Analysis of Financial Statements, Cost Accounting Video Lecture | Cost Accounting - B Com

you
hello students welcome to the lecture on
analysis of financial statements and
after this lecture we will be able to
learn the following objectives give
details of the concept and objectives of
financial statement analysis describe
the types of financial analysis
statement talk about the comparative
financial statements give details of the
trend analysis talk about the ratio
analysis let us start with the
introduction of analysis of financial
statements financial statement or
financial analysis is the process of
understanding the risk and profitability
of a firm business sub business or
project through analysis of reported
financial information particularly
annual and quarterly reports financial
analysis is the selection evaluation and
interpretation of financial data along
with other pertinent information to
assist in investment and financial
decision making financial analysis may
be used internally to evaluate issues
such as employee performance the
efficiency of operations and credit
policies and externally to evaluate
potential investments and the
creditworthiness of borrowers among
other things the analyst draws the
financial data needed in financial
analysis from many sources the primary
source is the data provided by the
company itself in its annual report and
required disclosures the annual report
comprises the income statement the
balance sheet and a statement of cash
flows as well as footnotes to these
statements we start the discussion first
of all what we have to ask to ourselves
is why we do need to know financial
statement analysis now the wrong reason
but this assumes that you are here
working in a bank you working as an
analyst and the bank basically asks you
on a daily basis to look at the share
price of these companies
examples look at their profitability
look at the liquidity look at their
solvency ratio and so on and so forth
forget about those sophisticated terms
what is what these boss actually are
want you to do is answer this question
so if you buy these shares of the
company or if there's company who asked
for Low's you'll be give them the loan
so this is basically the questions that
need to be answered when you know
they're talking about liquidity solvency
and so on and so forth how you can do
that a lot of ways to do that but one of
them is you look at the financial
statements and you make some sort of
analysis based on a financial statement
now financial statement analysis is
basically a small part of business
analysis so if your company probably
wants to invest in one come other
company you conduct business analysis if
you're working in the bank and the bank
wants to give loan to certain company
you conduct business analysis so
business NASA self is divided into
several you know terms with several
specific goals some people say it's it's
a credit worthiness analysis when a bank
do business analysis to us a company
that's called credit worthiness
um when there is a other company who
wants to invest in other companies
shares the core it called equity
valuations but basically this what is
similar is these two business analysis
both of them use financial statements as
their main sure's
what do they choose to use financial
statements is because financial
statements reduce a certainty and
increase confidence in concept and
objectives we know business is mainly
concerned with the financial activities
in order to ascertain the financial
status of the business every enterprise
prepares certain statements known as
financial statements financial
statements are mainly prepared for
decision making purposes but the
information as is provided in the
financial statements is not adequately
helpful in drawing a meaningful
conclusion thus an effective analysis
and interpretation of financial state
is required analysis means establishing
a meaningful relationship between
various items of the two financial
statements with each other in such a way
that a conclusion is drawn by financial
statements we mean two statements profit
and loss account or income statement
balance sheet opposition statement these
are prepared at the end of a given
period of time they are the indicators
of profitability and financial soundness
of the business concern the term
financial analysis is also known as
analysis and interpretation of financial
statements it refers to the establishing
meaningful relationship between various
items of the two financial statements
that is income statement and position
statement it determines financial
strength and weakness of the phone
analysis of financial statements is an
attempt to assess the efficiency and
performance of an enterprise thus the
analysis and interpretation of financial
statements is very essential to measure
the efficiency profitability financial
soundness and future prospects of the
business units financial analysis serves
the following purposes measuring the
profitability the main objective of a
business is to earn a satisfactory
return on the funds invested in it
financial analysis helps in ascertaining
whether adequate profits are being
earned on the capital invested in the
business or not it also helps in knowing
the capacity to pay the interest and
dividend indicating the trend of
achievements financial statements can be
compared and the trend regarding various
expenses purchases sales gross profits
and net profit etc can be ascertained
value of assets and liabilities can
compared and the future prospects of the
business can be envisaged assessing the
growth potential of the business the
trend and other analysis of the business
provides sufficient information
indicating the growth potential of the
business comparative position in
relation to other firms the purpose of
financial statements analysis is to help
the management to make a comparative
study of the profitability of various
firms engaged in similar businesses such
comparisons also help the management to
