Unit-3 Analysis: Analysis of Financial Statements A detailed study of accoun ing data for drawing concrete results Financial Statements: Af; T oA i accounting procedures, Its en to logical and consistent nancial \ Durpoce i utement is an organized callcton of data according d omenar ieee an understanding of some Financial aspects off business firm. It may scinte cef Kime inthe ease hlance shes, may reveal sere lof activities over @ given nancial statements’ generally era © ‘The Income Sisteniom Renerally refers to two basic statements: Position Statement or Balance Sheet Shee Financial Statements Income Statement Position Statement @) a Statement: The income Statement (also termed as Profit and Loss Account) is generally considered "0 ‘most useful ofall financial statements. It explains what has happened to business as a result of operations between two balance sheet dates. For this purpose matches the revenues and costs incurred in the process of ‘earning revenues and shows the net profit eared or loss suffered during a particular period. ‘The nature of the Income whic is the focus ofthe income statement can be well understood if business fs taken as an organization that uses ‘inputs’ to ‘produce’ output. The outputs ae the goods and services that the business provides to its customers. The values of these outputs are the amounts paid by the customers for then Thee anpeantsarcealled “revenues” in accounting. The inputs are the economic resources used by (he business in providing these goods and services. These are termed as ‘expenses’ in accounting, (b) Position Statement or Balance Sheet It's a statement of financial position of a business specified moment aefime: It represents all assets owned by the business ata particular moment of time and the claims ‘tr equities) Sethe owners and outsiders against those assets at that time, Its in a way a snapshot of the financial condition of the business at that time. @ ‘The important distinction between an Income Statement anda Balance Sheet is that the Income statement is fora period while Balance Sheet son particular dat. Income Statements therefore,a flow report, as te rested with the balance sheet which is ttc report, However, both are complementary to each other. Meaning of Analysis of Financial Statement: . Prnaneial Statements are the only sources for drawing met ingful conclusions about the economic position of any Fineness. Analysis and interpretation of financial statements essential for correctly ascertaining the financial position and progress of the concer. sag to Hampton, “Analysis of Financial Satements or Financial Analysis is the process of determining the eran eeangd ‘nancial characteristics of firm from accounting data.” e financial Statements analysis is largely a study of relationshi i ding to John Myers, “Financial St in ly ship among the various financial feos ng (ines as disclosed by a single se of statements and a study of the trend of these factors as shown in a series of statement.”According to the signifier emedy and . i mings, sene® teaming yt ne THE tle and interpretation of cil statements gan tempt to determine SS Mlty to pay interest and etl salements dita so at the forecast may be made ofthe prospects for future Ke ‘bt maturities ar In the nutshell, we and prof may co regarding the well-being, faa iy and sound dividend policy." Ne analysis and interpretation of financial statements reveals each and every aspect "dness, operational efficiency and creditworthiness of the concer. ice and Purpose of Finan Th jtatements 1 analysis of fin, y wancial stat ” Ie Position statement so ay yes CFS 0 sucha treatment of he information contained in the Income statement and of the profitability and financial soundness of the business. The inlerpretaton is advocated forthe following purposes: ihe pa} Soundness of the concern: The short as well as long term solvency of the firm can be he oe elb of financial statements analysis. The bondholders, debentures and moneylenders judge Pte cet 10 pay the principal as well as the interest. They are more interested in knowing the Sir ne concer given by various credit-ratin jes. While the trade creditors are interested in asst : edit-rating agencies. While the more ine the short term solvency of the business, the bankers, financial institutions and long-term financiers are attenti crested in long term creditworthiness of the concem. Thus, the analysis and interpretation will focus the ‘ntton on the general financial strength of the business enterprises. To judge the fi determined wit the ability of 1 credit-rating of 2 Inter-irm comparison: The analysis of financial statements makes inter-firm ‘comparison easy. Various ratios Seek tlated to have a comparative study of vatious concems and of similar concern for different time periods. ‘uch a comparison can be made for various financial characteristics like profitability, solvency and liquidity of any enterprise. 3 To judge the managerial efficiency of the concern: The analysis will enable the management to find out the overall as well as department-wise efficiency of the firm on the basis of available financial information. The management can easily locate the areas of efficiency or inefficiency and weak points can be highlighted to require immediate attention, 4, To judge the earning capacity of the concern: The analysis would enable the computation of not only the resent earning capacity of the business enterprise but also the estimation of the future-earning capacity as well. Present and the potential investors are more interested while making their investment to know about the Profitability of the concern. They generally talk about the E.P.S. or PIE ratio of a particular share to know the ‘worth of their investment in a particular company. ‘5. To make business forecasts: The analysis will help in assessing development in future by making forecasts and preparing budgets. Capital budgets are prepared for a given investment taking into consideration the profitability of various alternative proposals. The trend shown by financial statement analysis will pave way for future. Objects of Analysi Although the analysis of financial satements may be made with any specific object in view, yet the following are generally considered to be objects of analysis: To find out the financial stability of a business concern. To assess the earning capacity of the firm. ‘To estimate and evaluate the stock and fixed assets of the concern, To assess the firm’s capacity and ability to repay short term and long term loans. To estimate and examine the possibilities of future growth of business, To expect about the administrative efficiency of the management of the business concern ayaypn‘ 1 Statements Although financi jmitations. 1 financial 5 Statements provide us with much useful information yet they sulTer from mY Aen wre based on actual ‘ofa machine, bad winess and Financial | facts, ae aa Are not very definite: Although some figures in financial Sai debts and meth se Ses ete, Yet profits are influenced by many presumptet og, lite! Vien thea thee Of valuation of stock, etc, The accountant makes many ‘assumptions umptions do not prove tre there is los instead of profit. No kn Da knowledge of the present value ofthe business: Financial statements Book are cause there is a great difference in the market value and the book lue of assets may be same as market value, statements al alue of the i: tv il to give the preset ry that the value, It is not necessal 1g the business. Di in isclose only monetary facts: Financial statements do not give complete information Fees Na money, only those information are available that can be expressed in money. Those that cannot bbe expresse’ ¢ that cannot be expressed in money are let, howsoever, important they may be. Je which can prove the accuracy Figures of financi " ic cial statements are not very true: So far there is no such devi e ruthfulness oF of the figures given inthe financial statements. Thus there is no proper method of finding out th the figures. Decoration of accounts: Now-a-days too much atention is given on the decoration of accounts. Thus accounts are prepared in such a way that legal requirements are fulfilled and the financial position of the business seems to be sound but actually these accounts are far from the truth. Fixed time limit: Financial statements are true on the date on which they are prepared. Before and after that date they are not true, Interim reports: Financial statements are merely interim reports since true profitability of the business can only be judged when the business is actually closed down. Moreover, they do not reflect the piece level changes: hence the financial data for different accounting periods are not comparable. Financial Statements are affected by personal bias and knowledge: Financial statements are the result of various accounting concepts and conventions combined with the personal judgment on various factors, €.8., ‘accrual concept, convention of conservatism, treatment of deferred revenue expenditure, distinction between capital and revenue, method of charging depreciation, stock valuation methods and so on. Process of Financial Statement Analysis Rearrangement of Financial Statements 1 Approximation of figures I Establishing Relationship between elements(@) Rearran, gement of fi sheet and profit and lose Put, “Just as itis dif economic sense out files, counting is si ial stateme Statements: For comparative study of financial statements, the balance ‘omparative study of various la cult scott! Mus be classified in various parts in a systematic manner. Leaner, has nicely Of heaps to, Count the number of people in a disorganized crowd, so itis difficult to make mpliftages Of Uireated financial facts Once the crowd is arranged in numbered rows and (0) Approxim: ation of approximatedan io tes To. make crnprson easier and more andentandabe the figures may te ‘earest thousands, lacs or millions, as the case may be (©) Establishin, "8 relationship between elements: In the words of leaner, “An orderly and careful process of estimating probabil trained Ten iia. based upon a sound knowledge of the past, must meet with relative success just 25 2 future i save a higher proportion of ill patients than will a witch doctor.” Thus in financial analysis is proj a Projected on the basis of analysis and interpretation of past data and present trends. Techniques and Tools of Fir Analysis The followii ~€ lowing are the main techniques mainly used in the analysis and interpretation of financial statements: (a) Comparative Fi @ Compa mes nancial Statement (©) Common Size Financial Statement (@) Trend Analysis (@) Funds Flow Statement (Cash Flow Statement (a) Comparative Financial Statement: Comparative Financial Statement may refer to:- (i) Financial Statements of an enterprise for two or more successive accounting years. i) Financial Statements of different enterprises for the same accounting year. (iii) Financial Statements based on relationship among the components of financial statements for two or more successive accounting years. .¢ magnitude and direction of changes in enterprises financial position and These statements are prepared to study the in ascertaining the strengths and weaknesses of the enterprise in terms of performance. These statements are useful liquidity, profitability, solvency ete. rative Statement may show: 1, Absolute figures (rupee amounts). 2 Changes in absolute figures i.e. increase or decrease in absolute figures, 3. Absolute data in terms of percentages. 4. Increase or decrease in terms of percentages.Comparative Statements Comparative Income Statement Comparative Balance Sheet 1. Comparati . operations i Statement: The income statement discloses Net Profit or Net Lass om account of change from one earative Income Statement will show the absolute Figures for wo or more periods, the absolute or more periods Peo! © another and, i desired, the change in terms of percentages. Since the Figures for TH decreased, whe stow side by side, the reader can quickly ascertain whether sales have increased, oF Compara nhtther cost of sales has increased or decreased, ete. Thus only a reading of data included in ive Income Statements will be helpful in deriving meaningful conclusions. Comparative Balance Sheet: Comparative Balance Sheet as on two or more different dates can be used for Bae assets and liabilities and finding out any increase or decrease in those items. Thus. while in a single Baance Sheet the emphasis is on present position, itis on change in the comparative balance sheet. Such lance sheet is very useful in studying the trends in an enterprise. (b) Ratio Analysis: Ratio is one figure expressed in terms of another; it is an expression of relationship between one figure and the other figure which are mutually interdependent. Ratio Analysis is one of the techniques of financial analysis where ratios are used as a yardstick for evaluating the financial condition and performance of a firm. Analysis and interpretation of various accounting ratios gives a skilled and experienced analyst, a better understanding of the financial condition and performance of the firm than what hew could have obtained only through a perusal of financial statements Ratios can be expressed in various forms stated below: (Pure Ratio or Simple Ratio: Its expressed as a quotient as 2.5 as we do in calculating current ratio or acid test ratio, e.g., current assets are Rs. 500000 and current liabilities are Rs. 200000; the current ratio would be ‘current asseis/current liabilities ie. Rs. 500000/200000 = 2.5. Rate: The ratio between two numerical facts, usually over a period of time, e.g. stock turnover is 4.2 times 1 year or fixed assets turnover shows that the sales during the periods are 3.5 times more than the fixed assets. Percentage: A special type of rate which expresses the relation in hundredth, e.g., gross profit is 25% on sale or rate of return is 15% on capital employed. Gi Classification of Ratios Solvency Profitability Activity Liquidity Ratios Ratios. Ratios Ratios 5(1) Solvency Ratios: () Debt Equity Ratio The objective of ¢ fa firm, of Computing this ratio is to measure the relative proportion of debt and equity in financing the assets of ‘Components: TI te here are two components ofthis ratio are as under: (0 Long Term Debi: — Which mean loner lars eter secured or unsecured eg, debentures, bonds, oan fom Financial institutions), Gi) Shareholders funds: minus fictitious ass Which mean equity share capital plus preference share capital plus reserves and surplus ets (eg, preliminary expenses), Computatioy ____This ratio is computed by deci ratio may be expressed as under:— the long term debts by the shareholders funds. In the form of formula, this Long-term Debts Debt Equity Ratio ——=————_——_ uty Ratio areholders Funds Interpretation:— It indicates the margin of safety to long-term creditors A new debr equity ratio implies the use of more equity than debt which means a larger safety margin for creditors since owner's equity is treated as a margin of safety by creditors and. (@ vice-versa. Importance:— The Ideal Ratio is 2:1. t means that the shareholders funds must be equal to outsider’ funds. It can be said that if in a cconcem the outsiders funds are equal to shareholders funds then itis considered to be satisfactory, thus the aac ratio is calculated to measure the soundness ofthe long-term financial policies of a business concern, (by Interest Coverage Ratio (or Debt Service Ratio): Meaning:- “Tis ratio establishes a relationship between net profi before Interest and taxes and intrest on ong term debts, Objective: -te objet of computing hs ratios 0 mesure he debts evcng capacity oF frm so faras Fixed interest on long term debt is concerned. 