undefined | unit 4 analysis and interpretation of financial statements

Unit 4

Analysis and Intepretation of Financial Statements

Q1) The company's balance sheet for December 31 is as follows:

Liabilities	Rs	Assets	Rs
Share capital	2,00,000	Land and building	1.,40,000
Profit & loss account	30,000	Plant and machinery	3,50,000
General reserve	40,000	Stock	2,00,000
12% debenture	4,20,000	Sundry debtor	1,00,000
Sundry creditor	1,00,000	Bills receivable	10,000
Bills payable	50,000	Cash at bank	40,000
	8,40,000		8,40,000

Calculate :-

Current ratio

Quick ratio

Inventory to working capital

Debt to equity ratio

Proprietary ratio

Capital gearing ratio

Current assets to fixed assets

A1)

Current ratio =

=2.33:1

2. Quick ratio =

3. Inventory to working capital =

working capital= current assets – current liabilities

Rs 3,50,000 - Rs 1,50,000= Rs 2,00,000

4. Debt to equity ratio=

(or)

5. Proprietary ratio=

6. Capital gearing ratio =

7. Current assets to fixed assets =

Q2) From the following items listed in the trading and profit and loss accounts of the corporation.Working out, business concerns occupancy rate:

Trading account of a account LTD.

For the period ending December 21

Dr. Cr.

Expenses	Rs	Income	Rs
To opening stock	1,400	By net sales	10,000
To purchase	6,400	By closing stock.	600
To direct expenses	300
To gross profit	2,500
	10,600		10,600

Profit and loss account of a company LTD.

For the period ending December 31

Dr. Cr.

Expenses	Rs	Income	Rs
To operating expenses		By gross profit	2,500
Administrative expenses	1,600
b. Selling and distribution expenses	300
To financial expenses	100
To net profit	500
	2,500		2,500

A2)

cost of good sold	Rs
Opening stock	1,400
purchases	6,400
Direct expenses	300
	8,100
Less closing stock	600
Cost of good sold	7,500
Operating expenses	Rs
Administrative expenses	1,600
b. Selling and distribution expenses	300
c. Financial expenses	100
Operating expenses	2,000

Q3) Below is a summary profit and loss account of Taj Products Ltd. Published January 31-4:

Profit and loss account

	Rs		Rs
Opening stock of market	99,500	Sales	8,50,0000
Purchase of material	3,20,000	Stock of material (closing)	89,000
Direct wages	2,25,000	Stock of finished goods ( closing )	60,0000
Manufacturing expenses	14,250	Non- operating income interest	3,0000
Selling & distribution		Profit on sale of shares	6,000
Expenses	30,000
Administrative expenses	1,50,000
Finance charges	15,000
Non- operating expenses
Loss on scale of assets	4,000
Net profit	1,50,000
	10,08,000		10,08,000

Work out following ratios:-

Gross profit ratio

Net profit ratio

Operating ratio

Cost ratios( to cost of production)

Material consumed ratio

Labour cost ratio

Production overhead cost ratio

A3)

Gross sales (a)		8,50,000
Less: cost of good sold:	Rs
Opening stock of material	99,500
Add: material purchased	3,20,000
	4,19,500
Less: stock of material (closing)	89,000
Material consumed ; (b)	3,30,500
Direct wages	2,25,000
Manufacturing expenses	14,250
Cost of production	5,70,000
Less: closing stock of finished products	60,000
Cost of good sold
Gross profit (e)
Less: administrative expenses	1,50,000	5,10,000
selling and distribution	30,000	1,80,000
Net operating profit before interest and taxation		1,60,000
Add: non- operating income (g)
Interest	3,000
Profit on sales of shares	6,000	9,000
		1,69,000
Less: loss on sale of assets	4,000
Finance charges	15,000	19,000
Income before taxation		1,50,000

Gross profit ratio=

2. Net profit ratio=

4. i. material consumed ratio=

productive overheard ratio=

Q4) You need to calculate from the following balance sheet and additional information:

