CBSE Class 12 Accountancy HOTs Analysis of Financial Statement

UNIT 6. FINANCIAL STATEMENT ANALYSIS:

LEARNING OBJECTIVES:

After studying the lesson, students will be able to:

* Understand the meaning of financial statements and their objectives.

* Identify the parties interested in the financial statements.

* Understand the meaning of financial analysis and its objectives

* Understand the parties interested in financial Analysis

* Analyse the limitation of financial analysis

* Prepare comparative Income statement and Position Statement.

* Prepare Common Size Statements

* Understand the tools of Financial Analysis.

SALIENT POINTS:-

* Analysis of Financial statement is the systematic process of identifying the financial strength and weaknesses of the firm by establishing the relationship between the items of the Balance Sheet and income statement.

* The information available from the Analysis, serves the interest of different sections like Management, shareholders, workers, creditors, government, Potential Investors, Economist and Researchers and Stock Exchange.

* Financial analysis can be External Analysis and Internal Analysis, Horizontal analysis and Vertical Analysis.

* External Analysis: when analysis is made on the basis of Published statements, reports and information then this is known as External analysis.

* Internal Analysis: This analysis is based upon the information available to the business only.

* Horizontal Analysis: This analysis is based on the financial statements of different years of the same business unit or financial statements of a particular year of different business units.

* Vertical Analysis: According to this analysis financial statement of the same period or different items of the same financial statements are compared.

* Comparative statements, Common Size statements, Trend Analysis, Ratio Analysis, Fund Flow Statement, Cash flow statement are the Tools of financial statement analysis.

 * Comparative Statements: it helps in ascertaining change in the items of income statement and Position Statement of different years in terms of figures and percentage

QUESTIONS: 01 MARKS 

1. How would you show the following two items in a company‘s Balance Sheet as at 31st March, 2012 as per the requirement of Schedule VI:

General Reserve(Since 31st March, 2011) Rs. 3,00,000, Statement of Profit and Loss(Debit Balance) for 2011-12 Rs. 2,00,000.

Ans. Balance Sheet

As at 31st march, 2012

Equity and Liablities           Note No.      Rs.

Shareholders‘ fund

Reserve and Surplus             1              1,00,000

Notes to Accounts:

Reserve and Surplus

General Reserve(1st April, 2011)                       3,00,000

Less: Statement of Profit and Loss(Dr. Balance)  2,00,000

                                                                      1,00,000

2. Under Which main headings and sub-headings of Equity and Liabilities of the balance sheet as per the Revised Schedule VI of a company will you classify the following items:

i. Proposed dividend.

ii. Fixed Deposit from Public.

Ans. Sr. No.      Items                       Main-Heading                       Sub-Heading

       i.        Proposed dividend               Current-Liabilities             short-term provision

       ii.       Fixed deposit from Public       non-current liabilities       long term borrowing

3. State any two items which are shown under the head ‗Investment‘ in a company balance sheet. (1)

Ans. (i) Government Securities.

       (ii) Sinking Fund Investment.

4.How is analysis of Financial statements suffered from the limitation of window dressing ? (1)

Ans. Analysis of financial statements is affected from the limitation of window dressing as companies hide Some vital information or show items at incorrect value to portray better profitability and financial Position of the business, for example the company may overvalue closing stock to show higher profits.

5. What is the interest of Shareholders in the analysis of Financial Statements? (1)

Ans. (i) They want to judge the present and future earning capacity of the business.

       (ii) They want to judge the safety of their investment.

 6. Name two tools of Financial Analysis? (1)

Ans. (i) Comparative Financial Statements.

(ii) Ratio Analysis etc. 

7. What is Horizontal Analysis? (1)

Ans:The analysis which is made to review and compare the financial statements of two or more then two Years is called Horizontal Analysis.

8. Give the example of Horizontal Analysis. (1)

Ans. Comparative Financial Statement.

9. What is Vertical Analysis? (1)

Ans:11 The Analysis which is made to review the financial statements of one particular year only is called Vertical Analysis.

10. Give the example of Vertical Analysis? (1)

Ans. Ratio Analysis.

QUESTIONS 03 MARKS

1. Give the Main Heading and Sub- Heading of Equity and Liabilities of the Balance sheet of

a company as per the Revised Schedule VI of the companies Act.1956.

3. Give the Main Heading and Sub- Heading of Assets of the Balance sheet of a company as

per the Revised Schedule VI of the companies Act.1956.

