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A Research Project on A Significance of Financial Ratio Analysis in Decisions

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Thesis · January 2013

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 A Research Project on

A Significance of Financial Ratio Analysis in Decisions Making:

A Case Study of Kicons Pvt. Ltd.

Submitted to

Bharati Vidyapeeth University (India)

In Partial Fulfillment of
The Degree of
Master of Commerce
(Advanced Accounting )

By
Salih Rasul Agala
Roll No . 4391

Under the Guidance of

Dr. Shivaji N. Borhade

Yashwantrao Mohite College, Pune 411038

( 2013 - 2014 )
 Certificate

This is to certify that the work incorporated in the project report entitled:

A Significance of Financial Ratio Analysis in Decisions Making: A Case Study of

Kicons Pvt. Ltd.
has been carried out by Mr. Salih Rasul Agala in Bharati Vidyapeeth University

Yashwantrao Mohite College, Pune 411038 ( India ) under the guidance of Dr. Shivaji N.

Borhade.

Place: Pune Prin. K. D. Jadhav

Date: 28 / 03 / 2014 Principal

II
 List of Contents
Page
Subject Titles
No.
Certification 1………………………………………………..…………….………....... II
Certification 2……………………………………………..…………..……………...... III
Declaration…………………………………………….…..………………………........ IV
Dedication…………………………………………………………………………........ V
Acknowledgment……………………………………………………………………… VI
Abstract…………………………………………………………………………............ VII
List of Contents………………………………………………………………………... VIII
List of Tables…………………………………………..…………..…………………... XII
List of Figures……………………………………………………..…………………... XIII
List of Abbreviation………………………………………………..………………...... XIV
CHAPTER I : INTRODUCTION 1
1.1 Introduction………………………………………………………………………... 1
1.2 Problem of the Study.. …………………………………………………...……….. 2
1.3 Objectives of the Study…………………………………………………………… 2
1.4 Significance of the Study... ……………………………………………………… 3
1.5 Hypotheses……………………………………………………………………… 3
1.6 Data Collection……………………………………………………………………. 4
1.6.1 Primary Data……………………………………………………………………. 4
1.6.2 Secondary Data ………………………………………………………………… 4
1.7 Sample Selection………………………………………………………………..… 4
1.8 Limitations of the Study…………………………………………......……………. 4
1.9 Structure of Research …………………………………………………………….. 5
1.10 Literature review………………………………………………………………… 5
References…………………………………………………………………………….. 8
CHAPTER II: BASIC OF MANAGEMENT ACCOUNTING 9
2.1 Definition ………………….……………………………………………………... 9
2.2 Management Accounting and Financial Accounting…………………..……… 10
2.3 Management Accounting and Cost Accounting …………………………………. 12

2.4 The Concept of Management Accounting ……………………………………….. 14

15
2.5 The objectives of the management accountant…………………………………....
2.6 Management accounting versus financial accounting……………………………. 16
VIII
2.7 Limitations of Management Accounting………………………………………….. 17

2.8 Advantages Management Accounting…………………………………………… 19

2.9 Scope of Management Accounting………………………………………………. 19

2.10 Need and Importance of Management Accounting……………………………. 20

Reference………………………………….………………………………………….... 23

CHAPTER III : FINANCIAL RATIO ANALYSIS 26

3.1 Financial Statement Analysis………………………………………………….. 26

3.2 Parties Interested in Financial Statement Analysis…….…………..………… 26

27
3.2.1 Owners…………………………………………………………………………..
27
3.2.2 Management………………………….…………………………………………
27
3.2.3 Creditors……………………………….………………………………………..
27
3.2.4 Shareholders……………………………………………………………………
27
3.2.5 Financial analysis……………………………………………………………….
28
3.2.6 Purchaser of Business………………………………………………………......
28
3.2.7 Financial analysis……………………………………………………...………..
28
3.3 Objectives of Financial Statement Analysis ……………………………………
28
3.3.1 Assessment of Past Performance and Current Position…………………………
29
3.3.2 Prediction of Bankruptcy and Failure…………………………………………..
29
3.4 Sources of Information for Financial Statement Analysis………..………………
29
3.4.1 Reports Published by the Company…………………………………………….
29
3.4.2 SER Report……………………………………………………..………………..
3.4.3 Credit and Investment Advisory Services……………………...……………... 29
30
3.5 Tools and Techniques of Indianola Statement Analysis………….....……………
30
3.5.1 Horizontal Analysis…………………………….………………………………...
33
3.5.2 Vertical Analysis……………………….…………………………………………
35
3.5.3 Trend Analysis………………………………………………………………….....
36
3.6 Ratio Analysis………………………………………………………………………
36
3.7 Objective of Ratio Analysis…………………………………………………………
37
3.8 Classification of Ratio Analysis………………………..…………………………
37
3.8.1 Unvaried Ratio Analysis…………..…………………………………………….
3.8.2 Liquidity (Short-Term Solvency) Ratios………………………………………. 38
3.8.3 Current Ratio………………………………………...…………………………... 38

3.8.4 Quick (Acid Test) or Liquid Ratio…………………………………...………….. 39

IX
3.8.5 Profitability Ratio Related to Investments…………………………………….. . 40

3.8.6 Return on Sales or Net Profit Margin …………………………………………… 40

3.8.7 Gross Profit Ratio………………………………………………………………... 41

8.8.8 Net Profit Margin………………………………………………………………… 41

3.8.9 Turn on Assets ……………………………...…………………………………. 42

3.8.10 Return Operating Assets ………………………………………………………. 42

3.8.11 Return On total Assets……………………………………………………….... 43

3.8.12 Return on Equity (ROE)…………………………………..……………………. 44

3.8.13 Inventory Turnover………………………………………..……………………. 44

3.8.14 Accounts receivable turnover……………………………..……………………. 45

3.8.15 Interpretation of Average Collection Period Ratio…………………………….. 46

3.8.16 Total Assets Turnover ( TAT )……………………….………………………… 46

3.8.17 Fixed Assets Turnover ( FAT ) Ratio ………………..………………………... 47

3.8.18 Debt Management (long-tem solvency) Ratios………………………………… 48

3.8.19 Debt Ratio……………………………………………………………………… 49

49
3.8.20 Equity Ratio (proprietary) Ratio………………………………………………..
50
3.8.21 Debt Equity Ratio………………………….……………………………………
3.8.22 Leverage (Gearing) Ratio………………………………………………………. 50

3.8.23 Fixed Assets to Long-Term Liabilities……………………………………......... 51

3.8.24 Times Interest Earned (TIE)…………………………………………………..... 52

3.8.25 Investment (Market Value) Ratios……………………………………………... 52

3.8.26 Price/Earnings Ratio (P/E)……………………………...………………………. 53

3.8.27 Earnings Yield ………………………………………...……………………...... 54

3.8.28 Dividend Per Share……………………………………..………………………. 54

3.8.29 Dividend Payout Ratio (DPR)……………………………………………..…… 55

3.8.30 Dividend Yield Ratio……………………………………………..……………. 55

3.8.31 Fixed Dividend Coverage Ratio ……………………………………..………… 55

3.8.32 Market value to Book Value Ratio ………………………………..…………… 56

3.9 Advantages of Ratio Analysis…………………………………………………….... 56

3.10 Importance Limitations of Ratio Analysis ……………………………………...... 57

3.10.1 Importance……………………………………………………………………... 57

3.10.2 Limitations........................................................................................................... 57

Reference......................................................................................................................... 60

CHAPTER IV : DATA ANALYSIS AND INTERPRETATION 65

X
4.1 Profile and Stricture of the Company ……………………………….……………. 65

4.1.1 Profile the company……………………………………………………………... 65

4.1.2 Stricture of the Company……………..…….…………………………………… 67

4.2. Research Result and Analysis…………………………………………………….. 68

4.2.1 Discussion on Statistical Analysis…………………….………………...……….. 68

4.2.2 Respondents………………….………………………………………………….. 68

4.2.3 Data Analysis …………………………………………………………………..... 69

4.2.3.1 Question No.2…………………………….…………………………………… 69
4.2.3.2Question No.3………………………….………………………………………. 70
77
CHAPTER V: CONCLUSION AND RECOMMENDATION
5.1 Conclusion……………………..………..………………………………………..... 77
5.2 Recommendations………………………………………………………………..... 78
Bibliography…………………………………………………………………………… 79
Appendices…………………………………………………………………………….. 84

XI
 CHAPTER I

INTRODUCTION

1-1 Introduction

A Ratio is a quantitative equation between two figures done mathematically. In order to be

meaningful, the two figures of the ratio must be related. A Ratio is a tool used by all interested

parties to quantify the risk element before taking a decision. They use one figure as numerator and

another as denominator according to their purpose of analysis. ( Chatterjee, 2011 : p. 149)1 .

A ratio refer to the establishment of relationship between any two inter related variables. For

example, both the amount of profit and the amount of sales revenue earned are inter related as one

is influenced by another. Hence a meaningful and useful relationship may be established between

these two . It is because of the reason that the amount or the rate .of profit is influenced by the

sales revenue . Since the Analysis and Interpretation of Financial Statement is made with help of

ratio, it is called Ratio Analysis. The ratio analysis is , therefore an effective tool or a device to

diagnose the financial and operational diseases of business enterprises . The ratio analysis of

Financial Statement stands for the process of arrangement of data , computation of ratios ,

interpretation of the ratio so computed and projections through ratio .( Igben, 1999:p. 423 )2 .

Ratio are guides or shortcut that are useful in evaluating the financial position and operations of a

company and in comparing them to previous years or to other companies. The primary purpose of

ratio is to point out areas for further investigation. They should be used in connection with a

general understanding of the company and its environment. (Kothari, and Godha ,2010: p 353)3

According to ( Horngren , et., al., 2009 : p.441 )4 Managers usually follow a decision model for

choosing among different course of action . A decision model is a formal method of making a

choice , and it often involves both quantitative and qualitative analyses . Management Accounting

work with managers by analyzing and presenting relevant data to guide decision .

1
( Anthony , et., al., 2007: p.424)5 Annual reporting include a section referred to as Managements

Discussion and Analysis , which is a discussion by management of their company’s operating

results , Liquidity ,solvency , important developments during the periods covered by the primary

financial statement and the possible impact on future financial statements, and the possible impact

on future financial statement of known trends and events . Also is the potential impact of new

accounting standards on the company’s financial statement.

1. 2 Problem of the Study

The financial statements is to provide information about the financial position performance

and changes in financial position of an enterprise that is useful to a wide range of users in making

economic decisions.

1- Financial statements are prepared primarily for decision making but the from these

statement alone. Ratio analysis helps in making decision from the information provided

in these financial statements.

2- We have already studied that there are various methods or techniques used in analyzing

financial statements. The ratio analysis is one of the most powerful tools of financial

analysis, It is with the help of ratios that the financial statement can be analyzed more

clearly and decision made from such analysis.

1.3 Objectives of the Study

The objectives of the study are:

1- To facilitate the decisions making by the management

2- To show how ratio analysis aids business decisions

3- This study examines how the use of financial ratio in accounting and financial management

Analysis helps the management to know the profitability, financial position and operating
2
 Efficiency of an enterprise.

4 – To suggest on ways enhance efficient use of ratio analysis in decision making .

5- To help the management in its planning and forecasting activities

1.4 Significance of the Study

The significance of this study is that on its completion, the following benefits will be

Derived:

1. The study will help management of Kicons Ltd., Pune and others to know how ratio

analysis can help them understand the financial contained in financial statements and

enhance their business decisions.

2. The findings of the research and the supportive reference materials will be of immense

help to students in tertiary institutions and other researchers to investigate further in the

area of study.

3. It is hoped that the result of the research will facilitate optimal business decisions when the

recommendations are complied with.

1.5 Hypotheses

1- Is the Ratio Analysis simples the financial data, it becomes easy to

Understand the Financial Statements.

2- Is ratio analysis useful in evaluating and prediction the performance of a business as well

as intensifying areas that regret improvement?

3- Are there obstacles that affect the proper use of ratio analysis in business decisions?

4- Is accounting ratio help the managerial persons in their decision making task.

3
5- Is ratio analysis useful to management investors, shareholders and creditors in their

business divisions?

1.6 Data Collection

1.6.1 Primary Data

Data are collected by questionnaires with a lot of questions related to different aspects of

impact and importance of ratio analysis on financial performance. The questionnaires will be

sending to financial staff of Kicons Ltd.

1.6.2 Secondary Data

Along with the primary data the researcher will collect secondary data from various sources

like a books reference, theses, previous studies, journals, magazines.