(i)Total Return on resources

(ii)Return on employment capital

(iii) Shareholder fund return

Balance sheet as on 31stdec

	Rs		Rs
Share capital (Rs10)	8,00,000	Fixed assets	10,00,000
Reserve	2,00,000	Current assets	3,60,000
8% debenture	2,00,000
Creditors	1,60,000
	13,60,000		13,60,000

Net operating profit before tax is Rs 2,80,000. Assume tax rate at 50% . dividend declared amount to Rs 1,20,000

A4)

return on total resources =

ii. return on capital employed =

iii. return on shareholder’s fund=

Q5) The company has Rs capital. 10, 00,000; its turnover is 3 times the capital, and the margin of turnover is 6%. What is the return on investment?

Solution :-

Capital turnover ratio=

rate of return on investment =

Gross profit =6% of Rs 30,00,000

Rs= 1,80,000

Q6) From the following income statement,prepare a general size income statement for Jayant Ltd which ended 31st March, 2011.

Particular	Amount
revenue from operations	25,38,000
(+) other income	38,000
Total income	25,76,000
Expenses
Cost of revenue from operations	14,00,000
Operating expenses	5, 00,000
Total expenses	19,00,000
profit before tax	6,76,000
(-) income tax	3,38,000
profit after tax

A6)

Common size statement of profit and loss

for the year ended 31st March, 2011

Particular	Amt	Amt
Revenue from operation (sales)	25,38,000	100.00
II. Other income	38,000	1.50
III. Total revenue (I+II)	25, 76, 000	101.50
IV. Expenses
(a). cost of revenue from operations. (b). operations expenses	14,00,000 5,00,000	55.16 19.70
Total expenses	19,00,000	74.86
V. Profit before tax (III-IV)	6,76,000	26.64
VI. Tax	3,38,000	13.32
VII. Profit after tax ( V-VI)	3,38,000	13.32

Q7) Below is Raj Ltd's income statement for the year ended 31st March, 2011.

Particular	Amount
Revenue from operations	2,00,000
(+) other income	15,000
Total income	2,15,000
Expenses
Cost of revenue from operations .	1,10,000
Operating expenses	5,000
Total expenses	1,15000
Profit before tax	1,00,000
(-) income tax	40,000
profit after tax	60,000

Preparing a statement of the general size of Raj Ltd's profit and loss for the year ended 31st March, 2011.(Delhi 2012, fix)

A7)

Common size income statement

For the year ended 31st march, 2011

Particular	Amt.	Percentage of sales
Revenue from operations (sales)	2,00,000	100.00
II. Other income	15,000	7.50
III. Total revenue (I+II)	2,15,000	107.50
IV. Expenses (a) Cost of revenue from operations (b) Operating expenses	1,10,000 5,000	55.00 2.50
Total expenses	1,15,000	57.50
V. profit before tax ( III-IV)	1,00,,000	50.00
VI. Tax	40,000	20.00
VII. Profit after tax (V-VI)	60,000	30.00

Q8) Create a comparative statement of profit and loss from the following information.

Particular	31st march, 2009	31st march 2010
Revenue from operations	40,000	50,000
Cost of revenue from operations	30,000	35,000
Wage paid	16,000	14,000
Operating expenses	2,500	3,000
Other income	2,000	3,000
Income tax	4,750	7,500

A8)

Comparative statement of profit and loss

For the year ended 31stmarch , 2009 and 2010

Particular	31st march 2009	31st march 2010	Absolute change ( increase or decrease)	Percentage change ( increase or decrease )(%)
Revenue from operations (sales)	40,000	50,000	10,000	25.00
II. Other income	2,000	3,000	1,000	50.00
III. Total revenue (I+II)	42,000	53,000	11,000	26.19
IV. Expenses (a) Cost of revenue from operations. (b) Operating expenses Total expenses	30,000 2,500 32,500	35,000 3,000 38,000	5,000 500 5,500	16.67 20.00 16.92
V. Profit before tax ( III-IV)	9,500	15,000	5,500	57.89
VI. Tax	4,750	7,500	2,750	57.89
VII. Profit after tax (V-VI)	4,750	7,500	2,750	57.89

Note the paid wages are part of the direct costs and are included in the cost of goods already sold.

