ANALYSIS OF FINANACIAL

STATEMENTS
&
CASH MANAGEMENT

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ANALYSIS OF FINANACIAL
STATEMENTS

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FINANCIAL STATEMENT ANALYSIS

Analysis of financial statement means

a systematic and specialized
treatment of the information found in
financial statements so as to derive
useful conclusions on the profitability
and solvency of the business entity
concerned

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 Objectives of
Financial Statement
Analysis

Profitability Analysis Liquidity Analysis Solvency Analysis

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 Profitability Analysis: Users of financial statements
may analyze financial statements to decide past and
present profitability of the business

 Liquidity Analysis: Suppliers of goods, moneylenders

and financial institutions may do a liquidity analysis to
find out the ability of the company to meet its obligations

 Solvency Analysis: It refers to analysis of long term

financial position of the company. This analysis helps to
test the ability of a company to repay its debts.

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 TYPES OF
FINANCIAL
ANALYSIS

Intra Firm Inter Firm Standard Horizontal Vertical

Analysis Analysis Analysis Analysis Analysis

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 Intra Firm Analysis: Analysis of performance of the organization
over a number of years. It is also referred to as Time Series
Analysis or Trend Analysis

 Inter Firm Analysis: It is a comparison of two or more

organizations in terms of various financial variables.

 Standard Analysis: only one set of financial statements of an

organization is analyzed on the basis of standard set for the firm or
industry

 Horizontal analysis: It is a comparison of figures reported in

financial statements of two or more consecutive accounting periods
i.e. Analysis across years

 Vertical Analysis: comparing figures I the financial statements of a

single period is known as Vertical Analysis

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 1. COMPARATIVE FINANCIAL STATEMENTS

 Comparative financial statements are

statements of the financial position of a
business so designed as to facilitate
comparison of different accounting variables
for drawing useful inferences

 Comparative financial statements show:

d) Absolute data for each of the periods stated
e) Changes in absolute data in terms of rupees
f) Changes in absolute data in percentages
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PARTICULARS Y1 Y2 CHANGE CHANGE IN
(Rs) (Rs) IN AMT PERCEN-
(Rs) TAGE
Y2-Y1 Y2-Y1 *100
Y1

NET SALES 600 1,000 400 66.67

LESS: COST OF GOODS SOLD
OPENING STOCK 80 120 40 50
ADD:PURCHASES 300 800 500 166.66
WAGES 100 160 60 60
FACTORY EXPENSES
80 100 20 25
560 1180 620 110.7
LESS: CLOSING STOCK
120 300 180 150
COST OF GOODS SOLD
440 880 440 100
GROSS PROFIT
LESS: OPERATING EXPENSES 160 120 (40) (25)
12. ADMIN EXPENSES
13. SELLING & 18 22 4 22.22
DISTRIBUTION EXP.
14. FINANCE EXP. 33 23 (10) (30.30)
TOTAL OPERATING EXP. 1 - (1) (100)
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52 45 (7) (13.46)
 Advantages
 Indicates the direction of movement and
the financial position of the company.
 Used to compare the position of the every
month or every quarter.
 Used to compare with other firms.
 Presents a review of the past activites and
their effect on the financial position.
 Helps to determine the nature of trends of
current changes affecting the enterprise.
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 Disadvantages
 Loose their purpose if the application of accounting
principles over a period of time is not consistent.

 Consistentchanges in price levels render accounting

statements useless for comparisons

 To carry out inter firm comparison the firms need to be

of the same age, size and follow the same principle.

 Ifthe accounting period follows an abnormal period

the analysis would be rendered useless 11
2. Common-Size Statements
It is a statement which facilitates
comparison of two or more
business entities with a common
base

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 Common Size Balance Sheet
Particulars Amt Percentage
Sources of Funds

Owned Funds

Share Capital 80,000 64%

Reserves 20,000 16%

Proprietors Fund 100,000 80%

Add Borrowed Funds

Debentures 25,000 20%
Loan Fund 25,000 20%
Total Capital Employed 1,25,000 100

Application of Funds
Fixed Capital 75,000 60%

Add Working Capital 50,000 40% 13

Total Net Assets Owned 1,25,000 100

 Common Size Income Statement
Particulars Amt %
Net Sales 3,17,250 100

Less: Cost of Good Sold 1,77,750 56.02

Gross Profit 1,39,500 43.97

Less: Operating Expenses

Administration and General Exoenses 23,000 7.24

Selling Overheads 90,000 28.36
Total Operating Expenses 1,13,000 35.61
Net Operation Profit 26,500 8.35
Add: Non-Operating Profit
Other Income 3000 0.94
Less: Non-Operating Expenses

Loss on Sale of Investment 12,000 3.78

Net Profit before Tax 17,500 5.51
Less: Tax 8,500 2.67 14

Net Profit After Tax 9000 2.83

 Advantages
 It reveals the sources of funds and the
application of the total funds in the assets
of a business enterprise.
 It indicates the changing proportion of the
assets, liabilities, costs etc.
 It assists corporate evaluation and
ranking.

