Lecture- 4

Financial statement analysis

ACC 306

Financial Statements Analysis

Dr. ARPIT SIDHU

(Ph.D, UGC-NET, HP-SET, MBA,
MCOM, BCOM)
Learning Outcomes:
• Preparation and analysis of
Financial Statements of Entities
using Horizontal Analysis and
Vertical analysis
NEWS ANALYSIS
Revision
Which financial elements of Balance Sheet will be considered to comment
on HUL Working Capital Management or Liquidity Management of
Company?
a) CA, FA
b) CL, CA
c) CA, Non-CL
d) Non-CA, Non-CL
B
How to Measure Performance?
• Same tool can’t be used for all
types of analysis.
• For example, you can't use the
same golf club for every shot and
expect to be a good golfer. The
more you practice with each club,
however, the better able you will
be to gauge which club to use on
one shot.
• So too, we need to be skilled with
the financial tools we use.
Information for Analysis
Income
Stateme
nt

Statement
Balanc Sources of of
Changes
e Informatio in
Stockhold
Sheet n er’ Equity

Stateme
nt of
Cash
Flows
How to Measure Performance – Tools of
Analysis
Note : Vertical Analysis
Tools of Financial Statement Analysis
can be extended to
Horizontal analysis (Trend
Analysis)

Horizontal Analysis Vertical Analysis

Comparative Statement Common Size

Analysis Trend Analysis Ratio Analysis
Statement Analysis
Comparative Statement Analysis-
horizontal analysis
Comparing a
company’s financial
condition and
performance across
time

Time
The following steps may be followed to
prepare the comparative statements:
Step 1 : List out absolute figures in rupees relating to two points of time
(as shown in columns 2 and 3
Step 2 : Find out change in absolute figures by subtracting the first year
(Col.2) from the second year (Col.3) and indicate the change as increase
(+) or decrease (–) and put it in column 4.
The following steps may be followed to
prepare the comparative statements:
Step 3 : Preferably, also calculate the percentage change as follows and
put it in column 5.
Horizontal Analysis Example
The management of HUL Company provides you with comparative
balance sheets of the years ended March 31, 2020 and 2019.
Management asks you to prepare a horizontal analysis on the information.
Example:
Horizontal Analysis Example
Calculating Change in INR Amounts

INR Current Year Base Year

= –
Change Figure Figure
Horizontal Analysis Example
Calculating Change in INR Amounts

INR Current Year Base Year

= –
Change Figure Figure

Since we are measuring the amount of the

change between 2019 and 2020, the dollar
amounts for 2019 become the “base” year
figures.
Horizontal Analysis Example
Calculating Change as a Percentage

Percentage Change
100%
Change Base Year Figure
Rs. 4625- Rs. 3907 = Rs. 718
(Rs. 718÷ Rs. 3907)× 100 = 18.38%
Interpretations
1. Increase in FA by
18.09%---implies
increase in
production
capacity of HUL.
Hence, HUL is on
way of expansion.
2. Decrease in Non
current
Investments by
1.56%--implies
investments are
sold and funds
are idle funds are
invested in
business
operations.
3. Increase in CA by
4.49%---implies
improvement in
Interpretations
4. Increase in Long
term Loans and
advances by
14.39%---implies HUL
has lent more credit
in 2020.
5. Decrease in
Current investments
by 53.66%--implies
the short investments
are sold for
generating cash.
6. Increase in Stock
by 8.84%--implies
Sales decreased,
stock has piled up.
7. Decrease in Trade
receivables by
37.48%--less credit
sales, strict credit
policy, less chance of
bad debts.
Horizontal Analysis Example
Let’s apply the same
procedures to the
liability and stockholders’
equity sections of the
balance sheet.
Interpretations

1. Increase in R &S by 5%--

implies ploughing back
of profits, improves
operational efficiency.
2. Increase in
Shareholder’s funds by
5%--implies owners
contribution in business
has been gone up.
3. Increase in Non-CL
(Outsider’s funds) by
33%--implies increase in
financial risk due to
increase in interest
payment obligations,
outsiders’ claim on
business got increased,
may be HUL is on its
way of expansion or
undertaking strategic
changes.
Interpretations

