Financial Accounting & Analysis

Unit V Vertical Analysis & Horizontal Analysis Introduction Financial statement information is used by both external and internal users, including investors, creditors, managers, and executives. These users must analyze the information in order to make business decisions, so understanding financial statements is of great importance. Several methods of performing financial statement analysis exist. This article discusses two of these methods: horizontal analysis and vertical analysis. Horizontal Analysis ethods of financial statement analysis generally involve comparing certain information. The horizontal analysis compares specific items over a number of accounting periods. For example, accounts payable may be compared over a period of months within a fiscal year, or revenue may be compared over a period of several years. These comparisons are performed in one of two different ways. Absolute Dollars !ne method of performing a horizontal financial statement analysis compares the absolute dollar amounts of certain items over a period of time. For example, this method would compare the actual dollar amount of operating expenses over a period of several accounting periods. This method is valuable when trying to determine whether a company is conservative or excessive in spending on certain items. This method also aids in determining the effects of outside influences on the company, such as increasing gas prices or a reduction in the cost of materials. Percentage The other method of performing horizontal financial statement analysis compares the percentage difference in certain items over a period of time. The dollar amount of the change is converted to a percentage change. For example, a change in operating expenses from "#,$$$ in period one to "#,$%$ in period two would be reported as a %& increase. This method is particularly useful when comparing small companies to large companies. Vertical Analysis The vertical analysis compares each separate figure to one specific figure in the financial statement. The comparison is reported as a percentage. This method compares several items to one certain item in the same accounting period. 'sers often expand upon vertical analysis by comparing the analyses of several periods to one another. This can reveal trends that may be helpful in decision making. (n explanation of )ertical analysis of the income statement and vertical analysis of the balance sheet follows.
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Financial Accounting & Analysis

Income Statement ,erforming vertical analysis of the income statement involves comparing each income statement item to sales. -ach item is then reported as a percentage of sales. For example, if sales e.uals "#$,$$$ and operating expenses e.uals "#,$$$, then operating expenses would be reported as #$& of sales. Balance Sheet ,erforming vertical analysis of the balance sheet involves comparing each balance sheet item to total assets. -ach item is then reported as a percentage of total assets. For example, if cash e.uals "%,$$$ and total assets e.uals "/%,$$$, then cash would be reported as /$& of total assets.

Ratio Analysis Meaning The ratio is an arithmetical expression i.e. relationship of one number to another. 0t may be defined as an indicated .uotient of the mathematical expression. 0t is expressed as a proportion or a fraction or in percentage or in terms of number of times. ( financial ratio is the relationship between two accounting figures expressed mathematically. Suppose there are two accounting figures of a concern are sales 1s #$$$$$ and profits 1s #%$$$. The ratio between these two figures will be

1atios provide clues to the financial position of a concern. These are the indicators of financial strength, soundness, position or weakness of an enterprise. !ne can draw conclusions about the financial position of a concern with the help of accounting ratios. Example Suppose one shopkeeper *2+ earns a profit of 1s #$$$ and another *3+ earns 1s /$$$$ which one is more efficient4 5e may say that the one who earns a higher profit is running his shop better. 0n fact to answer the .uestions, we must ask, how much is the capital employed by each shopkeeper 6et, 2 employ 1s #$$$$$ and 3 1s 7$$$$$. 5e can work out the percentage of profit earned by each to the capital employed. Thus

By K.Arjun Goud *Assistant Professor+ Page 2

Financial Accounting & Analysis

These figures show that for every 1s#$$ of capital 2 earns 1s #$ and 3 earns 1s %. 3 is obviously making a better use of the funds employed by him. 8e must be treated as more efficient of the two. The above example shows that absolute figures by themselves do not communicate the meaningful information. Classification of ratios #+ Financial ratios S.no # 1atio 9urrent ratio Formula 9urrent assets 9urrent liabilities 0deal ratio /:# 9omments 0ndicates firm:s commitment to meet financial obligations. (very heavy ratio is not desirable as it indicates less efficient use of funds / ;uick ratio ;uick assets 9urrent liabilities < =ebt >-.uity ratios long term debt e.uity #:/ #:# This ratio also indicates short term solvency of a firm 0ndicates solvency long term

8igher ratio is riskier for the creditors 7 ,roprietary ratio Shareholders: funds Total tangible assets )ariant of debt?e.uity ratio Shows the extent of shareholders funds in the total assets employed in the business 8igher ratio indicates relatively little danger to creditors and vice versa
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Financial Accounting & Analysis

@otes #+ 9urrent assets are those assets which can be converted into cash within a period of one year or normal operating cycle of the business whichever is longer -xamples : 9ash in hand, cash at bank ,stock, debtors, bills receivable, prepaid expenses /+ 9urrent liabilities are those liabilities payable within an year or operating cycle <+ ;uick assets A current assets > *stockBprepaid expenses+ 7+ ;uick ratio is also known as the acid test ratio or li.uidity ratio %+ Tangible assets are those assets which have physical existence C+ 6ong term debt Dexternal fundsDexternal e.uities AdebenturesBtermloans E+ Share holders: fundsDinternal fundsDproprietary fundsDowners fundsAe.uity share capitalBpreference share capitalBreservesBprofit and loss account?fictitious assets /+ rofita!ility ratios S.no # 1atio Fross ,rofit 1atio Formula Fross profit 2 #$$ @et sales 0deal ratio comments

