ANALYSIS OF FINANCIAL

STATEMENTS
MEANING:
• The process of critical evaluation of the financial information
contained in the financial statements in order to understand
and make decisions regarding the operations of the firm is
called ‘Financial Statement Analysis’.
• The term ‘financial analysis’ includes both ‘analysis and
interpretation’. The term analysis means simplification of
financial data by methodical classification given in the
financial statements. Interpretation means explaining the
meaning and significance of the data. These two are
complimentary to each other. Analysis is useless without
interpretation, and interpretation without analysis is difficult
or even impossible.
OBJECTIVES:
1. To assess the earning capacity or profitability of the firm.
2. To assess the operational efficiency and managerial
effectiveness.
3. To assess the short term as well as long term solvency
position of the firm
4. To identify the reasons for change in the
profitability/financial position of the firm.
5. To make inter-firm comparison.
6. To make forecasts about future prospects of the firm.
7. To help in decision making and control.
IMPORTANCE:
Financial analysis is useful and significant to different users in
the following ways:
1. Finance manager: A finance manager must be well-
equipped with the different tools of analysis to make
rational decisions for the firm. The tools for analysis help in
studying accounting data so as to determine the continuity
of the operating policies, investment value of the business,
credit ratings and testing the efficiency of operations.
Financial statement analysis help manager analyze major
deviations and to take corrective action.
CONTINUED..,
2. Top Management: . Financial analysis helps the
management to see that the resources are utilized most
efficiently and in measuring the success of company’s
operations, appraising the individual’s performance and
evaluating the system of internal control.
3. Trade payables: Trade payables, through an analysis of
financial statements, appraises not only the ability of the
company to meet its short-term obligations, but also judges
the probability of its continued ability to meet all its
financial obligations in future. Trade payables are
particularly interested in the firm’s ability to meet their
claims over a very short period of time.
CONTINUED..,
4. Lenders: Suppliers of long-term debt are concerned with
the firm’s long-term solvency and survival. They analyze
the firm’s profitability over a period of time, its ability to
generate cash, to be able to pay interest and repay the
principal and the relationship between various sources of
funds (capital structure relationships). Long-term lenders
analyze the historical financial statements to assess its
future solvency and profitability.
5. Labour unions: Labour unions analyze the financial
statements to assess whether it can presently afford a wage
increase and whether it can absorb a wage increase
through increased productivity or by raising the prices.
CONTINUED..,
6. Investors: Investors, who have invested their money in the
firm’s shares, are interested about the firm’s earnings. As
such, they concentrate on the analysis of the firm’s present
and future profitability. They are also interested in the firm’s
capital structure to ascertain its influences on firm’s earning
and risk. Financial statement analysis helps them in
predicting the bankruptcy and failure probability of business
enterprises.
7. Others: The economists, researchers, etc., analyze the
financial statements to study the present business and
economic conditions. The government agencies need it for
price regulations, taxation and other similar purposes.
LIMITATIONS:
1. Dependence on historical costs: transactions are recorded
at historical costs and market prices are ignored as a result of
which true position may not be revealed.
2. Not always comparable across companies: If a user wants
to compare the results of different companies, their financial
statements are not always comparable, because the entities
use different accounting practices.
3. Subject to fraud: The management team of a company may
deliberately skew the results presented. This situation can
arise when there is undue pressure to report excellent results,
such as when a bonus plan calls for payouts only if the
reported sales level increases.
USERS OF FINANCIAL STATEMENT
ANALYSIS:
• Management