study the position of their firm in
respect of sales expenses profitability
and utilizing capital etc assess overall
financial strength the purpose of
financial analysis is to assess the
financial strength of the business
analysis also helps in taking decisions
where the funds required for the
purchase of new machines and equipments
are provided from internal sources of
the business or not if yes how much and
also to assess how much funds have been
received from external sources assess
solvency of the firm the different tools
of an analysis tell us whether the firm
has sufficient funds to meet its short
term and long term liabilities or not
types of financial statements financial
statements can be referred to as
representation of the financial status
of a company in a systematically
documented form there are different
types of financial statements financial
statements are required to be audited by
authentic efficient audit firms to avoid
manipulation of numbers statements are
usually audited by the accounting firms
after a thorough study of the company
records the accounting and the audit
firms make sure that the company is
obeying and operating as per norms laid
down by the generally accepted
accounting principles or GAAP basically
there are four different types of
financial statements the different types
of financial statements indicate the
different activities occurring in a
particular business house balance sheet
the balance sheet provides an insight
into the financial status of a company
at a particular time the balance sheet
type of financial statement is different
in comparison to the other types of
financial statements other financial
statements are prepared by taking into
account the financial help of the
company over a considerable span of time
income statements it is also known as
the PLN statement or the profit and loss
statement this statement ascertains the
profit and loss of any business this can
be again of two types single step income
statement multi-step income statement
statements of retained earnings this
financial statement denotes alterations
in these rights of equities in any
business cash flow statement this
statement highlights flow of cash over a
period of time the cash flow may be from
investment activities operations or
financing activities comparative size
income statements and balance sheets
comparative balance sheet the
comparative balance sheet shows the
different assets and liabilities of the
firm on different dates to make
comparison of balances from one day to
another the comparative balance sheet
has two columns for the data of original
balance sheets a third column is used to
show changes increase or decrease in
figures the fourth column may be added
for giving percentages of increase or
decrease
while interpreting comparative balance
sheet the interpreter is expected to
study the following aspects current
financial position and liquidity
position long-term financial position
profitability of the concern for
studying current financial position or
liquidity position of a concern
one should examine the working capital
in both the years working capital is the
excess of current assets over current
liabilities for studying the long-term
financial position of the concern one
should examine the changes in fixed
assets long-term liabilities and capital
the next aspect to be studied in a
comparative balance sheet is the
profitability of the concern the study
of increase or decrease in profit will
help the interpreter to observe whether
the profitability has improved or not
after studying various assets and
liabilities an opinion should be formed
about the financial position of the
concern Comparative income statement the
income statement provides the results of
the operations of a business this
statement traditionally is known as
trading and profit and loss account
important components of income
statements are net sales cost of goods
sold selling expenses office expenses
etc the figures of the above components
are matched with their corresponding
figures of individually and changes are
noted the comparative income statement
gives an idea about the progress of a
business over a period of time the
changes in money value and percentage
can be determined to analyze the
profitability of the business like
comparative balance sheet income
statement also has four columns the
first two columns are shown figures of
various items for two years third and
fourth columns are used to show in
is or decrease in figures in absolute
amount and percentages respectively the
analysis and interpretation of income
statement will involve the following the
increase or decrease in sales should be
compared with the increase or decrease
in cost of goods sold to study the
operating profits the increase or
decrease in net profit is calculated
that will give an idea about the overall
profitability of the concern common size
income statements and balance sheets the
common sight 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
common size balance sheet a statement
where balance sheet items are expressed
on the ratio of each asset to total
assets and the ratio of each liability
is expressed in the ratio of total
liabilities is called common size
balance sheet thus the common size
statement may be prepared in the
following way the total assets or
liabilities are taken as 100 the
individual assets are expressed as a
percentage of total assets that is 100
and different liabilities are calculated
in relation to total liabilities common
size income statement the items in
income statement can be shown as
percentages of sales to show the
relations of each item to sales trend
analysis trend analysis calculates the
percentage change for one account over a
period of time of two years or more
percentage change to calculate the
percentage change between two periods
calculate the amount of the increase or
decrease for the period by subtracting
the earlier year from the later year if
the difference is negative the change is
a decrease