8igher the This ratio expresses ratio better it the relationship is between gross profit and net sales Fross profit should be ade.uate to cover operating expenses

@et ,rofit ratio

@et profit 2#$$ @et sales

8igher the This ratio expresses ratio, better it the relationship is between net profit and @et sales profitDnet 8igher ratio is 8elps in determining better the efficiency with which the affairs of the business being managed 1atio should This ratio is a test of be low operating efficiency with which the

<

@et operating profit *@et operating ratio sales+2#$$

!perating 1atio

!perating cost 2#$$ net sales

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Financial Accounting & Analysis

business carried % Fixed charges cover ,G0T 0nterest

is

being

C ?E times for 0mportant from an industrial lender:s point of view concern 0t indicates whether the business would earn sufficient profits to pay periodically the interest charges 0ndicates ability of the company to repay principal 8igher ratio is 0ndicates the better percentage return on capital employed in the business 8igher ratio is 0ndicates the better percentage return on share holders: funds 8igher ratio is 0ndicates the better percentage return on e.uity shareholders funds 8igher ratio is 0ndicates the number better of times the earning per share is covered by the market price 8elps the investor in deciding whether to buy or not to buy the shares

=ebt Service ,G0TDinterestB*principal+D#? coverage ratio taxrate !verall profitability ratioD1eturn on investmentDreturn on !perating profit x #$$ 9apital employed capital employed 1eturn on share ,rofit after tax*,(T+ holders: funds Share holders funds 2#$$ 1eturn on -.uity ,(T?pref.dividend 2#$$ share holders Funds -..shareholders funds

#$

,rice -arnings 1atio

arket price per share -arnings per share

##

-arnings per share

,(T > pref.dividend @o of -.uity shares

8igher ratio is 8elps in estimating better company:s capacity to pay dividend to the shareholders

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Financial Accounting & Analysis

@otes #+ 9alculation of Fross profit Fross profit A Sales? 9ost of goods sold 9ost of goods sold *9!FS+ A opening stock BpurchasesB all direct expenses >closing stock /+ !perating profit A Fross profit?operating expenses !perating expensesA 9!FS Badministration expenses Bselling and distribution expenses @ote: does not include financial charges like interest and provision for tax <+ 9apital employedA sum total of all the long term funds employed in the business 9 -A -.uity share capitalB preference share capitalB reservesB profit and loss accountB long term loans?fictitious assets Shareholder:s fundsA -.uity share capital Bpreference share capital Breserves Bprofit and loss account?fictitious assets -.uity share holder:s fundsA e.uity share capital B reservesB profit and loss account?fictitious assets

<+ "urno#er ratios S.no # 1atio Fixed assets turn over ratios Formula @et sales Fixed (ssets 0deal ratio 8igher ratio better 8igher ratio better 8igher ratio better comments 0ndicates the extent to which is investment in fixed assets contribute towards sales This ratio indicates whether is or not working capital has been effectively utilized in making sales (verage debtorsA*opening is debtorsBopening bills receivableBclosing debtorsBclosing bills receivable+D/

5orking ratio

capital

turnover @et sales 5orking capital

<

=ebtors turnover @et credit sales ratio*=T1+Ddebtors velocity (verage debtors

=ebt collection period

onths in a year =T1

6ower ratio 0ndicates the extent to which is better debts have been collected in

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Financial Accounting & Analysis

time % 9reditors Turnover 9redit purchases ratio*creditors velocity+ (verage creditors *9T1+ 8igher ratio better 0ndicates the speed with is which the payments for the credit purchases are made (verage creditorsA opening creditorsBbills receivableBclosing creditorsBclosing bills payable C 9redit payment period onths in a year 9T1 9ost of goods sold (verage Stock 6ow ratio 0ndicates the promptness is better with which the payments are made to the creditors 8igher ratio better 0ndicates whether investment is in stock is efficiently used or not

Stock turnover ratio

(verage stockA *opening stockBclosing stock+D/

$roadly accounting ratios can !e grouped into t%e follo&ing categories' *a+ 6i.uidity ratios *b+ (ctivity ratios *c+ Solvency ratios *d+ ,rofitability ratios *e+ 6everage ratio (i)uidity Ratios The term li.uidity refers to the ability of the company to meet its current liabilities. 6i.uidity ratios assess capacity of the firm to repay its short term liabilities. Thus, li.uidity ratios measure the firms: ability to fulfill short term commitments out of its li.uid assets. The important li.uidity ratios are *i+ 9urrent ratio *ii+ ;uick ratio Current ratio 9urrent ratio is a ratio between current assets and current liabilities of period. This ratio establishes a relationship between current assets and obJective of computing this ratio is to measure the ability of the firm liability. 0t compares the current assets and current liabilities of the firm. as under:
By K.Arjun Goud *Assistant Professor+ Page 7

a firm for a particular current liabilities. The to meet its short term This ratio is calculated

