FINANCIAL STATEMENT

ANALYSIS
Meaning and Definitions of Financial Statement Analysis
Metcalf and Titard defined as, Financial Statement Analysis is a process of
evaluating the relationship between component parts of a financial statement to
obtain a better understanding of a firms position and performance.

Objectives of Financial Statement Analysis

The objectives of Financial Statement Analysis are stated as follows:
(i) To find out the operating performance of a company.
(ii) To find out the Financial performance of a company.
(iii) To Compare the performance of a company for different periods.
(iv) To find out the long-term solvency and liquidity of a concern.

Advantages or Uses of Financial Statement Analysis

1.
2.
3.
4.

Advantages
Advantages
Advantages
Advantages

to
to
to
to

the
the
the
the

owners of the Company:

Investors:
Management:
Suppliers:

Types of Financial Statement Analysis

1. Classification according to Material used

According to material used, financial Statement Analysis is classified as

(i)
Internal Analysis and
(ii)
External Analysis.

2. Classification according to Modus Operandi

According to Modus Operandi Financial Statement Analysis is classified as

(i)
Horizontal Analysis and
(ii)
Vertical Analysis

Procedures for Financial Statement Analysis

The following are the procedures in the Financial Statement Analysis.

(i)
(ii)
(iii)

(iv)

(v)

(vi)

The purpose for which the analysis is conducted should be determined

well in advance.
On the basis of the purpose the items in the Financial Statement should be
identified.
If the analysis to be carried on about the Income Statement, the items
should be clearly arranged on the basis of Sales, Cost of goods sold, Gross
Profit, Operating expenses, Operating Profit and Net Profit. This is to
establish a relationship between various items of the income statement.
If the analysis is to be carried on about the Balance Sheet, then the items
should be classified as Fixed Assets and Current Assets for Asset side and
Current Liabilities, Debt and Equity for the Liability side.
After the classification of the items in the Income Statement and Balance
Sheet increase or decrease of each items from one period to another
should be calculated. Also percentage of increase or decrease should be
calculated. The comparison may be done for each item on the basis of
percentage on sales for Income Statement and on total assets and total
liabilities for Balance Sheet.
Interpretation about the analysis should be very clearly explained after
the analysis in order to provide valuable information for managerial
decision making.

Methods or Devices of Financial Statement Analysis

1.
2.
3.
4.
5.
6.
7.

Comparative Statements
Trend Analysis
Common-size Statements
Fund Flow Analysis
Cash Flow Analysis
Ratio Analysis
Cost-Volume-Profit Analysis.

1.Comparative Statement
Comparative Statement deal with the comparison of different items of the Profit &
Loss Account and Balance Sheets of two or more periods. In the process of
comparison, the good or poor performance of each items for a period can be known
in order to take corrective action for the future.

Comparative Income Statement

Income statement gives detail about the Profit of a company. This statement
explains the Profit in three different stages namely, Gross Profit, Operating Profit
and Net Profit. The comparative income statement shows whether there is any
improvement in the profitability of a concern over a period of time. If the
profitability is low compared to the previous year, the management can able to
identify the reasons for it so that corrective action can be taken.

Prepare a Comparative Income Statement of K Ltd. For the following Profit and Loss.
Account for the year ended 31st March 2006 and 2007.

Profit & Loss Account for the year ended 31st March 2006
and 2007
Particulars
To Cost of goods
sold
To Operating
expenses
Administrative
exp.
Selling expenses
To Net Profit

2006
Rs.
7,00,000
90,000
60,000
1,50,000

10,00,000

2007
Rs.
8,90,000

Particulars
By Sales

2006
Rs.
10,00,000

2007
Rs.
12,00,000

10,00,000

12,00,000

1,40,000
40,000
1,30,000

12,00,000

Solution:

Comparative Income Statement

Particulars
Sales
Less: Cost of Good Sold

2006
Rs.

2007
Rs.

10,00,000

12,00,000
8,90,000

Change
Rs.
2,00,000
1,90,000

Percentag
e
20

7,00,000
27.14
Gross Profit

3,10,000

10,000

3,00,000
Operating Expenses:
Administrative Expenses
Selling Expenses

90,000

3.33
1,40,000
40,000

50,000
- 20,000

60,000
Total Operating Expenses

33.33
1,80,000

30,000

1,50,000
Net Profit

20
1,30,000

1,50,000

55.55

-20,000
13.33

Interpretation:

1. Gross Profit of the company increased by 3.33% . But the Net Profit reduced
by 13.33%.

2. The reasons for the reduced net profit is due to increase in administrative
expenses and cost of goods sold.
Comparative Balance Sheet
AB Ltd. Provided the Balance Sheets for the year ended 31 st March 2006 and 2007
as follows

Balance Sheets
Particulars
Share Capital
Profit & Loss A/c
Loan
Current
Liabilities

2006
Rs.
11,00,00
0

2007
Rs.
14,00,0
00

1,45,000

1,75,00
0

Particulars
Fixed Assets
Current Assets

2006
Rs.
12,80,00
0

2007
Rs.
15,20,0
00

2,40,000

3,00,00
0

15,20,00
0

18,20,0
00

2,00,000
75,000

1,50,00
0

95,000
15,20,00 18,20,0
0
00
Prepare a Comparative Balance Sheet.
Solution:

Comparative Balance Sheet

Particulars
Assets
Current Assets
Fixed Assets
Total Assets
Liabilities
Current Liabilities:
Debt-Loan
Equity:
Share Capital
Profit & Loss Account
Total Equity
Total Liabilities

Interpretation:

2006
Rs.

2007
Rs.

2,40,000
12,80,000

3,00,000
15,20,000

15,20,000

18,20,000
95,000

75,000
2,00,000

1,50,000

11,00,000
1,45,000
12,45,000
15,20,000

14,00,000
1,75,000
15,75,000
18,20,000

Change
Rs.
60,000
2,40,000
3,00,000

Percenta
ge
25.00
18.75
19.74

20,000

26.67

-50,000

-25.00

3,00,000
30,000
3,30,000
3,00,000

27.27
20.69
26.51
19.74

(i)
(ii)
(iii)
(iv)
(v)

There is an increase in the total Assets and Liabilities by 19.74%.

The growth of Fixed Assets is low when compared to the growth
of Current Assets
There is an increase in the value of Equity to the extent of
26.51%. But the Debt reduced by 25%.
The Net Profit also increased by 20.69%.
Increase in Current Assets when compared to Current Liabilities
showed the increase in Working Capital.
In this analysis, the important items of the financial statements
(both Profit & loss Account and Balance Sheet) for a long period
can be taken for Trend analysis. The period of comparison may be
5 years or more than that. Trend percentage should be calculated
by taking one year as base. Normally, the first year of comparison
in taken as base year. The index of base year should be 100 and
from that trend percentages for the subsequent years should be
calculated.

Procedures for calculating Trend Percentages

The following are the procedures for calculating the Trend Percentage
(i)
(ii)
(iii)
(iv)

The base year should be identified. Normally the first year is considered as
base year.
The items to be compared should also be identified.
The values of base year should be considered as 100.
Compare the values of the subsequent years with the base year and
convert it into Trend values (by dividing the value of current year with the
value of base year. This value should be multiplied by 100).

Illustration:7
The following are the information related to Sales and Profit of G Ltd. Calculated the
Trend Percentages by taking 2003 as base. Also interpret the result.
(Rs. in 000s)
Year
2003
2004
2005
2006
2007

Sales
4,500
5,300
6,000
6,500
7,000

Stock
340
450
700
550
400

Profit Before
Tax
420
370
510
300
750

Solution:

Statement of Trend Percentage

Sales

Stock

Year
Amount
Rs.
2003
2004
2005
2006
2007

4,500
5,300
6,000
6,500
7,000

Trend
Percent
age

Amount

100
117.78

340
450
700
550
400

Trend
Percent
age
100
132.35

Profit Before
Tax
Amount
Trend
Rs.
Percenta
ge
420
370
100
510
300
88
750
121.43

133.33

205.88

144.44

161.76

71.42

155.55

117.64

178.57

Interpretation:
(i)
(ii)

(iii)

Sales improved by 155.55% in the year 2007 compared to the year

2003. The improvement is gradual and steady.
Stock position is very high during 2005 when compared to other
periods. More or less same level of stock is maintained in 2007 also
(i) e., 117.64% when compared to 2003.
There is a wide fluctuation in the improvement of Profit before tax.
It reduced to 88% in 2004 and immediately raised to 121.43%. Then
it reduced to 71.42% level in 2006 and improved to 178.57%. The
overall improvement to 178.57% compared to 2003 is good.

3. Common Size Statement

Common size statement is concerned with the analysis of the financial
statements (Income statement and Balance Sheet) on percentage basis. It
explains each item of the financial statements in terms of the percentage to the
total. Hence, the share of each items of Expenses or Income, Assets or Liabilities
to total can be known through this analysis.
Common size statements are prepared on the following basis.

