Financial Statement Preparation and Analysis

Financial statement preparation & Analysis
And
Capital Budgeting Techniques
Presented By:
MD.SAIFUL ISLAM
SPO (Superintendent Engineer-Mechanical)
Industrial Credit Division
Rupali Bank Limited.
Contract Details:
[email protected],01717329991
Financial Statement Preparation & Analysis 1|Page

OBJECTIVES:
Upon completion of the discussion, you will be able to understand:
1. Basic concept of Financial Accounting
2. Basic Concept of IAS & IFRS;
3. Financial statements Preparation & Presentation for companies;
4. Financial statements Analysis for Companies;
5. Capital Budgeting Tools & Techniques.

TABLE OF CONTENTS:
1. Basic Concept of Financial Accounting ....................................................................... 5
1.1 Financial Accounting ..................................................................................................... 5
1.2 Accounting Standards ................................................................................................... 5
1.2.1 IAS (1973-2001) ......................................................................................................... 5
1.2.2 IFRS (2001-Onward) ................................................................................................ 6
1.3 Assumptions of Financial Reporting......................................................................... 6
1.3.1 Monetary Unit Assumption ................................................................................... 6
1.3.2 Economic Entity Assumption ............................................................................... 6
1.3.3 Time Period (Periodicity) Assumption ............................................................... 7
1.3.4 Going Concern Assumption .................................................................................. 7
1.4 Accounting Principle ...................................................................................................... 7
1.4.1 Measurement Principle ......................................................................................... 7
1.4.2 Revenue Recognition Principle (IFRS-15)........................................................ 7
1.4.3 Expense Recognition/Matching Principle ....................................................... 8
1.4.4 Accrual Basis Accounting ...................................................................................... 8
1.4.5 Cash Basis Accounting ........................................................................................... 8
1.5 Basic Accounting Equation .......................................................................................... 9
1.6 Double Entry Accounting System .............................................................................. 9
1.7 Rules for Journal Entries of Major Transactions .................................................. 9
1.8 Debiting And Crediting Of Major Business Transactions ............................... 10
1.9 Steps in The Accounting Recording Process ....................................................... 11
1.10 Adjusting Accounts .................................................................................................... 11
1.11 Framework for Adjustments .................................................................................. 12
1.11.1 Adjusting for Prepaid Expenses ........................................................................ 12
1.12 Accounting Cycle Summary ................................................................................... 13
2 Preparation of Financial Statements ............................................................................. 14
2.1 Type of financial statements ..................................................................................... 14

2.2 Users of Financial statements .................................................................................. 14
2.3 The characteristics of useful financial statement ............................................. 15
2.4 The Elements of financial statements .................................................................... 15
2.5 Comparison of Financial Statements ..................................................................... 16
2.6 Ereba Capsules Limited Financial Statement Preparation ............................ 17
3 Analysis of Financial Statements ..................................................................................... 23
3.1 Introduction ..................................................................................................................... 23
3.2 Type of Business Analysis ........................................................................................... 23
3.3 Tools and Technique for financial statement Analysis .................................... 24
3.3.1 Comparative financial statement Analysis ................................................... 24
3.3.2 Common size/Vertical financial statement Analysis .................................. 25
3.3.3 Ratio Analysis .......................................................................................................... 25
3.3.4 Cash Flow Analysis ................................................................................................ 36
3.3.5 Valuation Analysis.................................................................................................. 36
4 Capital Budgeting Tools & Techniques........................................................................... 37
4.1 What is capital investments/ Capital Budgeting ................................................. 37
4.2 Importance of capital Budgeting ............................................................................. 37
4.3 Steps of capital Budgeting ......................................................................................... 37
4.4 Time Value of Money (TVM) ....................................................................................... 37
4.5 Annuity .............................................................................................................................. 38
4.6 Cost of Capital ................................................................................................................ 38
4.7 Cost Volume and Profit Analysis .............................................................................. 38
4.8 Costing............................................................................................................................... 38
4.9 Break Even Point ........................................................................................................... 39
4.10 Summary of Capital Budgeting Techniques ..................................................... 39

1. Basic Concept of Financial Accounting
1.1 Financial Accounting
Financial accounting is the process of recording, summarizing, and reporting a
company’s business transactions through financial statements.
1.2 Accounting Standards

 International Accounting Standard Board (IASB) determined IFRS
 The Financial Accounting Standard Board (FASB) determined GAAP
IAS and IFRS are both set of accounting standards to prepare financial
statements by defining, recognizing, initial and subsequent measurement of line
items of financial statements
1.2.1 IAS (1973-2001)

 IAS 1 Presentation of Financial Statements
 IAS 2 Inventories
 IAS 7 Statement of Cash Flows (previously Cash Flow Statements)
 IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
 IAS 10 Events after the Reporting Period
 IAS 12 Income Taxes
 IAS 16 Property, Plant and Equipment
 IAS 19 Employee Benefits
 IAS 20 Government Grants and Disclosure of Government Assistance
 IAS 21 The Effects of Changes in Foreign Exchange Rates
 IAS 23 Borrowing Costs
 IAS 24 Related Party Disclosures
 IAS 26 Accounting and Reporting by Retirement Benefit Plans
 IAS 27 Separate Financial Statements
 IAS 28 Investments in Associates and Joint Ventures
 IAS 29 Financial Reporting in Hyperinflationary Economies
 IAS 32 Financial Instruments: Presentation
 IAS 33 Earnings Per Share
 IAS 34 Interim Financial Reporting
 IAS 36 Impairment of Assets
 IAS 37 Provisions, Contingent Liabilities and Contingent Assets
 IAS 38 Intangible Assets
 IAS 39 Financial Instruments: Recognition and Measurement
 IAS 40 Investment Property

 IAS 41 Agriculture
1.2.2 IFRS (2001-Onward)

