This document discusses various techniques for financial statement analysis, including ratio analysis. It outlines different types of ratios such as traditional ratios calculated from the balance sheet and income statement, as well as functional ratios related to liquidity, leverage, activity, and profitability. Specific balance sheet, income statement, and composite ratios are defined, such as current ratio, quick ratio, debt-to-equity, gross profit ratio, and return on equity. Formulas and components of key ratios like current ratio and quick ratio are provided. The interpretation and limitations of ratios are also addressed.

1. Financial Statement Analysis
Meaning and techniques
Dr. M. Kanchan

2. FSA
• Process of identifying the financial strengths and
weakness by establishing a strategic relationship
between Balance sheet and P/L A/c items.
• Consists of: Comparative statements, trend
analysis, schedule of changes in Working
Capital, Funds flow and Cash flow statements, CVP
analysis and Ratio Analysis
• Dr. M. Kanchan

3. Classification of Ratios
• 1. Traditional: B/S Ratio, P/L Ratio, Composite Ratio
• 2. Functional : Liquidity, Leverage, Activity,
Profitability
• Significance : Primary, Secondary
Dr. M. Kanchan

4. Balance Sheet Ratios
• a. Current Ratio
• b. Liquid /Acid test /Quick Ratio
• c. Debt-Equity
• d. Proprietary
• e. Capital Gearing
• f. Capital Inventory to WC Ratio
• g. Current assets: Fixed assets
Dr. M. Kanchan

5. P/L A/c Ratios
• Gross Profit Ratio
• Operating Ratio
• Operating Profit Ratio
• Net Profit Ratio
• Expense Ratio
• Interest Coverage Ratio.
Dr. M. Kanchan

6. Composite/Inter-statement Ratios
• Stock Turnover
• Debtors Turnover
• Payables Turnover
• Fixed Assets Turnover
• Return on Equity
• Return on Shareholders’ Funds
• Return on Total Resources
Dr. M. Kanchan

7. Functional Classification of Ratios
• Liquidity
• Long term solvency/Leverage
• Activity
• Profitability
Dr. M. Kanchan

8. Components of Current Ratio
• Current Assets: Current Liabilities
• Cash in hand Outstanding Expenses
• Cash at Bank Bills Payable
• Short term marketable securities Sundry Creditors
• Short term investments Short term advances
• Bills Receivables Income tax payable
• Sundry Debtors Dividend Payable
• Stock Bank Overdraft
• Work-in- progress
• Prepaid expenses
Dr. M. Kanchan

9. Interpretation of Current Ratio
• Rule of Thumb: 2 CA : 1 CL
High Current ratio may not be favourable
• There may be slow moving stock
• Debt collection may not be satisfactory
• Cash /Bank may be idle
Dr. M. Kanchan

10. Important factors
• Type of Business
• Type of Products
• Reputation of the Concern
• Seasonal Influence
• Type of Assets available
Limitations:
• Window Dressing
• Unrefined
Weighted Current Ratio
Time Adjusted Current Ratio
• DF= 1/(1+r)n Where DF= Discount Factor, r= annual Earnings Rate before
tax, n= time taken for each current asset and liability to be converted into
cash.
Dr. M. Kanchan

11. Quick/Acid Test/Liquid Ratio
• Components:
• Quick Assets Current Liabilities
• current Assets-(Inventories + prepaid exp)
• Cash in hand Outstanding expenses
• Cash at Bank Bills Payable
• Bills Receivables Sundry creditors
• Sundry Debtors Short-term advances
• Marketable securities Income tax payable
• Temporary Investments Dividends Payable
Bank overdraft
Rule of thumb: 1 : 1
Dr. M. Kanchan

12. Absolute Quick/Cash Ratio
• AQ Ratio= Cash in hand + at Bank +Short term securities /CL
Rule of thumb: 0.5 : 1
Interval Measure =Quick assets/Average Daily Cash exp
ADC exp= Cost of goods sold+Admn and sell & dist exp (less dep
and non-cash exp)/No. of days in a year
Dr. M. Kanchan