3

Financial Analysis and Planning

BASIC CONCEPTS AND FORMULAE

1. Financial Analysis and Planning
Financial Analysis and Planning is carried out for the purpose of obtaining material
and relevant information necessary for ascertaining the financial strengths and
weaknesses of an enterprise and is necessary to analyze the data depicted in the
financial statements. The main tools are Ratio Analysis and Cash Flow and Funds Flow
Analysis.
2. Ratio Analysis
Ratio analysis is based on the fact that a single accounting figure by itself may not
communicate any meaningful information but when expressed as a relative to some
other figure, it may definitely provide some significant information. Ratio analysis is
comparison of different numbers from the balance sheet, income statement, and cash
flow statement against the figures of previous years, other companies, the industry, or
even the economy in general for the purpose of financial analysis.
3. Types of Ratios
The ratios can be classified into following four broad categories:
(a) Liquidity Ratios
Liquidity or short-term solvency means ability of the business to pay its short-term
liabilities.
• Current Ratios: The Current Ratio is one of the best known measures of
financial strength.
Current Assets / Current Liabilities
• Quick Ratios: The Quick Ratio is sometimes called the "acid-test" ratio and is
one of the best measures of liquidity. It is a more conservative measure than
current ratio.
Quick Assets/ Current Liabilities
• Cash Ratio/ Absolute Liquidity Ratio: The cash ratio measures the

© The Institute of Chartered Accountants of India

 3.2 Financial Management

absolute liquidity of the business. This ratio considers only the absolute
liquidity available with the firm.
Cash + Marketable Securities
= Cash Ratio
Current Liabilities
• Basic Defense Interval: This ratio helps in determining the number of days
the company can cover its cash expenses without the aid of additional
financing.
(Cash + Receivables + Marketable Securities)
Basic Defense Interval =
( Operating Expenses + Interest + Income Taxes)/365
• Net Working Capital Ratio: It helps to determine a company's ability to
weather financial crises over time.
Net Working Capital Ratio = Current Assets - Current Liabilities
(excluding short-term bank borrowing)
(b) Capital Structure/Leverage Ratios
The capital structure/leverage ratios may be defined as those financial ratios
which measure the long term stability and structure of the firm.
(i) Capital Structure Ratios: These ratios provide an insight into the financing
techniques used by a business and focus, as a consequence, on the long-term
solvency position.
• Equity Ratio: This ratio indicates proportion of owners’ fund to total
fund invested in the business.
Shareholders' Equity
Equity Ratio =
Total Capital Employed
• Debt Ratio: This ratio is used to analyse the long-term solvency of a firm.
Total Debt
Debt Ratio =
Capital Employed
• Debt to Equity Ratio: Debt equity ratio is the indicator of leverage.
Debt + Preferred Long Term
Debt to Equity Ratio =
Shareholders' Equity
(ii) Coverage Ratios: The coverage ratios measure the firm’s ability to service the
fixed liabilities.
• Debt Service Coverage Ratio: Lenders are interested in debt service
coverage to judge the firm’s ability to pay off current interest and
instalments.

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.3

Earnings available for debt service

Debt Service Coverage Ratio =
Interest + Installments
• Interest Coverage Ratio: Also known as “times interest earned ratio”
indicates the firm’s ability to meet interest (and other fixed-charges)
obligations.
EBIT
Interest Coverage Ratio =
Interest
• Preference Dividend Coverage Ratio: This ratio measures the ability
of a firm to pay dividend on preference shares which carry a stated rate of
return.
EAT
Pr eference Dividend Coverage Ratio =
Preference dividend liability
• Capital Gearing Ratio: In addition to debt-equity ratio, sometimes
capital gearing ratio is also calculated to show the proportion of fixed
interest (dividend) bearing capital to funds belonging to equity
shareholders.
(Pr eference Share Capital + Debentures + Long Term Loan)
Capital Gearing Ratio =
(Equity Share Capital + Reserves & Surplus − Losses)

(c) Activity Ratios

These ratios are employed to evaluate the efficiency with which the firm manages and
utilises its assets.
(i) Capital Turnover Ratio
This ratio indicates the firm’s ability of generating sales per rupee of long term
investment.
Sales
Capital Turnover Ratio =
Capital Employed
(ii) Fixed Assets Turnover Ratio
A high fixed assets turnover ratio indicates efficient utilisation of fixed assets in
generating sales.
Sales
Fixed Assets Turnover Ratio =
Capital Assets

