Analysis and Interpretation of

Financial Statements

Ashutosh Kolte
PUMBA, University of Pune
 Classification of Accounting
Accounting

Financial Accounting Cost Accounting Management Accounting

Types of Financial Statements

• Profit and Loss Account
• Balance Sheet
 Fundamental Accounting Assumptions
• Going Concern
• Consistency
• Accrual
Accounting Concepts and Conventions
• Business Entity Concept
• Conservatism
• Materiality
• Historical Cost Concept
Accounting Policies
• Depreciation
• Valuation of Inventories
• Treatment of Goodwill
• Recognition of Profit on Long Term contracts.
• Treatment of Retirement Benefits.
 Accounting Standards
• Issued by ICAI
• Mandatory
• Represents ideal practice of Accounting
• Consistency in presentation of Financial
Statements.
• Ensures comparability of Accounts.
• Disclosure of Accounting Policies.
International Accounting Standards

Importance
• Globalization of the economy – Indian

Companies going Global.

• Appreciation by the Foreign Investors for

Accounts following IAS norms.

 Contents of Annual Reports
• Financial Statements
• Notes to Accounts
• Statement of Significant Accounting
Policies
• Auditor’s Report
• Directors Report
• EVA at a Glance
 Financial Analysis & control
Important tools in the hands of management
 Ratio Analysis
 Fund Flow Statement
 Cash Flow Statement
 Horizontal and Vertical analysis
 Trend Analysis
 Common size statements
 Application of Mathematics and Statistics
techniques on Financial Data
 Trading, P&L A/C
Particulars Rs. Particulars Rs.
To O/P Stock XXX By Sales XXX
To Purchases XXX By C/L Stock XXX

To Gross Profit c/f XXX  

  XXX XXX

   
To Expenses / depreciation /
interest / administrative XXX
expenses, etc..   By Gross Profit b/d XXX
By income from
investment XXX

To Provision for tax XXX  

To Net Profit c/f XXX  

  XXX   XXX
 P&L Appropriation A/C
Particulars Rs. Particulars Rs.
To Proposed Dividend XXX To Net Profit b/d XXX

To Transfer to General
Reserve XXX  

To Net Profit transferred to  

Balance sheet XXX  

  XXX   XXX
 Balance Sheet As On……..
Liabilities Assets

Equity Share Goodwill

Capital
XXX XXX
Preference Share Fixed Assets
Capital
XXX XXX
Reserves & Investments
surplus
XXX XXX
Secured Loans Current Assets
XXX XXX
Unsecured Loans Miscellaneous
XXX Expenses (To
XXX
The Extent
Not Written Off)
Current Liabilities
& Provisions
XXX
Financial Ratio Analysis

 Liquidity ratios
 Profitability or Efficiency ratios.
 Ownership ratios
* Earnings ratios
* Dividend ratios
* Leverage ratios
-- Capital structure ratios
-- Coverage ratios
 Turnover Ratios
 Liquidity ratios
 Current ratio
Current Assets
Current Liabilities

 Quick ratio (Acid-test ratio)

Quick Assets
Current Liabilities

* Quick assets =
Current Assets – Inventories – Prepaid Expenses
– Taxes paid in advance.
 Quick ratio (Acid-test ratio)

Quick Assets
Quick Liabilities
Quick Liabilities = CL – Bank OD and CC.

Cash Ratio / Super Quick Ratio =

Cash + Marketable Securities
Quick liabilities
 Profitability or Efficiency ratios
Profitability ratios measure a firm’s overall efficiency and
effectiveness in generating profit. Profitability Ratios are
calculated in percentage.
Profit before interest and tax (PBIT)
Margin 
Net sales
Profit after tax (PAT)
Net margin 
Net sales
PBIT
Before tax return on investment 
Net assets
Profit after tax
Return on equity 
Equity (net worth)
 Gross Profit Margin Ratio (GPM)

Gross Profit
Net Sales
* Net Sales = Sales – Excise Duty

 Net Profit Margin Ratio (NPM)

Net Profit
Net Sales
Cost of Goods Sold Ratio =
Cost of Goods Sold / Net Sales

Operating Expenses Ratio =

(Administrative Exp +Selling Exp)
Net Sales
Operating Ratio =
Cost of Goods Sold + Operating Expenses
Net Sales

Particular Expenses Ratio =

Particular Expenses / Net Sales.
 Ownership ratios
 Equity-related ratios measure the shareholders’
return and value.
Profit after tax
EPS 
Number of ordinary shares
Dividends
DPS 
Number of ordinary shares
DPS Dividends
Payout ratio  
EPS Pr ofit after tax
DPS
Dividend yield 
Market value per share
 EPS
Earnings yield 
Market value per share
Market value per share
P / E ratio =
EPS
Net worth
Book value per share 
Number of ordinary shares
Market value per share
M B value 
Book value per share
Market value of assets
Tobin ' s q 
Economic value of assets
 Solvency Ratios / Leverage ratios

Also called as Capital structure ratios

 Solvency ratios measure the dependence of a
firm on borrowed funds.
Debt
Debt-equity ratio 
Equity (Net Worth)
Debt Debt
Debt ratio  
Debt  Equity Capital employed
Earnings before interest and tax
Interest coverage 
Interest
Debt-assets ratio = Debt
Assets
*Coverage ratios

Interest coverage ratio

“gives the relationship between the financial

charges of a firm and its ability to service
them”.

. EBIT ..

Interest expense
 Debt service coverage ratio

PAT+ Depreciation+ other non-cash

charges + Interest on term loan
Interest on term loan + Repayment of
the term loan
 Turnover ratios
Accounts receivable/ Debtors turnover ratio

= Net credit sales

Average accounts receivable

Average collection period

= 365
Av. accounts receivable turnover

= Av.accounts receivable
Av. daily sales
Asset turnover ratio =
Cost of Goods Sold
Av. Assets

Inventory turnover ratio =

Cost of goods sold
Av. Inventory

Debtors Turnover Ratio =

Total Credit Sales
Average Debtors + Average Bills Receivable
Income Statement
Sales XXX
Less Variable Cost XXX
Contribution XXX
Less Fixed Cost XXX
Operating Profit XXX
(Earning Before Interest & Tax)  
Less Interest on debt XXX
Earning Before Tax XXX
Less Tax XXX
Profit After Tax XXX
Less Preference Dividend XXX
Profit Available to  
equity Share holder XXX
THANK YOU