ACCOUNTS SYJC

9. ANALYSIS OF FINANCIAL STATEMENTS

Meaning
The financial statements are those which are prepared periodically. Generally at the end of
financial year all the information recorded in the books of accounts of business is summarized in
Financial Statements.

There are two important Financial Statements

(1) Balance Sheet / A Position Statement
(2) Profit and Loss A/c / An Income Statement

Analysis of Financial Statements

1. Balance Sheet : The balance sheet need to be arranged in vertical format which is suitable for
further analysis. Its format is given below:
………… Company Ltd
Balance Sheet as on …….
Particulars Amount (Rs.) Amount (Rs.)
1) Sources of Funds
A) Owners Fund/Shareholders Fund
(a) Share Capital
Equity share Capital xxx
Preference Share Capital xxx
(b) Add : Reserves and surplus
Profit and Loss A/c xxx
General Reserve xxx
Securities Premium xxx
(c) Less : Fictitious Assets xxx
Net Worth/Owners Fund (xxx) xxx
B) Borrowed Funds
Bank Loan xxx
Debentures (xxx)
II) Application of Funds xxx
1) Fixed Assets
Land and Building xxx
Plant and Machinery xxx
Furniture xxx
Vehicle xxx xxx
2) Investment
3) Working Capital xxx
Current Assets
Quick Assets
Cash xxx
Bank xxx
Debtors xxx
Bills Receivable xxx xxx
Total Quick Assets
Non Quick Assets
Stock xxx
Prepaid Expenses xxx
Advances xxx xxx

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Total Non-quick Assets

Total Current Assets (Quick + Non Quick Asset) xxx
Less Current Liabilities
Quick Liabilities
Creditors xxx
Outside Expenses xxx
Bill Payable xxx xxx
Total Current Liability
Non Quick Liability
Bank Overdraft xxx xxx
Total Current Liabilities
Working Capital (Current Assets Less Current Liabilities) xxx
Total Funds Employed/Applied xxx

……… Company Ltd

Vertical Income Statement for the year ended……..
Particulars Amount (Rs.) Amount (Rs.)
Income
Sales xxx
(-) Sales Return xxx
Net Sales xxx
Less Cost of Goods Sold
Opening Stock xxx
Add: Purchases xxx
Add: Wages xxx
Add: Carriage Inward xxx
Add: Direct Expenses xxx
Less Closing Stock xxx xxx
Net Cost of Goods Sold
Gross Profit (Net Sales – Net Cost of Goods Sold) xxx
Less : Operating Exp xxx
(a) Administrative Exp. xxx
(b) Finance Exp. xxx
(c) Selling Exp. xxx
Total Operating Expenses xxxx
Operating Profit (Gross Profit – Operating Expenses) xxxx
Add : Non-operating Income xxx
Less : Non-operating Exp. (xxxx)
Net Profit Before Tax xxx
Less : Tax (Charged on Net Profit before Tax) xxx
Net Profit After Tax xxx

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Comparative Financial Statement :

Comparative Statement compares financial data at two points and helps in deriving the meaning
and conclusions regarding the changes in financial positions and operating results.

Comparative Balance Sheet of Varun Company Ltd. as on 31.03.2019 and 31.03.2020

Particulars 1 2 3 4
31.03.19 31.03.2020 Absolute Percentage
(Rs.) (Rs.) Change Change
(Rs.)
1. Sources of Funds
(a) share capital 2,50,000 3,70,000 1,20,000 48% Increase
(b) Reserves & Surplus 60,000 1,00,000 40,000 66.67% Increase
(A) Net Worth 3,10,000 4,70,000 1,60,000 51.61% Increase
B. Borrowed Funds
(a) Secured Loan 1,00,000 1,60,000 60,000 60% Increase
(b) Unsecured Loan 90,000 1,40,000 50,000 55.55% Increase
Total Borrowed Fund 1,90,000 3,00,000 1,10,000 57.89% Increase
Total Fund Available (A + 5,00,000 7,70,000 2,70,000 54% Increase
B)

