FAM Post Mid Term

8/2/2019 FAM Post Mid Term

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Analysis and Interpretation of

Financial Statements

It is the process of identifying the financial

strengths and weakness of the firm by

properly establishing relationship between

the items of the Balance Sheet and Profit &Loss Account and other operating data.

Therefore it refers to such a treatment of

information contained in Income Statement

and Balance Sheet so as to afford full

diagnosis of the profitability and financial

soundness of the business.


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Meaning

Analysis

It is used to mean the

simplification of

financial data bymethodical

classification of the

data given in the

financial statements.

Interpretation

It is the explaining the

meaning and

significance of thedata so simplified.


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Comparative Income Statement

This statement shows the operational

results of the business for a number of

accounting periods so that changes in

absolute figures from one period to

another period may be stated in terms of

money and percentage.


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Comparative Balance Sheet

Comparative Balance Sheet analysis is

the study of the trend of the same items,

group of items and computed items in

two or more balance sheets of the same

business enterprise on different dates


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Common- Size Statements

Common-size statements cover up the

shortcomings of the comparative

statements by expressing each item of

the statements as a percentage of total.

In common-size statements relative

values of items are shown.


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Common-Size Balance Sheet

In common-size balance sheets, various

items of assets and liabilities of balance

sheets of two or more years are shown

at their relative values. That is ,each

item of the assets is shown as

percentage of total assets and each item

of liabilities as percentage of totalliabilities and capital fund.


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Common-Size Income Statement

In this statement relationship is

established between items of income

statement and volume of sales in

percentage form. In other words, in a

common size income statement ,each

item of income statement is shown in

percentage based on net sales.


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Funds Flow Statement

Fund: Fund is used both in broader and

narrow sense. In broader sense, it

represents the working capital (current

assets current liabilities) of a concern

while in narrow sense it represents only

cash balance of firm


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FLOW

flow of fund would mean when a businesstransaction causes a change in the amountof fund (working capital) that exists beforethe maturity of the transaction. The flow of

fund is recognized from the degree ofchange in the amount of working capital. Itis referred to as source of fund (inflow)whereas decrease in working capitalindicates application of funds (out flow) If atransaction fails to cause change in amountof working capital, it does not amount toflow of funds.


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No Flow of Funds

Where both the accounts affected in anytransaction belonging to current assets category

Where both the account affected in anytransaction belong to current liability category

Where the change in current assets and currentliabilities is in the same direction and sameproportion.

Where the accounts related to fixed assets and

fixed liabilities or capital are affected in a sameproportion.

Where both the accounts affected by thetransaction are of non-current category.


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Flow of Funds

The effect of transaction lies on a currentasset and a fixed asset e.g. sale orpurchase of a fixed assets.

The effect of transaction lies on a currentasset and a fixed liability e.g issue ofdebentures for cash.

A current asset and capital are affected bythe transaction e.g issue of shares for cash

A fixed asset and current liability areaffected by the transaction e.g creditpurchase of machine


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Contd.

A current liability and fixed liability are affectedby the transaction e.g issue of debentures forsatisfying the claims of creditors

The capital and current liability are affected bythe transaction e.g issue of shares in paymentto creditors, acceptance of bill payable forredemption of preference shares.

The net profit or losses arising as a result of

the business activities also generate the flowof funds, which is called funds from operation.


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Current Assets

Inventories

Bills receivable

Cash and bank balance Investments (temporary)

Sundry debtors

Prepaid expenses Incomes receivable


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Current Liabilities

Bills payable

Sundry creditors

Outstanding expenses Provision against current assets

Proposed dividend

Provision for tax Bank overdraft


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Non-current : Fixed assets and others

Land and building Plant and machinery Furniture Long-term investment Goodwill preliminary expenses Trade mark Patent right Deferred expenses

Discount on issue of shares/ debentures Debit of balance sheet of profit/loss

account


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Long-term liability and others

Share capital (equity and preferential)

Share premium

Share forfeited

Capital redemption reserve

Capital reserve Capital reserve

Loans (long- term)

Debentures

General reserve Provision for depreciation on fixed assets

Bank loan

Credit balance of profit and loss account


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Impact on WorkingCapital on change

in CA and CL

Nature of

transaction

Increase in current

assets Decrease in current

assets

Increase in current

liabilities

Decrease in current

liabilities

Effect on working

capital

Increase (+)

