FINANCIAL ACCOUNTING FOR MANAGERS

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FINANCIAL ACCOUNTING FOR MANAGERS
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WHAT IS ACCOUNTING ?

• Accounting is the language of business
• Accounting is an Information System
• a) For Insiders
• b) For Outsiders
• Accounting provides reports to stakeholders about
  the economic activities and condition of a
  business

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WHAT IS ACCOUNTING ?

• Accounting refers to measurement of economic
  events and summarising and reporting them in the
  form of financial statements for use by the
  stakeholders i.e. bankers, creditors,
  shareholders, public and Govt. Reporting is thus
  the end function of accounting

4
BRANCHES OF ACCOUNTING

• Financial accounting is the preparation and
  communication of financial information mainly for
  those outside the organisation
• Management Accounting is the preparation and
  communication of financial and other information
  for the internal use of management
• Cost Accounting is the collation of data for
  inventory valuation

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CONCEPTUAL FRAMEWORK

• Purpose
• The purpose is to create a base for financial
  statements and provide assistance to
• Preparers
• Auditors
• Users
• The Accounting Standards Board of the ICAI

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COMPONENTS OF FINANCIAL STATEMENT

• Balance Sheet
• Income Statement
• Cash Flow Statement
• Notes to Accounts and Accounting Policies

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OBJECTIVE OF FINANCIAL STATEMENTS

• To provide information about the financial
  position, performance and cash flow of an
  enterprise
• However they do not provide all the information
  because
• 1.They largely portray the financial effects of
  past events
• 2.They do not provide information of
  non-financial nature
• Financial Position
• Economic Resources
• Financial Structure
• Liquidity and solvency
• Performance
• Cash Flows

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USERS OF FINANCIAL STATEMENTS

• Present and Potential Investors
• Employees
• Lenders
• Security Analysts and Advisers
• Suppliers and Creditors
• Customers
• Governments and Regulatory agencies
• Public
• Management

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Assumptions Underlying Preparation of Financial
Statements

• Accrual Basis The effects of transactions and
  other events are recognised when they occur and
  reported in the financial statements of the
  period to which they relate
• Going Concern The enterprise will continue for a
  forseeable future and has no intention to
  liquidate or curtail its operation materially.
• Consistency The accounting policies are followed
  consistently from year to year.

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Qualitative characteristics of Financial
Statements

• Understandability
• Relevance
• Materiality
• Reliability
• -- Faithful representation
• -- Substance over form
• -- Neutrality
• -- Prudence
• -- Completeness
• -- Comparability

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Financial Position

• Assets --- Assets are the resources controlled by
  an enterprise as a result of past events, from
  which future economic benefits are expected to
  flow to the enterprise.
• Liabilities Liabilities are the present
  obligations of the enterprise ,arising from past
  events, the settlement of which is expected to
  result in an outflow of resources embodying
  economic benefits.
• Equity Equity is the residual interest in the
  assets of the enterprise after deducting all its
  liabilities.

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ACCOUNTING EQUATION

• The relationship among asset , liability and
  equity can be expressed by the following equation
• Assets Liabilities Owners Equity
• The effect of all business transactions is
  reflected in this equation.

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Elements of Financial Statements

• Financial Position
• -- Assets
• -- Liabilities
• --Equity
• . Performance
• -- Income
• -- Expenses
• . Cash Flows

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Characteristics

• Assets
• 1. They represent potential to contribute ,
  directly or indirectly, to the flow of cash or
  cash equivalents to the enterprise.
• 2. Physical form not essential to the existence
  of the asset.
• 3. Legal right of ownership not essential in
  establishing the existence of asset.
• 4. Purchasing or producing not always essential
  to obtain asset.
• 5. Expenditure incurred for seeking future
  economic benefits may not result in asset.

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Characteristics

• Liabilities
• 1. Its a present obligation to be settled in
  future
• 2. Obligations may be due to a binding contract
  or statutory requirement
• 3. A present obligation and a future commitment
  differ from each other
• 4. Careful estimates are required to measure
  provisions.

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Characteristics

• Equity
• It is dependent on the measurement of assets and
  liabilities
• A change in net assets results in a change in the
  equity

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PERFORMANCE

• Elements
• Income - It represents the increase in economic
  benefits in the form of increase in assets or
  decrease in liabilities
• Expenses- It represents decrease in economic
  benefits in the form of outflows or depletion of
  assets or increase in liabilities ( Expense vs.
  Expenditure )

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Characteristics

• Income
• 1.Both revenue and gains
• 2. Revenue arises in the ordinary course of
  business
• 3.Gains may or may not arise in the ordinary
  course of business

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Characteristics

• Expenses
• 1. It includes both expenses and losses.
• 2. It arises in the ordinary course of business.
• 3. Losses may or may not arise in the ordinary
  course of business.