Q9) Create a comparative statement of profit and loss from the following information.

Particular	2009	2010
Revenue from operations	10,00,000	12,50,000
Cost of revenue from operations	5,00,000	6,50,000
Carriage inwards	30,000	50,000
Operating expenses	50,000	60,000
Income tax	50%	50%

A9)

Comparative statement of profit and loss

For the year ended 31st march, 2009 and 2010

Particulars	31st march 2009	31st march 2010	Absolute change(increases or decreases)	Percentage change (increase or decrease)
Revenue from operational (sales)	10,00000	12,50,000	2,50,000	25.0
II. Other income	-	-	-	-
III. Total revenue (I+II)	10,00000	12,50,000	2,50,000	25.0
IV. Expenses (a) Cost of revenue from operations (b) Operating expenses Total expense	5,00,000 50,000 5,50,0000	6,50,000 60,000 7,10,000	1,50,000 10,000 1,60,000	30.00 20.00 29.09
V. Profit before tax ( III-IV)	4,50,000	5,40,000	90,000	20.00
VI. Tax @ 50%	2,25,000	2,70,000	45,000	20.00
VII. Profit and tax (V-VI)	2,25,000	2,70,000	45,000	20.00

Note: inward carriage is part of the direct cost and is included in the cost of goods already sold.

Q10) Use the following information to create a comparative statement of profit and loss.

Particular	31st march, 2008	31st march, 2009
Revenue from operations	2,00,000	3,50,000
Purchase	1,00,000	2,00,000
Cost of revenue	60% of revenue from operations	70% of revenue from operations
Administrative expenses	5% on gross profit	7% on gross profit
Income tax	45%	45%

A10)

Comparative statement of profit and loss

For the year ended 31st march, 2008 and 2009

Particular	31st march 2008	31st march 2009	Absolute change	Percentage change
Revenue from operational sales	2,00,000	3,50,000	1,50,000	75.00
II. Other income	-	-	-	-
III. Total revenue (I+II)	2,00,000	3,50,000	1,50,000	75.00
IV. Expense Cost of revenue from operations. Administrative expenses Total expense	1,20,000 4,000 1,24,000	2,45,000 7,350 2,52,000	1,25,000 3,350 1,28,350	104.17 83.75 103.51
V. Profit before tax (III-IV)	76,000	97,650	21,650	28.49
VI. Tax @45%	34,200	43,943	9,743	28.49
VII. Profit after tax	41,800	53,707	11,970	28.49

Note purchases are not indicated individually, as they are part of the cost of the goods sold.

Working note

	2008	2009
Revenue from operational (sales)	2,00,000	3,50,000
(-) cost of revenue from operations	1,20,000	2,45,000
Gross profit	80,000	1,05,000
administrative expenses	5% on gross profit i.e 4,000	7% on gross profit i.e 7,350

Q11) Create a comparative income statement for profit and loss from the following information

Particular	31stmarch , 2008	31st , march 2009
revenue from operations	3,00,000	4,00,000
Sales return	1,00,000	2,00,000
Cost of revenue from operations	60% of revenue operations	50% of revenue from operations
Administrative expense	20% gross profit	10% on gross profit
Income tax	40%	40%

A11)

Comparative statement of profit and loss

For the year ended 31st march, 2008 and 2009

Particular	31st march 2008	31st march 2009	Absolute change (increase or decrease)	Percentage change( increase or decrease)
Revenue from operations ( sales)	2,00,000	2,00,000	-	-
II. Other income	-	-	-	-
III. Total revenue ( I+II)	2,00,000	2,00,000	-	-
IV. Expenses Cost of revenue from operations Administrative expenses Total expense	1,20,000 16,000 1,36,000	1,00,000 10,000 1,10,000	(20,000) (6,000) (26,000)	(16.67) (37.50) (19.12)
V. Profit before tax ( III-IV)	64,000	90,000	26,000	40.63
VI. Tax @40%	25,600	36,000	10,400	40.63
VII. Profit after tax (V-VI)	38,400	54,000	15,600	40.63

