FINANCIAL ACCOUNTING FOR

MANAGERS
WHAT IS ACCOUNTING ?
 Accounting is the language of business
 Accounting is an Information System
a) For Insiders
b) For Outsiders
 Accounting provides reports to
stakeholders about the economic
activities and condition of a business
WHAT IS ACCOUNTING ?
 Accounting refers to measurement of
economic events and summarising and
reporting them in the form of financial
statements for use by the stakeholders
i.e. bankers, creditors, shareholders,
public and Govt. Reporting is thus the
end function of accounting
BRANCHES OF ACCOUNTING
 Financial accounting is the
preparation and communication of
financial information mainly for those
outside the organisation
 Management Accounting is the
preparation and communication of
financial and other information for the
internal use of management
 Cost Accounting is the collation of
data for inventory valuation
CONCEPTUAL FRAMEWORK
 Purpose
The purpose is to create a base for
financial statements and provide
assistance to :
1. Preparers
2. Auditors
3. Users
4. The Accounting Standards Board of
the ICAI
 COMPONENTS OF
FINANCIAL STATEMENT
 Balance Sheet
 Income Statement
 Cash Flow Statement
 Notes to Accounts and Accounting Policies
OBJECTIVE OF FINANCIAL
STATEMENTS
 To provide information about the financial position,
performance and cash flow of an enterprise
 However they do not provide all the information because
 1.They largely portray the financial effects of past events
 2.They do not provide information of non-financial nature
 Financial Position
 Economic Resources
 Financial Structure
 Liquidity and solvency
 Performance
 Cash Flows
USERS OF FINANCIAL
STATEMENTS
 Present and Potential Investors
 Employees
 Lenders
 Security Analysts and Advisers
 Suppliers and Creditors
 Customers
 Governments and Regulatory agencies
 Public
 Management
 Assumptions Underlying
Preparation of Financial
Statements
 Accrual Basis: The effects of transactions and
other events are recognised when they occur
and reported in the financial statements of the
period to which they relate
 Going Concern: The enterprise will continue for
a forseeable future and has no intention to
liquidate or curtail its operation materially.
 Consistency: The accounting policies are
followed consistently from year to year.
Qualitative characteristics of
Financial Statements
 Understandability
 Relevance
 Materiality
 Reliability
-- Faithful representation
-- Substance over form
-- Neutrality
-- Prudence
-- Completeness
-- Comparability
Financial Position
 Assets --- Assets are the resources controlled
by an enterprise as a result of past events,
from which future economic benefits are
expected to flow to the enterprise.
 Liabilities – Liabilities are the present
obligations of the enterprise ,arising from
past events, the settlement of which is
expected to result in an outflow of resources
embodying economic benefits.
 Equity – Equity is the residual interest in the
assets of the enterprise after deducting all its
liabilities.
ACCOUNTING EQUATION
The relationship among asset , liability
and equity can be expressed by the
following equation
Assets = Liabilities + Owner’s Equity
The effect of all business transactions is
reflected in this equation.
Elements of Financial Statements

 Financial Position
-- Assets
-- Liabilities
--Equity
. Performance
-- Income
-- Expenses
. Cash Flows
Characteristics
 Assets
1. They represent potential to contribute , directly or
indirectly, to the flow of cash or cash equivalents to
the enterprise.
2. Physical form not essential to the existence of the
asset.
3. Legal right of ownership not essential in establishing
the existence of asset.
4. Purchasing or producing not always essential to
obtain asset.
5. Expenditure incurred for seeking future economic
benefits may not result in asset.
Characteristics
 Liabilities
1. It’s a present obligation to be settled
in future
2. Obligations may be due to a binding
contract or statutory requirement
3. A present obligation and a future
commitment differ from each other
4. Careful estimates are required to
measure provisions.
Characteristics
 Equity
1. It is dependent on the measurement
of assets and liabilities
2. A change in net assets results in a
change in the equity
PERFORMANCE
 Elements:
1. Income :- It represents the increase in
economic benefits in the form of
increase in assets or decrease in
liabilities
2. Expenses:- It represents decrease in
economic benefits in the form of
outflows or depletion of assets or
increase in liabilities ( Expense vs.
Characteristics
 Income;
1.Both revenue and gains
2. Revenue arises in the ordinary course
of business
3.Gains may or may not arise in the
ordinary course of business
Characteristics
 Expenses
1. It includes both expenses and losses.
2. It arises in the ordinary course of
business.
3. Losses may or may not arise in the
ordinary course of business.
RECOGNITION