 IFRS 1 First-time Adoption of IFRS
 IFRS 2 Share-based Payment
 IFRS 3 Business Combinations
 IFRS 4 Insurance Contracts
 IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
 IFRS 6 Exploration For and Evaluation of Mineral Resources
 IFRS 7 Financial Instruments: Disclosures
 IFRS 8 Operating Segments
 IFRS 9 Financial Instruments
 IFRS 10 Consolidated Financial Statements
 IFRS 11 Joint Arrangements
 IFRS 12 Disclosure of Interests in Other Entities
 IFRS 13 Fair Value Measurement
 IFRS 14 Regulatory Deferral Accounts
 IFRS 15 Revenue from Contracts with Customers
 IFRS 16 Leases
 IFRS 17 Insurance Contracts
 IFRS for SMEs
1.3 Assumptions of Financial Reporting
1.3.1 Monetary Unit Assumption

The company only record those transactions that can be expressed/measured as
monetary terms in a company's books of accounts.
Example: RBL has very talented, skilled, and passionate employees. The company
cannot record them as their assets under the monetary unit assumption.
1.3.2 Economic Entity Assumption

The corporations having separate legal entity under action of lawing and having
ownership divided into transferrable shares. An entity is something that has its

own distinct and independent existence. So, if we add on economic, it would be
something that is independent in all aspects, .
1.3.3 Time Period (Periodicity) Assumption

An organization can report its financial results within certain designated periods
of time. Example
1.3.4 Going Concern Assumption

An entity will remain in Operation for the foreseeable future.
1.4 Accounting Principle

1.4.1 Measurement Principle
As per conceptual frame works of IFRS asset measured in
1. Historical cost ( price paid for the asset at the time of its acquisition)
2. Current Cost (FV, Value in Use), FV is the price that would be received to
sell an asset in an orderly transaction between market participants at the
measurement date.
1.4.2 Revenue Recognition Principle (IFRS-15)

Companies recognize revenue in the accounting period in which the performance
obligation is satisfied.
Requires that revenue be recorded WHEN EARNED, not before and not after. The
goal is to have the revenue reported in the time period when it is earned. Revenue
is recognized on the books of a company when two criteria are met: The earnings
process is substantially complete. Cash has either been collected or the
collectability is reasonably assured.

1.4.3 Expense Recognition/Matching Principle
Expenses(efforts) be matched with revenues(results).Thus, expenses follow
revenues.
The concept that ALL costs and expenses that are incurred to generate revenues
must be recognized in the same period as the revenues. It is the accounting
principle that requires that the expenses incurred during a period be recorded in
the same period in which the related revenues are earned.
1.4.4 Accrual Basis Accounting

Record revenues and expenses when they accrue, regardless of the actual receipt
or payment of the amount.
Revenue recognition. A company sells Tk.10,000 to its customer in May, which

pays the invoice in July. Under the cash basis, the seller recognizes the sale in July,
when the cash is received. Under the accrual basis, the seller recognizes the sale
in May, when it issues the invoice.
Expense recognition. A company buys $500 of office supplies in May, which it

pays for in June. Under the cash basis, the buyer recognizes the purchase in June,
when it pays the bill. Under the accrual basis, the buyer recognizes the purchase
in May, when it receives the supplier's invoice.
1.4.5 Cash Basis Accounting

Recognizes revenues when cash is received and records expenses when cash is
paid. Up until now, we have focused on cash basis accounting, which is used for
some small businesses where the difference would be immaterial for tax
purposes, but is not GAAP. Cash basis is not consistent with GAAP.Is useful for
several business decisions-which are the reason companies must report a
Statement of Cash Flows.

1.5 Basic Accounting Equation
The Fundamental Accounting Equation also known as the Balance Sheet
Equation) through which transactions are measured equates
1.6 Double Entry Accounting System

It states that every financial transaction has equal and opposite effects in at least
two different accounts. It is used to satisfy the accounting equation:
Assets=Liabilities+ Equity
Assets= Liabilities+(Ordinary Share Capital/Equity+ Revenue-Expense-Dividend)
A = L+E+R-E-D
D+E+A (Normal Balance is Debit) = L+E+R ( Normal Balance is Credit)
1.7 Rules for Journal Entries of Major Transactions

D+E+A = L+E+R
+Debit - Credit +Credit -Debit
D Dividend L Liability
E Expense E Expense
A Asset R Revenue
+Debit -Credit +Credit -Debit

1.8 Debiting And Crediting Of Major Business Transactions
Transactions Account Titles L.F Debit Credit
Starting of Business Cash **
with/Investment of Cash Fixed Asset (If any) ** ***
and Fixed Asset(s) in the Owner’s Capital
Business 1
Purchase ***
Purchase of Goods/Assets Cash (If for cash) **
(If for resale/stock) Accounts Payable (If on credit) **
Notes Payable (If on notes payable) 2 **
Purchase of Assets (If for use in the Asset ***
business) Cash (If for cash) **
Accounts Payable (If on credit) **
Notes Payable (If on notes **
payable) 3
Return of Goods Purchased Cash (If cash received) **
Accounts Payable (If purchased on credit) **
Purchase Return 4 ***
Payment of Accounts Payable/to Accounts Payable ***
Creditor/for credit Purchase or Cash (If in cash) **
Service Bank (If by cheque) **
Receipts 5
Incurrence of Expenses (e.g. rent, Expense ***
salaries, advertising, etc.) [If for Cash (If in cash) **
current accounting period Accounts Payable (If on **
only] credit/account) 6
Cash Payment for Expenses (e.g,. Prepaid Expense **
rent, insurance, etc.) [If for more Cash **
than accounting period] 7
Sale of Goods/Providing of Services Cash (If for cash) **
Accounts Receivable (If on credit) **
Notes Receivable (If on notes) **
Sales/Service Revenue 8 ***
Return of Goods Sold on Sales Return **
Credit Accounts Receivable 9 **
Sale of Coupon (lottery) Books for Cash **
Cash/ Cash Receipts in Advance for Unearned Revenue **
Future Services 10
Opening of Current Bank **
Account/Deposit Cash into Cash **
Bank 11
Cash Withdrawal from Cash **
Bank for Business Use Bank 12 **
Interest Credited by Bank Bank **
Interest Revenue 13 **
Payment of Expense (e.g,. Expense (e.g,. rent, interest, etc.) **
rent, interest, etc.) by Cheque Bank 14 **
Discount Allowed Discount Expense (Expense Increase) **
Accounts Receivable (Asset Decrease) 15 **
Discount Received Accounts Payable (Liability Decrease) 16 **
Financial Statement Preparation & Analysis 10 | P a g e

Discount Revenue **
Depreciation on Plant Depreciation Expense **
Asset Accumulated Depreciation 17 **
Withdrawal of Cash/ Drawing **
Purchase of Asset for Cash **
Personal or Private Use 18
Withdrawal of Goods by Drawing **
Owners from Business Purchase/Inventory 19 **
Borrowing from Bank on Cash **
Notes Payable Notes Payable 20 **
Lost or Stolen Money of Miscellaneous Expense **
Business Cash 21 **
Destroyed or Stolen of Accidental Loss **
Goods of Business Purchase/Inventory 22 **
Issued Shares of Capital Cash **
Stock to Capital Stock **
Shareholders/Owners of
Company 23
Operating VAT Current VAT **
Account Cash 24 **
1.9 Steps in The Accounting Recording Process
1.10 Adjusting Accounts

Adjusting Entry-is recorded to bring an asset or liability account balance to its
proper amount; it also updates a related expense or revenue account.

1.11Framework for Adjustments
1.11.1 Adjusting for Prepaid Expenses
1.11.1.1 Prepaid Insurance {Adjustment (a)}

EXAMPLE: On December 1, we have to make a journal entry to recognize the cash
paid out. Since we still OWN the cash, our total assets should not drop. We need to
reclassify the cash paid to a Prepaid Expense as follows:
December 1 Prepaid Insurance 12,000
Cash 12,000
Paid a 6 month insurance policy in advance.
At the end of the year (Dec. 31), 1 of the 6 months of the insurance policy has been
used. Therefore the insurance company has earned 2/6 of the policy premium, or
$2,000. So we need to recognize an expense for the portion expired and decrease
our asset (prepaid) as follows:
December 31 Insurance Expense 2,000
Prepaid Insurance 2,000
To adjust & record insurance expense for 1 month.

1.12 Accounting Cycle Summary
 Accounting cycle-refers to the steps in preparing financial statements.

 It is called a "cycle" because the steps are repeated each reporting period.
 This following is a schematic of the entire accounting process. Some of the
steps, like the preparation of reversing entries have been omitted from this
course because they are optional.

2 Preparation of Financial Statements
2.1 Type of financial statements
According to IAS 1 a complete set of financial statements are:
 A statement of financial position (Balance Sheet)
 A statement of profit or loss and other comprehensive income (Income
statement)
 A statement of changes in equity
 A statement of cash flows
 A accounting policies and explanatory notes.
2.2 Users of Financial statements
Creditors and lenders: Should a loan be granted to the company? Will the
company be able to pay its debts as they become due? They are interested in the
liquidity position, solvency position – short-term as well as long-term and
profitability position of the company.

2.3 The characteristics of useful financial statement
Fundamental characteristics
 Relevant (Material)
 Faithful representation (Complete, Neutral, free from error)
When preparing financial reports, preparers should exercise prudence.
Prudence means that assets and income are not overstated and liabilities
and expenses are not understated.
Enhancing characteristics
 Comparability (year-on-year, and one company to another company.
 Timeliness – older information is less useful.
 Verifiability
 Understandability –presented as clearly and concisely as possible.
2.4 The Elements of financial statements

 statements of financial position report assets, liabilities and equity.
 statements of financial performance report income and expenses.
Economic Asset A present economic resource controlled by an entity as

Resource a result of a past event.
Economic Claim Liability A present obligation of the entity to transfer an
economic resource as a result of a past event.
Equity The residual interest in the net assets of an entity.
Changes in Income Increases in assets or decreases in liabilities that result
economic in an increase to equity (excluding contributions from
resources and claims equity holders).
as a Expenses Decreases in assets or increases in liabilities that result
result of financial in decreases to equity (excluding distributions to equity
performance holders).
Other changes in Contributions from, and distributions to, equity holders.
economic resources Exchanges of assets and liabilities that do not increase
and or decrease equity.
claims
An economic resource is a ‘right that has the potential to produce economic
benefits.

2.5 Comparison of Financial Statements

2.6 Ereba Capsules Limited Financial Statement
Preparation
Beacon Group is Largest Pharmaceuticals Manufacturer in Bangladesh. Ereba
Capsules is one of the sister concern of Beacon Group. Ereba Capsules Limited
intent to install a capsule shell manufacturing project at Valuka, Mymensing.
Here is the Transactions for installing that project.
Transaction-1:
The company invests Tk.100 Core cash in the company.
Journal Entry:
Cash-Dr-100
Share Capital-Cr-100
Transaction-2:
Company purchases PPE Costing Tk.50 Crore by taking Bank Loan.
Journal Entry:
PPE-Dr-50
Bank Loan-Cr-50
Transaction-3:
On October 2, 20XX Company receives Tk.12 Crore cash from his client to provide
the product by December 31,20XX.
Journal Entry:
Cash-Dr-12
Unearned Revenue (Liability)-Cr-12
Transaction-4:
The company pay office rent in Cash Tk. 9 Crore.
Journal Entry:
Rent Expense-Dr-9
Cash-Cr-9
Transaction-5:
On October 4, 20XX Company pays Tk. 6 Crore for one year insurance policy that
will expire next year on September 30.
Journal Entry:
Prepaid Insurance-Dr-6
Cash-Cr-6
Transaction-6:
Company purchases office supplies Costing Tk.25 Crore on Account.
Journal Entry:

Office Supplies-Dr-25
Account Payable-Cr-25
Transaction-7:
Company declares and pays Tk. 5 Core cash dividend to share holders.
Journal Entry:
Dividend-Dr-5
Cash-Cr-5
Transaction-8:
On October 26 company owes employees salaries of Tk.40 Core and pays them in
cash.
Journal Entry:
Salary & Wage Expense-Dr-40

Cash-Cr-40
Transaction-9:
Company receives Tk. 100 crore in cash from x company delivering the capsule
shell.
Journal Entry:
Cash-Dr-100
Revenue-Cr-100
Step-1: General Journal
ID Account Titles Debit Credit
1 Cash-Dr 100
Share Capital-Cr 100
2 PPE-Dr 50
Bank Loan-Cr 50
3 Cash-Dr 12
Unearned Revenue (Liability) 12
4 Rent Expense-Dr 9
Cash-Cr 9
5 Prepaid Insurance-Dr 6
Cash-Cr 6
6 Office Supplies-Dr 25
Account Payable-Cr 25
7 Dividend-Dr 5
Cash-Cr 5
8 Salary & Wage Expense-Dr 40
Cash-Cr 40
9 Cash-Dr 100
Revenue-Cr 100

Step-2: General Ledger
Cash
ID Debit Credit Balance
1 100 100
3 12 112
4 9 103
5 6 97
7 5 92
8 40 52
9 100 152
Office Supplies
6 25 25
Prepaid Insurance
5 6 6
[
PPE
2 50 50
Bank Loan
2 50 50
[
Accounts Payable
6 25 25
Unearned Service Revenue
3
[[
12 12
Share Capital-Ordinary
1 100 100
Dividends
7 5 5
[
Service Revenue
9 100 100
Salaries and Wage Expense
7 4 4
Rent Expense
7 4 4
Step-3: Unadjusted Trial Balance
EREBA Capsules Limited

Unadjusted Trial Balance
October 31, 20XX
Debit Credit
Cash 152
Supplies 25
Prepaid Insurance 6
PPE 50
Bank Loan 50
Account Payable 25
Unearned Revenue 12
Share Capital-Ordinary 100
Dividends 5
Service Revenue 100
Salary & Wage Expense 40
Rent Expense 9
Total 287 287
Step-4: Unadjusted Trial Balance
[
EREBA Capsules Limited

adjusted Trial Balance
October 31, 20XX
Debit Credit
Cash 152
Account Receivable 2
Supplies 10
Prepaid Insurance 5.5
PPE 50
Accumulated Depreciation 0.4
Bank Loan 50
Account Payable 25
Interest Payable 0.5
Unearned Revenue 8
Salary & Wage Payable 12
Retained Earnings 0
Dividends 5
Service Revenue 106
Salary & Wage Expense 52
Supplies Expense 15
Rent Expense 9
Insurance Expense 0.5
Interest Expense 0.5
Depreciation Expense 0.4
Total 301.9 301.9

Step-5: Financial Statements Preparation
EREBA Capsules Limited EREBA Capsules Limited
adjusted Trial Balance SOFP/ Income Statement
October 31, 20XX For the Month October 31, 20XX
Debit Credit Revenue 106
Cash 152
Account Receivable 2 Expenses
Supplies 10 Salary & Wage Expense 52
Prepaid Insurance 5.5 Supplies Expense 15
PPE 50 Rent Expense 9
Accumulated Depreciation 0.4 Insurance Expense 0.5
Bank Loan 50 Interest Expense 0.5
Account Payable 25
Interest Payable 0.5 Depreciation Expense 0.4
Unearned Revenue 8 Total Expenses 77.4
Salary & Wage Payable 12 Net Income 28.6
Retained Earnings 0
Dividends 5 EREBA Capsules Limited
Service Revenue 106 Retained Earnings Statement
Salary & Wage Expense 52 For the Month October 31, 20XX
Supplies Expense 15 Retained Earnings October 1 0
Rent Expense 9
Insurance Expense 0.5 Add: Net Income 28.6
Interest Expense 0.5 28.6
Depreciation Expense 0.4 Less: Dividends .5
Total 301.9 301.9 Retained Earnings October 30 23.6

Financial Statements Preparation EREBA Capsules Limited
EREBA Capsules Limited SOFP/ Balance Sheet
adjusted Trial Balance October 31, 20XX
October 31, 20XX Assets
Debit Credit PPE 50
Cash 152
Less Accumulated Depreciation .4 49.6
Account Receivable 2
Supplies 10 Cash 152
Prepaid Insurance 5.5 Account Receivable 2
PPE 50 Supplies 10
Accumulated Depreciation 0.4 Prepaid Insurance 5.5
Bank Loan 50 Total Assets
Account Payable 25
219.1
Equity and Liabilities
Interest Payable 0.5
Equity
Unearned Revenue 8
Salary & Wage Payable 12 Share Capital-Ordinary 100
Share Capital-Ordinary 100 Retained Earnings 23.6 123.6
Retained Earnings 0 Liabilities
Dividends 5
Bank Loan 50
Service Revenue 106
Salary & Wage Expense 52 Account Payable 25
Supplies Expense 15 Interest Payable 0.5
Rent Expense 9 Unearned Revenue 8
Insurance Expense 0.5 Salary & Wage Payable
Interest Expense 0.5
12 95.5
Depreciation Expense 0.4 Total Equity and Liabilities 219.1
Total 301.9 301.9
Retained Earnings October 30 from Retained Earning

Statement.

3 Analysis of Financial Statements
3.1 Introduction
Financial statement analysis is a part of business analysis. Here is the component
process of business analysis:
3.2 Type of Business Analysis

There are two major type of business analysis:
 Credit Analysis (Credit analysis is the evaluation of the credit worthiness of

a company. Credit worthiness is the ability of a company to repay interest
and principal to its lender. Main focus of the credit analysis is on risk not
profitability. This include both analysis of liquidity and solvency.
Liquidity- Ability to raise cash in the short term to meet its obligations.
Liquidity depends on a company s cash flows and the makeup of its current
asset and current Liabilities.
Solvency- A company s long run viability and ability to pay long-term
obligations. It depends on both a company s long-term profitability and
capital structure.
 Equity Analysis (Technical & Fundamental analysis)

3.3 Tools and Technique for financial statement Analysis
3.3.1 Comparative financial statement Analysis
Comparative financial statements are comparing financial data from two or more
accounting periods. There are two types of comparative statements which are as
follows
1. Comparative income statement

