NMIMS Global Access School for Continuing Education (NGA-SCE)

Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________
1. An investor wants to tests the financial position of Asian Paints Ltd. Thus, he wants to assess the
short term liquidity as well as long term solvency. Discuss the four relevant ratio’s which he will
definitely look into.

INTRODUCTION

Before making any investment into a company, it is paramount for an investor to access risk of the
investment, in other word to test whether the investment will be safe or risky apart from analyzing
the return from investment. One of the commonly used technique to assess this element of risk and
financial health of a company is ratio analysis.

Ratio analysis is used to represent the information from financial statements of the company into
comparative form and helps in evaluating the organization’s performance. Ration analysis is
significant in determining Financial strength, Solvency, liquidity and operating efficiency of an
organization. Financial ratios are categorized based on the financial aspect of a business being
measured by them. For example, to measure liquidity position and solvency position of a company,
Liquidity Ratio and solvency Ratios are used.

Solvency and liquidity are both terms that refer to an organization’s state of financial health, but
with some notable differences. Liquidity refers to an organization’s ability to pay short-term debts,
where solvency refers to its capacity to meet its long-term financial commitments

CONCEPT AND APPLICATION

As mentioned above, to measure short term liquidity and long-term solvency health of Asian paints,
Investor will utilize Liquidity and Solvency ratios. Liquidity ratios and solvency ratios are tools
investors use to make investment decisions. Liquidity ratios measure a company's ability to convert
its assets to cash. On the other hand, solvency ratios measure a company's ability to meet its
financial obligations over a long-term period.

1. Liquidity Ratios:
Liquidity ratios gauge a company's ability to pay off its short-term debt obligations or convert its
current assets to cash. It helps in assessing a company’s ability to meet its current liabilities into by
using its current assets. A healthy liquidity ratio is also essential when the company wants to
purchase additional assets. There are two commonly used liquidity ratios, an investor should look
into to analyze a company’s short-term liquidity health.

A. Current Ratio:
The current ratio measures a company's ability to meet its short-term debt obligations. It is
calculated by dividing its current assets by its current liabilities. Generally, a higher current ratio
indicates that the company can pay off all of its short-term debt obligations. Industry benchmark
of Current ratio is 2:1. Mathematically it is expressed as:

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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________
A current ratio that is lower than the industry average may indicate a higher risk of distress or
default. Similarly, if a company has a very high current ratio compared to their peer group, it
indicates that management may not be using their assets efficiently.

B. Quick Ratio:
The quick ratio is an indicator of a company’s short-term liquidity position and measures the
extend upto which its current liability can be paid off using its liquid assets. Since it indicates the
company’s ability to instantly use its near-cash assets to pay down its current liabilities, it is also
called as the acid test ratio. Industry benchmark of Debt-Equity ratio is 1:1. Quick ratio can be
mathematically expressed as:

2. Solvency Ratios
In contrast to liquidity ratios, solvency ratios measure a company's ability to meet its long-term debt
and the interest over that debt. Solvency ratios measures the long-term sustainability of the
organization. Solvency ratios are particularly of interests of long term creditors and shareholders as
these ratios gives a clear picture of the long-term health and survival of the companies. Two
commonly used solvency ratios are:

A. Debt-Equity Ratio:
The Debt-Equity ratio is a financial ratio that is used to compare a company’s total debt against
its total equity. In other words, this ratio compares the external equity with internal equity,
hence it is also called External-Internal Equity Ratio. Possibility of bankruptcy increases as Debt-
Equity ratio goes higher. Industry benchmark of Debt-Equity ratio is 2:1. It can be mathematically
expressed as:

B. Solvency Ratio:
The Solvency ratio measures whether a company’s cash flow or net income is sufficient to meet
its total liabilities. The solvency ratio is calculated by dividing a company's net income and
depreciation by its short-term and long-term liabilities. Generally, a company with a higher
solvency ratio is considered to be a more favorable investment.

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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________

Apart from above mentioned four relevant ratios, there are other ratios used to measure short term
liquidity and long-term solvency such as Cash ration, Debt-total Asset Ratio, Interest coverage Ratio,
Dividend Coverage Ratio etc

CONCLUSION

Liquidity ratios and solvency ratios are preferred ratios investors use to make investment decisions.
Liquidity ratios measure a company's short-term ability to convert its assets to pay off its liabilities,
however Solvency ratios measure a company's ability to meet its long term financial obligations.
Apart from above mentioned Ratio to analyze liquidity and solvency of a Company, there are other
ratios which can be used to measure Leverage, Profitability and Activity of a Company to be used
alongside these Ratios to better test financial health of Asian paints.