© The Institute of Chartered Accountants of India

 3.4 Financial Management

(iii) Working Capital Turnover

Sales
Working Capital Turnover =
Working Capital
Working Capital Turnover is further segregated into Inventory Turnover, Debtors
Turnover, and Creditors Turnover.
• Inventory Turnover Ratio: This ratio also known as stock turnover ratio
establishes the relationship between the cost of goods sold during the year
and average inventory held during the year.
Sales
Inventory Turnover Ratio =
Average Inventory *
Opening Stock + Closing Stock
* Average Inventory =
2
• Debtors’ T urnover R atio: The debtor’s turnover ratio throws light on the
collection and credit policies of the firm.
Sales
Average Accounts Receivable
• Creditors’ Turnover Ratio: This ratio shows the velocity of debt payment
by the firm. It is calculated as follows:
Annual Net Credit Purchases
Creditors Turnover Ratio =
Average Accounts Payable
(d) Profitability Ratios
The profitability ratios measure the profitability or the operational efficiency of the
firm. These ratios reflect the final results of business operations.
• Return on Equity (ROE) : Return on Equity measures the profitability of equity
funds invested in the firm. This ratio reveals how profitability of the owners’ funds
have been utilised by the firm.
Profit after taxes
ROE =
Net worth
• Earnings per Share: The profitability of a firm from the point of view of
ordinary shareholders can be measured in terms of number of equity shares.
This is known as Earnings per share.
Net profit available to equity holders
Earnings per share (EPS) =
Number of ordinary shares outstanding

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.5

• Dividend per Share: Dividend per share ratio indicates the amount of profit
distributed to shareholders per share.
Total profits distributed to equity share holders
Dividend per share =
Number of equity shares
• Price Earnings Ratio: The price earnings ratio indicates the expectation of equity
investors about the earnings of the firm. It relates earnings to market price and is
generally taken as a summary measure of growth potential of an investment, risk
characteristics, shareholders orientation, corporate image and degree of liquidity.
Market price per share
PE Ratio =
Earnings per share
• Return on Capital Employed/Return on Investment: It is the percentage of
return on funds invested in the business by its owners.
Return
Return on Capital Employed = × 100
Capital Employed
• Return on Assets (ROA): This ratio measures the profitability of the firm in terms
of assets employed in the firm.
Net profit after taxes
ROA =
Average total assets
• Gross Profit Ratio: This ratio is used to compare departmental profitability or
product profitability.
Gross Profit
Gross Profit Ratio = × 100
Sales
• Operating Profit Ratio

Operating Profit
Operating Profit Ratio = × 100
Sales
• Net Profit Ratio: It measures overall profitability of the business.

Net Profit
Net Profit Ratio = × 100
Sales
• Yield: This ratio indicates return on investment; this may be on average
investment or closing investment. Dividend (%) indicates return on paid up
value of shares. But yield (%) is the indicator of true return in which share
capital is taken at its market value.

© The Institute of Chartered Accountants of India

 3.6 Financial Management

Dividend
Yield = × 100
Average Share Price
Dividend
or × 100
Closing Share Price
• Market Value/Book Value per Share: This ratio indicates market response
of the shareholders’ investment.
Market value per share Average Share Price
=
Book value per share Net worth/ Number of Equity Shares
Closing Share Price
or
Net worth / Number of Equity Shares
4. Importance of Ratio Analysis
The importance of ratio analysis lies in the fact that it presents facts on a comparative
basis and enables drawing of inferences regarding the performance of a firm. It is
relevant in assessing the performance of a firm in respect of following aspects:
• Liquidity Position
• Long-term Solvency
• Operating Efficiency
• Overall Profitability
• Inter-firm Comparison
• Financial Ratios for Supporting Budgeting.
5. Cash Flow Statement
Cash flow statement is a statement which discloses the changes in cash position
between the two periods. Along with changes in the cash position the cash flow
statement also outlines the reasons for such inflows or outflows of cash which in turn
helps to analyze the functioning of a business.
6. Classification of Cash Flow Activities
The cash flow statement should report cash flows during the period classified into following
categories:
• Operating Activities: These are the principal revenue-producing activities of the
enterprise and other activities that are not investing or financing activities.
• Investing Activities: These activities relate to the acquisition and disposal of long-
term assets and other investments not included in cash equivalents. Cash equivalents
are short term highly liquid investments that are readily convertible into known