2. Comparative balance sheet
3.3.2 Common size/Vertical financial statement Analysis
3.3.3 Ratio Analysis

Ratio analysis is a quantitative method of gaining insight into a company's
Profitability, Leverage, Efficiency, Liquidity and Valuation. It helps simplify
complex figures and establish relationships.
As per ICRR Guidelines a bank officer must calculate the following six ratios for
understanding the financial risk of a business. Quantitative indicators in ICRR
fall into six broad categories: leverage, liquidity, profitability, coverage,
operational efficiency, and earning quality. Details indicators under these
categories and associated weights are furnished below
Quantitative Indicators Weight Definiti

on
a) Debt to Total Interest-Bearing Liabilities
Tangible Net 7 or
1. Leverage (10%) Worth (DTN) Financial Debt/Total
Tangible NetWorth

b) Debt to Total Total Interest-Bearing
3
Assets(DTA) Liabilities or Financial
Debt/Total Assets
a) Current Ratio 7 Current Assets/Current
2. Liquidity (10%) (CR) Liabilities
Cash and Easily
b) Cash Ratio (Cash) 3
Marketable
Securities/Current
Liabilities
3.Profitability a) Net Profit Margin 5 Net Profit after Tax/Net Sales
(10%) (NPM)
b) Return on Assets 3 Net Profit after Tax/Total Assets
(ROA)
c) Operating Profit Operating Profit/Average
2
to Operating OperatingAssets
Assets (OPOA)
Earnings Before
4. Coverage (15%) a) Interest Coverage 3
Interest and
(IC)
Tax/Interest Expense
b) Debt Service Earnings Before Interest Tax
Coverage Ratio 5 Depreciation
(DSCR) Amortization/Debts to be
Serviced
c) Operating Cash
Flow to Financial 4 Operating Cash Flow/Financial
Debt Ratio Debt
(OCDR)
d) Cash Flow Cash Flow from
3
Coverage Ratio Operation/Debts to beServiced
(CCR)
5.Operation a) Stock (Total Inventory/Cost of
4
al Turnover Days GoodsSold)*360
Efficiency (STD)
(10%) b) Trade Debtor 3 (Total Accounts
Collection
Receivable/Sales)*360
Days (TDCD)
c) Asset Turnover 3 Sales/Total Assets
(AT)
a) Operating Cash
3 Operating Cash Flow/Sales
6.Earning Flow to Sales
Quality(5%) (OCFS)
b) Cash Flow
NI-(CFO+CFI)/Average Net
based Accrual 2
OperatingAssets
Ratio (CFAR)

3.3.3.1 Leverage
Leverage is defined as use (something) to maximum advantage. When we use
borrowed capital for (an investment), expecting the profits made to be greater
than the interest payable. These ratios provide an indication of how the company’s
assets and business operations are financed (using debt or equity). Having high
leverage in a firm’s capital structure can be risky, but it also provides benefits.
We Know that, Re=Ru+(Ru-Rd)*D/E So leverage enables gain vice versa losses
also magnified.
3.3.3.1.1How the firm establish capital structure/taking loan

Parameters Measurement D/E
Tangibility PPE/TA- High High
Uncertainty of Income High Low
Profitability(ROCE) (EBIT/CE), High High(Trade of Theory)
Low (Pecking Order Theory)
Growth ROE*RR- High High
Tax High High
3.3.3.1.2 Trade of Theory
Static Trade-off theory that an optimal capital structure can be attained at the
trade-off point between interest tax shield and financial distress cost. This
theory implies that debt financing is preferred till the optimal level and equity is
preferred after the optimal level. But it says that certain level of gearing Ke will
increase in non-linear manner. Kd also will increase (instead of staying constant).
For high level of gearing entity will have
 High bankruptcy risk and associated cost

 High agency risk and associated cost (bank will monitor closely)
 Entity will not get tax savings on debt interest (tax exhaustion)
So owing to high risk
 Ke increases in non-linear manner

 Kd starts to increase instead of staying constant
 As a results WACC will keep increasing with further increase in gearing.
 The gearing that offers the lowest WACC is the optimal gearing.

1. Debt to Tangible NetWorth (DTN)
Over view:
It indicates the percentage of Tangible assets that are being financed with debt. The
higher the ratio, the greater the degree of leverage and financial risk. This ratio is
commonly used by creditors to determine the amount of debt in a company, the
ability to repay its debt, and whether additional loans will be extended to the
company. On the other hand, investors use the ratio to make sure the company is
solvent, have the ability to meet current and future obligations, and can generate a
return on their investment.
Formula
Total Interest-Bearing Liabilities or Financial Debt/Total Tangible NetWorth
Debt to Tangible Net Worth = Total Debt ÷ Tangible Net Worth
Interpretation
If a company’s debt to tangible net worth exceeds 1.0x, that would be viewed as a
potential red flag and a cause for concern to lenders in terms of the perceived
credit risk.
2. Debt to Total Assets (DTA)
Overview
The debt ratio, also known as the debt-to-asset ratio, is a leverage ratio that
indicates the percentage of assets that are being financed with debt. The higher the
ratio, the greater the degree of leverage and financial risk.
The debt ratio is commonly used by creditors to determine the amount of debt in a
company, the ability to repay its debt, and whether additional loans will be
extended to the company. On the other hand, investors use the ratio to make sure

the company is solvent, have the ability to meet current and future obligations, and
can generate a return on their investment.
Formula
Debt to Asset = Total Interest-Bearing Liabilities orFinancial Debt/Total Assets
Interpretation
A ratio equal to one (=1) means that the company owns the same amount of liabilities
asits assets. It indicates that the company is highly leveraged.
A ratio greater than one (>1) means the company owns more liabilities than it does
assets. It indicates that the company is extremely leveraged and highly risky to invest in
or lend to.
3.3.3.2 Liquidity
Liquidity ratios are used by financial analysts to evaluate the financial soundness
of a company. These ratios measure a company’s ability to repay both short-term
and long-term debt obligations. Liquidity ratios are often used to determine the
riskiness of a firm to decide whether to extend creditto the firm.
1. Current Ratio (CR)
Overview
The current ratio, otherwise known as the working capital ratio, measures the
ability of a business to meet its short-term obligations that are due within a year.
The current ratio looks at how a company can maximize the liquidity of its current
assets to settle its debt obligations.
Formula
Current Ratio = Current Assets/Current Liabilities
Interpretation
Typically, a current ratio greater than 1 suggests financial well-being for a
company. However, too high of a current ratio also suggests that the company is
leaving too much excess cash unused, rather than investing the cash into projects
for company growth.
2. Cash Ratio (Cash)
Overview