1.7 Sample Selection

This study is related to the analysis of the Statement and the Balance Sheet by means of

financial ratio. Therefore researcher decided to consider a case study of (Kicons Ltd).

1.8 Limitation of Study

In the course of this research work, the researcher was faced with some constraints which

paved a limit the ability and performance of the researcher encountered the following constraints

among others.

1. The researcher needed a lot of money to travel. Money was also required to visit secondary data

sources such as the internet, libraries, and professional bodies.

2. Time allowed was not enough for through completion of the research, in consideration of the

fact that we were also facing studies during the semester.

4
1.9 Structure of the Research

This study consists of five chapters and organized as follow:

Chapter 1 is introduction and research methodology and introduces the problem of research, and

the significance of the project, a structure of the project.

Chapter 2 gives a review of the relevant literature. Specifically it gives information about the

basic Management Accounting.

Chapter 3 gives a review of the relevant literature. Significant relationship between financial

ratio analyses.

Chapter 4 is about data analysis and interpretation present the of the hypotheses.

Chapter 5 includes the conclusions and recommendation of researches.

1.10 Literature Review

(Stanislav, 2008: p12)5. Financial analysis of the Russian forest product companies. The thesis

applies financial analysis and assesses the financial performance . evaluate how well the

companies perform. The goal is achieved through implementation of different financial analysing

tools and techniques, mainly financial ratio analysis. Different financial measures are evaluated.

Furthermore, comparisons are made between companies, their past and expected future

development is analysed and compared with the economy in general. Ratio analysis showed as

well that all studied companies had problems with the absolute liquidity.

(Kabera ,2009:p 44)6. tried to find out the degree to which accounting ratios can be used to draw

conclusion upon which decision are made. This has been done considering Amazi Ya huye as a

case study. The research specifically had to identify different ratios used in financial statement

analysis in decision making, also the role of financial ratios analysis in decision making had to be

indicated and lastly the use and limitation of accounting ratios . his study revealed that the
5
accounting ratios are indispensable in reasonable decision making. Generally, some of business

entity uses accounting ratios in a proper way. The use of accounting ratios in financial statements

analysis varies according to the decision to be made by those who use them. Different managers

use different analytical tools and techniques depending on the objectives of the analyst and nature

of the business, it was further found out that the accounting ratios reduce the long array of

financial statement in decision making.

(Sudip , 2010:p127 )7. Analysis and interpretation of financial statements is an important tool in

assessing company’s performance. It reveals the strengths and weaknesses of a firm. It helps the

clients to decide in which firm the risk is less or in which one they should invest so that maximum

benefit can be earned. It is known that investing in any company involves a lot of risk. So before

putting up money in any company one must have thorough knowledge about its past records and

performances. Based on the data available the trend of the company can be predicted in near

future. This project mainly focuses on the basics of different types of financial statements. Balance

Sheet and Profit & Loss statements of five different coal and non coal mining companies have

been studied.

(Amedu, 2012:p95)8. The researcher concludes by saying that financial statement plays a vital

role in investment decision making; for instance, where companies invest hundreds of billions of

naira every year in fixed assets. By their nature, these investment decisions have the potential to

affect the firm’s fortunes over several years. For a good decision can boost earning sharply and

dramatically increase the value of the firm. This financial information can be subjected to various

scrutiny and analysis depending on the investors before making their investment decisions. This is

quickly appreciated in the banking sector as one of the major criteria’s the demand from their

borrowers at the financial statements of the concern for various years. This is subjected to their
6
analysis and interpretations before they can go ahead in the loan negotiation concerning any

company. Hence it is opined that companies should try as much as possible to posit financial

statements that reflects a true and fair view of what is propose to represent as a way of

appreciating their companies the more.

(Raju, 2012: p67)9. The purpose of the thesis was to evaluate and compare the financial

statements of different companies to rate their performances. The emphasis was to be able to

choose among several companies the best one to invest in. The aim of the study was met by

comparing the risk of different companies, their rate of return, future trends and their strengths and

weaknesses. Several comparison models used in this thesis can be adopted by anyone to rate a

company’s performance with the other companies. Although, the four automotive companies have

been used for the research, the aim of the research is not to choose among them the best one for

the purpose of investment. The impact of an individual component of the financial statement in the

company’s overall performance has also been revealed in the empirical frame work. Another

feature of this thesis is the ratio analysis of the companies. The impact of financial ratio over the

company’s overall performance was also discussed and verified in the thesis.

(Margit , 2012: p267)10. The Role of Management Accounting in New Public Management

Reforms. Accounting constitutes a frame for presenting information which makes it an assistant

tool, whereas economics take this information and make monetary decision making upon it.

Management accounting techniques such as performance measures, budgets and costing

techniques are specific types of calculation methods indicating the role as means. The information,

that management accounting techniques present, is often related to management accounting itself,

especially in the discussion of efficiency, savings and productivity. However, if we divide the

accounting techniques with the economic decision making.

7
 REFERENCE

1- Chatterjee , D., K. , ( 2011 ) . Basic accounts Finance For Non Accountants. India :

Himalaya House Pvt., Ltd.,

2- Igben, Robert O. (1999). Financial Accounting Made Simple. Lagos: ROI .

3- Kothari , R., and Godha , A., ( 2007) .Management Accounting Concepts & Applications.

New Delhi, India: Macmillan India Ltd,.

4- Horrngren , C., T., at el., ( 2009 ) .Introduction to Management Accounting .India: Dorling

Kindersley India Ltd .

5- Stanislav S., (2008). Financial analysis of the Russian forest product companies. Master

Thesis ISSN 1654-1367, No 20.

6- Kabera L., (2009). The use of accounting ratios in decision making. . M., thesis.

7- Sudip, D., (2010).Analysis and Interpretation of Financial Statements. . M., thesis.

8- Amedu, M., A. (2012). Role of financial Statement in Investment Decision Making. . M.,

thesis.

9- Raju S., (2012). Comparing and Analyzing Financial Statements to Make an Investment

Decision. M., thesis.

10- Margit M, (2012). The Role of Management Accounting in New Public Management

Reforms. PhD. dissertation.

8
 CHAPTER II
BASIC Of MANAGEMENT ACCOUNTING

2.1 Definition
The term management accounting is defined in different ways in the literature with different
scopes. The traditional way of defining management accounting includes all planning and
monitoring in an organisation, which can be financially quantified. The focus is on economic
goals with financial character and concepts like income, expense and profitability are important
(Simons, 1991: pp. 29- 40)1 Management accounting is used to formulate achievements for
planning, implementation, follow-up, evaluation and adaptation in the company. Unlike external
accounting, there are no laws or rules to regulate the management accounting systems. Therefore,
firms can adjust their management accounting system to their own needs (Ax et al., 2002:p.25)2.
Today, the definition of management accounting includes a wider scope, e.g. more non- monetary
measures, such as identifying , measuring , accumulating, analyzing, preparing , interpreting , and
, communicating, information that helps managers fulfill organization objectives (Horngren, et
al , 2012:p. 5)3 . The field of management accounting has, in other words, changed from the
traditional designation including budgeting, product calculation and internal auditing to a more
modern definition. This definition puts more focus on aspects concerning customers, market,
productivity, quality, personnel and competitors. There has been an increased interest for
management accounting related to the human behavior, such as firm culture, motivation, and
competence development (Saxena, 2012: p. A6.37)4. The introduction of new ideas within the
field of management accounting has resulted in new approaches and models within the field, e.g.
the Balanced Scorecard, intellectual capital etc. (Shields, and Young, 1992:p154) 5.
For a formal definition, management accounting involves identifying, collecting, sorting,
estimating, and analyzing cost, performance, and other information to make timely decisions. The
time reference is on decisions to plan and control the future. Budgets, forecasts, and estimates,
while based on historic data retrieved from the accounting system, guide future management
actions. The perspective, unlike financial reporting, gives detailed analysis to smaller parts of the
entity and intertwining relationships. It can divide and/or compare the data by products, regions,
delivery channel, etc.

9
2.2 Management Accounting and Financial Accounting
Though the financial accounting is the basis of management accounting, it is not the same
old wine served in a new bottle with a new label. Management accounting dose not supplant
financial accounting, but the distinctive features of management accounting.Accounting provides
an account – an explanation or report in financial terms – about the transactions of an
organization. Accounting enables managers to satisfy the stakeholders in the organization (owners,
government, financiers, suppliers, customers, employees etc.) that they have acted in the best
interests of stakeholders rather than themselves.( Collir :2003 p. 67 ) 6 .
But as stated and( Miroshnik, 2002 :p. 25)7., which is necessary for a particular culture may not
be appropriate for another, each medium has a different culture which requires different driving
behaviors, strategies, organizational structures, planning and control and finally put their mark on
accounting. ( Jain , and Narang , 2010: p. 1.4 )8 In Financial Accounting it does not provide
complete analysis of losses due to defective material , idle time , idle plant and equipment .In other
words , on distinction is made between avoidable and unavoidable wastage. To meet the
intended purpose it is necessary first to make a foray into international theory and practice because
you can not understand the influence of culture of a country without knowing the overall look.
Regardless of the accounting culture is usually seen as having two distinct components, namely:
• Management accounting, which seeks to meet the accounting needs of managers;
• Financial accounting which aims to meet the accounting requirements of all other users,
The different interests of users of accounting information have led to the existence of differences
between management accounting and financial accounting, accounting regardless of culture, as
shown in Table 2.1.

10
2.1 Table Differences between Management Accounting and Financial Accounting.
Comparison Financial Accounting
Criteria
Regulation It is compulsory and standardized.
It is based on some rules of the
state in the form of accounting law
or regulations issued by
professional bodies
Purpose Preparation of financial statements
general nature useful to a wide
range of users
Level detail statement Financial statements are intended to
(reports) accounting provide a broad overview of
performance (expenses are
classified by nature) and financial
position for some time. By
aggregating detailed character
information is lost
Objectives Registration of real and monetary
flows, the calculation result
obtained by the company, the
presentation of the financial
position and financial statements
Frequency of For most enterprises countries
Reporting prepare annual financial statements,
although there are exceptions where
some companies do quarterly or
half-yearly reports
Temporal The financial statements reflect the
Orientation performance and financial position
for the past period. Therefore
suggests that retrograde aspect not
included expectations of future
business
The range and * The financial statements include
quality of information which is measured only
information in monetary terms;
* Financial information put more
emphasis on the use of objective
and verifiable evidence
Management Accounting
It is compulsory and
standardized. It is based on
some rules of the state in the
form of accounting law or
regulations issued by
professional bodies
Development of management
accounting reports more
specific purpose, for a specific
manager
Management accounting
reports provide managers with
analytical detail to support
decision making (expenses are
classified by function
Costing analysis of deviations,
preparation of budgets,
monitoring of compliance
budgets
Reports are made whenever
information is needed having a
regular character. In many
companies are provided daily
reports, weekly or monthly for
monitoring progress
Management reports are based
both on the information
presented and the predictions
(expense budgets) offering the
possibility of creating a vision
for the future of business
* management accounting
reports contain information
that is quantified in terms of
both monetary and non
monetary terms;
* management accounting
reports based on less objective
and verifiable information but
can provide managers with the
data they need
11
 Therefore, management accounting is less constrained than financial accounting based on a
variety of sources and information that have different degrees of reliability. The only restriction
that requires management accounting information concerns their ability to improve the quality of
decisions.
The distinction between management accounting and financial accounting suggests that there are
differences between the information needs of managers who have more control over the form and
content of information they receive from other users, without excluding some on the other, on the
contrary, they become complementary.
Although the scope of the financial statements give a noticeable increase international fears about
the loss of competitive advantage and the reliability of the data projected by ignorance contributed
to restricting other users to provide detailed and comprehensive information as made available to
managers.
The literature shows (Malik , and, Turan, 2013 : p. 75 )9. That traditional accounting
systems are too oriented towards regulatory requirements in financial accounting and less able to
provide information to managers. In other words, financial accounting was apriority, for which
management accounting has suffered.

2.3 Management Accounting and Cost Accounting

Though a few numbers of differences exist between Cost Accounting and Management
Accounting, the line of difference is very thin. Because , Cost Accounting , at present , comprises
of some of the advanced techniques and systems of Costing such as Marginal Costing , Standard
Costing , Budgetary Control , Responsibility Accounting , etc., and therefore , it ( etc., Cost
Accounting ) tends to conform to Management Accounting ) . Consequently, no much difference
can be found between the two. Further, both serve the internal parties (viz., management).
However, a very few minor differences that exist between the two are presented below.
( Madegowda , 2007 :pp.13-14 ) 10.