 Condition for Recognition

1. It is probable that future economic
benefits will flow to or from the
enterprise.
2. The item can be measured reliably.
MEASUREMENT
 Historical Cost
 Current Cost
 Realisable Value
 Present Value
Accounting Concepts
 Dual Aspect Concept
 Business Entity Concept
 Accrual Concept
 Cost Concept
 Money Measurement Concept
 Realisation Concept
GAAP
 Conceptual Framework of Financial
Statements
 Accounting Concepts
 Requirements of Companies’ Act
 Accounting Standards
 Requirements of Income Tax Act
Requirements of Companies
Act
 Books of Accounts ( Sec.209 )
1. All sums of money received and
expended by the company
2. All Sales and Purchases of goods by
the company
3. All assets and liabilities of the
company
4. Cost records in case of companies
engaged in production, manufacturing
, processing, mining activities
Requirements of Companies
Act
 Annual Accounts ( Sec.210 )
1. A balance sheet and
2. A profit and loss account at every AGM
Form and Contents
1. Balance sheet to exhibit true and fair view of the
state of affairs of the company and to comply with
part I of schedule VI
2. Profit and loss account to give a true and fair view
of the profit and loss of the company and to
comply with part II of schedule VI
3. Every balance sheet and Profit and loss account to
comply with accounting standards
Requirements of Companies
Act
 Company not complying with AS to
disclose
1. Deviation from AS
2. Reasons for such deviation
3. Financial effect
ACCOUNTING STANDARDS
 Accounting Standards Board
 Applicability of AS
 Scope of AS
 Details of AS
 Authority attached to AS
Requirements of Income Tax
Act
 I.T. Act allows both cash as well as
mercantile system of accounting
 Companies Act allows only mercantile
system of accounting
ACCOUNTING PROCESS
 Documentation
 Recording
 Classifying
 Summarising
ACCOUNTING PROCESS
 Account :- An account is an individual record
of increases or decreases in an item that is
likely to be of interest or importance.
 Ledger :- It is a book which contains
accounts.
 Journal :- The journal is a chronological
record of transactions entered into by a
business.
CLASSIFICATION OF ACCOUNTS
ACCORDING TO NATURE
 Personal account :- Accounts of persons
or firms with whom the firm enters into
transactions. It includes both natural
persons’ accounts and artificial persons’
accounts.
 Real account :- Accounts of properties
under the control of the firm.
 Nominal account :- Accounts of revenue
, gains, expenses and losses.
PRINCIPLES OF DEBIT AND
CREDIT
 Personal account:-Debit the receiver
credit the giver
 Real account:-Debit what comes in
credit what goes out
 Nominal account:-Debit all expenses
and losses credit all incomes and gains
 THE ACCOUNTING CYCLE
To record opening entries in the general ledger

To record transactions and events in the journal

To post journal entries in appropriate accounts in the general ledger

To balance the accounts in the general ledger

To prepare the trial balance

To pass adjustment entries

To prepare the revised trial balance

To pass closing entries to prepare financial statements

TYPES OF JOURNALS
 Purchase Day Book
 Sales Day Book
 Purchase Return Book
 Sales Return Book
 Cash Book
 Journal Proper
MATCHING PRINCIPLE
 Revenues have to be matched and
correlated with all the expenses of a
particular year
 In other words , profit is determined
after charging the expenses of a period
with the revenues earned in the same
period
PRINCIPLE OF
CONSERVATISM
 This principle requires the accountants
not to anticipate gains but to provide
for all possible losses
 Example : “Lower of cost or market
price” policy is adopted while valuing
inventory.
MATERIALITY

 Information is material if its

misstatement could influence the
decisions of users taken on the basis of
financial statements
 Materiality depends on the size and
nature of the item or error
 It is necessitated by practicability and
feasibility
ADJUSTMENT PROCESS
 Why Adjustment Is Necessary ?
It ensures that revenues and expenses are
recorded or recognised in the period to
which they relate to.
1. It affects both Balance Sheet and Income
Statement .
2. It never affects the cash account.
3. Adjustments are required when transactions
affect revenue and expense of more than
one accounting year.
ADJUSTMENT PROCESS
 Adjusting Entries Result In:
1. Deferral : A deferral is a delay in the
recognition of an expenditure or of a
revenue already received
2. Accrual : An accrual is the recognition
of an expense that has not been paid
or of a revenue that has not been
received
Trial Balance
Features
 Closing balances of accounts in the
ledger as well as cash balance are taken
 It tests the arithmetical accuracy of
ledger balances
 It can be prepared monthly, quarterly
and yearly
 It is a source document for preparing
financial statement
CLOSING ENTRIES
 STEPS
1. Transfer balances in revenue accounts
to the Profit & Loss account
2. Transfer balances in the expense
account to the Profit & Loss account
3. Transfer balances in the Profit & Loss
account to Profit & Loss Appropriation
account
Balance Sheet
 Asset side
Items under Fixed Asset
1. Land
2. Building
3. Plant and Machinery
4. Furniture and Fixture
5. Vehicles
Balance Sheet
 Investment
1. Investment in govt. securities
2. Investment in shares ,debentures and
bonds
3. Investment in immovable properties
4. Investment in the capital of
partnership firms
Balance Sheet

