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FAR Module 4

Financial statement analysis involves evaluating financial information to understand a firm's operations, profitability, and efficiency. Key techniques include comparative statements, common size statements, trend analysis, ratio analysis, and cash flow analysis, each serving specific purposes for decision-making. The analysis aids in assessing past performance, predicting future outcomes, and informing loan decisions, thereby highlighting its importance in financial management.

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20 views11 pages

FAR Module 4

Financial statement analysis involves evaluating financial information to understand a firm's operations, profitability, and efficiency. Key techniques include comparative statements, common size statements, trend analysis, ratio analysis, and cash flow analysis, each serving specific purposes for decision-making. The analysis aids in assessing past performance, predicting future outcomes, and informing loan decisions, thereby highlighting its importance in financial management.

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darshanmadiwalar24
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We take content rights seriously. If you suspect this is your content, claim it here.
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FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem —— MODULE - 4 ANALYSIS OF FINANCIAL STATEMENT Meaning of Analysis of Financial Statements ‘The process of critical evaluation of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm is called “Financial Statement Analysis’, It is basically a study of relationship among various financial facts and figures as given in a set of financial statements, and the interpretation thereof to gain an insight into the profitability and gg@mational efficiency of the firm to assess its financial health and future prospects. Nature of Financial Statements Analysis der to disclose the financial position of riod under review. yes shown in the Generally, financial statements are prepare business concerns at a point of time and also The interested parties of the financial statements financial statements to be shown in the financial nts never convey the current or economic Wallies. The data sed for preparing financial statements. After Help in Evaluating the operational efficiency of the Concern: - It is necessary to analyse the financial statement for matching the total expenses incurred in manufacturing, Advertising, selling and distribution of the finished goods and total financial expanses of the current year comparing with the total expanses of the previous year and evaluate the manageri -y of concern, > Help in Evaluating the short- and Position: - It is necessary to analyse the financial statement for cofifparing the current assets and current liabilities to evaluate the short term and long-teMgmfinancial soundness. > Help in calculating the profitabil tis necessary to analyse the financial statement to know the gross profit and n > Help in indicating the trend of achievs i helps in comparing@f financial position of previous year and al expenses, purcl sales growth, gross and net profit. Cost of value of assets and Ii financial statement. = the’ i alysis of financial stafément which helps in s of actual performance with target show all What is Ratio Analysis? “Ratio Analysis” refers to th computed based on the financial other public domains. Using. vari ‘company’s financial and operational pos! ytical technique wherein various financial ratios are analysis formulas helps assess the subject We broadly categorize the financial ratios used in the ratio analysis technique into the following four major categories: Accounting Ratios are broadly classified into 4 categories: - Liquidity Ratios Solvency Ratios . Activity or Tumover Ratios Pepe Profitability or Income Ratios SS, Assistant Professor, Department of Management Studies VTU CPGS. 4 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem 1, Liquidity Ratios: ‘The short-term financial position of an enterprise is assessed by liquidity ratios. “Liquidity” refers to the firm’s ability to meet its current liabilities. Liquidity ratios indicate the firm’s ability to meet its current obligations out of the current resources. Liquidity ratios include: 1, Current Ratio or Working Capital Ratio: re i — _Current Assets Current Ratio = (oe cs 2. Quick Ratio or Acid Test Ratio or Liquid aad 6 Liquid Assets Liquid Ratio = gyirrent Liabilities 2. Solvency Ratios: The firm’s ability to meet its lot liabilities at the time Lurid computed by solvency rati Solvency ratios 1, Debt to Equity Rat uity Ratio = xf Debt to or Debt to Equity Ratio = xp, 7 2. Total Assets to Debt Ratio: Total Assets to Debt Ratio = ? or Total Assets to Debt Ratio = total Assets — — ee Mrs. Nirmala S S, Assistant Professor, Department of Management Studies VTU_ one Mysuru. FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem 3. Proprietary Ratio: Proprietory Ratio = teptistor’s Fund/Shareholder's Fund/Net Worth 4, Interest Coverage Ratio: Net Profit Before Interest and Tax Interest Coverage Ratio = tied Tatereat Chai 3. Activity Ratios: Activity ratios indicate how efficiently the Wor obtain revenue from operations. It indicates the speet employed has been rotateddfithe process of doing business. Activity Ratios include 1. Inventory Sesto or St Inventory Turnove 2. Debtors or Recei i t Credit ‘enue_from Operations Receivable Turnover Ratio tevenue from 6 3. Creditors or Payables Turnover iy Payable Turnover Ratio = Credit Pu jverage 4, Working Capital Turnover Ratio’ Net Revenue from Operations Net Working Capita Working Capital Turnover Ratio = _ Mrs. Nirmala § S, Assistant Professor, Department of Management Studies VTU CPGS Mysuru. 6 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem —eee—ee———eEE 4, Profitability Ratios: The efficiency of any business is measured by the profit earned by the company. Profitability ratios measure the various aspects of the profitability of a company. Profitability Ratios include: A. General Profitability Ratios: 1. Gross Profit Rati Gross Profit Ratio = jer Fraenur Fron Operations * 100 2, Operating Ratio: Operating Ratio = 100 3. Operating Profit Rati Operating Profit Ratio = eResemae from Operations( Ne 4, Not Profit rao Net Profit Ratio(before Tax) = war peee fee toe Nat Balen) * 100 Net Profit Ratiolafter Tax) = erties front OpationstNAt Sales) * 100 vw B. Overall Profitability Ratios: 1, Return on Investment: before Interest and Tax Capltal enloyed * Return on Investment or Return on Capital Employed 100 Cash flow statement ‘A cash flow statement is a financial statement that summarizes the amount of cash that enters and leaves your business, giving you more information about the amount of working capital that’s available over a given period. It includes all the cash brought in from sales, but not ees Mrs. Nirmala § S, Assistant Professor, Department of Management Studies VTU CPGS Mysuru. 