12
Table 2.2 Differences between Management Accounting and Cost Accounting
Cost Accounting Management Accounting
1- Primary Objective : Cost accounting aims Management Accounting aims at the
ascertaining the cost of goods and services . It presentation of cost data , to the extent required
lays emphasis on the stage by stage , wherever and whenever the are required
computation of costs . Further , it deals with together with other relevant information to the
cost control , matching of cost and revenue and management for taking decisions and for
assessment of performance of the operating planning and co-ordinating the activities of the
activities . business enterprise

2- Information coverage : Cost reports deal Cost data from part of managerial reports but
mainly with the costs – incurred or budgeted not the sole aspects. Because, managerial
and standards , variances , savings , etc. reports cover various aspects such as cost,
budgets , tax planning projection , etc. Hence,
the scope of Management Accounting is
broader.
3- Nature of data: Normally, cost Accounting Management Accounting uses and supplies not
lays emphasis on the past and therefore, the only the quantitative but also the qualitative
quantitative data are recorded in cost books of information.
accounts.
4- Governing principles, Rules, etc: Cost No such rigidity is there in the case of
Accounts and Reports are to be prepared as per managerial reports. The procedure, format etc.
certain rules, principles, procedures, etc., as can be modified from time to time depending
specified by the appropriate authority to the upon convenience and requirements.
industry to which the company belongs to.
5- Time Factor: It lays more emphasis on the It predicts the future on the basis of the past
past and present, and less emphasis on the events, present happenings and future estimates.
future. The means, it report about costs that It also facilitates the formulation of plans and
have been incurred. policies.
6- Utility of Reports: Though cost reports are Management reports are useful only to the
meant for management, they are useful even to management but to both internal and external
the external parties. parties.

13
2.4 The Concept of Management Accounting
The Chartered Institute of Management Accountants (CIMA , 2005:p.18)11 .States that
management accounting is an integral part of the core management function that requires the
identification, measurement, accumulation, analysis, preparation, interpretation and
communication of information used by management to plan, evaluate and control within an
organisation and to ensure appropriate use of and accountability for its economic resources. CIMA
(2009) further defines management accounting as the practical science of value creation within
organisations in both the private and the public sectors. It combines accounting, finance and
management with the leading edge techniques needed to drive successful businesses.
(Frank , 1990: p.155)12. Views management accounting as the preparation of financial and non-
financial reports for non-management groups such as shareholders, creditors, regulatory agencies
and tax authorities. He outlines management accounting as a practice that covers three areas which
are explained as follows:

 Strategic management: Advancing the role of the management accountant as a strategic

partner in the organisation.
 Performance management: Developing the practice of business decision-making and
managing the performance of the organisation.
 Risk management: Contributing to frameworks and practices for identifying, measuring,
managing and reporting risks to the realisation of the objectives of the organisation.
The integration of these three aspects of management accounting adds value to innovative
management accounting practices. These practices provide an organisation with strategies that
focus on the dynamic business environment. Management accounting skills are driven by the
management accountants who constitute the management accounting function in an organisation
(Shah, 2009: p. 9)13. asserts that management accountants apply their professional knowledge and
skill in the preparation and presentation of financial and other decision-oriented information. They
do this in order to assist management in the formulation of policies and in the planning and
controlling of operations in their organisations. Management accountants may therefore be seen as
value-creators which in turn may assist an organisation to gain a competitive advantage.
asserts that management accountants are much more interested in looking forward and making
decisions that will affect the future of an organisation. This is opposed to the historical recording
and compliance (scorekeeping) aspects of the profession. Management accounting knowledge and

14
experience is therefore obtained from various fields and functions within an organisation. This
includes areas such as information management, treasury, efficient auditing, marketing, valuation,
pricing and logistics. These aspects assist the management in the development of strategies for the
creation of a competitive advantage in the highlighted fields.

2.5 The objectives of the management accountant

(Simon, et al., 1954: p. 123)14 describe accounting in the context of three functions:
scorekeeping, attention directing and problem solving. Scorekeeping data includes routine
financial reports and accounts. Attention directing data includes data which compares actual
performance with standard so that deviations may be highlighted. Problem solving data includes
any type of data which helps managers to make decisions. ( Laverty, 2004: p. 949)15. considers
scorekeeping and attention directing to fall under the common umbrella of control, while considers
problem solving and to be inextricably linked. In this way, the fundamental objective of the M A,
as traditionally presented in the literature, is the provision of information to support control
(Belkaoui, 1980:p.18)16
Hence , management accounting is called management – oriented accounting or accounting for
management . In order to accomplish this aime , management accountant has to perform a number
or function and process. These function may also be called objectives of management accountant .
Because these functions of management accountant may also be interpreted as the factors which
high – lights the need for management accountant . However , the following are the major
objectives of management accountant (Mahajan and Kulkarni , 2013: p. 17 ) 17 .

i) providing management with information ( data ) for decision making and planning
aims at modifying the data to suit to the requirements of the decision .
ii) with the help of the tools of financial analysis to analyse and interpret the data and
present the results with necessary comments conclusion etc. to the management .
iii) Assisting Management ( managerial personnel) in directing and controlling operation
with the help of standard costing , budgetary control and responsibility accounting .
iv) Motivating managers and other employees towards the organisations goals .
v) Measuring the performance of sub unite , management and other employees within the
organisation .
vi) To submit comprehensive reports which includes both the quantitative and the
qualitative information .
15
2.6 Management Accounting versus Financial Accounting
Accounting systems take two forms, management accounting and financial accounting,
and can be tightly linked through the use of standard costing common to both. However, the
functions of these two forms of accounting are quite different: management accounting is focused
on monitoring and analyzing the effect of management decisions, financial accounting is focused
on short - term, external reporting ( Fry, et al., 1998:p. 56 )18 .
Management accounting and financial accounting are often mixed up (Sharman, 2003: p. 23) 19.
Financial accounting has an external purpose for external stakeholders and should not be used for
internal decision making in the daily operations management. A company may do as much or as
little management accounting as it wants (Maskell, 2009:p.78)20. Financial accounting has to be
done by law and has to follow generally accepted accounting principles (GAAP) to be transparent
enough and understandable for shareholders, authorities and others who might have an interest in
the financial situation at the company. This means it involves compliance with common and
standard rules and regulations established by external authorities, maintaining official records,
preparing reports responding to questions defined by external bodies, and coordinating and
responding to audits. Financial accounting also deals with managing financial transactions and
valuations such as balance sheet valuation as well as processing cash interactions with suppliers,
customers, tax, and other authorities. They are similar in the way that they are both based on
financial information and non-financial quantitative information about the operations (Atkinson et
al., 2012:p.122)21. But as shown in Table there are some important differences.

Table 2.3. Financial Accounting vs. Management Accounting:

Financial Accounting Management Accounting

Perspective Retrospective – Summarizing the
financial result of past decisions
and transactions.
Role Report to external stakeholders
such as shareholders, investors,
creditors, and tax authorities
Content Has to follow external standards
(GAAP) for how to be developed
and presented.
Both retrospective and prospective –
Both providing feedback of past
operations and help to plan for future
events .
Help employees and managers
internally in their decision making in
how to run the operations
No prescribed regulations. Can
contain and be presented in any way
found suitable for the purpose of
manage the operations.

16
 It is required by authorities for a company to do financial accounting while there is nothing
saying that a company has to spend resources on doing management accounting at all. It is up to
each and every one how they manage their operations, if at all . Other characteristics for financial
accounting are that it looks at the business as a whole and is an end in itself, while management
accounting also focuses on parts and is a means to the end , which is to support manufacturing
decision making .

2.7 Limitations of Management Accounting

Management Accounting is comparatively a new branch of Accounting. It is still in the
developing stage . Though it has made much progress during this short span of time , it suffers
from a few limitations. The important limitations are noted blow. However most of theses
limitations from which Management Accounting is suffering can be overcome be convincing the
Management about the need for , and significance and utility of , Management Accounting .
( Madegowda , 2007 :pp. 15-16 ) 22.

1- Personal Bias and Lack of Objectivity : Management Accounting ,in his reports to
Management , has to include the prediction about the future based on the post, present and
future Therefore , the report include both the actual and estimates, and both the quantitative
and the qualitative information . further , the managerial reports lay more emphasis on
relevancy rather than on objectivity . The reports are , therefore , influenced by the
personal judgments . Analysis and interpretation of financial information is also influenced
by the ability of the Management Accounting and therefore, there is every likelihood of
personal bias in analysis and interpretation which significantly influences the decisions.
Hence, it is said that they are more subjective than objective.
2- Intuitive Decision Making : Though the Management Accounting with the help of
advanced and sophisticated decision tools like , Marginal Costing , Mathematical
programming , Statistical Tools , etc., is capable of serving and assisting Management with
relevant data to take decisions , there is a tendency in Management to prefer a short – cut
method of taking decisions intuitively . consequently , the entire effort of Management
Accounting becomes useless and therefore , this type of attitude of managerial personnel
limits the utility of Management Accounting .

17
3- High Cost for Installation and Operation : In order to install a system of Management
Accounting , it is necessary to make elaborate arrangements . This requires a medium –
scale organization can ill – afford .
4- Limitations of Financial and cost Accounting : Management Accounting bases its
reports on the data gathered even from financial and cost books of accounts impairs the
quality of reports prepared and submitted by the Management Accounting . This has
resulted in a situation wherein some of the limitation of Management Accounting are due
to the dependence of Management Accounting on Financial accounting and cost
Accounting for the information. Hence , the limitation of Financial Accounting and Cost
Accounting can also be considered as the limitation of Management Accounting .
5- Wide Scope : It is very difficult to prescribe the boundary for Management Accounting ,
Because , it requires the services of Cost Accounting , Financial Accounting , Quantitative
Techniques , Mathematical Programming , Production Engineering , Marketing Aspects ,
etc . Therefore, it is very difficult to develop a Management Accounting Department with
the people who have full knowledge about all these disciplines. This acts one of the
limitations of Management Accounting.
6- Resistance : The successful installation and function of Management Accounting system
depends , to a greater extent , upon the co operation of management . Because , it
involves the basic changes in the organizational set – up and the reporting system , and
also the attitude of management towards viewing a problem and solving it . The
managerial personnel may consider this as an unnecessary interference by the Management
Accounting may also resist the changes . Even the staff of Financial and Cost Accounting
Departments may resist the installation of Management Accounting System .
7- Not a Substitute for Management : Management Accounting which provides only
information but dose not take decisions is not a substitute for management . because ,it
only helps the management in its functions such as planning controlling, communication ,
etc., by furnishing the timely and relevant information. Hence , Management Accounting
performs only the service function . But it ( i.e. , Management Accounting ) cannot act as
substitute for management and therefore it cannot replace management .

18
 2.8 Advantages Management Accounting
Following are the important Advantages Management Accounting . ( Mahajan, and
Kulkarn, 2013: p.13)23 .

i) It increases the efficiency in the activities of the business.

ii) It ensures efficient regulation of business activities by establishing efficient system of
planning and budgeting .
iii) It make possible the efficient utilization of the available resources and thereby increase
the return on capital employed .
iv) It ensures effective control by comparing actual results with the standards .
v) It maintains a goods public relation by providing quality services to the customers of
the business .
vi) It provides means to motivate the employees of the organisation .
vii) It keeps management informed about the going operations enabling it to suggest
remedial measures in case of deviations .
viii) It helps in evaluating the efficiency and effectiveness of the company’s business
policies with the incorporation of management audit .
ix) It is one of the ( diagnostic techniques) available to the management and executives for
improving economic performance by relation of the accounting system in use .
x) It helps in devilment of realistic data in respect of future transaction .
xi) It provides technique for useful interpretation of accounting information .
2.9 Scope of Management Accounting
After considering the various objectives the Management Accounting aims at, it can be
noted that the scope of Management Accounting is much wide . It covers virtually every area and
every aspect of business operation . However, to be more precise, the various areas covered by
Management Accounting con be stated as blow.( Inamdar ,2012: p. 67)24.
1- Accounting :
It deals with recording , summarizing and analyzing various business transaction . The
process of accounting may take basically two forms .
( a) Financial Accounting : It deals with recording the business transaction which are financial in
nature .It aims at the preparation of what is called financial statements which may be basically in
two forms . Firstly , the Balance sheet which tells about the state of affairs of the business in terms
of the various assets and liabilities an Secondly , the profitability statement which tells about the
19
result of operation of the business i.e. profit earned or loss incurred . The financial statements are
mainly meant for the outsiders dealing with the business .
(b) Cost Accounting : It deals with recording of income and expenditure , ascertainment of cost
and profitability and the presentation of information derived there from for the purpose of
managerial decision making Thus , the cost accounting is basically meant for the management to
enable it to take decisions .