 Current Assets, Loans, and Advances

Current Assets
--- Inventories
--- Sundry debtors
--- Cash and bank balances
Loans and Advances
--- Advances recoverable in cash or in kind or for value
to be received
---Advance income tax
--- Advance deposit of sales tax and excise
--- Inter-corporate deposits
BALANCE SHEET
 Miscellaneous Expenditure
 Debit balance in Profit and Los account
Balance Sheet
 Liabilities side
Share Capital
--- Equity Share Capital
--- Preference Share Capital
Reserves and Surplus
--- Capital reserves
--- General reserve
--- Capital redemption reserve
--- Debenture redemption reserve
Balance Sheet
 Loan Funds
Secured Loans
-- Term Loans
-- Debentures
--Working capital loans
Unsecured Loans
-- Fixed deposits
--Debentures
--Security deposits
Balance Sheet
 Current Liabilities and Provisions
Current Liabilities
--- Sundry Creditors
--- Expenses Payable
--- Advances from customers
--- Unclaimed dividends
--- Interest accrued but not due
Provisions
--- Provision for taxation
--- proposed dividend
--- provision for contingencies
PROFIT & LOSS ACCOUNT
 Domestic Sales
 Exports
 others
PROFIT AND LOSS ACCOUNT
 Expenditure
--- Materials Consumed
---Salaries, wages, bonus
---Staff welfare expenses
---Power and fuel
---Repairs and maintenance
---Rent, rates and taxes
---Freight, transportation
---Travelling exp.
---Interest
---Excise duty
---Depreciation
---Provision for taxation
---Extraordinary items
PROFIT & LOSS ACCOUNT
 Profit After Tax : It is measured as excess of
revenues over expenses.
 Profit & Loss Appropriation Account : From
the PAT following appropriations take place
1. Prov. for dividend to Pref. Shareholders
2. Interim dividend
3. Provision for final dividend
4. Prov. for Corp. dividend tax
5. Transfer to general reserve, debenture
redemption reserve
CASH FLOW STATEMENT
 Features
1. Prepared for a given period
2. Comparative position for each element of
cash flow is given.
3. Cash inflows and outflows for operating ,
investing and financing activities are
disclosed.
4. It shows the reconciliation between opening
and closing cash balances.
5. It’s a derived statement.
CASH FLOW STATEMENT
 Operating Activity – The principal revenue
producing activity
 Investing Activity– Refers to acquisition and
disposal of long-term assets and other
investments
 Financing Activity– Those activities that result
in changes in the size and composition of the
owners’ capital including preference capital
CASH FLOW STATEMENT
 Operating Activities
1. Cash receipts from sale of goods or
services
2. Cash receipts from royalties, fees,
commission
3. Cash payments to suppliers,
employees
4. Cash payments or refunds of income
tax
CASH FLOW STATEMENT
 Investing Activities
1. Cash payments to acquire fixed assets
2. Cash receipts from disposal of fixed asset and
intangibles
3. Cash payments to acquire shares, warrants or debt
instruments
4. Cash receipts from disposal from shares, warrants
or debt instruments
5. Cash advances and loans made to third parties
6. Cash receipts from the repayment of advances and
loans made to third parties
CASH FLOW STATEMENT
 Financing Activities
1. Cash proceeds from issue of shares,
debentures, loans, bonds
2. Cash repayments of amount borrowed
VALUATION OF INVENTORIES
 Meaning of Inventories
Inventories consist of assets held :
a) For Sale ( finished goods )
b) In the process of production for such sale (
raw material and W.I.P )
c) In the form of materials or supplies to be
consumed in the production process (
stores, spares, consumables, raw material)
VALUATION OF INVENTORIES
 Applicability
AS-2 does not cover the following
1. W.I.P arising under construction
contract
2. W.I.P arising in case of service
providers
3. Shares, debentures, bonds held as
stock-in-trade
4. Livestock, agricultural and forest
VALUATION OF INVENTORIES
Valuation Policy
Inventories are valued at lower of cost
or net realisable value
NRV means estimated selling price minus
estimated costs of completion and costs
necessary to make the sale
VALUATION OF INVENTORIES
 Cost of Inventory includes---
1. Cost of purchase
2. Cost of conversion
3. Other costs incurred in bringing the
inventories to their present location
and condition
VALUATION OF INVENTORIES
 Exclusion of certain costs
1. Abnormal amounts of wasted
materials, labour, other production
costs
2. Storage cost
3. Administrative overhead
4. Selling and distribution cost
5. Interest and borrowing cost
VALUATION OF INVENTORIES
 Cost Formulas
1. Specific Identification Method :--
It means directly linking the cost with
specific item of inventories
2. FIFO ( First In First Out ) or
Weighted Average cost
Where specific identification method is not
applicable the cost of inventories is valued
by either of the above two formulas.
FINANCIAL REPORTS
A Company’s annual report contains the
following :
1. Auditors’ Report
2. Directors’ Report, and
3. Corporate Governance Report
FINANCIAL REPORT
Auditors’ Report
Sec. 227 of the Companies’ ACT requires the auditor :
1. To make a report to the members on the accounts examined