Internal • Shareholders
• Employees

• Competitors
• Government

External •
•
•
Investors
Customers
Researchers
• Trade creditors/Suppliers
TECHNIQUES:
1.Comparative Statement:
These are the statements showing the profitability
and financial position of a firm for different periods of
time in a comparative form to give an idea about the
position of two or more periods. Comparative figures
indicate the trend and direction of financial position
and operating results. This analysis is also known as
‘HORIZONTAL ANALYSIS’.
TYPES OF COMPARATIVE
STATEMENTS
1. Comparative Income Statement: The comparative income
statement gives an idea of the progress of a business over a period of
time. The changes in absolute data in money values and percentages
can be determined to analyze the profitability of the business.
2. Comparative Balance Sheet: Comparative balance sheet analyses
the assets and liabilities of a business for the current year and also
compares the increase or decrease in them in relative as well as
absolute parameters. A comparative balance sheet not only provides
the state of assets and liabilities in different time periods but it also
provides the changes that have taken place in individual assets and
liabilities over different accounting periods.
THE FOLLOWING STEPS MAY BE FOLLOWED TO PREPARE
THE COMPARATIVE STATEMENTS:
The following steps may be followed to prepare the
comparative statements: Step 1 : List out absolute figures in
rupees relating to two points of time.
Step 2 : Find out change in absolute figures by subtracting the
first year (Col.2) from the second year (Col.3) and indicate the
change as increase (+) or decrease (–) and put it in column 4.
Step 3 : Calculate the percentage change as follows and put it
in column 5.
10
0
Absolute increase/decrease (col 4)
First year absolute figure (col 2)
 FORMAT OF COMPARATIVE
STATEMENT:
Comparative
Particul Absolute statement
Absolute Absolute
ars values(₹) increase(+)/decr increase(+)/decreas
Year Year 2 ease(-) e(-)
1 (₹) (%)
PROBLEM 1:
From the following particulars, prepare comparative statement of
profit and loss of Narang Colours Ltd. for the year ended March
31, 2014 and 2015:
Particulars Note 2014(₹) 2015(₹)
number
1. Revenue from Operations 40,00,0 35,00,00
2. Dividend received 00 0
3. Cost of materials consumed 50,000 50,000
4. Changes in inventory 15,00,0 18,00,00
5. Salary and wages 00 0
6. Depreciation and amortisation 10,000 15,000
7. Other expenses 2,40,00 2,40,000
8. Tax 0 22,500
25,000 3,02,000
2,66,00 30%
 SOLUTION:
Comparative income statement of Narang colours Ltd
for the year ending on 31/03/14 and 31/03/15
Particulars Absolute Absolute Absolute
values(₹) increase(+)/decre increase(+)/decrea
ase(-) se(-)
(₹) (%)
2014 2015

Revenue from operations 40,00,00 35,00,00 (5,00,000) (12.5)

Add: Other Income 0 0 0 0
Total Revenue (A) 50,000 50,000 (5,00,000) (12.34)
Less: Expenses 40,50,0 35,50,0
Cost of materials consumed 00 00 3,00,000 20
Changes in inventory 5,000 50
Employee benefit expenses 15,00,00 18,00,00 0 0
Depreciation and 0 0 (2,500) (10)
amortisation 10,000 15,000 36,000 13.53
Other expenses 2,40,000 2,40,000 3,38,500 16.58
Total Expenses (B) 25,000 22,500 (8,38,500) (41.73)
Profit before tax (C=A-B) 2,66,000 3,02,000 (2,51,550) (41.73)
PROBLEM 2:
From the following information of Sagar Ltd., Prepare a
Comparative Income Statement for the years 2016 and 2017
Particulars 2016(₹) 2017(₹)
Revenue from Operations 10,25,000 12,65,00
Sales returns (25,000) 0
10,00,000 (15,000)
Add: Other revenue 10,000 12,50,00
Total Revenue (A) 10,10,000 0
Less: Expenses 12,000
Employee benefit expenses 5,50,000 12,62,00
Depreciation 1,00,000 0
Financial Expenses 25,000
Other Expenses 15,000 6,00,000
Total Expenses (B) 6,90,000 1,20,000
Profit before Tax (A-B) 3,20,000 30,000
20,000
7,70,000
4,92,000
 Comparative income statement of Sagar ltd for the year ending on 31/03/16 and 31/03/17

Particulars Absolute values(₹) Absolute Absolute

2016 2017 increase(+)/decreas increase(+)/decrea
e(-) se(-)
(₹) (%)
 PROBLEM 3:
From the following information prepare Comparative Income
Statement.
Particulars 31.03.2018(₹ 31.03.2019(₹
) )
Net Revenue from operations 70,000 86,000
Other Revenue 300 400
Cost of materials consumes 18,000 20,000
Employees benefit expenses 9,000 10,000
Financial Expenses 3,000 3,500
Other Expenses 6,000 6,600
Total Expenses 36,000 40,100
 Comparative income statement of Sagar ltd for the year
ending on 31/03/16 and 31/03/17
Particulars Absolute values(₹) Absolute Absolute
2016 2017 increase(+)/decr increase(+)/decr
ease(-) ease(-)
(₹) (%)