Financial Accounting & Analysis

Current Assets are those assets which can be converted into cash within a short period i.e. not exceeding one year. 0t includes the following: 9ash in hand, 9ash at Gank, Gill receivables, Short term investment, Sundry debtors, Stock, ,repaid expenses Current lia!ilities are those liabilities which are expected to be paid within a year. 0t includes the following: Gill payables, Sundry creditors, Gank overdraft, ,rovision for tax, outstanding expenses *ignificance 0t indicates the amount of current assets available for repayment of current liabilities. 8igher the ratio, the greater is the short term solvency of a firm and vice a versa. 8owever, a very high ratio or very low ratio is a matter of concern. 0f the ratio is very high it means the current assets are lying idle. )ery low ratio means the short term solvency of the firm is not good. Thus, the ideal current ratio of a company is + ' , i.e. to repay current liabilities, there should be twice current assets. Illustration , 9alculate current ratio from the given information Sundry debtors 7, $$,$$$, Stock #C$,$$$, arketable securities H$,$$$, 9ash #/$,$$$, prepaid expenses 7$,$$$, Gill payables H$,$$$, Sundry creditors #C$,$$$, =ebentures /$$,$$$, !utstanding -xpenses #C$,$$$

Current Assets A Sundry debtors B Stock B arketable securities B 9ash B ,repaid expenses A 1s *7$$,$$$ B #C$,$$$ B H$,$$$ B #/$,$$$ B 7$,$$$+ A 1s H$$,$$$ Current lia!ilities A Gill ,ayables B Sundry creditors B !utstanding -xpenses A 1s *H$,$$$ B #C$,$$$ B #C$,$$$+ A 1s 7$$,$$$

Interpretation From the above ratio we can say that the li.uidity position of the company is very strong -uic. ratio
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Financial Accounting & Analysis

;uick ratio is also known as (cid test or 6i.uid ratio. 0t is another ratio to test the liability of the concern. This ratio establishes a relationship between .uick assets and current liabilities. This ratio measures the ability of the firm to pay its current liabilities. The main purpose of this ratio is to measure the ability of the firm to pay its current liabilities. For the purpose of calculating this ratio, stock and prepaid expenses are not taken into account as these may not be converted into cash in a very short period. This ratio is calculated as under:

5here, li)uid assets A current assets > *stock B prepaid expenses+ Current lia!ilities are those liabilities which are expected to be paid within a year. 0t includes the following: Gill payables, Sundry creditors, Gank overdraft, ,rovision for tax, outstanding expenses *ignificance ;uick ratio is a measure of the instant debt paying capacity of the business enterprise. 0t is a measure of the extent to which li.uid resources are immediately available to meet current obligations. ( .uick ratio of , ' , is considered goodDfavourable for a company Illustration + 9alculate current ratio from given information Sundry debtors 7, $$,$$$, Stock #C$,$$$, arketable securities H$,$$$, 9ash #/$,$$$, prepaid expenses 7$,$$$, Gill payables H$,$$$, Sundry creditors #C$,$$$, =ebentures /$$,$$$, !utstanding -xpenses #C$,$$$ calculates the .uick ratio.

;uick (ssets A currents assets > *Stock B ,repaid expenses+ A 1s H$$,$$$ > *1s #C$,$$$ B 1s 7$,$$$+ A 1s C$$$$$ 9urrent liabilities A 1s C$$$$$

Interpretation From the above ratio we can say that the li.uidity position of the company is very strong A!solute -uic. ratio 0t is another ratio to test the liability of the concern. This ratio establishes a relationship between (bsolute .uick assets and current liabilities. This ratio measures the ability of the firm to pay its current liabilities. The main purpose of this ratio is to measure the ability of the firm to pay its current liabilities. For the purpose of calculating this ratio, only cash may be taken as (bsolute .uick assets. This ratio is calculated as under:

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Financial Accounting & Analysis

A!solute )uic. assets are cash, cash at bank Current lia!ilities are those liabilities which are expected to be paid within a year. 0t includes the following: Gill payables, Sundry creditors, Gank overdraft, ,rovision for tax, outstanding expenses *ignificance (bsolute ;uick ratio is a measure of the instant debt paying capacity of the business enterprise. 0t is a measure of the extent to which li.uid resources are immediately available to meet current obligations. ( absolute .uick ratio of /01 ' , is considered goodDfavourable for a company Illustration + 9alculate current ratio from given information Sundry debtors 7, $$,$$$, Stock #C$,$$$, arketable securities H$,$$$, 9ash #/$,$$$, prepaid expenses 7$,$$$, Gill payables H$,$$$, Sundry creditors #C$,$$$, =ebentures /$$,$$$K !utstanding -xpenses #C$,$$$ calculates the .uick ratio.

(bsolute ;uick (ssets A cash in hand B cash at bank #/$$$$B$ A #/$$$$ 9urrent liabilities A 1s C$$$$$

Interpretation' From the above ratio we can say that the li.uidity position of the company is very weak AC"IVI"2 3R "4R53VER RA"I3* (ctivity ratios measure the efficiency or effectiveness with which a firm manages its resources. These ratios are also called turnover ratios because they indicate the speed at which assets are converted or turned over in sales. These ratios are expressed as Ltimes: and should always be more than one. Some of the important activity ratios are : *i+ Stock turnover ratio *ii+ =ebtors turnover ratio *iii+ 9reditors turnover ratio *iv+ 5orking capital turnover ratio *toc. turno#er ratio Stock turnover ratio is a ratio between cost of goods sold and the average stock or inventory. -very firm has to maintain a certain level of inventory of finished goods. Gut the level of
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Financial Accounting & Analysis

inventory should neither be too high nor too low. 0t evaluates the efficiency with which a firm is able to manage its inventory. This ratio establishes relationship between costs of goods sold and average stock.