Common Size Statement

Meaning – Common size statements are those in which individual figures are converted into
percentage to some common base. Percentage of each individual item shows its relation to its
respective total i.e., Total Assets or Total Liabilities or Total Net Sales. In the income statement
the sales figure is assumed to be 100 and all figures are expressed as a percentage of this total. In
case of Balance sheet Total Fund Available are considered as 100 and all figures are expenses as
a percentage of this total. For example: if the Total Funds available in of Balance Sheet is Rs.
16,00,000 and building is Rs. 4,00,000

Amount of Building
Formula = 100
Total Fund Available
4,00,000
= 100  25%
16,00,000
Common Size Income Statement for the year ended 31.03.2019 and 31.03.2020
Particulars Amount Percentage Amount Percentage
(Rs.) % (Rs.) %
Net Sales 5,00,000 100% 6,00,000 100%
Less → Cost of Sales 3,00,000 60% 3,60,000 60.0%
Gross Profit 2,00,000 40% 2,40,000 40.0%
Less → Office and
Administrative Expense 55,000 11% 72,000 12%
Selling and Distribution 52,000 10.5% 66,000 11%
Expense
Net Profit 92,500 18.5% 1,02,000 17%

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Cash Flow Statement :

Cash Flow Analysis is another important technique of financial analysis. It shows the sources
and applications of cash by preparing Cash Flow Statement. It is inflows (Receipts) and
outflows (Payments) of cash from various activities during the particular period.

Cash Flow from Operating Activities

(1) Inflows : Cash inflow from operating activities should be shown in the CFS under the
following heads –
a) Cash receipt from sale of goods;
b) Cash receipt from rendering of services;
c) Cash receipts from royalties, fees, commission, etc;

(2) Outflows : Cash Outflow from operating activities should be shown in the CFS under the
following heads –
a) Cash payments to suppliers for goods and services (i.e. purchases and expenses);
b) Cash payments to employees

Cash Flow from Investing Activities

(1) Inflows : Cash inflows from investing activities should be shown in the CFS under the
following heads –
a) Cash receipts from sale of fixed assets or intangible assets;
b) Cash receipts from sale of investments;

(2) Outflows : Cash outflows from investing activities should be shown in the CFS under the
following heads –
a) Cash payments to purchase fixed assets (building, machinery, etc)
b) Cash payments to acquire intangible assets (goodwill, patents, etc)
c) Cash advances and loans made to outsiders
d) Cash payments for purchase of investments

Cash flow from financial activities

(1) Inflows : Cash inflows from financing activities should be shown in the CFS under the
following heads –
a) Cash received from issue of shares etc;
b) Cash received from issue of debentures, loans, bonds, and other long term borrowings

(2) Outflows : Cash outflows from financing activities should be shown in the CFS under the
following heads –
a) Repayment of amounts borrowed
b) Redemption of preference shares etc.

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Ratio Analysis – Meaning, Objectives and Classification of Ratios

Meaning :
Ratio is a mathematical number that measures the relationship between two accounting figures.
It is also called as “Financial Ratio”. It can be expressed as fraction proportion or percentage in
between two accounting figures.
The use of different types of accounting ratios to evaluate the financial performance of business
is called Ratio Analysis.

Classification of Ratios : Ratios are classified into various groups based on the purpose for
which ratio is compared as follows.

Ratio

Balance Sheet Income Statement Combined/ Mixed

Ratio Ratio Ratio

Current Liquid Gross Operating Net Returne Returne

Ratio Ratio Profit Expenses Profit on Capital on
Ratio Ratio Ratio Employed Investment
(RCOE) (ROI)

(A) Balance – Sheet – Ratio :

(1) Current Ratio : This ratio compare the current Assets with Current Liabilities. The ideal
current ratio is 2:1 which indicates that Current Assets are twice the Current Liabilities. It
measures short term solvency of business enterprises.

Current Assets
Current Ratio :
Current Liabilities

(2) Liquid Ratio/Quick ratio/ Acid Test Ratio :

The ratio of quick assets to current liability is called quick ratio or acid ratio or liquid Ratio. The
assets which can be converted into cash immediately or at short notice are called Quick Assets.
All current assets except Stock and Prepaid expenses are considered as quick assets.
The ideal quick ratio is 1:1. It measures the liquidity position of business enterprises.

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Note : Prepaid expenses, Advance taxes etc are excluded because they cannot be converted into
cash. Stock is excluded because it is uncertain as to when and how much it will realises
Liquid Assets / Quick Assets
Liquid Ratio =
Current Liabilities
Liquid Assets = Current Asset – (stock + Prepaid Expense)
Quick Assets
Liquid Assets = Cash Balance + Bank Balance + debtors + bills receivable + Marketable
securities
Liquid Liabilities = Current Liabilities – (Bank overdraft and advance received)

(B) Income Statement Ratio/Turnover or Margin Ratio:

(1) Gross Profit Ratio : This ratio measure relationship between Gross Profit and Net sales. It
is calculated to measure the efficiency of production department. It is usually expressed in the
form of percentage.

Gross Profit = Net Sales – Cost of Goods Sold

Cost of Good Sold = Opening Stock + Purchase + Direct Expense – Closing Stock

Net Sales = Sales – Sales Return

Gross Pr ofit
Gross Profit Ratio = 100
Net Sales

Expenses may be divided into two parts:

(a) Operating Expenses : Expenses which are incurred by the business for routine operation of
business are called Operating Expenses. For Example – Office and Administrative Expenses,
Selling and Distribution Expenses.
Operating Profit = Gross Profit – Operating Expenses

(b) Non Operating Expenses : Includes loss on sale of fixed assets, loss by fire Goodwill written
off, discount on issue of shares and debentures, Preliminary Expenses etc. Operating profit
ratios shows the operational efficiency of business.
Net Profit Ratio: Net Profit ratio shows the relationship between Net Profit and Net Sales. It is
expressed in percentage. This ratio measures the overall efficiency of business.
Net Pr ofit
(1) Net Profit Ratio = 100
Net Sales
Net Pr ofit beforeTax
(2) Net Profit Ratio = 100
Net Sales
Net Pr ofit afterTax
(3) Net Profit Ratio = 100
Net Sales
Profit – Operating Profit + Non Operating Income – Non Operating Expenses

Non Operating Income : It includes income from non trading activities e.g. Interest received,
dividend received, Profit on sale of fixed assets and investments

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Operating Profit Ratio :

Meaning : Operating Profit Ratio indicates the relationship between operating profit and the net
sales. It is usually expressed in the form of a percentage and is also known as Net Operating
Profit Ratio.

Formula :
OperatingPr ofit
Operating Profit = 100
Net Sales
Where (OP) = Gross Profit – Operating Expenses
Net Sales (S) = Sales – Return – Allowances

4. Operating Ratio

Meaning : It expresses the relationship between total operating costs and net sales and is
expressed by way of percentage

Formula :
Cost of Goods Sold  OperatingExpenses
Operating Ratio = 100
Net Sales
Where cost of Goods Sold = Opening Stock + Purchases + Wages – Closing Stock

Operating Expenses = 1. Office and Administrative Expenses

2. Selling and Distribution Expenses
3. Finance Expenses (Excluding Interest on Loans and Debentures)

Combine Mixed Ratio

(A) Return on Investment (ROI) : This ratio measures net profit before tax and interest and
capital invested. This ratio is computed to measure the overall efficiency or profitability of
business.

Return on Capital Investment :

Pr ofit beforeTax, Interestand Dividend
100
Capital Employed
Considering 12th syllabus does not have company act in detail
Net Pr ofit
ROI should be = 100
Capital Employed

Capital Employed : Equity Share Capital + Preference Share Capital + Reserves and Surplus +
Debenture Capital and Other Long Term Loans

Capital Employed = Fixed Assets + Current Assets – Current Liabilities.

This ratio indicates the ability of company to generate the profit per rupee of capital employed.

