Analysis of Financial Statement

1/28/24, 6:19 PM Unit 8 Analysis of Financial Statement for BBA 2nd Sem 2079 Magh
Unit 8 / Chapter 9: Analysis of Financial Statements

Concept:
Financial statement analysis is the process of classifying, evaluating and interpreting the relationship
between different heads of account of financial statements. This provides relevant information to the
management and other interested persons and institutions to understand the result of performance and
position of the entity.
Financial statements analysis helps to know solvency and profitability position of the organization for
a given period of time. This supports to the management, creditors, lenders, and shareholders to make
decision for future action.
Management prepares future action plan on the basis of financial information obtain from financial
statement analysis. Creditors decide whether to supply goods on credit or not, lenders decide whether
to grant loan or not only analyzing financial statement of the organization. Shareholders are interested
on financial statement analysis to know profitability position of the organization and safety of their
investment.
The main processes of financial statement analysis and interpretation are: re-arrangement of financial
statement, comparison of different elements of accounts, analysis with reference to financial
characteristics and interpretation of financial information.
Things to Remember (TTR)
• Financial statement analysis provides information whether sale made is enough for expected profit, profit earned
adequate to provide return on investment, interest and dept is payable out of profit or not etc.
Objectives of financial statements analysis

The objective of analysis of financial statements is to provide readymade financial information to the
management, creditors, lenders, shareholders, customers etc. and support them to take decision
to prepare future action plan. The following are the common objective of financial statement
analysis:
i. To judge liquidity: Analysis of financial statement helps to judge the short-term solvency position
of the company. It can be determined by comparing the amount of current assets and current
liabilities. Trade creditors are more interested in assessing liquidity position of the company as
they have to recover short term debts from the company.
ii. To assess solvency: Financial statements analysis supports to assess long term solvency position
of the company. It can be determined by comparing the amount of long term debts with
shareholders fund and long terms assets. Debenture holders and lenders are more interested in
assessing long term solvency position of the organization as they have to recover their principal
amount and interest from the company.
iii. To judge profitability: Financial statement analysis judges the profitability position of the
company. The amount of gross profit and net profit is compared with sales, assets, shareholder
fund and other heads and accounts. It helps to know the weightage of net profit margin, return on
investment, return on assets etc. All the investors have more interest in this context as they get
return on their investment.
iv. To judge operational efficiency: The objective of financial statement analysis is to assess the
operational efficiency of the company. The comparison of actual revenues and expenses for a
period with the standard determined helps to judge the operational strength and weakness of the
1 BMC-BBA/2nd Sem/ACC - 201/2022-23/ Chapter: 9 Theory and Formulae/by Tulsi Ram Ghemosu
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company. This supports to the management to minimize weaknesses and to capitalize strength for
better performance in future course of action.
v. To help for planning and budgeting: Planning and budgeting should be prepared on the basis of
past financial information and estimation about probable change in environment. Financial
statement analysis helps for planning and budgeting for future performance as it provides
readymade financial information to the management.
vi. To compare inter-company performance: A comparative study of financial statements of
different companies in different way helps to know their probable strengths and weaknesses. A
financial statement analysis supports to make study of different ratios of the companies on the
basis requirement. The inter-company comparison of financial statements helps to remove
weakness in future performance.
The objective of financial statement analysis is to provide information of profitability and affairs position
to investors, solvency position to lenders, liquidity position to trade creditors, operating result to
employees etc.
Need and Importance/Significance of financial statements analysis

Financial statements provide a summarize figure of operational result and overall financial position of
the company for a particular period. A careful study of the financial statements of a company provides
a kind of relationship among different elements of accounts, which is part of financial statement
analysis. The following are the importance of financial statement analysis:
i. Helps to know liquidity and solvency: Analysis of financial statement helps to know the short-
term solvency position of the company. It can be determined by comparing the amount of current
assets and current liabilities. Trade creditors are more interested in assessing liquidity position of
the organization.
ii. Helps to know turnover and profitability: Financial statement analysis helps to know the
volume of sales by comparing its relationship with other components of accounts like stock,
debtors, assets, shareholders fund etc. It also helps to know the profitability position of the
company. The amount of gross profit and net profit is compared with sales, assets, shareholder
fund and other heads and accounts.
iii. Helps in evaluation of performance: Financial statement analysis helps to assess the operational
efficiency of the company. The comparison of actual revenues and expenses for a period with the
standard determined helps to judge the operational strength and weakness of the company. This
supports to the management to minimize weaknesses and to capitalize strength for better
performance in future course of action.
iv. Helps to planning and budgeting: Analysis of financial statement helps for planning and
budgeting of the company for future performance. Planning should be prepared on the basis of
past financial information and estimation about probable change in environment. Financial
statement analysis provides readymade financial information to the management for planning and
budgeting.
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v. Helps for determination standard and control: Financial statement analysis helps to determine
standard for future performance. It also helps to compare actual result achieved with that of
standard set. It is the basis of controlling.
Limitations of financial statements analysis

The analysis of financial statement is essential to know about liquidity, solvency, turnover, and
profitability position of the company. It is helpful to prepare plans and policies for future course of
action. However, it also involves some limitations, they are as follows:
i. Only focus on quantitative aspects: Financial statements analysis does not consider and evaluate
the qualitative aspects of the company like team work, dedicated employees, effective
management, good relation between management and employees etc. of a company. It provides
only monetary information like profit and loss, solvency position, liquidity position etc. For
qualitative aspect managers need to consider their experience, skill and other information.
ii. May mislead to the user: In some cases financial statement analysis may mislead to the user,
especially, when information given in financial statements are incorrect. The analysis of wrong
information may lead to wrong decision to the user. Ultimately, it provides impact on future
performance of the company.
iii. Not reveal the current worth: Financial statements involve information of past performance of
the company. Therefore, analysis of historical financial statements provides readymade
information of past performance. It does not provide reveal the position of current performance.
iv. Based on personal judgment: Financial statement analysis provides only the information
liquidity, solvency, turnover and profitability position of past performance. It also provides the
trend of business affairs. But, it does not provide readymade information to the managers to take
right decision. Managers need to use their personal judgment on the basis of skill and experience
for taking any decision.
v. Alone do not help in planning: Past information and anticipation of future environmental factors
is the basis of planning. Financial statements provide information of past performance only,
therefore, analysis of such data alone do no help in planning.
Analysis of incorrect financial statements and lack of use of appropriate tools for analysis may mislead in
decision making to the managers. This may be the reason of wastage of time and resources of the
company.
Parties involved in financial statements analysis

