Class 12-commerce NCERT Solutions Accountancy Chapter 4: Analysis of Financial Statements

Commonly used techniques of Financial Statement Analysis:

1. Comparative Financial Statements
2. Common Size Financial Statements
3. Trend Analysis
4. Ratio Analysis
5. Cash Flow Statement
6. Fund Flow Statement

The above listed techniques can be classified on the following basis:

 A. On the basis of Comparison

1. Inter-firm Comparison
1. Comparative Statement (Balance Sheet, Profit and Loss Account) a
2. Common Size Statement (of the same period)
3. Ratio of Two or More Competitive Firms (of the same period)
4. Cash Flow Statement of Two or More Competitive Firms
5. Polygon, Bar Diagram
2. Intra-firm  Comparison
1. Comparative Statement (Balance Sheet, Profit and Loss Account) a
2. Common Size Statement (of the same period)
3. Ratio of Two or More Competitive Firms (of the same period)
4. Cash Flow Statement of Two or More Competitive Firms
5. Polygon, Bar Diagram
3. Horizontal Comparison
4. Vertical Comparison

B. On the basis of Time

1. Inter-period Comparison
1. Comparative Statement (two or more periods)
2. Cash Flow Statement (two or more periods)
2. Cross Sectional (Intra period) Comparison
1. Common Size Statement
2. Ratio Analysis

C. Horizontal Analysis

1. Time Series
2. Bar Diagram
3. Polygon
4. Comparative Statement
5. Ratio Analysis  

D. Vertical Analysis

1. Common Size Statement
2. Pie Diagram 

Analysis and interpretation refers to a critical and detailed examination of financial statements. The main purpose of analysis and interpretation is to present financial data in a manner which is easily understandable and self-explanatory. This not only helps accounting users to assess the financial performance of the business over a period of time but also helps them in decision making and policy and financial designing process.

Interpretation:

1. Sales of the company has increased by 50% during the year 2013-14, whereas the cost of goods sold has also increased but at a lesser rate. From this, we can conclude that the company has followed an efficient sales strategy, consequent of which the gross profit of the company has increased by 80% compared to the previous year (2012-13).
2. In 2013-14, operating expenses have also increased, but on the contrary, operating profit has increased at a higher rate than the rate of operating expenses.
3. Profit before interest and tax has also increased by 115.38% during these two years. This indicates the improvement in the operating efficiency of the company.

Financial analysis has a vast importance to various accounting users on various matters. Income statements, balance sheets and other financial data provide information about expenses, sources of income, profit or loss and help in examining the financial position of a business. These financial data are of no use until they are analysed. There are various tools and methods to analyse financial data such as ratio analysis and cash flow statements which make financial data to cater to the varying needs of various accounting users. Reasons in favour of financial analysis:

1. It assists in evaluating the profit earning capacity and financial viability of a business.
2. It assists in evaluating the long-term solvency of the business.
3. It helps in evaluating the relative financial status of a firm in comparison to other competitive firms.
4. It helps the management in the decision-making process, drafting various plans and in establishing an effective controlling system.

Financial statements which enable intra-firm and inter-firm comparisons of financial statements over a period of time are called comparative financial statements. These statements help accounting users to evaluate financial progress in relative terms. Comparative financial statements present financial data in a manner that is easily understandable and can be analysed without any ambiguity. Comparative financial statements enable meaningful comparisons only if the accounting policies and practices for the treatment of the items are the same over the period of study. Two comparative financial statements which are commonly prepared are

1. Comparative Balance Sheet
2. Comparative Income Statement

A common size statement represents the relationship between various items of financial statements and some common items (Net Sales and Total of Balance Sheet) in terms of percentage. Various items of trading and profit and loss account such as cost of goods sold, non-operating incomes and expenses are expressed in terms of percentage of net sales. Likewise, different items of the Balance Sheet such as Fixed Assets, Current Assets, Share Capital etc. are expressed in terms of percentage of Total of Balance Sheet. These percentage figures are easily comparable with those of previous years (i.e. intra-firm comparison) and with the figures of other firms in the same industry (i.e. inter-firm comparison) as well. Analyses based on these statements are commonly known as Vertical Analyses.

Commonly prepared common size statements are

1. Common Size Balance Sheet
2. Common Size Income Statement

Working Notes:

1. Calculation of Net Sales
   Net Sales= Cost of Goods Sold + Gross Profit-Sales Returns
   Or
   Net Sales= Purchase + Manufacturing Expenses + Change in Inventory + Gross Profit - Sales Returns
   Net Sales (2016)=80,000+20,000+30,000+90,000-4,000
   = Rs.2,16,000
   Net Sales (2017)=1,40,000+50,000-60,000-30,000-8,000
   = Rs.92,000
2. Calculation of Finance Cost
   Finance Cost = Interest on short-term loans + Interest on 10% Debenture
   Finance Cost (2016)=20,000+1,000=Rs.21,000
   Finance Cost (2017)=20,000+2,000=Rs.22,000
3. Calculation of other Expenses
   Other Expenses=Freight Outward+ Carriage Outward +Loss on sale of office car
   Other Expenses(2016)=10,000+10,000+60,000=Rs.80,000
   Other Expenses(2017)=20,000+20,000+90,000=Rs.1,30,000

1. Calculation of Net Purchases and Change in Inventory
   Net Purchase of Stock in Trade = Cash Purchase + Credit Purchase - Purchase Returns
   2016=1,20,000+1,50,000-4,000=Rs.2,66,000
   2017=40,000+60,000-60,000=Rs.94,000
   Change in Inventory=Opening Stock-Closing Stock
   2016=30,000-45,000=Rs.(15,000)
   2017=60,000-1,00,000=Rs.(40,000)
2. Calculation of Finance Cost
   Finance Cost = Interest on Bank Overdraft + Interest on Debentures
   Finance Cost (2016) = 5,000+20,000=Rs.25,000
   Finance Cost (2017)=0+20,000=Rs.20,000
3. Calculation of Other Expenses
   Other Expenses=Carriage outward + other operating expenses
   Other Expenses(2016)=10,000+20,000=Rs.30,000
   Other Expenses(2017)=30,000+10,000=Rs.40,000

Working Notes: