Analysis Of Financial Statements

ANALYSIS OF FINANACIAL STATEMENTS & CASH MANAGEMENT

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ANALYSIS OF FINANACIAL STATEMENTS

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FINANCIAL STATEMENT ANALYSIS Analysis of financial statement means a systematic and specialized treatment of the information found in financial statements so as to derive useful conclusions on the profitability and solvency of the business entity concerned 3

Objectives of Financial Statement Analysis

Profitability Analysis

Liquidity Analysis

Solvency Analysis

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

Profitability Analysis: Users of financial statements may analyze financial statements to decide past and present profitability of the business



Liquidity Analysis: Suppliers of goods, moneylenders and financial institutions may do a liquidity analysis to find out the ability of the company to meet its obligations



Solvency Analysis: It refers to analysis of long term financial position of the company. This analysis helps to test the ability of a company to repay its debts.

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TYPES OF FINANCIAL ANALYSIS

Intra Firm Analysis

Inter Firm Analysis

Standard Analysis

Horizontal Analysis

Vertical Analysis

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

Intra Firm Analysis: Analysis of performance of the organization over a number of years. It is also referred to as Time Series Analysis or Trend Analysis



Inter Firm Analysis: It is a comparison of two or more organizations in terms of various financial variables.



Standard Analysis: only one set of financial statements of an organization is analyzed on the basis of standard set for the firm or industry



Horizontal analysis: It is a comparison of figures reported in financial statements of two or more consecutive accounting periods i.e. Analysis across years



Vertical Analysis: comparing figures I the financial statements of a single period is known as Vertical Analysis

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1. COMPARATIVE FINANCIAL STATEMENTS 

Comparative financial statements are statements of the financial position of a business so designed as to facilitate comparison of different accounting variables for drawing useful inferences



Comparative financial statements show: Absolute data for each of the periods stated Changes in absolute data in terms of rupees Changes in absolute data in percentages

d) e) f)

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PARTICULARS

NET SALES LESS: COST OF GOODS SOLD OPENING STOCK ADD:PURCHASES WAGES FACTORY EXPENSES

Y1 (Rs)

Y2 (Rs)

CHANGE IN AMT (Rs) Y2-Y1

CHANGE IN PERCENTAGE Y2-Y1 *100 Y1

600

1,000

400

66.67

80 300 100 80 560 LESS: CLOSING STOCK 120 COST OF GOODS SOLD 440 GROSS PROFIT LESS: OPERATING EXPENSES 160 12. ADMIN EXPENSES 18 13. SELLING & DISTRIBUTION EXP. 14. FINANCE EXP. 33 TOTAL OPERATING EXP. 1 52

120 800 160 100 1180 300 880 120

40 500 60 20 620 180 440 (40)

50 166.66 60 25 110.7 150 100 (25)

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4

22.22

23 45

(10) (1) (7)

(30.30) (100) (13.46)

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Advantages  Indicates

the direction of movement and the financial position of the company.  Used to compare the position of the every month or every quarter.  Used to compare with other firms.  Presents a review of the past activites and their effect on the financial position.  Helps to determine the nature of trends of current changes affecting the enterprise. 10

Disadvantages  Loose

their purpose if the application of accounting principles over a period of time is not consistent.

 Consistent

changes in price levels render accounting statements useless for comparisons

 To

carry out inter firm comparison the firms need to be of the same age, size and follow the same principle.

 If

the accounting period follows an abnormal period the analysis would be rendered useless 11

2. Common-Size Statements It is a statement which facilitates comparison of two or more business entities with a common base

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Common Size Balance Sheet Particulars

Amt

Percentage

Sources of Funds Owned Funds Share Capital

80,000

64%

Reserves

20,000

16%

100,000

80%

Debentures

25,000

20%

Loan Fund

25,000

20%

Total Capital Employed

1,25,000

100

Fixed Capital

75,000

60%

Working Capital

50,000

40%

Total Net Assets Owned

1,25,000

100

Proprietors Fund Add

Borrowed Funds

Application of Funds

Add

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Common Size Income Statement Particulars

Amt

%

Net Sales

3,17,250

100

Less: Cost of Good Sold

1,77,750

56.02

Gross Profit

1,39,500

43.97

Less: Operating Expenses

Administration and General Exoenses

23,000

7.24

Selling Overheads

90,000

28.36

Total Operating Expenses

1,13,000

35.61

Net Operation Profit

26,500

8.35

3000

0.94

Loss on Sale of Investment

12,000

3.78

Net Profit before Tax

17,500

5.51

Less: Tax

8,500

2.67

Net Profit After Tax

9000

2.83

Add: Non-Operating Profit Other Income Less: Non-Operating Expenses

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Advantages  It

reveals the sources of funds and the application of the total funds in the assets of a business enterprise.  It indicates the changing proportion of the assets, liabilities, costs etc.  It assists corporate evaluation and ranking.