and if the difference is positive it is
an increase divide the change by the
earlier years balance the result is the
percentage change calculation nodes 20
into zero is the earlier year so the
amount in the 20 into zero kilometer one
column the percent change is the
increase or decrease divided by the
earlier amount 20 into zero in this
example times hundred written as a
formula the percent changes percentage
is equal to 20 multiple by one amount
minus 20 multiplied by zero amount
multiple by hundred divided by twenty
multiple by amount if the earliest year
is zero or negative the percent
calculated will not be meaningful an
oblique M is used in the above table for
not meaningful most percents are rounded
to one decimal place unless more are
meaningful a small absolute dollar item
may have a large percentage change and
we considered misleading trend
percentages to calculate the change over
a longer period of time for example to
develop a sales trend follow the steps
below select the base year for each line
item divide the amount in each non-base
year by the amount in the base year and
multiply by 100 in the following example
20 w 7 is the base here so it's
percentages see bottom half of the
following table are all 100.0 the
percentages in the other years were
calculated by dividing each amount in a
particular year by the corresponding
amount in the base year and multiplied
by 100
calculation nodes the base year trend
person
teachers always 100.0 percent a trend
percentage of less than 100 point zero
percent means the balance has decreased
below the base year level in that
particular year a trend percentage
greater than hundred point zero percent
means the balance in that year has
increased over the base year a negative
trend percentage represents a negative
number if the base year is zero or
negative the trend percentage calculated
will not be meaningful in this example
the sales have increased fifty nine
point three percent over the five-year
period while the cost of goods sold has
increased only fifty five point nine
percent and the operating expenses have
increased only 57 point five percent the
trends look different if evaluated after
four years at the end of twenty into
zero the sales had increased almost
twenty percent but the cost of goods
sold had increased 31 percent and the
operating expenses had increased almost
41 percent these twenty into zero
trained percentages reflect an
unfavorable impact on net income because
costs increased at a faster rate than
sales the trend percentages for net
income appear to be higher because the
base year amount is much smaller than
the other balances ratio analysis the
ratio is an arithmetical relationship
between two numerals it is expressed as
a proportion or a fraction or in
percentage or in terms of number of
times for example expenses are seventy
percent of sales or sales of current
here are four times more than that of
the last year net profits are one by
tenth of the capital employed etc thus
accounting ratios are ratios formed out
of figures taken from financial
statements
these are calculated by placing two
figures taken from financial statements
in the form of ratio they are tools in
the hands of users and help the
management in taking decision
significance of ratio analysis analyzing
financial statements from various
aspects of a business through the
techniques of accounting ratios is
called ratio analysis ratio analysis is
an important technique of financial
analysis it is a means for judging the
financial health of a business
enterprise it determines and interprets
the liquidity solvency profitability etc
of a business enterprise simplification
of accounting data it becomes simple to
understand various figures in the
financial statements through the use of
different ratios for example a profit of
INR 20,000 may not sound very impressive
but if it is earned with the help of a
capital of INR 20,000 it becomes easy to
say that the profit is reasonably good
by stating that it is hundred percent of
the capital accounting ratios simplified
summarized and systematize the
accounting figures presented in
financial statements helpful and
comparative study with the help of ratio
analysis comparison of profitability and
financial soundness can be made between
one firm and another in the same
industry
similarly comparison of current year
figures can also be made with those of
with the help of ratio analysis and if
some weak points are located remedial
measures are taken to correct them focus
on trends if accounting ratios are
calculated for a number of years they
will reveal the trend of cost sales
profits and other important facts such
trends are useful for planning for
example if sales of a firm during this
year are INR 10
an average amount of stock kept during
the year is three lakh that is 30% of
sales and the firm wishes to increase
sales next year to INR five lakh it must
be ready to keep a stock of INR four
point five zero zero zero zero zero that
is 30 percent of 15 lakh selling
standards accounting ratios based on a
desired level of activities can be set
as standards for judging actual
performance of a business
for example if owners of a business aim
at earning profit at the rate of 25
percent on the capital which are the
prevailing rate of return in the
industry then this rate of 25 percent
becomes the standard the rate of profit
of each year is compared with this
standard and the actual performance of
the business can be judged easily study
of financial soundness ratio analysis
discloses the position of business with
different viewpoints it discloses the
position of business with the liquidity
viewpoints solvency viewpoint
profitability viewpoint etc with the
help of such a study we can draw
conclusions regarding the financial
health of the business enterprise
advantages and uses of ratio analysis
there are various groups of people who
are interested in analysis of financial
position of a company they use the ratio
analysis to work out a particular