Ans. ASSETS

(1) Non-Current Assets

(a) Fixed Assets

i. Tangible Assets

ii. Intangible assets

iii. Capital work-in progress

iv. Intangible assets under development

(b) Non-current investments

(c) Deferred tax assets (net)

(d) Long-term loans and advances

(e) Other non-current assets

(2) Current Assets

(a) Current investments

(b) Inventories

(c) Trade receivables

(d) Cash and cash equivalents

(e) Short-term loans and advances

(f) Other current assets

4. Rearrange the following items under assets according to Revised or New Schedule VI:

a. Livestock

b. Loose Tools.

c. Goodwill

d. Trademarks

e. Bills Receivable

f. Debtors

g. Land

h. Leasehold

i. Stock-in-Trade

j. Stores and Spare Parts

k. Vehicles

l. Cash at Bank

m. Work in Progress(Machinery)

n. Interest accrued on Investment

o. Furniture

p. Advance to Subsidiaries

q. Cash in Hand

r. Plant

s. Deposits with electricity supply company.

Ans.

i. Fixed Assets(Tangible): Livestock, Land, Leasehold, furniture, vehicles and plant

ii. Capital Work-in-progress: Work in progress(Machinery)

iii. Fixed Assets(Intangible): Goodwill and Trademarks

iv. Inventories: Loose Tools, Stock-in-Trade, Stores and Spare Parts.

v. Trade Receivables: Bill Receivables, Debtors

vi. Cash and Cash Equivalents: Cash at Bank, Cash in Hand

vii. Long term Loans and Advances: Advance to Subsidiaries, Deposits with

Electricity Supply Company.

viii. Other Current Assets: Interest Accrued on Investments.

4. List any three items that can be shown as contingent Liabilities in a company‘s Balance sheet.

Ans: (i) Claims against the Company not acknowledged as debts.

(ii) Uncalled Liability on partly paid shares.

(iii)Arrears of Dividend on Cumulative preference shares.

5. How is a Company‘s balance sheet different from that of a Partnership firm? Give Two point only.

Ans. (i) For company‘s Balance Sheet there are two standard forms prescribed under the companies Act.1956 .Whereas, there is no standard form prescribed under the Indian partnership Act,1932 for a partnership Firms balance sheet.

(ii) In case of a company‘s Balance sheet previous year‘s figures are required to be given whereas it is not so in the case of a partnership firms balance sheet.

QUESTIONS 04 MARKS

1. Prepare Comparative and Common Size income statement from the following information for the year‘s ended march 31, 2008 and 2009.

RATIO AND ANALYSIS

Learning outcomes:

• Explain the meaning of accounting ratios.

• Understand the objectives and limitation of accounting ratios.

• Classify the ratios as profitability, activity and solvency.

• Compute various profitability, activity and solvency ratios.

• Express your views about the operational efficiency and financial soundness of the company.

•Comment upon the performance of the enterprise.

• Recommend financial measures to be adopted to strengthen financial structure of the company

IMPORTANT FORMULAE OF RATIO ANALYSIS

Profitability ratio

1. Gross Profit Ratio = Gross profit/Net sales*100 {gross profit=Net sales- cost of goods sold}

2. (a) Net profit ratio= Net Profit/Net sales*100 {Net Profit=Gross profit+operating and non operatingincome-operating and non operating expenses.}

    (b)Operating Net profit ratio =Operating Net profit/Net sales*10

3 Operating Ratio= (Cost of goods sold + Operating expenses) / Net Sales x 100 

4 Return on investment ( ROI)= Net Profit before interest,tax and dividend / Capital Employed  X 100 

Capital employed= Share Capital+Undistributed profit+long term loans- (fictitious assets like underwriting commission, preliminary expenses,

discount or loss on issue of shares and non-operating assets like Investments).

                        or

Net fixed assets+Working capital

working capital= Current assets-current liabilties.

5 Earning per share= Net Profit-Preference dividend / No.of Equity shares

6 Dividend per share=Net Profit after interest, taxes and preference dividend / Number of equity shares.

7 Price Earning Ratio=Market price of a share / Earning per share

(B) TURNOVER OR ACTIVITY OR PERFORMANCE RATIOS:

1 Working capital turnover ratio=Net Sales

working capital

Working Capital= Current assets- current Liabilities

3 Debtors turnover ratio= Net credit sales / Average Debtors

Average Debtors=Debtorsin the beginning+Debtors at the end / 2

Receivables= Debtors+Bills receivable

4 Payable turnover ratio= Net credit purchases / Account Payable

5 Fixed Assets Turnover ratio= Sales or cost of goods sold /  Net fixed assets

6 Current assets Turnover Ratio=Net sales or cost of goods sold / current Assets.

LIQUIDITY RATIOS:

1 Current ratio= current Assets /  current liabilities

2 Liquid or quick or acid test ratio= liquid assets

              current liabilities

Solvency ratios

1 Debt to equity ratio= Long term loans

          Shareholder's funds

2 Total assets to debt ratio= Total assets / Long term debts.

3 Proprietory ratio= Proprietors fund or shareholders fund / Total Assets

4 Current asset turnover ratio= Net sales/cost of goods sold / current assets

5 Fixed assets turnover rqatio= Net sales / Net fixed assets.

Ratio Analysis

Questions for 1 mark

1) X Ltd has a debt Equity Ratio at 3:1. According to the Management, it should be maintained at 1;1. What are the two choices to do so ?