Net Revenue from 70,000 86,000 16,000 22.85

operations
Add:Other 300 400 100 33.33
Revenue ________ _______ __________ ________
70,300 86,400 16,100 22.90
TOTAL
REVENUE(A)
EXPENSES:
Cost of materials 2,000 11.11
consumes 18,000 20,000
Employees 9,000 10,000 1,000 11.11
benefit expenses
Finance cost 3,000 3,500 500 16.66
Other Expenses 6,000 6,600 600 10

TOTAL 36,000 40,100 4,100 11.38

EXPENSES(B)
PROBLEM 4:
From the following information prepare a comparative balance
sheet of RCB Ltd., as on 31/03/2018 and 31/03/2019.
Particulars 31/03/2018(₹) 31/03/2019(₹
)
Equity share capital 3,00,000 4,00,000
Reserves and Surplus 1,50,000 1,00,000
Long term Loans 2,00,000 2,50,000
Current Liabilities 1,50,000 2,00,000
Total 8,00,000 9,50,000
Fixed assets 4,50,000 5,00,000
Non-current Investment 2,00,000 1,50,000
Current assets 1,00,000 2,00,000
Short term loans and advances 50,000 1,00,000
Total 8,00,000 9,50,000
 Comparative balance sheet of RCB ltd., As on 31/03/2018 and
31/03/2019
Particulars Absolute Absolute Absolute
values(₹) increase(+)/decre increase(+)/decr
2018 2019 ase(-) ease(-)
(₹) (%)

I. Equity and Liabilities:

1. Share holders’ Fund:
a. Share capital 3,00,00 4,00,00 1,00,000 33.33
b. Reserves & Surplus 0 0 (50,000) (33.33)
2. Non-current 1,50,00 1,00,00
Liabilities: 0 0 50,000 25
a) long term borrowings 50,000 33.33
3. Current Liabilities: 2,00,00 2,50,00
0 0 1,50,000 18.75
Total 1,50,00 2,00,00
0 0
II. Assets:
1. Non-Current Assets: 8,00,00 9,50,0 50,000 11.11
a. Fixed assets 0 00 (50,000) (25)
b. Other Non-Current Assets
2. Current Assets: 1,00,000 100
PROBLEM 5:
From the following information prepare Comparative position
statement
Particulars 31/03/201 31/03/2019
8(₹) (₹)
Share Capital 10,00,000 14,00,000
General Reserve 2,00,000 1,40,000
Secured Loans 5,00,000 6,00,000
Current Liabilities 3,00,000 3,60,000
Land and Buildings 8,00,000 10,00,000
Machinery 6,00,000 8,00,000
Stock 4,50,000 5,00,000
Debtors 1,50,000 2,00,000
 Particulars Absolute values(₹) Absolute Absolute
Comparative income statementincrease(+)/decre
for the year ending on
increase(+)/decr
31/03/20 31/03/20
31/03/2018
18 19and 31/03/19
ase(-) ease(-)
(₹) (%)

I EQUITY AND
LIABILITIES
1. Share holders 10,00,00 14,00,00
funds 0 0
a. Share capital 2,00,000 1,40,000
b. Reserves and
surplus
5,00,000 6,00,000
2. Non current
liabilities 3,00,000 3,60,000
c. Long term
borrowings 20,00,00 25,00,00
0 0
3. Current liabilities
TOTAL EQUITY AND
LIABILITIES

II ASSETS 14,00,00 18,00,00

1. Non current 0 0
 PROBLEM 6:
The following is the balance sheet of Mandya Sugar mills Ltd..,
as on 31/03/2018 and 31/03/2019. Prepare comparative
balance sheet.
Liabilities 31/03/201 31/03/2019 Assets 31/03/2018( 31/03/2019
8(₹) (₹) ₹) (₹)
Share capital 6,50,000 12,00,000 Fixed Assets 7,00,000 10,00,000
Reserve Fund 3,00,000 4,50,000 Investments 3,50,000 5,00,000
Long term 5,00,000 4,00,000 Inventory 3,50,000 4,00,000
loans 2,00,000 1,00,000 Cash in hand 2,50,000 2,50,000
Creditors 16,50,000 21,50,000 Total 16,50,000 21,50,000
Total
Comparative income statement of Mandya Sugar Ltd.., for the year
ending on 31/03/2018 and 31/03/19
Particulars Absolute values(₹) Absolute Absolute
increase(+)/decr increase(+)/decre
31/03/20 31/03/20
ease(-) ase(-)
18 19
(₹) (%)
COMMON SIZE STATEMENT:
• Common Size Statement is a financial tool for studying the
key changes and trends in the financial position and
operational result of a company. Here, each item in the
statement is stated as a percentage of the aggregate, of
which that item is a part.
• Common size analysis is of immense use for comparing
enterprises which differ substantially in size as it provides an
insight into the structure of financial statements. Common
size analysis is also knows as ‘VERTICAL ANALYSIS’.
TYPES OF COMMON SIZE STATEMENT:
1. Common size Income Statement: The items in income
statement can be shown as percentages of sales to show
the relation of each item to sales. A significant relationship
can be established between items of income statement and
volume of sales. The increase in sales will certainly increase
selling expenses and not administrative or financial
expenses.
2. Common size Balance Sheet: A statement in which
balance sheet items are expressed as the ratio of each
asset to total assets and the ratio of each liability is
expressed as a ratio of total liabilities is called common-size
balance sheet
 THE FOLLOWING PROCEDURE MAY BE ADOPTED FOR
PREPARING THE COMMON SIZE STATEMENTS

