Acc205 Fsa1

Financial Statement Analysis
Learning Outcomes
1. To develop an ability to understand and interpret the financial statements

2. To enable users to extract useful information from financial statements for
decision making
3. How to keep a check on the financial health of the company?
Financial Statements
• It represents a formal record of the financial activities of
an entity.
• These are written reports that quantify the financial
strength, performance and liquidity of a company.
• Financial Statements reflect the financial effects of
business transactions and events on the entity.
3
Accrual Basis Financials
The “Big 3”
Balance Sheet Income Statement Statement of Cash Flow
“The Moving “Cash is King”
“A Snapshot in Picture”
Time”
4
Balance Sheet
Purpose: Overview
A “snap shot” in time regarding organization’s financial position
Components: Assets = Liabilities + Owners’ Equity
Assets – Liabilities = Owners’ Equity
Current Assets: Current Liabilities:
• Cash • Accounts Payable
• Accounts Receivable • Accrued Expenses
• Client Trust Funds • Short-Term Loans/Debt
• Deposits & Prepaids Long-Term Loans/Debt
Fixed Assets (Net of Accum. Depr.) Capital & Draw (Owners’ Equity)
• Partners’ Capital Contribution
• (Partners’ Draw / Distributions)
• Retained Earnings
TOTAL ASSETS TOTAL LIABILITIES / CAPITAL & DRAW
5
Statement of Cash Flow
Overview
Purpose: Explains movement of money in and out of the

organization’s cash accounts during a particular time
period. Provides explanation for changing amounts in the
organization’s accounts.
6
Statement of Cash Flow
Key Questions
SOLVENCY: Did we have positive cash flow from operating activities? (If answer is
“no,” indicator of big problems!)
CASH MANAGEMENT: How did we invest any excess cash? Did we reinvest in
the business?
FINANCING:
• Did we have to borrow more money in order to finance operations or invest in the
business? Did the partners have to contribute more?
• Did we generate enough cash that we could repay some or all of our bank
debt?
FORECASTING: Do we have sufficient cash on hand to cover normal operating

expenses for next few months? 7
Financial Statement Analysis will help business owners and other

interested people to analyse the data in financial statements to
provide them with better information about such key factors for
decision making and ultimate business survival.
Effective Financial Statement Analysis
Requires that you:

• Understand the nature of the industry in which the organisation
works. This is an industry factor.
• Understand that the overall state of the economy may also have an
impact on the performance of the organisation.
Financial statement analysis is more than just “crunching numbers”, it

involves obtaining a broader picture of the
organisation in order to evaluate appropriately
how that organisation is performing
Objectives of
(i) To assess the earning capacity or profitability of the firm.
(ii) To assess the operational efficiency and managerial effectiveness.

(iii) To assess the short term as well as long term solvency position of the firm.
(iv) To identify the reasons for change in profitability and financial position of the firm.
(v) To make inter-firm comparison.

(vi) To make forecasts about future prospects of the firm.
(vii) To assess the progress of the firm over a period of time.
(viii) To help in decision making and control.

Business Survival
There are two key factors for business survival:

• Profitability
• Solvency
• Profitability is important if the business is to generate

revenue (income) in excess of the expenses incurred in
operating that business.
• The solvency of a business is important because it
looks at the ability of the business in meeting its
financial obligations.
Profitability
Profit = Revenue - Expenditure
Finance Marketing Production HR Administration

Solvency
The term ‘solvency’ implies
ability of an enterprise to
meet its long-term
indebtedness and thus,
solvency ratios convey an
enterprises ability to meet its
long-term obligations.
Business Intelligence
Which of the following Company have better profitability

Particular A B
Sale 600 600
COGS 360 390
GP 240 210
Salaries 50 40
Rent 20 25
Insurance 10 10
Inerest paid 45 30
Selling & Distribution 25 15
Operating Income 90 90
Interest received 15 15
Net Profit Margin 105 105
Basics of Analysis
Application of
analytical tools
Involves
Reduces
transforming
uncertainty
data
Information for Analysis
Income
Statement
Statement of
Balance Sources of Changes in
Stockholder’
Sheet Information Equity
Statement
of Cash
Flows
Knowledge check from previous lecture
MCQ
18
• Which of the following is the main objective of a financial
statement?
• a) to know the solvency
• b) to know the debt capacity
• c) to know the earning capacity
• d) All
• d) All
How to Measure Performance – Tools of Analysis
• Comparative Statement – Horizontal Analysis
• Common Size Statement – Vertical Analysis

