fsa dr. varadraj bapat, iit mumbai module 7 interpretation and analysis of accounts

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Module 7Module 7

Interpretation and Interpretation and Analysis of Analysis of AccountsAccounts

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IndexIndex

Financial Statement AnalysisFinancial Statement AnalysisVertical & Horizontal AnalysisVertical & Horizontal AnalysisHorizontal vs. Vertical Balance Horizontal vs. Vertical Balance

SheetSheet

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Analysis of Financial Analysis of Financial StatementsStatements

Financial statement analysis refers to Financial statement analysis refers to detailed study of these statements to detailed study of these statements to arrive at useful interpretations.arrive at useful interpretations.For the users, the details in the For the users, the details in the financial statements signify only raw financial statements signify only raw data. This raw data needs to be re-data. This raw data needs to be re-organized, processed and converted organized, processed and converted into relevent and useful information.into relevent and useful information.

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Horizontal Horizontal and Vertical and Vertical AnalysisAnalysis

The analysis of financial The analysis of financial statements is done by various statements is done by various techniques like Horizontal analysis techniques like Horizontal analysis and Vertical Analysis.and Vertical Analysis.

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Horizontal AnalysisHorizontal Analysis

Horizontal analysis involves Horizontal analysis involves comparison of two years for the comparison of two years for the same concerns. It involves same concerns. It involves preparation of Comparative preparation of Comparative Statement.Statement.

Every item on the financial Every item on the financial statementstatement

is compared with that in the is compared with that in the previous year.previous year.

The change is calculated in The change is calculated in absolute amount absolute amount

and also and also as a percentage of that as a percentage of that basebase

Horizontal Horizontal AnalysisAnalysis

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Vertical AnalysisVertical Analysis

Vertical analysis on the other hand Vertical analysis on the other hand involves finding out the involves finding out the relationship between two items in relationship between two items in respect of the same concern and in respect of the same concern and in same year. It involves preparation same year. It involves preparation of Common-size Statement.of Common-size Statement.

Vertical Vertical Analysis...Analysis...

compares each item in a financial compares each item in a financial statement to a base number set to statement to a base number set to 100%.100%.

Every item on the financial Every item on the financial statement is then reported as a statement is then reported as a percentage of that base.percentage of that base.

Common-size Common-size StatementsStatements

On the income statement, each item is On the income statement, each item is expressed as a percentage of net sales.expressed as a percentage of net sales.

On the balance sheet, the common size is On the balance sheet, the common size is the total on each side of the accounting the total on each side of the accounting equation.equation.

Common-size statements are used to Common-size statements are used to compare one company to other companies, compare one company to other companies, and to the industry average.and to the industry average.

they are also used to compare financials they are also used to compare financials with earlier years.with earlier years.

BenchmarkingBenchmarking

43.0%

38.2%

8.0%

10.8%

51.4%

28.8%

7.4%

12.4%

Percent of Net Sales

Company BCompany A

Cost of goods sold Operating expenses Income tax Net income

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Balance Sheet Balance Sheet horizontal formathorizontal format

Financial statements are Financial statements are traditionally prepared for the traditionally prepared for the owners of the organisation. A owners of the organisation. A typical traditional balance sheet typical traditional balance sheet is prepared in Horizontal format.is prepared in Horizontal format.

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Horizontal Horizontal Balance SheetBalance Sheet

LiabilitiesLiabilities `̀ AssetsAssets `̀

CapitalCapital Fixed AssetsFixed Assets

Reserves & SurplusReserves & Surplus InvestmentsInvestments

Long Terms LoansLong Terms Loans Current AssetsCurrent Assets

Short Term LoansShort Term Loans Loans & AdvancesLoans & Advances

Current LiabilitiesCurrent Liabilities

ProvisionsProvisions

TotalTotal TotalTotal

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Vertical formatVertical format

The conventional horizontal The conventional horizontal form of Balance Sheet is not form of Balance Sheet is not suitable for financial analysis, suitable for financial analysis, precisely becauseprecisely because

1. It is designed for the owner. 1. It is designed for the owner.

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Vertical formatVertical format

2. Its presentation and sequence or 2. Its presentation and sequence or order of items is relevant only in order of items is relevant only in the event of liquidation; it is the event of liquidation; it is unsuitable for financial analysis unsuitable for financial analysis of a ‘going concern’.of a ‘going concern’.

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Vertical formatVertical format

Hence financial analysts generally Hence financial analysts generally converts horizontal balance sheet, converts horizontal balance sheet, into vertical format which is more into vertical format which is more suitable for financial analysis, suitable for financial analysis, especially in ratio analysis. especially in ratio analysis.

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Vertical Balance SheetVertical Balance Sheet

ParticularsParticulars `̀

I. SOURCES OF FUNDSI. SOURCES OF FUNDS

1. Owners Fund1. Owners Fund

(a) Capital (a) Capital

(b) Reserves & Surplus(b) Reserves & Surplus

Less: P & L A/c Dr. BalanceLess: P & L A/c Dr. Balance

Misc. Expenditure not w/offMisc. Expenditure not w/off

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Vertical Balance SheetVertical Balance Sheet

ParticularsParticulars `̀

Own Funds or Net WorthOwn Funds or Net Worth

2. Loan Funds2. Loan Funds

(a) Secured Loan(a) Secured Loan

(b) Unsecured Loan(b) Unsecured Loan

Total Loan FundsTotal Loan Funds

Total Capital EmployedTotal Capital Employed

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Vertical Balance SheetVertical Balance Sheet

ParticularsParticulars `̀

II. APPLICATION OF FUNDSII. APPLICATION OF FUNDS

1. Fixed Assets1. Fixed Assets

A. Tangible Assets (Gross Block)A. Tangible Assets (Gross Block)

Less: DepreciationLess: Depreciation

Net BlockNet Block

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Vertical Balance SheetVertical Balance Sheet

B. Intangible AssetsB. Intangible Assets `̀

2. Long Term / Trade Investments2. Long Term / Trade Investments

3. Working Capital3. Working Capital

Current AssetCurrent Asset

Less: Current LiabilitiesLess: Current Liabilities

Net Current Assets Net Current Assets

Total Assets EmployedTotal Assets Employed