by him, and on every balance sheet and profit and loss
account and on every other document forming part of B/S
and P/L
2. To express an opinion whether the accounts
a) give the information required by the Companies’ Act in the
manner so required
b) give a true and fair view
1. In the case of balance sheet, of the state of affairs
of the company
2. In the case of profit and loss account, of the profit or loss
for the financial year
FINANCIAL REPORT
Auditors’ Report
3. The report shall also state :
a) Whether all the information and explanations were
obtained for the purpose of audit
b) Whether proper books of account as required by
law have been kept and whether adequate reports
from branches not visited by him have been received
c) Whether the B/S and P/L are in agreement with
the books of account
d) Whether the B/S and P/L comply with the
accounting standard
e) Whether any director is disqualified u/s 274
FINANCIAL REPORT
 Directors’ Report (sec. 217)
The report shall state :
1. The state of the company’s affairs
2. The proposed amount of transfer to any
reserves
3. Amount recommended for dividend
4. Material changes taken place between the
end of financial year and the date of report
5. Conservation of energy, technological
absorption, foreign exchange earnings and
outgo
FINANCIAL REPORT
 Directors’ Responsibility Statement
It shall state the following:
1. All relevant accounting standards have been
followed in the preparation of annual accounts
2. The directors have selected proper accounting
policies and applied them consistently and made
reasonable judgments and estimates so as to give
a true and fair view of the state of affairs
3. The directors have taken proper and adequate care
for maintenance of accounting records and
safeguarding of assets and preventing and
detecting fraud
4. The accounts have been prepared on a going
concern basis
 FINANCIAL REPORT
 The directors’ report shall further include
1. Information and explanation on every qualification, or
adverse remark in the auditors’ report
2. Reasons for delay in completing buy-back process
3. a) A statement showing name of employees who are in
receipt of Rs. 24 lacs or more per annum, if employed
throughout the year
b) If employed for part of the year Rs.2 lacs per
month
c) If employed throughout or part of the year, was in
receipt of remuneration in excess of that drawn by
M.D. or whole-time director or manager and holds by
himself or together with spouse not less than 2% of
equity shares of the company
 FINANCIAL REPORT
Corporate Governance Report
Objectives:-
1. To protect the interest of small investors
2. To promote transparency within business
and industry
3. To develop a high level of public
confidence through increase in
shareholders’ wealth
FINANCIAL REPORT
 Corporate Governance : Clause 49
Audit Committee:-
1. It shall have minimum three members, all
being non-executive directors
2. At least one director should have financial
and accounting knowledge
3. The chairman of the committee shall be an
independent director
4. The company secretary is the secretary of
the committee
FINANCIAL REPORT
 Audit committee
5. The Chairman shall be present at AGM
to answer shareholders’ queries
6. At least three meetings should be held
in a year
7. Quorum is either two members or one
third of the members of the
committee w.e. is higher and
minimum of two independent directors
FINANCIAL REPORT
 Powers of the Audit Committee
1. To investigate any matter within its
area of activity
2. To seek information from any
employee
3. To obtain legal or professional advice
FINANCIAL REPORT
 Role of Audit Committee
1. To review the financial reporting process and to
ensure that the financial statement is correct
2. Recommending the appointment and removal of
external auditor and their fees
3. To review the financial statements before
submission to the board in order to ensure
compliance with accounting standards
4. To review the internal audit function and the
adequacy of internal control system
5. To discuss any significant findings by the I.A.
6. To look into the reasons for default in the payment
to the depositors, debenture holders, shareholders
FIXED ASSETS ACCOUNTING
 Meaning and Significance of Fixed Assets
1. Fixed assets are used for production or
providing goods or services
2. They are not meant for resale in the
ordinary course of business
3. They constitute a significant portion of total
assets
4. Proper allocation between revenue and
capital expenditure necessary to recognise
and measure fixed asset
FIXED ASSETS ACCOUNTING
 Cost of Fixed Assets
1. Purchase price inclusive of import duties less trade
discount, rebates
2. Any directly attributable cost incurred to bring the
asset to its present working condition
3. Admin. and general overhead charges specifically
attributable to construction of a project
4. Cost to be adjusted for exchange fluctuation
5. If acquired in exchange for another asset , the cost
is recorded either at FMV or net book value of the
asset given up
FIXED ASSETS ACCOUNTING
 Cost of fixed assets is affected by two
following factors