• Trend Analysis
• Ratio Analysis
Tools of Analysis
Comparative Statement Analysis - Horizontal
Comparing a
company’s
financial
Time
condition and
performance
across time
COMPARATIVE FINANCIAL STATEMENTS
 Comparison Compare
 How to compare?
Matching, the similarities and dissimilarities
 What do you need for comparing?
Two or more things, facts, persons etc
 What is the objective of comparison? To ascertain the
difference
 Why do we compare?
– To ascertain which is good / bad?
– To ascertain the favorable / unfavorable changes
– To ascertain the efficiency and effectiveness
 COMPARATIVE STATEMENTS ARE USED FOR COMPARISON
 Statements which summarise and present related accounting data for a
number of years incorporating therein the changes (absolute or relative
or both) in individual item
 Figures of two or more period are placed side by side to facilitate
comparison
 Tool used for analysing financial statements
 Aims to study the changes in individual items when compared to the
previous year
 On the basis of the changes, valid conclusions on financial condition
and/or profitability, strengths and weaknesses etc., of the firm
 The changes can be shown either in absolute or relative terms or both
Comparative financial statement show:-
1. Accounting variables in their current and previous values
(values for comparison)
2. Changes (increase / decrease) in the values of individual
items
3. Changes (increase / decrease) in percentages of the
individual items.
Advantages of comparative statements
1. Facilitates for inter-firm and/or inter-period comparisons
2. Highlights upon the tends in different accounting variables relating

to performance, efficiency and financial position
3. Helps to identify weaknesses in operating efficiency, financial

conditions etc and to take appropriate remedial actions
Disadvantages (limitations / demerits) of comparative
statements
1. Frequent changes in accounting principles, conventions, methods

policies etc., make inter- period comparison difficulty
2. Differences in age, size, lack of uniformity in accounting policies and

practices between different firms make inter-firm comparison difficult
COMPARATIVE INCOME STATEMENT
Values Change (+ / - )
Particulars
CY PY Absolute Percentage
Net sales 120 100 +20 +20.00
Less Cost of Goods Sold 40 30 +10 +33.33
Gross Profit 80 70 +10 +14.30
Operating expenses 40 25 +15 +60.00
Operating Profit (EBIT) 40 45 -5 -11.10
Less Interest 10 10 0 0
Earning Before Tax 30 35 -5 -14.30
Less Tax 12 15 +3 +20.00
Earnings After Tax 18 20 -2 -10.00
Less Preference Share Dividend 8 8 0 0
Earnings available to Equity Share Holders 10 12 -2 -16.67
Knowledge check from previous lecture
MCQ
43
• Interpretation of accounts is the
a) Art and science of translating the figures

b) To know financial strengths and weaknesses of a
business
c) To know the causes for the prevailing performance of
business
d) All of the above
• D
• The term financial statement refers to…
• a) Income statement
• b) Cash flow and Fund Flow
• c) Balance sheet
• d) All
• d) All
Thank you

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Financial Statement Analysis

1. To develop an ability to understand and interpret the financial statements

Purpose: Explains movement of money in and out of the

FORECASTING: Do we have sufficient cash on hand to cover normal operating

Financial Statement Analysis will help business owners and other

Requires that you:

Financial statement analysis is more than just “crunching numbers”, it

(ii) To assess the operational efficiency and managerial effectiveness.

(v) To make inter-firm comparison.

(viii) To help in decision making and control.

There are two key factors for business survival:

• Profitability is important if the business is to generate

Profit = Revenue - Expenditure

Finance Marketing Production HR Administration

Which of the following Company have better profitability

• Comparative Statement – Horizontal Analysis

• Common Size Statement – Vertical Analysis

Comparative Statement Analysis - Horizontal

1. Facilitates for inter-firm and/or inter-period comparisons

2. Highlights upon the tends in different accounting variables relating

3. Helps to identify weaknesses in operating efficiency, financial

1. Frequent changes in accounting principles, conventions, methods

2. Differences in age, size, lack of uniformity in accounting policies and

a) Art and science of translating the figures

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