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RECOGNITION

• Condition for Recognition
• It is probable that future economic benefits will
  flow to or from the enterprise.
• The item can be measured reliably.

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MEASUREMENT

• Historical Cost
• Current Cost
• Realisable Value
• Present Value

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Accounting Concepts

• Dual Aspect Concept
• Business Entity Concept
• Accrual Concept
• Cost Concept
• Money Measurement Concept
• Realisation Concept

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GAAP

• Conceptual Framework of Financial Statements
• Accounting Concepts
• Requirements of Companies Act
• Accounting Standards
• Requirements of Income Tax Act

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Requirements of Companies Act

• Books of Accounts ( Sec.209 )
• All sums of money received and expended by the
  company
• All Sales and Purchases of goods by the company
• All assets and liabilities of the company
• Cost records in case of companies engaged in
  production, manufacturing , processing, mining
  activities

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Requirements of Companies Act

• Annual Accounts ( Sec.210 )
• A balance sheet and
• A profit and loss account at every AGM
• Form and Contents
• Balance sheet to exhibit true and fair view of
  the state of affairs of the company and to comply
  with part I of schedule VI
• Profit and loss account to give a true and fair
  view of the profit and loss of the company and to
  comply with part II of schedule VI
• Every balance sheet and Profit and loss account
  to comply with accounting standards

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Requirements of Companies Act

• Company not complying with AS to disclose
• Deviation from AS
• Reasons for such deviation
• Financial effect

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ACCOUNTING STANDARDS

• Accounting Standards Board
• Applicability of AS
• Scope of AS
• Details of AS
• Authority attached to AS
  
  

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Requirements of Income Tax Act

• I.T. Act allows both cash as well as mercantile
  system of accounting
• Companies Act allows only mercantile system of
  accounting

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ACCOUNTING PROCESS

• Documentation
• Recording
• Classifying
• Summarising

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ACCOUNTING PROCESS

• Account - An account is an individual record of
  increases or decreases in an item that is likely
  to be of interest or importance.
• Ledger - It is a book which contains accounts.
• Journal - The journal is a chronological record
  of transactions entered into by a business.

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CLASSIFICATION OF ACCOUNTS ACCORDING TO NATURE

• Personal account - Accounts of persons or firms
  with whom the firm enters into transactions. It
  includes both natural persons accounts and
  artificial persons accounts.
• Real account - Accounts of properties under the
  control of the firm.
• Nominal account - Accounts of revenue , gains,
  expenses and losses.

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PRINCIPLES OF DEBIT AND CREDIT

• Personal account-Debit the receiver credit the
  giver
• Real account-Debit what comes in credit what
  goes out
• Nominal account-Debit all expenses and losses
  credit all incomes and gains

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THE ACCOUNTING CYCLE

• To record opening entries in the general ledger
• To record transactions and events in the journal
• To post journal entries in appropriate accounts
  in the general ledger
• To balance the accounts in the general ledger
• To prepare the trial balance
• To pass adjustment entries
• To prepare the revised trial balance
• To pass closing entries to prepare financial
  statements

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TYPES OF JOURNALS

• Purchase Day Book
• Sales Day Book
• Purchase Return Book
• Sales Return Book
• Cash Book
• Journal Proper

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MATCHING PRINCIPLE

• Revenues have to be matched and correlated with
  all the expenses of a particular year
• In other words , profit is determined after
  charging the expenses of a period with the
  revenues earned in the same period

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PRINCIPLE OF CONSERVATISM

• This principle requires the accountants not to
  anticipate gains but to provide for all possible
  losses
• Example Lower of cost or market price policy
  is adopted while valuing inventory.

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MATERIALITY

• Information is material if its misstatement could
  influence the decisions of users taken on the
  basis of financial statements
• Materiality depends on the size and nature of the
  item or error
• It is necessitated by practicability and
  feasibility

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ADJUSTMENT PROCESS

• Why Adjustment Is Necessary ?
• It ensures that revenues and expenses are
  recorded or recognised in the period to which
  they relate to.
• It affects both Balance Sheet and Income
  Statement .
• It never affects the cash account.
• Adjustments are required when transactions affect
  revenue and expense of more than one accounting
  year.