Since Ratio Analysis is based upon accounting information, its effectiveness is limited by the
distortions arise by inaccuracy in accounting. It should also be noted that in case analyst doesn’t
possess required qualifications to interpret the ratios, the conclusion drawn may be misleading.
Therefore, Ratio Analysis should only be used as a first step in financial analysis, to obtain a quick
indication of a company's performance and to identify areas which need to be investigated further.

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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________
2. Discuss the components of Other Income under the statement of Profit and Loss accounts of any
Indian Corporate. How other income is different from revenue from normal operations under the
vertical format.

INTRODUCTION

The Profit and loss account is one of a company’s core financial account that shows their net profit
earned or net loss suffered over a period. The profit or loss is determined by adding up all revenues
and subtracting all expenses from both operating and non-operating activities. The income
statement is one of three statements used in both corporate finance and accounting. The statement
displays the company’s revenue, costs, gross profit, selling and administrative expenses, other
expenses and operating income, profit, other income, taxes paid, and net profit, in a coherent and
logical manner.

One of the component of profit and loss account is “Other Income”. Other income is the income
component which is not generated by core operations of the company. It includes:
(i) Interest income (in case of a company other than a finance company),
(ii) Dividend income,
(iii) Net gain/loss on sale of investments,
(iv) Other non-operating income such as rent received, etc).

CONCEPT AND APPLICATION

The profit and loss statement is also called as income statement of an organization as it reflects how
company has performed in the period. To elaborate further, lets refer to the below snapshot from
Statement of Profit and Loss for the year ended March 31, 2018:

It is noted that Larsen and Toubro ltd has reported “Other income” as Rs 1,885 crore for the year
2017- 18.

Below summary of the explanation provided in company’s annual report, briefly describe reported
“Other income” as combination of:
a) Interest income on investments and loans on investments from profit or other comprehensive
income.
b) Interest receivable on customer dues.
c) Dividend income received.
d) Other items of reliable and measurable income are accounted which are probable economic
benefits will flow to the Company.

Detailed values under Other income is reported as:

1) Interest income form subsidiary and associate companies – Rs 209.59 Cr
2) Interest income from others - Rs 287.30 Cr
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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________
3) Dividend income form subsidiary and associate companies – Rs 535.59 Cr
4) Dividend income from others - Rs 2,693.08 Cr
5) Net gain / Loss on sale or fair valuation of investments – Rs -2,233.72 Cr
6) Net gain/loss on derivatives at fair value through profit or loss – Rs -125.74 Cr
7) Net Gain/loss on sale of property, plant and equipment – Rs 60.18 Cr
8) Lease rentals – Rs 62.75 Cr
9) Miscellaneous income (net of expenses) – Rs 395.39 Cr
Hence Net “Other Income” – Rs 1884.82 Cr.

Now let’s study how Other Income (or Non-operating income) is different from Operating income

Operating Income:
Every company has some core operations, when company perform these core operations, they
generate revenue. Any activity undertaken by a company during ordinary business, or its ancillary
activities or its extension are called core operations. On a profit and Loss statement, the revenues
and expenses associated with these core operations are included in the operating section and
identified as operating Income/revenue or Operating expenses.

Other income:
Companies not only make money off of their main business, any income resulting from events,
actions or transactions that are clearly distinct from the company's ordinary activities are called
classified as other income or Non-operating revenue. It will be reported under the section titled
“Other Income/Revenue”. Another example of other revenue of the interest that company earn
when it sells its products or services on credit. For this reason, other income is sometimes referred
to as non-operating income.

Difference between normal Income and other Income:

It was earlier mentioned that the multi-step income statement has an operating section, where the
operating income are accounted. Then all the accounted operating expenses will be subtracted to
get operating profit of the company. On this operating profit, other income is added to calculate
gross profit. It is from the gross profit when subtracted the non-operating expenses results in Profit
before tax. Deduct the tax from that and you have your net income.

Non-operating incomes can affect the bottom line of an income statement. For example, non-
operating revenue may artificially increase profit margins. Even though operating profit is negative.
Hence to nullify these impacts, there must be differentiation of non-operating income from
operating income in financial statement. This helps Analyst’s to portrait a more accurate picture of
operating efficiencies of the company.