Decrease (-)

Decrease (-)

Increase (+)


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Funds Flow Statement

Sources of funds

Funds from operation

Issue of share capital

Issue of debentures Long-term loans

Sale of non-currentassets

Non-operating

receipts Decrease in working

capital

Application of funds

Funds lost inoperation

Redemption ofpreference shares

Repayment of loans

Purchase of noncurrent assets

Non-operatingpayments

Increase in workingcapital


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Cash Flow Statement

A cash flow statement is a statementdepicting change in cash position from oneperiod to another period. Here, the termcash stands for cash and cash equivalents,

while flow means movement of cash. Thuscash flow statement may be defined as asummary of receipts and disbursements (orpayments), reconciling the opening cashand bank balance with closing balance

concerned period related to various itemsappearing in the Balance Sheet and Profit/Loss Account


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Impact of cash position of concern

Change in balance sheetitems

Increase in current assetsother than cash

Decrease in current assetsother than cash

Increase in non-currentassets

Decrease in non-currentassets

Increase in current liability Decrease in current liability

Increase in long-termliability

Decrease in long-term

liability

Impact on cash

Out flow of cash

Inflow of cash Outflow of cash

Inflow of cash

Inflow of cash

Outflow of cash Inflow of cash

Outflow of cash


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Sources ofCash

Issue of share capital

Issue of long-term debt such as

debentures

Sale of assets

Cash from operation

Decrease in current assets

Increase in current liability


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Application ofCash

Redemption of capital

Purchase of fixed assets

Repayment of long term debt Cash lost in operation

Increase in current assets

Decrease in current liability


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Non-cash transactions

Depreciation on fixed assets

Profit/Loss on the sale of fixed assets

Profit /Loss on revaluation of fixedassets

Writing off intangible assets like patents,

goodwill and trade mark

Writing of miscellaneous expenses like

preliminary expenses, discount on issue

of share or debentures


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Ratio Analysis

Meaning: - In general words, a ratio isan expression of relationship of onefigure with another. It may be defined as

the relationship, or proportion that oneamount bears to another. It is found bydividing a figure with another. A ratiomay be expressed in percentage in

which the base, is taken as equal to 100and the quotient is expressed as perhundred of the base


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Various Ratios

Liquidity ratios

Capital structure or leverage ratio

Activity or turnover ratio Profitability or profit earning capacity

ratios.


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Current Assets

Cash in hand, cash at bank, debtors,

prepaid expenses, short term deposits,

bills receivable, money at call and short

notice, stock ,finished goods, work inprogress stock of raw materials and

sundry supplies


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Current Liabilities

Bills payable, income tax payable,

creditors. Outstanding expenses, bank

overdraft, provision for taxation, interest

due on fixed liabilities, reserve forunbilled expenses, installment payable

on long-term loans.


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Current Ratio

Current ratio =

Current assets / Current liabilities

Standard Norm:=2

:1


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Liquid Ratio

Liquid ratio = Liquid assets / Current

liabilities

Or

Liquid ratio = Liquid assets / Liquid

liability

Liquid assets = Current assets Stock

prepaid expenses Liquid liability = Current liability Bank

over draft

Standard norm: 1 : 1


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Absolute Liquid Ratio

Absolute liquid ratio = Absolute liquid

assets / Absolute liquid liabilities

Absolute liquid assets = Cash in hand,

cash at bank and short term marketable

securities.

Absolute liquid liabilities = Current

liability bank over draft. Standard norm: .5 :1


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Capital Structure Ratio or long

term solvency ratios

Debt equity ratio

Solvency ratio

Proprietary ratio Fixed asset ratio

Capital gearing ratio

Debt service ratio or interest coverageratio


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Debt Equity Ratio

Debt equity ratio = Outsiders fund / shareholdersfund

Alternative:

Debt equity ratio = long-term debt / share holdersfund or net worth

Note: in this case current liabilities will be ignored.

Standard norm: 2 : 1, however lending institutions prefer 1:1

A low ratio signifies a smaller claim of creditors. More precisely, the greater the debt-equity ratio, greater the risk to the creditor.


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Outsiders fund

Debt, long-term or short term, whether in

the form of mortgage, bills or debentures


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Share holders fund

Preference share capital, equity share

capital, capital reserves, retained

earnings and any other reserves

representing the accumulated profit


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Proprietary Ratio

This is also known as equity ratio, net

worth to total assets ratio.

