills Receivables 20,000 30,000
Bills Payable 20,000 16,000 Cash in Hand 15,000 10,000
Liability for Expenses 30,000 36,000 Cash at Bank 10,000 8,000
Provision for Tax 40,000 50,000 Preliminary Expenses 15,000 10,000
6,77,000 8,17,000 6,77,000 8,17,000

Additional Information:

1. A piece of land has been sold out in 2007 and the profit on sale has been credited to
capital reserve.
2. A machine has been sold out for ₹10,000. The written down value of the machine was
₹12,000. Depreciation of ₹10,000 is charged on plant account in 2007.
3. The investments are trade investments, ₹3,000 by way of dividends is received
including ₹1,000 from pre-acquisition profit which has been credited to investment
account.
4. An interim dividend of ₹20,000 has been paid in 2007 in addition to the dividend
proposed in 2006.
5. A provision of ₹50,000 for taxation was made in 2007.

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 Solution:

Cash Flow Statement

(For the year ended 31st, March, 2007)
Particulars Details (₹) Amount (₹)
A) Cash Flows from Operating Activities:
Closing Balance of Profit and Loss Account 48,000
Less: Opening Balance of Profit and Loss Account 30,000
Net Profit before Tax and Extra-ordinary Items 18,000
Adjustment for Non-Cash/Non-Operating Items:
Add: Non-Cash/Non-Operating Items already debited to P&L A/c
a) Depreciation on plant 10,000
b) Transfer to general reserve 10,000
c) Provision for Taxation 50,000
d) Proposed Dividend 50,000
e) Goodwill written-off 20,000
f) Preliminary expenses written-off 5,000
g) Interim dividend paid 20,000
h) Loss on sale of plant 2,000
1,85,000
Less: Non-Cash/Non-Operating items which have already been credited to
P&L A/c
i) Dividend received on investment (3,000 – 1,000) (2,000)
Operating Profit before working capital changes 1,83,000
Adjustment for changes in working capital:
Add: Decrease in Current Assets & Increase in Current Liabilities
a) Increase in sundry creditors 22,000
b) Increase in liability for expenses 6,000
Less: Increase in Current Assets & Decrease in Current Liabilities
a) Increase in sundry debtors (30,000)
b) Increase in stock (32,000)
c) Increase in bills receivables (10,000)
d) Increase in bills payable (4,000)
Cash generated from (used in) operations before tax 1,35,000
Less: Income Tax paid (40,000)
Cash flow from OAs before EOIs 95,000
Less: EOIs -

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Net Cash Flows from Operating Activities 95,000
B) Cash Flows from Investing Activities:
Sale of land 50,000
Sale of machine 10,000
Dividend received on investments 3,000
Purchase of plant (1,42,000)
Purchase of investments (11,000)
Net Cash used in Investing Activities (90,000)
C) Cash Flows from Financing Activities:
Issue of Equity Share Capital 1,00,000
Redemption of Preference Share Capital (50,000)
Payment of Interim Dividend (20,000)
Payment of Proposed Dividend for 2006 (42,000)
Net Cash used in Financing Activities (12,000)
Net Decrease in Cash and Cash Equivalents (7,000)
Cash and Cash Equivalents at the beginning of the period 25,000
Cash and Cash Equivalents at the end of the period 18,000

Working Notes:

Ledger Accounts forming part of Cash Flow Statement:

Dr. 1. Land & Building A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 2,00,000 By cash (Sale) Bal. Fig 50,000
By Balance c/d 1,70,000
2,20,000 2,20,000

Dr. 2. Plant & Machinery A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 80,000 By cash (Sale) 10,000
By P&L A/c (loss on
To capital reserve 1,42,000 2,000
sale)
By Depreciation 10,000
By balance c/d 2,00,000
2,22,000 2,22,000

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Dr. 3. Investment A/C Cr.
Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 20,000 By dividend 1,000
To cash (Pur.) Bal. Fig By Balance c/d 30,000
31,000 31,000

Dr. 4. General Reserve A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To balance c/d 50,000 By balance b/d 40,000
By P&L A/c (Bal. Fig.) 10,000
50,000 50,000

Dr. 5. Provision for Tax A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To balance c/d 50,000 By balance b/d 40,000
By P&L A/c (current
10,000
year prov.) (Bal. Fig.)
50,000 50,000