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Disadvantages  Do

not show variation in various item from time to time  If it is not prepared on a consistent basis comparative study will be misleading.  It does not establish any relationship between items in profit and loss account with that of items of balance sheet

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3. Trend Analysis – overview  What

is trend analysis?  Advantages of trend analysis  Disadvantages of trend analysis  Example of trend analysis  Comments derived from trend analysis.

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What is Trend Analysis  Also

termed as trend percentage.

 Used

for comparing financial statements over a number of years.

 At

least 3 years data required.

 Base

year 18

Trend analysis  Each

base year item taken as 100.

 Upward

trend will be indicated by the trend % being more than 100.

 Downward

trend % will be indicated by the trend% being less than 100. 19

particulars

02 Rs.

02 %

03 Rs.

03 %

02 Rs.

04 %

4

100

7.2

180

10.2

255

4 4

100 100

3 3

75 75

2 2

50 50

Total capital employed 8

100

10.2

128

12,2

153

Application of funds. Fixed assets Less:Depreciation prov.

1.6 0.6

100 100

2.4 0.9

150 150

3.2 1.5

200 250

Net fixed assets.

1

100

1.5

150

1.7

170

sources of funds 1)Net worth 2)Borrowed funds Debentures Total loan funds.

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particulars

02 Rs.

02 %

03 Rs.

03 %

02 Rs.

04 %

Working capital 2) Current assets Quick assets Debtors Bank Total Q.A

4.5 1 5.5

100 100 100

5.4 0.8 6.2

120 80 113

7.2 1.1 8.3

160 110 151

3 1.5 4.5 10 3 7

100 100 100 100 100 100

3.6 2.2 5.8 12 3.3 8.7

120 147 129 120 110 124

4.2 1.9 6.1 14 3.9 10.5

140 127 136 144 130 150

Non quick assets Stock St advances Total non quick assets Total C.A less C. L

Working capital

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Comments/derivations  Company

reliance on borrowed funds has declined whereas the dependence on owned funds has increased which can be revealed by 80%.  The company has gone for an expansion program which is reflected by addition to the Fixed assets which has increased by 50% in the year 2003 and 70% in 2004 compared to the base year calculated on net Fixed Assets. 22

Comments/derivations  Due

to increase in Fixed Assets there is also an additional requirement of working capital in order to mobilize the Fixed Assets which is reflected by 24% in the year 2003 and 50% increase in the year 2004 compared to the base year.

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Advantages  Indicates

the direction of movement of financial performance of the company.  Indicated the increase or decrease in an accounted item.  Shows the magnitude change , hence more effective than regular data.  An efficient method to showcase the financial performance of a company over a period of time. 24

Disadvantages  Any

1 trend by itself does not show the true picture.  Trend percentages without absolute data reference tend to be absurd.  Comparison of trend meaningless if accounting practices change during the years.  The base year selected may not be normal or typical. 25

Cash Management

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Motives for Holding Cash:  Transaction

motive- Holding of cash to finance routine transactions occurring during ordinary course of business  Precautionary motive- Holding of cash for unpredictable circumstances E.g: Floods, increase in cost of raw materials etc.  Speculative motive- Take advantage of unexpected opportunities E.g: making purchase at favorable prices  Compensating motive- Banks use the minimum balance in accounts to compensate themselves for the services rendered to the business firm 27

Cash Management Models: Baumol’s Model: EOQ management of cash C= sqrt (2FT) I where, C= Optimal transaction size F= Fixed Cost per transaction T= Estimated cash payments during the period I= Interest on marketable securities per annum Limitation- Too much uncertainty when trying to predict what the return will be. •

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2. Miller- Orr Model: 



Upper Control Limit (UCL)- Marketable securities are bought- Decided with the help of a formula Lower Control Limit (LCL)- Marketable securities are sold- Decided by management

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UCL= 3RP- 2LCL where, RP= Return Point RP= 3 sqrt(3bδ2) 4I where, RP= Return Point b= Fixed Cost per order for converting marketable securities into cash I= Daily interest on marketable securities δ2= Standard Deviation – Variance of daily changes in expected cash balance 30

Objectives of Cash Management:  Meet

cash disbursement needs  Minimize funds held in the form of cash balance  To prevent bankruptcy  Good relation with bank, trade creditors and suppliers  To lead strong credit rating  To meet unexpected cash expenditure  To maintain balance level 31

Cash Budget:  It

is a statement showing the estimated cash inflows over a period of time.  It shows the net cash position (surplus or deficiency) of a firm as it moves from one budgeting period to another.  It is a device to help a firm plan and control the use of cash.