Proprietary ratio = Share holders fund /

Total assets

Higher the ratio better is the financial

position of the firm.


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Solvency Ratio or debt to total

assets ratio

Solvency ratio = Total outside liabilities /

total assets

If the amount is enough to pay the

external liabilities then the company

is said to be solvent.


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Fixed Asset Ratio

Fixed assets ratio = Net fixed assets /(shareholders fund + long term liability)

Or

Fixed asset ratio = Net fixed assets /Share holders fund

Standard norm: 1 :1. It is well established that fixed assets shouldbe financed only out of long-termfunds. This ratio shows whether thisis so.


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Capital gearing ratio

CGR = Share holders fund / out siders

fund

Share holders fund = Equity capital +

reserve +surplus

Outsiders fund = Preference share

capital + Debentures + Other long term

loans.

Note : If capital gearing ratio is less

than 1, we will call it high gearing of

capital and if gearing ratio is more than

1 then low gearing of capital is assumed


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Debt service ratio or interest

coverage ratio

Interest coverage ratio =

Net profit before interest and tax /Interest

on fixed long term loans or debentures.

Note : This ratio measures the margin of

safety for the lenders. The higher the

number, more secure the lender is in

respect of his periodical interest

income. Normally, fixed interest charges

should be covered six to seven times.


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Activity analysis or turnover ratio

Stock or inventory turnover ratio

Debtors or receivable turnover ratio

Average collection period or debtor velocity

Creditors or payable turnover ratio

Average payment period

Total assets turnover ratio

Fixed asset turnover ratio

Current asset turnover ratio

Working capital turnover ratio

Capital or net worth turnover ratio

Total capital turnover ratio


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Stock turnover ratio

Cost of goods sold / Average stock

Cost of goods sold = opening stock + purchases+direct expenses closing stock

Average stock = opening stock + closing stock / 2

Note :1. If cost of goods sold cannot be calculatedthen sales will be taken as base

2. if opening and closing stock is not given in thatcase closing stock will be treated as average

stock 3. Higher the ratio good for the organization. A

low stock turnover ratio indicates that thegoods do not sell quickly and efficiently, so themaximum inventory remains lying in the

warehouse.


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Debtors or receivable turnover

ratio

DTR = Net credit sales / Average

receivables

Net credit sales = Total sales cash

sales sales return

Avg. receivables = opening receivable

+closing receivable / 2

Receivable = Debtors + Bills receivable


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Average collection period or

debtor velocity (in months or days)

Average trade receivable / Net credit salesX no of month or day or weeks

Or

Months or weeks or days in a year / DTR

Note: The amount of provision for bad anddoubtful debts may be given in thequestion but this figure does not affect thecalculation of debtor turnover ratio or

average collection period. However, ifclosing debtors are to be computed, thenthe amount of bad debts is taken in toaccount.


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Creditors or payable turnover ratio

CTR = Net credit purchases / Average

payables (creditor +BP)

Net credit purchase = Total purchase

cash purchase purchase return

Average payable = opening payable +

closing payable / 2

Note : if opening and closing is not giventhen closing will be considered as

average


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Average payment period

Average payable / net credit purchase X

no. of month or weeks or days

Or

No. of month or week or days / CTR


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Total assets turnover ratio

Cost of goods sold or net sales / Total

assets

Total assets = Fixed assets + current

assets fictitious assets- depreciation onfixed assets

This relationship indicates the efficiency

of the utilization of assets to attain the

maximum turnover on sales. A rise in

the ratio indicates more intensive

utilization of assets, while fall in the

turnover suggests under utilization of

assets.


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Fixed assets turnover ratio

Cost of goods sold or net sales / net fixed

assets

Net fixed assets = Fixed assets

depreciation

If there is an increase in this ratio, it will

show that there is better utilization of

fixed assets .If there is a fall in this ratio,

it will show that investment in fixed has

not been utilized efficiently. Ideal of this

in a manufacturing company is 5:1.


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Current assets turnover ratio

Cost of goods sold or net sales / current

assets

This ratio measures the concerns

efficiency in utilization of its current

assets. This ratio also indicates the

over investment or under investment

position of current assets in aconcern.


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Working capital turnover ratio

Cost of goods sold or net sales / working

capital

The high ratio indicates efficient use

of working capital in the concern

while low working capital turnover

ratio indicates under utilization of

working capital in the concern.