Working note

	2008	2009
Revenue from operations	3,00,000	4,00,000
(-) sales return	1,00,000	2,00,000
Revenue from operations	2,00,000	2,00,000
(-) cost of revenue from operations	1,20,000	1,00,000
Gross profit	80,000	1,00,000
Administrative expenses	20% on gross profit i.e 16,000	10% on gross profit i.e 10,000

Q12) Create a comparative statement of profit and loss from the following

Particular	31st march 2008	31st march , 2009
Revenue from operations	140% of cost of revenue from operations	160% of cost of revenue from operations
Purchases	2,50,000	4,50,000
Cost of revenue from operations	3,00,000	5,00,000
Administrative expenses	10% of cost of revenue from operations	8% of cost of revenue from operations
Income tax	40%	50%

A12)

Comparative statement of profit and loss

For the year ended 31st march, 2008 and 2009

Particular	31st march 2008	31st march 2009	Absolute change	Percentage change
Revenue from operations (sales)	4,20,000	8,00,000	3,80,000	90.48
II. Other income	-	-	-	-
III. Total revenue (I+II)	4,20,000	8,00,000	3,80,000	90.48
IV. Expenses Cost of revenue from operations Administrative expenses Total expenses	3,00,000 30,000 3,30,000	5,00,000 40,000 5,40,000	2,00,000 10,000 2,10,000	66.67 33.33 63.64
V. Profit before tax ( III-IV)	90,000	2,60,000	1,70,000	188.89
VI. Tax @ 40% and 50%	36,000	1,30,000	94,000	261.11
VII. Profit after tax (V-VI)	54,000	1,30,000	76,000	140.74

Note purchases are not indicated individually, as they are part of the cost of the goods sold.

Q13) Create a comparative statement of profit and loss from the following

Particular	31st march, 2008	31st march, 2009
Revenue from operations	140% of cost of revenue from operations	150% of cost of revenue from operations
Purchases	1,50,000	2,50,000
Cost of revenue from operations	2,00,000	3,00,000
Operating expenses	10,000	15,000
Income tax	40%	40%

A13)

Particular	31st march 2008	31st march 2009	Absolute change	Percentage change
Revenue from operations (sales)	2,80,000	4,50,000	1,70,000	60.71
II. Other income	-	-	-	-
III. Total revenue (I+II)	2,80,000	4,50,000	1,70,000	60.71
IV. Expenses c. Cost of revenue from operations d. Administrative expenses Total expenses	2,00,000 10,000 2,10,000	3,00,000 15,000 3,15,000	1,00,000 5,000 1,05,000	50.00 50.00 50.00
V. Profit before tax ( III-IV)	70,000	1,35,000	65,000	92.86
VI. Tax @ 40% and 50%	28,000	54,000	26,000	92.86
VII. Profit after tax (V-VI)	42,000	81,000	39,000	92.86

Note the purchase is part of the cost of the goods sold and therefore does not appear separately.

Q14) Explain Analysis and interpretation of Financial Statements.

A14)

What are financial statements?

The term financial statement refers to a statement of change in financial condition, statement of retained earnings, balance sheet, income statement, and so on. But in general, financial statements contain only two statements; they are profit and loss accounts and balance sheets. It is observed that the mere presentation of these statements does not serve anyone's purpose anyway. The importance of these statements lies in their analysis and interpretation. Initially, the analysis was carried out only to extend credit, but now it is used as the most important function of management accountants to provideinformation.

Hampton J.J. "A statement disclosing the status of an investment is known as a balance sheet and a statement indicating the result is known as a profit and loss account, “the statement said.

Some of the schedules are prepared and submitted alongside financial statements for meaningful presentation. Such a schedule is based on the schedule of fixed assets, the schedule of debtors, the schedule of creditors, the schedule of investments.

Meaning of analysis

Analysis means the process of splitting or splitting the content of financial statements into many parts to obtain maximum meaningful information.