The cash ratio, sometimes referred to as the cash asset ratio, measures a
company’s ability to pay off its short-term debt obligations with cash and cash
equivalents. Compared to the current ratio and the quick ratio, the cash ratio is a
stricter, more conservative measure because only cash and cash equivalents – a
company’s most liquid assets – are considered.
Cash equivalents are assets that can be converted quickly into cash and are
subject to minimal levels of risk. Examples of cash equivalents include savings
accounts, treasury bills, and money market instruments.
Formula
Cash Ratio= Cash and Easily Marketable Securities/Current Liabilities
Interpretation
Creditors prefer a higher crash ratio as it indicates the company can easily pay off
its debt. There is no ideal figure but a ratio between 0.5 to 1 is usually preferred. As
with the current and quick ratios, too high of a cash ratio indicates that the company
is holding onto too much cash instead of utilizing its excess cash to invest in
generating returns or growth.
3.3.3.3 Profitability
Profitability ratios are financial metrics used by analysts and investors to
measure and evaluate the ability of a company to generate income (profit)
relative to revenue, balance sheet assets, operating costs, and shareholders’
equity during a specific period of time. They show how well a company utilizes its
assets to produce profit and value to shareholders.
1. Net Profit Margin
Overview
Net profit margin (also known as “profit margin” or “net profit margin ratio”) is a
financial ratio used to calculate the percentage of profit a company produces from
its total revenue. It measures the amount of net profit a company obtains per
dollar of revenue gained.
The net profit margin is equal to net profit (also known as net income) divided by
total revenue, expressed as a percentage.
Formula
Net Profit Margin= Net Profit after Tax/Net Sales

Interpretation
10% profit margin means for each $1 of revenue the company earns $0.10 in net
profit. Companies can increase their net margin by increasing revenues, such as through
selling more goods or services or by increasing prices .Companies can increase their net
margin by reducing costs (e.g., finding cheaper sources for raw materials).
2. Return on Assets
Overview
Return on assets (ROA) is a type of profitability ratio that measures the profitability
of a business in relation to its total assets. This ratio indicates how well a company
is performing by comparing the profit (net income) it’s generating to the total capital
it has invested in assets. The higher the return, the more productive and efficient the
management is in utilizing economic resources. Below is a breakdown of the ROA
formula.
Formula
ROA = Net Profit after Tax/Total Assets
Interpretation
Different industries have different ROAs. Industries that are capital-intensive and
require a high value of fixed assets for operations will generally have a lower ROA,
as their large asset base will increase the denominator of the formula. However, a
company with a large asset base can have a large ROA, if their income is high
enough, it is all relative.
3. Operating Profit to Operating Assets (OPOA)
Overview
It shows the profit from day-to-day operating assets such as fixed assets,
inventory, cash, and accounts receivable.
Formula
Operating Profit to Operating Assets (OPOA) = Operating Profit/Average
OperatingAssets
Interpretation

The higher the return, the better it is for the company. Operating assets include
cash, accounts receivable, inventory, and fixed assets that contribute to everyday
operations.
3.3.3.4 Coverage Ratio

A coverage ratio, broadly, is a measure of a company's ability to service its debt
and meet its financial obligations.
1. Interest Coverage (IC)
Overview
It is used to determine how well a company can pay the interest on its outstanding
debts. The ICR is commonly used by lenders, creditors, and investors to determine
the riskiness of lending capital to a company. The interest coverage ratio is also
called the “times interest earned” ratio.
Formula
Interest Coverage (IC) = EBIT/Interest Expense
Interpretation
A high ratio indicates that a company can pay for its interest expense several
times over, while a low ratio is a strong indicator that a company may default on
its loan payments.
2. Debt Service Coverage Ratio (DSCR)
Overview
The debt-service coverage ratio (DSCR) is a measure of the cash flow available to
pay current debt obligations. It assess an entity's ability to generate enough cash
to cover its debt service obligations. These obligations include interest, principal,
and lease payments.
Formula
DSCR = EBITDA/Debts to beServiced
Interpretation
A DSCR calculation greater than 1.0 indicates there is barely enough operating
income to cover annual debt obligations, while a calculation less than one
indicates potential solvency problems.

3. Operating Cash Flow to Financial Debt Ratio (OCDR)
Overview
The Operating Cash to Financial Debt Ratio measures the percentage of a
company’s total debt that is covered by its operating cash flow for a given
accounting period. The operating cash flow refers to the cash that a company
generates through its core operating activities.
Formula
Operating Cash Flow to Financial Debt Ratio (OCDR) = Operating Cash
Flow/Financial Debt
Interpretation
A high ratio indicates a company likely has a lower probability of defaulting on its
loans, making it a safer investment opportunity for debt providers. Conversely, a
low ratio indicates the company has a higher chance of defaulting, as it has less
cash available to dedicate to debt repayment.
4. Cash Flow Coverage Ratio (CCR)
Overview
The cash flow coverage ratio is a liquidity formula that shows the relationship
between a company’s total debt and operating cash flow. In other words, it
shows how well a company can pay its debts using cash from operations.
Formula
Cash Flow Coverage Ratio (CCR)= Cash Flow from Operation/Debts to beServiced
Interpretation
The ideal ratio is anything above 1.0. However, the types of debt payments
involved in the computation should also be taken into account. This is especially
true if the company’s debt for the studied period is extraordinarily large.
Conversely, a ratio lower than 1.0 shows that the business is generating less
money than it needs to cover its liabilities and that refinancing or restructuring
its operations could be an option to increase cash flow.
3.3.3.5 Operational Efficiency

