 INTRODUCTION TO FINANCIAL STATEMENT ANALYSIS

 According to “ American Institute of certified public Accountants” (AICPA) the art of recording, classifying
and summarizing in a significant manner and in terms of many transactions and events, which are in part at
least, of a financial character and interpreting the results there of.
 According to Professor G.A. Lee the accounting system has two stages.

 THE FIRST STAGE IS BOOK KEEPING, SECOND STAGE IS ACCOUNTING.

 Book Keeping: It involves the chronological records of financial transactions in a set of books in a
systematic manner.
 Accounting: It is concerned with the maintenance of accounts giving stress to the design of the system of
records, the preparation of reports based on the recorded data and the interpretation of the reports.
Thus, the terms, book-keeping and accounting are very closely related, through there is a subtle
difference as mentioned below.

1. Object: The object of book-keeping is to prepare original books of Accounts. It is restricted to journal,
subsidiary book and ledge accounts only. On the other hand, the main object of accounting is to record
analyse and interpret the business transactions.

2. Level of Work: Book-keeping is restricted to level of work. Clerical work is mainly involved in it.
Accountancy on the other hand, is concerned with all level of management.

3. Principles of Accountancy: In Book-keeping Accounting concepts and conventions will be followed by

all without any difference. On the other hand, various firms follow various methods of reporting and
interpretation in accounting.
4. Final Result: In Book-Keeping it is not possible to know the final result of business every year,
 FUNCTIONS OF AN ACCOUNTANT

The job of an accountant involves the following types of accounting works:

 Designing Work: It includes the designing of the accounting system, basis for identification and
classification of financial transactions and events, forms, methods, procedures, etc.
 Recording Work

 Summarizing Work: The work includes the preparation of profit and loss account, balance sheet. This phase
is called ‘preparation of final accounts’
 Analysis and Interpretation Work: The financial statements are analysed by using ratio analysis, break-
even analysis, funds flow and cash flow analysis.
 Reporting Work
 Preparation of Budget
 Taxation Work
 Auditing
CLASSIFICATION OF BUSINESS TRANSACTIONS or ACCOUNTS
All business transactions are broadly classified into three categories:

These three classes of accounts are maintained for recording all business transactions. They are

1. Personal Accounts (A/c)

2. Real Accounts (A/c)

3. Nominal Accounts (A/c)

Classification of accounting principles: Accounting principles can be broadly classified in to two categories:
1. Accounting Concepts. 2. Accounting Conventions
 Journal A Journal is a book in which all the transactions of a
business are recorded for the first time. The process of recording
transactions in the journal is called journalising.
 Every transaction affects two accounts, one is debited and the other
one is credited. ‘Debit’ (Dr.) and ‘Credit’ (Cr,) are the two terms or
signs used to denote the financial effect of any transaction. The
word ‘journal’ has been derived from the French word ‘JOUR’
meaning daily records. Journal Book is maintained to have prime
records for small firms. After preparing the journal book, the
transactions are then posted to Ledger.
 LEDGER “A ledger is a book which contains various accounts.”
The process of transferring entries from journal to ledger is
called “POSTING”.

DR Particulars account CR

Date Particulars Jfno Amount Date Particulars Jfno Amount

 TRAIL BALANCE A trail balance is a statement of debit and
credit balances. It is prepared on a particular date with the
object of checking the accuracy of the books of accounts.

PROFORMA FOR TRAIL BALANCE:

Trail balance for MR…………………………………… as on …………

NO NAME OF ACCOUNT DEBIT CREDIT

AMOUNT(RS) AMOUNT(RS.)
(PARTICULARS)
 TRADING ACCOUNT.
 The first step in the preparation of final account is the preparation of trading
account. The main purpose of preparing the trading account is to ascertain
gross profit or gross loss as a result of buying and selling the goods
PROFIT AND LOSS ACCOUNT
 The business man is always interested in knowing his net income or net
profit.Net profit represents the excess of gross profit plus the other revenue
incomes over administrative, sales, Financial and other expenses. The debit side
of profit and loss account shows the expenses and the credit side the incomes.
If the total of the credit side is more, it will be the net profit. And if the debit side
is more, it will be net loss
BALANCE SHEET
 The second point of final accounts is the preparation of balance sheet. It is
prepared often in the trading and profit, loss accounts have been compiled and
closed. A balance sheet may be considered as a statement of the financial
position of the concern at a given date.
 Trading A/C of __________ For the year ended 31st March 2024
Particulars Amount (Dr) Particulars Amount (Cr)
To Opening Stock a/c XXX By Sales a/c
To Purchases a/c Less: Sales returns XXXXX
Less: Purchase returns a/c XXXX By Closing stock a/c XXXXX
To Wages a/c XXXXX By Gross loss (transferred to P&L a/c) XXXXX
To freight, customs duty, octroi
To carriages on Purchases ( carriage inwards) XXXX
To Factory rent a/c XXXX
To Factory lighting a/c XXXX
To Factory heating a/c XXXX
To Factory power a/c XXXX
To factory insurance a/c XXXX
To fuel and gas a/c XXXX
To Customs duties a/c XXX
To duck dues a/c XXXX
To Gross profit ( transferred to P & L a/c)
XXXXXX XXXXXX
 Profit & Loss a/c of _______ for the year ended 31st march 2024

Particulars Amount (Dr) Particulars Amount (Cr)

To Gross loss transferred from Trading a/c XXXX By Gross profit transferred from Trading a/c XXXX
To Rent a/c XXX By Rent( received ) a/c XXX
To Salaries a/c XXX By Commission (received) a/c XXX
To Expenses a/c XX By Interest (received ) a/c XXXX
To Depreciation a/c XXX By Dividend (received) a/c XXX
To Amortization on goodwill a/c XX By Discount (received ) a/c XXXX
To Carriage on sales a/c (Carriage outwards) XXX By Net loss (transferred to capital a/c) XXX
To Commission a/c (Paid) XXX
To Audit Fees a/c XXX
To Bad debts a/c XX
To Provision for bad debts a/c XXX
To Discount a/c (allowed) XXX
To Net profit (transferred to capital a/c) XXX
XXXXX XXXXX
 Balance Sheet of _______ as on 31 March 2024
Liabilities Amount Assets Amount
Long- term Liabilities Fixed Assets
Capital Land & Buildings
Add: Interest on Capital Plant& Machinery
Add: Net profit Goodwill
Less: Drawings Furniture & Fixtures
Less : Interest on Drawings XXXX Patents, tm ,copyrights
Long- term Loans Investments
Debentures Current Assets
Reserve fund Closing Stock
Current Liabilities Sundry Debtors
Sundry Creditors Bills receivable
Bills Payable Short-term investments
Bank overdraft Income accrued due
Income received in advance Prepaid expenses
Outstanding expenses Cash in Bank
Cash in Hand
XXXXX XXXX
 Treatment of Adjustments in Final Accounts
Item Trading a/c Or P&L a/c Balance Sheet
Assets side ,
Closing Stock Credit side Of Trading a /c under Current Assets

Outstanding Factory expenses Debit side of Trading a/c Liabilities side , under Current Liabilities

Outstanding administrative, selling and distribution Liabilities side ,

expenses Debit side of P&L a/c under Current Liabilities
Assets side ,
Income Earned but not received Credit side Of P&L a /c under Current Assets

Income received in advance (income received but not Deducted from the relevant income on credit side Liabilities side ,
Earned ) of P&L a/c under Current Liabilities
Subtracted from the concerned
Depreciation Debit side of P&L a/c fixed asset, on the Assets side

Subtracted from the concerned intangible fixed asset, on the

Amortization Debit side of P&L a/c Assets side

Subtracted from Sundry debtors on the Assets side

Further bad debts Debit side of P&L a/c (under current Assets )

Subtracted from Sundry debtors on the Assets side

New Provision for bad debts Debit side of P&L a/c (under current Assets )
The Manager of the firm is entitled to 10% commission on net profit (a) before charging such
commission (or) (b) after charging such commission.