Meaning of interpretation

Explaining the meaning and significance of the rearrangement and/or modified data of the financial statements is called Interpretation

F.Wood:Putting the meaning of a press release in simple words for the advantage of a person is called "Interpretation

Procedures for analysis and interpretation

In order to conduct an effective analysis and interpretation of financial statements, it is necessary to complete the following basics:

The purpose of the financial table analysis is the basis for the selection of analytical techniques. Therefore, the organization must determine the purpose of the financial table analysis.

The scope of interpretation also decided to choose the right type of technique of analysis of financial statements.

Financial statements are prepared on the basis of certain assumptions, principles and practices that are confirmed to understand their importance.’

Additional information necessary for the work of interpretation should be properly collected.5. The collected data should be presented in logical order by rearrangement of the data.

To analyse and interpret the collected facts, we take into account the general market situation and the economic situation

The interpreted data and information must be presented in the appropriate reporting format.

Purpose of analysis and interpretation

Many stakeholders of financial statements are analysed and interpreted according to their various purposes. Despite the variability of the purposes of analysis and interpretation by different classes of people, there are several common purposes of interpretation, which are given below.

1. To find out the income capacity and efficiency of various business activities with the help of the income statement.

2. Measure management efficiency under different business situations.

3. Estimate the performance ratings of different departments over a period of time.

4. With the help of the balance sheet, measure the short-and long-term solvency position of the business organization.

5. To find out the source of Finance and how to utilize available finance.

6. To determine the future prospects of earnings capacity and business concerns.

7. Identify the role of fixed assets in maintaining revenue capacity for how they are utilized and business concerns.

8. Investigate the future potential of business concerns.

9. Compare the operational efficiency of similar concerns engaged in the same industry.

10. Identify the growth trend of the business organization.

The importance of analysis and interpretation

All quantitative information i.e. financial accounting information is comprehensively analysed and interpreted so that important facts and relationships regarding various aspects of financial life of business concerns are known to everyone. Thus, various factors increase the importance of analysing and interpreting financial statements.

1. Wrong and incomplete decisions are taken by the management team in the absence of analysis and interpretation.

2. Sometimes, decisions are also taken by various responsible executives in haste.

3. Everyone has limited experience in business activities. Therefore, the complexity of business activities can be easily understood through analysis and interpretation.

4. If a decision is made based on intuition or conclusions, then the decision has no meaning, and no one understands the decision. In other words, if the decision is based on scientific analysis and interpretation, then everyone understands the decision very easily.

5. Analysis and interpretation are necessary to verify and consider the correctness and correctness of selections already made on the idea of intuition.

Q15) Explain ratio analysis.

A15)

Ratio analysis is used to evaluate relationships among financial statement items. It is used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency.

Ratio analysis is concerned with the calculation of relationship to provide indicators of past performance in terms of critical success factors of a business. This is an accounting ratio. The accounting ratio offer quick ways to evaluate a business's financial condition.

According to Accounting Scholar, ratios are the most frequently used accounting formulas in regard to business analysis. Analyzing your finances with these ratios helps you identify trends and other data that inform important business decisions.

Different types of accounting ratio

Liquidity ratios

These ratios are used to evaluate the company ability in paying its debts, usually by measuring current liabilities and liquid assets. This determines the ability of the company to pay off short-term debts. These are some common liquidity ratios:

Current Ratio = Current Assets/Current Liabilities:

It is also known as working capital ratio. The purpose of this ratio is to measure the company ability to pay off short-term debts by liquidating the assets. Current assets includes stock, debtors, cash and bank balances, bills receivable, etc. current liabilities includes creditors, bank overdrafts, outstanding expenses, etc. The ideal ratio is considered to be 2:1

Quick Ratio = Quick Assets/Current Liabilities:

This ratio is similar to the current ratio above, except that to measure "quick" assets, which includes Cash + Cash Equivalents + Short Term Investments + Accounts Receivables. The ideal ratio is 1:1.

Net Working Capital Ratio = (Current Assets - Current Liabilities)/Total Assets:

By calculating the net working capital ratio, the company is calculating the liquidity of the assets. An increasing net working capital ratio indicates that the business is investing more in liquid assets than fixed assets.