Ans : The Two choices to maintain Debt Equity ratio at 1:1 are:

a) To increase the Equity

b) To reduce the debt

2) Assuming that the Debt equity ratio is 1:2, state giving reason whether the ratio will improve, decline or will have no change if equity shares are issued for cash.

Ans It will decrease the ratio as Equity increases without change in the debt.

3) State the satisfactory ratio of Current ratio and Liquid Ratio

Ans The Standard Current ratio is 2:1 whereas Ideal Liquid ratio is 1:1.

4) Current ratio of a firm is 2:1. State whether ‗Purchase of goods for cash‖ will improve, decrease or will not have any change in the ratio.

Ans. It will not change the ratio as stock increases and cash decreases.

5) Define ―ratio Analysis‖

Ans Ratio Analysis refers to the process of computing, determining and explaining the relationship between the component items of financial statements in terms of ratios.

2-3 MARKS

6) A company has a current ratio of 4:1 and Quick ratio is 2.5;1. Assuming that the inventories are Rs 22500, find out total current assets and current liabilities.

Ans Current ratio ---4:1

      Quick ratio ---2.5:1

      Inventory =4-2.5=1.5

      If inventory is 1.5, then Current assets =4

      If inventory = 22500, then current assets = 4X 22500/1.5 =60,000

      Current Liabilities = 60,000/4 = Rs 15000.

7) From the following, calculate stock turnover ratio—

Net Sales –Rs 2,00,000 Gross Profit = 25% Opening stock = 5000

Closing stock : 15000

Ans – Stock Turnover ratio = Cost of goods sold/Average stock

Cost of sales= sales-gross profit

Cost of sales = 2,00,000 – 50,000 = 1,50,000

Average stock = Opening stock + closing stock / 2 = 20,000/2 =10,000

  1,50,000/10,000 = 15 times.

8) Calculate Gross profit and sales—

Average stock = Rs 80,000

Stock turnover ratio = 6 times

Selling price = 25% above cost

Ans. Stock Turnover ratio = cost of sales/average stock

       6 = cost of sales/80,000

       Cost of sales = 80,000X 6 = 4,80,000

      Gross profit = 4,80,000 X 25/100 = 1,20,000

      Sales = Cost of sales + Gross Profit

            4,80,000 + 1,20,000 = Rs 6,00,000

9) A Company made credit sales of Rs 7,20,000 during the year. If the collection period is 50 days and the year is assumed to be of 360 days. Calculate –

a) Average Debtors b) Debtors Turnover ratio c)Opening and Closing Debtors if the closing Debtors are Rs 10,000 more than the opening Debtors.

Ans Credit sales per day = 7,20,000/360 = Rs 2000 per day.

      Average Debtors = 2000 X 50 days = Rs 1,00,000

      Debtors Turnover ratio = Net credit sales/Average Debtors

                                       = 7,20,000/1,00,000 = 7.2 times.

      Let the Opening Debtors be ―x‖

      Closing Debtors = ―x + 10,000‖

      Total Debtors = x + x + 10,000 = 2,00,000

                          = 2x+ 10,000 = 2,00,000

                          = 2x = 1,90,000

                        x = 95,000 ( Opening Debtors = 95000)

Closing Debtors = 95000 + 10000 = Rs 1,05,000

10) Calculate Operating ratio                — Rs

          Net Sales =                            5,40,000

          Net Purchases                        3,10,000

         Opening Stock                        75,000

         Direct expenses                      32,000

         Closing Stock                          50,000

        Selling expenses                      25,000

        Distribution expenses               15,000

Operating ratio = Cost of sales +Operating expenses/Net sales *100

Cost of sales = Opening stock + Net purchases + direct expenses-closing stock

                   = 75000+3,10,000+32,000-50,000 = 3,67,000

Operating expenses = Selling expenses + Distribution expenses

                   = 25000+15000 = 40,000

Operating ratio = 3,67,000+40,000/5,40,000 X 100 = 75.37%

11) Net profit after Interest but before tax Rs 1,40,000

     15% Long term debt : Rs 4,00,000

     Shareholders fund : Rs 2,40,000

     Tax rate : 50% , Calculate Return on capital employed.

