0MODULE 2: ANALYSIS AND INTERPRETATION OF FINANCIAL

STATEMENTS

CONCEPT OF FINANCIAL STATEMENT ANALYSIS:

The process of critical evaluation of financial information contained in the

financial statements in order to understand and make the decisions regarding the
operations of the firm is called financial statement analysis.

It is basically a study of relationship among various financial facts and figures as

given in a set of financial statements and interpretation thereof to gain an insight
into the profitability and operational efficiency of the firm to assess its financial
health and future prospects.

A financial analysis includes both analysis and interpretation.

MEANING OF ANALYSIS:

The term analysis means simplification of financial data by methodical

classification given in the financial statements.

MEANING OF INTERPREATION:

Interpretation means explaining the meaning and significance of data.

MEANING OF FINANCIAL STATEMENT ANALYSIS:

Financial statement analysis is the process of analyzing a company’s financial

statements for decision-making purposes.

Financial statement analysis is the process of reviewing and analyzing a company’s

financial statements to make better economic decisions to earn income in future.
These statements include the income statement, balance sheet, statement of cash
flows, notes to accounts and a statement of changes in equity.

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SIGNIFICANCE OF ANALYSIS OF FINANCIAL STATEMENTS:

1) FINANCE MANAGER:
Financial analysis focuses on the facts and relationships related to managerial
performance, corporate efficiency financial strengths and weaknesses, credit worthiness
of the company. A finance manager must be well-equipped with different tools of
analysis to make rational decisions of the firm. The tools for analysis helps in studying
accounting data so as to determine the continuity of the operating policies and investment
value of the balance sheet, credit ratings and testing the efficiency of operations. The
techniques are equally important in the area of financial control, enabling the finance
manager to make constant reviews of the actual financial operations of the firm to analyse
the causes of major deviations which may help in corrective actions whenever indicated.

2) TOP MANAGEMENT:
The importance of financial analysis is not limited to the finance manager alone. It has a
broad scope which includes top management in general and other functional managers.
Management of the firm would be interested in every aspect of the financial analysis. It is
their overall responsibility to see that the resources of the firm are used most efficiently
and that the firm’s financial condition is sound. Financial analysis helps the management
in measuring the success of the companies operations, appraising the individual’s
performance and evaluating the system of internal control.

3) TRADE PAYABLES:
Trade payables through analysis of financial statements, appraises not only the ability of
the company to meet its short term obligations but also judges the profitability 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 term
period of time, their analysis will therefore, evaluate the firm’s liquidity position.

4) LENDORS:
Suppliers of long term debt are concerned with the firm’s long term solvency and
survival. They analyse 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 relationship between various
sources of funds. Long term lenders analyse the historical financial statements to assess
its future solvency and profitability.
5) 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

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 influences on firm’s earnings and risk. They also evaluate the efficiency of the
management and determine whether a change is needed or not. However, in some large
companies, the shareholders interest is limited to decide whether to buy, sell or hold the
shares.

6) LABOUR UNIONS:
Labour unions analyze the financial statements to assist whether it can presently offer an
increased wage through increased productivity or by rising share prices.

OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS:

1) To assess the profitability and operational efficiency of the firm as a whole as well as
its difference departments so as to judge the financial health of the firm.
2) To ascertain the relative importance of different components of the financial position
of the firm.
3) To identify the reasons for change in the profitability or financial position of the firm.
4) To judge the ability of the firm to repay its debt and assessing the short-term as well
as the long-term liquidity position of the firm.

TOOLS OF FINANCIAL STATEMENTS ANALYSIS:

1) Comparative statements
2) Common-size statements
3) Trend analysis
4) Ratio analysis
5) Cash flow analysis
6) Fund flow analysis

1) COMPARATIVE STATEMENTS:
Any financial statement that reports and comparison of data of two or more consecutive
accounting periods are known as comparative financial statements.
These are the statements showing the profitability and financial position of the firm. It
usually applies to the two important financial statements, viz., income statement and
position statement.
The comparative statements are statements of financial position of different points of
time. The elements of financial position are shown in a comparative form so as to give
idea of financial positions at two or more periods.