9ost of goods sold A !pening stock B ,urchases B =irect expenses > 9losing Stock !1 9ost of goods sold A Sales > Fross ,rofit

*ignificance The ratio signifies the number of times on an average the inventory or stock is disposed off during the period. The high ratio indicates efficiency and the low ratio indicates inefficiency of stock management. Illustration ' 9alculate stock turnover ratio from the following information: !pening stock 1s 7%$$$ 9losing stock 1s %%$$$ ,urchases 1s #C$$$$ *olution'

(verage stock A 7%$$$ B%%$$$ A 1s %$$$$ /

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Financial Accounting & Analysis

9ost of goods sold A !pening stock B ,urchases > closing stock A 1s 7%$$$ B #C$$$$ > %%$$$ A 1s #%$$$$ 1s #%$$$$ A < times 1s %$$$$ Illustration ' !pening stock 1s #I,$$$ 9losing stock 1s /#,$$$ Sales 1s /, $$,$$$ Fross ,rofit /%& of sale. 9alculate stock turnover ratio. *olution' 9ost of goods sold A Sales > Fross profit A 1s /,$$,$$$ > /%& of 1s /,$$,$$$ A 1s */,$$,$$$ > %$,$$$+ A 1s #,%$,$$$ Stock Turnover 1atio A

(verage stock A

#I,$$$ B /#,$$$A 1s /$,$$$ / 1s #%$$$$ 1s /$,$$$ A E.% times

Stock Turnover 1atio A

6e!tors "urno#er ratio This ratio establishes a relationship between net credit sales and average account receivables i.e. average trade debtors and bill receivables. The obJective of computing this ratio is to determine the efficiency with which the trade debtors are managed. This ratio is also known as 1atio of @et Sales to average receivables. 0t is calculated as under

0n case, figure of net credit sale is not available then it is calculated as if sales are credit sales

5ote ' 0f opening debtors are not available then closing debtors and bills receivable are taken as average debt 6e!t collection period This period refers to an average period for which the credit sales remain unpaid and measures the .uality of debtors. ;uality of debtor:s means payment made by debtors within the permissible credit period. 0t indicates the rapidity at which the money is collected from debtors. This period may be calculated as under :
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Financial Accounting & Analysis

*ignificance =ebtor:s turnover ratio is an indication of the speed with which a company collects its debts. The higher the ratio, the better it is because it indicates that debts are being collected .uickly. 0n general, a high ratio indicates the shorter collection period which implies prompt payment by debtor and a low ratio indicates a longer collection period which implies delayed payment for debtors. Illustration ,/ Find out *a+ debtors turnover and *b+ average collection period from the following information for one year ended <#st arch /$$C. (nnual credit sales %$$$$$ =ebtors in the beginning H$$$$ =ebtors at the end #$$$$$ =ebt to be taken for the year <C$ days *olution

H$$$$ B#$$$$$ / =ebtor turnover ratio A %$$$$$ I$$$$

= 1s I$$$$ = %.%C times

(verage collection period

<C$ A C7.E days %.%C

Creditors "urno#er Ratio

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Financial Accounting & Analysis

0t is a ratio between net credit purchases and average account payables *i.e creditors and Gill payables+. 0n the course of business operations, a firm has to make credit purchases. Thus a supplier of goods will be interested in finding out how much time the firm is likely to take in repaying the trade creditors. This ratio helps in finding out the exact time a firm is likely to take in repaying to its trade creditors. This ratio establishes a relationship between credit purchases and average trade creditors and bill payables and is calculated as under

*ignificance 9reditor:s turnover ratio helps in Judging the efficiency in getting the benefit of credit purchases offered by suppliers of goods. ( high ratio indicates the shorter payment period and a low ratio indicates a longer payment period 6e!t payment period This period shows an average period for which the credit purchases remain unpaid or the average credit period actually availed of :

Illustration ,, 9alculate creditor:s turnover ratio and debt payment period from the following information: 9ash purchases #,$$,$$$, Total purchases 7,$E,$$$ !pening sundry creditors /%,$$$ 9losing sundry creditors %$,$$$ 9losing bill payables /%,$$$ !pening bill payables /$,$$$ ,urchase returns E,$$$ *olution' 9reditors turnover ratio A @et 9redit ,urchases (verage trade creditors

@et purchases A Total purchases > ,urchase returns A 1s 7$E$$$ > 1s E$$$ A 1s 7$$$$$ @et credit purchases A @et purchases > cash purchases
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Financial Accounting & Analysis

A 1s 7,$$,$$$ > 1s #,$$,$$$ A 1s <,$$,$$$ (verage creditors A 1s /%,$$$ B 1s /$,$$$ B 1s %$,$$B 1s /%,$$$ / (verage creditors A #,/$,$$$ A 1s C$,$$$ / 9reditors Turnover 1atio A <,$$,$$$ A % times C$,$$$ =ebt payment ratio A <C% 9reditors =ebt payment ratio A <C% A turnover E< days ratio % 7or.ing Capital "urno#er Ratio 5orking capital of a concern is directly related to sales. The current assets like debtors, bill receivables, cash, stock etc, change with the increase or decrease in sales. 5orking capital turnover ratio indicates the speed at which the working capital is utilised for business operations. 0t is the velocity of working capital ratio that indicates the number of times the working capital is turned over in the course of a year. This ratio measures the efficiency at which the working capital is being used by a firm. ( higher ratio indicates efficient utilization of working capital and a low ratio indicates the working capital is not properly utilised. This ratio can be calculated as