1. Government grants
2. Borrowing costs
FIXED ASSETS ACCOUNTING
 Accounting for Govt. grants
Grants related to specific asset
1. The grant is shown as a deduction from the
gross value of asset. Where the grant
equals the entire cost of the asset , the
asset is shown at a nominal value
2. A) Grants related to depreciable asset are
treated as deferred income
B) Grants related to non-depreciable asset
are credited to capital reserve
FIXED ASSETS ACCOUNTING
 Borrowing costs
Borrowing costs are interest and other costs incurred
relating to borrowing of funds. Borrowing costs
attributable directly to the acquisition or
construction of fixed asset are capitalised.
Conditions for capitalisation
1. Borrowing costs are incurred
2. Activities essential to prepare the asset for its
intended use are in progress
3. Expenditure for the acquisition or construction of
asset is incurred
DEPRECIATION
 Definition:- Depreciation is a measure
of the wearing out, consumption or
other loss of value of a depreciable
asset arising from use, effluxion of time
or obsolescence through technology
and market changes.
In other words depreciation is nothing
but distribution of total cost of an asset
over its useful life.
DEPRECIATION
 Significance
1. It represents the charge of a fair proportion
of the depreciable amount to P&L account
over the useful life of an asset.
2. Depreciable amount is the historical cost or
revalued amount of the asset less residual
value.
3. It plays a significant role in determining the
financial performance of an enterprise.
4. It is charged in each accounting year.
DEPRECIATION
 Depreciable Asset means an Asset which
1. Is held by an enterprise for use in the
production or supply of goods and services.
2. Is not meant for resale in the ordinary
course of business.
3. Is expected to be used during more than
one accounting period
4. Has limited useful life.
 DEPRECIATION
Methods of Depreciation
1. Straight Line Method:- Under this method
depreciation is charged equally over the
useful life of the asset.
Formula:
Depreciation =
Cost of asset- Estimated residual value
------------------------------------------------------
Estimated useful life
DEPRECIATION
2. Written down value method:- Under
this method depreciation is charged at a
fixed rate on the reduced balance of the
asset every year.
Rate of Estimated residual
Depreciation = 1- n value
-----------------------
----
Cost of asset
DEPRECIATION
 Requirements of Companies Act
Sec. 205 and 350 deal with depreciation
1. Sec.205 states that no dividend shall be declared or
paid out of profits without providing for
depreciation.
2. Depreciation has to be provided
a) as provided in sec.350, or
b) as arrived at by dividing 95% of the original cost
of the asset by the specified period
3. Sec.350 provides that depreciation has to be charged
as per schedule XIV to the Companies Act.
DEPRECIATION
 Provisions of Income Tax Act
1. Only WDV method is recognised
2. Block of assets method is followed
3. 100% dep. Is allowed if the asset is
used for 180 days or more. 50% dep.
if used for less than 180days
DEPRECIATION
 Consistency Principle
It requires that a method of dep. , once
adopted , should be applied consistently
unless
1. The statute requires the adoption of a new
method.
2. It is required to comply the provisions of an
accounting standard
3. The change is necessary for a more
appropriate preparation and presentation of
the financial statements.
FINANCIAL STATEMENT
ANALYSIS
 Objectives of Analysis
1. To know whether the company is making
enough profit or not
2. To evaluate the financial strength of the
company
3. To judge the ability of the company to
generate enough cash and cash equivalents
and their timing
4. To know the future growth prospects
FINANCIAL STATEMENT
ANALYSIS
 Tools available for analysis
1. Multi-step income statement
2. Horizontal analysis
3. Common-sized analysis
4. Trend analysis
5. Analytical balance sheet
FINANCIAL STATEMENT
ANALYSIS
 Multi-step Income Statement
From the reported statement , it is necessary to
segregate information and break-up of
manufacturing, administrative and selling expenses
which will show the profitability and disclose the
following
a) Gross Profit—GP
b) Profit before depreciation, interest and tax—PBDIT
c) Operating Profit—OP or PBIT
d) Profit before tax and extraordinary items—PBTEOT
e) Profit before tax—PBT
f) Net profit--PAT
FINANCIAL STATEMENT
ANALYSIS
 Horizontal Analysis
The percentage analysis of increase or
decrease in each item of comparative balance
sheet and profit and loss account is known as
horizontal analysis
Formula:
(Current year’s fig.- Previous year’s fig.)*100
-----------------------------------------------------------
-
Previous year’s fig.
FINANCIAL STATEMENT
ANALYSIS
 Common-sized Analysis
1. The tool is useful in comparing the
performance and financial position of two
companies within the same industry or in
different industries