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.7

amounts of cash and which are subject to an insignificant risk of changes in value.
• Financing Activities: These are activities that result in changes in the size and
composition of the owners’ capital (including preference share capital in the case of a
company) and borrowings of the enterprise.
7. Procedure in Preparation of Cash Flow Statement
• Calculation of net increase or decrease in cash and cash equivalents accounts:
The difference between cash and cash equivalents for the period may be computed by
comparing these accounts given in the comparative balance sheets. The results will
be cash receipts and payments during the period responsible for the increase or
decrease in cash and cash equivalent items.
• Calculation of the net cash provided or used by operating activities: It is by the
analysis of Profit and Loss Account, Comparative Balance Sheet and selected
additional information.
• Calculation of the net cash provided or used by investing and financing
activities: All other changes in the Balance sheet items must be analysed taking into
account the additional information and effect on cash may be grouped under the
investing and financing activities.
• Final Preparation of a Cash Flow Statement: It may be prepared by classifying all
cash inflows and outflows in terms of operating, investing and financing activities. The
net cash flow provided or used in each of these three activities may be highlighted.
Ensure that the aggregate of net cash flows from operating, investing and financing
activities is equal to net increase or decrease in cash and cash equivalents.
8. Reporting of Cash Flow from Operating Activities
There are two methods of converting net profit into net cash flows from operating activities-
• Direct Method: actual cash receipts (for a period) from operating revenues and actual
cash payments (for a period) for operating expenses are arranged and presented in
the cash flow statement. The difference between cash receipts and cash payments is
the net cash flow from operating activities.
• Indirect Method: In this method the net profit (loss) is used as the base then adjusted
for items that affected net profit but did not affect cash.
9. Funds Flow Statement
It ascertains the changes in financial position of a firm between two accounting periods. It
analyses the reasons for change in financial position between two balance sheets. It shows
the inflow and outflow of funds i.e., sources and application of funds during a particular
period.
• Sources of Funds

© The Institute of Chartered Accountants of India

 3.8 Financial Management

(a) Long term fund raised by issue of shares, debentures or sale of fixed assets and
(b) Fund generated from operations which may be taken as a gross before payment
of dividend and taxes or net after payment of dividend and taxes.
• Applications of Funds
(a) Investment in Fixed Assets
(b) Repayment of Capital
10. Funds Flow Statement vs. Cash Flow Statement
Cash flow statement Funds flow statement
(i) It ascertains the changes in balance (i) It ascertains the changes in
of cash in hand and bank. financial position between two
accounting periods.
(ii) It analyses the reasons for changes in (ii) It analyses the reasons for change
balance of cash in hand and bank. in financial position between two
balance sheets.
(iii) It shows the inflows and outflows of (iii) It reveals the sources and
cash. application of funds.
(iv) It is an important tool for short term (iv) It helps to test whether working
analysis. capital has been effectively used or
not.
(v) The two significant areas of analysis
are cash generating efficiency and
free cash flow.

UNIT – I : APPLICATION OF RATIO ANALYSIS FOR PERFORMANCE EVALUATION,

FINANCIAL HEALTH AND DECISION MAKING

Question 1
Discuss any three ratios computed for investment analysis.
Answer
Three ratios computed for investment analysis are as follows:
Profit after tax
(i) Earnings per share =
Number of equity shares outstanding

