FSA Dr. Varadraj Bapat, IIT Mumbai Module 7 Interpretation and Analysis of Accounts

FSA Dr. Varadraj Bapat, IIT Mumbai Index  Financial Statement Analysis  Vertical & Horizontal Analysis  Horizontal vs. Vertical Balance Sheet

FSA Dr. Varadraj Bapat, IIT Mumbai Analysis of Financial Statements Financial statement analysis refers to detailed study of these statements to arrive at useful interpretations. For the users, the details in the financial statements signify only raw data. This raw data needs to be re-organized, processed and converted into relevent and useful information.

FSA Dr. Varadraj Bapat, IIT Mumbai Horizontal and Vertical Analysis The analysis of financial statements is done by various techniques like Horizontal analysis and Vertical Analysis.

FSA Dr. Varadraj Bapat, IIT Mumbai Horizontal Analysis Horizontal analysis involves comparison of two years for the same concerns. It involves preparation of Comparative Statement.

Every item on the financial statement Every item on the financial statement is compared with that in the previous year. is compared with that in the previous year. The change is calculated in absolute amount The change is calculated in absolute amount and also as a percentage of that base and also as a percentage of that base Horizontal Analysis

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical Analysis Vertical analysis on the other hand involves finding out the relationship between two items in respect of the same concern and in same year. It involves preparation of Common-size Statement.

Vertical Analysis... compares each item in a financial statement to a base number set to 100%. compares each item in a financial statement to a base number set to 100%. Every item on the financial statement is then reported as a percentage of that base. Every item on the financial statement is then reported as a percentage of that base.

Common-size Statements On the income statement, each item is expressed as a percentage of net sales. On the income statement, each item is expressed as a percentage of net sales. On the balance sheet, the common size is the total on each side of the accounting equation. On the balance sheet, the common size is the total on each side of the accounting equation. Common-size statements are used to compare one company to other companies, and to the industry average. Common-size statements are used to compare one company to other companies, and to the industry average. they are also used to compare financials with earlier years. they are also used to compare financials with earlier years.

Benchmarking Percent of Net Sales Company BCompany A Cost of goods sold Operating expenses Income tax Net income

FSA Dr. Varadraj Bapat, IIT Mumbai Balance Sheet horizontal format Financial statements are traditionally prepared for the owners of the organisation. A typical traditional balance sheet is prepared in Horizontal format.

FSA Dr. Varadraj Bapat, IIT Mumbai Horizontal Balance Sheet Liabilities`Assets` Capital Fixed Assets Reserves & Surplus Investments Long Terms Loans Current Assets Short Term Loans Loans & Advances Current Liabilities Provisions TotalTotal

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical format The conventional horizontal form of Balance Sheet is not suitable for financial analysis, precisely because 1. It is designed for the owner.

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical format 2. Its presentation and sequence or order of items is relevant only in the event of liquidation; it is unsuitable for financial analysis of a ‘going concern’.

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical format Hence financial analysts generally converts horizontal balance sheet, into vertical format which is more suitable for financial analysis, especially in ratio analysis.

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical Balance Sheet Particulars` I. SOURCES OF FUNDS 1. Owners Fund (a) Capital (b) Reserves & Surplus Less: P & L A/c Dr. Balance Misc. Expenditure not w/off Misc. Expenditure not w/off

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical Balance Sheet Particulars` Own Funds or Net Worth 2. Loan Funds (a) Secured Loan (b) Unsecured Loan Total Loan Funds Total Capital Employed

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical Balance Sheet Particulars` II. APPLICATION OF FUNDS 1. Fixed Assets A. Tangible Assets (Gross Block) Less: Depreciation Net Block

FSA Dr. Varadraj Bapat, IIT Mumbai Vertical Balance Sheet B. Intangible Assets ` 2. Long Term / Trade Investments 3. Working Capital Current Asset Less: Current Liabilities Net Current Assets Total Assets Employed