(i)

(i)
Common-size Income Statement
(ii)
Common-size Balance sheet
Common Size Income Statement: In this statement, the value of each item
of expenses are analysed as a percentage to the total sales. For example, if
the sales is Rs. 4,00,000 and the administrative expenses

Illustration: 8
The Income Statement of a manufacturing Company for 31st March 2006 and
2007 are stated as follows.
Particulars
Sales
Non-operating income (Dividend
received)

Expenses
Cost of production
Administrative Expenses
Selling Expenses
Interest
Total Expenses
Net Profit

Solution:

2006
Rs.
29,00,000
1,50,000
30,50,000

16,40,000
5,40,000

2007
Rs.
34,00,000
1,00,000
35,00,000
18,85,000
6,20,000
2,75,000
3,90,000

2,10,000
3,70,000
27,60,000

31,70,000

2,90,000

3,30,000

Particulars
Rs.
Sales
Less:Cost of
production
Gross Profit
Operating
Expenses
Administrative
Expenses
Selling Expenses
Total Operating
Expenses
Operating Profit
Non-operating
income
(Dividend)
Total Income
Less: Nonoperating
Expenses
Interest
Net profit

2006
%

2007
Rs.

29,00,00
0
16,40,00
0
12,60,00
0

100.00

34,00,000

100.00

56.55

18,85,000

55.44

43.45

15,15,000

44.56

5,40,000

18.62

6,20,000

18.24

2,10,000

7.24

2,75,000

8.08

7,50,000

25.86

8,95,000

26.32

5,10,000

17.59

6,20,000

18.23

1,50,000

5.17

1,00,000

2.94

6,00,000

22.76

7,20,000

21.17

3,70,000

12.76

3,90,000

11.47

2,90,000

10.00

3,30,000

9.70

Interpretation
(i)

(ii)
(iii)

The operating efficiency of the company is more or less same. This is seen
from the percentage of Operating Expenses, Operating Profit and Net
Profit on Sales.
The Gross Profit for 2006 and 2007 on Sale are almost same as 43.45%
and 44.56% respectively.
The Net profit on Sales for 2006 and 2007 are same as 10% and 9.7%.

(ii) Common-size Balance Sheet

Common size Balance Sheet is prepared by analysing each item of the
Balance Sheet as on percentage of the Total Assets or Total Liabilities.

Illustration:10
The Balance Sheets of N Ltd. And H Ltd. As on 31 st March 2007 are stated as follows.
Particulars
Assets
Cash
Sundry Debtors
Stock
Outstanding Income
Prepaid Expenses
Fixed Assets
Total Assets

Liabilities
Sundry Creditors
Bills Payable
Long-term Loan
Capital
Total Liabilities

N Ltd.
Rs.

H Ltd.
Rs.

75,000

95,000

70,000

77,000

79,000

85,000

26,000

23,000

20,000

10,000

10,20,000

12,10,000

12,90,000

15,00,000

45,000

32,000

25,000

13,000

4,00,000

5,00,000

8,20,000

9,00,000

12,90,000
15,00,000
Prepare a common size Balance Sheet and interpret the result.

Solution :
Common Size Balance Sheet
Particulars
Amount
Current Assets
Cash
Sundry debtors
Stock
Outstanding Income
Prepaid expenses
Total Current Assets

75,000
70,000
79,000
26,000
20,000
2,70,000

N Ltd.
Rs.
%
5.81
5.43
6.12
2.02
1.55
20.93

H Ltd.
Rs.
Amount
95,000
77,000
85,000
23,000
10,000
2,90,000

%
6.33
5.13
5.67
1.53
0.67
19.33

10,20,000
12,90,000

Fixed Assets
Total Assets
Current Liabilities
Sundry Creditors
Bills Payable
Total Current Liabilities
Interpretation:
(i)
(ii)

(iii)

45,000
25,000
70,000
4,00,000
8,20,000
12,90,000

79.07
100.00
3.49
1.94
5.43
31.00
63.57
100.00

12,10,000
15,00,000
32,000
13,000
45,000
5,55,000
9,00,000
15,00,000

80.67
100.00
2.13
0.87
3.00
37.00
60.00
100.00

H Ltd. has more Total Assets compared to N Ltd.

The Current Assets to Total Assets for H Ltd. is slightly low than N Ltd. But
it is compensated by low amount of Current Liabilities for H Ltd. compared
to N. Ltd. Hence, the Working Capital of H Ltd. is comparatively better.
The Debt-Equity of H Ltd. is not good compared to N Ltd. since N Ltd. has
more percentage of equity compared to H ltd.