2- Cost Control Procedures :

It deals with the various steps involved in the process of controlling the cost . Thus , in turn it
may deal with .
( a) Establishment of plans or budgets for the future .
( b) Comparison of variations between the planned and actual performance .
3- Reporting :
It deals with the presentation of cost data , statistical data or any other information to the
various levels of management . It may be required for the purpose of decision making or for the
purpose of fulfillment of various legal obligation .
4- Taxation:
It deals with the computation of income as per the law and filing the tax reruns and making
the tax payment .
5- audit :
It deals with devising the internal control systems and internal audit system to cover the
various operational areas of business . In many case , it may also deal with the management audit
which is the evaluation of the managerial performance .
6- Methods an services :
It deals with providing the management services and the management information systems .
It also deals with the various methods of reducing the cost and improve efficiency of accounting
and other office operation and preparing and issuing the accounting and other operational manuals.

2.10 Need and Importance of Management Accounting

Management Accounting deals with the internal reporting . On basis of the nature of these
reporting and their contents and the parties who receive these reporting , it may be said that the
Management Accounting deals primarily with the furnishing of required and relevant data to the
20
managerial personnel for purpose of planning , controlling and decision making . The type of
accounting information required by the management differs from one type of decision to another.
It not necessarily confined to the financial accounting information but it is much more than this
depending upon the type, importance , complexity , etc. of the problem .
The financial accounting and the cost accounting lay emphasis on different objectives .
Management cannot base its decision only on the information furnished by the financial and cost
accounting . Therefore there is a need for a system which views , utilizes and analyses the
abundant data ( generated by financial an cot accounting ) with the sole objective of furnishing
the relevant data to the management for the purpose of assisting it to take a number of appropriate
decisions . Management Accounting furnishes only those data which are relevant to the decision
under consideration and these relevant data may include the data collected from both financial an
cost records and other sources .
The following points highlight the need and importance of Management Accounting :
( Mahajan and Kulkarni , 2013 : pp. 15-17 )25.
i) Management Accounting includes all those accounting services by means of which
assistance is rendered to the management in their managerial function i.e. decision
making profit planning control etc. It also helps management for execution of their
plans and measurement of performance .
ii) Financial accounting in its traditional from cannot apply the information necessary to
the management for functioning efficiently and effectively . Management Accounting
is the accounting which provides in non- technical language , cost , profits and other
information necessary to the management for discharging their function .
iii) Management Accounting is the presentation of accounting information in such a way
as to assist management in the creation of policy of the day to day operation of
undertaking .
iv) Management Accounting goes beyond the figures provided by financial accounting
which are mute in nature and make them self explanatory .
v) Management Accounting is an extension of the managerial aspects of cost
accounting . It utilises the principles principles and practices of both cost accounting
and Financial Accounting .
vi) The term accounting is used in more broad sense in Management Accounting so that
the scope of management is very wide and the term comprises with every activity of a
business .
21
vii) Since the managerial personnel are accountable to the owners of the company and
since their very continuation in the company depends upon the results produced which
in turn depends upon the quality of decisions and their implementation ,the managerial
personnel need a system which furnishes the relevant information to them to take
decisions . Therefore , the need for management accounting . It ( i.e Management
Accounting ) has been devised to serve the management through the report .
viii) It is very well known that planning , controlling , co-ordinating , organizing ,
motivating and communicating are the six important managerial functions .
Management Accounting helps the managerial personnel to perform each one these
functions more effectively and profitably by providing relevant information at the right
time . For this purpose , management accounting collects the information from
different sources , analyses them systematically to find out their relevance to the
decision under consideration and supplies only relevant information to the management
to take proper decisions
ix) Since the decisions have a number of implication on the detriments of profit ,
performance , etc, it is necessary to have a comprehensive evaluation of each of the
possible and available alternatives so that the management selects the best alternative
. In order to evaluate the alternatives , it is necessary to consider all influencing factors
. The influencing factors include both the quantitative and the qualitative factors . From
the above analysis ,it is obvious that the management has to take a number of decisions
and to take decisions , it needs information about the relevant influencing factors .
There is therefore a need for a system of accounting which ensures the furnishing of
relevant information to the management undertakes a comprehensive evaluation of the
problem and takes the most appropriate decision . Hence , the need for an accounting
system for management .

22
 REFERENCE

1- Simons, R., (1991). Strategic orientation and top management attention to control systems.

Strategic Management Journal. 12, 49-62.

2- Ax c. Johansson c. and kullven , H. , ( 2002 ). Den nay economist .Malmo , Liber Economic .

3- Horngren , Sundem , Stratton, Burgstahler, Schatzberg,( 2012).Introduction to Management

Accounting ,14ed . New Delhi, India :Dorling Kindersley.

4- Saxena , V.,K., Vashist , C., D.,( 2012 ) . A advanced Management Accounting. New Delhi

India: Sultan Chand & Sons.

5- Shields, M. Dand Young, S. M. (1992). Effect long-term cost reduction: a strategic perspective.

Journal of Cost Management, spring, Vol. 16,No. 30.

6- Collir , P., M. , (2003 ). Accounting for Managers , Interpreting accounting information for

decision-making British Library Cataloguing in Publication Dat.

7- Miroshnik, V. (2002). "Culture and international management: a review." Journal of

Management Development 21(7): 521-44.

8- Jain S.,P., and Narang , K.,L., ( 2010 ) . Cost Accounting Principles & Practice . New Delhi ,

India: PHI Learning Private Ltd., .

9- Malik, N.S., and Turan, M.S. (2010). Management Accounting, mcom/mc-105. , Guru

Jambheshwar University of Science and Technology, Hisar – Haryana, India,

10 - Madegowda, J., ( 2007 ). Management Accounting . Mumbai India: Himalaya Publishing

House .

11- CIMA BPP Professional Education, (2005). Management Accounting. Business Strategy.

London: BPP .

23
12- Frank, W.G. (1990). Back to the future: A retrospective view of J. Maurice Clark's Studies in

the Economics of Overhead Costs . Journal of Management Accounting Research , Vol.20,

No.2.

13- Shah, P. (2009). Management Accounting . New Delhi, India: Oxford University Press.

14- Simon, H. A., H. Guetzkow, G. Kozmetsky and G. Tyndall, 1954. Centralizations.

Decentralization in the Controller’s Department . New York: Controllership Foundation.

15-. Laverty, K.J. (2004). Managerial Myopia or Systemic Short-terms? The Importance of

Managerial Systems in Valuing the Long Term. Management Decision, Vol.42, No.8

16- Belkaoui, A., (1980). Conceptual foundations of management accounting. Don Mills Ontario:

Addison-Wessley .

17- Mahajan, S., and Kulkarni , M., (2013 ). Management Accounting .text book, India: nirali

prakashan.

18- Fry, T. D., Steele, D. C. & Saladin, B. A. (1998).The use of Management Accounting Systems

in Manufacturing. International Journal of Production Research, Vol 36, No 2.

19- Sharman, P. A. (2003). Bring on German Cost Accounting. Strategic Finance,Vol 85, No 6,

pp. 30-38.

20- Maskell, B. H. (2009). Making the Numbers Count. New York: the accountant as change

agent on the world class team, Productivity Press, 21- Atkinson, A. A., Kaplan, R. S., Matsumura,

E. M. & Young, S. M. (2012). Management accounting: information for decision-making and

strategy execution, Prentice Hall, Upper Saddle River, NJ

22- Madegowda, J., (2007). Management Accounting . Mumbai, India: Himalaya Publishing

House.

23- Mahajan, S., and Kulkarni , M., (2013 ). Management Accounting , text book, India: nirali

prakashan , printed by , Repro India LTD .

24- Inamdar , S. M. ,( 2012 ) Management Accounting , 9 Edition . Pune, India: Everest House.
24
25- Mahajan, S., & Kulkarni , M., (2013 ) Management Accounting , text book. india, nirali

prakashan .

25
 CHAPTER III

FINANCIAL RATIO ANALYSIS

3.1 Financial Statement Analysis

According to ( Khan, and Jain , 2010 :p. 6.1)1 The focus of financial statement analysis

is on key figures in the financial statements and the significant relationship that exists between

them. The fist task of the financial analysis is to select the information relevant to the decision

under consideration from the total information contained .The second step is to arrange the

information in a way to highlight significant relationships. The final step is interpretation and

drawing of inferences and conclusions, the financial statement analysis its use for decision making

by various interested in them. ( Pandey, 2013:p.1o8)2 financial statement analysis is the process

of identifying the financial strengths and weaknesses of the firm by property establishing

relationships between the items of the balance sheet and the profit and loss account. ( Foster ,

1986: p.5)3 financial analysis can be undertaken by management of the firm or by parties outside

the firm, viz. owners, creditors, investors and others . The nature of analysis will differ depending

on the purpose of the analyst.

3.2 Parties Interested in Financial Statement Analysis

Information contained in financial statement is useful to different categories of users

of financial data.( Jain, and Narang , 2013:p. 917)4 Uses of financial data for each of

these are briefly described below:

26
3.2.1 Owners

The owners provide funds for the operation of a business and they want to know whether

their funds are being property utilized or not. The financial statement prepared from time to time

satisfies their curiosity.

3.2.2 Management

Management of a company is interested in its financial condition profitability and progress.

It uses a number of methods , tools and techniques available to it to analyze the financial data

.such analysis used by the management to exercise control over the business and to make

decisions to run it more efficiently.

3.2.3 Creditors

Creditors include short term creditors like bankers trade creditors and also long term

credit grantors like debenture holders and financial institution. Creditors are mainly interested in

the short term and long term solvency of the company The information given in the financial

statement is vary useful to a number of parties as given blow :

3.2.4 Shareholders

Shareholders are the suppliers of basic capital to run the business. Such capital is exposed to

all the risks of ownership. Shareholders are interested in the profitability dividends declared and

market value of their holdings.

3.2.5 Financial analysis

Financial statement analysis enables financial analysis to offer professional advice to their

clients on investments.

27
3.2.6 Purchaser of Business

Any person interested in the purchase of a going concern financial statement to determine its

real value . It makes an assessment of the financial and operating strengths and weaknesses of the

business .

3.2.7 Financial analysis

Financial analysis is an information processing system designed to provide data for decision

making models.

3.3 Objectives of Financial Statement Analysis

According to (Gupta, and Sharma , 2013: p. 5.3 )5 The primary objective of financial

statement analysis is to assists in decision making . To provide adequate information about the

financial performance and the assets –liabilities position of the entity . The major objectives of

financial statement analysis is to provide decision making information about a business enterprise

for use decision making . Users of financial statement information are the decision making

concerned with evaluating the economic of the firm and predicting its future course. ( Baruch ,

1974: p. 5)6

3.3.1 Assessment of Past Performance and Current Position

Past performance is often a good indicator of future performance . Therefore ,on investor

or creditor is interested in the trend of past sales , expenses . net income , cash flow and return on

investment . These trends offer a means for judging managements past performance and are

possible indicator of future performance.

28
3.3.2 Prediction of Bankruptcy and Failure

The financial statement analysis helps in predicting the earning prospects and growth rates

in the earnings which are used by investors while comparing investment alternatives and other

users untested in judging the earning potential of business enterprises . Investors also consider the

risk . Financial statements which contain information on past performances are analyzed and

interpreted as a basis for forecasting future rates of return and for assessing risk.

3.4 Sources of Information for Financial Statement Analysis

According to (Needles, 1996: p, 773)7, the major sources of information about publicly

held corporations are repots published by the company, SEC reports, business periodical, and

credit and investment advisory services.

3.4.1 Reports Published by the Company

The annual report of a publicly help corporation is an important source of financial

information.

3.4.2 SEC Reports

Annual, quarterly and current financial reports filed by publicly help corporations with the

Securities and Exchange Commission (SEC) are sources of information for analysis of financial

statements.

3.4.3 Credit and Investment Advisory Services

There provide data and information about the performance of companies as well as on

industry norm, for example. Dun and Bradstreet Corporation in USA offers an annual analysis

using fourteen rations of 125 industry groups.

29
3.5 Tools and Techniques of Indianola Statement Analysis

These are various methods and processes used to analyze financial statements and show

relationships and change among comparative financial data. The most widely used tools for this

purpose are horizontal analysis, vertical analysis, trend analysis, and ratio analysis.