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 The analyst will be able to draw meaningful conclusions when figures are given in a
comparative form. The comparative figures will also indicate the trend and direction of
financial position and operating result. The financial data will be comparative only when
same accounting principles are used in preparing these statements.

TYPES OF COMPARATIVE STATEMENTS:

A) COMPARATIVE INCOME STATEMENTS:

The comparative income statement gives an idea of the progress of a business enterprise
over a period of time. The figures and comparative statements can be used for identifying
the direction of changes and also the trend in different indicators of performance of an
organization.
The following steps may be followed to prepare the comparative statement:
Step 1: list out the absolute figures in rupees relating to two periods (as shown in column
2 and column 3 of table 1)
Step 2: find out the change in absolute figures by subtracting the 1 st year(column 2) from
the second year (column 3) and indicate the change as increased or decreased and writw
it in column 4.
Step 3: calculate the % changed as follows and write it in column 5.

Increase/decrease (column 4) *100

st
1 year absolute figures (column 2)

PROBLEMS ON COMPARATIVE INCOME STATEMENT:

1) From the following information of ABC ltd. prepare the comparative income statement
for the year ending 31/03/2018 and 2019
PARTICULARS 31/03/2018 31/03/2019
Revenue from operations 600,000 750,000
Other incomes 12,000 15,000
Expenses 506,000 440,000
Income tax 35% 35%

2) From the following information of XYZ ltd. prepare the comparative income statement
for the year ending 31/03/2019 and 2020
PARTICULARS 31/03/2019 31/03/2020
Revenue from operations 16,00,000 20,00,000
Employee benefit expenses 800,000 10,00,000
Other Expenses 200,000 100,000
Income tax 40% 40%

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 3) From the following information of PQR ltd. prepare the comparative income statement
for the year ending 31/03/2018 and 2019
PARTICULARS 31/03/2018 31/03/2019
Revenue from operations 500,000 400,000
Other incomes 20,000 10,000
Employee benefit Expenses 60,000 40,000
Cost of material consumed 300,000 200,000
Other expenses 40,000 30,000
Income tax 30% 30%

4) From the following information of ABC ltd. prepare the comparative income statement
for the year ending 31/03/2018 and 2019
PARTICULARS 31/03/2018 31/03/2019
Revenue from operations 16,00,000 17,50,000
Other incomes 120,000 150,000
Expenses 500,000 400,000
Income tax 30% 30%
5) From the following information of MNO ltd. prepare the comparative income statement
for the year ending 31/03/2020 and 2021
PARTICULARS 31/03/2020 31/03/2021
Revenue from operations 60,00,000 75,00,000
Other incomes 150,000 200,000
Expenses 600,000 800,000
Income tax 35% 35%

PROBLEMS ON COMPARATIVE POSITION STATEMENT:

1) From the following balances, prepare comparative balance sheet

Particulars 2018 2019
Share capital 800,000 10,00,000
Reserves 100,000 120,000
Debentures 30,000 40,000
Long term loans 20,000 10,000
Trade payables 80,000 100,000
Building 400,000 500,000
Machinery 300,000 400,000
Inventories 200,000 180,000
Trade receivables 100,000 150,000
Cash and cash equivalents 30,000 40,000

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 2) From the following balances, prepare comparative balance sheet
Particulars 2018 2019
Equity Share capital 600,000 12,00,000
10% Preference share
capital 500,000 900,000
Reserves fund 400,000 500,000
Profit and loss a/c 200,000 300,000
Long term loans 200,000 500,000
Trade payables 100,000 300,000
Fixed assets 10,00,000 20,00,000
Inventories 450,000 650,000
Investments 400,000 500,000
Trade receivables 100,000 400,000
Cash and cash equivalents 50,000 150,000

3) From the following balances, prepare comparative balance sheet

Particulars 2020 2021
Equity Share capital 200,000 400,000
Reserves and surplus 100,000 150,000
Non- current investment 100,000 125,000
Long term loans 200,000 300,000
Trade payables 120,000 170,000
Fixed assets 200,000 500,000
Current assets 255,000 325,000
Loans and advances 65,000 70,000

4) From the following balances, prepare comparative balance sheet

Particulars 2019 2020
Share capital 400,000 500,000
Reserves 50,000 60,000
Secured loans 15,000 20,000
Trade payables 50,000 70,000
Building 200,000 250,000
Machinery 150,000 200,000
Inventories 100,000 110,000
Trade receivables 65,000 90,000

5) From the following balances, prepare comparative income statement

Particulars 2018 2019
Revenue from operations 725,000 815,000
Less: Sales return 25,000 15,000
Net sales 700,000 800,000
Other revenue income 1200 8000

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 Total revenue 701,200 808,000
Less: Employee benefit
expenses 595,000 615,000
Depreciation 12700 12500
Financial expenses 23,000 24,000
Other expenses 1500 2000
Total expenses 632,200 153,500

PBT 69,000 154,500

6) From the following balances, prepare comparative income statement

Particulars 2020 2021
Revenue from operations 800,000 900,000
Other incomes 20,000 40,000
Employee benefit expenses 100,000 120,000
Depreciation 70,000 70,000
Financial expenses 30,000 20,000
Other expenses 20,000 30,000
Cost of material consumed 400,000 500,000
Income tax @ 30%

2) COMMON-SIZE
STATEMENTS:
Common-size statements are those statements in which the data or figures reported in the
financial statement or converted into % of a common base amount.
When the financial statements, financial data are shown in the shape of vertical
percentage, it is called as common-size statements. A common-size statement is also
known s component % statement or % statement.
There are two types of common-size statements, they are:
Common-size income statement and common-size position statement.

In common-size income statements, the sales figures are taken to be 100% and all other
items of cost of goods sold or cost of sales are expressed as percentage of sales.
A common-size position statement shows the percentage in relation to each item of assets
to total assets and each item of liabilities to total liabilities and capital.

PROBLEMS ON COMMON-SIZE INCOME STATEMENT:

1) The following is the statement of P&L for the year ending 31/3/2019 and 31/3/2020.
Prepare CSIS.

Particulars 31/3/2019 31/3/2020

Revenue from operations 20,00,000 25,00,000

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 Other income 250,000 325,000
Total revenue 22,50,000 28,25,000
Expenses:
Employee benefit
expenses 450,000 825,000
Other expenses 100,000 200,00
Total expenses 550,000 10,25,000
PBT 17,00,000 18,00,000
Less: Tax 340,000 540,000
PAT 13,60,000 12,60,000

2) The following is the statement of P&L for the year ending 31/3/2020 and 31/3/2021.
Prepare CSIS.

Particulars 31/3/2020 31/3/2021

Revenue from operations 60,000 86,000
Other income 300 400
Total revenue 60,300 86,400
Expenses:
Employee benefit
expenses 18,000 20,000
Cost of material 9000 10,000
consumed 3000 3400
Financial expenses 6000 6600
Other expenses 36,000 40,000
Total expenses 24300 46400
PBT 4000 6000
Less: Tax 20300 40400
PAT

3) The following is the statement of P&L for the year ending 31/3/2019 and 31/3/2020.
Prepare CSIS.

Particulars 31/3/2019 31/3/2020

Revenue from operations 500,000 400,000
Other income 20,000 10,000
Cost of material consumed 300,000 200,00
Employee benefit 60,000 40,000
expenses 10,000 15,000
Financial cost 20,000 25,000
Depreciation 40,000 30,000
Other expenses 40% 40%
Tax rate

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 4) The following is the statement of P&L for the year ending 31/3/2020 and 31/3/2021.
Prepare CSIS.

Particulars 31/3/2020 31/3/2021

Revenue from operations 10,00,000 15,00,000
Other income 200,000 180,000
Total revenue 12,00,000 16,80,000
Expenses:
Material consumed 500,000 900,000
Finance cost 20,000 30,000
Other expenses 80,000 120,000
Total expenses 600,000 10,50,000
Tax rate 30% 30%

PROBLEMS ON COMMON-SIZE POSITION STATEMENT:

1) Prepare common-size position statement

Particulars 31/3/2018 31/3/2019
Share capital 12,00,000 15,00,000
Reserves 500,000 500,000
Long term borrowing 500,000 600,000
Trade payables 10,50,000 15,50,000
Machinery 10,00,000 15,00,000
Goodwill 10,00,000 15,00,000
Non-current investment 10,00,000 10,00,000
Inventories 250,000 150,000

2) Prepare common-size position statement

Particulars 31/3/2018 31/3/2019
Share capital 750,000 10,00,000
Reserves 150,000 100,000
Long term borrowing 450,000 675,000
Trade payables 150,000 225,000
Motor car 750,000 10,00,000
Goodwill 3,00,000 450,000
Inventories 150,000 250,000
Trade receivables 75000 100,000
Cash 225,000 200,000

3) Prepare common-size position statement

Particulars 31/3/2018 31/3/2019
Preference share capital 12,00,000 16,00,000
Equity share capital 15,00,000 40,00,000
Reserves 140,000 180,000

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 Long term borrowing 13,0,,
Long term loans 11,50,000 13,00,000
Bills payable 20,000 -
Sundry creditors 120,000 40,000
Outstanding expenses 150,00 60,000
Proposed dividend 100,000 900,000
Land and building 800,000 12,30,000
Machinery 334,000 60,00,000
Temporary investment 10,000 400,000
Inventories 100,000 250,000
Debtors 40,000 80,000
Prepaid expenses 10,000 20,000
Cash and bank balance 80,000 100,000

4) Prepare common-size position statement

Particulars 31/3/2018 31/3/2019
Share capital 200,000 290,000
General Reserves 40,000 43500
Profit and loss a/c 16,000 14500
Long term borrowing 18,000 20,000
Creditors 5000 5000
Bills payable 2000 2900
Bank overdraft 15,000 14500
o/s expenses 2000 1600
land and building 50,000 70,000
Machinery 100,000 100,000
Furniture 30,000 62,000
Stock 7000 8000
Debtors 40000 58,000
Bills receivable 50,000 43500
Cash 10,000 14500
Prepaid expenses 11,000 36,000

TREND ANALYSIS:

Comparison of past data over a period of time with the base year is known as trend
analysis. It computes the changes in percentage of different variables over a long period
and then makes a comparative study of them. Each item in the base year is taken as 100
and on that basis, trend analysis for the corresponding items in the other years are
calculated.

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 STEPS FOR CALCULATING TREND ANALYSIS:
1) Selecting a base year, i.e., one year is taken as base year, generally the first or the last
is taken as base year.
2) The figures of the base year are taken as 100.
3) Trend percentage is calculated in relation to base year.
Trend % = Present year value *100
Base year value

PROBLEMS ON TREND ANALYSIS:

1) Calculate the trend % from the following figures of sales, stock and profit taking 2010 as
the base year.
YEAR SALES STOCK PBT
2010 188100 70900 32100
2011 234000 78100 43500
2012 265500 81600 45800
2013 302100 94400 52700
2014 376800 115400 62700

2) Calculate the trend % from the following figures of sales, stock and profit taking 2015 as
the base year.
YEAR SALES STOCK PBT
2015 100,000 50,000 30,000
2016 200,000 70,000 40,000
2017 250,000 80,000 450,00
2018 300,000 90,000 50,000
2019 350,000 100,000 60,000

3) From the following balance sheet, compute the trend % using 2018 as the base year.

Particulars 2018 2019 2020

Share capital 200,000 250,000 300,000
Reserves 100,000 150,000 150,000
Long term loans 200,000 100,000 50,000
Trade payables 300,000 400,000 200,000
Building 200,000 250,000 300,000
Plant 200,000 250,000 100,000
Inventory 250,000 250,000 150,000

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 Trade receivables 100,000 100,000 100,000
cash 50,000 50,000 50,000

4) From the following balance sheet, compute the trend % using 2019 as the base year.

Particulars 2019 2020 2021

Share capital 300,000 350,000 400,000
Reserves 200,000 250,000 250,000
Long term loans 300,000 200,000 150,000
Trade payables 400,000 500,000 300,000
Building 300,000 350,000 400,000
Plant 300,000 350,000 200,000
Inventory 350,000 350,000 250,000
Trade receivables 200,000 200,000 200,000
cash 50,000 50,000 50,000

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