2. In case of balance sheet , each item is
restated taking the total sources of fund or
application of fund as 100
3. Similarly, in case of income statement, all
items are expressed as a percentage of net
sales which is taken at 100
FINANCIAL STATEMENT
ANALYSIS
 Analytical Balance Sheet
1. It is a modified version of vertical balance sheet
2. It starts with ‘Application of funds’ side as against
the vertical balance sheet that starts with ‘Sources
of Funds’ side
3. It proves the basic accounting equation : Assets -
outside liabilities= Owners’ Funds
4. It shows that equity shareholders are the residual
claimants on the assets of the company
FINANCIAL STATEMENT
ANALYSIS
 Trend Analysis
1. It is an extension of horizontal
analysis
2. Unlike in horizontal analysis, trend
analysis compares position for more
than two years, say, five years
3. Analysis for a longer period confirms
the findings of horizontal analysis
FINANCIAL STATEMENT
ANALYSIS
 Ratio Analysis:
Ratio refers to relationship between two
variables expressed either in percentages
or in multiples and seeks to establish the
cause and effect relationship.
It assists in the following cases
1. Inter-firm comparison
2. Intra-firm comparison
3. Comparison against industry benchmark
4. Analysis of performance over a long period
FINANCIAL STATEMENT
ANALYSIS
 Classification of Ratios
1. Return on Investment ( ROI ) ratios
2. Solvency ratios
3. Liquidity ratios
4. Efficiency or Turnover ratios
5. Profitability ratios
6. Du Pont Analysis
7. Capital Market ratios
FINANCIAL STATEMENT
ANALYSIS
 Return on Investment (ROI) ratios
This ratio seeks to measure the efficiency of
performance or otherwise of the company.
Higher the ratio, greater is the financial
security for investors. Maximisation of ROI
is the ultimate objective of any company.
Under this group, the following ratios are
computed
1. Return on Net Worth
2. Earnings per Share
FINANCIAL STATEMENT
ANALYSIS
 Return on Net Worth (RONW)
The ratio measures the net profit earned on
equity shareholders’ funds. It is the measure
of overall profitability of a company.
Formula:
(PAT-Pref.dividend)*100
-----------------------------------------------------------
Net Worth (Equity capital + Reserves & Surplus-
Misc. expenditure not written off)
FINANCIAL STATEMENT
ANALYSIS
 Earning per Share ( EPS)
The ratio measures the overall
profitability in terms of per equity share
of capital contributed.This is the most
widely used ratio across industries.
Formula:
PAT-Pref.Dividend
---------------------------------------------------
--------
Weighted average no. of equity shares
 FINANCIAL STATEMENT
ANALYSIS
 Solvency Ratios
The capacity of a company to discharge its
long-term obligation indicates its financial
strength and solvency position.
Under this group, the following ratios are
computed.
1. Debt-Equity ratio
2. Interest coverage ratio
3. Debt-service coverage ratio
FINANCIAL STATEMENT
ANALYSIS
 Debt-Equity ratio ( times )
The ratio measures the proportion of debt and capital –
both equity and preference in the capital structure of
a company. It helps in knowing whether a company
is relying more on debt or capital for financing its
assets. Higher the debt , more is the financial risk.
Formula:
Long term debt
-------------------------------------------------------------------
Total net worth( Eq. shareholders’ funds+Pref. cap)
FINANCIAL STATEMENT
ANALYSIS
 Interest Coverage Ratio ( times )
The ratio measures the ability of a company to
service the interest obligations out of its cash
profits. Higher the ratio, greater is the ability.
Formula:
PAT+Int. on long-term debt+Non-cash charges
-----------------------------------------------------------
Interest on long-term debt
FINANCIAL STATEMENT
ANALYSIS
 Debt Service Coverage Ratio (times)
This ratio helps in assessing whether a
company has the ability to service its
instalments of the principal due and the
interest obligations out of the revenues
generated. Higher the ratio, greater is the
ability.
Formula:
PAT+Int. on long term debt+Non-cash charges
-----------------------------------------------------------
------
FINANCIAL STATEMENT
ANALYSIS
 Liquidity Ratio
Liquidity refers to the capacity a company to
meet its day to day expenses and discharge
short-term obligations of suppliers and
other creditors smoothly.
Following ratios are calculated under this head.
1. Current Ratio
2. Quick Ratio
3. Collection period
4. Suppliers Credit
5. Inventory Holding period
FINANCIAL STATEMENT
ANALYSIS
 Current Ratio ( times )
The ratio measures the ability of a company to
discharge its day to day obligations. A company
should possess adequate level of current assets over
current liabilities to be able to do so. A current ratio
of more than 1 indicates that value of short-term
assets is more than short-term liabilities. A current
ratio of less than 1 indicates poor liquidity.
Formula:
Current Assets, loans and advances+short-term