3.5.1 Horizontal Analysis

In horizontal analysis financial date of two or more years of the company is presented

horizontally in a number of columns in comparative form . Comparative financial statements and

trend percentages are types of horizontal analysis. (Jawaharlal 2010:p.351)8. The percentage

analysis of increases and decreases in corresponding items in comparative financial statements is

called horizontal analysis In horizontal analysis, the previous year is always the base year in

calculating the percentage increase or decrease. The percentage change is computed as follows:

Percentage change in Assets = change in Assets x 100

Previous Year Assets

Table 2.1 resents the Comparative Balance Sheet of a Kicons Ltd. As on 31/03/2012 and

31/03/2013. Changes from 2012 to 2013 for example, Kicons’s total assets increased by Rs.5.47

crore (from Rs.6.82 crore To Rs.12.29 crore) or by 80.19 percent. This was computed as follows:

Percentage increase = 54,699,402 x 100

68,212,219
= 80.19 %

According to ( Maheshwari , and Maheshwari, 2012 :pp. B.6-B7 )9, Such an analysis gives the

management considerable insight into levels and areas of strength and weakness. Since this type of

analysis is based on the data from year to year rather than on one data , it is also termed as

Dynamic Analysis .

30
Table 3.1 Comparative Balance Sheet With Horizontal Analysis. Liabilities

Kicons Limited Comparative Balance Sheet As at 31 March 2012 and 31 March 2013

Liabilities

Increase /
Particulars March 31 , 2013 March 31 , 2012 Decrease Percentage
in Amount (%)

Equity and Liabilities

Shareholders' funds
(a) Share Capital 47,587,200 47,587,200 0.00 0.00%
(b) Reserves and Surplus (11,263,853) (5,646,725) (5617128) 99.48%
36,323,347 41,940,475 (5,617,128) (13.39)%

Non-current liabilities - - - -

Current liabilities
(a)Short-term
22,012,358 5,711,218
Borrowings 16301140 285.42%
(b) Trade Payables 52,199,759 9,922,581 42277178 426.07%
(c)Other Current
9,010,647 7,748,739
Liabilities 1261908 16.29%
(d) Short-term
3,365,510 2,889,206
Provisions 476304 16.49%
86,588,274 26,271,744 60,316,530 229.59%

Total 122,911,621 68,212,219 54,699,402 80.19%

31
Table 3.2 Comparative Balance Sheet with Horizontal Analysis, Assets

Assets
Increase
Particulars March 31 , 2013 March 31 , 2012 Decrease Percentage
in Amount (%)

ASSETS

Non-current Assets
(a) Fixed Assets
(i) Tangible Assets 3,660,391 2,830,015 830376 29.34%
(ii) Intangible Assets 289,765 385,790 (96025) (24.89)%
(b) Non-current
0 0
Investments 0 0.00%
(c) Deferred tax Assets
4,982,485 4,192,376
(net) 790109 18.85%
(d) Long term Loans and
3,000,401 5,679,125
Advances (2678723) (47.17)%
11,933,042 13,087,306 (1,154,263) (8.82)%

Current assets
(a) Current Investments 10,417,000 0 10417000 100 %
(c) Trade Receivables 12,197,541 22,891,463 (10693922) (46.72)%
(d) Cash and Cash
49,130,875 12,448,688
Equivalents 36682187 294.67%
(e) Short-term Loans and
26,911,344 18,580,121
Advances 8331223 44.84%
(f) Other Current Assets 12,321,819 1,204,641 11117178 922.86%
110,978,579 55,124,913 55,853,666 101.32%

Total 122,911,621 68,212,219 54,699,402 80.19%

32
3.5.2 Vertical Analysis

(Jawaharlal , 2010:p.352)10 defines vertical analysis as “the vertical analysis uses

percentages to show the relationship of different parts to the total in a single statement . Vertical

analysis sets a total figure in the statement equal to 100 per cent and computes the percentage of

each component of that figure . the figure to be used as 100 per cent will be total assets or total

liabilities and equity capital in the case of balance sheet and revenue or sales in the case of the

profit and loss account.

For instance, in the Comparative Income Statement with vertical analysis of Kicons Ltd.,

shown in figure 2.2, the Revenue from Operations increased from 78.94% in 2012 to 89.76% in

2013 whereas the amounts increased from 2.35 Crore in 2012 to 9 crore in 2013

33
 Table 3. 3 Comparative Income Statements with Vertical Analysis

Kicons Ltd Comparative Income Statement for The Years Ended

31 March 2012 and 31 March 2013

March 31 ,
Particulars March 31 , 2013 % %
2012
Revenue from Operations 90,100,084 89.76% 23,540,642 78.94%
Other Income 10,275,407 10.24% 6,279,552 21.06%

Total Revenue 100,375,491 100.00% 29,820,194 100.00%

Expenses:
Cost of Materials Consumed 33,262,077 33.14% 0 0.00%
Employee Benefit Expenses 31,967,163 31.84% 11,585,189 38.85%
Finance Costs 543,273 0.54% 76,683 0.26%
Depreciation and Amortization
0.99% 1.38%
Expense 995,112 411,659
Administrative and Other
27.10% 47.49%
Expenses 27,200,629 14,162,183

Total Expenses 93,968,254 93.38% 26,235,714 87.98%

Profit/(Loss) Before Tax 6,407,237 6.38% 3,584,480 12.02%

Tax expense
(1) Current tax - -
(2) Deferred tax (790,109) (0.79%) (111,812) (0.37%)

Profit/(Loss) for the year 5,617,128 5.60% 3,472,668 11.64%

Add / (Less) Prior Period

Adjustment :
Excess provision for Tax written
back 0 144,433 0.48%

Profit/(Loss) for the period 5,617,128 5.60% 3,617,101 12.12%

34
 3.5.3 Trend Analysis

Trend analysis is a devise to study relationship between the two related variables over a

period of time. For example ,changes in the behavioral relationship of sales and inventories ,sales

and receivables ,current assets and current liabilities ,net profit to total capital employed etc. Over

a period of time can be gainfully studied with the help of trend ratio .

According to ( Srivastava , 2009: p82))11, trend analysis uses an index number to show

changes in related items over a period of time, (usually 5 years). Each item in the base year

(selected) is assigned the value of 100% and each item in the other years is expressed as a

percentage of the naira amount in the base year. Thus, trend percentage or index can be calculated

as follows:

Trend Percentage = Amt for item in any year x 100

Amt for item in base year

For instance, the trend percentage for total revenue for 2013 in the trend analysis shown in

figure 2.3 (taking 2012 as the base year), was calculated as follows:

Trend percentage for Total Revenue (in 2013) = 90,100,084 x 100

23,540,642

= 382.74%

35
Table 3. 4 Trend Analysis

Kicons Ltd

Total Revenue Trend Analysis

For The Two Years Ended 31 March 2013

Particulars 2012 2013

Total Revenue from Operations 23,540,642 90,100,084

Trend Analysis (%) 100% 382.74%

3.6 Ratio Analysis

(Grewal, and Gupta, 2013:p.772)12 defined ratio An intelligent study of a firms profit

and loss Account and Balance sheet will generally yield good results towards understanding the

financial position in which the company is placed and the degree of efficiency with which its

operations are being conducted . Ratio the arithmetic relationship between two figures .

(Jawaharlal 2010: p.353)13 To be useful , a ratio must represent a meaningful relationship but use

of ratio cannot take the place of studying the underlying data.

3.7 Objective of Ratio Analysis

Following are important objectives of ratio analysis (Mahagan, and kulkarni, 2013 :p. 3.4)14

i) To provide the necessary basis for inter-firm comparison as well as intra –firm comparison

,comparison .

ii) To provide the necessary basis for Inter period comparison I,e, comparison , between two year .

iii) To help in providing a part of information needed in the process of decision making .

iv) To focus on facts on a comparative basis and facilitate drawing of conclusion relating to the

performance of the firm .

36
v) To evaluate the performance of a firm in determining the important aspects of a business.

vi) To throw light on the degree of efficiency in the management and the effectiveness in the

utilization of its assets .

vii) To provide the way for effective control of the enterprise in the matter of achieving the

physical and monetary targets .

viii) To help the management in discharging its basic function like forecasting , planning , co-

ordination , communication , control .

ix) To point out the financial condition of business whether it is very strong , questionable or poor

and enables the management to take necessary steps .

3.8 Classification of Ratio Analysis

The use of ratio analysis is not confined to financial mangarer only . There are different

parties interested in the ratio analysis for knowing the financial position of a firm for different

purposes. Ratio analysis is divided into two types, namely; univariate ratio analysis and multi –

variate ratio analysis. Meanwhile, for the purpose of this study, the Comparative Balance Sheet

and Income Statement of Kicons Ltd., shown in figure 2.1 and 2.2 respectively will be used to

illustrate these. Also, where a ratio calls for the use of an average amount will be used where the

beginning –of – year amount is not available. (Madegowda , 2007:p. 27)15 . However , the

modus operandi and the material or information used are the two common bases used for

classification .

3.8.1 Unvaried Ratio Analysis

This is the traditional and most popular approach to ratio analysis used by accounting

textbooks. It examines one ratio at a time and shows how it is possible to draw tentative

conclusions by comparing the result of the ratio with some yardsticks of comparison. By studying
37
a number of ratios in this way, it is possible to piece together a picture of the company’s

performance and position. (Lewis , 1996:p.375)16.

Owing to its role in achieving the objectives of ratio analysis discussed earlier, univariate

ratio analysis will be the major focus of this study. Five of its categories to be discussed include

liquidity Ratios, Profitability Ratios, Assets Management Ratios, Debt Management Ratios, and

Investment Ratio.

3.8.2 Liquidity (Short-Term Solvency) Ratios

From among various feasible alternatives available short-term decisions are of a special

nature , the type of information required for decision – making. (Khan, and Jain, 2010:p.22)17

depends on the decision situation under consideration. “Liquidity is the ability of a business to

meet its financial obligations as they fall due” One the other hand, defines liquidity, as “a

company’s ability to pay bills when they are due and to meet unexpected needs of cash”.

Liquidity ratios can be divided into two – short-term liquidity (solvency) ratios .Liquidity

ratios (short-terms solvency ratios) are of particular concern to short-term lenders and suppliers

who provide products and services to the firm on credit. They want to be sure the company has

the ability to pay its debts. Liquidity Ratios include Current Ratio and Quick or Acid Test Ratio.

However, for the purpose of this study, liquidity Ratios refers to short-term liquidity ratios while

Debt Management Ratios refer to long-term liquidity ratios.

3.8.3 Current Ratio

( Venkatasivakumar , 2011:p.17.7)18 Current assets includes cash and other assets

convertible or meant to be converted into cash during the operating cycle of the business .

(Jawaharlal 2010: pp. 355-356)19 Current ratio is sometimes referred to as working capital ratio

or bankers ratio . Current ratio expresses the relationship of current assets to current liabilities . It
38
is widely used as a broad indicator of a companies liquidity and short- term debt – paying ability.

Current ratio is a more dependable indication of solvency than is working capital .

( Venkatasivakumar , 2011:p.17.7)20 The ratio help us in understanding the liquidity position of

the company .liquidity position refers to the ability of the company to meet its day –to-day

obligation . For many years the guideline for the minimum current ratio has been 2 : 1 .

Current Ratio = Current Assets

Current Liabilities
For Kicons Ltd., Current ratio=

2013 2012

110,978,579 = 1.26 : 1 55,124,913 = 2.10 :1

86,588,274 26,271,744

From the above computations, it can be detected that Kicons’s Current Ratio decreased in

2013 over 2012 and ratio for 2013 is not standard.

3.8.4 Quick (Acid Test) or Liquid Ratio

Quick Ratio , also known as Acid Test or Liquid Ratio, is a more rigorous test of

liquidity than the current ratio . The term liquidity refers to the ability of a firm to pay its short –

term obligation as and when they become due . The two determinants of current ratio, as a

measure of liquidity . In the same manner , prepaid expenses are also excluded from the list of

quick / liquid assets because they are not expected to be converted into cash .( Gupta , and

Sharma ,2013: p. 9.14 ) 21 . The standard for quick ratio is 1:1.

Quick or Acid Test Ratio = Quick or Liquid Assets

Current Liabilities

i.e. Current Assets - Inventory

Current Liabilities

39
For Kicons Ltd, Quick ratio =

2013 2012

110,978,579 = 1.27 :1 55,124,913 = 2.10 :1

86,588,274 26,271,744

For the above computations, it can be detected that Kicons Quick Ratio decreased in 2013

over 2012 but both are good.