(B) Return on Capital Employed (ROCE) : This ratio measures a relationship between net
profit before interest and Tax and share holders fund. The funds are supplied Equity and
Preference share holders

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Net Pr ofit beforeint erest and Tax

Return on Capital Employed =
Net Capital Employed / Equity
Net Capital Employed = Total Assets – Current Liabilities
= Fixed Assets + Current Assets – Current Liabilities
This ratio indicates whether share holders fund is efficiently used or not.
This ratio should be higher than ROI

Objective Questions
A. Select the most appropriate alternative from those given below and rewrite the sentences:
1. Gross Profit Ratio indicates the relationship of gross profit to the ……… .
(a) Net Cash (b) Net Sales
(c) Net Purchases (d) Gross Sales
.......... .......
2. Current Ratio =
Current Liabilities
(a) Quick Assets (b) Quick Liabilities
(c) Current Assets (d) None of these
3. Liquid Assets = ………… .
(a) Current Assets + Stock (b) Current Assets - Stock
(c) Current Assets – stock + Prepaid Expenses (d) None of these
4. Cost of Goods sold …………..
(a) Sales – Gross Profit (b) Sales – Net Profit
(c) Sales Proceeds (d) None of these
5. Net Profit Ratio is equal to ………..

(a) Operating Ratio (b) Operating Net profit ratio

(c) Gross Profit Ratio (d) Current Ratio
6. The common size statement requires ………. .
(a) Common base (b) Journal Entries
(c) Cash flow (d) Current Ratio
7. Bills Payable is ……………. .
(a) Long term loan (b) Current Liabilities
(c) Liquid Asset (d) Net loss
8. Generally Current Ratio should be ………. .
(a) 2:1 (b) 1:1
(c) 1:2 (d) 3:1
9. From financial statement analysis the creditors are specially interested to know ……… .
(a) Liquidity (b) Profit
(c) Sale (d) Share Capital
10. Own Funds + Loan Funds Equal to
(a) Total Funds Available
(b) Capital Employed only
(c) Fixed Assets + Investments + Working Capital only
(d) Each of the above
11. Total Assets are equal to
(a) Fixed Assets + Investments + current Assets
(b) Fixed Assets + Investments + Working Capital
(c) Own Funds + Loan Funds + Current Liabilities
(d) Fixed Assets + Investments + current Liabilities
12. Following is not a Quick asset
(a) Loose Tools (b) Advance Tax

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(c) Bills Receivable (d) Interest Accrued

13. Following is not a Quick Liability
(a) Unclaimed Dividends (b) Public Deposits
(c) Bank Overdraft (d) Advances Received
14. Interest accrued on investments is shown in the vertical financial statements as
(a) part of investments (b) part of loans and advances
(c) part of current assets (d) none of the above
15. Debentures repayable within 1 year are shown in the vertical financial statements as
(a) current assets (b) current liabilities
(c) loan funds (d) none of the above
16. Long Term Loans given are shown in the vertical financial statements as
(a) current liabilities (b) loan funds
(c) Investments (d) current assets
17. Cost of Goods =
(a) Opening Stock + Purchases + Direct Expenses + Closing Stock
(b) Opening Stock + Purchases + Direct Expenses – Closing Stock
(c) Sales – Opening Stock + Purchases – Direct Expenses – Closing Stock
(d) Opening Stock + Purchases – Direct Expenses – Closing Stock
18. Loss on sale of fixed assets
(a) is ignored in the vertical financial statements
(b) is shown as non-operating expenditure in the vertical financial statements
(c) is shown as operating expenditure in the vertical financial statements
(d) is shown as cost of goods sold in the vertical financial statements
19. Depreciation of machinery
(a) is ignored in the vertical financial statements
(b) is shown as non-operating expenditure in the vertical financial statements
(c) is shown as administrative expenditure in the vertical financial statements
(d) is shown as cost of goods sold in the vertical financial statements
20. In ……… figures of two or more periods are placed side by side to facilitate easy and
meaningful comparisons
(a) comparative statement analysis
(b) common-size statement analysis
(c) trend percentage analysis
(d) none of these
21. The comparative income statement shows the increase or decrease of ……… over the
previous year.
(a) only sales (b) only profit
(c) only expense (d) all of the above
22. In common size income statement analysis the ……….. is a assumed to be hundred and all
other figures are expressed as a percentage of ………….
(a) sales, sales (b) sales, profit
(c) sales, net profit (d) none of these
23. In common size balance sheet analysis, the …….. are taken as cent percent.
(a) fixed assets (b) total capital
(c) total assets (d) none of these
24. Operating Ratio
(a) Balance sheet Ratio (b) Revenue Statement Ratio
(c) Composite Ratio (d) None of the above
25. Expenses Ratio
(a) Balance sheet Ratio (b) Revenue Statement Ratio
(c) Composite Ratio (d) None of the above
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26. Return on Capital Employed