In a company, many persons and institutions may have direct or indirect interest in its welfare and
prosperity. These stakeholders look financial statements of the company in different ways on the
basis of their interest. The following parties have interest in the information in financial
statements:
i. Investors: Shareholders, partners, or proprietors may be the investors in any firm. In company
form of business, shareholders generally do not involve in day to day functions, they are interested
in operating results and future prosperity of business. They assess this information only through
financial statement and its analysis.
ii. Trade creditors: Trader creditors supply raw materials and other goods on credit to the company.
They are interested in short term solvency position of the company. They assess financial
statements to ascertain that whether company will be able to pay short term debts on time.
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iii. Lenders: Lenders to the business involve debenture holders, banks, financial companies, and
other financial institutions. They provide both short term and long-term financial assistance to the
company in certain rate of interest. They are interested in both short term and long-term financial
solvency position of the company. They assess short term solvency to ascertain whether company
will be able to pay the interest on time and assess long term solvency to ascertain whether company
will be able to pay principal amount of loan at maturity period.
iv. Employees: Employees directly involve in day to day function of the company. They have interest
in good salary, wage, bonus and other financial benefits. Therefore, they assess the profitability
position of the company, which can be ascertained through financial statements analysis. They
negotiate with management regarding salary, bonus and other facilities on the basis of profitability
position of the company.
v. Government agencies: Government agencies need financial information of any company to

impose tax, regulate the activities, and to determine national income etc. Therefore, income tax
authorities are interested in profit, value added authorities on product and sales volume etc.
financial statements analysis helps them to ascertain operating result and overall financial position
of the company.
vi. Customers: Customers are interested for continuous service of the company. They expect supply
of right quantity and quality of goods at the right time in reasonable price. In case, it seems that a
company will not be able to supply goods for the long time, customers may think for alternative
sources. Financial statements show the overall position of the company.
vii. General public: General public have also interest in progress and prosperity of the business of
their locality. They are affected by business enterprises of their locality in different ways like
improvement of economy, development of social welfare activities, infrastructure development
etc. The information of progress and prosperity of the company can be known from financial
statements analysis.
Reality Bites
Validity of financial statements analysis totally depends on correctness of financial statements of any
entity.
Types /Method or Tools of Financial Statement Analysis

Financial statement analysis provides essential financial information to the stakeholders on the basis
of their requirement. On the basis of situation and requirement different tools of financial statement
analysis can be used. The following are the common tools used by the interested persons or institutions
on the basis of their convenience:
1) Horizontal Analysis /Comparative Balance Sheet Analysis
2) Trend Analysis
3) Vertical Analysis / Common Size Statement Analysis
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4) Ratio Analysis
5) Cash Flow Statement Analysis
Horizontal Analysis /Comparative Balance Sheet Analysis

It is a financial statement analysis technique that shows changes in the amount or in percentage of
corresponding statement items over a period of time. It is a useful tool to evaluate the trend situations.
The statements of two or more periods are used in this analysis. The earliest period is usually used as
the base period and the items on the statement for all later period are compared with items on the
statement of the base period.
Amount and percentage changes are computed as follows:
1) Amount Change = Analysis Period - Base period Amount
Amount Changes
2) Percentage Change = x 100%
Base Period Amount
An example of the horizontal analysis of comparative balance sheet is given below:

Lincon Co.
Comparative Balance Sheet
December 31st 2008 and 2007
Details 2008 2007 Changes Percentage %
Assets:
Current Assets 5,50,000 5,33,000 17,000 3.2%
Long term Investment 95,000 1,77,500 (82,500) (46.5%)
Property, plant & equipment 4,44,500 4,70,000 (25,500) (5.4%)
Intangible Assets 50,000 50,000 0 0
Total Asset 11,39,500 12,30,500 (91,000) (7.4%)
Liabilities and Equity
Current liabilities 2,10,000 2,43,000 (33,000) (13.6%)
Long term liability 1,00,000 2,00,000 (100,000) (50%)
Share holder Equity 8,29,500 7,87,500 42,000 30.50%
Total Liabilities and Equity 11,39,500 12,30,500 (91,000) (7.4%)
Amount Changes 17000
550000-533000= 17000, Base Period Amount
x 100% =
533000
x 100% = 3.2%
Lincon Co.
Comparative Income Statement
Dec 31st 2008 and 2007
Details 2008 2007 Changes Percentage %
Sales Revenue 14,98,000 12,00,000 298,000 24.80%
Less: COGS 10,43,000 8,20,000 (233,000) 27.20%
Gross Profit 4,55,000 3,80,000 75,000 19.70%
Less: Operating expenses 2,95,000 2,44,400 50,600 20.70%
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Income before tax 1,60,000 1,35,600 24,400 18%

Less: Tax expenses 64,000 54,240 9,760 18%
Income after tax 96,000 81,360 14,640 18%
Amount Changes 14640
96000-81360= 14640, Base Period Amount x 100% = 81360
x 100% = 17.99% i.e. 18%
In above analysis, 2007 is base year and 2008 is the comparison year.
Trend Analysis
1) Select a base period and assign each item in a base period with a weight of 100%.
2) Express the financial numbers as the percentage of their base period numbers.
Analysis Period Amount

Trend % = Base period Amount
x 100%
Consider the following financial data of Lincon Co. to illustrate trend analysis
Items 2017 2016 2015 2014 2013
Salves Revenue 140000 125000 115000 110000 100000
Cost of Goods Sold 115000 104000 90000 85000 80000
Operating expenses 15000 12000 11000 11000 10000
Solution:
The trend % for above revenues & expenses are calculated below:
Items Analysis Period Base Period
2017 2016 2015 2014 2013
Sales Revenue 140% 125% 115% 110% 100%
GOGS 143.80% 130% 112.50% 106.30% 100%
Operating expenses 150% 120% 110% 110% 100%
Common Size Statement Analysis/Vertical Analysis

Vertical Analysis is also known as common size analysis, is a popular method of financial statement
analysis that shows each item on the statement as a percentage of base figure i.e., total assets or total
liabilities and shareholder's equity or total sales within a statement.
In a vertical analysis, the percentage is computed by following formula:
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Amount of individual items

% of base = Amount of base
x 100
An example of the vertical analysis of comparative balance sheet is given below:

Lincon Co.
Comparative Balance Sheet
As on 31st December 2008 & 2007
Particulars 2008 2007
Amount % Amount %
Assets:
Current Assets 5,50,000 48.30% 5,33,000 43.30%
Long term Investment 95,000 8.30% 1,77,500 14.40%
Property, plant & equipment 4,44,500 39.00% 4,70,000 38.20%
Intangible Assets 50,000 4.40% 50,000 4.10%.
Total Asset 11,39,500 100% 12,30,500 100%
Liabilities and Equity:
Current liabilities 2,10,000 18.4% 2,43,000 19.7%
Long term liability 1,00,000 8.8% 2,00,000 16.3%
Share holder Equity 8,29,500 72.8% 7,87,500 64%
Total Liabilities and Equity 11,39,500 100% 12,30,500 100%
Amount of individual items 550000
For 2008, % of base = x 100= x100= 48.267% i.e. 48.30%
Amount of base 1139500
For 2007, % of base = x 100= x100= 43.31% i.e. 43.30%
Lincon Co.
Comparative Income Statement
As on 31st December 2008 & 2007
Particulars 2008 2007
Amount % Amount %
Sales Revenue 14,98,000 100% 12,00,000 100%
Less: COGS 10,43,000 69.60% 8,20,000 68.3%
Gross Profit 4,55,000 30.40% 3,80,000 31.7%
Less: Operating expenses 2,95,000 19.70% 2,44,400 20.40%
Income before tax 1,60,000 10.70% 1,35,600 11.30%
Less: Tax expenses 64,000 4.30% 54,240 4.50%
Income after tax 96,000 6.40% 81,360 6.8%
For 2008 COGS , % of base = x 100= x100= 69.60%
For 2007 COGS, % of base = x 100= x100= 68.33%
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Ratio Analysis
Relationship between two accounting figures is called ratio. Financial ratio analysis is a widely and
frequently used tool for financial statement analysis. Ratio Analysis in the process of calculating
financial ratios which are mathematical indicators calculated by comparing key financial information
appearing in financial statement of a business and analyzing those to find out- reasons behind a
business's current financial position and its recent financial performance and develop expectation
about its future outlook.
Different ratios can be expressed by following ways:
a) Proportion
b) Percentage
c) Times
d) Rate / Rupees
Meaning of ratio analysis

Ratio is the expression of mathematical relation between two inter-dependent components. It is used
as an indicator to know about the relation among different related figures. Any figure or number given
does not provide meaning until and unless a relation is not maintained with other related figures.
Therefore, to test the relationship between related components, ratio is used. The determination of
ratios of different components of financial statements is the basis of ratio analysis.
According to R.N. Anthony, "a ratio is simply one number expressed in terms of another. It is found
by dividing one number by the other."
According to Kohler, " a ratio is the relationship of one amount to another expressed as the ratio or
as a simple fraction, integer, decimal fraction or percentage."
Ratio analysis is one of the techniques of financial statements analysis. It is the process of determining
and interpreting mathematical relationship between different figures in financial statements. It helps
to measure the financial strength and weakness of an entity and also facilitates to compare the
operating results and financial positions of two or more entities. It helps to ascertain the liquidity,
solvency, turnover, and profitability position of the entities for any fiscal year. It is supportive to the
stakeholders like management, investors, employees, creditors, lenders, and customers etc. for taking
decision.
For example, A. Ltd. has sales Rs. 5,00,000 and B. Ltd. has sales Rs.4,00,000 in any fiscal year.
However, A. Ltd. has net profit Rs.50,000 and B. Ltd. has net profit Rs. 50,000. We can ascertain net
profit ratio of two companies and can analysis and compare their operating efficiency as:
Net Profit 50,000

Net Pr ofit Ratio ( A Ltd .) = x 100 = x 100 = 10%
Sales 5,00,000
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Net Profit 50,000

Net Pr ofit Ratio ( B. Ltd .) = x100 = x 100 = 12.50%
Sales 4,00,000
From the above figure, it is shown that A. Ltd. has 10% net profit on sales whereas B. Ltd. has 12.5%
net profit on sales. When we analyze the percentage of profit of both the companies, it is found that
the operating efficiency of B. Ltd. has more than the A. Ltd. as it has more percentage of profit on
sales.
Methods of ratio analysis

Ratio can be determined in any one of the following way on the basis of convenience of the user:
1. Percentage method: In this method, the relationship between two different inter-related
components is determined on percentage. For instance, if current assets of an entity is Rs.40,000 and
current liabilities is Rs.25,000, the relationship can be shown as current assets is 160% of current
liability as:
Current Assets 40,000
Percebtage of current assets to current liability = x 100 = x100 =160%
Cuurent Liabilites 25,000
2. Rate method: In this method, the relationship between two different inter-related components is
expressed in terms of relative figure. For instance, if current assets of an entity is Rs.40,000 and
current liabilities is Rs.25,000, the relationship can be shown as current assets is 1.6 time or 8/5of
current liability as:
Current Assets 40,000 8
Rate of current assets to current liability = = = or 1.6 times
Cuurent Liabilites 25,000 5
3. Ratio method: In this method, the relationship between two different inter-related components is
expressed in terms of ratio. For instance, if current assets of an entity is Rs.40,000 and current
liabilities is Rs.25,000, the relationship of current assets and current liabilities can be shown as 8:5
or 1.6:1
Current Assets 40,000
Ratio of current assets to current liability = = =8 : 5 or 1.6 : 1
Cuurent Liabilites 25,000
Use and Importance of ratio analysis:

1. Useful for manager to analyze, control and thus improve firm’s operations.
2. Useful for credit analyst to help ascertain a company's ability to pay its debts.
3. Useful for security analyst to help ascertain a company's ability to pay interest on its bond as
well as with the liquidating value of assets.
4. Useful in financial position analysis.
5. Useful in simplifying accounting figure.
6. Useful in assessing the operational efficiency.
7. Useful in locating the weak spot.
8. Useful in comparison of performance
Limitation of Ratio analysis:

1. False result if based on incorrect accounting data.
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2. No idea of probable happening in future.

3. Difficult to develop a meaningful set of industry average.
4. Only one method of analysis.
5. Different meaning assigned to the same term.
6. Ignoring qualitative factor.
Types of Accounting Ratios

I. Liquidity Ratios
II. Capital structure or Leverage or Solvency Ratios
III. Activity or Turnover or velocity Ratios
IV. Profitability Ratios
Types of Ratios
Liquidity Ratio Solvency Ratio Turnover Ratio Profitability Ratio Earning evaluation Ratio
• Debt equity ratio • Inventory turnover • Gross profit margin • Earning per share
• Debt to total ratio • Net profit margin • Dividend per share
capital ratio • Debtors turnover • Operating ratio • Dividend payout ratio
• Interest coverage ratio • Return on assets • Dividend yield ratio
• Debt collection • Return on • Earning yield ratio
ratio
period shareholder equity • Price earning ratio
• Fixed charge
• Fixed assets turnover • Return on common • Earning power ratio
coverage ratio
ratio shareholder equity
• Total assets turnover • Return on capital
ration employed
• Capital employed
• Current ratio turnover ratio
• Liquid ratio
Types of Ratios:
Liquidity Ratio:
The ratios show the relationship of firm's cash and other current assets to its current liabilities.
i) Net working Capital (NWC): = Current Assets - Current Liabilities
Interpretation: The greater is the amount of NWC, the greater is the liquidity of the firm and vice versa.
ii) Current ratio: The ratio indicates to extend which current liabilities assets cover accepted to be
covered to cash in the near future. The current ratio measures the capacity to pay short-term creditors
from short-term assets.
Current asset
Current ratio = Current Liabilities
Interpretation: Standard ratio is 2:1. The higher and below standard ratio is not preferable. The higher current
ratio shows the higher the liquidity of the firm and vice versa.
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Where, Current assets include Cash, bank balance, short-term investment, short-term marketable securities,
bills receivable, trade debtors, inventories, prepaid expenses, and accrued income.
Current Liabilities includes bank overdraft, bills payable, trade creditors, provision for taxation, short term
loan and advances, purposed dividend, unclaimed dividend, advance payment, unexpired discount accrued
interest on loan and debenture, outstanding expenses and portion of long term debt to mature within one years.
iii) Liquid (or acid test or Quick) Ratio: The purpose of the ratio is to test the ability of the firm for
immediate payment of current liabilities.
Liquid asset
Liquid Ratio =
Current Liabilities
Interpretation: Standard ratio is 1:1. The higher liquid ratio shows the higher the liquidity of the firm that
shows the quick assets (i.e. cash and cash equivalent) are capable to pay the current liabilities.
Where, Liquid asset = Current assets - (Inventories + prepaid Expenses)
Leverage/Capital structure/solvency ratio
i) Debt to equity ratio: It is the test of long-term solvency of the firm. The ratio indicates the proportionate
claims of owner and the outsider against the assets of the firm.
Long term debt Total debt
Debt to equity ratio = or Shareholders' equity
Shareholders' equity
Interpretation: The low ratio is generally viewed as favorable from long-term creditor's point of view because
large margin of protection provides safety for the creditor. Thus, 1:2 is acceptable and from the view of
shareholders' just opposite implication, for the point of company, Low ratio is acceptable.
Where, Long-term debt includes debenture, long-term loan or debt, debenture premium, mortgage, bonds, and
secured loan, public deposits etc.
Shareholders' equity/funds includes share capital, preference share capital, share premium, retained earnings,
reserve and surplus, p/l a/c, general reserve, capital reserve, sinking fund, reserve for contingencies less fictions
assets.
Total debt = Long term debts +Current liabilities.
Permanent Capital or Capital Employed includes Shareholders’ equity plus long-term debts.
ii) Debt to total capital ratio or proprietary ratio:

Long term debt Total debt
= Total capital = Permanent capital + current liabilities
Interpretation: - A low ratio of debt to total capital is desirable from the point of the creditor as there is sufficient
margin is safety available to them. Thus the firm should have neither a very high ratio nor very low ratio.
EBIT
iii) Interest coverage ratio: = Interest
Interpretation: - The higher ratio is desirable. The ratio shows the secured the lender will be in respect of their
periodical interest income. But too high ratio indicates the conservative.
EBIT
iv) Fixed charge coverage ratio: = Fixed charge
Interpretation: - the higher ratio is better.
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Where, Fixed charge = interest on loan + preference dividend + repayment of loan
Efficiency/Turnover (or performance or Activity) ratio: -
Cost of goods sold Sales- gross profit

i) Inventory (or stock) Turnover ratio= Average inventory = Opening stock +closing stock
2
Cost of goods sold = opening stock +Purchases +manufacturing expenses -closing stock
Net sales
Inventory Turnover ratio =
closing inventory
Interpretation: - Higher ratio is preferable because it shows that finished stock is rapidly turnover.
ii) Receivable (or Debtors) turnover ratio

Net credit sales Net credit sales
= average debtors = Opening debtors +closing debtors
2
Sales
Receivable turnover ratio = Debtors
Interpretation: -Higher the ratio, more the chances of bad debts and lower the ratio, less the chance of bad
debts. Thus lower ratio is better.
iii) Average collection period/debtors collection period/Days sales outstanding(DSO)

365 or 360 days average debtors
= = X No. Of months (or days) in a period
debtors turover ratio Net credit sales
Interpretation: -Higher the period, higher the bad debt and lower period, lower bad debt, so the lower period
is better.
iv) Creditors (or account payable) turnover ratio
credit purchase
=
average account payable (creditors + bills payable)
365 or 360 days

Average age of payable or average payment period =
creditors turover ratio
Interpretation: - The high ratio shows that creditors are not paid in time while a low ratio gives an idea that
the business is not taking full advantages of credit period by the creditors.
v) Sales to fixed asset (or Fixed asset turnover) ratio
Net Sales
= Net fixed assets(i.e. fixed assets - depreciation)
Interpretation: - The higher the ratio, the better is the performance.

vi) Sales to capital employed (or Capital Turnover) ratio:
Sales
=
Capital employed(i.e. Shareholder's fund + long term liabilities)
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Interpretation: - The higher the ratio, the greater are the profit, the lower ratio should be tacked to mean that
sufficient sales are not being made and forfeits.
vii) Sales to working capital (Working Capital Turnover) Ratio:
Sales
=
Net working capital(i.e. current asset- current liabilities)
Interpretation: - Higher the ratio, the lower is the investment in working capital, and the greater are the profits.
Net Sales
viii) Total Asset turnover ratio: =
Total Assets
Interpretation: - The high ratio is an indicator of over trading of total assets while a low ratio reveals idle
capacity; The traditional standard for the ratio is two times.
Profitability Ratio:
Gross profit
i) Gross profit Ratio: = Net Sales X 100%
Interpretation: - Higher ratio is better.
Cost of goods sold + operating expenses

ii) Operating Ratio: = Net Sales X 100%
Cost of goods sold = Sales - gross profit.
Cost of goods sold = opening stock + purchases + direct expenses +Manufacturing Expenses -
closing stock.
Operating Expenses = Administrative expenses +selling distribution expenses
Interpretation: Lower ratio is better, higher the ratio, less favorable it is because it would have a smaller
margin of operating profit for the payment of dividends and the creation of reserve.
Net profit after tax
iii) Net profit Ratio: = Net Sales X 100%
Interpretation: - Higher ratio is better because it gives idea of improved efficiency of the concern.
Operating profit
iv) Operating Profit Ratio: = X 100%
Net Sales
Operating Profit = Net profit + Non-operating expenses -Non Operating income.
Operating Profit = Gross profit + Operating Expenses
Operating profit
v) Return on capital employed: =
Capital employed X 100%
Operating Profit = Profit before interest on long term borrowing and tax
Capital employed = Equity share capital + preference share capital + undistributed profit +
reserve and surplus + Long term liabilities -fictions assets - non business asset
Capital employed = Tangible and intangible fixed assets + current asset -current liabilities
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Net profit after tax + interest expenses

vi) Return on Assets (ROA): = Total Assets X 100%
or
Net profit after interest and tax
Return on total asset: = X 100%
Total asset
Total Assets = fixed assets + current asset
vii) Return on shareholders’ Equity/fund (ROSE): =

Net profit after interest and tax
Shareholders' fund X 100%
viii) Return on Common/equity shareholders' Equity /fund (ROCSE) =
Net profit after interest tax and preference dividend

Equity shareholders' fund X 100%
Others Ratios:
Net profit after interest tax - preference dividend

i) Earnings Per share =
No. of Equity share
Dividend paid to shareholder

ii) Dividend per share =
No. of Equity share
Market price per equity share

iii) Price earnings Ratio = x 100%
Earning Per share
Dividend per equity share

iv) Dividend payout ratio = x 100%
Earning Per share
Dividend per equity share

v) Dividend yield ratio =
Market price Per share x100%
Earning Per share

vi) Earning yield Ratio =
Market price per equity share x 100%
Earning Before interest and tax

vii) Earning Power ratio =
Total asset
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Long Answer Questions

Question 48
The following is the trading and profit and loss account for year ended 30th Ashad 2073:
Trading and profit & loss account
Particulars Amount Rs. Particulars Amount Rs.
To opening stock 4,00,000 By Sales 15,00,000
To purchase 6,00,000 By closing stock 3,00,000
To wages 2,00,000
To factory overheads 1,10,000
To gross profit c/d 4,90,000
18,00,000 18,00,000
To administrative expenses 1,50,000 By gross profit b/d 4,90,000
To selling expenses 1,10,000 By commission received 30,000
To distribution expenses 1,00,000 By rent received 50,000
30,000
To interest on loan 30,000 By interest received
To provision for taxation 50,000
To net profit c/d 1,60,000
6,00,000 6,00,000
Balance sheet as on 30th Ashad 2073

Liabilities Amount Rs. Assets Amount Rs.
Equity share capital 10,00,000 Land and building 8,00,000
Reserve and surpl 40,000 plant and machinery 2,00,000
Profit and loss A/c 1,60,000 Furniture 1,00,000
10% bank loan 3,00,000 Stock 1,00,000
Bank overdraft 1,00,000 Debtors 3,50,000
Sundry creditors 2,00,000 Cash at bank 2,50,000
Bills payable 1,00,000 Bills receivable 80,000
50,000 Prepaid expenses 30,000
Provision for taxation
Preliminary expenses 40,000
19,50,000 19,50,000
Additional Information:
a) Market value per equity share Rs.120 b) Dividend paid to equity shareholders Rs.32,000
Required:
a. Current ratio b. Liquid ratio c. Debt equity ratio
d. Debt to total capital ratio e. Stock turnover ratio f. Debtors turnover ratio
g. Debt collection period h. Fixed assets turnover ratio i. Total assets turnover ratio
j. Capital employed turnover ratio k. Gross profit margin 1. Net profit margin
m. Return on assets n. Return on shareholders' fund o. Return on capital employed
p. Earnings Per share q. Dividend per share r. Price earning share
Ans: a. 1.8:1; b. 1.51:1; c. 25.86%; d. 20.55%; e. 4.04 times; f. 3.49 times; g. 103.15 days or 104 days; h.
1.36 times; i. 0.77 times; j. 1.03 times; k. 32.67%; l. 10.67%; m. 9.95%; n. 13.79%; o. 13.01%:
p. Rs16 q.Rs3.20 r. 7.5 times
about:blank 15/28
Solution:
CA 810000
a) Current ratio = = = 1.8: 1
CL 450000
Where,
CA = Stock + debtor + Cash at Bank + Bills receivable + Prepaid expenses.
= 100,000 + 350,000 + 250,000 + 80,000 + 30,000 = 810,000
CL = Bank overdraft + Sundry creditors + Bills payable + Provision for taxation
= 100,000 + 200,000 + 100,000 + 50,000 = 450,000
Quick assets 680000

b) Liquid ratio = = = 1.51: 1
Current liabilities 450000
Where,
Quick assets = Debtor + Cash at Bank + Bills receivable
= 350,000 + 250,000 + 80,000 = 680,000
Long term debt 300000
c. Debt equity ratio = = = 25.86%
Share holders Fund 1160000
Where, Shareholder’s fund = Equity + Reserve Surplus + P/L a/c – Preliminary expenses
= 10,00,000 + 40,000 + 160,000 – 40,000 = 1160,000
Long term debt Long term debt

d. Debt to total capital ratio = =
Capital employed Shareholders fund + Long term debt
300,000
=11,60,000 + 300,000 = 20.55%
Where, capital employed = 11,60,000 + 300,000 = 14,60,000
Cost of goods sold Sales – Gross profit

e. Stock turnover ratio = =
Average stock (Op.Stock + Closing stock)/2
15,00,000 – 490,000 10,10,000
= = = 4.04 times
(400,000 + 100,000)/2 250,000
Sales 15,00,000
f. Debtor turnover ratio = = 350,000+80,000
= 3.49 times
Debtor and receivables
Days in year 360
g. Debt. Collection period = = = 103.15 days or 104 days
Debtor turnover ratio 3.49
Sales 15,00,000
h. Fixed assets turnover ratio = = 11,00,000
= 1.36 times
Fixed Assets
Where, Fixed assets = Land Building + Plant machinery + Furniture

= 800,000 + 200,000 + 100,000 = 1100,000
Sales 15,00,000
i. Total assets turnover ratio = = 19,50,000 = 0.77 times
Total Assets
Sales 15,00,000
j. Capital employed turnover ratio= = 14,60,000
= 1.03 times
Capital employed
about:blank 16/28
Gross Profit 490,000

k. Gross profit margin = =15,00,000
x100 = 32.67%
Sales
Net Profit 160,000
l. Net profit margin = = 15,00,000
x100 = 10.67%
Sales
Net Profit+Interest 160,000+30,000
m. Return on assets = = 19,10,000
x100 = 9.95%
Total Assets
Net Profit after tax 160,000
n. Return on Shareholder fund = = 11,60,000
x100 = 13.79%
Shareholders fund
Net Profit after tax+interest 160,000+30,000
o. Return on capital employed = = 14,60,000
x100 = 13.01%
Capital Employed
Net profit after interest tax - preference dividend 160,000−0
p. Earnings Per share =
No. of Equity share
= 10,000
x100 =Rs.16/share
Dividend paid to shareholder 32000

q. Dividend per share =
No. of Equity share
=
10,000
= Rs.3.2/share
Market price per equity share 120