1. List out absolute figures in rupees at two points of time, say

year 1, and year 2.
2. Choose a common base (as 100%). For example, revenue
from operations may be taken as base (100%) in case of
statement of profit and loss and total assets or total
liabilities (100%) in case of balance sheet.
3. For all items of Col. 2 and 3 work out the percentage of that
total. Column 4 and 5 shows these percentages.
 FORMAT OF COMMON SIZE
STATEMENT:
Common size statement
Particulars Absolute Percentage of
values(₹) Revenue from
Operations (%)
Year 1 Year 2 Year 1 Year 2
PROBLEM 1:
From the following information, prepare common size
statement of profit & loss for the year ending 31st march 2016
and 31st march 2017.
Particulars 31-3- 31-3-
2016(₹) 2017(₹)
Revenue from operations 5,00,000 4,00,000
Other income 20,000 10,000
Cost of materials consumed 3,00,000 2,00,000
Employees benefit expenses 60,000 40,000
Financial cost 10,000 15,000
Depreciation 20,000 25,000
Other expenses 40,000 30,000
Tax rate 40% 40%
 Common size Income statement for the year ending 31/03/2016 and 31/03/2017

Particulars Absolute values(₹) Percentage of Revenue

from Operations (%)
31/03/16 31/03/17 31/03/16 31/03/17
Revenue from Operations 5,00,000 4,00,000 100 100
Add: Other income 20,000 10,000 4 2.5
Total Revenue (A) 5,20,000 4,10,000 104 102.5
Less: Expenses
a) Cost of materials 3,00,000 2,00,000 60 50
consumed 60,000 40,000 12 10
b) Employee benefit 10,000 15,000 2 3.75
expenses 20,000 25,000 4 6.25
c) Financial cost 40,000 30,000 8 7.5
d) Depreciation 4,30,000 3,10,000 86 77.5
e) Other expenses 90,000 1,00,000 18 25
Total Expenses (B) 36,000 40,000 7.2 10
Profit before tax (C=A-B) 54,000 60,000 10.8 15
Less: Tax (D)
Profit after tax (E=C-D)
PROBLEM 2:
From the following information prepare Common Size Income
Statement. Particulars 31.03.2018 31.03.2019
(₹) (₹)
Net Revenue from operations 60,000 86,000

Other Revenue 300 400

Cost of materials consumed 18,000 20,000
Employees benefit expenses 9,000 10,000
Financial Expenses 3,000 3,400
Other Expenses 6,000 6,600
Total Expenses 36,000 40,000
Income Tax 400 600

