FINANCIAL REPORTING AND

STATEMENT ANALYSIS
(FRSA)
 INTRODUCTION
•Financial statement analysis is the process of examining relationships among financial
statement elements and making comparisons with relevant information. It is a valuable tool
used by investors and creditors, financial analysts, and others in their decision-making
processes related to stocks, bonds, and other financial instruments. The goal in analyzing
financial statements is to assess past performance and current financial position and to
make predictions about the future performance of a company. Investors who buy stock
are primarily interested in a company’s profitability and their prospects for earning a return
on their investment by receiving dividends and/or increasing the market value of their stock
holdings. Creditors and investors who buy debt securities, such as bonds, are more interested
in liquidity and solvency: the company’s short- and long-run ability to pay its debts.
Financial analysts, who frequently specialize in following certain industries, routinely
assess the profitability, liquidity, and solvency of companies in order to make
recommendations about the purchase or sale of securities, such as stocks and bonds.
 MEANINGAND CONCEPT OF FSA
Analysts can obtain useful information by comparing a company’s most recent financial
statements with its results in previous years and with the results of other companies in the
same industry. Three primary types of financial statement analysis are commonly known as
horizontal analysis, vertical analysis, and ratio analysis.

Horizontal Analysis
When an analyst compares financial information for two or more years for a single company,
the process is referred to as horizontal analysis, since the analyst is reading across the page to
compare any single line item, such as sales revenues.
 MEANINGAND CONCEPT OF FSA
Vertical Analysis
When using vertical analysis, the analyst calculates each item on a single financial statement
as a percentage of a total. The term vertical analysis applies because each year’s figures are
listed vertically on a financial statement. The total used by the analyst on the income statement
is net sales revenue, while on the balance sheet it is total assets.

The primary difference between vertical analysis and horizontal analysis is that vertical
analysis is focused on the relationships between the numbers in a single reporting period,
or one moment in time. Horizontal analysis looks at certain line items, ratios, or factors
over several periods to determine the extent of changes and their trends.
Ratio Analysis
Ratio analysis enables the analyst to compare items on a single financial statement or to
examine the relationships between items on two financial statements. After calculating ratios
for each year’s financial data, the analyst can then examine trends for the company across
years. Since ratios adjust for size, using this analytical tool facilitates inter-company as well
as intra-company comparisons.
Notes The entire financial statement analysis can be classified into various
c
ategories:
r n
• Compa ativefinancial stateme ts
n
• Common size financial stateme ts
r
• Trend pe centages
o Fund flow statements
o Cash Eow statements and
o Ratio analysis
 SELF ASSESSMENT
Fill in the blanks:
1. When an analyst compares financial information for two or more years for
a single company, the process is referred to as ..................... analysis.
2. ..................... enables the analyst to compare items on a single financial statement or to
examine the relationships between items on two financial statements.
3. When using ....................., the analyst calculates each item on a single financial statement
as a percentage of a total.
 TYPES OF FINANCIAL STATEMENTS
There are four different types of financial statements. The different types of financial
statements indicate the different activities occurring in a particular business house.

1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows
4. Fund Flow Statement
 INCOME STATEMENT
Income statement, also called profit and loss statement (P&L) and Statement of Operations,
is a company’s financial statement that indicates how the revenue (money received from the
sale of products and services before expenses are taken out, also known as the “top line”) is
transformed into the net income (the result after all revenues and expenses have been
accounted for, also known as the “bottom line”). The purpose of the income statement is
to show managers and investors whether the company made or lost money during the
period being reported. The important thing to remember about an income statement is that
it represents a period of time.
 Sample Company Incozrte Statement
January 1, 2009 to December 3i, 2009

Income
Gross Sales 346,400
Less returns and allowances 1,000
Net Sules
Cost of Goods
Merchandise Inventory, January 1 160,000
h 90,000
Purc ases
Freight Charges 2,000
Total Merchandise Handled 252,000
Less Inventory, December 31 100,000
Cost of Goods S•old ]52,000
Gross Profit 191400
Interest Income 500
Totalncome 193,900
Expenses
lakes 68,250
Uhhhes 5,800
Rent 23000
Office Supplies 2,250
 Telephone
"lravel and Entertainment 2,550
Dues & Subscriptions 1,100
lnterest Paid 2,140
Repairs & Maintenance 1,250
Taxes & Licenses
Total Expenses 133,29
In 0
Net come
T
60,110
 BALANCE SHEET