6 eeComponents;~ There a Te Wo components of this ratio which are as under: a Net profits before Interest and Taxes Interest on long-term debts. Computatior This ratio is computed usually expressed ac Nye the net profits before Interest and Taxes by interest on long-term debt. This ratio is ‘number of times. In the form of a formula, this ratio may be expressed as under:— Net Profit Before Interest & Tax Intereston Long-term Debt Interest Coverage Rat ‘ Interpretation: This ratio measures the margin of safety of the tenders. If profit ust equals interest, itis a bad position for the company Since nothing will be left for shareholders and an unsafe one for the tenders. Importance: This ratio is important from tender’s point of view and indicates whether the business can eam sufficient profits to pay periodically the interest charges on fixed or long term loans or debentures, Ideal Ratio is 6 or 7 times. (c) Debt to Total Funds Ratio:— Meanin; ‘This ratio establishes a relationship between long term debts and capital employed. Objectiv @ The objective of computing this rato is to determine the relative stake in the concem of outsiders as well as shareholders. Components:— of this ratio which are as under: “There are two components Long term debis @ Capital Employed (Long term 6 Gi ‘Computation:— ; se computed by dividing the Ing term det bythe capital employed nthe Form of formula, this rato may be ois febis plus shareholders flunds) This rati his ted as under —Long-term debt_ Debt to Total Funds Rati u Capital Employedn financial soundness of the jo would be risky. It may the concern will find ratio and measures the long. term This "S ratio establishes a relationship between proprietors funds and total assets Objective: The objective of computing this ratio is to determine the long-term solvency of the concern, ‘Componeats:— ‘There are two components of this ratio which are ‘as under: (Proprietors funds (i) Total assets ‘Computation:— This ratio is computed by dividing proprietor’s funds by the total assets. In the form of formula, this ratio may be expressed as under:— ; a Proprietor funds Proprietary Ratio= e Total Assets @ interpretation:— [As proprietary ratio represents the relationship of owners funds to total assets, higher the ratio or the share of the ‘Shareholders in the total capital of the company, better is the long-term solvency position of a company. Importance:— “This ratio is important as it indicates the extent fo which the assets of the company can be lost without affecting the interest of creditors of the company. (2) Profitability Ratios:— (y Profitability ratios in relation to sates: (c) Gross Profit Ratio:~ Meaning:— This ratio establishes the relationship between gross Profit and Net Sales. 8Objective:— The main object hective of comput ; an — Operations are carried op Utns this ratio is to determine the efficieney with which production ind oF put ‘Components:— qT here are two components ofthis ratio which ae as under @ Gross Pr i *s Profit — Which is excess of Net Sales over cost of goods sold. Or GP = NS - COGS ii) Net Sales — Which ‘ et Sales — Which is gross sales (both cash and credit) minus sales return. ‘Computation:— This ratio is computed by dividi . i sales. It is express tage. In the form of a ‘= formula, this ratio may we the gross profit by the net sales. It is expressed as percentage. sed as under:— Gross Profit Ratio= S88 Profit 100 ‘Net Sales Interpretation:— This ratio indicates (a) an average gross margin earmed on a sales of Rs. 100, (b) the imit beyond which the fall in sales Prices will definitely result in losses, and (c) what portion of sales is left to cover operating expenses, (other than the cost of goods sold) and non operating expenses (e.g. interest on borrowed funds), to pay dividends and to create reserves. Importance:~ This ratio is important as it measures the profitability of the enterprise. It shows the efficiency of the works (factory) of the organization Higher the ratio the more efficient the production and / or production management. ‘This ratio establishes a relationship between Net Profit and Net Sales. Objectives ‘The main objective of computing this ratio is to determine the overall profitability due to various factors such as operational efficiency, trading on equity ete. ‘Componen “There are two components of this ratio which are as under: (Net Profit (iy Net Sales Computation:dj as a percentage. In the form of @ ressed as 4 This ratio is comy Puted by div i a formula, this ratio may viding he ne Profit by the met sales. It is exp Net Profit. 199 ‘Net Sales Net Profit Rati Interpretation:— ‘ i id This ratio indicates (a) an J sales is left to pay dividens Average net margin eamed on a sale of Rs. 100, (b) what portion of fo a ll and to create reserves, and (6) i's capacity fo wisn adverse economic eondtons when sling piss dcr To wih retion is rising and the demand forthe product i falling. /7igher the rato, greater is the capac Withstand adverse economic conditions and vice-versa, Importance: This ratio is very useful to proprietors and prospective investors because it reveals the overall efficiency and profitability c of the concern, (©) Operating Profit Ratio: Meaning: This ratio measures the relationship between operating profit and net sales. Objective: ‘The main objective of computing this ratio is to determine the operational efficiency of the management. Components:— There are two components of this ratio which are as under: (i) Operating Profits: Which is the excess of gross margin/gross profit over other operating expenses (eg. office and administrative expenses, selling and distribution expenses, discount, bad debts, interest on short-term debts) and (i) Net Sales: Which means gross sales (both cash and credit minus sales return). ‘Computation:— This ratio is computed by dividing the operating profit by the net sales. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as under: Operating Profit , Operating Profit Ratio=. pene Net Sales 100 Interpretation:— ‘This rato indicates (a) an average operating margin etme ona sle of Rs, 100 and (b what portion of sales is leh les is left to cover non-operating expenses 1 pay dividend and to create reserves, Higher the rom Geni management, This ratio may increase due to any one ofthe following factors”: Me More efficient is the operating (Higher gross profit Lower operating expenses ) 10Gi) A combination of aforesaid two factors Importance:— This ratio is useful as ch reveals only overall ‘i io whi efficiency, I measures eeeNides the operational efficiency as against net profit rat w he rate of net operating profit to sales (@) Operating Ratio: Meaning:— ‘This ratio measures the relationship between operation cost and net sales. Objective:— ‘The main objective of computing this ratio is to determine the operational efficieney with which production and / oF _ Purchases and selling operation are carried on. © Components: There are two components ofthis ratio which areas under: (Operating Cast: Which comprises (a) cost of goods sold and (b) other operation expenses (e.g. Administrative expenses, selling and distribution expenses, interest on short term loans, discount allowed and bad debts.) (ii) Net Sales: Which means gross sales minus sales return. ‘Computation: “This ratio is computed by dividing the operating cost by the net sales. This ratio is expressed as a percentage. In the form of a formula, this ratio may be expressed as under:— go Operating Cost Operating Ratio= QPeTting Cost 199 ing Rano Net Sales Interpretatio C ‘This ratio indicates an average operating cost increased on a sales of goods worth Rs. 100. Lower the ratio, greater is the operating profit to cover the non-operating expenses, to pay dividend and to create reserves and vice-versa, Importance:— “The main purpose of this rato is to compare the various cost components for determining any increase or decrease thorein, It is used to determine which element of cost has given up. (c) Expenses Ratio:- ‘These ratios are calculated for individual item of expenses to test the profitability of a c i Trhaarship betwen operating expenses and volume of sls, I is also valuable forthe purpone sf findign ee nea setioteat extent expenses vary as between diferent trading periods nding out whether are generally calculated:— ‘The following rat (a) Ratio of Materials used to sales: it3t Material Cost 199 Direct Material Cost to Sales Ratio ‘Net Sales (©) Ratio of Labor Cost to Sales: Direct Labour Cost to Sales Ratio = Ditect Labour Cost. 99 Net Sales (©) Ratio of Factory Expenses to Sales: Direct Expenses to Sales Ratio = Diteet Expenses , 199 Net Sales (Ratio of Office and Administrative Expenses to Sales: Office and Administrative Expenses €. Net Sales id (©) Ratio of Selling and Distribution Expenses to Sales: Selling and Distribution Expenses to Sales = ots! Selling and Distribution EXP... 199 Net Sales (f) —_ Fimancial Expenses Ratio: Total Financial Expenses , 199 ‘Net Sales. Lower the ratio, the greater is the profitability and higher the ratio, lower is the profitability. Interpretati ii) Profitability Ratios in Relation to Investment (a) Retura on Investment (RON or Return on Capital Employed: (C Meaning:- ‘This ratio measures a relationship between net profit before interest and tax and capital employed. Objective:~ ‘The objective of computing this ratio i to find out how efficiently the long-term funds supplied by the credi shareholders have been used. ipplied by the creditors and ‘Components:— ‘There are two components of this ratio which are as under: (i) Net Profit before Interest and Tax. (i) Capital Employed: Which refers to long-term funds s ‘comprises the long-term debt and shareholders funds, Prued OY the long-term creditors and shareholders, It 12Computation:— i rat is expressed a5 @ pore COMPU by ving th et pt tere nee and a by epi enpayed 15 =P conage 3 net profit before interest an Inthe form ofa formula this ratio'may be expressed oo under Net Profit before Interest and TAX , | gg Capital Employed Return on capital employed Interpretation;— io indi rat re TH tio indicates the firm's ability of generating profit per rupee of capital employed. Higher the ratio, the mo icient the management and utilization of capital employed. Importance:~ 1; Tean be used for planning the capital structure. C 7 lis ameasure of overall profitability of an enterprise 3. Itshows the earning capacity ofthe net assets used in the busines. (b) Return on Equity/Return on Shareholders funds:~ Meaning: This ratio measures a relationship between net profit after interest and tax and shareholders funds. Objective: The objective of computing this ratio to find out how efficiently the funds supplied by the equity and preference shareholders have been used, ‘Components:~ ‘There are two components of this ratio as under:— Ce) Net profit after Interest and Tax (it) Shareholders funds which mean equity share eaptal plus preference share capital plus Reserves and Surplus minus fictious assets (if any). Computation:— This ratio is computed by dividing the net profit after interest and tax by shareholders funds. Iti percentage. Inthe form of a formula, this ratio may be expressed as under-- nds. Tis expressed as a Net Profit after interest and tax Shareholders Funds = Return on Shareholders Funds 100. Interpretation:— This ratio indicates the firm's ability of generating profit Per rupee of sh the management and utilization of shareholders frrds. Pee of shareholders funds. Higher the ratio, more efficient 13Tmportance:— Whel PS in measuring a profit earning capacity efficiency an financial decision ofthe management (©) Retura on Equity Shareholders Funde:- Meaning: This ratio measures ce dividend and equity shareholders Ranure® & ‘elationship etween the net profit afer interest, tax and preference dividen Objective:— Tix ohiestive of computing this ratio to find out how efficiently the funds supplied by the equity shareholders have been ‘Components:~ e There are two components of this ratio, which are as under (i) Net profit after Interest and Tax. preference dividend (including participating dividend of any, due to Participating preference share) (ii) Equity Shareholders funds which mean equity share capital plus Reserves and Surplus minus fictious assets (if any). ‘Computation: This ratio is computed by dividing the net profit after interest and tax and preference dividend by shareholders funds. It is expressed as a percentage. In the form of a formula, this ratio may be expressed as under:— Net Profit after interest, tax andpreference dividend wen on Esty Mera Shareholders Funds 100 This ratio indicates the firm's ability of generating profit per rupee of equity shareholders funds. Higher the ratio, more © csiicient the management and utilization of equity shareholders funds. Importance: ‘This ratio is more meaningful to the equity sharcholders who are interested to now profits eared by the company and those profits which can be made available to pay dividend to them. (b) Earning Per Share (EPS) Meaning: “This ratio measures the eaming available 10 an equity shareholder on a per share basis ‘Objective: The objective of computing this ratio o measure the poftaility ofthe frm on pet equity per share bas y is 4There a “e {WO Components of this ratio, which . » Which are as under:~ “1PrOft after Interest, Tex: and Preference Dividend (i) Number of Equity Shares, ‘Computation:— This ratio is cor - is expressed come ake viing the net prof afer intrest, tex and preference dividend by the vo fealty shares € figure. In the form of a formula, this ratio may be expressed as under:— Ne ot Profit after Interest, Tax and Preference Divident, yy ‘No. of Equity shares * Interpretation: I jn Seneral, higher the figure, bitter it is and vice-versa while interpreting tis ratio, it must be seen whether there is ny yerease in equity shareholders funds as a result of retained earings without any change in numbers of outstanding Importance:— ‘This ratio helps in evaluating the penciling market price of share inthe light of earning capacity of the concern. G) Activity Ratios:— (a) Capital Turnover Ratio:— Meaning:~ This ratio establishes a relationship between net sales and capital employed. Objective:— ‘The objective of computing this ratio is to determine the efficiency with which the capital employed is utilized. EeComponents:— ‘There are two components of this ratio as under: ‘Net Sales — Which mean gross sales minus sales return. @ Gi) Capital Employed — Which mean long erm deb pus sharholers funds Computation:— «ratio is computed by dividing the net sales by the capital employed. This ratio is usual i This ee orm ofa formula, this ratio may be expressed as under: iy expreased as nanan of ; ratio= ——Net Sales Capital Turnover Capital Employed Interpretation: 1sIt indicates the . firm's abil efficient the mani er 10 generate sales per rupee of capital employed. IN ge trading (or under-ea \utlization of capital employed, A too high ratio may italization), ploy’ ih sneral, higher the ratio, the more indicate the situation of an over (b) Fixed Assets Turnover Rat Meaning:— Thi i "S Tati establishes a relationship between net sales and fined assets employed Objective: The otheci i " objective of computing this ratio isto determine the efficiency with which the fixed assets employed are utilized. Components: ‘There are two components of this ratio as under: Gi) Net fixed (Operating) Assets — Which mean gross fixed assets minus depreciation thereon. Net Sales — Which mean gross sales minus sales return. ‘Computation: This ratio is computed by dividing the net sales by the net fixed assets. This ratio is usually expressed as ‘x’ number of times. In the form of a formula, this ratio may be expressed as under: Net Sales Fixed Assets Turnover Ratio = ——————_ Net Fixed Assets Interpretation:— It indicates the firm's ability to generate sales per rupee of investment in fixed assets. In general, higher the ratio, the more efficient the management and utilization of fixed assets and vice versa. (© Working Capital Turnover Ratio:— Gearing: This ratio establishes a relationship between net sales and working capital. Objective:— “The objective ofthis ratio is to know how many times working capital results in sales. ‘Components:— ‘There are two components of this ratio, which are as under; (i) _Net Sales — Which means gross sales minus sales return, Gi) Capital Employed — Which means current assets minus current liabilities, ‘Computation:— 16This ratio is f ‘omputed by divi sed as x’ number of times. Int ted by dividing the net 's ratio is usually expre: the form of formula, thc rtin ineybe coeds cee “ Working Capital Tumover Ratio = —Net Sales _ Working Capital Interpretation:— higher the ratio, the more efficient (©) Stock Turnover Ratio:— Meaning: This ratio establishes a relationship between cost of goods and average inventory Gviectives The objective of computing this ratio is to determine the efficiency with which the inventory is utilized Components: ‘There are two components of this ratio, which are as under: @ Cost of goods sold — Which is calculated as under:— Cost of goods sold= Opening Stock +Net Purchases + Direct Expenses — Closing Stock (ii) Average Inventory — Which is calculated as under:~ Opening Stock + Closing Stock Average Inventory 7 (@omputation:- This ratio is calculated by dividing the cost of goods sold by the average inventory. This ratio is usually expressed as 'x’ no. of times. In the form of a formula, this ratio may be expressed as under:— Cost of Goods Sold “Average Inventory Stock Turnover Ratio = Interpretation:— It indicates the speed with which the inventory is converted into sales. In general, a high ratio indi , performance since an improvement in the rato shares than other the same volume of sales fas beth, ened in fower investment in stocks, onthe volume of sales has increased without any increase inthe amount of siocke faon ta rato may be the result of very low iavenory levels which may result in frequent stock outs and tna vee os high stock out costs. On the other and «10 low ratio may be the result of excessive inventory levels hee ne net ‘absolute inventory and thus, the firm may incur high carrying costs, moving on 7The objecti ve of computing this ratio; ‘Omputing this ratio is to determine the efficiency with which the trade debtors are managed. Components: There are tw *¢ two components of this ratio, which are as under: Net Credi . €t Credit Sates — which mean gross credit sles minus sles return (i) Average Trade Debtors ( ¢ ‘including bills receivables) which are calculated as under: Average Trade Debtors = Pehing Debtors + Closing Debtors 2 Computation: no. of times. This ratio is calculated by dividing the net credit sales by average trade debtors. This ratio is expressed as Ina form of formula, this ratio may be expressed as under:~ Net Credit Sales Debtors Turnover Ratio = “+ STECT SES _ ‘Average Trade Debtors Interpretatio It indicates the speed with which the debtors tumover on an average year. In general, a high ratio indicates the shorter collection periods which implies prompt payments by debtors and alow ratio indicates a longer collection periods, which implies delayed payments by debtors. However Zoo high ratio may be the result ofa restrictive credit and collection policy, which may curtail the sales and consequently profs. On the other hand, a too low ratio may be the result of Ped and inefficient credit and collection policy, which may involve the risk of bad debts and burden of high interest © cost involved in maintaining a higher level of debtors Average Debtors ‘Net Credit Sales “1? "mS ‘Average Collection Period in Months = Average Debtors ‘Net Credit Sales “> "28S ‘Average Collection Period in Weeks (©) Creditors Turnover Ratio: ‘Meaniny rie rato establishes a relationship between net credit purchase end average trade creditor, is opjective- computing this rato isto determin he efficiency with which the trade creditors are managed ‘The objective of 18‘Components: Ther ¥© are tWo components of this ratio, which are as under: @ Net Credi ‘ "edit Purchase — Which mean gross eredit purchase minus purchase return. ii) 4 ; Yerage Trade Creditors (including bills payables) which are calculated as under: Average Trade Creditors = Opening Creditors + Closing Creditors 2 Computation:— ng the net credit purchase by average trade creditor. This rato is expressed a5 x' no. of ratio may be expressed as under:~ € Creditors Turnover Ratio = —Net Credit Purchases Average Trade Creditors Interpretatio It indicates the speed with which the creditors tumover on an average each year. In general, a high ratio indicates the shorter payment period, which implies either the availability of less credit or earlier payments and a /ow ratio indicates a larger payment period which implies either the availability of more credit or delayed payments. Average Trade Creditors Average Payment Period in Months = x12 months = see Net Credit Sales ai Average Trade Creditors t Petiod in Weeks = Average Trade Creditors. > weeks Average Payment Period in Weeks = Aveae= Trace Ca (4) Liquidity Rati (a) Current Ratio:— € Meanii ‘This ratio establishes a relationship between current assets and current liabilities. Objective: “The objective of computing tis ratio isto measure the ability ofthe fim to meet its short the short-term financial strength solvency of a firm. In other words, the objective is available for short term creditors. term obligations and to reflect, to measure the safety margin ‘Components:— “There are two components of this rato, which are as under: (iy Curren Asset — Which mean the assets which are held for tet conver cash bank, debtors, bills receivable, marketable Securities, other short term securnacg ni & YER" ad include 2 . stock, prepaid expenses 19i yclude Which mean the liabli hort term loans and ad ‘Computation;— This is ratic . x form of formula, this ratio may be expressed as under:— Current Ratio = _Current Assets Current Liabilities Interpretation: ca aes rupees of eater the margin of edit, {Sets available for each rupee of current liability. Higher the ratio prea in safety for short term creditors and vine ‘versa Too high rate may indicate the presence of ile funds wit the frm on the eeNCe Of investment opportunites wit te eae ay may indiate the over trading/under capitalization if the capital tumover ratio is high, (©) Quick Ratio/Acid Test Ratio/Liquid Ratio: Meaning:— ‘This ratio establishes a relationship between quick assets and current liabilities, Objective:— The objective of computing this ratio is to measure the ability ofthe firm to meet its short term obligations as and when due without relying upon the realization of stock. ‘Component ‘There are two components of this ratio, which are as under: i) Quick Assets — Which mean those current assets which can be converted into each immediately or at a short Bice wnt vans¢ mle ena ace current assets except stock and prepaid expenses. Current Liabilities — Which mean the liabilities which are expected to be matured within a year, ivi by the current liabilities. This ratio is expressed as a pure ratio eg. Jculated by dividing the quick assets by Tr amo formula, this rai maybe expressed ws under Quick Assets Quick Ratio Cent Liabi Interpretation:— It indicates rupees of current assets avaable foreach rupee of current iailty. It measures the short term solvency of the tind company. 20into percentage ize Financial Stat {68 10 some commor < are conver ements: Common-Size Finaneal Statements are those in which TENE reported are i 0 ind all figures are expre: a bereentage ofthis torah base In the Income statement the sale figure is assumed t0 be 100 a © statements comprise the f © the followis GAbsolue or the following statements: “eine pots i ‘ ‘nts of individual items of balance sheeUprofit and loss account For two oF more Se (_Persntage to some common tase Unless oss ales ins sales eu ken ase oR ements faut items and the total of iailtes and assets taken as base tothe Balance Soe eM i yaig indicates the stat ee he vertical analysis since each acconting variable i analyzed tae eally. This type of analy’ . static relationship si i . Comma. Si ip since the relative changes are studied at a specified date. . Hower Fa an Statements are useful for aeribg ie ‘comparative financial position of two or nt esr 7 be more or lees rahe omarison relly meaning its necessary that the financial statements of all such comp 7 is ing practi depreciation on fixed assets shoal ete SAN ARE they shou be fllowing the same aeeountng pacts the method of depr Common-Size Financial Statements Common-Size Income Statement Common-Size Balance Sheet (@) Trend Analysis: Trend percentage analysis is atime series analysis to determine the trend of the financial data over a series of years. The working of the trend percentage analysis involves the following three steps: (i) Selection of a base year, ‘Assignment of an index number of 100 to each item of the base; and }) Calculation of percentage relationship that each item bears to the same item in the base year. While calculating trend percentages, care should be taken regarding the following matters: 1. The accounting principles and practices followed should be constant throughout the period for which analysis is made. In the absence of such consistency, the comparability will be adversely affected. 2. The base year should be carefully selected, It should be a normal year and be representative of the items shown in the statement, Trend percentages should be calculated only for items having logical relationship with one another. Trend percentages should be studied after considering the absolute figures on which they are based, otherwise, they may give misleading results, For example, one expense may increase from Rs. 100 to Rs. 200 while the dther expense may increase from Rs. 10000 to Rs. 15000. In the first case trend percentage will show 100% Srerease while in the second case it will show 50% increase. This is misleading because in the first case the change though 100% is not at al significant in real terms as compared tothe other. 5, ‘The figures for the current year should also be adjusted in the light of price level changes as compared to the base year, before calculating the trend percentages. In case this is not done, the trend percentages may make the whole comparison meaningless. For example, ifthe prices in the year 1998 have increased by 100% as compared. wenr90%, the increase in sales in 1998 by 60% as compared to 1997 will give misleading results, Figures of 1998 ust be adjusted on account of rise in prices before calculating the trend percentages, ” 3 4 vrunds Flow Statement: Funds Flow Statement is statement prepared to indicate the increases i (©) Funds jeation of such resources of business during the accounting peiod eases in the cash resources Funds Flow analysis has become an important tool in the analytical kit of financial analysts, credi ici Fund cial manages. This is because the balance sheet ofa business reveals is financial san ae rants shone an it does not sharply focus those major financial ransactions which have been behind the balaeec ewes ee ete ‘example, if a loan of Rs 200000 sas cise and Paid during the accounting year, balance ee ae ie transaction. However a financial an now the purpose for which the loan was util not depict this utilized and the x source fromWhich it was obtai : obtained. i Policies, ained. This will help him in making «beter estimate about the company’s financial position and wihich the working n. It tells about the sources from which t et. Workii igs out in open the changes which have taken place /orking capital being the life-blood of the business, such an analysis is extremely useful si ; carital was cota sis reveals the changes in working capital posit behind the balance she Preparing Funds Fl Fem Tron ee rands Flow Statement: ‘edule of changes in Working Capit 7 Funds Flow Statement eer {P.Cash Flow Statement: A cash flow statement can be defined as a statement which summarizes Soures of cash inflows and uses of cash outflows ofa firm during particular period of ime, say month ora year In the preparation of cash flow statement we restrict ourselves strictly to sources and uses of cash alone and even a most liquid current asset like bills receivable or book debts is excluded for this purpose. Since the idea of preparing this statement is to summarize the impact of various transactions immediately resulting in cash inflows and cash outflows. ‘Transactions which increase the cash position are termed as inflows of cash and those which deerease the cash position © as outflows of cash, In nuishell, we ean say that a cash flow statement shows the sources of cash receipts and the purposes for which payments are made thus explaining the changes inthe cash balances of the business. Steps or process of preparing Cash Flow Statement: )) Cash form Operations Gi) Cash Flow Statement 2What is Forensic Forensic account detailed research Prepare for fi fraud, skimming, forming extremely re often hired to embezzlement, Accounting? ng isthe investigation of fraud or financial manipulation By Per rd analysis of financial information. Forensic accountants igation related to insurance claims, insolvency. divorces, and any type of financial theft financial statements, and Forensic Accou gal support, and resolving other related conflict, This i forge, Fequires technical skills in accounting, investigation and legal. These are what dri accounting to become more attractive and highly paid. Tinea is an art of investigation over accounting records, ancial records. The result of investigation mostly use for le ive as a dispute The investigation is cover certain areas include fraud, crime, insurance claims as well among shareholders. The investigation and verification are normally done to the company's financial statements, management accounts, and other related documents, data, and information related to the subject matter being investigated. The common procedures would be financial statement analysis, computer assistance, supporting document examination, investigation, and interview. This engagement is engaged with the professional firms that have professional experiences, expertise in accounting standards, and legal background. Preparing for Litigation ‘You might have heard the phrase “forensic evidence” before, which simply means evidence that is able to be presented in a court of law. Hence, forensic accounting is an analysis of financial information that can be used to support a case in a court of law. The process of digging through all of a company’s or individual's financial information can take months or even years, and requires a team of specialized accountants that act like detectives trying to solve a mystery. Typically, an accounting firm will be engaged by a client either looking to defend themselves, or one looking to prosecute someone. Most medium- to large-sized companies have a forensic accounting, department, which may consist of various forensic auditors. ‘Types of Forensic Accounting are various types of forensic auditing that can take place, and they are typically organized by the types of legal proceeding that they fall under. Below are some of the most common example: 2 Financial theft (customers, employees, or outsiders) Securities fraud Bankruptcy Defaulting on debt Economic damages (various types of lawsuits to recover damages) M&A related lawsuits Tax evasion or fraud Corporate valuation disputes Professional negligence claimsMoney laundering ivacy information * Divorce proceedings The two major aspects within fermen Hahah in forensic accounting practices are: ‘ hee rpbort services. A forensic accounting expert measures the damages experienced z courtroom, Meh i Heel disputes and can aid in settling conflicts, even before it reaches the could event that a conflict reaches the courtroam, the forensic accounting profestio" 2 in eatigativel® evidence as an expert ee Sach oe aeativefact-finding services, A forensic accountant must determine whether iegat MAN account Oe felony, securities embezzlement (including tampering and distortion of financial The ), Ider theft and insurance racket have taken place. scope of forensic accounting is to: 1. Look for evidence of unusual development in the accounting and financial systems. 2. Design accounting processes for verifying important premises and data. A forensic accounting orientation also. calls. for _—skills.—in’— identifying —_possible ‘fraud. 3. Perform audit type processes on a routine schedule in order to reduce transaction processing risks. 4. Cover a broad range of businesses and locations that require customary or continuous surveillance of all transaction processing systems. Relevance of forensic accounting in an organisation * Assessing working transactions for compliance with basic operating processes and agreement. * Performing thorough scrutiny and examination of financial payment dealings in the accounting system to decide if they are standard + or _—beyond company _policy. + Assessing standard ledger and financial reporting system transactions for likely unlawful tampering or falsification of information or accounts and its consequences on the ensuing financial accounts. Analysing warranty requests or returns for practices of fraudulence or misuse. « Assisting in estimating the economic damages and the ensuing insurance demands that arise from catastrophes such as fires or other natural setbacks. « Assessing or affirming business rating in consolidations and accomplishments. Forensic Accountants: Scope of work ‘Although the focus is fundamentally on accounting concems, the function of a forensic accountant may also cover a more generic investigation including collection of evidence. ‘Almost every accounting firm in the country today has forensic accounting sections. Within these Sections, there may be sub-differentiations; for instance, some forensic accounting experts. may Specialize in insurance applications, personal injury declarations, and fraudulence, construction or royalty audits. Forensic accountants may also offer their services in retrieving profits from crime and in relation to appropriation proceedings relevant to definite or assumed proceeds of crime or dubious transfer of Fonds’ Unique only to India, there is a specific species of forensic accountants known as Certified Forensic Accounting Professionals. certifiesIsorily ‘ 7 i in (RBI) has compulsorily Gren ‘the nae aa Tee of fraud in India, the Reserve Bank of ney. The sae eoreni made forensic “ccounting audit mandatory for all banks hecome the turning poin Serious Fraud Investigation Ofen (SFIO) in India eo nae ar the fold xt a pnattants in the country. The indications of the growing 7 Ale Browing list of online criminal offences en - Bresson regulators to trace and detect pirmantiy ta ~ The long chain of co-operative banks going buHuman Reso The concept Resource Ac 7 5 ay Accounting ~ Meaning ‘countin, a fesource accounting has been defined by the Of the American Accounting Association as “the process of identifying sd measuring d lata about hy Parties.” tuman resources and communication this information (0 interested -ommitiee on Human The Americ an Ac fallows— ‘counting Society Committee on Human Resource Accounting defines it as “Human Re tesource Accounti resources and. irce Accounting is the process of identifying and measuring data about human san eee Ia simpl communicating this information to interested parties.” le terms, it i . nple terms, it is an extension of the accounting principles of matching costs and revenues and of or; of organizing data to communicate relevant information in financial terms. Since the beginning of globalisation of business and services, the human resources are becoming more important and decisional input for the success of any corporate enterprise. Human resource accounting (HRA) involves accounting for expenditures related to human resources as assets. lll the processes of the organisation are operated by human resources, thereby the changes in the HR cost and benefits