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 Disadvantages
 Do not show variation in various item from
time to time
 If it is not prepared on a consistent basis
comparative study will be misleading.
 It does not establish any relationship
between items in profit and loss account
with that of items of balance sheet

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 3. Trend Analysis – overview
 What is trend analysis?
 Advantages of trend analysis
 Disadvantages of trend analysis
 Example of trend analysis
 Comments derived from trend analysis.

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 What is Trend Analysis
 Also termed as trend percentage.

 Used for comparing financial statements

over a number of years.

 At least 3 years data required.

 Base year
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 Trend analysis
 Each base year item taken as 100.

 Upwardtrend will be indicated by the trend

% being more than 100.

 Downward trend % will be indicated by the

trend% being less than 100.

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particulars 02 Rs. 02 % 03 Rs. 03 % 02 Rs. 04 %

sources of funds
1)Net worth 4 100 7.2 180 10.2 255
2)Borrowed funds
Debentures 4 100 3 75 2 50
Total loan funds. 4 100 3 75 2 50

Total capital employed 8 100 10.2 128 12,2 153

Application of funds.
Fixed assets 1.6 100 2.4 150 3.2 200
Less:Depreciation prov. 0.6 100 0.9 150 1.5 250

Net fixed assets. 1 100 1.5 150 1.7 170

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particulars 02 Rs. 02 % 03 Rs. 03 % 02 Rs. 04 %
Working capital
2) Current assets
Quick assets
Debtors 4.5 100 5.4 120 7.2 160
Bank 1 100 0.8 80 1.1 110
Total Q.A 5.5 100 6.2 113 8.3 151

Non quick assets

Stock 3 100 3.6 120 4.2 140
St advances 1.5 100 2.2 147 1.9 127
Total non quick assets 4.5 100 5.8 129 6.1 136
Total C.A 10 100 12 120 14 144
less C. L 3 100 3.3 110 3.9 130
Working capital 7 100 8.7 124 10.5 150

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 Comments/derivations
 Company reliance on borrowed funds has
declined whereas the dependence on owned
funds has increased which can be revealed by
80%.
 The company has gone for an expansion
program which is reflected by addition to the
Fixed assets which has increased by 50% in the
year 2003 and 70% in 2004 compared to the
base year calculated on net Fixed Assets.

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 Comments/derivations
 Due to increase in Fixed Assets there is
also an additional requirement of working
capital in order to mobilize the Fixed
Assets which is reflected by 24% in the
year 2003 and 50% increase in the year
2004 compared to the base year.

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 Advantages
 Indicates the direction of movement of
financial performance of the company.
 Indicated the increase or decrease in an
accounted item.
 Shows the magnitude change , hence
more effective than regular data.
 An efficient method to showcase the
financial performance of a company over a
period of time.
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 Disadvantages
 Any 1 trend by itself does not show the
true picture.
 Trend percentages without absolute data
reference tend to be absurd.
 Comparison of trend meaningless if
accounting practices change during the
years.
 The base year selected may not be
normal or typical.
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Cash Management

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 Motives for Holding Cash:
 Transaction motive- Holding of cash to finance
routine transactions occurring during ordinary
course of business
 Precautionary motive- Holding of cash for
unpredictable circumstances E.g: Floods,
increase in cost of raw materials etc.
 Speculative motive- Take advantage of
unexpected opportunities E.g: making purchase
at favorable prices
 Compensating motive- Banks use the minimum
balance in accounts to compensate themselves
for the services rendered to the business firm
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 Cash Management Models:
• Baumol’s Model: EOQ management of cash
C= sqrt (2FT)
I
where, C= Optimal transaction size
F= Fixed Cost per transaction
T= Estimated cash payments
during the period
I= Interest on marketable securities per
annum
Limitation- Too much uncertainty when trying to
predict what the return will be.
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 2. Miller- Orr Model:

 Upper Control Limit (UCL)- Marketable securities

are bought- Decided with the help of a formula
 Lower Control Limit (LCL)- Marketable securities
are sold- Decided by management

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UCL= 3RP- 2LCL

where, RP= Return Point

RP= 3 sqrt(3bδ2)
4I

where, RP= Return Point

b= Fixed Cost per order for converting marketable
securities into cash
I= Daily interest on marketable securities
δ2= Standard Deviation – Variance of daily changes
in expected cash balance

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Objectives of Cash Management:
 Meet cash disbursement needs
 Minimize funds held in the form of cash balance
 To prevent bankruptcy
 Good relation with bank, trade creditors and
suppliers
 To lead strong credit rating
 To meet unexpected cash expenditure
 To maintain balance level

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 Cash Budget:
 It is a statement showing the estimated cash
inflows over a period of time.
 It shows the net cash position (surplus or
deficiency) of a firm as it moves from one
budgeting period to another.
 It is a device to help a firm plan and control the
use of cash.