Return on capital employed = Net profit before interest and tax/Capital employed X 100

Interest on long term debt = 15/100 X 4,00,000

                                       = 60,000

   Net Profit before Interest = 1,40,000 + 60,000 = 2,00,000

   Capital employed = Debt + Shareholders fund

                                    = 4,00,000 + 2,40,000 = 6,40,000

  Return on Capital employed = 2,00,000/6,40,000 X 100 = 31.25%

12) Calculate Inventory Turnover Ratio—

      Sales = Rs 4,00,000 Average stock – Rs 55,000 Gross Loss ratio =10%

      Inventory Turnover ratio = Cost of sales/Average stock

                                          =4,40,000/55000 = 8 times .

13) Calculate Fixed Assets turnover ratio-

      Cost of goods sold : Rs 16,80,000

      Gross profit = Rs 5,60,000

      Capital employed = Rs43,00,000

      Working capital = Rs 80,000

Fixed assets turnover ratio = Net sales/ Net fixed assets

Net sales = Cost of goods sold + Gross profit

              = 16,80,000 + 5,60,000

              = 22,40,000

Capital employed = Net fixed assets + Net working Capital

4,00,000 = Net Fixed assets + 80,000

Net Fixed assets = 3,20,000

Fixed assets turnover ratio = 22,40,000/3,20,000 = 7 times

14) Calculate Current Asset Turnover ratio if –

     Cost of goods sold = Rs 7,50,000

    Gross profit                 = Rs 2,10,000

    Total Assets                = Rs 3,00,00

    Capital employed        = Rs 3,00,000

    Working capital              Rs 60,000

Current Assets Turnover ratio = Net Sales/ Net Current assets

Net sales = Cost of sales + Gross Profit

             = 7,50,000 + 2,10,000

              = 9,60,000

Capital Employed = Net Fixed +Net Working Capital

Net Fixed Assets = Capital employed – Net working Capital

                       = 3,00,000 – 60,000

                       = 2,40,000.

Total Assets = Rs 3,00,000

Current Assets = Total assets – Fixed assets

                      = 3,00,000 – 2,40,000

                      = 60,000

Current Assets turnover ratio = Net Sales/Net current Assets

                   = 9,60,000/60,000 = 16 times.

15) From the following information calculate =

a) Debt equity ratio

b) Total Assets to Debt ratio

c) Proprietory ratio

Equity share capital = Rs 20,00,000

Reserves and Surplus = Rs 12,00,000

12% Debentures = Rs 10,00,000

Bank Loan = Rs 8,00,000

Current Liabilities = Rs 5,00,000

Fixed Assets = Rs 25,00,000

Goodwill = Rs 4,00,000

Current Assets = Rs 18,00,000

        a) Debt Equity Ratio = Debt/Equity

            Debt = 12% Debentures + Bank Loan

                    = 10,00,000 + 8,00,000

                    = 18,00,000

          Equity = Equity share capital + Reserves and Surplus

                    = 20,00,000+12,00,000

                     = Rs 32,00,000

         Debt / Equity = 18,00,000/32,00,000 = 0.56:1

        b) Total Assets to Debt ratio = Total Assets/Long term Debt

            Total Assets = Fixed assets + Goodwill + Current assets

                             = 25,00,000 + 4,00,000 + 18,00,000

                             =Rs 47,00,000

            Long Term Debt = 12% Debentures + Bank Loan

                                    = 18,00,000

            Total Assets to Debt Ratio = 47,00,000/18,00,000 = 2.6:1

       c) Proprietory Ratio = Equity/Total Assets

                                    = 32,00,000/47,00,000 = 0.68 or 68%

Unit 5
Analysis of Financial Statements 

 

Analysis of Financial Statement

&

Cash Flow Statements

Q.1   How are the various activities classified according to AS-3 (Revised) while preparing the Cash Flow Statement?

Ans. While preparing the cash flow statement according to AS-3 (Revised) the activities are classified into

        three groups :

        (i)  Operating activities    (ii) Investing activities and    (iii) Financing activities. 

Q.2   Mutual Fund Company receives a dividend of Rs.25 lakhs on a investments in another company's shares.Why is its cash in flow from operating activities for this company?

Ans. A mutual fund company is a financial enterprises and so a dividend of Rs. 25 lacs received by this company from

          its investment in units will be cash in flow from operating activities.

Q.3   Dividend by a manufacturing company is classified under which kind of activity while preparing the Cash         Flow Statement.

Ans. Dividend paid by a manufacturing company is classified under Financing activities.

Q.4   What are contingent liabilities? Mention any two examples.

Ans. The liability existences of which depends on a happening in future is known as contingent liabilities.

        Such liabilities are disclosed by way of a note.

        Examples of contingent liabilities are :

        (i) Claim against the company not acknowledge as debt.

        (ii) Uncalled liability on shares partly paid