Investments
--------------------------------------------------------------------
-----------
Current Liabilities+Provisions+Short-term debt
FINANCIAL STATEMENT
ANALYSIS
 Quick Ratio ( times )
The ratio measures as to how fast the company is able
to meet its current obligations as and when they fall
due. This is also known as acid-test ratio. Inventory
and working capital limits are taken out of current
assets and current liabilities respectively. A quick ratio
of 1: 1 is indicates highly solvent position.
Formula:
Current Assets, Loans and Advances-Inventories
--------------------------------------------------------------------
Current Liabilities+Provisions-Working Capital Limits
FINANCIAL STATEMENT
ANALYSIS
 Collection Period ( days )
The ratio measures how fast the company is
able to realise the dues from the customers
on credit sales. It helps to understand the
credit policy of the company.
Formula:
Receivables *365
---------------------------
Credit sales
FINANCIAL STATEMENT
ANALYSIS
 Suppliers’ Credit ( days )
The ratio measures the average credit period
enjoyed by the company from its suppliers. It
also helps to understand the credit policy
extended to a company by the suppliers.
Formula:
Payables*365
----------------------
Credit Purchases
FINANCIAL STATEMENT
ANALYSIS
 Inventory Holding Period( days )
The ratio measures the average period for
which cash is blocked in inventory. In other
words the ratio explains how fast the
company is able to convert its inventory into
cash.
Formula:
Inventory*365
--------------------
Cost of goods sold
FINANCIAL STATEMENT
ANALYSIS
 Turnover Ratios
These ratios indicate how efficiently the assets
of the company are used to generate
revenue .
Following ratios are calculated under this group.
1. Overall Efficiency Ratio
2. Fixed Assets Turnover Ratio
3. Debtors Turnover Ratio
4. Inventory Turnover Ratio
5. Creditors Turnover Ratio
FINANCIAL STATEMENT
ANALYSIS
 Overall Efficiency Ratio ( times )
It shows how effectively the capital
employed has helped in revenue
generation. Higher the ratio greater is
the efficiency.
Formula:
Sales
----------------------------------------------
Capital Employed
FINANCIAL STATEMENT
ANALYSIS
 Fixed Assets Turnover Ratio ( times )
The ratio measures the sales revenue per
rupee of fixed assets. It plays an
important role in improving the overall
profitability and financial position of the
company.
Formula :
Sales
------------------------------------------------
Net Block of Fixed Assets
FINANCIAL STATEMENT
ANALYSIS
 Debtors Turnover Ratio ( times )
It represents the number of times
average dues from customers are
realised. Higher the ratio, the better is
the position.
Formula:
Credit Sales
-------------------------------------------------
Average Debtors
 FINANCIAL STATEMENT
ANALYSIS
 Creditors Turnover Ratio ( times )
The ratio shows the average time taken to pay
for goods and services. Longer the credit
period achieved the better.
Formula:
Credit Purchase
----------------------------------------------------
Average Creditors
FINANCIAL STATEMENT
ANALYSIS
 Inventory Turnover Ratio
The ratio measures the amount of capital
tied up in raw material, W.I.P. and
finished goods
Formula:
Cost of Goods Sold
---------------------------------------
Average Inventory
FINANCIAL STATEMENT
ANALYSIS
 Profitability Ratios
The purpose of study of these ratios is to
assess the adequacy or otherwise of the
profit earned by the company. The following
ratios are calculated under this group.
1. Multi-step Profit Margin to Sales
2. Individual Cost and Expense to Sales