 (a) Before charging the commission, the Net Profit is Rs. 2,200
 The amount of commission = 2,200 x 10/100 = Rs 220

 (b) Commission payable = 10% on Net Profit (after charging the commission)
 If Net Profit is Rs. 100, Commission payable = Rs. 10

 Thus profit before charging the commission = 100 + 10 = 110

 Of Rs. 110, Rs. 10 is commission payable and the balance Rs. 110- Rs. 10 =
Rs. 100 is the profit, left after charging the commission.
The following trial balance has been extracted from the books of Rajesh on 31st
December, 2016.
The following adjustments are to be made:

 i. Stock on 31st December, 2016 was Rs. 28,000


 ii. Unexpired insurance was Rs. 15,000

 iii. Provision for doubtful debts is to be maintained at 5% on
sundry debtors.

 iv. Depreciate plant and machinery at 20%.

 You are required to prepare trading and profit and loss account for the
year ended 31st December, 2016 and a balance sheet as on that date.
 Ratio Analysis: Ratio analysis is a useful management tool that
will improve your understanding of financial results and trends
over time, and provide key indicators of organizational
performance. Managers will use ratio analysis to pinpoint
strengths and weaknesses from which strategies and initiatives
can be formed.

 Objectives of Ratio Analysis

 Measuring the profitability
 Determining operational efficiency
 Measuring financial position
 Facilitating comparative analysis
 Indicating overall efficiency
 Budgeting and forecasting
 Advantages
 Performance over time
 Performance against competitors

 Disadvantages

 Narrow Focus
 Accounting Methodologies
Types or Classification Of Ratios:
Profitability (Profitability Ratios)

Efficiency of Assets (Activity Ratios) Short-term Solvency (Liquidity Ratios)

Long-term Solvency (Leverage Ratios)

 Liquidity Ratios: They measure the firm’s ability to meet current
obligations.
 Current Ratio: It is also known as working capital ratio. This is calculated by
dividing total current assets by total current liabilities.
Current A ssets
Current Ratio = Current Liabilities

Acid Test Ratio Quick ratio (also known as “Quick ratio” and “liquid ratio”) is used to
test the ability of a business to pay its short-term debts

Liquid assets = (Total current assets) – (Inventories + Prepaid expenses)

Leverage / Solvency Ratios

Long-term solvency ratios analyze the long-term financial

position of the organization. Bankers and creditors are
interested in the liquidity of the firm, whereas shareholders,
debenture holders and financial institutions are concerned with
the long term prosperity of the firm. There are thus two aspects
of the long-term solvency of a firm.

 Debt equity ratio

 Proprietary (Equity) ratio
 Debt service (Interest coverage) ratio
 Capital Gearing Ratio.
 Profitability ratios

measure the efficiency of management in the employment of

business resources to earn profits. These ratios indicate the success
or failure of a business enterprise for a particular period of time.

 Gross Profit Ratio

 Net profit ratio
 Operating Ratio
 Operating Profit Ratio
 Expenses Ratio
 Return on capital Employed Ratio
 Return on shareholders’ investment ratio
 Earnings per share (EPS) ratio
 Activity ratios (also known as turnover ratios)
measure the efficiency of a firm or company in
generating revenues by converting its production
into cash or sales. Generally a fast conversion
increases revenues and profits.

 Fixed Assets Turnover Ratio

 Stock Turnover Ratio or Inventory Turnover Ratio
 Assets Turnover Ratio or Debtors Turnover Ratio
 Creditors Turnover Ratio / Accounts Payable Turnover
Ratio
SOLE PROPRIETORSHIP
A business that runs under the exclusive ownership and control of an individual is called sole proprietorship
or single entrepreneurship.

PARTNERSHIP
 Section 4 of the Indian Partnership Act, 1932 defines partnership as “the relation between persons who
have agreed to share the profits of a business carried on by all or any of them acting for all.”

THE JOINT STOCK COMPANY

 A company is an incorporated voluntary association of persons in business having joint capital divided
into transferable shares of a fixed value, along with the features of limited liability, common seal and
perpetual succession.

THE COOPERATIVE FORM AN ORGANIZATION

 A cooperative organization is “an association of persons, usually of limited means, who have voluntarily
joined together to achieve a common economic end, through the formation of a democratically controlled
business organization, making equitable contributions to the capital required and accepting a fair share of
risks and benefits of the undertaking.”