Efficiency ratios are used to measure how well a company is utilizing its assets
and resources. These ratios generally examine how many times a business can

accomplish a metric within a certain period of time, or how long it takes for a
business to fulfill segments of its operations.
1. Inventory Turnover Days
Overview
Inventory Turnover Days are the number of days on average it takes to sell a
stock of inventory. This formula is derived using the previously mentioned
inventory turnover ratio. Like the inventory turnover ratio, inventory turnover
days is a measure of a business’ efficiency.
Formula
(Inventory Turnover Days = Total Inventory/Cost of GoodsSold)*360
Interpretation
As with the inventory turnover ratio, this number should be compared to industry
averages to see how efficient the company is in converting inventory into sales
versus its competitors.
2. Accounts Receivable Days/ trade Debtor Collection Days (TDCD)
Overview
Accounts receivable days are the number of days on average that it takes a
company to collect on credit sales from its customers. This formula is derived by
using the previously mentioned accounts receivable turnover ratio.
Formula
Accounts Receivable Days = (Total Accounts Receivable/Sales)*360
Interpretation
TDCD compared to industry averages to see how efficient the company is in
collecting payments versus its competitors.
3. Asset Turnover Ratio
Overview
The asset turnover ratio, also known as the total asset turnover ratio, measures
how efficient a company uses its assets to generate sales. This ratio looks at how
many dollars in sales is generatedper dollar of total assets that the company owns.

Formula
ATR = Sales/Total Assets
Interpretation
A higher ratio is generally favorable as it indicates efficient use of assets.
Conversely, a low ratio may imply poor utilization of assets, poor collection
methods, or poor inventory management.
3.3.3.6 Earning Quality

1. Operating Cash Flow toSales (OCFS)
Overview
It shows the ability of a company to turn its sales into cash. It is expressed as a
percentage. Ideally there should be a parallel increase in operating cash flows
with the increase in sales. It will be worrisome if the changes in cash flows are
not parallel to the changes in sales revenue. If the cash flows do not increase with
the increase in sales it may indicate the following two factors:
The change in terms of sales
Inefficient or ineffective management of trade receivables
Formula
Operating Cash Flow toSales (OCFS)= Operating Cash Flow/Sales
Interpretation
The higher this ratio is the better it is for the company. Greater amounts of
operating cash flows are always desirable. Although there is not any standard
guideline for this ratio but a consistent and/or increasing trend in this ratio is a
positive indication of good debtor’s management. Companies with such a trend in
this ratio are good investment opportunities.
b) Cash Flow based Accrual Ratio (CFAR)
Overview
This accrual ratio examines the company’s net income less its cash flows from
investing and operating activities, and it compares this number with the average
“net operating assets” over a particular time period.

The cash flow accrual ratio ( CFAR ) measures free cash flow compared to debt
over the next 5-year period.
Formula
Cash Flow based Accrual Ratio (CFAR)= NI-(CFO+CFI)/Average Net OperatingAssets
Interpretation
Companies with strongly negative accruals ratios (cash flow that exceeds
earnings) are consistent winners.” Once you can calculate this ratio, you can start
choosing “winning” investments.
3.3.4 Cash Flow Analysis
3.3.5 Valuation Analysis

To estimate the intrinsic value of stock. The basis of valuation is present value
theory.
1. Present Value (PV) = Future Value (FV)/(1+i)^n for single individual return.
2. V=D+E
3. VL= Vu = EBIT/ Ke ( No Tax)
4. VL = Vu +D* Tc= PBIT*(1-Tc)/Ku + D*Kd*Tc/Kd
5. PV = CFt /K(Perpetuity)
6. PV = CFt /(K-G)(Perpetuity With growth)
7. PV= A * ( 1-(1+i)^-n)/r

4 Capital Budgeting Tools & Techniques
4.1 What is capital investments/ Capital Budgeting
Capital Budgeting is a process of identifying, analyzing, selecting investment projects
whose returns (inflows) are expected to more than year.
4.2 Importance of capital Budgeting

1. Long term investment
2. Return/benefits are expected more than a year
3. Investment involves huge amount of cash flows
4. Investment decision is generally irreversible
5. Providing high degree of risk.
4.3 Steps of capital Budgeting

1. Determination of cash outflow/investment
2. Determination of future expected cash inflow
3. Figure it out the appropriate discount rate
4. Investment decision is generally irreversible
5. Providing high degree of risk.
4.4 Time Value of Money (TVM)

The time value of money (TVM) is the concept that a sum of money is worth more
now than the same sum will be at a future date due to its earnings potential in the
interim. In simpler terms, it would be safe to say that a dollar was worth more
yesterday than today and a dollar today is worth more than a dollar tomorrow,
Simply Present Value is greater than Future Value because:
1. Rate of Inflation (RI)

2. The time the funds are committed (Required Return)
3. Uncertainty of future cash flows/benefits (Risk Premium)
Example:
Time Line Diagram:
Y-0 Y-1 Y-2 Y-3

10% 10% 10% 10%
100 110 121 133
100*(1+.1)^1 = 110
PV*(1+i)^1 = FV
So, PV = FV/(1+i)^n

FV=Future value
PV=Present value (original amount of money)
i=Interest rate per period
n=Number of periods.
4.5 Annuity
An annuity is a series of payments made at equal intervals. Examples of annuities
are regular deposits to a savings account, monthly home mortgage payments,
monthly insurance payments and pension payments. Annuities can be classified
by the frequency of payment dates. The payments (deposits) may be made weekly,
monthly, quarterly, yearly, or at any other regular interval of time.
The present value of an annuity, PV = P×(1−(1+r)-n) / r

The future value of an annuity, FV = P×((1+r)n−1) / r
4.6 Cost of Capital
Cost of Capital is the minimum return that the entity must earn to satisfy the
suppliers of capital.
Wacc = Ke *We + Kd*Wd + Kp*Wp

Ke = Ku+(Ku-Kd)*D/E*(1-Tc)
4.7 Cost Volume and Profit Analysis
1. Manufacturing and Non-Manufacturing cost
Manufacturing cost (direct materials, direct labor and factory overhead) and
nonmanufacturing cost or commercial cost (administrative and marketing cost).
2. Manufacturing overhead
All manufacturing costs except direct materials, direct labor. Variable
manufacturing overhead-In direct materials, Indirect labor, Utility.Fixed
manufacturing overhead-Depreciation, Insurance, rent & Tax.
3. Cost in relation to activity