Net Profit 23,900 45,800

 Common size statement for the year ending on
31/03/2018 and 31/03/2019
Particulars Absolute values(₹) Percentage of Revenue
from Operations (%)
31/03/201 31/03/2019 31/03/201 31/03/2019
8 8
PROBLEM 3:
From the following information prepare Common Size Income
Statement.
Particulars 31.03.2018 31.03.2019
(₹) (₹)
Revenue from Operations 6,00,000 5,00,000
Rent received 30,000 25,000
Purchases 2,00,000 1,50,000
Wages 60,000 40,000
Interest 12,000 10,000
Depreciation and 15,000 20,000
amortization 18,000 12,000
Repairs to machinery 30% 30%
Tax
 Common size statement for the year ending on
31/03/2018 and 31/03/2019
Particulars Absolute values(₹) Percentage of Revenue
from Operations (%)
31/03/201 31/03/201 31/03/2018 31/03/201
8 9 9
PROBLEM 4:
The following are the Balance sheets of Alpha Ltd., as at March 31st 2016
and 2017.Particulars 31/3/2016 (₹) 31/3/2017 (₹)
I. Equity and liabilities:-
1. Share holders’ fund:
a) Equity share capital 2,00,000 4,00,000
b) Reserves and Surplus 1,00,000 1,50,000
2. Non-Current Liabilities:
a) Long Term Loans 2,00,000 3,00,000
3. Current Liabilities 1,20,000 1,70,000
Total 6,20,000 10,20,000
II. Assets:-
1. Non-current Assets:
a) Fixed Assets 2,00,000 5,00,000
b) Non-Current Investment 1,00,000 1,25,000
2. Current Assets:
a) Inventory 2,55,000 3,25,000
b) Term loan and Advances 65,000 70,000
Total 6,20,000 10,20,000
 Common size position statement as on 31/03/2018 and 31/03/2019
Particulars Absolute values(₹) Percentage of total
Assets/ total Liabilities
(%)
31/03/201 31/03/201 31/03/2018 31/03/201
8 9 9

I. Equity and Liabilities:

1. Share holders’ fund:
a) Equity share capital 2,00,000 4,00,000
b) Reserves and Surplus 1,00,000 1,50,000
2. Non-current Liabilities:
a) Other long term loans 2,00,000 3,00,000
3. Current Liabilities 1,20,000 1,70,000

Total 6,20,000 10,20,000 100 100

II. Assets:
1. Non-current Assets:
a) Fixed Assets 2,00,000 5,00,000
b) Other Non-current Assets 1,00,000 1,25,000
2. Current Assets:
a) Inventory 2,55,000 3,25,000
b) Short term loans and 65,000 70,000
 PROBLEM 5:
From the following balance sheet of Ramya Exports Pvt Ltd., as
on 31/03/2018 and 31/03/2019, Prepare a common size
balance sheet.31/03/18( 31/03/19(
Liabilities Assets 31/03/18( 31/03/19(
₹) ₹) ₹) ₹)
Equity share 6,00,000 8,00,000 Buildings 5,00,000 7,00,000
capital 4,00,000 4,50,000 Machinery 4,00,000 6,00,000
Reserves and 5,00,000 4,00,000 Goodwill 3,00,000 2,00,000
Surplus 3,00,000 3,50,000 Current Assets 6,00,000 5,00,000
Debentures 18,00,00 20,00,00 Total 18,00,00 20,00,00
Current Liabilities 0 0 0 0
Total
 Common size statement for the year ending on
31/03/2017 and 31/03/2018
Particulars Absolute values(₹) Percentage of total
Assets/ total
Liabilities(% (%)
31/03/20 31/03/20 31/03/201 31/03/201
17 18 7 8
PROBLEM 6:
From the following information, prepare common size Balance
sheet (position statement)
Particulars 31/3/2016(₹ 31/3/2017(
) ₹)
Share Capital 5,00,000 7,00,000
General Reserve 1,00,000 60,000
Secured Loans 25,000 40,000
Current Liabilities 75,000 1,00,000
Buildings 3,00,000 4,50,000
Machinery 1,50,000 2,50,000
Stock 1,00,000 1,10,000
Trade Receivables 1,50,000 90,000
 Common size statement for the year ending on
31/03/2016 and 31/03/2017
Particulars Absolute values(₹) Percentage of total
Assets/ total
Liabilities(% (%)
31/03/201 31/03/201 31/03/201 31/03/201
6 7 6 7
DIFFERENCES BETWEEN HORIZONTAL
ANALYSIS AND VERTICAL ANALYSIS
Basis of
Horizontal Analysis Vertical Analysis
Difference
Meaning It refers to the comparison of It refers to the comparison of
an item of the financial items of the financial
statement of one period or statement to the common
periods to its corresponding item of the same accounting
item of the base accounting period.
period.
Purpose Its purpose is to determine theIts purpose is to determine
change in an item during an the proportion of item/items
accounting period. The change to the common item of the
in the item is expressed eithersame accounting period. The
in absolute figures or in change in the item is
percentage or in both terms. expressed either in ratio or in
percentage terms.
Usefulness It indicates growth or decline It helps in predicting and
of the item. determining the future
relative proportion of an item
to the common item.
THANK YOU