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ADJUSTMENT PROCESS

• Adjusting Entries Result In
• Deferral A deferral is a delay in the
  recognition of an expenditure or of a revenue
  already received
• Accrual An accrual is the recognition of an
  expense that has not been paid or of a revenue
  that has not been received

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Trial Balance

• Features
• Closing balances of accounts in the ledger as
  well as cash balance are taken
• It tests the arithmetical accuracy of ledger
  balances
• It can be prepared monthly, quarterly and yearly
• It is a source document for preparing financial
  statement

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CLOSING ENTRIES

• STEPS
• Transfer balances in revenue accounts to the
  Profit Loss account
• Transfer balances in the expense account to the
  Profit Loss account
• Transfer balances in the Profit Loss account to
  Profit Loss Appropriation account

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Balance Sheet

• Asset side
• Items under Fixed Asset
• Land
• Building
• Plant and Machinery
• Furniture and Fixture
• Vehicles

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Balance Sheet

• Investment
• Investment in govt. securities
• Investment in shares ,debentures and bonds
• Investment in immovable properties
• Investment in the capital of partnership firms

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Balance Sheet

• Current Assets, Loans, and Advances
• Current Assets
• --- Inventories
• --- Sundry debtors
• --- Cash and bank balances
• Loans and Advances
• --- Advances recoverable in cash or in kind or
  for value to be received
• ---Advance income tax
• --- Advance deposit of sales tax and excise
• --- Inter-corporate deposits

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BALANCE SHEET

• Miscellaneous Expenditure
• Debit balance in Profit and Los account

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Balance Sheet

• Liabilities side
• Share Capital
• --- Equity Share Capital
• --- Preference Share Capital
• Reserves and Surplus
• --- Capital reserves
• --- General reserve
• --- Capital redemption reserve
• --- Debenture redemption reserve

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Balance Sheet

• Loan Funds
• Secured Loans
• -- Term Loans
• -- Debentures
• --Working capital loans
• Unsecured Loans
• -- Fixed deposits
• --Debentures
• --Security deposits

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Balance Sheet

• Current Liabilities and Provisions
• Current Liabilities
• --- Sundry Creditors
• --- Expenses Payable
• --- Advances from customers
• --- Unclaimed dividends
• --- Interest accrued but not due
• Provisions
• --- Provision for taxation
• --- proposed dividend
• --- provision for contingencies

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PROFIT LOSS ACCOUNT

• Domestic Sales
• Exports
• others

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PROFIT AND LOSS ACCOUNT

• Expenditure
• --- Materials Consumed
• ---Salaries, wages, bonus
• ---Staff welfare expenses
• ---Power and fuel
• ---Repairs and maintenance
• ---Rent, rates and taxes
• ---Freight, transportation
• ---Travelling exp.
• ---Interest
• ---Excise duty
• ---Depreciation
• ---Provision for taxation
• ---Extraordinary items

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PROFIT LOSS ACCOUNT

• Profit After Tax It is measured as excess of
  revenues over expenses.
• Profit Loss Appropriation Account From the
  PAT following appropriations take place
• Prov. for dividend to Pref. Shareholders
• Interim dividend
• Provision for final dividend
• Prov. for Corp. dividend tax
• Transfer to general reserve, debenture redemption
  reserve

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CASH FLOW STATEMENT

• Features
• Prepared for a given period
• Comparative position for each element of cash
  flow is given.
• Cash inflows and outflows for operating ,
  investing and financing activities are disclosed.
• It shows the reconciliation between opening and
  closing cash balances.
• 5. Its a derived statement.

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CASH FLOW STATEMENT

• Operating Activity The principal revenue
  producing activity
• Investing Activity Refers to acquisition and
  disposal of long-term assets and other
  investments
• Financing Activity Those activities that result
  in changes in the size and composition of the
  owners capital including preference capital

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CASH FLOW STATEMENT

• Operating Activities
• Cash receipts from sale of goods or services
• Cash receipts from royalties, fees, commission
• Cash payments to suppliers, employees
• Cash payments or refunds of income tax

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CASH FLOW STATEMENT

• Investing Activities
• Cash payments to acquire fixed assets
• Cash receipts from disposal of fixed asset and
  intangibles
• Cash payments to acquire shares, warrants or debt
  instruments
• Cash receipts from disposal from shares, warrants
  or debt instruments
• Cash advances and loans made to third parties
• Cash receipts from the repayment of advances and
  loans made to third parties

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CASH FLOW STATEMENT

• Financing Activities
• Cash proceeds from issue of shares, debentures,
  loans, bonds
• Cash repayments of amount borrowed

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VALUATION OF INVENTORIES

• Meaning of Inventories
• Inventories consist of assets held
• a) For Sale ( finished goods )
• b) In the process of production for such sale (
  raw material and W.I.P )
• c) In the form of materials or supplies to be
  consumed in the production process (
  stores, spares, consumables, raw material)