r. Price earnings Ratio =
Earning Per share x 100%= 16 = 7.50%
about:blank 17/28
Illustration - 12: Sachin Company's Statement of Profit and Loss account and Statement of Financial
Position for two years have been given below: (KEC Publication)
Sachin Company
Statement of Financial Position as on 31st Ashad
Assets: Note 2077 2078
Non-current assets:
Plant, property and equipment 900,000 1,200,000
Investment 60,000 120,000
Total non-currents assets A 960,000 1,320,000
Current assets:
Sundry Debtors 141,000 54,000
Stock 30,000 60,000
Cash at bank 120,000 60,000
Total Current assets: B 291,000 174,000
Fictitious assets:
Preliminary expenses C 9,000 6,000
Total Assets (A+B+C) 12,60,000 15,00,000
Liabilities and equity:
Equity:
Equity share capital of Rs. 100 each. 720,000 900,000
Share premium 72,000 90,000
Retained earning 24,000 36,000
Total Equity A 816,000 1,026,000
Non-current liabilities:
10% Long term debt 120,000 60,000
Total non-current liability a 120,000 60,000
Current liabilities:
Sundry creditors 96,000 144,000
Short term loan 138,000 96,000
Bank overdraft 90,000 174,000
Total current liabilities b 324,000 414,000
Total liabilities a+b B 444,000 474,000
Total Capital and liabilities A+B 1,260,000 1,500,000
Sachin Company
Profit and Loss Statement for the year 2078
Particulars Notes Amount
Revenue from operation 2,000,000
Cost of Sales (1,000,000)
Gross profit 1,000,000
Administration expenses (200,000)
Premium on redemption of debenture (20,000)
Finance cost (interest on long term debt). (30,000)
Distribution expenses (150,000)
Profit from operation 600,000
Profit from sale of machinery 30,000
Net profit 630,000
about:blank 18/28
Required for 2076:

1. Ratios on:
i. Current Ratio (2:1)
ii. Quick Ratio (1:1)
iii. Debt to Total Capital Ratio (less than 40%)
iv. Inventory Turnover Ratio (at least 8 times)
v. Total Assets Turnover Ratio (more than 1 times)
vi. Net Profit Ratio (at least 12%)
vii. Return on Equity (at least 7%)
viii. Return on Investment (at least 8%)
ix. Interest Coverage Ratio (more than 1 times)
x. Account Receivable Turnover Ratio (at least 8 times)
2. Comment on the calculated ratios:
Solution:
Current Assets 174000
i. Current ratio = = 414000
= 0.42: 1
Current Liabilities
Quick assets 114000

ii. Liquid ratio = = 414000
= 0.275: 1
Current liabilities
Quick Assets= Current Assets - Stock=174000-60000=114000
Long term debt 60,000

iii. Debt to total capital ratio = = 10,20,000 + 60,000
= 5.55%
Shareholders fund + Long term debt
Where,
Shareholder’s fund = Equity + Share Premium +Retained earnings – Preliminary expenses
= 9,00,000 + 90,000 + 36,000 – 6,000 = 10,20,000
Cost of goods sold 10,00,000

iv. Inventory turnover ratio = =
Average Inventory (Op.Stock + Closing stock)/2
10,00,000 10,00,000
= (30,000 + 60,000)/2 = 45,000
= 22.22 times
Sales 20,00,000
v. Total assets turnover ratio = = = 1.33 times
Total Assets 14,94,000
Net Profit 630,000

vi. Net profit margin = = x100 = 31.50%
Sales 20,00,000

vii. Return on Equity/Shareholder fund = = x100 = 61.40%
Shareholders fund 10,26,000
about:blank 19/28

viii. Return on Investment/assets = = x100 = 44.18%
Total Assets 14,90,000
EBIT Net Profit+Interest 630,000+30,000

ix. Interest coverage ratio = = = =22 times
Interest Interest 30,000
Net credit sales

x. Account Receivable (or Debtors) turnover ratio = average debtors =
Net credit sales
Opening debtors +closing debtors
2
20,00,000
= =20.51 times
97,500
141,000+54,000
Average Debtors = 2
=97,500
2. Since calculated current ratio and quick ratio of the company are below to standard so it can be said
that the liquidity position of the company is not good. But, the debt to total capital ratio of the
company is the highest lower than the industry average so the company is not in more interest
obligation. However, inventory turnover ratio is higher than the industry average which indicates
the company is able to convert its inventory or stock into sales. Similarly, its net profit ratio, return
on equity and return on investment are more than industry average which indicate the well
profitability ratios of the organization. The total assets turnover ratio of the company is slightly more
to standard which indicates its good utilization of assets within the organization. But its interest
coverage ratio is higher than industry average which indicate the company has higher interest paying
capacity. Account receivable turnover ratio is also more than standard. Which indicates the
company is able to collect its credit sales on time.
Extra Que: Data for Universal Company and its industry averages follow:
Universal Company
Balance Sheet
as at December 31, 2017
Particulars Amount Amount Particulars Amount Amount

Account payables 130000 Cash 67500
Notes payables 83000 Receivables 335000
Other current liabilities 115000 Inventories 240000
Total current liabilities 328000 Total current assets 642500
Long term debt 257000 Net fixed assets 292500
Common equity 350000
Total liabilities & equity 935000 Total assets 935000
about:blank 20/28
Universal Company
Income Statement
for the year ended Dec, 2017
Particulars Amount
Sales of products and services 1,607,500
Less: Cost of goods sold 13,53,000
Gross profit 2,54,500
Less: Fixed operating expenses except depreciation 1,42,000
Less: Depreciation 42,500
Earnings before interest and taxes 70,000
Less: Interest 26,000
Earnings before taxes 44,000
Less: Taxes 40% 17,600
Net income 26,400
Required:
a) Following Ratios and Comment on the calculated ratios on: (10x1.5+5)
Ratio Industry Average
Current ratio 2 times
Quick ratio 1 time
Day's sales outstanding 35 days
Inventory turnover 5.6 times
Total assets turnover 3 times
Profit margin on sales 1.2%
Return on assets 3.6%
Return on equity 9%
Debt to equity ratio 60%
Times interest earned 7 times
Solution:
a) Calculation of ratio for 'Universal Company
Current Asset 642500
i. Current Ratio = Current liabilities = =1.96.1
328000
Interpretation:
Current ratio for universal company is 1.96 that the industry average is 2. Current ratio of 1.96 is
acceptable as minimum ratio of current ratio is 2 which is nearly close for universal company It can
pay short term liability of company with ease.
Quick Asset 642500−240000

ii. Quick Ratio =Current liabilities = = 1.231
328000
Interpretation:
Quick ratio for universal company is greater than the industry average more than acceptable ratio
Minimum requirement for quick ratio is 1.
about:blank 21/28
Account receivable 335000−1607500