3. Other Income , Extraordinary Items and
Prior Period Adjustments to PBT or Sales
4. Effective Tax Rate
FINANCIAL STATEMENT
ANALYSIS
 Multi-step Profit Margin to Sales Ratios(%)
These ratios measure several profit margin indicators.
All these ratios are computed in relation to Sales.
1. Gross Profit Margin-GP
2. Profit Before Depreciation, Interest and Tax-PBDIT
3. Operating Profit-OP
4. Profit Before Tax and Extra-ordinary Items-PBTEOT
5. Profit Before Tax-PBT
6. Net Profit Margin-PAT
FINANCIAL STATEMENT
ANALYSIS
 Gross Profit Margin (%)
This reflects the efficiency with which
management produces each unit of output. It
also indicates the spread between the cost of
goods sold and the sales revenue.
Formula:
Sales-Cost of Goods Sold
------------------------------------- x 100
Sales
FINANCIAL STATEMENT
ANALYSIS
 Operating Profit Margin (%)
This ratio indicates profitability from operating
activities. A higher margin implies better sales
realisation and effective cost control.
Formula:
Operating Profit
---------------------- X 100
Sales
FINANCIAL STATEMENT
ANALYSIS
 Net Profit Margin( % )
The ratio is the overall measure of the firm’s
ability to earn profit per rupee of sales. It also
establishes relationship between
manufacturing, administering and selling the
products.
Formula:
Profit After Tax
--------------------- x100
Sales
FINANCIAL STATEMENT
ANALYSIS
 Individual Costs and Expenses to Sales Ratios
(%)
These ratios measure the proportion of
individual items of cost and expense in
relation to sales. They also assist the analyst
in cost minimisation and cost reduction.
Formula:
Raw Materials Consumed
---------------------------------------- x100
Net Sales
FINANCIAL STATEMENT
ANALYSIS
 Other Income, Extraordinary Items and
Prior Period Adjustments to PBT or Net
Sales (%)
These ratios seek to measure the impact
of the above items on PBT or net sales.
Formula:
Extraordinary Item
-------------------------- x 100
PBT
FINANCIAL STATEMENT
ANALYSIS
 Effective Tax Rate(%)
The ratio measures the actual effective
rate at which a company pays income
tax as against the statutory rate.
Formula:
Current Income Tax
---------------------------- x100
PBT
FINANCIAL STATEMENT
ANALYSIS
 DU PONT Analysis
RONW is a function of Net Profit Margin and Net worth
Turnover. DU PONT analysis seeks to measure and
establish this relationship between the two
determinants. Through these ratios a firm can devise
suitable remedies to overcome the weak area of
overall performance.
Formula:
(PAT-Pref. Div)X100 Net Sales
----------------------------X--------------------------------------
Net Sales Net Worth
FINANCIAL STATEMENT
ANALYSIS
 Capital Market Ratios
Following ratios are computed under this
group.
1. EPS
2. Price Earning Ratio-P/E
3. Market Capitalisation
4. Yield to Investors
FINANCIAL STATEMENT
ANALYSIS
 Price Earning Ratio ( times )
P/E multiple is an important indicator of
the premium that the market wishes to
put on a firm’s earnings. It can be used
to price a share and value a firm.
Formula:
Market Price of Equity Share
------------------------------------------
EPS
FINANCIAL STATEMENT
ANALYSIS
 Market Capitalisation (Rs.)
The ratio measures the total market value
of the number of equity shares
outstanding.
Formula:
No. of Equity Shares O/S X Market Price
FINANCIAL STATEMENT
ANALYSIS
 Yield to Investors (%)
The ratio measures the total gain or loss
suffered by investors in relation to their
investment in equity shares of a
company.
Dividend recd.+ Market Appreciation
---------------------------------------------x100
Initial Investment