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.9

Equity dividend per share × 100

(ii) Dividend yield ratio =
Market price per share
Net profit before interest and tax × 100
(iii) Return on capital employed =
Capital employed
Question 2
Discuss the financial ratios for evaluating company performance on operating efficiency and
liquidity position aspects.
Answer
Financial ratios for evaluating performance on operational efficiency and liquidity position aspects
are discussed as:
Operating Efficiency: Ratio analysis throws light on the degree of efficiency in the management
and utilization of its assets. The various activity ratios (such as turnover ratios) measure this kind
of operational efficiency. These ratios are employed to evaluate the efficiency with which the firm
manages and utilises its assets. These ratios usually indicate the frequency of sales with respect to
its assets. These assets may be capital assets or working capital or average inventory. In fact, the
solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by
use of its assets – total as well as its components.
Liquidity Position: With the help of ratio analysis, one can draw conclusions regarding liquidity
position of a firm. The liquidity position of a firm would be satisfactory, if it is able to meet its
current obligations when they become due. Inability to pay-off short-term liabilities affects its
credibility as well as its credit rating. Continuous default on the part of the business leads to
commercial bankruptcy. Eventually such commercial bankruptcy may lead to its sickness and
dissolution. Liquidity ratios are current ratio, liquid ratio and cash to current liability ratio. These
ratios are particularly useful in credit analysis by banks and other suppliers of short-term loans.
Question 3
Explain the need of debt-service coverage ratio.
Answer
Debt Service Coverage Ratio: Lenders are interested in this ratio to judge the firm’s ability to
pay off current interest and installments.
Earnings available for debt service
Debt service coverage ratio =
Interest + Instalment
Where,
Earning for debt service = Net profit
+ Non-cash operating expenses like depreciation and other
amortizations

© The Institute of Chartered Accountants of India

 3.10 Financial Management

+ Non-operating adjustments like loss on sale of

+ Fixed assets + Interest on Debt Fund.
Question 4
Diagrammatically present the DU PONT CHART to calculate return on equity.
Answer
Du Pont Chart
There are three components in the calculation of return on equity using the traditional DuPont model-
the net profit margin, asset turnover, and the equity multiplier. By examining each input individually,
the sources of a company's return on equity can be discovered and compared to its competitors.
Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier)

Profit Margin =
EBIT ÷ Sales
Return on Net Assets
(RONA) = EBIT ÷ NA
Assets Turnover =
Sales ÷ NA

Return on Equity Financial Leverage (Income)

(ROE) = PAT ÷ NW = PAT ÷ E BIT

Financial Leverage (Balance

Sheet) = NA ÷ NW

Du Pont Chart
Question 5
How return on capital employed is calculated? What is its significance? (November 2008)
Answer
Return on Capital Employed (ROCE): It is the most important ratio of all. It is the percentage
of return on funds invested in the business by its owners. In short, it indicates what returns
management has made on the resources made available to them before making any
distribution of those returns.
Return
Return on Capital Employed = × 100
Capital Employed

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.11

Where,
Return = Net Profit
± Non-trading adjustments (but not accrual adjustments
for amortization of preliminary expenses, goodwill, etc.)
+ Interest on long term debts + Provision for tax
– Interest/Dividend from non-trade investments
Capital Employed = Equity Share Capital
+ Reserve and Surplus
+ Pref. Share Capital
+ Debentures and other long term loan
– Misc. expenditure and losses
– Non-trade Investments.
Intangible assets (assets which have no physical existence like goodwill, patents and
trademarks) should be included in the capital employed. But no fictitious asset should be included
within capital employed.
Question 6
What is quick ratio? What does it signify?
Answer
Quick Ratio: It is a much more exacting measure than the current ratio. It adjusts the current
ratio to eliminate all assets that are not already in cash (or near cash form). A ratio less than
one indicates low liquidity and hence is a danger sign.
Quick Assets
Quick Ratio =
Current Liabilities
Where,
Quick Assets = Current Assets – Inventory
Question 7
What do you mean by Stock Turnover ratio and Gearing ratio?