financial characteristic of the company
in which they are interested ratio
analysis helps the various groups in the
following manner to work out the
profitability accounting ratio helps to
measure the profitability of the
business by calculating the various
profitability ratios it has the
management to know about the earning
capacity of the business concern in this
way profitability ratios show the actual
performance of the business
to work out the solvency with the help
of solvency ratios solvency of the
company can be measured these ratios
show the relationship between the
liabilities and assets in case external
liabilities are more than that of the
assets of the company
it shows the unsound position of the
business in this case the business has
to make it possible to repay its loans
helpful in analysis of financial
statement ratio analysis helps the
outsiders
just like creditors shareholders
debenture holders bankers to know about
the profitability and ability of the
company to pay them interest and
dividend etc helpful in comparative
analysis of the performance with the
help of ratio analysis a company may
have comparative study of its
performance in this way company comes to
know about its weak point and be able to
improve them to simplify the accounting
information accounting ratios are very
useful as they briefly summarize the
result of detailed and complicated
computations to work out the operating
efficiency ratio analysis helps to work
out the operating efficiency of the
company with the help of various
turnover ratios all turnover ratios are
worked out to evaluate the performance
of the business in utilizing the
resources to work out short term
financial position ratio analysis helps
to work out the short term financial
position of the company with the help of
liquidity ratios in case short term
financial position is not healthy
efforts are made to improve it helpful
for forecasting purposes accounting
ratios indicate the trend of the
business the trend is useful for
estimating future with the help of
ratios estimates for future can be made
in this way these ratios provide the
basis for preparing budgets and also
determine future line of action
limitations of ratio analysis in spite
of many advantages there are certain
limitations of the ratio analysis
techniques and they should be kept in
mind while using them in interpreting
financial statements the following are
the main limitations of accounting
ratios limited comparability different
firms apply different accounting
policies therefore the ratio of one firm
cannot always be compared with the ratio
of other firm some firms may value the
closing stock on LIFO basis option on
leaf o basis while some other firms may
value on FIFO basis some firms may value
the closing stock on LIFO basis while
some other firms may value on FIFO basis
similarly there may be difference in
providing depreciation of fixed assets
or certain of provision for doubtful
debts etc false results accounting
ratios are based on data drawn from
accounting records in case that data is
correct then only the ratios will be
correct for example valuation of stock
is based on very high price the profits
of the concern will be inflated and it
will indicate a wrong financial position
the data therefore must be absolutely
correct effect of price level changes
price level changes often make the
comparison of figures difficult over a
period of time changes in price affect
the cost of production sales and also
the value of assets therefore it is
necessary to make proper adjustment for
price level changes before any
comparison qualitative factors are
ignored ratio analysis is a technique of
quantitative analysis and thus ignores
qualitative factor
which may be important in
decision-making
for example average collection period
may be equal to standard credit period
some debtors may be in the list of
doubtful debts which is not disclosed by
ratio analysis effect of window dressing
Effect of window dressing in order to
cover up their bad financial position
some companies resort to window dressing
they may record the accounting data
according to the convenience to show the
financial position of the company in a
better way
costly technique ratio analysis is a
costly technique and can be used by big
business houses small business units are
not able to afford it misleading results
in the absence of absolute data the
result may be misleading for example the
gross profit of two firms is 25% whereas
the profit earned by 1 is just INR 5,000
and sayings are INR 20,000 and the
profit earned by the other one is INR 10
lakh and sales are INR 40 lakh even the
profitability of the two forms the same
but the magnitude of their business is
quite different absence of standard
university accepted terminology there
are no standard ratios which are
universally accepted for comparison
purposes as such the significance of
ratio analysis technique is reduced
summary financial statement analysis or
financial analysis is the process of
understanding the risk and profitability
of a firm business some business or
project through analysis of reported
financial information particularly
annual and quarterly reports the annual
report comprises the income statement
the balance sheet and the statement of
cash flows as well as footnotes to these
statements analysis means establishing a
meaningful relationship between various
items of the two financial statements
with each other in
such a way that a conclusion is drawn
analysis of financial statements is an
attempt to assess the efficiency and
performance of an enterprise financial
statements are documents or reports
which have been systematically
maintained to indicate the financial
health of a company in trend analysis
the trend percentages are calculated for
each item by taking the figure of that
item for the base year taken as 100 the
ratio is an arithmetical relationship
between two numerals it is expressed as
a proportion or a fraction or in
percentage or in terms of number of
times