Cash Ratio = Cash/Current Liabilities:

This ratio tells the ability of business in covering its debts using only cash.

Cash Coverage Ratio = (Earnings Before Interest and Taxes + Depreciation)/Interest:

The cash coverage ratio is similar to the cash ratio, but it calculates the business ability to pay interest on its debts.

Operating Cash Flow Ratio = Operating Cash Flow /Current Liabilities: This ratio tells you how your current liabilities are covered by cash flow.

2. Profitability ratios

This ratio is used by accountant to measure a business's earnings versus its expenses. Profitability is the ability of a business to earn profit over a period of time. The profitability ratios show the combined effects of liquidity, asset management and debt management on operating results. These are some common profitability ratios:

Gross profit margin = (Gross Profit/Net Sales)*100

This ratio determines the basic profitability of the firm. The ratio is represented as a percentage of sales. Higher the ratio, the higher is the profit earned on sales

Operating profit margin = (Operating Profit/Net Sales)*100

This ratio measures the equation between the cost of operating activities and the net sales, or revenue from operations. This ratio expresses the cost of goods sold as a percentage of the net sales. Lower the ratio, lower the expense related to the sales

Net profit margin = (Net Profit/Net Sales)*100

This ratio measures the ultimate profitability. Higher the ratio, the more profitable are the sales.

Return on Assets = Net Income/Average Total Assets:

The return on assets ratio indicates how much profit businesses make compared to their assets. Higher the return, the more efficient is the management in utilizing its asset base

Return on Equity = Net Income/Average Stockholder Equity:

It measures how much the shareholders earned for their investment in the company. Higher percentage indicates better return to investors.

Return on capital employes = profit before income and tax/capital employes:

This ratio measures the overall efficiency of the utilization of the firm’s funds. It indicates the productivity of capital employed.

Earnings Per Share = Net Income/Number of Common Shares Outstanding:

The earnings-per-share ratio is similar to the return-on-equity ratio, except that this ratio indicates the company profitability from the outstanding shares at the end of a given period.

3. Leverage ratios

A leverage ratio is a important indicator of financial strength, it sees how much of the company's capital comes from debt and how the company can meet its financial obligations.

Debt-to-Equity Ratio = Total Debt/Total Equity:

This ratio compares the company’s total debt to its total assets. The higher the debt ratio the more difficult it becomes for the firm to raise debt.

Equity ratio = (Ordinary Shareholder’s Interest / Total assets)*100:

This ratio measures the strength of the financial structure of the company. A high equity ratio reflects a strong financial structure of the company.

Capitalization ratio = Long-Term Debt/(Long-Term Debt + Total Equity):

This ratio measures the debt component of a company’s capital structure. A low level of debt and a healthy proportion of equity in a company’s capital structure is an indication of financial strength.

4. Turnover ratios

Turnover ratios are used to measure the company's income against its assets. There are many different types of turnover ratios. Here are some common turnover ratios:

Inventory Turnover Ratio = Costs of Goods Sold/Average Inventories: The inventory turnover rate indicates how much inventory sold in a year or other specified period.

Assets Turnover Ratio = Sales/Average Total Assets: This ratio is a good indicator of how good the company uses its assets to produce revenue.

Accounts Receivable Turnover Ratio = Sales/Average Accounts Receivable: this ratio evaluates how quickly the company is able to collect funds from its customers.

Accounts Payable Turnover Ratio = Total Supplier Purchases/(Beginning Accounts Payable + Ending Accounts Payable)/2): This ratio measures the speed at which a company pays its suppliers.

5. Market value ratios

Market value ratios deal entirely with stocks and shares. Many investors use these ratios to determine if your stocks are overpriced or underpriced. These are a couple of common market value ratios:

Price-to-Earnings Ratio = Price Per Share/Earnings Per Share. Investors use the price-to-earnings ratio to see how many times a stock is trading (its price) per each rupee of EPS

Market-to-Book Ratio = Market Value Per Share/Book Value Per Share. This ratio compares your company's historic accounting value to the value set by the stock market.

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