•The balance sheet provides an insight into the financial status of a company at a
particular time. The balance sheet is different in comparison to the other types of
financial statements. Other financial statements are prepared by taking
into account the financial health of the company over a considerable span of
time.
 l
Sample Ba ance Sheet
for the Month Ended
A e Liabilitie
ss ts s
Cash 15,300
Accounts Payable
Accounts Receivable 1,000 Equity 600
Supplies Sample Busincs.« Plan, C pital
a
Lazld
2s,000 Total L res
Total Assets 51,800 Owner's EquitJ• 51,800
 STATEMENT OF CASH FLOWS

•Statement of cash flows reports on a company’s cash flow over a period of time.
The cash flow may be from many activities of a firm involving particularly its
operations, investment and finance.
 Sample Business Plan
Sample Cash Flnw Statement
Staleutent for Le Month Ended
A
Cash Flow From Operating ctivities
Net Income 1,800
Non-cash Expenses and Revenues
lnclude income
Increase in Accounts Receivable 1,000
Increase in Supplies
Increase in Accounts Paya le
b
Net Cash Flow from Operating Activitie 900
s
Cash Flows From Investing Activities
Purchase of land (10,000)
Purchase of Building (25,000)
Net Cash Flow used by Investing Activities
Cash Flow Financing Activities
t
Inves ed
50,ooo
Withdrawals (600)
Net Cash Flow Provided by Financing Activities 49,400
Net Increase (Decrease) in Cash 15000
 SELF ASSESSMENT

1. Income statement is also called profit and loss statement (P&L) and ........................
2. The purpose of the ........................ is to show managers and investors whether the
company made or lost money during the period being reported.
3. The ........................ provides an insight into the financial status of a company at a
particular time.
4. The cash flow may be from many activities of a firm involving
particularly its operations, ........................ and finance.
 CLASS WORK
BALANCE SHEET ELEMENTS Meaning to understand Ratio
1. Accounts receivable:
Analysis.
2. Income taxes payable:
3. Long-term debt:
4. Contingencies:
5. Property, plant & equipment:
6. Inventory:
7. Current portion of capital lease obligation:
8. Cash and equivalents:
9. Common shares/stock:
10. Current portion of long-term debt:
11. Goodwill:
12. Deferred income tax assets (expected to reverse in 12 months):
13. Unearned revenue:
14. Accounts payable:
15. Retained earnings:
16. Intangible assets:
17. Capital lease obligation:
18. Accrued liabilities:
19. Prepaid expenses:
20. Preferred shares/stock:
 CLASS WORK – ANSWER KEY
1. Customers who have purchased on credit – accounts to be collected.
2. Corporate taxes for the period that must be remitted to government.
3. Borrowing for business – one or multiple loans where term is longer than 12 months.
4. A potential future liability that the company can reasonably estimate (eg, from a pending lawsuit)
5. Physical assets used to generate income over a period of time greater than 12 months. Include things
such as buildings, furniture, computers, vehicles, manufacturing equipment.
6. Goods either purchased or produced for sale to customers.
7. The amount owing over the next 12 months for capital lease payments.
8. Cash or items that act like cash (eg, short term money market funds) that a business holds.
9. Shares held by investors in the company. These shares allow for voting rights and participation in
profits.
10. The amount of any loan(s) repayments due within the next 12 month period.
 CLASS WORK – ANSWER KEY

11. The premium paid on the acquisition of another business.

12. A timing difference due to the difference between accounting income and taxable income.
Difference will reverse in the next reporting period.
13. Revenues that have been collected from customers but have not yet been earned by the company
(eg, performance of service has not yet occurred, or product has not yet been delivered).
14. Supplier invoices that relate to the current reporting period but that have not yet been paid.
15. The accumulated profits and losses of the business since inception. If the company has more losses
than profit, then this would be stated as “retained deficit”.
16. Long term assets of the business that have no physical substance. Examples include licences,
patents and trademarks.
17. Capital leases are leases that are related to specific assets. They act the same as a loan – except
instead of borrowing money to purchase the item outright, the company leases the asset – but all
the benefits of ownership are substantially transferred through the lease.
18. Liabilities that are related to the current reporting period but have not been paid. Typical accrued
liabilities include compensation, audit and legal fees.
19. Expenses that have been incurred where the service has not as yet been “earned”/delivered. Typical
prepaid expenses include insurance, rent and utilities.
20. Shares purchased by investors that have fixed dividends that have a priority over common
shareholders.
 UNIT –
2
RATIO ANALYSIS
•14 to 17 Mark Unit (Theory + Practical)
 INTRODUCTION
The ratio analysis is one of the important tools of financial statement analysis to study the
financial stature of the business Entity.
According to J. Batty, “The term accounting ratio is used to describe significant
relationships which exist between figures shown in a balance sheet, in a profit and loss
account, in a budgetary control system or in any other part of the accounting
organization”.
Financial statements contain substantial information (figures) relating to profit or loss and
financial position of the business. If these items in financial statements are considered
independently it may or may not be of much use. To make a meaningful reading of
financial statements, these items found in financial statements have to be compared with
one another. Ratio analysis, as a technique or analysis of financial statement uses this
method of comparing the various items found in financial statements.
 PURPOSES OF THE RATIO
ANALYSIS
•1. To study the short-term solvency of the firm — liquidity of the firm
•2. To study the long-term solvency of the firm — leverage position of the firm
•3. To interpret the profitability of the firm — Profit earning capacity of the
firm
•4. To identify the operating efficiency of the firm — turnover of the ratios
•What is meant by the accounting ratio?
•The accounting ratios are computed on the basis available accounting information
extracted from the financial statements which are not in a position to reveal the status
of the enterprise. The accounting ratios are applied to study the relationship in
between the quantitative information available and to take decision on the financial
performance of the firm.