Dr. 6. Proposed Dividend A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To cash (assumed to By balance b/d
42,000 42,000
be paid this year)
To balance c/d 50,000 By P&L A/c (Bal. Fig.) 50,000
92,000 92,000

Dr. 7. Goodwill A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To balance b/d By P&L A/c (w/off)
1,00,000 20,000
(Bal. Fig.)
By Balance c/d 80,000
1,00,000 1,00,000

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Dr. 8. Preliminary Expenses A/C Cr.
Particulars Amount (₹) Particulars Amount (₹)
To balance b/d By P&L A/c (w/off)
15,000 5,000
(Bal. Fig.)
By Balance c/d 10,000
15,000 15,000

Funds Flow Statement (Funds Flow Analysis):

Introduction

The purpose of measuring trading performance, operational efficiency, profitability and financial
position of a concern is revealed by Trading, Profit and Loss Account and Balance Sheet. These
financial statements are prepared to find out the Gross Profit or Gross Loss, Net Profit or Net Loss
and financial soundness of a firm ~ a whole for a particular period of time. From the management
point of view, the usefulness of information provided by these income statements functions
effectively and efficiently. In the true sense they do not disclose the nature of all transactions.
Management, Creditors and Investors etc. want to determine or evaluate the sources and
application of funds employed by the firm for the future course of action. Based on these
backgrounds, it is essential to analyze the movement of assets, liabilities, funds from operations
and capital between the components of two year financial statements. The analysis of financial
statements helps to the management by providing additional information in a meaningful
manner.

Meaning of Fund

The term "Fund" refers to Cash, to Cash Equivalents or to Working Capital and all financial
resources which are used in business. These total resources of a concern are in the form of men,
materials, money, plant and equipments and others. In a broader meaning the word "Fund"
refers to Working Capital. The Working Capital indicates the difference between current assets
and current liabilities. The term working capital may be

a) Gross Working Capital and

b) Net Working Capital.
 "Gross Working Capital" represents total of all Current Assets.
 "Net Working Capital" refers to excess of Current Assets over Current Liabilities.
 In a narrow sense the word "Fund" denotes cash or cash equivalents.

28 | P a g e
Meaning of Flow of Funds

The term "Flow of Funds" refers to changes or movement of funds or changes in working capital
in the normal course of business transactions. The changes in working capital may be in the form
of inflow of working capital or outflow of working capital. In other words, any increase or
decrease in working capital when the transactions takes place is called as "Flow of Funds." If the
components of working capital results in increase of the fund, it is known as Inflow of Fund or
Sources of Fund. Similarly, if the components of working capital effects in decreasing the financial
position it is treated as Outflow of Fund. For example, if the fund raised by way of issue of shares
will be taken as a source of fund or inflow of fund. This transaction results in increase of the
financial position. Like this, the fund used for the purchase of machinery will be taken as
application or use of fund or outflow of fund. Because it stands to reduce the fund position.

The following chart shows the movement of funds:

Movement of fund

Inflow Firm Outflow

Of Of
Business
Funds Funds
Transactions

No Flow of Funds
Some transactions may not make any movement or changes in the fund position. Such
transactions are involved within the business concern. Like the transaction which involves both
between current assets and current liabilities and between non-current assets and non-current
liabilities and hence do not result in the flow of funds. For example, conversion of shares in to
debenture. Such transaction involves non-currents account only and this activity does not effect
in increase or decrease of the working capital position.

Statement of Changes in Financial Position

It is a statement prepared on the basis of all financial resources, i.e., assets, liabilities and capital.
This statement is attempt to measure changes in both current and non-current accounts. The
changes in financial position may occur in deal with following transactions:

29 | P a g e
 a) Involves between current assets and non-current assets (fixed assets or permanent
assets).
b) Involves between current liabilities and non-current assets.
c) Involves between current assets and non-current liabilities (long-term liabilities and
capital).
d) Involves between current liabilities and non-current liabilities.

The following chart explains the flow of funds when transaction involves between current and
non-current accounts:
Flow of Funds Chart

Transactions Between.