Form the above computations; it is obvious that Kicons can pay off its current liabilities

without selling any inventory.

3.8.5 Profitability Ratio Related to Investments

( Khan , and Jain, 2010 : p. 6.21 )22 Return on investments ( ROI) As already observed

, The Profitability ratio can also be computed by relating the profits of a firm to investment . Such

ratio are popularly termed as return on investments (ROI) There are three different concepts of

investments in vogue in financial literatures : assets , capital employed and shareholders equity

.Based on each of them , there are three broad categories of ROIs . are (i) return on assets, (ii)

return on capital employed and (iii) return on shareholders equity

3.8.6 Return on Sales or Net Profit Margin

Managers carefully follow the return on sales ratio ( also known as the net profit margin

ratio) , which shows the relationship of net income to sales revenue . The ratio gauges a companies

ability to control the level of all its expenses relative to the level of its sales . (Horngern, et al,

2011:p.156)23.

As with the gross profit percentage ,the return on sales tends to vary by industry , but the range is

not as great .

40
3.8.7 Gross Profit Ratio

According to (Madegowda , 2007:p84)24 This Ratio established the relation between

Gross profit ( GP) on sales and Net Sales in terms of percentage indicating the percentage of Gross

Profit earned on sales . Gross Profit which is sometimes referred to as Gross Margin is the

difference between the net sales ( i.e., Total Sales Revenue – Sales Return ) and the cost of goods

sold ( i.e., Manufacturing Cost of Goods Sold ) . That means ,

Gross Profit = { Net Sales _ Cost of goods sold }

Net Sales Revenue = { Total Sales Revenue _ sales Return }

Gross Profit
Therefore , Gross Profit Ratio= { ---------------------- x 100}
Net Sales Revenue
Gross profit margin can be calculated as follows:

2013 2012

6, 407, 237 x 100 3,584,480 x 100

90,100,084 23,540,642
= 7.11 % = 15.22

3.8.8 Net Profit Margin

According to ( Pandey, 2013 :p.133) 25 The profit after tax (PAT) Figure excludes interest on

borrowing . Interest is tax deductible, and therefore, a firm which pays more interest pays less

taxes .

(Shukla et al 2013 : p.24. 5)26 This measures the rate of net profit earned on sales .The Ratio

establishes the relationship between the amount of net profit or net income and the amount of sales

revenue . Net Profit is arrived at by adding non – operating income ( such as, interest and dividend

on investments, profit on sale of fixed assets ) .

Net profit margin can be calculated as follows:

41
Net Profit Margin = Net Income x 100
Net Sales
For Kicons Ltd., Net profit Margin =

2013 2012

(5,617,128) x 100 3,696,292 x 100

90,100,084 23,540,642

= 6.23 = 15.70

The above figures indicate that the Net profit Margin is far below the Gross profit Margin

in both years. Nevertheless, the results were generally favorable in the year 2012 and not favorable

in the year 2013

3.8.9 Return On Assets

The Return On Assets ratio (ROA) compares net income with invested capital as measured

by average total assets . The company invests its resources in assets , which it uses to generate

revenues and ultimately ,net income . (Horngern, et al , 2011:pp.156-157)27 . The return on

assets ratio measures how effectively those assets generate profits. The are numerous variations of

the return on assets ratio.

3.8.10 Return Operating Assets

This measures the Profitability of a business in carrying out its primary functions, by

indicating the proportion of the operating assets that become net operating income. Operating

assets are all assets actively used in producing operating revenues. Therefore, non operating assets

such as land held for future use, a factory building ranted to another company, and long-term bond

investments are excluded when calculating return on operating assets. (Hermasnon et al,

1992:p.837)28 the formula is:

42
Return on Operating Assets = Net Operating Income

Average Operating Assets

Or Net Operating Assets .

Average Total Assets (Where there are no non-operating assets)

For Kicons Ltd., Return on Operating Assets =

2013 2012

6,407,237 x 100 3,584,480 x100

122,911,621 68,212,219

= 5, 21% = 5.25%

3.8.11 Return On Total Assets

The (ROA) measures the profitability of the firm in terms of assets employed in the firm .

The ROA is calculated by establishing the relationship between the profits and the assets

employed to earn that profit . ( Rustagi , 2012:p.73)29 Usually the profit of the firm is measured in

terms of the net profit after tax and the assets are measured in term of total assets or total tangible

assets or total fixed assets . Conceptually , the ROA may be measured as follows:

Return On Total Assets = Net Income x 100

Average Total Assets

For Kicons Ltd., Return On Total Assets or ROA =

2013 2012

5,617,128 x 100 3,696,292 x 100

122,911,621 68,218,219

= (4.57%) = 5.41 %

From the above computations, it can be deduced that although the assets were not

efficiently used to earn profit in the year 2013.

43
3.8.12 Return On Equity (ROE)

The ROE examines profitability from the perspective of the equity investors by relating

profits available for equity shareholders with the book value of the equity investment . (Rustagi,

2012:p.74)30. The return from the point of view of equity shareholders may be calculated by

comparing the net profit less preference dividend with their total contribution in the firm .

Sometimes the ROE is also calculated to show the return on total shareholders fund ( both equity

and preference ) . In such a case , the ROE is as follows :

ROE = Net Income x 100

Average Stockholder’s Equity

For Kicons Ltd, ROE =

2013 2012

5,617,128 x 100 3,696,292 X 100

36,323,347 41,940,475

= (15.46%) = 8.81%

The above results are not good.

3.8.13 Inventory Turnover

As Kicons Limited is a service based industry therefore it is unable to calculate Inventory

Turnover Ratio. Inventory Turnover measures the number of times in which the average inventory

or stock is sold in a given period. This is of prime importance to management because for a

business to generate greater sales volume for the year, it must but sell and replenish its goods or

stock as rapidly as possible. ( Gupta , and Sharma, 2013:p. 9.24)31 .Inventory Turnover it may

be interest to see average time taken for clearing the stocks. This can be possible by calculating

44
inventory conversion period. This period is calculated by dividing the number of days by

inventory turnover.

3.8.14 Accounts Receivable turnover

Accounts receivable turnover is a measure that indicates how quickly a company is

collecting its accounts receivable. It is the number of times per year that the average amount of

accounts receivable or debtors is a collected (Dansby et al ,2000:p.829)32. It measurers the

relative size of accounts receivable balance and effectiveness of credit polices. The higher the

accounts receivable turnover.

Accounts receivable Turnover can be calculated as follows:

Accounts Receivable Turnover = Net Credit Sales

Average Accounts Receivable
Or Net Sales
Accounts Receivable
(where net credit sales and average accounts receivable are not possible or available.).

Therefore, for Kicons Ltd.,

Accounts Receivable Turnover =

2013 2012
90,100,084 = 7.39 times 23,540,642 = 1.03 times
12,197,541 22,891,463
From the above computations, it can be understood that Kicons’s already low accounts

receivable turnover reduced the more in 2012

45
3.8.15 Interpretation of Average Collection Period Ratio

The shorter the average collection period, the better is the equality of debtors as a short

collection period implies quick payment by debtors. Similarly a higher collection period implies

an inefficient collection performance which in turn adversely affects the liquidity or short term

paying capacity of a firm out of its current liabilities.( Gordon ,et al ,2010 : p.50)33 The ration

measures average liquidity of accounts receivable and gives an indication of their quality. A

comparison of the average collection period with the credit extended customers by a company or

the firms, credit extension policy will provide further insight into the quality of accounts

receivable.

The formula for this ratio is

ACP = 365 Days .

Accounts Receivable Turnover

For Kicons Ltd., ACP =

2013 2012

365 days = 49.41 days 365 days = 354.93 days

7.39 1.03

Depending on the credit terms, the above computation shows that Kicons Limited ACP is

long. That is, the credit sales stay over 12 months in 2012 before they are collected. This indicated

poor collection effort.

3.8.16 Total Assets Turnover (TAT)

This ratio expresses relationship between the amount invested in the assets and the results

accruing in terms of sales .This is calculated by diving the net sales by total assets . Total assets

46
turnover indicate the efficiency with which assets of the company have been utilized . (Srivastava

, 2009:p.92)34 . Total Assets Turnover can be calculated as follows.

Total Assets Turnover

= Net Sales .
Average Total Assets (excluding investments)

Investments are excluded from the formula since they are not intended to produce sales. In

other words, the ratio is known as Turnover of Operating Assets, because it to generate sales

revenue.

For Kicons Ltd., TAT =

2013 2012

90,100,084 = 7.5 times 23,540,642 = 1.7 times

11,933,042 13,087,306

Kicons Ltd’s assets turnover rates of 7.5 times in 2013, it is not high. This could mean that

the firm is not generating enough sales for the amount of assets it has available. However, the fact

that this is just one measure should compel the firm to compare it with the figure shown by similar

business in the same industry.

3.8.17 Fixed Assets Turnover (FAT) Ratio

This ratio indicates the extent to which the investments in fixed assets contributed to wards

sales .If compared with a previous period . (Maheshwari et al , 2011:p.3.22)35 it indicates

whether the investment in fixed assets has been judicious or not . The ratio is calculated as

follows:

Fixed Assets Turnover = Nest Sales .

47
 Average fixed Assets

For Kicons Ltd., FAT =

2013 2012

90,100,084 23,540,642
11,933,o42 3,215,805
=22.81 times =7.32 times

From the above computations it can be deduced that Kicons improved its equipment

utilization in generating sales in 2013.

3.8 18 Debt Management (long-tem solvency) Ratios

Debt management Ratios measure how the firm uses other peoples money to its own

advantage. The primary concern is to ensure that the firm does not borrow so much that becomes

overly risky. ( Lasher , 1997:p.73)36.

Therefore debt management ratios measure the briskness of a business. They are also

known as long-tern solvency, liquidity or stability ratios because they focus on the long-tern

stability and capital structure of the firm. They are of interest to management, stockholders and

creditors. Management wants to know the long-term stability of the business. Creditors want to

make user funds are available to pay interest and principal. Stockholders are concerned about the

impact of excessive debt and interest on long-term Profitability of the business. Thus, Debt

Management Ratios tell the size of owner’s investments in the business as well as the strength of

the business to pay its total liabilities (current and-term liabilities) or all of its financial obligations

to outsiders at long run. Therefore, for the purpose of this purpose of this study, debt refers to total

debt or total liabilities.

48
 Debt management Ratios include Debt Ratio, Equity Ratio, debt-to Equity Ratio, Leverage

Ratio, Fixed Assts to Long-term liabilities, times interest Earned, cash Coverage and fixed charge

coverage.

3.8 19 Debt Ratio

Debt Ratio measures the relationship between total debt and equity in supporting assets of

a business. It tells how much of the firm’s assets are supported by other people’s money. (Lasher,

1997:p.74)37. It also known as the ratio of total liabilities to total assets , because it shows the

proportion or percentage of total assets supported by debt or total or debt. A high debt ratio is

viewed as risky by investors, especially lenders.

Debt ratio calculated as follows:

Debt ratio = Total Liabilities x 100

Total Assets

For Kicons, the debt ratio =

2013 2012

86,588,274 x100 26,271,744 x 100

122,911,621 68,212,219

= 70.45% = 38.51%

From the above results, it can be seen that although the debt ratio is good in both years, the

firm appears less risky in 2012.

3.8.20 Equity Ratio (proprietary) Ratio

A variant to the debt –equity ratio is the proprietary ratio which indicates the relationship

between owners equity and total assets. ( Sahaf , 2004:p.55)38 The ratio of owners equity to total

assets is a measure of the financial strength or weakness of the enterprise .

The ratio is worked out as follows :

49
Equity Ratio = Stockholders’ Equity x 100
Total Assets

For Kicons ltd., Equity Ratio =

2013 2012

36,323,347 x 100 = 29.55% 41,940,475 x 100 = 61.49%

122,911,621 68,212,219

3.8.21 Debt Equity Ratio

According to ( Gupta , and sharma, 2013: p. 9.41 )39 Debt –Equity Ratio , also known as

External –Internal Equity Ratio is calculated to measure the relative claims of outsiders and the

owners ( shareholders ) against the firms assets . This ratio indicates the relationship between the

external equities or the outsiders funds and the internal equities or the shareholders funds.

Debt-to-Equity Ratio = Stockholders’ Equity

Total Liabilities

For Kicons, Debt-to-Equity Ratio =

2013 2012

36,323,347 = 0.42:1 41,940,475 = 1.6:1

86,588,274 26,271,744

Form the above results, it is obvious that Kicons’s debt-equity ratio is better in 2012

than 2013.