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VALUATION OF INVENTORIES

• Applicability
• AS-2 does not cover the following
• W.I.P arising under construction contract
• W.I.P arising in case of service providers
• Shares, debentures, bonds held as stock-in-trade
• Livestock, agricultural and forest products,
  mineral oils, ores and gases

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VALUATION OF INVENTORIES

• Valuation Policy
• Inventories are valued at lower of cost or net
  realisable value
• NRV means estimated selling price minus
  estimated costs of completion and costs necessary
  to make the sale

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VALUATION OF INVENTORIES

• Cost of Inventory includes---
• Cost of purchase
• Cost of conversion
• Other costs incurred in bringing the inventories
  to their present location and condition

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VALUATION OF INVENTORIES

• Exclusion of certain costs
• Abnormal amounts of wasted materials, labour,
  other production costs
• Storage cost
• Administrative overhead
• Selling and distribution cost
• Interest and borrowing cost

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VALUATION OF INVENTORIES

• Cost Formulas
• Specific Identification Method --
• It means directly linking the cost with
  specific item of inventories
• 2. FIFO ( First In First Out ) or
• Weighted Average cost
• Where specific identification method is
  not applicable the cost of inventories is valued
  by either of the above two formulas.

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FINANCIAL REPORTS

• A Companys annual report contains the
  following
• 1. Auditors Report
• 2. Directors Report, and
• 3. Corporate Governance Report

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FINANCIAL REPORT

• Auditors Report
• Sec. 227 of the Companies ACT requires the
  auditor
• To make a report to the members on the accounts
  examined by him, and on every balance sheet and
  profit and loss account and on every other
  document forming part of B/S and P/L
• To express an opinion whether the accounts
• a) give the information required by the
  Companies Act in the manner so required
• b) give a true and fair view
• 1. In the case of balance sheet, of the
  state of affairs of the company
• 2. In the case of profit and loss
  account, of the profit or loss for the financial
  year

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FINANCIAL REPORT

• Auditors Report
• 3. The report shall also state
• a) Whether all the information and
  explanations were obtained for the purpose of
  audit
• b) Whether proper books of account as required
  by law have been kept and whether adequate
  reports from branches not visited by him have
  been received
• c) Whether the B/S and P/L are in agreement
  with the books of account
• d) Whether the B/S and P/L comply with the
  accounting standard
• e) Whether any director is disqualified u/s 274

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FINANCIAL REPORT

• Directors Report (sec. 217)
• The report shall state
• The state of the companys affairs
• The proposed amount of transfer to any reserves
• Amount recommended for dividend
• Material changes taken place between the end of
  financial year and the date of report
• Conservation of energy, technological absorption,
  foreign exchange earnings and outgo

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FINANCIAL REPORT

• Directors Responsibility Statement
• It shall state the following
• All relevant accounting standards have been
  followed in the preparation of annual accounts
• The directors have selected proper accounting
  policies and applied them consistently and made
  reasonable judgments and estimates so as to give
  a true and fair view of the state of affairs
• The directors have taken proper and adequate care
  for maintenance of accounting records and
  safeguarding of assets and preventing and
  detecting fraud
• The accounts have been prepared on a going
  concern basis

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FINANCIAL REPORT

• The directors report shall further include
• Information and explanation on every
  qualification, or adverse remark in the auditors
  report
• Reasons for delay in completing buy-back process
• a) A statement showing name of employees who are
  in receipt of Rs. 24 lacs or more per annum, if
  employed throughout the year
• b) If employed for part of the year Rs.2
  lacs per month
• c) If employed throughout or part of the
  year, was in receipt of remuneration in excess of
  that drawn by M.D. or whole-time director or
  manager and holds by himself or together with
  spouse not less than 2 of equity shares of the
  company

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FINANCIAL REPORT

• Corporate Governance Report
• Objectives-
• 1. To protect the interest of small investors
• 2. To promote transparency within business and
  industry
• 3. To develop a high level of public confidence
  through increase in shareholders wealth

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FINANCIAL REPORT

• Corporate Governance Clause 49
• Audit Committee-
• It shall have minimum three members, all being
  non-executive directors
• At least one director should have financial and
  accounting knowledge
• The chairman of the committee shall be an
  independent director
• The company secretary is the secretary of the
  committee

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FINANCIAL REPORT

• Audit committee
• 5. The Chairman shall be present at AGM to answer
  shareholders queries
• 6. At least three meetings should be held in a
  year
• 7. Quorum is either two members or one third of
  the members of the committee w.e. is higher and
  minimum of two independent directors

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FINANCIAL REPORT

• Powers of the Audit Committee
• To investigate any matter within its area of
  activity
• To seek information from any employee
• To obtain legal or professional advice

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FINANCIAL REPORT

• Role of Audit Committee
• To review the financial reporting process and to
  ensure that the financial statement is correct
• Recommending the appointment and removal of
  external auditor and their fees
• To review the financial statements before
  submission to the board in order to ensure
  compliance with accounting standards
• To review the internal audit function and the
  adequacy of internal control system
• To discuss any significant findings by the I.A.
• To look into the reasons for default in the
  payment to the depositors, debenture holders,
  shareholders

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FIXED ASSETS ACCOUNTING

• Meaning and Significance of Fixed Assets
• Fixed assets are used for production or providing
  goods or services
• They are not meant for resale in the ordinary
  course of business
• They constitute a significant portion of total
  assets
• Proper allocation between revenue and capital
  expenditure necessary to recognise and measure
  fixed asset

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FIXED ASSETS ACCOUNTING

• Cost of Fixed Assets
• Purchase price inclusive of import duties less
  trade discount, rebates
• Any directly attributable cost incurred to bring
  the asset to its present working condition
• Admin. and general overhead charges specifically
  attributable to construction of a project
• Cost to be adjusted for exchange fluctuation
• If acquired in exchange for another asset , the
  cost is recorded either at FMV or net book value
  of the asset given up

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FIXED ASSETS ACCOUNTING

• Cost of fixed assets is affected by two following
  factors
• Government grants
• Borrowing costs

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FIXED ASSETS ACCOUNTING

• Accounting for Govt. grants
• Grants related to specific asset
• The grant is shown as a deduction from the gross
  value of asset. Where the grant equals the
  entire cost of the asset , the asset is shown at
  a nominal value
• A) Grants related to depreciable asset are
  treated as deferred income
• B) Grants related to non-depreciable asset
  are credited to capital reserve

78
FIXED ASSETS ACCOUNTING

• Borrowing costs
• Borrowing costs are interest and other costs
  incurred relating to borrowing of funds.
  Borrowing costs attributable directly to the
  acquisition or construction of fixed asset are
  capitalised.
• Conditions for capitalisation
• Borrowing costs are incurred
• Activities essential to prepare the asset for
  its intended use are in progress
• Expenditure for the acquisition or construction
  of asset is incurred

79
DEPRECIATION

• Definition- Depreciation is a measure of the
  wearing out, consumption or other loss of value
  of a depreciable asset arising from use,
  effluxion of time or obsolescence through
  technology and market changes.
• In other words depreciation is nothing but
  distribution of total cost of an asset over its
  useful life.

80
DEPRECIATION

• Significance
• 1. It represents the charge of a fair proportion
  of the depreciable amount to PL account over the
  useful life of an asset.
• 2. Depreciable amount is the historical cost or
  revalued amount of the asset less residual value.
• 3. It plays a significant role in determining the
  financial performance of an enterprise.
• 4. It is charged in each accounting year.

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DEPRECIATION

• Depreciable Asset means an Asset which
• Is held by an enterprise for use in the
  production or supply of goods and services.
• Is not meant for resale in the ordinary course of
  business.
• Is expected to be used during more than one
  accounting period
• Has limited useful life.

82
DEPRECIATION

• Methods of Depreciation
• Straight Line Method- Under this method
• depreciation is charged equally over the
  useful life of the asset.
• Formula
• Depreciation
• Cost of asset- Estimated residual value
• -----------------------------------------------
  -------
• Estimated useful life

83
DEPRECIATION

• 2. Written down value method- Under this method
  depreciation is charged at a fixed rate on the
  reduced balance of the asset every year.
• Rate of Estimated residual
• Depreciation 1- n value
• 
  ---------------------------
• Cost of asset

84
DEPRECIATION

• Requirements of Companies Act
• Sec. 205 and 350 deal with depreciation
• Sec.205 states that no dividend shall be declared
  or paid out of profits without providing for
  depreciation.
• Depreciation has to be provided
• a) as provided in sec.350, or
• b) as arrived at by dividing 95 of the
  original cost of the asset by the specified
  period
• 3. Sec.350 provides that depreciation has to be
  charged as per schedule XIV to the Companies Act.
  

85
DEPRECIATION

• Provisions of Income Tax Act
• Only WDV method is recognised
• Block of assets method is followed
• 100 dep. Is allowed if the asset is used for 180
  days or more. 50 dep. if used for less than
  180days

86
DEPRECIATION

• Consistency Principle
• It requires that a method of dep. , once adopted
  , should be applied consistently unless
• The statute requires the adoption of a new
  method.
• It is required to comply the provisions of an
  accounting standard
• The change is necessary for a more appropriate
  preparation and presentation of the financial
  statements.

87
FINANCIAL STATEMENT ANALYSIS

• Objectives of Analysis
• To know whether the company is making enough
  profit or not
• To evaluate the financial strength of the company
  
• To judge the ability of the company to generate
  enough cash and cash equivalents and their timing
• To know the future growth prospects

88
FINANCIAL STATEMENT ANALYSIS

• Tools available for analysis
• Multi-step income statement
• Horizontal analysis
• Common-sized analysis
• Trend analysis
• Analytical balance sheet

89
FINANCIAL STATEMENT ANALYSIS

• Multi-step Income Statement
• From the reported statement , it is necessary to
  segregate information and break-up of
  manufacturing, administrative and selling
  expenses which will show the profitability and
  disclose the following
• Gross ProfitGP
• Profit before depreciation, interest and
  taxPBDIT
• Operating ProfitOP or PBIT
• Profit before tax and extraordinary itemsPBTEOT
• Profit before taxPBT
• Net profit--PAT

90
FINANCIAL STATEMENT ANALYSIS

• Horizontal Analysis
• The percentage analysis of increase or decrease
  in each item of comparative balance sheet and
  profit and loss account is known as horizontal
  analysis
• Formula
• (Current years fig.- Previous years fig.)100
• --------------------------------------------------
  ----------
• Previous years fig.

91
FINANCIAL STATEMENT ANALYSIS

• Common-sized Analysis
• The tool is useful in comparing the performance
  and financial position of two companies within
  the same industry or in different industries
• In case of balance sheet , each item is restated
  taking the total sources of fund or application
  of fund as 100
• Similarly, in case of income statement, all items
  are expressed as a percentage of net sales which
  is taken at 100
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

92
FINANCIAL STATEMENT ANALYSIS

• Analytical Balance Sheet
• It is a modified version of vertical balance
  sheet
• It starts with Application of funds side as
  against the vertical balance sheet that starts
  with Sources of Funds side
• It proves the basic accounting equation Assets
  - outside liabilities Owners Funds
• It shows that equity shareholders are the
  residual claimants on the assets of the company
  

93
FINANCIAL STATEMENT ANALYSIS

• Trend Analysis
• It is an extension of horizontal analysis
• Unlike in horizontal analysis, trend analysis
  compares position for more than two years, say,
  five years
• Analysis for a longer period confirms the
  findings of horizontal analysis

94
FINANCIAL STATEMENT ANALYSIS

• Ratio Analysis
• Ratio refers to relationship between two
  variables expressed either in percentages or in
  multiples and seeks to establish the cause and
  effect relationship.
• It assists in the following cases
• Inter-firm comparison
• Intra-firm comparison
• Comparison against industry benchmark
• Analysis of performance over a long period

95
FINANCIAL STATEMENT ANALYSIS

• Classification of Ratios
• Return on Investment ( ROI ) ratios
• Solvency ratios
• Liquidity ratios
• Efficiency or Turnover ratios
• Profitability ratios
• Du Pont Analysis
• Capital Market ratios

96
FINANCIAL STATEMENT ANALYSIS

• Return on Investment (ROI) ratios
• This ratio seeks to measure the efficiency of
  performance or otherwise of the company. Higher
  the ratio, greater is the financial security for
  investors. Maximisation of ROI is the ultimate
  objective of any company.
• Under this group, the following ratios are
  computed
• Return on Net Worth
• Earnings per Share

97
FINANCIAL STATEMENT ANALYSIS

• Return on Net Worth (RONW)
• The ratio measures the net profit earned on
  equity shareholders funds. It is the measure of
  overall profitability of a company.
• Formula
• (PAT-Pref.dividend)100
• --------------------------------------------------
  ---------
• Net Worth (Equity capital Reserves
  Surplus-Misc. expenditure not written off)

98
FINANCIAL STATEMENT ANALYSIS

• Earning per Share ( EPS)
• The ratio measures the overall profitability in
  terms of per equity share of capital
  contributed.This is the most widely used ratio
  across industries.
• Formula
• PAT-Pref.Dividend
• --------------------------------------------------
  ---------
• Weighted average no. of equity shares O/S

99
FINANCIAL STATEMENT ANALYSIS

• Solvency Ratios
• The capacity of a company to discharge its
  long-term obligation indicates its financial
  strength and solvency position.
• Under this group, the following ratios are
  computed.
• 1. Debt-Equity ratio
• 2. Interest coverage ratio
• 3. Debt-service coverage ratio

100
FINANCIAL STATEMENT ANALYSIS

• Debt-Equity ratio ( times )
• The ratio measures the proportion of debt and
  capital both equity and preference in the
  capital structure of a company. It helps in
  knowing whether a company is relying more on debt
  or capital for financing its assets. Higher the
  debt , more is the financial risk.
• Formula
• Long term debt
• --------------------------------------------------
  -----------------
• Total net worth( Eq. shareholders fundsPref.
  cap)