0f the figure of cost of sales is not given, then the figure of sales can be used. !n the other hand if opening working capital is not discussed then working capital at the year?end will be used Illustration' Find out working capital turnover ratio for the year /$$C. 9ash #$,$$$ Gills receivable %,$$$ Sundry debtors /%,$$$ Stock /$,$$$ Sundry creditors <$,$$$ 9ost of sales #,%$,$$$ *olution ' 5orking capital turnover ratio A 9ost of sales 5orking capital By (verage creditors A !pening creditors B !pening bills payable B 9losing creditors B 9losing Gill payable / K.Arjun Goud *Assistant Professor+ Page 15

Financial Accounting & Analysis

9urrent assets A 1s #$,$$$ B %,$$$ B /%,$$$ B /$,$$$ A 1s C$,$$$ 9urrent liabilities A 1s <$,$$$ @et working capital A 9( > 96 A 1s C$,$$$ > <$,$$$ A 1s <$,$$$ So, working capital turnover ratio A 1s #,%$,$$$ = % times 1s <$,$$$

ractice pro!lems #+ From the following information calculate current ratio and .uick ratio 9ash in hand ? 1s /$$$

Gank overdraft ? 1s 7$$$$ 9ash at Gank ? 1s #$$$$ Gills receivable > 1s <$$$$ 9reditors >1s C$$$$ !utstanding expenses?1s E$$$ ,roposed dividend? 1s#$$$$ =ebtors?1s E$$$$ Stock >1s 7$$$$ ,rovision for taxation >1s/$$$$ /+ From the following details calculate current ratio and li.uidity ratio Current assets 8loans and Rs ad#ances Stock in trade debtors 9ash in hand 6oans and advances ,repaid expenses EE%$$ 7CH$$ C<$$ #<E$$ E$$ Rs

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Financial Accounting & Analysis

9urrent liabilities Sundry debtors M creditors 0nterest accrued Gills payable /<$$$ #I$$ E%C$

#7%$$$ 7<$$$

=ividend warrants issued but <I$ not encashed ,rovision for taxation #$#%$

<+ 9alculate the following ratios from the balance sheet given below #+ 9urrent ratio /+ ;uick ratio <+ 0nventory turnover ratio 7+ (verage collection period assuming <C$ days in a year %+ =ebt? -.uity ratio C+ Fross profit ratio E+ Fixed assets turnover ratio H+ ,roprietary ratio liabilities Share capital 1eserves Surpluses debentures creditors Gills payable !ther liabilities 1s /$$$$$ and %H$$$ #,$$,$$$ 7$,$$$ /$,$$$ current /$$$ 7,/$,$$$ (ssets Foodwill ,lant and machinery stock debtors cash isc.9urrent assets 1s #,/$,$$$ #,%$,$$$ H$$$$ 7%,$$$ #E$$$ H$$$ 7,/$,$$$

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Financial Accounting & Analysis

Sales ? 1s 7$$$$$ Fross profit > 1s #,C$,$$$ 7+ Following is the ,rofit and 6oss (ccount of )ector 6imited for the year ended /$$H and the Galance Sheet as on that date. rofit and (oss Account for t%e year ended Marc% 9,8 +//: 6etails *ales 6ess: Cost of ;oods *old ;ross rofit 6ess 3perating Expenses Selling -xpenses (dministrative -xpenses 1ent of !ffice =epreciation Earnings !efore Interest and "ax 6ess: Interest Expense 0nterest on Gank !verdraft 0nterest on =ebentures 3perating rofit !efore tax (dd. Interest on In#estment Total ,rofit before tax "axes < 1/=> 5et rofit after taxes $alance *%eet as on Marc% 9,8 +//: 6etails *ources -.uity Share 9apital 1eserve and Surplus
By K.Arjun Goud *Assistant Professor+ Page 18

arch <#,

Value in Rs

Value in Rs <$,$$,$$$ /%,H$,$$$ 7,/$,$$$

//,$$$ 7$,$$$ /H,$$$ #,$$,$$$ #,I$,$$$ /,<$,$$$ <,$$$ 7/,$$$ 7%,$$$ #,H%,$$$ #%,$$$ /,$$,$$$ #,$$,$$$ ,8//8///

Value in Rs %,$$,$$$ 7,$$,$$$

Financial Accounting & Analysis

E& ,reference Share 9apital C& ortgage =ebentures Current (ia!ilities Sundry 9reditors Gills ,ayable !utstanding -xpenses ,rovision Taxation "otal Application Fixed (ssets N @et of =epreciationO Current Assets 0nventory Sundry =ebtors arketable Securities 9ash "otal Calculate t%e follo&ing financial ratios and interpret t%e same 1eturn on 0nvestment =ebt 9ollection ,eriod =ebt -.uity 1atio 9urrent 1atio 0nventory Turnover 1atio Fixed assets turnover ratio ,roprietary ratio 1eturn on share holders: funds 1eturn on e.uity shareholders funds Fross profit ratio @et profit ratio !perating ratio %+ 9alculate earnings per share from the following data @et profit before tax A 1s #$$$$$ Tax rateA %$&
By K.Arjun Goud *Assistant Professor+ Page 19

