Week 2 – Part 2 & 3 Financial Analysis Tools FINA321 – Fall 2016 UoN Abdullah Al Shukaili

Index-Number Trend Analysis A useful tool for long-term trend comparisons is index-number trend analysis. Analyzing data using index-number trend analysis requires choosing a base period, for all items, with a preselected index number usually set to 100. When using index numbers, we compute percentage changes by reference to the base period.

Index-Number Trend Analysis For index-number trend analysis, we need not to analyze every item in financial statements. Instead, we want to focus on significant items. Changes in using index-number trend comparisons might be due to economy or industry factors.

Index-Number Trend Analysis In brief, the procedure for calculating trends is as : One year is taken as a base year which is generally is the first year or last year. Trend percentages are calculated in relation to base year

illustration 1 The change in cash balance between Year 1 and Year 2 for this illustration is 50% (150 100), and is easily inferred from the index numbers. However, the change from Year 2 to Year 3 is not 75% (150 75), as a direct comparison might suggest. Instead, it is 50%, computed as $9,000/$18,000. This involves computing the Year 2 to Year 3 change by reference to the Year 2 balance. The percentage change is, however, computable using index numbers only. For example, in computing this change, we take 75/150 0.50, or a change of 50%.

Trend change Year 1 Year 2 Year 3 Cash balance 12,000 18,000 9,000 Trend Analysis 100 150 75 % change to the base year - 50 % (25)%

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Solution Take 2004 as a base year – Index year Use this formula for the years 2005 , 2006 & 2007:

Interpretation Trend analysis On the whole, 2005 was a bad year but the recovery was made during 2006. In this year there is increase in sales as well as profit. The figure of 2005 when compared with 2004 reveal that the sales have come down by 5%. However, the cost of goods sold and the expenses have decreased only by 1.8% and 3% respectively. This has resulted in decrease in Net profit by 12%. The position was recovered in 2006 and not only the decline but also there is positive growth in both 2006 and 2007. Moreover, the increase in profit by 31.3% (2006) and 50.6% (2007) is much more than the increased in sales by 20% and 30% respectively. This shows major portion of cost of goods sold and expenses is of fixed nature.

Common-Size Financial Statement Analysis Financial statement analysis can benefit from knowing what proportion of a group or subgroup is made up of a particular account. In analyzing a balance sheet, it is common to express total assets (or liabilities plus equity) as 100%. Then, accounts within these groupings are expressed as a percentage of their respective total Because the sum of individual accounts within groups is 100%, this analysis is said to yield common-size financial statements.

Common-Size Financial Statement Analysis Common-size financial statement analysis is useful in understanding the internal makeup of financial statements. For example, in analyzing a balance sheet, a common-size analysis stresses two factors: Sources of financing & Composition of assets. Temporal (time) comparisons of a company’s common-size statements are useful in revealing any proportionate changes in accounts within groups of assets, liabilities, expenses, and other categories.

Common-Size Financial Statement Analysis The common size statements (Balance Sheet and Income Statement) are shown in analytical percentages. The figures of these statements are shown as percentages of total assets, total liabilities and total sales respectively.

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Interpretation of common size analysis – Balance Sheet For the previous exercises we can notice the following:- Both the companies are suffering from shortage of working capital. The percentage of current liabilities is more than the percentage of current assets in both the companies. A close look at the balance sheet shows that investments in fixed assets have been from working capital in both the companies. In Anoop Ltd. fixed assets account for 94.52% of total assets while in Bansal Ltd fixed assets a ccount for 89.48%.

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Interpretation of common size analysis – Income Statement Interpretation per to the last exercise:- The sale and gross profit have increased in absolute figures in 2007 as compared to 2006. But the percentage of gross profit to sales has gone down in 2007. The increase in cost of sales as a percentage of sales has brought the profitability from 34% to 27.14%. Operating expenses have remained the same in both the years. Net profit have decreased both in absolute figures and as a percentage in 2007 as compared to 2006.