must be considered. Though it has been accepted that HR is capital resource thereby the valuation of this resource is very necessary and information about the valuation should be given to the investors, the management and others through financial statements. Human resources accounting is basically an information system that tells management what changes are occurring over time to the human resources of the business Human resources accounting (HRA) is one of the latest concept adopted by few corporations in our country. Most of the corporations have realised that human resources are their most precious resources. $0 itis required to taken some measures to develop thelr human resources but also taken measures to accelerate their values. tives of human resource accounting are as under: The basic object s managing the people as one of the resources of the organization. (1) HRA facilitate: 2) To help the management for making decision about acquiring, allocating, developing and vnaintaining human resources in order to Keep control on human resource cost as one of the organizational objective. formation o the management regarding human resource cost and value. (3) To provide in! (4) To see whether the human resourees are effectively utilized or notfinancers such as bankers, Tesources accounting de and creditors etc. Human Resources Accounting — Development & Wel 1. Acquisition Cost: ne sos incured in acquiring the ight man fr the Fight job at the right time and in cost is taken into consi site expenses incurred on recruitment, selection and placement entire ee sideration including those who are not selected. within on ee ~ Wis the cost incurred to identify sources of human resources both from side the organisation. For example, cost of recruiting materials, administrative expenses, advertising costs, agency fees, recruiter's salary and travel and outstation costs ii, Selection cost — It depends on several factors such as the type of personnel being recruited and the method of recruitment. The cost of selection defends on the position for which a person is being selected. The higher the position, the greater is the selection cost. It includes cost of application blanks, administrative cost of processing applications, conducting tests, interview, financial institutions to outsiders like ing and Top 3 Costs Involved: Acquisition, re medical examination and the consulting fees of the selectors. iii, Placement cost — In deciding upon the placement, the individual’s ability, attitude, interest, temperament and aspirations are taken into consideration with reference to the job requirements. ‘The cost of placement can be collected for the purpose of human resource accounting. 2. Training and Development Cost: It refers to the sacrifice that must be made to train a person either to provide the expected level of performance or to enrich the individual's skill. Training improves the productivity potential of both the individual and the organisation. ‘The training cost includes the following: <. Formal training cost ~ It refers to the cost incurred in conventional training for the orientation “fan individual so that he can handle the work. The remuneration to the training staff and the schools are essentially Human Resource Investment items, fixed cost of the training — Once the employee is placed on the job, he must be trained to do the ii, On the job training cost job efficiently and effectively and in this regard the employee learns while he is on his job. In the process, the costs of mishandling the job and the payments to the employee more than what he actually contributes, are ‘on-the-job training cost. Thus it is an investment in Human Resource. "Special training cost ~ To achieve the performance standards sometimes specific training programmes may be devised. The costs of such training are called special training costs and fall investment of the organisation, under the human resource iiv. Development programme development programmes to lectures to international con interact with other executives Cost — Employees may be allowed to participate in @ variety of enrich their faculties, These programmes may range from ordinary ferences and seminars, ‘The participants have an opportunity (0 ‘on national and international level, h association involves cost Such as delegate fees, the travel cost, loss of output during the development programme etc: Which are to be accounted for as 4 human resource investment 3. Welfare Cost: Management is afterall the creation and maintenance of an environment. Therefore, itis a vital function of an employer to provide an atmosphere to the employces to perform their work in healthy, congenial climate conducive for good health and high morale, The expenses incurred for this purpose will facilitate the employee to increase the quality of his civic life. These welfare costs can be classified as follows: i, Welfare and amenities within the organisation ~ Creches, rest shelters and canteens, latrines and urinals, washing and bathing facilities, drinking water and occupational safety etc., are the welfare facilities provided by the employer within the organisation, ii. Welfare outside the organisation — Social insurance measures, maternity benefit, medical ies, education facilities, housing, recreational facilities, holiday homes and leave travel facilities are some of the welfare measures provided outside the establishment, faciWhat do you me re ‘an by Corporate Social Responsibility? “Orporate Social R, big sized corporat sections of society, > As Per the C Buidelines The board shall ensure that the company spends, in every financial year at least 2% of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its corporate social responsibility policy What activities should be included by companies in their Corporate Social Responsibility? Encouraging education under poor sections of society > Promoting gender equality > Promoting women empowerment Eradicating extreme hunger and povertyReducing chi 8 chil i ld mortality and improving maternal health ‘ombating human ; i i , malaria and other di immunodeficiency virus, acquired immune deficiency syndrome, seases Ensuring envi ring environmental ‘Sustainability, Emy ployment enhancing vocational skills Social business projects > Contributi it tribution to Prime Minister's National Relief Fund Accountin; ig treatment of Corporate Social Responsibility expenditure > > Schedule VII to the company's bill, 2013 specifies a list of CSR activities. The accounting of CSR activities will be done as under: n case a contribution is made to a fund specified in Schedule VII to the Act, the same would be treated as an expense for the year and charged to the statement of profit and loss. > In case the company incurs any expenditure on any of the activities as per schedule VII on its own, the company needs to analyse the nature of the expenditure keeping in mind the “Framework for Preparation and Presentation of Financial Statements issued by ICAL. ‘on any of the activities as per schedule VII is > Incase the company incurs any expenditure .d as an expense to the statement of profit or of revenue nature, the same should be charge: loss. > Incase the company incurs any expenditure which give rise to an asset the company reed to analyse whether the expenditure qualifies the definition of the term asset as per ‘whether it has control over the asset and derives future economic