ANALYSIS OF FINANCIAL STATEMENTS Dr. BALAMURUGAN MUTHURAMAN Chapter

NATURE OF FINANCIAL STATEMENT The data exhibited by financial statements are affected by a)Recorded facts b)Accounting Concepts, Conventions & Principles c)Personal Judgment

ACCOUNTING PRINCIPLES Accounting concepts Accounting Conventions a)Entity Concepta)Disclosure b)Going Concern Conceptb)Materiality c)Accounting period conceptc)Consistency d)Money Measurement Conceptd)Conservatism e)Cost Concept f)Cost Attach Concept g)Dual Aspect Concept h)Accrual concept i)Periodic Matching of cost and Revenue Concept j)Realisation Concept k)Verifiable Objective Evidence Concept

ESSENTIAL QUALITIES OF FINANCIAL STATMENTS 1.Relevance 2.Understandability : 3.Reliability and Accuracy 4.Comparability 5.Completeness 6.Timeliness

LIMITATIONS OF FINANCIAL STATEMENTS 1.Lack of Precision 2.Lack of Exactness 3.Incomplete Information 4.Interim Reports 5.Hiding of Real Position or Window Dressing 6.Lack of Comparability 7.Historical Costs

ANALYSIS Analysis – To Analyse – to cut into pieces But only analyse – No – It means also Interpretation. Financial Statement Analysis means “Analysis, comparisons and interpretation of Financial data to achieve the desired result”

TOOLS OF FINANCIAL STATEMENT ANALYSIS 1.Comparative Statements 2.Common Size Statements 3.Trend Analysis 4.Ratio Analysis 5.Fund Flow Statement 6.Cash Flow Statement

TYPES OF FINANCIAL ANALYSIS 1.Intra-Firm Comparison 2.Inter-firm Comparison 3.Industry Average or Standard Analysis: 4.Horizontal Analysis 5.Vertical Analysis

INTERPRETATION The Analysis is of no use without interpretation The Company has to interpret the financial statement which it has analysed. The Analysis is made to serve the following purpose 1.Profitability Analysis 2.Liquidity Analysis 3.Solvency Analysis (To know the financial structure)

Interested Parties in Analysis of Financial Statements 1.Management 2.Investors (In the form of Shareholders or Debentureholders) 3.Banks and Financial Institution 4.Trade Creditors 5.Government and their Agencies 6.Employees 7.Customers 8.Public 9.Trade Association 10.Stock Exchange

COMPARATIVE FINANCIAL STATEMENTS Comparative Financial Statements is a statement of Financial Position of a business designed in such a way where a comparative study is undertaken of different accounting items, to measure the performance of a Business Activity

TYPES OF COMPARISON There are 3 types of Comparison 1)Inter Firm Comparison 2)Intra Firm Comparison 3)Inter Period Comparison

MERITS OF COMPARISON 1)Indicate the Direction of Financial Position 2)Reveal Nature & Trend 3)Identifying Trouble Spots

DISADVANTAGES OF COMPARISON 1)Misleading picture, if consistency in accounting principle not followed. 2)Constant change in price level tender accounting statement useless for comparison. 3)Inter firm comparison is useless, unless all the firms are of the same age, size and follow the same principles. 4)If there exists any Abnormal Period between 2 successive accounting period then it will prove to be a pointless analysis

COMMON SIZE STATEMENTS It is a Statement in Vertical Form in which every item of the Financial Statement is reduced to a common base. This was introduced with a view to overcome the limitation of Comparative Statement

TYPES OF COMMON SIZE STATEMENTS. (1) Common Size Balance Sheet (2) Common Size Income Statement:

ADVANTAGES OF COMMON SIZE STATEMENT 1) It reveals Sources and Application of Funds in a nutshell which help in taking decision. (2) If common size statements of 2 or more years are compared it indicate the changing proportion of various components of Assets, Liabilities, Cost, Net Sale & Profit. (3) When Inter Firm Comparison is made with the help of Common size statement it helps in doing corporate evaluation and Ranking

DISADVANTAGES OF COMMON SIZE STATEMENT (1)No Established Standard Proportion: Common Size Statements are regarded as useless as there is no established standard proportion of an asset to the total asset or an item of expense to the net sales. (2)Consistency Required:- If Financial Statement of a Particular business organization are not prepared year after year on a consistent basis comparative study of common size statement will be misleading

TREND ANALYSIS Trend Analysis is a statement in vertical form where the earliest year is taken as base year and the value of all the items in the financial statements will be related to the base year in terms of percentage where value of each item in base year will be considered as 100. Trend percentage analysis move in one directions either upward or downward progression or regression