101
FINANCIAL STATEMENT ANALYSIS

• Interest Coverage Ratio ( times )
• The ratio measures the ability of a company to
  service the interest obligations out of its cash
  profits. Higher the ratio, greater is the
  ability.
• Formula
• PATInt. on long-term debtNon-cash charges
• --------------------------------------------------
  ---------
• Interest on long-term debt

102
FINANCIAL STATEMENT ANALYSIS

• Debt Service Coverage Ratio (times)
• This ratio helps in assessing whether a company
  has the ability to service its instalments of the
  principal due and the interest obligations out of
  the revenues generated. Higher the ratio, greater
  is the ability.
• Formula
• PATInt. on long term debtNon-cash charges
• --------------------------------------------------
  ---------------
• Int. on long term-debt Instalments of principal
  due

103
FINANCIAL STATEMENT ANALYSIS

• Liquidity Ratio
• Liquidity refers to the capacity a company to
  meet its day to day expenses and discharge
  short-term obligations of suppliers and other
  creditors smoothly.
• Following ratios are calculated under this head.
• Current Ratio
• Quick Ratio
• Collection period
• Suppliers Credit
• Inventory Holding period

104
FINANCIAL STATEMENT ANALYSIS

• Current Ratio ( times )
• The ratio measures the ability of a company to
  discharge its day to day obligations. A company
  should possess adequate level of current assets
  over current liabilities to be able to do so. A
  current ratio of more than 1 indicates that value
  of short-term assets is more than short-term
  liabilities. A current ratio of less than 1
  indicates poor liquidity.
• Formula
• Current Assets, loans and advancesshort-term
  
• 
  Investments
• --------------------------------------------------
  -----------------------------
• Current LiabilitiesProvisionsShort-term debt

105
FINANCIAL STATEMENT ANALYSIS

• Quick Ratio ( times )
• The ratio measures as to how fast the company is
  able to meet its current obligations as and when
  they fall due. This is also known as acid-test
  ratio. Inventory and working capital limits are
  taken out of current assets and current
  liabilities respectively. A quick ratio of 1 1
  is indicates highly solvent position.
• Formula
• Current Assets, Loans and Advances-Inventories
• --------------------------------------------------
  ------------------
• Current LiabilitiesProvisions-Working Capital
  Limits

106
FINANCIAL STATEMENT ANALYSIS

• Collection Period ( days )
• The ratio measures how fast the company is able
  to realise the dues from the customers on credit
  sales. It helps to understand the credit policy
  of the company.
• Formula
• Receivables 365
• ---------------------------
• Credit sales

107
FINANCIAL STATEMENT ANALYSIS

• Suppliers Credit ( days )
• The ratio measures the average credit period
  enjoyed by the company from its suppliers. It
  also helps to understand the credit policy
  extended to a company by the suppliers.
• Formula
• Payables365
• ----------------------
• Credit Purchases

108
FINANCIAL STATEMENT ANALYSIS

• Inventory Holding Period( days )
• The ratio measures the average period for which
  cash is blocked in inventory. In other words the
  ratio explains how fast the company is able to
  convert its inventory into cash.
• Formula
• Inventory365
• --------------------
• Cost of goods sold

109
FINANCIAL STATEMENT ANALYSIS

• Turnover Ratios
• These ratios indicate how efficiently the assets
  of the company are used to generate revenue .
• Following ratios are calculated under this group.
• Overall Efficiency Ratio
• Fixed Assets Turnover Ratio
• Debtors Turnover Ratio
• Inventory Turnover Ratio
• Creditors Turnover Ratio

110
FINANCIAL STATEMENT ANALYSIS

• Overall Efficiency Ratio ( times )
• It shows how effectively the capital employed has
  helped in revenue generation. Higher the ratio
  greater is the efficiency.
• Formula
• Sales
• ----------------------------------------------
• Capital Employed

111
FINANCIAL STATEMENT ANALYSIS

• Fixed Assets Turnover Ratio ( times )
• The ratio measures the sales revenue per rupee of
  fixed assets. It plays an important role in
  improving the overall profitability and financial
  position of the company.
• Formula
• Sales
• ------------------------------------------------
• Net Block of Fixed Assets

112
FINANCIAL STATEMENT ANALYSIS

• Debtors Turnover Ratio ( times )
• It represents the number of times average dues
  from customers are realised. Higher the ratio,
  the better is the position.
• Formula
• Credit Sales
• -------------------------------------------------
• Average Debtors