4. Increase in CL by
9%--implies more
credit period taken
from creditors, may
adversely affect the
liquidity position of
HUL.
Poll 3:
A
Horizontal Analysis
Income Statement

Now, let’s apply the

procedures to the
income statement.
Interpretations

1. The revenue has

been increased by
just 1.63% but the
PAT have been
increased by 11.63%
due efficiently
control over
expenses as they
have been increased
by 0.30%.
2. Finance Cost have
increased by
278.57%, implying
hike in Non CL
tremendously.
3. Depreciation is
increased by 79.01%
implying purchase
of more FA in 2020.
Interpretations
Fixed Asset Utilization

Increase in FA by 18.09% and on other side, Revenue from operations have also increased by
1.63%---implies FA utilization has been improved. Yet, the FA have been increase highly
comparatively to increase in sales. So it gives further scope to HUL for taking best utilization
of its investment in FA.
Operational Efficiency:

The profits in 2020 has got increased by 11.63% and Reserves are also increased
by 5%--implies improvement in Operational efficiency of HUL.
Inventory Management

The increase in inventory is 8.84% is much higher than increase in Sales, implying
less efficient Inventory management. The inventory has been piled up.
Creditors/ Trade Payable Management

Purchases of Finished goods have been increase by 34.71%, however Trade payables have
just risen up by 5% in 2020 implying Company has purchased the Finished goods more on
cash in 2020. So, it signifies better payable management. Even Cost of Material consumed
has been decreased that signifies decrease of production comparatively to 2019 and more
focus on buying finished goods for further trading.
Debtors/Receivable Management

The revenue has been increased by 1.63%, however the trade receivables have
been decreased by 37.48%. It implies that there was more cash sales in 2020 and
HUL has recollected their funds from Debtors. It shows better Receivable
management. But the rate of decrease in Debtors is too high that is 37.48%, it
implies that HUL has followed strict credit policy in 2020 and it can give adverse
impact on its total sales in long period.
Leverage—To know the Finance Risk

Long term debt has been increased by 33%, even short term debt has been risen up by 9%. On
other side, the shareholder’s funds has been increased by just 5% that is due to equivalent
increase in R&S. It may increase Finance risk for HUL in long run. It will also increase burden of
regular interest payment. However, if individual amounts are considered then Shareholders
funds is too high as comparative to Non current Liabilities thus provides safe window for
lenders to provide credit to HUL.
The balance sheets of Delaware Drillers
include the following current assets:
• Based on horizontal analysis, what is the
percentage for accounts receivable for
Year 3 and by what percentage did it
decrease over Year 2?
• A) 89.12% and 10.88%
• B) 98.79% and 1.21%
• C) 110.88% and 10.88%
• D) 112.21% and 12.21%
•A

• In horizontal analysis financial statement items are expressed as a

percentage of a base amount.
• If Year 2 is the base, then accounts receivable for Year 3 would be
expressed as Year 3 Amount ÷ Year 2 Amount.
• In this example, the Year 3 percentage is 89.12% ($6,225 ÷ $6,985). By
definition, the Year 2 percentage is 100%, so the decrease from Year 2
is 10.88%.
Trend analysis

Compare Across Periods

ly sis
Ana Include more than three
nd
Tr e years of data and supports to
build prediction model and
forecasts financial
statements. Financial
Elements can show upward,
downward and Sideway
Cont.
• Trend analysis, compares key financial statement values or
relationships for the same company over a period of years.
• This analysis sets the base year at a value of 100% and then shows
subsequent years in relation to increases or decreases over the base
year.
• Horizontal or trend analysis helps the analyst examine relationships to
detect strengths and weaknesses, such as a faster growth in cost of
sales compared to sales, as shown in the example ahead.
• The purpose of horizontal analysis is primarily to direct attention to the
accounts that require further investigation.
Cont…..
Formula of Calculating Trend percentages:
Current year figure
Base Year figure
100
Example:
Trend Analysis of HUL (Balance Sheet)
Trend Analysis of HUL (P&L)