7 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem SS sales made on credit that haven’t actually been paid for, Similarly, it won't show raw materials and other items that have been purchased on credit but not paid for. In short, cash flow statements are a measurement of how well a company is able to generate cash to fund operating expenses and pay debt obligations. Cash flow statement format There are two ways to prepare a cash flow statement: the direct method and the indirect method: Direct method — Operating cash flows are presented as a list of ingoing and outgoing cash flows. Essentially, the direct method subtracts the money you spend from the money you receive. Indirect method — The indirect method from profit to cash flow. This means that dey S operaifhig cash flows as a reconciliation iation is factored into your calculations. Importance of a cash flow statement For a business to be successful, it should always back bank loans, buy comm@iities, or invest to get proft bankrupt if it doesn’t h: ugh cash to pay its debts. Here are some o} cash flow statement: enables it to pay Gives details about spending: flow statement gives principal pa the company Wilkes to its creditors. It also'8 fansactions which are record statements, These include purchases of ‘ite credit to customers, and buying capital equipment. Helps maintain optimu optimum level of cash on hat its cash is lying idle, or if there idle, then the business can use it to 1 funds, the company can look for sou! business going. statement helps in maintaining the s important for the Company to determine if too much of rtage or excess of funds. If there is excess cash lying in shares or buy inventory. If there is a shortage of where they can borrow funds to keep the Helps you focus on generating eash: Profit plays a key role in the growth of a company by generating cash, But there are several other ways to generate cash. For instance, when company finds a way to pay less for equipment, it is actually generating cash. Every time it collects receivables from its customers quicker than usual, it is gaining cash. Useful for short-term planning: A cash flow statement is an important tool for controlling cash flow. A successful business must always have sufficient liquid cash to fulfill short-term obligations like upcoming payments. A financial manager can analyze incoming and outgoing cash from past transactions to make crucial decisions. Some situations where Mrs. Nirmala § S, Assistant Professor, Department of Management Studies VTU CPGS Mysuru. 8 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem decisions have to be made based on the cash flow include for seeing cash deficit to pay off debts or establishing a base to request for credit from banks. Presentation of a statement of cash flows The statement of cash flows shall report cash flows during the period classified by operating, investing and financing activities. ‘An entity presents its cash flows from operating, investing and financing activities in a manner which is most appropriate to its business. Classification by activity provides information that allows users to assess the impact of those activities on the financial position of the entity and the amount of its cash and cash equivalents. This information may also be used to evaluate the relationships among those activit A single transaction may include cash flow; when the instalment paid in respect of an ite deferred payment basis includes interest, 1 activities and the loan element is classified u sified differently. For example, if Property, Plant and Equipment acquired on terest element is classified under financing investing activities. Operating activities the extent to pay loans, investments components information, in ‘The amount of cash flows which the operations maintain the operating capabl without recourse to external sour of historical ins cash flows forecastin; {ing from operating activities is a key indict tity have generated sufficient cash flows f the entity, pay dividends and make financing. Information at seful, in conjunction Cash flows from producing activities ol other events that enter int operating activities are: ily derived from the principal revenue erally result from the transactions and loss. Examples of cash flows from (b) cash receipts from royalties, fees, co ns and other revenue; (©) cash payments to suppliers for goods dnd services; (d) cash payments to and on behalf of employees; (©) cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits; (f) cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and (g) cash receipts and payments from contracts held for dealing or trading purposes. —_—_—_— Mrs, Nirmala SS, Assistant Professor, Department of Management Studies VIU CPGS Mysuru. 9 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem ‘Some transactions, such as the sale of an item of plant, may give rise to a gain or loss that is included in recognized profit or loss. The cash flows relating to such transactions are cash flows from investing activities, However, cash payments to manufacture or acquire assets held for rental to others and subsequently held for sale as described in paragraph 68A of Ind ‘AS 16, Property, Plant and Equipment, are cash flows from operating activities. The cash receipts from rents and subsequent sales of such assets are also cash flows from operating activities. Investing activities ‘The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expegditures have been made for resources intended to generate future income and cash, nly expenditures that result in a recognized asset in the balance sheet are eli sification as investing activities. Examples of cash flows arising from investi ities are: (a) cash payments to acquire property, plant assets, These payments include those relatin constructed property, plant and equipment; 1uipment, intangibles and other long-term ital ment costs and self- (b) cash receipts from sal assets; (c) cash payments to acquire equ i ferests in joint equivalents or those held. (@) cash receipts joint ventures (other (e) cash advances and loans financial institution); other parties (other than advances and loans made by a (O cash receipts from the repayment of Mes and loans made to other parties (other than advances and loans of a financial institut (g) cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and (h) cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities. When a contract is accounted for as a hedge of an identifiable position the cash flows of the contract are classified in the same manner as the cash flows of the position being hedged. ao Mrs. Nirmala $ S, Assistant Professor, Department of Management Studies VTU CPGS Mysuru, 10 FINANCIAL ACCOUNTING & REPORTING MBA Ist Sem Financing activities ‘The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. Examples of cash flows arising from financing activities are: (a) cash proceeds from issuing shares or other equity instruments; (b) cash payments to owners to acquire or redeem the entity’s shares, (©) cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short- term or long-term borrowings; (d) cash repayments of amounts borrowed; and (©) cash payments by a lessee for the redi finance lease. Mrs. Nirmala S S, Assistant Professor, Department of Management Studies VTU CPGS. Mysuru, u

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