113
FINANCIAL STATEMENT ANALYSIS

• Creditors Turnover Ratio ( times )
• The ratio shows the average time taken to pay for
  goods and services. Longer the credit period
  achieved the better.
• Formula
• Credit Purchase
• --------------------------------------------------
  --
• Average Creditors

114
FINANCIAL STATEMENT ANALYSIS

• Inventory Turnover Ratio
• The ratio measures the amount of capital tied up
  in raw material, W.I.P. and finished goods
• Formula
• Cost of Goods Sold
• ---------------------------------------
• Average Inventory

115
FINANCIAL STATEMENT ANALYSIS

• Profitability Ratios
• The purpose of study of these ratios is to assess
  the adequacy or otherwise of the profit earned by
  the company. The following ratios are calculated
  under this group.
• Multi-step Profit Margin to Sales
• Individual Cost and Expense to Sales
• Other Income , Extraordinary Items and Prior
  Period Adjustments to PBT or Sales
• Effective Tax Rate

116
FINANCIAL STATEMENT ANALYSIS

• Multi-step Profit Margin to Sales Ratios()
• These ratios measure several profit margin
  indicators. All these ratios are computed in
  relation to Sales.
• Gross Profit Margin-GP
• Profit Before Depreciation, Interest and
  Tax-PBDIT
• Operating Profit-OP
• Profit Before Tax and Extra-ordinary Items-PBTEOT
• Profit Before Tax-PBT
• Net Profit Margin-PAT

117
FINANCIAL STATEMENT ANALYSIS

• Gross Profit Margin ()
• This reflects the efficiency with which
  management produces each unit of output. It also
  indicates the spread between the cost of goods
  sold and the sales revenue.
• Formula
• Sales-Cost of Goods Sold
• ------------------------------------- x 100
• Sales

118
FINANCIAL STATEMENT ANALYSIS

• Operating Profit Margin ()
• This ratio indicates profitability from operating
  activities. A higher margin implies better sales
  realisation and effective cost control.
• Formula
• Operating Profit
• ---------------------- X 100
• Sales

119
FINANCIAL STATEMENT ANALYSIS

• Net Profit Margin( )
• The ratio is the overall measure of the firms
  ability to earn profit per rupee of sales. It
  also establishes relationship between
  manufacturing, administering and selling the
  products.
• Formula
• Profit After Tax
• --------------------- x100
• Sales

120
FINANCIAL STATEMENT ANALYSIS

• Individual Costs and Expenses to Sales Ratios ()
• These ratios measure the proportion of individual
  items of cost and expense in relation to sales.
  They also assist the analyst in cost minimisation
  and cost reduction.
• Formula
• Raw Materials Consumed
• ---------------------------------------- x100
• Net Sales

121
FINANCIAL STATEMENT ANALYSIS

• Other Income, Extraordinary Items and Prior
  Period Adjustments to PBT or Net Sales ()
• These ratios seek to measure the impact of the
  above items on PBT or net sales.
• Formula
• Extraordinary Item
• -------------------------- x 100
• PBT

122
FINANCIAL STATEMENT ANALYSIS

• Effective Tax Rate()
• The ratio measures the actual effective rate at
  which a company pays income tax as against the
  statutory rate.
• Formula
• Current Income Tax
• ---------------------------- x100
• PBT

123
FINANCIAL STATEMENT ANALYSIS

• DU PONT Analysis
• RONW is a function of Net Profit Margin and Net
  worth Turnover. DU PONT analysis seeks to measure
  and establish this relationship between the two
  determinants. Through these ratios a firm can
  devise suitable remedies to overcome the weak
  area of overall performance.
• Formula
• (PAT-Pref. Div)X100 Net Sales
• ----------------------------X---------------------
  -----------------
• Net Sales Net Worth
  
  
  
  

124
FINANCIAL STATEMENT ANALYSIS

• Capital Market Ratios
• Following ratios are computed under this group.
• EPS
• Price Earning Ratio-P/E
• Market Capitalisation
• Yield to Investors

125
FINANCIAL STATEMENT ANALYSIS

• Price Earning Ratio ( times )
• P/E multiple is an important indicator of the
  premium that the market wishes to put on a firms
  earnings. It can be used to price a share and
  value a firm.
• Formula
• Market Price of Equity Share
• ------------------------------------------
• EPS

126
FINANCIAL STATEMENT ANALYSIS

• Market Capitalisation (Rs.)
• The ratio measures the total market value of the
  number of equity shares outstanding.
• Formula
• No. of Equity Shares O/S X Market Price

127
FINANCIAL STATEMENT ANALYSIS

• Yield to Investors ()
• The ratio measures the total gain or loss
  suffered by investors in relation to their
  investment in equity shares of a company.
• Dividend recd. Market Appreciation
• ---------------------------------------------x100
• Initial Investment