Current Assets
And
Non-Current Assets

Current Assets
And
Non-Current Liabilities
Flow of Funds
(Inflow or Outflow of Funds)

Current Liabilities
And
Non-Current Assets

Current Liabilities
And
Non-Current Liabilities

No Movement of Funds

When the transaction takes place between non-current account and current account, it doesn’t
result in movement of funds. The following chart shows the no flow of funds:

30 | P a g e
 No “Flow of Funds” Chart

Transactions Between

Current Assets
And
Current Liabilities
No Flow of Funds

Non-Current Assets
And
Non-Current Liabilities

Examples of Flow of Funds:

Examples Transactions Between Flow of Funds From

(1) Purchase of Machinery for Current Asset and Non-Current
Current to Non-Current Account
Cash Asset
(2) Issue of Share for Cash Current Asset and Capital Current to Capital Account
(3) Redemption of Debenture in Current Asset. and Non-Current Current to Long-Term Liabilities
Cash Liabilities Account
(4) Creditors Paid off in Current Liabilities and Non- Non-Current Liabilities to Current
Debenture Current Liabilities Liabilities
(5) Land Transferred to Creditors Current Liability and Non-Current Non-Current Assets to Current
for their Statement Assets Liability

Examples of No Flow of Funds:

Examples Transactions Between Flow of Funds From

Current Asset and Current
(1) Payment made to Creditors No Flow of Funds
Liabilities
(2) Machinery Purchased and
Non-Current Assets and No- No Flow of Funds
Payment
Current Liabilities
made in Debenture
(3) Machinery Purchased and
Non-Current Asset and Capital No Flow of Funds
Payment made in Shares

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Importance or Uses of Fund Flow Statement:

Fund Flow Statement is prepared for financial analysis in order to meet the needs of people
serving the following purposes:

1. It highlights the different sources and applications or uses of funds between the two
accounting period.
2. It brings into light about financial strength and weakness of a concern.
3. It acts as an effective tool to measure the causes of changes in working capital.
4. It is an instrument used by the investors for effective decisions at the time of their
investment proposals.
5. It also presents detailed information about profitability, operational efficiency and
financial affairs of a concern.
6. It serves as a guide to the management to formulate its dividend policy, retention policy
and investment policy etc.
7. It helps to evaluate the financial consequences of business transactions involved in
operational finance and investment.
8. It gives the detailed explanation about movement of funds from different sources or uses
of funds during a particular accounting period.

Procedure for the Preparation of ‘Funds Flow Statement’:

The preparation of Funds Flow Statement consists of two parts:

1. Statement or Schedule of Changes in Working Capital

2. Statement of Sources and Applications of Funds.

Statement of Changes in Working Capital:

This statement is prepared to show the changes in the working capital between the two balance
sheet dates. This statement is prepared with the help of current assets and current liabilities
derived from two balance sheets.

As Working Capital = Current Assets – Current Liabilities

So
a) Increase in Current Assets Lead to Increase in Working Capital
b) Decrease in Current Assets leads to Decrease in Working Capital
c) Increase in Current Liabilities leads to Decrease in Working Capital
d) Decrease in Current Liabilities leads to Increase in Working Capital

32 | P a g e
 Note:
Proposed Dividend
Provision for Taxation May or may not be taken as current liability.
Dividend Payable

Statement of Sources and Applications of Funds:

This statement indicates various sources from which funds (working capital) have been
obtained during a certain period and the uses or applications to which these funds have been
put during that period. Generally, this statement is prepared in two formats:

a) Report Form
b) ‘T’ Form or an account form or Self-Balancing type.

Format of Funds Flow Statement (Self-Balancing Type):

Funds Flow Statement

(For the year ended)
SOURCES AMOUNT (₹) APPLICATIONS AMOUNT (₹)
Funds from operations xxx Funds lost in operations xxx
Redemption of Redeemable
Issue of Shares/Debentures xxx xxx
Preference Shares/Debentures
Raising of L.T. Loans xxx Payment of Dividend xxx
Sale of Non-Current Assets xxx Payment of Tax xxx
Purchase of Non-Current Assets xxx
Net Decrease in Working Capital xxxx Net Increase in Working Capital xxxx
xxxxx xxxxx

Sources of Funds:

Funds from Operations:

These are the important and major sources of funds e.g. sales represent inflow (i.e. cash, debtors
or B/Rs) but at the same time funds flow out of business for expenses and COGS. The net effect
can be either inflow (if sales exceed expenses & COGS) or outflow (if vice-versa happens).

Profits as shown by P&L A/c don’t necessarily show only operational profits rather they may
include certain items of non-fund or non-operational nature.

