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Comparative Income Statementcommon Size Statement and Trend Analysis
Comparative Income Statementcommon Size Statement and Trend Analysis
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
i.e. Income statement and position statement. It determines financial strength and
weaknesses of the firm. 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.
1) Comparative statement
2) Common size statement
3) Trend analysis
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.
Financial statements of the previous years 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 be 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.
The purpose of financial analysis is to assess the financial strength of the business. Analysis
also helps in taking decisions, whether 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.
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.
PARTIES INTERESTED
Analysis of financial statements has become very significant due to widespread interest of
various parties in the financial results of a business unit. The various parties interested in
the analysis of financial statements are:
(i) Investors :
Shareholders or proprietors of the business are interested in the well being of the business.
They like to know the earning capacity of the business and its prospects of future growth.
(ii) Management :
The management is interested in the financial position and performance of the enterprise as
a whole and of its various divisions. It helps them in preparing budgets and assessing the
performance of various departmental heads.
They are interested in financial statements for negotiating the wages or salaries or bonus
agreement with the management.
(iv) Lenders :
Lenders to the business like debenture holders, suppliers of loans and lease are interested
to know short term as well as long term solvency position of the entity.
The suppliers and other creditors are interested to know about the solvency of the business
i.e. the ability of the company to meet the debts as and when they fall due.
Tax authorities are interested in financial statements for determining the tax liability.
(vii) Researchers:
They are interested in financial statements in undertaking research work in business affairs
and practices.
(viii) Employees :
They are interested to know the growth of profit. As a result of which they can demand
better remuneration and congenial working environment.
Government and their agencies need financial information to regulate the activities of the
enterprises/ industries and determine taxation policy. They suggest measures to formulate
policies and regulations.
The stock exchange members take interest in financial statements for the purpose of
analysis because they provide useful financial information about companies. Thus, we find
that different parties have interest in financial statements for different reasons.
COMPARATIVE STATEMENT
Comparative statements are financial statements that cover a different time frame, but are
formatted in a manner that makes comparing line items from one period to those of a
different period an easy process. This quality means that the comparative statement is a
financial statement that lends itself well to the process of comparative analysis. Many
companies make use of standardized formats in accounting functions that make the
generation of a comparative statement quick and easy.
Along with being an excellent way to broaden the understanding of the success of the sales
effort, a comparative statement can also help address changes in production costs. By
comparing line items that catalogue the expense for raw materials in one quarter with
another quarter where the number of units produced is similar can make it possible to spot
trends in expense increases, and thus help isolate the origin of those increases. This type of
data can prove helpful to allowing the company to find raw materials from another source
before the increased price for materials cuts into the overall profitability of the company.
A comparative statement can be helpful for just about any organization that has to deal with
finances in some manner. Even non-profit organizations can use the comparative statement
method to ascertain trends in annual fund raising efforts. By making use of the comparative
statement for the most recent effort and comparing the figures with those of the previous
year’s event, it is possible to determine where expenses increased or decreased, and
provide some insight in how to plan the following year’s event.
FEATURES OF COMPARITIVE STATEMENTS:-
1) A comparative statement adds meaning to the financial data.
3) Comparative statement analysis is used for intra firm analysis and inters firm
analysis.
6) If the value in the first year is zero then change in percentage cannot be indicated.
This is the limitation of comparative statement analysis. While interpreting the
results qualitative inferences need to be drawn.
8) A comparative statement analysis cannot be used to compare more than two years
financial data.
COMMON SIZE FINANCIAL STATEMENTS
Common size ratios are used to compare financial statements of different-size companies or
of the same company over different periods. By expressing the items in proportion to some
size-related measure, standardized financial statements can be created, revealing trends
and providing insight into how the different companies compare.
The common size ratio for each line on the financial statement is calculated as follows:
Item of Interest
Common Size Ratio =
Reference Item
For example, if the item of interest is inventory and it is referenced to total assets (as it
normally would be), the common size ratio would be:
Inventory
Common Size Ratio for Inventory =
Total Assets
The ratios often are expressed as percentages of the reference amount. Common size
statements usually are prepared for the income statement and balance sheet, expressing
information as follows:
The following example income statement shows both the rupee amounts and the common
size ratios:
The above common size statements are prepared in a vertical analysis, referencing each line
on the financial statement to a total value on the statement in a given period.
