Finance

1. ANALYSIS OF FINANCIAL STATEMENT We know that Financial Accounting ends with preparation of preparation of Financial Statements i.e. Profit and Loss Account, Balance Sheet (also Cash flow Statement in case of Listed Companies) So when we talk about Analysis of Financial Statement, we mean analysis of Profit and Loss Account, Balance Sheet etc. Then what is Analysis? As per Dictionary, it is the separation of a whole into its components for study and interpretation.

2. So analysis of Financial Statement refers to classification of the various items given in Financial Statement and further its interpretation. It is the powerful mechanism of ascertaining the financial strengths and weaknesses of a firm. The importance of making analysis of Financial Statement may be better understood from this fact that Financial Statement, though itself reflects the net results for a particular period and state of affairs of the company on that date, but still we have to go for analysis of the same for more specific and deeper understanding of strengths and weaknesses . For example, NTPC Ltd., though a very good profit making company, but often it faces fund problem because of purchasing inputs from Coal India Ltd., GAIL etc on cash basis while selling electricity to various State Electricity Board on credit basis.

3. Types of Financial Analysis : A) External Analysis : Done by outsiders like Shareholders, Banks, Creditors, Clients etc B) Internal Analysis : Done by Management, Employees etc C) Horizontal Analysis : Financial statements for a number of years are reviewed, compared and analyzed. D) Vertical Analysis : The Analysis is made by reviewing the relationship quantitatively of various items in the financial statement on a particular date.

4. Techniques of Financial Analysis: - Comparative Statements : In this case Comparative Balance Sheet and Comparative Income Statement are prepared on the basis of financial statement of two periods. The objective is to see the increase or decrease in assets, liabilities, income and expenditure in the current year as compared to last year (Say). - Trend Analysis : Here one year is taken as the base year and increase or decrease in items of financial statements over a number of years is calculated based on the base year. - Common Size statement : In this case one item say Net Sales of any year is taken as the base and all other items of the Income statement are evaluated in terms of % of net sales and then over the years, the increase or decrease in every item is analyzed. - Ratio Analysis : So analysis is made on the basis of some important ratios. - Cash Flow Statement : Sources and application of cash and cash equivalents are presented through a statement. As per the listed companies’ requirement, the sources and applications are presented under three heads i.e. Operation, Investment and Financing. - Funds Flow Statement : In this case sources and application of funds are prepared through a statement. Here fund means working capital.

5. RATIO ANALYSIS A Ratio refers to arithmetical or numerical relationship between items or variables. This relation can be expressed as percentage (%) or Fraction (one-fifth) or Proportion (1:4). So ratio analysis in the context of Financial Statement refers to establishing an arithmetical relationship between various items of the same, so as to draw some meaningful conclusion from them. This is one of techniques of analysis of Financial Statement. It gives answers to various important questions such as, Is the company financially viable? Will the company be able to pay for its short term obligations? Is the profitability of the company sufficient enough for shareholders/Bank/Creditors? Etc .

6. Types of Ratios : Ratios can be classified into the following four broad groups: A) Liquidity Ratios B) Capital Structure or Leverage Ratios C) Profitability Ratios D) Activity Ratios

7. Liquidity Ratios : The objective of this ratio is to assess the ability of the firm to meet its current/short tem obligations . The concerned users of this ratio here are creditors, Banks, who are interested in the short term solvency or liquidity of a firm. Every company should strike a balance between two very essential contradictory requirements i.e. liquidity and profitability for efficient financial management. The example of NTPC Ltd., as already given is more appropriate to substantiate the aforesaid statement. The appropriate ratios to throw light on liquidity are as follows : A) Current Ratio B) Liquid / Quick Ratio C) Super Quick Ratio

8. 1) Current Ratio : Current Assets Current Ratio = --------------------------- Current liabilities Current Assets include Cash and Bank Balance, Marketable Securities, Inventory, Debtors, Bills Receivable, Prepaid Expenses etc. Current Liabilities include Creditors, Bills Payable, Bank Overdraft, Proposed Dividend, Provision for Taxation, Outstanding expense etc. Current Ratio assesses short term solvency i.e. the ability to meet short term obligation of the company. Subject to deeper enquiry, generally a current ration of 2:1 is considered satisfactory.

9. 2) Liquid / Quick Ratio : Quick Assets Quick Ratio = --------------------------- Current liabilities Quick Assets: CA - (Inventory + Prepaid Expenses) The idea behind Quick Ratio is to assess more strictly the firm’s ability to meet out short term obligations. Inventory and prepaid expenses being excluded because these two items are generally considered less liquid-able than any other items of Current assets . Generally a quick ratio of 1:1 is considered satisfactory, subject to deeper enquiry .

10. 3) Super Quick / Acid Test Ratio: Super Quick Assets Super Quick Ratio = --------------------------- Current liabilities In a more appropriate sense, this ratio is also interpreted as follows: Super Quick Assets Super Quick Ratio = --------------------------- Quick liabilities Super Quick Assets: Cash and marketable Securities Quick Liabilities: Current Liabilities – Bank Overdraft Super quick assets does not include also debtors and bills receivable. Bank overdraft being excluded because of its kind of permanent nature with the Bank. This ratio is the most strict and very conservative test of the firm’s liquidity position .

14. 1) Debt Equity Ratio : Outsiders’ Funds External Equities Debt Equity Ratio = --------------------------- or ---------------------------- Insiders’ Funds Internal Equities Total Debt or ---------------------------- Shareholders’ Funds Long Term Loan + Current Liabilities = --------------------------------------------------------- Share Capital (Equity+Pref.)+ Reserve &Surplus- Accumulated loss