iii. Day's Sales Outstanding = x100 = 328000
x365 =76.06 or 76 days
Sales
Interpretation:
Days sales outstanding of universal company is 76 days which is greater than industry average ie 35
days which indicates that credit collection of universal company is poor than that of industry
average.
Cost of goods sold 1353000
iv) Inventory Turnover: = = 5.64 times
Inventory 240000
Interpretation:
Inventory turnover ratio of universal company is 5.64 times. The higher inventory turnover ratio
indicates the company is selling goods very quickly and from that we can understand that there is
high demand of product.
Net Sales 1607500
v) Total Assets Turnover = = = 1.72 times
Total Assets 935000
Interpretation:
Total assets turnover of universal company is 1.72 times which is less than industry average i.e. 3
times which shows poor in total assets turnover. This means the Co. is not able to maintain its
turnover regarding to total assets.
Net Profit after tax 26400
vi) Profit margin on sales = = x100 = 1.64%
Sales 1607500
Interpretation:
Net profit margin of universal company is higher than that of industry average ie 1.64>1.2. So,
higher profit margin is good for the company.
Net Profit after tax 26400
vii) Return on Assets= x100 = x100 =2.80%
Total Assets 935000
Interpretation:
Return on assets of universal company is 2.8% and ROA of industry average is 3.6 % Since the
ROA of company is less than that of industry, the ROA of industry is not acceptable which indicates
that return on investment on total asset is in weak.
viii) Return on Equity: = x100 =7.54%
Total equity 350000
Interpretation:
Return on equity of company is 7.54% and industry average is 9%. The higher ROE is accepted. So,
Co. should focus on higher ROE than industry average.
Total Debt 257,000
ix) Debt to equity ratio= Total equity = x100 =73.43%
350000
Interpretation:
The debt-to-equity ratio of universal company is 73.43% which is higher than that of industry
average i. e. 60%. Lower debt to equity ratio is acceptable. Higher debt to equity ratio indicates the
higher debt of the company.
EBIT 70000
x) Times Interest earned =Interest = =2.69 times
26000
Interpretation:
Times interest earned of universal Company is 2.69 times which is lower than industry average of 7
times. This indicates earnings before interest and tax is lower as its operating cost is more than
industry.
about:blank 22/28
Model Question:
The MM Company's Statement of Profit and Loss account and Statement of Financial Position for two years
have been given below:
Statement of Profit and Loss for the year 2021

Particulars Amount (Rs.)
Revenue from operation 1,200,000
Less: Cost of sales (800,000)
Gross margin 400,000
Add Other income 40,000
Total 440,000
Less: Distribution expenses (120,000)
Less: Administrative expenses (230,000)
Operating Profit 90,000
Less: Finance cost 15,000
Net profit 75,000
Statement of Financial Position of a company for 2020 and 2021

Assets 2020 2021
Non-Current Assets:
Property, plant and equipment 400,000 500,000
Intangible assets 20,000 15,000
Investments (long term) 90,000 110,000
Total Non-Current Assets 510,000 625,000
Current Assets:
Inventories/Stock 40,000 60,000
Cash and cash equivalents 50,000 60,000
Account receivables 40,000 30,000
Trade and Other receivables 30,000 40,000
Total Current Assets 160,000 190,000
Fictitious Assets - -
Total Assets (Total Non-current and Current Assets) 670,000 815,000
Equity:
Share capital @Rs.100 each 400,000 450,000
Reserve/Net Profit 90,000 165,000
Non-controlling interests - -
Total Equity 490,000 615,000
Liabilities
Non-Current Liabilities:
10% Loans and borrowings 120,000 150,000
Total Non-Current Liabilities 120,000 150,000
Current Liabilities:
Trade and other payable 30,000 50,000
Income tax liabilities - -
Provisions 30,000 -
Total Current-Liabilities 60,000 50,000
Total Liabilities (Total Non-current and Current) 180,000 200,000
Total Equity and Total Liabilities 670,000 815,000
about:blank 23/28
Required for 2021:

a. Current ratio (2:1)
b. Acid test ratio (1:1)
c. Debt to total capital ratio (less than 40%)
d. Stock turnover ratio (at least 8 times)
e. Total assets turnover ratio (more than 1 time)
f. Net profit margin (at least 12%)
g. Return on equity (at least 7%)
h. Return on assets (at least 5%)
i. Average sales period (45 days or less than 45 days)
j. Account receivable turnover ratio (at least 8 times)
k. Comment on the results (10x1.5+5)
Q-49. Following trading and profit & loss account & balance sheet of IPL Co. Ltd. as below:
Trading and Profit & Loss Account for the year ended .....
Particulars Amount Rs. Particulars Amount Rs.
To Opening stock 68,000 By Sales 300,000
To Purchase 244,000 By Closing stock 72,000
To Gross profit c/d 60,000
372,000 372,000
To Office expenses 22,000 By Gross profit b/d 60,000
To Selling expenses 10,000
To Net profit 28,000
60,000 60,000
Balance Sheet as at...
Liabilities Amount Rs. Assets Amount Rs.
Equity share capital 300,000 Fixed assets 220,000
Retained earnings 28,000 Inventory 72,000
Bank overdraft 4000 Sundry debtors 32,000
Trade creditors Bank balance
60,000 8,000
Unearned revenue Marketable securities
Reserve fund 10,000 80,000
10,000
412,000 412,000
Required:
a. Current ratio b. Liquid ratio c. Inventory turnover ratio
d. Receivable turnover ratio e. Capital employed turnover ratio
f. Fixed assets turnover g. Total assets turnover ratio
h. Gross profit margin i. Net profit margin
j. Return on fixed assets. k. Return on shareholders’ equity l. Operating ratio
Ans: a. 2.59:1; b. 1.62:1; c. 3.43:1; d. 9.375:1; e. 0.8876:1; f. 1.36 times; g. 0.73:1; h. 20%; i.
9.33%; j. 12.73%; k. 8.28%; I. 90.66%;
about:blank 24/28
Extra Que. Himal Manufacturing Company is in the process of preparing the income statement and
balance sheet. Since you are the chief account officer of that company, you have given the
responsibility of preparing these statements from the unadjusted trial balance given below:
Particulars Debit Rs. Credit Rs.
Cash 400,000 --
Bank 708,000 --
Discount allowed 10,000 --
Machinery 240,000 --
Purchases 400,000 --
Debtors 170,000 --
Interest on loan 12,000 --
Salary 120,000 --
Rent 60,000 --
Capital -- 10,00,000
Creditors -- 100,000
Discount received -- 20,000
Sales -- 800,000
10% bank loan -- 200,000
21,20,000 21,20,000
Adjustment:
i. Closing stock Rs.100,000 ii. Prepaid rent was Rs.4,000
iii. Outstanding interest on bank loan was Rs.8,000 iv. Depreciation on machinery at 10% p.a.
Required: a. Income statement b. Balance Sheet

c. Quick ratio, debt equity ratio and inventory turnover ratio, Gross profit margin,
return on assets and return on shareholder's equity.
Ans: a. 290,000; b. 14,90,000; c. Quick ratio 11.83:1 Debt equity ratio 15.5038% Inventory
turnover ratio 3 times Gross profit margin 62.5% Return on assets 20.81% Return on
shareholder's equity 22.48%
about:blank 25/28
Himal Manufacturing Co. Ltd