•Classification of Ratios
•The accounting ratios are classified into various categories, viz.:
•1. On the basis of financial statements
•2. On the basis of functions
 ON THE BASIS OF FINANCIAL STATEMENTS
1. Income Statement Ratios: These ratios are computed from the statements of Trading,
Profit & Loss account of the enterprise. Some of the major ratios are as following GP ratio,
NP ratio, Expenses Ratio and so on.
2. Balance Sheet or Positional Statement Ratios: These types of ratios are calculated from
the balance sheet of the enterprise which normally reveals the financial status of the
position
i.e. short-term, long-term financial position, share of the owners on the total assets of the
enterprise and so on.
3. Inter Statement or Composite Mixture of Ratios: Theses ratios are calculated by
extracting the accounting information from the both financial statements, in order to
identify stock turnover ratio, debtor turnover ratio, return on capital employed and so on.
 ON THE BASIS OF FUNCTIONS
•1. On the basis of solvency position of the firms: Short-term and long-term solvency
position of the firms.
•2. On the basis of profitability of the firms: The profitability of the firms are studied on
the basis of the total capital employed, total asset employed and so on.
•3. On the basis of effectiveness of the firms: The effectiveness is studied through the
turnover ratios — Stock turnover ratio, Debtor turnover ratio and so on.
•4. Capital structure ratios: The capital structure position are analyzed through leverage
ratios as well as coverage ratios.
 SELF ASSESSMENT
Fill in the blanks:
1. Ratio analysis, as a technique or analysis of .................. uses this method of comparing
the various items found in financial statements.
2. The accounting ratios are applied to study the relationship in between the ..................
information available and to take decision on the financial performance of the firm.

3. The ............... position are analyzed through leverage ratios as well as coverage ratios.
4. The .................. of the firms are studied on the basis of the total capital employed, total
asset employed and so on.
 Risk assessment
Decision-making precision
Every buзineзз operateз in an environment fraught with riзkз.
Ratios provide a concise snapshot of a company's financial Ratioз aid in riзk aззeззment by зhedding light on the сompany'з
performance, enabling decision-makers to evaluate various ability to meet finanсial obligationз and handle unexpeсted
aspects of their operations. From assessing profitability and сhallengeз. Thiз iз partiсularly important for potential lenderз and
liquidity to gauging efficiency and solvency, ratios offer a inveзtorз who зeek aззuranсe of the сompany'з finanсial зtability.
well-rounded view that supports precise decision-making.
Forecasting and planning
Performance evaluation Suссeззful buзineззeз are forward-looking, and ratioз aззiзt in
сrafting aссurate foreсaзtз and planз. By analyzing trendз in
Businesses aim to measure their success over time, and ratioз, сompanieз сan antiсipate future finanсial зсenarioз, align
ratios serve as the yardstick. By comparing current ratios their зtrategieз, and alloсate reзourсeз aссordingly.
with historical data or industry benchmarks, companies can
track their progress and identify areas needing Comparative analysis
improvement. This evaluation fosters continuous growth and Ratioз enable buзineззeз to сompare their finanсial performanсe
adaptability. with that of сompetitorз or induзtry зtandardз. Thiз benсhmarking
aidз in identifying areaз where the сompany outperformз or lagз
Identifying strengths and weaknesses behind, offering inзightз for зtrategiс differentiation.