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Capital on net worth turnover ratio

Net sales or cost of goods sold / net

worth or share holders fund

It indicates whether the capital

employed by the shareholders in a

business is used efficiently or not.


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Total capital turnover ratio

Cost of goods sold or net sales / capitalemployed

Capital employed = long term and short

term capital By calculating this ratio, efficiency of

capital employed may be known. Thisratio shows how many times capital has

been rotated for generating the sales.The higher the ratio, better it is for thebusiness concerns. No ideal standardcan be fixed for this ratio.


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Profitability ratios:

Based on sales

Gross profit ratio

Operating ratio

Expenses ratio

Operating profit ratio

Net profit ratio


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Gross profit ratio

Gross profit / net sales X100

Net sales = Sales sales return

Gross profit = net sales cost of goods

sold. The gross profit ratio is primarily a

test of the efficiency of purchasesand sales management. No ideal standard is fixed for this ratio, but thegross profit ratio must be adequate.


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Operating ratio

Cost of sales + operating expenses / net

sales X 100

Operating expenses = office and

administrative expenses + selling

expenses + discount allowed + bad

debts etc.


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Expenses ratio

Particular expenses / net sales X100


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Operating profit ratio

Operating profit / net sales X100


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Net profit ratio

Net profit / net sales X100


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Profitability ratios based on

capital

Return on gross capital employed

Return on net capital employed

Return on proprietors net capital

Return on average capital employed

Return on total assets


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Return on gross capital employed

EBIT / Gross capital employed X100

Gross capital = Equity share capital +preference share capital +reserve and

surplus + all long and short termexternal loans

Or

All net fixed assets + current assets +

including goodwill of the firm butfictitious assets are not included


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Return on net capital

EBIT / Net capital employed X100

Net capital employed = Equity share

capital + preference share capital +

reserve and surplus + long term loans


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Return on proprietors capital

employed

Net profit after interest and tax /

proprietors net capital employed X100

Proprietors net capital = Equity share

capital + preference share capital +reserves and surplus accumulated

losses, if any


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Return on average capital

employed

Net profit / average capital X100

Average capital = Opening capital + closing

capital / 2

Or

Opening capital +1/2 of current years profit

Or

Closing capital of current years profit Return on capital employed reflects the

overall profitability of the business


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Return on total assets

Net profit / Total net assets X 100

Total net assets = Total assets

fictitious assets


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Return on proprietors fund or

equity or return on net worth

Net profit / Proprietors fund X100

Proprietors fund =Equity share capital +

preference share capital +reserves and

surplus+ undistributed profit debitbalance of profit & loss if any.


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Ratios showing profitability on

shares

Earning per share(EPS)

Earning Yield Ratio(EYR)

Dividend Per share (DPS)

Pay-out Ratio (POR)

Dividend Yield Ratio (DYR)

Dividend coverage ratio (DCR)

Price earning ratio (PER)


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EarningPer share (EPS)

EPS =

Net profit after tax, interest and

preference dividend / no of equity

sharesIt indicates theamount ofearnings that anequity sharecommands.


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Earning Yield ratio (EYR)

EYR = EPS / Market price per share X

100

This ratio indicates the relationship

between earning per share and marketprice per share


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Dividend Per Share (DPS)

DPS = Dividend for equity share

holders/ no. of equity shares

Higher the ratio, the better is for equity

share holders of the concern. This ratioshows the amount of dividend per share

paid by the management of the

company


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Pay-out ratio (POR)

Payout ratio= dividend per equity

shares/ earning per share X100

This ratio helps us to calculate the

percentage of dividend paid out ofearned incomes and the percentage of

earned profits retained in the business

concern


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Dividend Yield Ratio (DYR)

Dividend Yield Ratio = Dividend per

share / Market price per share X100

Dividend yield ratio helps investors to

ascertain the effective return on theamount they invest or intend to invest

in the equity shares of a company.


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Dividend cover ratio (DCR)

y This ratio indicates the relationship

between dividend per share and earning

per share. This ratio calculated by dividing

earning per share by dividend per share.

Dividend Cover = EPS / DPS


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Price EarningRatio (PER)

y This ratio indicates relationship between

market price per equity shares and

earning per share. In other words, this

ratio indicates the number of times the

earning per share is covered by its market

price.

P/E ratio = MPS /EPS


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Documents

FAM Post Mid Term