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 Various purposes of Cash
Budget:
 To co-ordinate the timings of cash needs
 It pinpoints the period when there is likely to be
excess cash
 Enables a firm to take advantage of cash
discounts on its accounts payable, pay
obligations when due, formulate a dividend
policy etc
 Helps arrange needed funds on the most
favorable terms
 Prevents accumulation of funds

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 Proforma of a Cash Budget:
Particulars Month 1 Month 2 Month 3

Opening Balance xxxx xxxx xxxx

Receipts:
(1) Cash Sales xx xx xx
(2) Collection from Debtors xx xx xx
to credit sales
(3) Income from xx xx xx
Investments
(4) Any other Cash xx xx xx
Receipts
Total receipts including xxxx xxxx xxxx
Opening Balance (A)

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 Contd…

Payments:

(1) Cash Payments xx xx xx

(2) Suppliers (Creditors) for xx xx xx

earlier credit purchases
(3) Other Cash Expenses xx xx xx

Total payments (B) xxxx xxxx xxxx

Closing Balance (A-B) xxxx xxxx xxxx

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CASH CYCLES

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 Meaning
 The cash conversion cycle is the number of days
between paying for raw materials and receiving the cash
from the sale of the goods made from that raw material.

Inventory Period A/Cs Receivable period

Day 0 : Purchase Day X : Cash Day Y : Sell Day Z :

stock on credit paid for stock finished goods Cash
on credit received
A/Cs Payable period

CASH CYCLE

CASH CYCLE = Y + Z - X
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 Significance
 A short cash conversion cycle is a sign of good working
capital management.
 Conversely, a long cash conversion cycle indicates that
capital is tied up while the business waits for customers
to pay.
 It is quite possible for a business to have a negative cash
conversion cycle.
 E.g.- Dell Computers in 2005

Inv. period A/Cs receivable

Cash Cycle =
- 41 days 4 30
X Y Z
(4 + 30 – 75)
A/Cs payable period
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 Concept of Float
 Itis the difference between the available
balance and the book or ledger balance.
 Disbursement float
 Collection float
 Plays an important role in the 2 types of
cash cycles viz. Disbursement & Receipt
cycles

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 Disbursement cycle
 Itis the total time between when an obligation
occurs and when the payment clears the bank.
Activity Day

Obligation to supplier 0
Invoice from supplier 10
Send cheques 25
FLOAT
Payment clears the bank 35

 Totalcycle time = 35 days

 Main objective is to increase the cycle time.

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 Methods of delaying payments
 Increasing Mail floats by mailing cheques
from locations not close to parties.

 Increasing
Clearance float by disbursing
cheques from a remote bank.

 Increasing Processing float by purchasing

with credit cards.
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 Receipt cycle
 It is the total time between products /services are
delivered and when payment from the customer
clears the bank.

Activity Day
Begin services to customer 0
Issue Invoice to customer 30
Receive payment FLOAT 62
Payment clears the bank 66

 Total cycle time = 66 days

 Main objective is to shorten the cycle.
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Methods to shorten overall cycle
 Invoicing customer as soon as possible and monthly
reminders.

 Evaluating financial soundness of customers before

extending credit.

 Rewarding early payments with discounts

 Shorten Collection float

 Lock boxes
 Concentration banking

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 Marketable Securities
 Short term investment instruments.

 Theycan be easily converted into cash in

a short period of time.

 Characteristics
A ready market and safety of principal
 Little or no loss in the value over time

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 Selection Criteria
 Financial Risk –
Uncertainty of the expected returns from a marketable
security.

 Interest Rate Risk –

Uncertainty of the expected returns from a marketable
security attributable to changes in interest rate.

 Taxability –
Market yields are affected because of different tax
structures with different market securities.
eg – municipal bonds are tax free

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 Selection Criteria
 Liquidity

Ability to transform a security into cash in no

time.

 Yield

Affected by all the four factors. If a given risk is

assumed, such as lack of liquidity, then higher
yield may be expected.

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 Types of Marketable Securities
 Term deposit with scheduled bank
Banks accept deposit for periods ranging from
15 days to 5 years.
interest rate varies from 5% - 8.5%

 Treasury Bills

Short term obligations of the government, which

have maturities like 91, 182, 364 days. It is sold
at discount and redeemed at par.

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 Types of Marketable Securities
 Certificate of deposits
Negotiable receipt of funds deposited with the
bank with a fixed rate of interest. They can be
transferred from one party to another.
 Commercial Papers

Short term unsecured promissory note with fixed

maturity period issued by leading, nationally
reputed credit worthy and large business firms to
raise cash.

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 Types of Marketable Securities
 Mutual Fund Scheme –
A financial intermediary ... investment objective.
It accepts small amounts from small investors
and further invests in huge securities.

 Inter-corporate deposits
Short term deposit with other companies.
It has high degree of risk and also it takes one
month to convert them into cash.

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 Types of Marketable Securities
 Billsdiscounting
Seller discounts the bill with the bank and the
bank releases the funds to the seller.

 Ready forward deal

A commercial bank or some organization may do
a ready forward deal with a company interested
in deploying surplus funds on short term basis.

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 Types of Marketable Securities
 Gilt-
edged Securities
Most government securities bong are gilt edged
securities because of less risk involved. Their
returns are lower than other forms of investment.

 Municipal Bonds
Bonds raised by municipal bodies of local
government for financing core urban
infrasturucture facilities like drinking water.
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THANK YOU

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