Question

Why does the management of any companies analyze financial statements? Explain by using the different tools in analyzing financial statement with proper numerical example.

Answer 1

The purpose of creating financial statements is to capture a company’s financial position for a given period. This allows users of financial information to analyze and compare the health of one company to another. Financial statements provide assessment of a company’s profitability, liquidity and operational efficiency. As a result, there are a number of reasons why managers analyze financial statements. Financial statements are prepared to have complete information regarding assets, liabilities, equity, reserves, expenses and profit and loss of an enterprise .

To anaylse the financial statements tools which are most commonly used are:-

1.Comparative statements:- Comparative statements give an idea of the enterprise financial position of two or more periods. Comparison of financial statements is possible only when same accounting principles are used in preparing these statements.

Let us now understand with an example:-

Example:-

Convert the following statement of profit and loss into the comparative statement of profit and loss of BCR Co. Ltd.:

Particulars	Note No.	2013-14 Rs.	2014-15 Rs.
(i)     Revenue from operations		60,00,000	75,00,000
(ii) Other incomes	1,50,000	1,20,000
(iii) Expenses	44,00,000	50,60,000
(iv) Income tax	35%	40%

Solution:

Comparative statement of profit and loss for the year ended March 31, 2014 and 2015:

Particulars	2013-14	2014-15	Absolute Increase (+) or Decrease (–)	Percentage Increase (+) or Decrease (–)
	Rs.	Rs.	Rs.	%
I. Revenue from operations	60,00,000	75,00,000	15,00,000	25.00
II. Add: Other incomes	1,50,000	1,20,000	(30,000)	(20.00)
III. Total Revenue I+II	61,50,000	76,20,000	14,70,000	23.90
IV Less: Expenses	44,00,000	50,60,000	6,60,000	15.00
Profit before tax	17,50,000	25,60,000	8,10,000	46.29
V Less: Tax	6,12,500	10,24,000	4,11,500	67.18
Profit after tax	11,37,500	15,36,000	3,98,500	35.03

From the above example we can conclude that in the year 2014-15 company is earning more profit and it has a good sound position .

2.Trend Analysis :-Trend analysis is know as studying the operational results and financial position over a series of years.Whether the enterprise is trending upward or backward, the analysis of the ratios over a period of years is done. By observing this analysis, the sign of good or poor management is detected.

Example:-Calculate the trend percentages from the following figures of sales, stock and profit of X Ltd., taking 2010 as the base year and interpret them.

(Rs. in lakhs)

Year	Sales (Rs.)	Stock (Rs.)	Profit before tax (Rs.)
2010	1,881	709	321
2011	2,340	781	435
2012	2,655	816	458
2013	3,021	944	527
2014	3,768	1,154	627

solution:-

Year	Sales Rs.	Trend %	Stock Rs.	Trend %	Profit Rs.	Trend %
2010	1881	100	709	100	321	100
2011	2340	124	781	110	435	136
2012	2655	141	816	115	458	143
2013	3021	161	944	133	527	164
2014	3768	200	1154	163	627	195

Interpretatiion :- 1) The sales have continuously increased in all the years up to 2014, though in different proportions. The percentage in 2014 is 200 as compared to 100 in 2010. The increase in sales is quite satisfactory.

2) Profit has substantially increased. The profits have increased in greater proportion than sales which implies that the company has been able to reduce their cost of goods sold and control the operating expenses

3.Ratio Analysis :-Quantitative analysis of information contained in a company’s financial statements is ratio analysis. It describes the significant relationship which exists between various items of a balance sheet and a statement of profit and loss of a firm.

4.Cash Flow Analysis :- The actual movement of cash into and out of a business is known as cash flow analysis. It is an important analytical tool. Analysis of cash flow explains the reason for a change in cash. It helps in assessing the liquidity of the enterprise and in evaluating the operating, investment & financing decisions.