#,$$,$$$ E,$$,$$$ C$,$$$ #,$$,$$$ #$,$$$ #,<$,$$$ +/8//8/// #<,$$,$$$ <,$$,$$$ /,$$,$$$ #,%$,$$$ %$,$$$ +/8//8///

Financial Accounting & Analysis

#$& preference capital *1s.#$ each+ A 1s #$$$$$ -.uity share capital *1s #$ per share+ A 1s #$$$$$

C+ The following are the balance sheets of 1obert 6imited for the year /$$% and /$$C liabilities Share capital Feneral reserve /$$% #$$$$$ %$$$$ /$$C #$$$$$ %$$$$ #$$$$$ H$$$$ %$$$$ /$$$$ 7$$$$$ <$$$$$ 7$$$$$ assets Fixed assets stock debtors cash ,repaid expenses /$$% /$$$$$ 7$$$$ <$$$$ /$$$$ #$$$$ /$$C /%$$$$ C$$$$ 7$$$$ <$$$$ /$$$$

,rofit M loss %$$$$ (Dc H& debentures Sundry creditors ,roposed dividend %$$$$ 7$$$$ #$$$$ <$$$$$

9alculate the following ratios a+ 9urrent ratio b+ (cid?Test ratio c+ =ebt?e.uity ratio d+ Fixed assets?shareholders ratio e+ ,roprietary ratio E+ The current ratio is /.%, li.uid ratio #.% and working capital is 1s.#$$$$$.find current assets, current liabilities and stock. H+ The average stock is 1s.H$$$$ and the opening stock is #$$$$ less than the closing stock. Find opening and closing stock. I+ 0t is given that the long term debt to e.uity ratio is /:< and the e.uity amount is 1s %$$$$.compute the value of long term debt
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Financial Accounting & Analysis

#$+ The following financial data is given: Sales for the year Stock > 1s #$$$$$ 9redit sales A 1s #%$$$$ =ebtorsA 1s E%$$$ Total assets A 1s<$$$$$ Share capital*#$$$$ shares of #$ each+ A 1s #$$$$$ @et profit A 1s %$$$$ arket price per share is 1s #/.from the above information calculate and give your opinion on each ratio a+ Stock turnover ratio b+ =ebtors turnover ratio c+ =ebt collection period d+ ,rice?earnings ratio e+ -arnings per share ##+ Fross profit ratio is /$& .gross profit is 1s %$$$$.calculate sales #/+ Fiven below is the trading and profit and loss account !pening stock 9ash purchases 9redit purchases Fross profit Total Feneral expenses depreciation 0ncome tax @et profit #/$$$$ C$$$$ </$$$$ #H$$$$ CH$$$$ 7$$$$ /$$$$ <$$$$ I$$$$ #H$$$$
By K.Arjun Goud *Assistant Professor+ Page 21

A 1s /$$$$$

9ash sales 9redit sales 9losing stock

#/$$$$ 7H$$$$ H$$$$

Total Gy gross profit

CH$$$$ #H$$$$

#H$$$$

Financial Accounting & Analysis

$alance *%eet Share capital Feneral reserve ,rofit and account creditors Gills payable <$$$$$ C$$$$ loss ##$$$$ H$$$$ /$$$$ %E$$$$ 9ompute: a? Current ratio !? Acid test ratio c? 6e!t@e)uity ratio d? roprietary ratio Fixed assets stock investments debtors cash #E$$$$ H$$$$ #$$$$$ #C$$$$ C$$$$ %E$$$$

e? *toc. turno#er ratio f? Creditors turno#er ratio g? 6e!tors turno#er ratio %? 6e!t collection period i? Credit payment period A? ;ross profit ratio .? 5et profit ratio l? Return on s%are %olders funds

#<+ Gelow is the summarized balance sheet and profit and loss account of hero limited for the year ended <#D<D$H amounts are in lakhs lia!ilities Rs Assets Fixed assets 6i.uid assets Rs ## <

Share capital*1s #$ 7 each+ reserves <

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Financial Accounting & Analysis

overdraft 9urrent liabilities

7 H #I

!ther current assets

#I

,rofit and 6oss account To opening capital ,urchases expenses @et profit / // < 7 <# <# Gy sales less returns 9losing stock /H <

9alculate all the key ratios and comment on the financial position of the company

#7+ The following is the information of a textile company. 9omplete the proforma balance sheet if the sales are </$$$$$ Sales to networth ? /.< times

9urrent debt to networth > 7/& Total debt?networth > E%& 9urrent ratio > /.I times @etsales to inventory > 7.E times (verage collection period?C7 days Fixed assets to @etworth > %<./& ,ro ? forma Galance Sheet

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Financial Accounting & Analysis

@etworth 6ong term debt 9urrent debt

4 4 4

Fixed assets 9ash Stock Sundry debtors

4 4 4 4 4

#%+ From the following particulars calculate current assets current liabilities and stock Sales #/$$$$$, F, ratio /%&, 9urrent ratio #.E%, ;uick ratio #./%