CONCLUSION

Income statement analysis determines a company’s earnings performance and provide outlook
potentials with respect to its historical trends, providing an insight of how the company conducts its
business in past. It is important to bifurcate the company earnings based on their core operating
activities. Non-operating income is generally not recurring and is therefore usually excluded or
considered separately when evaluating performance over a period. For this reason, elimination of
the non-operating incomes/expense from operating income need to be done. Since non-operating
income is not recurring, it is should not be included in the measurement of company success.

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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________

3. The following information is provided by a dealer in computer chips. The dealer follows FIFO
method for valuing stock, calculate from the following figures

A) Cost of goods available for sale?

The cost of goods available for sale (COGAS) refers to maximum cost of goods or inventory a firm
can sell in a given period. In Other words, it is the total recorded cost of beginning finished goods or
stock in an accounting period, plus the cost of any finished goods produced or stock added during
the period.

FIFO method is First-in, First-out Method. Available data after re-arranging as per FIFO method is
presented in below table:

Date Particulars Qty Unit Cost Unit Price Total Cost Total Sale
1-Apr-19 Opening Stock 750 1,550 11,62,500
10-Apr-19 Purchase 1,000 1,750 17,50,000
15-Apr-19 Less Sales 900 3,000
27,00,000
16-Apr-19 Less Sales 1,950 3,250
63,37,500
20-Apr-19 Purchase 1,650 1,875 30,93,750

Cost of Goods available for sale in given period is calculated as:

Cost of Goods Available for Sale = Opening stock + Purchases

Opening stock = Rs 11,62,500
Total Purchase = Rs 17,50,000 + Rs 30,93,750 = Rs 48,43,750

Hence Cost of Goods Available for Sale = Rs 11,62,500 + Rs 48,43,750 = Rs 60,06,250

Date Particulars Qty Unit Cost Total Cost

1-Apr-19 Opening Stock 750 1,550 11,62,500
10-Apr-19 Purchase 1,000 1,750 17,50,000
20-Apr-19 Purchase 1,650 1,875 30,93,750
Cost of Goods available for Sale 60,06,250

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 NMIMS Global Access School for Continuing Education (NGA-SCE)
Course: Financial_Accounting_and_Analysis
Internal Assignment Applicable for June 2019 Examination (Sem 2)
_____________________________________________________________________

B) Gross Profit?

All periodic inventory systems calculate inventory at the end of the period. Therefore, we are not
concerned about which units are on hand when a sale occurs. But to understand how inventory is
being sold, lets separate the purchase from Sales.

Date Particulars Qty Unit Cost Unit Price Total Cost Total Sale
1-Apr-19 Opening Stock 750 1,550 11,62,500
10-Apr-19 Purchase 1,000 1,750 17,50,000
20-Apr-19 Purchase 1,650 1,875 30,93,750
3,400 60,06,250
15-Apr-19 Less Sales 900 3,000 27,00,000
16-Apr-19 Less Sales 1,950 3,250 63,37,500
2,850 Total Sale 90,37,500

As shown above, our goods available for sale is 3400 Chips. And we know that we have sold 2850
chips.
Hence Inventory available at closing will be 3400 – 2850 = 550 Chips @ Rs 1,875

Now we will keep picking the units until we have the cost of all the chips sold.

This means that total units sold, were selected from opening stock, stock purchased on 10-Apr-2019
and Stock purchased on 20-Apr-2019 less 550 units left over from stock purchased on 20-Apr-2019.

Unit Total
Date Particulars Qty Unit Cost Total Cost
Price Sale
1-Apr-19 Opening Stock 750 1,550 11,62,500
10-Apr-19 Purchase 1,000 1,750 17,50,000
20-Apr-19 Purchase 1,100 1,875 20,62,500
Units of Chips Sold 2,850 Cost of Goods Sold 49,75,000

Hence Total Cost of Goods Sold (COGS) = Rs 49,75,000

Now that we have accounted for all 2850 chips sold and have determined that the cost of those
chips is Rs 49,75,000. Also, we know that we sold these chips for Rs 90,37,500. Now we can calculate
gross profit. Gross profit is sales less cost of goods sold. Gross profit tells us how much profit we are
making off the sale of our product before all other expenses.

Gross Profit = Total Sale – Cost of Goods Sold

Gross Profit = 90,37,500 – 49,75,000 = Rs 40,62,500

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