The ratios in common size statements tend to have less variation than the absolute values
themselves, and trends in the ratios can reveal important changes in the business. Historical
comparisons can be made in a time-series analysis to identify such trends.
Common size statements also can be used to compare the firm to other firms.
Common size financial statements can be used to compare multiple companies at the same
point in time. A common-size analysis is especially useful when comparing companies of
different sizes. It often is insightful to compare a firm to the best performing firm in its
industry (benchmarking). A firm also can be compared to its industry as a whole. To
compare to the industry, the ratios are calculated for each firm in the industry and an
average for the industry is calculated. Comparative statements then may be constructed
with the company of interest in one column and the industry averages in another. The result
is a quick overview of where the firm stands in the industry with respect to key items on the
financial statements
1. A common size statement analysis indicates the relation of each component to the
whole.
2. In case of a Common Size Income statement analysis Net Sales is taken as 100% and
in case of Common Size Balance Sheet analysis total funds available/total capital
employed is considered as 100%.
3. It is used for vertical financial analysis and comparison of two business enterprises or
two years financial data.
4. Absolute figures from the financial statement are difficult to compare but when
converted and expressed as percentage of net sales in case of income statement and
in case of Balance Sheet as percentage of total net assets or total funds employed it
becomes more meaningful to relate.
5. A common size analysis is a type of ratio analysis where in case of income statement
sales is the denominator (base) and in case of Balance Sheet funds employed or total
net assets is the denominator (base) and all items are expressed as a relation to it.
6. In case of common size statement analysis the absolute figures are converted to
proportions for the purpose of inter-firm as well as intra-firm analysis.
Limitations
As with financial statements in general, the interpretation of common size statements is
subject to many of the limitations in the accounting data used to construct them. For
example:
1. Different accounting policies may be used by different firms or within the same firm
at different points in time. Adjustments should be made for such differences.
2. Different firms may use different accounting calendars, so the accounting periods
may not be directly comparable.
TREND STATEMENT
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/ (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 year's balance. The result is the percentage change.
Calculation notes:
1. 2000 is the earlier year so the amount in the 20X0 column is subtracted from the
amount in the 2001 column.
2. The percent change is the increase or decrease divided by the earlier amount (2000
in this example) times 100. Written as a formula, the percent change is:
3. If the earliest year is zero or negative, the percent calculated will not be meaningful.
N/M is used in the above table for not meaningful.
4. Most percents are rounded to one decimal place unless more are meaningful.
5. A small absolute rupee item may have a large percentage change and be 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:
(amount in rupees)
Historical Data
Calculation notes:
1. The base year trend percentage is always 100.0%. A trend percentage of less than
100.0% means the balance has decreased below the base year level in that particular
year. A trend percentage greater than 100.0% means the balance in that year has
increased over the base year. A negative trend percentage represents a negative
number.
2. If the base year is zero or negative, the trend percentage calculated will not be
meaningful.
3. In this example, the sales have increased 59.3% over the five-year period while the
cost of goods sold has increased only 55.9% and the operating expenses have
increased only 57.5%. The trends look different if evaluated after four years. At the
end of 2000, the sales had increased almost 20%, but the cost of goods sold had
increased 31%, and the operating expenses had increased almost 41%. These 2000
trend percentages reflect an unfavourable 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.
FEATURES OF TREND ANALYSIS
1) In case of a trend analysis all the given years are arranged in an ascending order.
2) The first year is termed as the “Base year” and all figures of the base year are taken
as 100%.
3) Item in the subsequent years are compared with that of the base year.
4) If the percentages in the following years is above 100% it indicates an increase over
the base year and if the percentages are below 100% it indicates a decrease over the
base year.
5) A trend analysis gives a better picture of the overall performance of the business.
6) A trend analysis helps in analysing the financial performance over a period of time.
7) A trend analysis indicates in which direction a business is moving i.e. upward or
downwards.
8) A trend analysis facilitates effective comparative study of the financial performance
over a period of time.
9) For trend analysis at least three years financial data is essential. Broader the base the
more reliable is the data and analysis.
SUBMITTED BY
1. JAIVEER DUGGAL 21
2. HARDIK GOKEL 29
3. AFTAB KHAN 45
4. RAJDEEP PANDERE 71
5. POOJA PATIL 76
6. RITEN SAKHIYA 85
7. SAGAR SANGANI 86
8. SWATI TIKKU 101