UNIT-3

Q1.) Bring out the advantage of ratio analysis?

Ans:- Ratio analysis refers to the analysis and interpretation of the figures
appearing in the financial statements (i.e., Profit and Loss Account, Balance Sheet
and Fund Flow statement etc.).

It is a process of comparison of one figure against another. It enables the users

like shareholders, investors, creditors, Government, and analysts etc. to get
better understanding of financial statements.

Advantages of Ratio Analysis:

Ratio analysis is widely used as a powerful tool of financial statement analysis. It

establishes the numerical or quantitative relationship between two figures of a
financial statement to ascertain strengths and weaknesses of a firm as well as its
current financial position and historical performance. It helps various interested
parties to make an evaluation of certain aspect of a firm’s performance.

The following are the principal advantages of ratio analysis:

1. Forecasting and Planning:

The trend in costs, sales, profits and other facts can be known by computing ratios
of relevant accounting figures of last few years. This trend analysis with the help
of ratios may be useful for forecasting and planning future business activities.

2. Budgeting:

Budget is an estimate of future activities on the basis of past experience.

Accounting ratios help to estimate budgeted figures. For example, sales budget
may be prepared with the help of analysis of past sales.

3. Measurement of Operating Efficiency:

Ratio analysis indicates the degree of efficiency in the management and utilisation
of its assets. Different activity ratios indicate the operational efficiency. In fact,
solvency of a firm depends upon the sales revenues generated by utilizing its
assets.

4. Communication:

Ratios are effective means of communication and play a vital role in informing the
position of and progress made by the business concern to the owners or other
parties.

5. Control of Performance and Cost:

Ratios may also be used for control of performances of the different divisions or
departments of an undertaking as well as control of costs.

6. Inter-firm Comparison:

Comparison of performance of two or more firms reveals efficient and inefficient

firms, thereby enabling the inefficient firms to adopt suitable measures for
improving their efficiency. The best way of inter-firm comparison is to compare
the relevant ratios of the organisation with the average ratios of the industry.

7. Indication of Liquidity Position:

Ratio analysis helps to assess the liquidity position i.e., short-term debt paying
ability of a firm. Liquidity ratios indicate the ability of the firm to pay and help in
credit analysis by banks, creditors and other suppliers of short-term loans.

8. Indication of Long-term Solvency Position:

Ratio analysis is also used to assess the long-term debt-paying capacity of a firm.
Long-term solvency position of a borrower is a prime concern to the long-term
creditors, security analysts and the present and potential owners of a business. It
is measured by the leverage/capital structure and profitability ratios which
indicate the earning power and operating efficiency. Ratio analysis shows the
strength and weakness of a firm in this respect.
9. Indication of Overall Profitability:

The management is always concerned with the overall profitability of the firm.
They want to know whether the firm has the ability to meet its short-term as well
as long-term obligations to its creditors, to ensure a reasonable return to its
owners and secure optimum utilisation of the assets of the firm. This is possible if
all the ratios are considered together.

10. Signal of Corporate Sickness:

A company is sick when it fails to generate profit on a continuous basis and

suffers a severe liquidity crisis. Proper ratio analysis can give signal of corporate
sickness in advance so that timely measures can be taken to prevent the
occurrence of such sickness.

11. Aid to Decision-making:

Ratio analysis helps to take decisions like whether to supply goods on credit to a
firm, whether bank loans will be made available etc.

12. Simplification of Financial Statements:

Ratio analysis makes it easy to grasp the relationship between various items and
helps in understanding the financial statements

Q2.) Explain the advantage of fund flow statement?

Ans:- The fund flow statement provides a comprehensive view of a company's
financial activities, emphasizing changes in its financial position over a specific
period. Its advantages include:

1. Insight into Cash Flow: It highlights the sources and uses of funds, helping
stakeholders understand how cash is generated and utilized in the business.
2. Financial Analysis: Enables effective financial analysis by revealing the reasons
behind changes in a company's financial position, aiding in better decision-
making.

3. Monitoring Working Capital: Helps in assessing changes in working capital,

crucial for understanding a company's short-term liquidity and operational
efficiency.

4. Investor Confidence:Provides investors with a clearer picture of a company's

financial health, fostering confidence and aiding in investment decisions.

5. Management Decision Support: Assists management in identifying areas

requiring attention, facilitating strategic planning and resource allocation.

6. Comparison Over Time: Allows for trend analysis, helping to identify patterns
and evaluate the effectiveness of financial strategies over different periods.

In summary, the fund flow statement is a valuable tool for stakeholders to

comprehend a company's financial dynamics, make informed decisions, and
assess its overall financial health.

Q3.) Distinguish between funds flow statement and cash flow

statement?
Ans:- fund flow

Fund flow is the working capital of a business and includes the net movement of
funds. The fund flow statement records any changes in the company’s net
working capital during a given period. The statement can be used to determine
the financial position of a company and assists in long-term financial planning.
Any irregular financial activity or expense can be detected by studying the fund
flow statement. Fund flow is useful to gauge investor sentiment although it is not
as comprehensive as a cash flow statement.
Cash flow

The cash flow statement is a key document to understand the movement of cash
in an organization. It subsequently records the amount of money that has moved
in and out of the organization’s accounts over time. The movement of cash may
be due to operating, investing, or financing activities. Therefore, the statement is
an analytical reconciliation of the opening cash balance and closing balance in a
given period. It is among the four most important financial statements for
investors. It shows them whether or not there are any potential liquidity
problems with the company before investing.

Fund Flow Cash Flow

Funds flow statements record the changes in working capital. Cash flow statements record the movement of cash only.

It helps understand the financial position of the company. It helps understand the net cash flow of the company.

The fund flow statement determines the source and application of funds. The cash flow statement records changes in
opening balance and closing balance of cash.

It works on the accrual basis of accounting. It works on a cash basis of accounting.

The analysis is for the long term. The analysis is for a short duration.

Fund flow is useful for capital budgeting. Cash flow is useful for cash budgeting.

Q4.) Define the ratio analysis and its types?

Ans:- Ratio analysis is a financial tool used to evaluate and interpret relationships
between various financial variables in a company's financial statements. It
involves calculating and comparing ratios that provide insights into the company's
performance, profitability, liquidity, and overall financial health. Common ratios
include liquidity ratios, profitability ratios, leverage ratios, and efficiency ratios.
Analyzing these ratios helps stakeholders, such as investors and management,
make informed decisions about the company's financial position and
performance.

Ratio analysis includes various types such as:

1. Liquidity Ratios:* Measure a company's ability to meet short-term obligations.

2. Profitability Ratios:* Assess the company's ability to generate profit in relation

to its revenue, assets, and equity.

3. Efficiency Ratios:* Evaluate how well a company utilizes its assets and liabilities.

4.Solvency Ratios:* Indicate a company's long-term financial stability and ability

to meet long-term obligations.

5. Market Ratios:* Provide insights into a company's stock performance and

market value.

Q5.) What is the basic objective of observing trends in data and

ratios?
Ans:- The basic objective of observing trends in data and ratios is to gain insights
into patterns, relationships, and changes over time. Analyzing trends helps in
making informed decisions, identifying opportunities, and understanding the
underlying factors influencing the data. Ratios, on the other hand, provide a
quantitative way to compare different aspects of data, aiding in performance
evaluation and benchmarking. Both practices contribute to informed decision-
making and strategic planning.