Ratios unveil both the strengths and weaknesses of a Investor and creditor confidence
business. They pinpoint areas of operational excellence as For buзineззeз зeeking external funding, ratioз зerve aз a
well as areas that might need corrective measures. language that inveзtorз and сreditorз underзtand. A healthy зet of
Businesses can channel their efforts effectively by focusing ratioз зignifieз зtability and сompetenсe, foзtering inveзtor
on enhancing strengths and addressing weaknesses. сonfidenсe and improving сreditworthineзз.
 CLASS WORK
BALANCE SHEET ELEMENTS Meaning to understand Ratio
1. Accounts receivable:
Analysis.
2. Income taxes payable:
3. Long-term debt:
4. Contingencies:
5. Property, plant & equipment:
6. Inventory:
7. Current portion of capital lease obligation:
8. Cash and equivalents:
9. Common shares/stock:
10. Current portion of long-term debt:
11. Goodwill:
12. Deferred income tax assets (expected to reverse in 12 months):
13. Unearned revenue:
14. Accounts payable:
15. Retained earnings:
16. Intangible assets:
17. Capital lease obligation:
18. Accrued liabilities:
19. Prepaid expenses:
20. Preferred shares/stock:
 CLASS WORK – ANSWER KEY
1. Customers who have purchased on credit – accounts to be collected.
2. Corporate taxes for the period that must be remitted to government.
3. Borrowing for business – one or multiple loans where term is longer than 12 months.
4. A potential future liability that the company can reasonably estimate (eg, from a pending lawsuit)
5. Physical assets used to generate income over a period of time greater than 12 months. Include things
such as buildings, furniture, computers, vehicles, manufacturing equipment.
6. Goods either purchased or produced for sale to customers.
7. The amount owing over the next 12 months for capital lease payments.
8. Cash or items that act like cash (eg, short term money market funds) that a business holds.
9. Shares held by investors in the company. These shares allow for voting rights and participation in
profits.
10. The amount of any loan(s) repayments due within the next 12 month period.
 CLASS WORK – ANSWER KEY

11. The premium paid on the acquisition of another business.

12. A timing difference due to the difference between accounting income and taxable income.
Difference will reverse in the next reporting period.
13. Revenues that have been collected from customers but have not yet been earned by the company
(eg, performance of service has not yet occurred, or product has not yet been delivered).
14. Supplier invoices that relate to the current reporting period but that have not yet been paid.
15. The accumulated profits and losses of the business since inception. If the company has more losses
than profit, then this would be stated as “retained deficit”.
16. Long term assets of the business that have no physical substance. Examples include licences,
patents and trademarks.
17. Capital leases are leases that are related to specific assets. They act the same as a loan – except
instead of borrowing money to purchase the item outright, the company leases the asset – but all
the benefits of ownership are substantially transferred through the lease.
18. Liabilities that are related to the current reporting period but have not been paid. Typical accrued
liabilities include compensation, audit and legal fees.
19. Expenses that have been incurred where the service has not as yet been “earned”/delivered. Typical
prepaid expenses include insurance, rent and utilities.
20. Shares purchased by investors that have fixed dividends that have a priority over common
shareholders.
 Procedure for computation of ratios

Generally, ratio analysis involves four steps:

(i) Collection of relevant accounting data from financial statements.
(ii) Constructing ratios of related accounting figures.
(iii) Comparing the ratios thus constructed with the standard ratios which may be
the corresponding past ratios of the firm or industry average ratios of the
firm or ratios of competitors.
(iv) Interpretation of ratios to arrive at valid conclusions.
 Objectives of Ratio Analysis
Ratio analysis is indispensable part of interpretation of results revealed by the financial statements. It provides
users with crucial financial information and points out the areas which require investigation. Ratio analysis is a
technique which involves regrouping of data by application of arithmetical relationships, though its
interpretation is a complex matter. It requires a fine understanding of the way and the rules used for preparing
financial statements. Once done effectively, it provides a lot of information which helps the analyst:

1. To know the areas of the business which need more attention;

2. To know about the potential areas which can be improved with the effort in the desired direction;
3. To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in the business;
4. To provide information for making cross-sectional analysis by comparing the performance with the best
industry standards; and
5. To provide information derived from financial statements useful for making projections and estimates for the
future.
 Figure 4.4: DUPONT Chart

Net Cost of goods

profit sold
Nel profit
ratio
Administrative, selling and
distribution expense

Return on capital
employed

Current assets
Working
Capital turnover
capital
ratio Capital Current liabilities
employe
d
This was an analysis established by the DUPONT INC., USA to study the return on
investment. It was the first company developed the chart which depicted the influences of
Return on Investment. The company underwent for the consideration two important
ratios, Net profit ratio and Capital turnover ratio, for the return on investment. A change
in any one of the two ratios reflects immediately on the Return on investment. The
various associated factors are considered to study the impact of the profitability of the
firm. This type of analysis to correct the problems not only to identify with the specific
cause which drastically affects the profitability but also to find the possible ways and
means to improve the profitability. Having developed the chart for analysis was called as
DUPONT Chart.
 THANK YOU !

Happy Learning !

Prof. Kavit Anjaria