Stock turnover ratio I times #C+ 5ith the help of following details prepare balance sheet of the firm concerned: 5orking capital E%$$$ #$$$$$ C$$$$ #.E% #.#% $.E% @06

1eserves and surpluses Gank overdraft 9urrent ratio 6i.uid ratio

Fixed assets?proprietary funds 6ong term liabilities

#E+ 5ith the help of following ratios regarding suJith films, draw a balance sheet of the company for the year /$$E: 9urrent ratio 6i.uidity ratio @et working capital Stock turnover ratio*cost of salesDcl stock+ Fross profit ratio Fixed assets turnover ratio*on cost of sales+ =ebt collection period
By K.Arjun Goud *Assistant Professor+ Page 24

/.% #.% 1s <$$$$$ C times /$& / times / months

Financial Accounting & Analysis

Fixed assets to shareholders net worth 1eserve and surplus to capital

$.H$ $.%$

#H+ The following are the ratios extracted from the balance sheet of a firm 9urrent ratio ?/.% 5orking capital > <$$$$$ 6i.uid ratio > #.% Stock turnover ratio > C Fross profit as a percentage of sales /$& debt collection period > / months share capital > 1s %$$$$$ reserves and surpluses? /%$$$$ fixed assets turnover ?/ #I+ From the following information prepare a balance sheet 9urrent ratio > /.% 6i.uid ratio? #.% ,roprietary ratio *fixed assetsDproprietary funds+ $.E% 5orking capital > 1s C$$$$ 1eserves and surpluses >1s 7$$$$ Gank overdraft? 1s #$$$$ There is no long term or fictitious assets /$+ Following is the ,rofit and 6oss account and Galance Sheet of Pai 8ind 6td. 9alculate the following ratios: a+ 6i.uidity ratio b+ (ctivity ratio c+ ,rofitability ratio articulars AmountBRs? articulars AmountBRs? To opening stock of finished stock #$$$$ Gy sales H$$$$$ To 1aw materials %$$$$ Gy closing stock To manufacturing exp #$$$$ 1aw materials #%$$$$ To purchase <$$$$$ Finished goods #$$$$$ To (dministration exp %$$$$ Gy profit on sale of share %$$$$
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Financial Accounting & Analysis

To Selling exp To 6oss sale of ,lant To interest on =ebentures To net profit

%$$$$ %%$$$ #$$$$ <H%$$$ ,,///// Assets Fixed (ssets Stock of raw materials Stock of Finished goods sundry =ebtors Gank balance AmountBRs? /%$$$$ #%$$$$ #$$$$$ #$$$$$ %$$$$

,,/////

(ia!ilities Share capital -.uity share capital ,reference shares capital 1eserves =ebentures Sundry creditors Gills payable

AmountBRs? #$$$$$ #$$$$$ #$$$$$ /$$$$$ %$$$$ %$$$$ %$$$$ C1////

C1////

6upont Analysis 6efinition 6u ont formula *also known as the 6u ont analysis8 6u ont Model8 6u ont e)uation or the 6u ont met%od+ is a method for assessing a companyQs return on e.uity *1!-+ breaking its into three parts. The name comes from the =u,ont 9orporation that started using this formula in the #I/$s. Calculation Bformula? 1!- *=u,ont formula+ A *@et profit D 1evenue+ R *1evenue D Total assets+ R *Total assets D -.uity+ A @et profit margin R (sset Turnover R Financial leverage =u,ont model tells that 1!- is affected by three things:

!perating efficiency, which is measured by net profit marginK (sset use efficiency, which is measured by total asset turnoverK Financial leverage, which is measured by the e.uity multiplierK

0f 1!- is unsatisfactory, the =u,ont analysis helps locate the part of the business that is underperforming

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Financial Accounting & Analysis

IA*@IFR*@4* Definition of 'International Financial Reporting Standards - IFRS' ( set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. 0F1S are issued by the 0nternational (ccounting Standards Goard. 0F1S are sometimes confused with 0nternational (ccounting Standards *0(S+, which are the older standards that 0F1S replaced. *0(S were issued from #IE< to /$$$.+ Definition of 'International Accounting Standards - IAS' Standards for the preparation and presentation of financial statements created by the 0nternational (ccounting Standards 9ommittee *0(S9+. They were first written in #IE<, and stopped when the
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Financial Accounting & Analysis

0nternational (ccounting Standards Goard *0(SG+ took over their creation in /$$#. See also Fenerally (ccepted (ccounting ,rinciples *F((,+.

Accounting *tandards issued !y t%e ICAI

5ithdrawal of the (nnouncement issued by the 9ouncil on LTreatment of exchange differences under (ccounting Standard *(S+ ## *revised /$$<+, The -ffects of 9hanges in Foreign -xchange 1ates vis?S?vis Schedule )0 to the 9ompanies (ct, #I%C:

Accounting *tandards BA*s?

(S # =isclosure of (ccounting ,olicies (S / )aluation of 0nventories (S < 9ash Flow Statements (S 7 9ontingencies and -vents !ccuring after the Galance Sheet =ate (S % @et ,rofit or 6oss for the period,,rior ,eriod 0tems and 9hanges in (ccounting ,olicies (S C =epreciation (ccounting (S E 9onstruction 9ontracts *revised /$$/+ (S H (ccounting for 1esearch and =evelopment (S I 1evenue 1ecognition (S #$ (ccounting for Fixed (ssets (S ## The -ffects of 9hanges in Foreign -xchange 1ates *revised /$$<+, (S #/ (ccounting for Fovernment Frants (S #< (ccounting for 0nvestments (S #7 (ccounting for (malgamations (S #% *revised /$$%+ -mployee Genefits 6imited 1evision to (ccounting Standard *(S+ #%, -mployee Genefits *revised /$$%+ (S #% *issued #II%+(ccounting for 1etirement Genefits in the Financial Statement of -mployers

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Financial Accounting & Analysis

(S #C Gorrowing 9osts (S #E Segment 1eporting (S #H, 1elated ,arty =isclosures (S #I 6eases (S /$ -arnings ,er Share (S /# 9onsolidated Financial Statements (S // (ccounting for Taxes on 0ncome (S /< (ccounting for 0nvestments in (ssociates in 9onsolidated Financial Statements (S /7 =iscontinuing !perations (S /% 0nterim Financial 1eporting (S /C 0ntangible (ssets (S /E Financial 1eporting of 0nterests in Point )entures (S /H 0mpairment of (ssets (S /I ,rovisions,9ontingentT 6iabilities and 9ontingent (ssets (S <$ Financial 0nstruments: 1ecognition and easurement and 6imited 1evisions to (S /, (S ## *revised /$$<+, (S /#, (S /<, (S /C, (S /E, (S /H and (S /I (S <#, Financial 0nstruments: ,resentation (ccounting Standard *(S+ </, Financial 0nstruments: =isclosures, and limited revision to (ccounting Standard *(S+ #I, 6eases

7indo& dressing Window dressing in accounting is actions taken by management to improve the appearance of a companyQs financial statements, usually shortly before the end of an accounting period. 5indow dressing is particularly common when a business has a large number of shareholders, so that management can give the appearance of a well?run company to investors who probably do not have much day?to?day contact with the business. 0t may also be used when a company wants to impress a lender in order to .ualify for a loan. 0f a business is closely held, the owners are usually better informed about company results, so there is no reason for anyone to apply window dressing to the financial statements. -xamples of window dressing are:
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Financial Accounting & Analysis

Cash. ,ostpone paying suppliers, so that the period?end cash balance appears higher than it should be. Accounts receivable. 1ecord an unusually low bad debt expense, so that the accounts receivable *and therefore the current ratio+ look better than is really the case. Fixed assets. Sell off those fixed assets with large amounts of accumulated depreciation associated with them, so the net book value of the remaining assets appears to indicate a relatively new cluster of assets. Revenue. !ffer customers an early shipment discount, thereby accelerating revenues from a future period into the current period. Depreciation. Switch from accelerated to straight?line depreciation in order to reduce the amount of depreciation charged to expense in the current period. xpenses. 5ithhold supplier expenses, so that they are recorded in a later period.

The window dressing concept is also used by fund managers, who replace poorly?performing securities with higher?performing ones Just before the end of a reporting period, to give the appearance of having a robust set of investments. The entire concept of window dressing is clearly unethical, since it is misleading. (lso, it merely robs results from a future period in order to make the current period look better, so it is extremely short?term in nature (imitations of Financial *tatement "%ese are some of t%e limitations of financial analysis t%at credit managers must !e a&are of &%en t%ey are re#ie&ing a customers financial statements'

,ast financial performance, good or bad, is not necessarily an accurate predictor of future performance. Financial statements do not tell you about changes in senior management. Financial statements do not tell you about the loss of maJor customers. Financial statements do not tell you about the competitive environment in which the company operates. Financial statements do not disclose the companys future prospects, or the results of its expenditures on 1esearch and =evelopment, or new product introductions, or new marketing campaigns, or new pricing strategies, or the customers recent decision to enter or exit a particular market segment.

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Financial Accounting & Analysis

The more out?of?date a customers financial statements are, the less reliable they are as a risk management tool. 5ithout reading the @otes to the financial statements, credit managers cannot get a clear idea of the risk they are evaluating. 'naudited statements may or may not follow Fenerally (ccepted (ccounting ,rinciples, and if they do not follow F((, relying on them could be a serious mistake. Financial statements can be altered legally by adJusting certain types of reserves. Financial results can be improved by reducing or eliminating discretionary expenditures ? even if this cost cutting is at the expense of long term growth and profits. Foreign financial statements do not follow F((,. 0n some cases, local accounting rules are so different from F((, accounting rules that it is easy to make the wrong decision after reviewing the foreign financial data. 'naudited statements may be inaccurate, misleading, or even deliberately fraudulent ? and if they seem too good be true, they may be Just that. To see the big picture, it is necessary to have at least two consecutive periods of financial statements for comparison. Trends will only become apparent this way. The corollary is that it is not enough to know a customers financial weaknesses. 0t is also important to know whether the customers financial performance is weak but improving or weak and deteriorating. (udited statements do not guarantee accuracy. -ven audited financial statements are subJect to a degree of manipulation. !ff balance sheet financing is lawful, but can have a devastating effect on a customers financial health. The fact that a company is publicly traded and its financial statements are readily available does not guarantee that the company in .uestion is financially stable and creditworthy.

By K.Arjun Goud *Assistant Professor+ Page 31