Non-Fund items:
These items which may be operational but don’t affect the funds of business e.g. depreciation.
These type of items don’t really make funds move out of the business.

33 | P a g e
Non-Operating Items:
These items which although may result in the inflow or outflow of funds but don’t relate to
trading operations of the business e.g. loss on sale of machine, profit on sale of investment etc.

So we’ve to adjust the profits as shown by P&L A/c and reach to the level of earnings which are
purely generated from operations.

Methods of Preparation of Funds from Operations (FFOs):

a) The first method is to prepare P&L A/c afresh by taking into consideration only fund and
operational items.
b) The second method is to use the net profit figure (or sometimes retained earnings figure)
either from P&L A/c or from B/S and adjust it accordingly.

Note: We will be using the second for the calculation of FFOs.

The format for the calculation of FFOs using second method is reproduced as under:

Calculation of FFOs
Particulars Amount (₹)
Closing Balance of P&L A/c or Retained Earnings in B/S xxx
Less: Opening Balance xxx
xxx
Add: Non-Fund/Non-Operating items which have been already debited
xxx
to P&L A/c
Less: Non-Fund/Non-Operating Items which have been already credited
(xxx)
to P&L A/c
Funds from Operations xxx

Preparation & Format of ‘Schedule or Statement of Working Changes’:

The change in the amount of any current asset or current liability in the current balance sheet as
compared to that of the previous balance sheet either results in increase or decrease in working
capital. The difference is recorded for each individual current asset and current liability. The total
increase and the total decrease are compared and the difference shows either the net increase
or net decrease in working capital.

Format of Statement of Changes in Working Capital

P. Year C. Year Effects on W. Capital

Particulars
(₹) (₹) INC. (₹) DEC. (₹)
A) Current Assets
Cash X X X X

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 Debtors X X X X
Stock etc. X X X X
Total (A) X X X X
B) Current Liabilities
Bills Payable X X X X
Creditors X X X X
Outstanding Expenses X X X X
Total (B) X X X X
C) Working Capital (A - B) X X
D) Net INC/DEC in W. Capital X X X X

Practical Problems on Funds Flow Statement:

Problem/1: calculate funds from operations from the following P&L A/c of M/S Al-Aziz & Co.

Profit and Loss Account

Particulars Amount (₹) Particulars Amount (₹)
To Salaries 10,000 By Gross Profit 2,00,000
To Rent 3,000 By Profit on Sale of Machine 5,000
To Commission 2,000 By Refund of Tax 3,000
To Discount Allowed 1,000 By Dividends received 2,000
To Provision for Depreciation 14,000
To Transfers to General Reserve 20,000
To Provision for Tax 10,000
To Loss on Sale of Investment 5,000
To Discount on Issue of Deb. 2,000
To Preliminary Expenses 3,000
To Selling Expenses 20,000
To Net Profit 1,20,000
2,10,000 2,10,000

Solution:
Computation of Funds from Operations
Details Amount
Particulars
(₹) (₹)
Net Profit as per Profit & Loss A/c 1,20,000
Add: Non-Cash/Non-Operating Items which have been debited
to P&LA/c:
a) Provision for Depreciation 14,000
b) Transfer to General Reserve 20,000

35 | P a g e
 c) Provision for Tax 10,000
d) Loss on Sale of Investment 5,000
e) Discount on Issue of Debentures (written-off) 2,000
f) Preliminary Expenses (written-off) 3,000 54,000
1,74,000
Less: Non-Cash/Non-Operating Items which have already been
credited to P&L A/c:
a) Profit on Sale of Machine 5,000
b) Refund of Tax 3,000
c) Dividend received 2,000 (10,000)
Funds from Operations 1,64,000

Problem/2: From the following balance sheet of Meridian Ltd., as on 31st December, 2006 and
2007, make out:
1. Statement of changes in Working Capital
2. Funds Flow Statement

