Comparative Statement,Common size Statement and Trend Analysis Video Lecture - Commerce

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hi there welcome to the module on
financial statement analysis in this
module we are going to cover the
following topics introduction to
financial statement analysis need for
financial analysis and we'll also look
at some of the popular techniques of
financial statement analysis financial
statements provide a great deal of
information to the users however to
enable these users to make informed
decisions statements on their own do not
always provide sufficient information
for the financial statements to become
more meaningful and useful to the users
both internal and external the financial
performance of a business has to be
evaluated not just for one year but
across time periods and also in the
context of the policies and accounting
assumptions adopted by the business such
an attempt to get a better understanding
of the present and expected future
financial health of a company is called
financial statement analysis are simply
financial analysis financial statement
analysis facilitates comparison of
financial data across years across
companies in the same industry and
provides information to support informed
decision making by the users so
financial statement analysis is
essential for the following two reasons
first reason is that it helps diagnose
profitability and financial soundness of
a business that is the financial
statements help users assess viability
stability and profitability of a firm
the second reason is that financial
statement analysis helps users reliably
forecast future performance of a
business
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financial analysis is usually done to
diagnose or assess the following
parameters of a company first
profitability of a company that is the
ability of the company to earn income
and sustain the growth both in the long
term and short term perspective second
solvency that is the ability of the
company to pay obligations to creditors
and third parties both in the short term
and long term third liquidity that is
the ability of the company to maintain
positive cash flows while meeting
immediate obligations or paying off
immediate obligations fourth stability
that is the ability to remain in
business in the long run without having
to sustain significant losses in the
day-to-day operations with the help of
financial analysis investors can
evaluate the financial condition or
performance of a company the CEO can
decide what the immediate priorities for
the future need to be managers working
in the company can monitor whether the
results achieved are in line with the
budget and market analysts can detect
potential threats to the business
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so what are some of the popular
techniques used by companies to analyze
financial statements
there are several popular techniques
adopted some of them are listed in your
screen horizontal analysis also known as
comparative statements trend analysis
vertical analysis ratio analysis fun
flow analysis and cash flow analysis now
in this module we will cover the first
four techniques fun flow and cash flow
analysis will be discussed in the
subsequent modules so the first
technique for analyzing financial
statements is what is known as
horizontal analysis this is also
popularly known as comparative
statements analysis in this technique
two or more financial statements are
placed side by side to facilitate
comparison what profit and loss account
and balance sheet can be prepared in the
form of comparative financial statements
now
the comparative profit and loss
statement on your screen shows the
profit and loss account for a
hypothetical company for two years that
is 2000 and 2001 the absolute increase
or decrease in amounts of all the line
items in the P&L account are shown you
can see that the sales is increased by
200 rupees in 2001 compared to sales of
2000 the operating profit has also
increased by 40 rupees in the year 2001
compared to the operating profit of the
year 2000 the last column in the
statement shows the percentage increase
in line items of 2001 compared to profit
and loss account in the year 2000 so by
looking at this comparative profit and
loss statement we can conclude the
following first sales and cost of goods
sold have increased by the same
percentage so gross profit as
so increased by the same percentage
point second there's no increase in
administration expenses but selling
expenses have increased by 33 percent of
one-third operating profit has increased
by twenty six point five seven percent
in the last two years the CEO has now
checked if the increase in sales and
operating profits is in line with the
expectations of the investors the
increase of one third in selling
expenses also needs to be verified and
additional controls need to be put in
place by the CEO or the top management
if these expenses are much more than
what had been originally planned for the
comparative balance sheet for asset site
of this hypothetical company is also
shown on your screen similar to profit
and loss account the balance sheet also
contains their net increase or decrease
in all line items in the balance sheet
along with the percentage increase or
decrease we can see that there's been a
huge increase in all current assets of
the company but fixed assets except
furniture have not increased or have
increased only marginally the
accountants should now highlight the
excess increase in debtors and stock to
the top management and assess whether
this increase again is in line with the
growth strategy of the company moving on
to the second technique of financial
statement analysis trend analysis trend
analysis involves making a comparative
study of financial statements over
several years the trend percentages are
calculated in relation to a base year
all line items are projected in
comparison to that base year by assuming
each line item as hundred trends are
usually tracked only for the major and
critical items in the financial
statements so that the important changes
are highlighted to the top management
now while using trend analysis the
following points should be noted
accounting policies should have been
consistently followed for the periods
being analyzed
if accounting policies change
inch remember compatibility will be
affected there has to be a careful
selection of base here this base here
should be a normal year trend analysis
should also include comparison with
absolute amounts as increase in certain
amounts might sometimes be misleading
for example and expense might increase
from 10 rupees to 30 rupees and short
when 200% increase but this amount is
not significant enough to warrant an
analysis let us now look at the trend
analysis of an IT company the absolute
amounts are mentioned in the top half of
the table and the trend ratios in the
rows below as you can see in 2006-2007
all the amounts have been taken as
hundred so 2006-2007 is considered as
the base year for calculating the trend
ratios you might notice that the revenue
has almost doubled in the four years
right and operating profit has also more
than doubled
so clearly this company has excelled not
only in increasing the sales but also in
managing the operations efficiently to
ensure that the profit increases in line
with the increase in revenue the third
technique of financial statement
analysis is what is known as vertical
analysis or common size financial
statements in this technique financial
information is converted into
percentages using some common base in
the profit and loss account the sales
figure is assumed to be the common base
and all figures are expressed as a
percentage of this total in the balance
sheet balance sheet total is assumed to
be the common base and all assets and
liabilities of the company are expressed
as a percentage of this amount since
this analysis depends on the data for
just one period this is conducive for a
thorough analysis of a company's
financial position however this
technique does not show variations in
financial items across time periods or
across several years one of the
advantages of vertical analysis is that
it is useful for star
in comparative financial position of two
or more businesses operating in the same
industry however for the intercompany
comparison to be meaningful companies
should follow the same accounting
practices and policies what you see on
your screen is the profit and loss
account of a company for two years
vertical analysis will highlight the
following points sales has been
considered as the base and all other
items have been computed as a percentage
of sales cost of goods sold for this
company is approximately 75% of the
total sales for the year administration
expenses as a percentage of sales have
decreased in year 2 compared to year 1
while selling expenses as a percentage
of sales have increased marginally
leading to increase in operating profit
percentage in year 2 compared to your 1
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you