Variable cost, fixed cost and mixed cost
4. Costs classification based on financial statements

(a)Income statement – Cost of goods manufactured and cost of goods sold.
(b)Balance sheet – Raw materials, work-in-process and finished goods inventory.
4.8 Costing
1. Absorption costing

All Manufacturing costs considered as product cost(DM,DL,V.Mfgo,F.Mfgo).
2. Variable costing
All costs that are involving or making a product considered as product cost(DM,
DL, V.Mfgo,).
4.9 Break Even Point

1. Profit = Sales-cost = SPPU*Q – (VC+FC)
At BEP, Profit = 0
Q = FC/(SPPU+VCPU) = FC/CM = (FC+TP)/ CM
2. Profit = Sales-cost = SPPU*Q – (VC+FC) = (SPPU – VCPU) – FC = CM -FC =

CM/Sales * Sales – FC
At BEP, Profit = 0 , Sales(Tk.) = FC/( CMR or P/V Ratio)
4.10 Summary of Capital Budgeting Techniques

Param Remarks Pros/Cons
eters
Net NPV (Net Pros:

Presen Present
 CF based measure. CF is better measured value than
t Value Value) =
profit.
(NPV) PV of
 Absolute Measurement (Amount of wealth increase or
Cash
decrease)
Inflow –
PV of  Consider the whole life of the project.
Cash Cons:
Outflow
If NPV is  CF & Project life estimate is troublesome and estimated.
positive,  COC is constant, Real Options ignore.
accept  Not incorporating risk.
the  Financial side effect ignored.
project. If  To overcome the shortcomings suggested Technique is
negative APV = NPV+ Financial Side Effect
reject the
project.
Interna Rate of discount that Pros:

l Rate makes NPV of a

Of project zero i.e. PV of  Provide % rate of return.
Return Cash Inflow = PV of  Decision is simple (irr>coc), Accept.
(IRR) Cash Outflow.
Cons:
The average rate of
IRR=LR
return available from  Not tell how much wealth will be increased.
+(HR-
investing in a project.  Higher IRR may not be the best project that
LR)/(LR
If IRR > Cost of Capital maximizes wealth.
n-
Accept the project,
HRn)*L  Cant Deal with Non-Conventional Projects.
otherwise, reject the
Rn  Assumes IRR reinvested immediately @ IRR
project.
Rate.
 To overcome the limitations MIRR =
(PVR/PVI)^(1/n)*(1+re)-1
PI (Profitability PI (Profitability Index) or Benefit-Cost It is useful for

Index) or Benefit- Ratio = PV of CI/ PV of CO ranking and
Cost Ratio choosing between
If PI > 1, accept the project. Otherwise, projects when
reject the project. capital is rationed.
Payback Period Number of years it takes for Cash IT is very simple

(PB) Inflows to pay the original Cost of an method to
Investment i.e. Cash Outflow calculate the
Accept-Reject Criterion: If calculated PB period required
is less than the pre-determined PB,
accept the project.
Otherwise, reject the project.
Debt Service DSCR= Net Operating Income/ Debt Measurement of a

Coverage Ratio Service firm's available
(Dscr) DSCR above 1.25 is often considered cash flow to pay
“strong,” whereas ratios below 1.00 could current debt
indicate that the company is facing obligations.
financial difficulties.

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Financial statement preparation & Analysis

Financial Statement Preparation & Analysis 1|Page

Financial Statement Preparation & Analysis 2|Page

Financial Statement Preparation & Analysis 3|Page

Financial Statement Preparation & Analysis 4|Page

1.2 Accounting Standards

1.2.1 IAS (1973-2001)

Financial Statement Preparation & Analysis 5|Page

1.2.2 IFRS (2001-Onward)

1.3 Assumptions of Financial Reporting

1.3.1 Monetary Unit Assumption

1.3.2 Economic Entity Assumption

Financial Statement Preparation & Analysis 6|Page

1.3.3 Time Period (Periodicity) Assumption

1.3.4 Going Concern Assumption

1.4 Accounting Principle

1.4.2 Revenue Recognition Principle (IFRS-15)

Financial Statement Preparation & Analysis 7|Page

1.4.4 Accrual Basis Accounting

Revenue recognition. A company sells Tk.10,000 to its customer in May, which

Expense recognition. A company buys $500 of office supplies in May, which it

1.4.5 Cash Basis Accounting

Financial Statement Preparation & Analysis 8|Page

1.6 Double Entry Accounting System

1.7 Rules for Journal Entries of Major Transactions

+Debit - Credit +Credit -Debit

Financial Statement Preparation & Analysis 9|Page

Financial Statement Preparation & Analysis 10 | P a g e

1.9 Steps in The Accounting Recording Process

1.10 Adjusting Accounts

Financial Statement Preparation & Analysis 11 | P a g e

1.11.1 Adjusting for Prepaid Expenses

1.11.1.1 Prepaid Insurance {Adjustment (a)}

December 1 Prepaid Insurance 12,000

Paid a 6 month insurance policy in advance.

December 31 Insurance Expense 2,000

Prepaid Insurance 2,000

To adjust & record insurance expense for 1 month.

Financial Statement Preparation & Analysis 12 | P a g e

 Accounting cycle-refers to the steps in preparing financial statements.

Financial Statement Preparation & Analysis 13 | P a g e

2.2 Users of Financial statements

Financial Statement Preparation & Analysis 14 | P a g e

When preparing financial reports, preparers should exercise prudence.

and expenses are not understated.

2.4 The Elements of financial statements

Economic Asset A present economic resource controlled by an entity as

Financial Statement Preparation & Analysis 15 | P a g e

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Financial Statement Preparation & Analysis 17 | P a g e

Salary & Wage Expense-Dr-40

Financial Statement Preparation & Analysis 18 | P a g e

Financial Statement Preparation & Analysis 19 | P a g e

EREBA Capsules Limited

Financial Statement Preparation & Analysis 20 | P a g e

Financial Statement Preparation & Analysis 21 | P a g e

Retained Earnings October 30 from Retained Earning

Financial Statement Preparation & Analysis 22 | P a g e

Wacc = Ke We + KdWd + Kp*Wp