(a) Balance sheet Ratio (b) Revenue Statement Ratio
(c) Composite Ratio (d) None of the above
27. Standard Current Ratio
(a) 2:1 (b) 1:1
(c) 65% (d) 1.33
28. Standard Liquid ratio
(a) 2:1 (b) 1:1
(c) 65% (d) 1.33
29. Cash sales of goods in trade will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
30. Cash paid to suppliers of raw materials will be shown in the Cash Flow Statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
31. Cash payments of salaries and wages to employees will be shown in the Cash Flow
Statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
32. Cash payment to acquire a fixed asset, say, machinery will be shown in the Cash Flow
Statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
33. Cash proceeds from issuing shares at a premium will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
34. Payment of dividends will be shown in the Cash Flow Statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
35. Interest received on investments will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
36. Interest paid on debentures will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
37. Dividends received on shares of other companies held as investment will be shown in the
cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
37. Cash payment of a long term loan will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
38. Purchase of Building will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
39. Proceeds from issue of Prof. Share capital will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
40. Sale of Land will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
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42. Purchase of Govt. Securities will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
43. Redemption of Preference Shares will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
44. Cash Purchases will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
45. Sale of Investments will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
46. Cheques paid to suppliers will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
47. Interim Dividend paid on Equity shares will be shown in the cash flow statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents
48. Interest Received on Debentures held as investments will be shown in the cash flow
statement as
(a) operating cash flow (b) investing cash flow
(c) financing cash flow (d) cash or cash equivalents

B. Give one word/term/phrase for each of the following statement.

1. The statement showing profitability of two different periods.
2. The ratio measures the relationship between Gross Profit and Net sales
3. Critical evaluation of financial statement to measure profitability
4. A particular mathematical number showing relationship between two accounting figures.
5. An asset which can be converted into cash immediately.
6. The ratio measuring the relationship between net profit and ownership capital employed
7. The statement showing financial position for different periods or previous year and
current year.
8. Statement showing changes in cash and cash equivalent during a particular period.
9. Activity related to acquisition of long term assets and investment
10. The ratio that establishes relationship between Quick Assets and Current Liabilities

C. State true of false with reasons.

1. Financial Statement includes only Balance Sheet.
2. Analysis of financial statement is a tool but not a remedy.
3. Purchase of Fixed Assets is operating cash flow.
4. Dividend paid is not a source of fund.
5. Gross Profit depends upon Net Sales.
6. Payment of cash against purchase of stock is use of fund.
7. Ratio Analysis is useful for inter firm comparison.
8. The short term deposits are considered as cash equivalent.
9. Activity Ratios Turnover Ratios are the same.
10. Current Ratio measures the liquidity of the business.
11. Ratio analysis measures profitability efficiency and financial soundness of the business.
12. Usually current ratio should be 3:1.
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D. Answer in one sentence only.

1. Mention two objectives of comparative statement.
2. State three examples of cash in flows.
3. State three examples of cash out flows.
4. Give the formula of Gross profit ratio.
5. Give the formula of gross profit.
6. State any three examples of current assets.
7. Give the formula of current ratio.
8. Give the formula of quick assets
9. State the formula of cost of goods sold.
10. State the formula of Average Stock

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