3.8 22 Leverage (Gearing) Ratio

This is similar to ratio but the only difference is that it measures the size of long-term

liabilities or fixed-interest debts in comparison with the stockholders’ or owners’ equity. The

50
standard for this ratio is 1:1. A firm with high leverage ratio is said to be highly geared and such

makes the firm to be financially because high interest charges will reduce the profitability of the

business as well as dividends payable to shareholders, especially in times of economic downturns

or fluctuations in earnings. In practice, a gearing ratio greater than 0.6:1 is often regarded as high

while the one that is less than 0.1:1 is regarded as low. The lower the gearing, the better and more

secure the company is to settle long-term debts.

Leverage (Gearing) ratio can be calculated as follows:

Leverage Ratio = Long-term Liabilities

Stockholders’ Equity

For Kicons, leverage Ratio =

For calculating a Leverage Ratio there must be a Long Term Liabilities but in the Kicons there is

no any long term liability.

There fore Leverage Ratio can not be calculated.

3.8.23 Fixed Assets to Long-Term Liabilities

This measures the strength of fixed assets of a business to provide collateral security or

cover for the long-term liabilities. The higher the ratio, the more secure the long-term creditors or

lenders. A ratio of 2:1 or higher provides a margin of safety to long-term note holders. (Dansby,

et al, 2000:p.832)40. The ratio is calculated as follows:

Fixed Assets to Long-Term Liabilities = Fixed Assets

Long-Term Liabilities

51
 For calculating a Leverage Ratio there must be a Long Term Liabilities but in the Kicons

there is no any long term liability.

There fore Leverage Ratio can not be calculated.

As shown above, it is clear that Top tree has a strong and improving ratio of fixed assets to

long-term liabilities. Thus, it is in a good position to secure additional long-term credit facilities,

and using the firm’s plant assets as collateral.

3.8.24 Times Interest Earned (TIE)

Times interest Earned (TIE) measures the number of times interest expense can be paid out

of earnings before interest and taxes (EBIT) or income from operation. It is also called Interest

Coverage Ratio, and indicates the credit worthiness of a firm. According to ( Hermanson et al.

1992:p.842)41, “TIE helps creditors, especially long-term creditors to know whether a borrower

can meet its required interest payments when these payments come due”. The higher the ratio, the

safer it is to lead the firm more money.

TIE is calculated as follows:

TIE = Income from Operations or EBIT

Interest expense

For Kicons, TIE =

For calculating the Interest Coverage Ratio OR TIE there must be Interest paid but unavailability

of Interest, ratio can not be calculate.

3.8.25 Investment (Market Value) Ratios

These measure the performance or market value of investment in the shares or stock of a

firm. Investment ratios provide investors information about the potential return and risk associated

52
with owing shares in a company. (Needles , 1996:p.793)42. Thus, they guide investors in their

investment decisions in a company.

In fact, investment rations indicate the profitability of investing in the shares or stock of a

company. They show the relationship between the earnings of the firm or dividend paid by the

firm and the market price of its shares. Investment ratios include earnings Per Share, Price/

earnings Ration, Earnings Yield, Dividend Coverage, and market to book value Ratio.

Earnings per share (EPS) are the amount of net income available to the owner of each

share of common stock or ordinary share in existence over a particular period. In the words of EPS

is probably the measure used, most widely to appraise a company’s operations. The Accounting

Principles Board (APB) noted the significance attached to EPS by requiring that such amounts be

reported on the face of income statement”.

EPS is calculated as follows:

EPS = Net income or profit After Tax and Preferred Dividend

Average number of common stock Number of Ordinary Share outstanding

For Kicons, EPS =

2013 2012

5,617,128 3,472,668

4,758,7200 47,587,200

= 1.18 = 0.81

The above figures shows that the Kicons Ltd has suffered by loss in 2013, EPS is negative

in this year.

3.8.26 Price/Earnings Ratio (P/E)

Price/Earnings Ratio (P/E) ratio is a measure of investor confidence in a company or how the

stock rates or values a business. It indicates the future prospects of stock. The ratio compares the
53
market price of the stock to the EPS calculated from the latest income statement. It tells how much

or number of times investors are willing to pay for a naira of the firm’s earnings. The higher the

P/E ratio the better, because a naira of earnings translates into more shareholder wealth at higher

P/E ratio.

The ratio can be calculated as follows:

P/E = Market Price Per Share of common stock

EPS

Due to unavailability of market price per share price earning ratio can not be calculated.

3.8.27 Earnings Yield

Earnings Yield indicates return on investment. It is inverse of P/E ratio expressed as a

percentage. It shows EPS in proportion to market price per share. The higher the earnings yield the

better the return on investment on the stock of a firm. The ratio is calculated as follows:

EPS
Earnings Yield =------------------------------ x 100
Market price per share

Due to unavailability of market price per share Earnings Yield Ratio can not be calculate.

3.8.28 Dividend Per Share

Dividend per Share measures the amount of dividends paid per ordinary share

outstanding. It shows the amount of returns earned by investors in terms of dividend in relation to

their investment in each unit of common stock. The higher the Dividend Per Share the better the

returns on stockholders’ investment as well as the share holds’ wealth. Dividend Per Share as

shown blow.

54
 Dividend
Dividend Per Share = ---------------------------------------------
Number of common stock outstanding

Dividend distributed information is not available so DPS can not be calculate.

3.8.29 Dividend Payout Ratio (DPR)

Dividend Payout ratio reveals the dividend payment and retention policy of the firm. It

measures the percentage of a firm’s distributable earnings that paid out to ordinary shareholders as

dividends. The balance or retained earnings is reserved as part of shareholders’ fund to meet future

financial needs. It is the percentage of DPS to EPS.

3.8.30 Dividend Yield RATIO

According to ( Madegowda , 2007 : p. 125)43 When a person acquires the shares of an

organization from the capital market by paying the prevailing market price he naturally wishes to

compute the effective rate of return he receives on his investment . Hence the relationship is

established between (a) dividend per share , and ( b) market price per share . That means,

Dividend Yield ratio is computed by dividing the dividend per share by the market price of an

equity as shown below :

Dividend Dividend Per Share

Yield Ratio = ------------------------------------------ x 100
Market price per share

3.8.31 Fixed Dividend Coverage Ratio

The preference shareholders are entitled to receive dividend only after meeting the

debenture interest and other fixed charges and taxation liability. The ratio establishes the

55
relationship between the amount of net profit after interest and tax but before dividend , Fixed

Dividend Coverage Ratio indicates how secure the dividends are for the preference shareholders.

Net profit after Interest

and Tax but before dividend

Fixed Dividend Coverage =----------------------------------------------
Preference
3.8.32 Market value to Book Value Ratio

Market value to book value ratio is the relationship between market value per share of a

firm and its book value per share ( Gupta, and Sharma, 2013:p. 9.72)44It must be noted that

Book Value Per Share is total value of equity divided by number of common stock outstanding. A

market to book value blow 1.0 indicates grave concern about the company’s future. (Horne ,

2008:p. 389)45 Book Value per share indicates the net worth per equity share and the ratio of

market value to book value may be used to analysis its stock market position

Market value to Book Value Ratio is calculated as follows:

Market Price Per Share

Market value to Book Value Ratio = ---------------------------------------
Book Value Per Share
(Number of shares outstanding)

3.9 Advantages of Ratio Analysis

Following are same of the advantages of ratio analysis :

1- Simplifies Financial Statements: Ratio analysis simplifies comprehension of financial

statement .Ratio tell the whole story of changes in the financial condition of business.

2- Facilitates Inter – firm comparison: Ratio analysis provides data for inter-firm comparison.

Ratios highlight the factors associated with successful and unsuccessful firms. They also reveal

strong firm and weak firms, over-valued and under – valued firm.

56
3- Makes Intra-firm Comparison possible: Ratio analysis also makes possible comparison of

the performance of the different divisions of the firm. The ratios are helpful in deciding about their

efficiency or otherwise in the post and likely performance in the future .

4- Helps in Planning : Ratio analysis helps in planning and forecasting . Over a period of time , a

firm or industry develops cert ion norms that may indicate future success or failure .If relationship

changes in firms data over different time periods. The ratio may provide clues on trends and future

problems. (Maheshwari et al., 2011: p 3.32)46

3.10 Importance Limitations of Ratio Analysis

3.10.1 Importance

According to (Khan, and Jain , 2010: p. 6.41 )47 . As a tool of financial management ,

ratio are of crucial significance . the importance of ratio analysis lies in the fact that it presents

facts on a comparative basis and enables the drawing of inferences regarding the performance of

the firm .Ratio analysis is relevant in assessing the performance of a firm in respect of the

following aspects : ( i) liquidity position ,(ii) long-term solvency ,( iii) operating efficiency, (iv)

overall profitability , (v) inter-firm comparison , and ( vi )trend analysis .

3.10.2 Limitations

According to ( Gupta, and Sharma, 2013:p 9.5-6 )48. The ratio analysis is one of the

most powerful tools of financial management. Though ration are simple to calculate and easy to

understand, ratio analysis is no doubt useful in many respects .But its importance should not be

exaggerated. This is because; ratio analysis suffers from a number of limitations. They suffer

from some serious limitations:

1- Comparative study required: Ratio are useful in judging the efficiency of the business only

when they are compared with the past results of the business or with the results of a similar
57
business. However , such a comparison only provides a glimpse of the past performance and

forecasts for future may not prove correct since several other factors, like market conditions and

management polices .may affect the future operation .(Maheshwari , et al, 2011 : p 3.32 )49

2.Impact of Inflation: The second major limitation of ratio analysis as a tool of financial analysis

is associated with price level changes. Financial statements do not reveal the impact of inflation on

the reporting entity. Real estate purchased years ago for example, will be carried on the Balance

sheet at its original cost. Yet it may be worth many times the amount in today’s market. During

periods of rapid inflation, inventory, cost of sales and depreciation can badly distort true results.

3.Window Dressing: Financial statement can easily be window dressed to present a better picture

of its financial and profitability position to outsiders . Hence one has to be very careful in making

a decision from ratio calculated from such financial statement . But it may be vary difficult from

an outsider to know about the window dressing made by a firm.

4- Limited Use of a Single Ratio. There are not well accepted standards or rules of thumb for all

rations which can be accepted as norms. It renders interpretation of the ratios difficult.

5-Historical Information: financial ratios are computed from historical accounts, and historical

information is of little use in assessing future prospects of a company. This is because trends do

reverse and past may not be a useful measure of adequacy. Thus, past performance may not be

enough to meet present needs and make reliable projections.

6- Uniqueness Of Companies: Every Company is unique in size, operation, management,

and location. Thus, two companies that operate in the same industry may not be strictly

comparable. For instance, comparing a firm which finances its fixed plant through rental, (thus not

showing it as an asset).(Omuya, 1983:P 456)50. With a firm which purchases its own assets will

be difficult irrespective of their operation in the same industry or sector.

58
7-Limited Information: Financial statements do not present information that covers all aspects of

the business. Therefore, financial ratios provide only quantifiable or quantitative information and

omits non-quantifiable or qualitative information such as managerial skills, staffing requirement,

and changes in the operating environment, which are all necessary variables determining the

success of a business.

8-No fixed standards: No fixed standards can be laid down for ideal ratio. The ratio analysis is an

aid to management in taking correct decisions , but as a mechanical substitute for thinking and

judgment ,it is worse than useless. The ratio ,it discriminately calculated and wisely interpreted ,

can be a useful tool of financial analysis .( Maheshwari, et al , 2011:p. 3.34)51

9. Interpretation: Interpretation of ratios is not always clear. Interpretation of changes in a ratio

needs careful examination of changes in the figures used in the computation (both the numerator

and denominator). Without a very full and detailed investigation, some wrong conclusions can be

drawn. Also, only experts can understand and interpret ratios properly..

10. Conceptual Diversity: Yet another factor which influences the usefulness of ratio is that

there is difference of opinion as to what constitutes shareholders equity, debt assets profit and so

on. Different firm may use these terms in different senses or the same firm may use them to mean

different things at different times. ( Khan , and Jain , 2010 p 6. 41-42)52 Finally, ratios are only

a post – mortem analysis of what has happened between two balance sheet dates. For one thing,

the position in the interim period is not revealed by ratio analysis. Moreover, they give no clue

about the future.

59
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New Delhi, India: kalyani published.

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Accounting. 4th ed. st. Paul, MN: Paradigm publishing Inc.

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Accounting , Himalaya Publishing House , India Mumbai .