Liabilities 2006 (₹) 2007 (₹) Assets 2006 (₹) 2007 (₹)
Equity Share Capital 1,00,000 1,30,000 Goodwill - 7,500
General Reserve 25,000 30,000 Land & Building 1,00,000 95,000
Profit & Loss A/c 15,200 15,400 Machinery 75,000 84,500
Bank Loan (Long-term) 35,000 - Stock 50,000 37,000
Sundry Creditors 75,000 67,500 Sundry Debtors 40,000 32,100
Provision for Tax 15,000 17,500 Bank - 4,000
Cash 200 300
2,65,200 2,60,400 2,65,200 2,60,400
Additional Information:
a) Dividend of ₹11,500 was paid
b) Assets of another company were purchased for a consideration of ₹30,000 payable in
shares.
The following assets were purchased: Stock ₹10,000; Machinery ₹12,500
c) Machinery was further purchased for ₹4,000
d) Depreciation written off machinery ₹6,000
e) Income Tax provided during the year ₹16,500
f) Loss on sale of machine ₹100 was written off to General Reserve.

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Solution:

Schedule of Working Capital Changes

2006 2007 Effects on W. Capital
Particulars
(₹) (₹) INC (₹) DEC (₹)
A) Current Assets:
 Stock 50,000 37,000 - 13,000
 Sundry Debtors 40,000 32,100 - 7,900
 Bank - 4,000 4,000 -
 Cash 200 300 100 -
Total (A) 90,200 73,400
B) Current Liabilities:
 Sundry Creditors 75,000 67,500 7,500 -
Total (B) 75,000 67,500
C) Working Capital (A - B) 15,200 5,900
D) Net Decrease in Working Capital 9,300 9,300
Total 15,200 15,200 20,900 20,900

Working Notes:

Note:
1. Provision for Tax has been taken as a non-current liability.
2. Purchase of machinery and goodwill for shares is neither a source nor an application of
funds as both the accounts involved are of non-current nature. But purchase of stock for
issue of shares is a source as stock is a current asset and shares are a non-current liability.

Ledger Accounts forming part of preparation of Funds Flow Statement:

Dr. 1. Share Capital A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
By balance b/d 1,00,000
By Machinery 12,500
By Stock 10,000
To balance c/d 1,30,000 By Goodwill (Bal. Fig) 7,500
1,30,000 1,30,000

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Dr. 2. Machinery A/C Cr.
Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 75,000 By depreciation(C. Year) 6,000
By general reserve (loss on
To share capital 12,500 100
sale)
To Cash (Purchases) 4,000 By cash (Sale)(Bal. Fig) 900
By balance c/d 84,500
91,500 91,500

Dr. 3. Land & Building A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
By depreciation (C. Year)(Bal.
To balance b/d 1,00,000 5,000
Fig)
By balance c/d 95,000
1,00,000 1,00,000

Dr. 4. Provision for Tax A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To Cash (Tax Paid) (Bal. Fig) 14,000 By balance b/d 15,000
To balance c/d 17,500 By P&L A/c (C. Year Prov.) 16,500
31,500 31,500

Dr. 5. General Reserve A/C Cr.

Particulars Amount (₹) Particulars Amount (₹)
To Machinery (Loss on Sale
100 By balance b/d 25,000
wrongly credited)
To balance c/d By P&L A/c (Transfer out of C.
30,000 5,100
Year Profits) (Bal. Fig)
30,100 30,100

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 Calculation of Funds from Operations:
Particulars Details (₹) Amount (₹)
Closing Balance of P&L A/c 15,400
Less: Opening Balance of P&L A/c 15,200
Net Profit before adjustments 200
Add: Non-Cash/Non-Operating Items which have been
already debited to P&L A/c:
a) Depreciation on Land & Building 5,000
b) Provision for Tax 16,500
c) Transfer to General Reserve 5,100
d) Depreciation on Machinery 6,000
e) Dividend Paid during the year 11,500 44,100
44,300
Less: Non-Cash/Non-Operating Items which have been - -
already credited to P&L A/c:
Funds From Operations 44,300

Funds Flow Statement

(For the year ended 31st, December, 2007)
SOURCES AMOUNT (₹) APPLICATIONS AMOUNT (₹)
Purchase of Machine ( for
Funds from Operations 44,300 4,000
cash)
Issue of Share Capital (for
10,000 Payment of Bank Loan 35,000
Stock)
Sale of Machine 900 Payment of Tax 14,000
Dividend Paid 11,500
Net Decrease in W. Capital 9,300
64,500 64,500

Note: The net increase/decrease in working capital that we get while preparing ‘statement of
changes in working capital’ should also match with the net increase/decrease in working capital
which we get while preparing ‘funds flow statement’.

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