Income Statement
As on 31st Ashad ……….
Particulars Amount Amount
Sales Revenue (Less sales return and sales discount) 800,000
Less, Cost of goods sold:
Opening stock 000
Purchase (less purchase return) 400,000
Less: Closing stock (100,000)
Cost of goods sold 300,000
Gross profit 500,000
Less: Operating Expenses:
Administrative and Selling expenses
Discount allowed 10,000
Salary 120,000
Rent 60000-4000 56,000
Interest on loan (12000+8000) 20,000
Depreciation 24,000
Total operating expenses 230,000
Operating Income/profit (Gross profit – total operating expenses) 270,000
Add: Non-operating income
Discount received 20,000
Less: Non-operating expenses
Goodwill written off (000)
Net Loss before tax 290,000
Less: Provision for tax/tax expenses (this year’s if any) 00
Net income after tax 290,000
Add: Opening balance of retained earning 00
Less:
Interim Dividend paid (00)
Proposed dividend (00)
Transfer to any reserves and funds (00)
(00)
Closing balance of retained earning 290,000
about:blank 26/28
Himal Manufacturing Co. Ltd

Balance Sheet
As on 31st Ashad 2078
Particulars Amount Amount
Sources of fund:
Owner’s fund (insiders' equity)
Equity Share capital (Paid up) 10,00,000
Reserve and surplus ….
Retained earning 290,000
Preference share capital 12,90,000 (A)
Loan Fund (outsiders' equity)
Debenture/ Bond (secured loan) 000
Long term loan (unsecured loan) 200,000
Non-Current Liabilities 000 200,000(B)
Total Capital Employed A+B 14,90,000
Application of funds:
Fixed/Non-current assets
Goodwill/ trademark/ patent right etc………….. 000
Lees: Amortization 000 00
Machinery 240,000
Less: Depreciation 24000 216,000
Assets under construction (WIP) 0000
Total Non-Current Assets 216,000
Investment in shares and deb. of other Co’s 00
216,000 (A)
Current assets:
Closing Inventory 100,000
Debtors 170,000
Prepaid rent 4000
Other current assets: Cash 400,000
Bank 708,000
Total Current Assets (CA) 13,82,000
Less: Current liabilities and provisions
outstanding interest on loan 8,000
Other current liabilities: Creditors 100,000
Total current liabilities (CL) 108,000
Net Current Assets/ Working Capital (CA-CL) 12,74,000(B)
Preliminary expenses (remained to be written off) 000 (C)
Total Assets/Applications A+B+C 14,90,000
about:blank 27/28
C)
Quick assets 1278000
i) Quick/Liquid ratio = = 108000
= 11.83: 1
Current liabilities
Where, Quick assets = Cash + Bank + Debtors = 400,000 + 708,000 + 170,000 = 127,8,000
Long term debt 200000
ii) Debt equity ratio = Share holders Fund 𝑥100 = 𝑥100 = 15.5038%
1290000
Where, Shareholder’s fund = Equity + Reserve Surplus + P/L a/c – Preliminary expenses
= 10,00,000 + 00 + 290,000 – 00 = 1290,000
Cost of goods sold 3,00,000

iii) Inventory turnover ratio = = = 3 times
Closing stock 100,000
Gross Profit 500,000

iv) Gross profit margin = = x100 = 62.50%
Sales 8,00,000

v) Return on assets = = 14,90,000
x100 = 20.81%
Total Assets
or,
Net Profit 290,000
= 14,90,000
x100 = 19.46%
Total Assets

vi) Return on Shareholder fund = = 12,90,000
x100 = 22.48%
Shareholders fund
Good Luck
about:blank 28/28

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1/28/24, 6:19 PM Unit 8 Analysis of Financial Statement for BBA 2nd Sem 2079 Magh

Unit 8 / Chapter 9: Analysis of Financial Statements

Objectives of financial statements analysis

Things to Remember (TTR)

Need and Importance/Significance of financial statements analysis

Limitations of financial statements analysis

Parties involved in financial statements analysis

v. Government agencies: Government agencies need financial information of any company to

Types /Method or Tools of Financial Statement Analysis

Horizontal Analysis /Comparative Balance Sheet Analysis

An example of the horizontal analysis of comparative balance sheet is given below:

Income before tax 1,60,000 1,35,600 24,400 18%

Analysis Period Amount

Common Size Statement Analysis/Vertical Analysis

Amount of individual items

An example of the vertical analysis of comparative balance sheet is given below:

Meaning of ratio analysis

Net Profit 50,000

Net Profit 50,000

Methods of ratio analysis

Use and Importance of ratio analysis:

Limitation of Ratio analysis:

2. No idea of probable happening in future.

Types of Accounting Ratios

Leverage/Capital structure/solvency ratio

ii) Debt to total capital ratio or proprietary ratio:

Where, Fixed charge = interest on loan + preference dividend + repayment of loan

Efficiency/Turnover (or performance or Activity) ratio: -

Cost of goods sold Sales- gross profit

ii) Receivable (or Debtors) turnover ratio

iii) Average collection period/debtors collection period/Days sales outstanding(DSO)

365 or 360 days

Interpretation: - The higher the ratio, the better is the performance.

Cost of goods sold + operating expenses

Operating Profit = Gross profit + Operating Expenses

Net profit after tax + interest expenses

Total Assets = fixed assets + current asset

vii) Return on shareholders’ Equity/fund (ROSE): =

viii) Return on Common/equity shareholders' Equity /fund (ROCSE) =

Net profit after interest tax and preference dividend

Net profit after interest tax - preference dividend

Dividend paid to shareholder

Market price per equity share

Dividend per equity share

Dividend per equity share

Earning Per share

Earning Before interest and tax

Long Answer Questions

Balance sheet as on 30th Ashad 2073

Quick assets 680000

Long term debt Long term debt

Cost of goods sold Sales – Gross profit

Where, Fixed assets = Land Building + Plant machinery + Furniture

Gross Profit 490,000

Dividend paid to shareholder 32000

Market price per equity share 120

Required for 2076:

Quick assets 114000

Quick Assets= Current Assets - Stock=174000-60000=114000