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ed. st. Paul, MN: Paradigm publishing Inc.

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Boston MA: Richard D. Irwin, Inc.

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House.

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New Delhi, India: kalyani published.

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Kindersley, Pvt. Ltd.

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Management, 2nd Edition. New Delhi, India: USB publishers Distributors. PVT Ltd.

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Mc Graw Hill Education Private Limited.

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practice. New Delhi, India: kalyani .

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Management , 2nd Edition , New Delhi, India: USB publishers Distributors . PVT Ltd.

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Mc Graw Hill Education Private Limited.

64
 CHAPTER IV

DATA ANALYSIS AND INTERPRETATION

4.1 Profile and Stricture of the Company

4.1.1 Profile the company

KICONS LIMITED was established in 1963, by the visionary and industrious Mr. S. L.

Kirloskar. Come 2011, FDG took over Kirloskar Consultants Ltd., now renamed as “KICONS

LIMITED.” The company has witnessed a victorious stretch of over 50 years of infrastructure,

energy and engineering consulting in the country. Kicons Ltd. - pioneers of Engineering,

Architectural & Management Consulting in India. They specialize in Conceptualizing, Designing

and Executing Architectural, Civil, Structural, Electrical, Mechanical, HVAC, Fire & Life Safety

Water Supply, Drainage, Storm Water Management, WTP/STP, Networking, Surveillance, PA,

Telephone and Building Management Systems required for any large integrated project.

The company has a very large repertoire for Institutional, Commercial, and Business &

Industrial works.

The population of the study is 40 members of the management and staff of Kicons Ltd,

Pune. It cores all the departments of sales and marketing, the purchase and supply department, the

administration and personnel department and the finance and accounts department. All the is staff

of these departments are further grouped into two groups namely; management staff and Non

management staff.

65
The management staff is 30 comprises of administration and personnel department, and the

finance and accounts departments. While the Non-management staff is 10 comprises of the sales

and marketing department, and purchasing and supply department.

66
4.1.2 Stricture of the Company

67
4.2 Research Result and Analysis

4.2.1 Discussion on Statistical Analysis

----------In this chapter, the discussion on statistical analysis is about the respondents, the data

analysis method.

4.2.2 Respondents

---------- 40 questionnaires are sent to KICONS LIMITED management staff and non management

staff. The table shows the response rate of the questionnaires.

Table 4.1: Response Rate of the Questionnaires

Frequency/ Frequency/
Response Rate of Mgt Rate of
Staff Non Mgt Staff
Distributed questionnaires 30 10

Returned questionnaires 30 8

Not returned questionnaires 0 2

Response rate 95% 5%

68
4.2.3 Data Analysis

4.2.3.1 Question No.2

Table 4.2 Questionnaire Distributions and Collection

Management staff Non Management staff Total

Questions
No Percentage No Percentage No Percentage

Administered 30 75% 10 25% 40 100%

Returned 30 75% 8 20% 38 95%

Non Returned 0 0 2 5% 2 5%

As shown in the table above, 38 (95%) of the total number of questionnaire distributed

were returned, while 2 (5%) were not returned.

The questionnaire used in the data collection had 11 questions. The first 2 questions (question 1

and 2) relates to the sexes and staff positions of the respondents respectively. The remaining Que 8

- Que 11 questions were used to achieve the objectives of the study.

However, as stated earlier, only questions that are must relevant to the research questions

were presented and analyzed. In these regards, the response given to question 4,4,6,7,8,9.10 and

11 were presented and analyzed, as well as used he draws the conclusions.

69
4.2.3.2 Question No.3

Table 4.3 Highest Education Qualification Level Obtained

Management staff Non Management staff
Level Total
No Percentage No Percentage

Msc 5 13.15% 0 0% 13.15%

Bsc 5 13.15% 0 0% 13.15%

Hnd 10 26.3% 4 10.55% 36.85%

Ond 5 13.15% 2 5.275% 18.425%

O level 5 13.15% 2 5.275% 18.425%

Total 30 78.9% 8 21.1% 100%

From the table 4.2 above showing the highest qualification education obtained by all the
staff, shows that 5 (13.15%) out of 30 (78.9%) is an Msc holders, 5 (13.15%) out of 30 (78.9%) of
the management staff are Bsc holders, 2(10%) out of 30 (78.9%) of the management staff are
HND holders10(26.3%) out of 30(78.9%),Ond 5(13.15%)out of 30(78.9%),O level 5(13.15%) out
of 30(78.9%), Coming to the Non management staff 4 (10.55%) out of 8 (21.1%) are HND
holders, 2 (5.275%) out of 8 (7521.1%) are OND holders, while 2 (5.275%) of the remaining are
O level holders.

70
 Table (4.4) Show the Number of Responses of Management Staff

Responses Percentage Responses Percentage

Questions
Yes Yes No No

1. Do you believe that financial statements-

income statement and balance sheet are effective 25 83.3% 5 16.7%
ways of communicating financial information?
2. Is Ratio Analysis used by your firm as a
30 100% 0 0
decision making tool?
3.Do you agree that ratio analysis facilitates
proper understanding of information contained in 27 90% 3 10%
financial statements?
4. Do you think that Ratio Analysis is useful to
management, investing shareholders and creditors 30 100% 0 0
in their business decisions?
5. Do you think that financial ratios are useful in
evaluating and predating the performance of a
30 100% 0 0
business as well as certifying areas that require
improvement?
6. Do you agree with the saying that ratio analysis
helps it’s to ask the right questions but do not
29 96.7% 1 3.3%
provide answers unless the right comparative
standards and techniques are used?
7. Are there obstacles to the proper use of rotor
28 93.3% 2 6.7%
analysis in your business clerisies?
8. Does financial retro helps to unravel the mass
of truth hidden in financial statement? 29 96.7% 1 3.3%

71
 Figure 4.1 show the number of responses of management staff

As shown in the table (4.1) above of management staff that

1. Do you believe that financial statements- income statement and balance sheet are effective ways
of communicating financial information?

 83.3% of respondents agreed that the financial statements- income statement and balance

sheet are effective ways of communicating financial information and 16.7% not agree.

2. Is Ratio Analysis used by your firm as a decision making tool?

 100% of respondents agreed that the Ratio Analysis used by your firm as a decision

making tool and 0% not agree.

3. Do you agree that ratio analysis facilitates proper understanding of information contained in

financial statements?

 90% of respondents agreed that the ratio analysis facilitates proper understanding of

information contained in financial statements and 10% not agree.

72
 4. Do you think that Ratio Analysis is useful to management, investing shareholders and

creditors in their business decisions?

 100% of respondents agreed that the Ratio Analysis is useful to management, investing

shareholders and creditors in their business decisions and 0% not agree.

5. Do you think that financial ratios are useful in evaluating and predating the performance of

a business as well as certifying areas that require improvement?

 100% of respondents agreed that the financial ratios are useful in evaluating and predating

the performance of a business as well as certifying areas that require improvement and 0%

not agree.

6. Do you agree with the saying that ratio analysis helps its to ask the right questions but do not

provide answers unless the right comparative standards and techniques are used?

 96.7% of respondents agreed that the ratio analysis helps it’s to ask the right questions but

do not provide answers unless the right comparative standards and techniques are used and

3.3% not agree.

7. Are there obstacles to the proper use of rotor analysis in your business clerisies?

 93.3% of respondents agreed that the proper use of rotor analysis in your business clerisies

and 6.7% not agree.

8. Does financial ratio helps to unravel the mass of truth hidden in financial statement?

 96.7% of respondents agreed that the financial retro helps to unravel the mass of truth

hidden in financial statement and 3.3% not agree.

73
 Table (4.5) Show the Number of Responses of Non-Management Staff

Responses Percentage Responses Percentage

Questions
Yes Yes No No

1. Do you believe that financial statements-

income statement and balance sheet are effective 8 100% 0 0
ways of communicating financial information?
2. Is Ratio Analysis used by your firm as a
8 100% 0 0
decision making tool?
3. Do you agree that ratio analysis facilitates
proper understanding of information contained in 7 87.5% 1 12.5%
financial statements?
4. Do you think that Ratio Analysis is useful to
management, investing shareholders and creditors 6 75% 2 25%
in their business decisions?
5. Do you think that financial ratios are useful in
evaluating and predating the performance of a
7 87.5% 1 12.5%
business as well as certifying areas that require
improvement?
6. Do you agree with the saying that rotor analysis
helps it’s to ask the right questions but do not
5 62.5% 3 37.5%
provide answers unless the right comparative
standards and techniques are used?
7. Are there obstacles to the proper use of rotor
7 87.5% 1 12.5%
analysis in your business clerisies?
8. Does financial retro helps to unravel the mass
of truth hidden in financial statement? 7 87.5% 1 12.5%

74
 Figure 4.2 show the number of responses of non-management staff

As shown in the table (4.1) above of management staff that

1. Do you believe that financial statements- income statement and balance sheet are effective ways
of communicating financial information?

 100% of respondents agreed that the financial statements- income statement and balance

sheet are effective ways of communicating financial information and 0% not agree.

2. Is Ratio Analysis used by your firm as a decision making tool?

 100% of respondents agreed that the Ratio Analysis used by your firm as a decision

making tool and 0% not agree.

3. Do you agree that ratio analysis facilitates proper understanding of information contained in

Financial statements?

 87.5% of respondents agreed that the ratio analysis facilitates proper understanding of

information contained in financial statements and 12.5% not agree.

75
 4. Do you think that Ratio Analysis is useful to management, investing shareholders and

creditors in their business decisions?

 75% of respondents agreed that the Ratio Analysis is useful to management, investing

shareholders and creditors in their business decisions and 25% not agree.

5. Do you think that financial ratios are useful in evaluating and predating the performance of

a business as well as certifying areas that require improvement?

 87.5% of respondents agreed that the financial ratios are useful in evaluating and predating

the performance of a business as well as certifying areas that require improvement and

12.5% not agree.

6. Do you agree with the saying that ratio analysis helps its to ask the right questions but do not

provide answers unless the right comparative standards and techniques are used?

 62.5% of respondents agreed that the ratio analysis helps its to ask the right questions but

do not provide answers unless the right comparative standards and techniques are used and

37.5% not agree.

7. Are there obstacles to the proper use of rotor analysis in your business clerisies?

 87.5% of respondents agreed that the proper use of rotor analysis in your business clerisies

and 12.5% not agree.

8. Does financial ratio helps to unravel the mass of truth hidden in financial statement?

 87.5% of respondents agreed that the financial retro helps to unravel the mass of truth

hidden in financial statement and 12.5% not agree.

76
 CHPTER V

CONCLUSION AND RECOMMENDATION

5.1 Conclusion

Financial statement is prepared primarily for decision making .They play a dominant role in

setting the framework of managerial decision. But the information provided in the financial

statement is not end in itself as no meaningful conclusions can be drawn from this statement alone.

However, the information provided in the financial statement is of immense use in making

decisions through analysis and interpretation of financial statement.

Ratio analysis is the process of identifying the financial strengths and weaknesses of the firm by

properly establishing relationship between the items of the balance sheet and the profit and loss

account.

Ratio analysis is one of the powerful tools of the financial analysis. A ratio is the relationship

between two accounting items expressed mathematically.

Ratio analysis helps the analyst to make quantitative judgment with regard to concerns financial

position and performance.

Ratio analysis even helps in making effective control of the business. Standard ratio can be based

upon perform financial statement and variances or deviations , if any ,can be found by comparing

the actual with the standards so as to take a corrective action at the right time.

Ratio analysis is of much help in financial forecasting and planning.

77
5.2 Recommendations

With special reference to the finding of the study, the researcher recommends the

following:

1- Financial ratio should be used with careful examination and proper understanding of

meaning implication and effect of the actual figures shown in financial statement in order

to avoid making wrong judgment , conclusions and decision .

2- Users of financial statement who are not knowledgeable enough to analysis or understand

the information contained in them should seek the services of qualified financial analysts,

accountants, stockbrokers, bankers.

3- Financial ratio should be judiciously used by firms, investors, lenders shareholders,

managers, and other stakeholders, in view of their numerous benefits and limitation.

4- Ratio Analysis help the managerial persons in their decision making task.

5- In view of the remarkable influence which accounting information’s have on the decision

of the users, it is pertinent that only qualified and honest persons should and audit financial

statement.

6- Ratio Analysis helps the management in its planning and forecasting activities.

7- As the Ratio Analysis simples the financial the financial data, it becomes easy to

understand the financial statement.

8- Prospective investors should properly analyze the financial statement of companies before

deciding to invest in the companies.

78
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