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Various purposes of Cash Budget:  To

co-ordinate the timings of cash needs  It pinpoints the period when there is likely to be excess cash  Enables a firm to take advantage of cash discounts on its accounts payable, pay obligations when due, formulate a dividend policy etc  Helps arrange needed funds on the most favorable terms  Prevents accumulation of funds 33

Proforma of a Cash Budget: Particulars

Month 1

Month 2

Month 3

xxxx

xxxx

xxxx

(1) Cash Sales

xx

xx

xx

(2) Collection from Debtors to credit sales

xx

xx

xx

(3) Income from Investments

xx

xx

xx

(4) Any other Cash Receipts

xx

xx

xx

xxxx

xxxx

xxxx

Opening Balance Receipts:

Total receipts including Opening Balance (A)

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Contd… Payments: (1) Cash Payments

xx

xx

xx

(2) Suppliers (Creditors) for earlier credit purchases

xx

xx

xx

(3) Other Cash Expenses

xx

xx

xx

Total payments (B)

xxxx

xxxx

xxxx

Closing Balance (A-B)

xxxx

xxxx

xxxx

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CASH CYCLES

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Meaning 

The cash conversion cycle is the number of days between paying for raw materials and receiving the cash from the sale of the goods made from that raw material. Inventory Period

Day 0 : Purchase stock on credit

Day X : Cash paid for stock

A/Cs Payable period

A/Cs Receivable period

Day Y : Sell finished goods on credit

Day Z : Cash received

CASH CYCLE

CASH CYCLE = Y + Z - X 37

Significance 







A short cash conversion cycle is a sign of good working capital management. Conversely, a long cash conversion cycle indicates that capital is tied up while the business waits for customers to pay. It is quite possible for a business to have a negative cash conversion cycle. E.g.- Dell Computers in 2005 Cash Cycle = - 41 days (4 + 30 – 75)

A/Cs receivable

Inv. period 4

X

30

Y

Z

A/Cs payable period 75

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Concept of Float  It

is the difference between the available balance and the book or ledger balance.  Disbursement float  Collection float  Plays an important role in the 2 types of cash cycles viz. Disbursement & Receipt cycles 39

Disbursement cycle  It

is the total time between when an obligation occurs and when the payment clears the bank. Activity Obligation to supplier Invoice from supplier Send cheques Payment clears the bank

Day

FLOAT

0 10 25 35

 Total

cycle time = 35 days  Main objective is to increase the cycle time. 40

Methods of delaying payments  Increasing

Mail floats by mailing cheques from locations not close to parties.

 Increasing

Clearance float by disbursing cheques from a remote bank.

 Increasing

Processing float by purchasing with credit cards. 41

Receipt cycle It is the total time between products /services are delivered and when payment from the customer clears the bank.



Activity Begin services to customer Issue Invoice to customer Receive payment Payment clears the bank  

Day

FLOAT

0 30 62 66

Total cycle time = 66 days Main objective is to shorten the cycle. 42

Methods to shorten overall cycle 

Invoicing customer as soon as possible and monthly reminders.



Evaluating financial soundness of customers before extending credit.



Rewarding early payments with discounts



Shorten Collection float  

Lock boxes Concentration banking 43

Marketable Securities  Short

term investment instruments.

 They

can be easily converted into cash in a short period of time.

 Characteristics A

ready market and safety of principal  Little or no loss in the value over time 44

Selection Criteria 

Financial Risk – Uncertainty of the expected returns from a marketable security.



Interest Rate Risk – Uncertainty of the expected returns from a marketable security attributable to changes in interest rate.



Taxability – Market yields are affected because of different tax structures with different market securities. eg – municipal bonds are tax free 45

Selection Criteria  Liquidity

Ability to transform a security into cash in no time.  Yield

Affected by all the four factors. If a given risk is assumed, such as lack of liquidity, then higher yield may be expected.

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Types of Marketable Securities  Term

deposit with scheduled bank Banks accept deposit for periods ranging from 15 days to 5 years. interest rate varies from 5% - 8.5%

 Treasury Bills

Short term obligations of the government, which have maturities like 91, 182, 364 days. It is sold at discount and redeemed at par. 47

Types of Marketable Securities  Certificate

of deposits Negotiable receipt of funds deposited with the bank with a fixed rate of interest. They can be transferred from one party to another.  Commercial Papers Short term unsecured promissory note with fixed maturity period issued by leading, nationally reputed credit worthy and large business firms to raise cash. 48

Types of Marketable Securities  Mutual

Fund Scheme – A financial intermediary ... investment objective. It accepts small amounts from small investors and further invests in huge securities.

 Inter-

corporate deposits Short term deposit with other companies. It has high degree of risk and also it takes one month to convert them into cash. 49

Types of Marketable Securities  Bills

discounting Seller discounts the bill with the bank and the bank releases the funds to the seller.

 Ready forward

deal A commercial bank or some organization may do a ready forward deal with a company interested in deploying surplus funds on short term basis. 50

Types of Marketable Securities  Gilt-

edged Securities Most government securities bong are gilt edged securities because of less risk involved. Their returns are lower than other forms of investment.

 Municipal

Bonds Bonds raised by municipal bodies of local government for financing core urban infrasturucture facilities like drinking water. 51

THANK YOU

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