© The Institute of Chartered Accountants of India

 3.12 Financial Management

Answer
Stock Turnover Ratio and Gearing Ratio
Stock Turnover Ratio helps to find out if there is too much inventory build-up. An increasing
stock turnover figure or one which is much larger than the "average" for an industry may
indicate poor stock management. The formula for the Stock Turnover Ratio is as follows:
Cost of Sales Turnover
Stock Turnover ratio = or
Average inventory Average inventory
Gearing Ratio indicates how much of the business is funded by borrowing. In theory, the higher
the level of borrowing (gearing), the higher are the risks to a business, since the payment of
interest and repayment of debts are not "optional" in the same way as dividends. However,
gearing can be a financially sound part of a business's capital structure particularly if the
business has strong, predictable cash flows. The formula for the Gearing Ratio is as follows:
Borrowings (all long term debts including normal overdraft)
Gearing Ratio =
Net Assets or Shareholders' funds
Question 8
How is Debt service coverage ratio calculated? What is its significance?
Answer
Calculation of Debt Service Coverage Ratio (DSCR) and its Significance
The debt service coverage ratio can be calculated as under:
Earnings available for debt service
Debt Service Coverage Ratio =
Interest + Installments
EBITDA
Or, Debt Service Coverage Ratio =
Principal Repayment Due
Interest +
1 − Tc
Debt service coverage ratio indicates the capacity of a firm to service a particular level of debt
i.e. repayment of principal and interest. High credit rating firms target DSCR to be greater than
2 in its entire loan life. High DSCR facilitates the firm to borrow at the most competitive rates.
Question 9
Discuss the composition of Return on Equity (ROE) using the DuPont model.
Answer
Composition of Return on Equity using the DuPont Model: There are three components in
the calculation of return on equity using the traditional DuPont model- the net profit margin,

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.13

asset turnover, and the equity multiplier. By examining each input individually, the sources of
a company's return on equity can be discovered and compared to its competitors.
(a) Net Profit Margin: The net profit margin is simply the after-tax profit a company
generates for each rupee of revenue.
Net profit margin = Net Income ÷ Revenue
Net profit margin is a safety cushion; the lower the margin, lesser the room for error.
(b) Asset Turnover: The asset turnover ratio is a measure of how effectively a company
converts its assets into sales. It is calculated as follows:
Asset Turnover = Revenue ÷ Assets
The asset turnover ratio tends to be inversely related to the net profit margin; i.e., the
higher the net profit margin, the lower the asset turnover.
(c) Equity Multiplier: It is possible for a company with terrible sales and margins to take on
excessive debt and artificially increase its return on equity. The equity multiplier, a
measure of financial leverage, allows the investor to see what portion of the return on
equity is the result of debt. The equity multiplier is calculated as follows:
Equity Multiplier = Assets ÷ Shareholders’ Equity.
Calculation of Return on Equity
To calculate the return on equity using the DuPont model, simply multiply the three
components (net profit margin, asset turnover, and equity multiplier.)
Return on Equity = Net profit margin× Asset turnover × Equity multiplier
Question 10
Explain the following ratios:
(i) Operating ratio
(ii) Price earnings ratio
Answer
(i) Concept of Operating Ratio
Cost of goods sold + operating expenses
Operating ratio= × 100
Net sales
This is the test of the operational efficiency with which the business is being carried; the
operating ratio should be low enough to leave a portion of sales to give a fair return to the
investors.

© The Institute of Chartered Accountants of India

 3.14 Financial Management

(ii) Concept of Price-Earnings ratio

Market price per equity share
Price Earnings Ratio =
Earning per share
This ratio indicates the number of times the earnings per share is covered by its market
price. It indicates the expectation of equity investors about the earnings of the firm.
Question 11
Explain briefly the limitations of Financial ratios.
Answer
Limitations of Financial Ratios
The limitations of financial ratios are listed below:
(a) Diversified product lines: Many businesses operate a large number of divisions in quite
different industries. In such cases, ratios calculated on the basis of aggregate data
cannot be used for inter-firm comparisons.
(b) Financial data are badly distorted by inflation: Historical cost values may be substantially
different from true values. Such distortions of financial data are also carried in the
financial ratios.
(c) Seasonal factors may also influence financial data.
(d) To give a good shape to the popularly used financial ratios (like current ratio, debt- equity
ratios, etc.): The business may make some year-end adjustments. Such window dressing
can change the character of financial ratios which would be different had there been no
such change.
(e) Differences in accounting policies and accounting period: It can make the accounting
data of two firms non-comparable as also the accounting ratios.
(f) There is no standard set of ratios against which a firm’s ratios can be compared: Sometimes
a firm’s ratios are compared with the industry average. But if a firm desires to be above the
average, then industry average becomes a low standard. On the other hand, for a below
average firm, industry averages become too high a standard to achieve.
(Note: Students to write any four limitations)
Question 12
Explain the important ratios that would be used in each of the following situations:
(i) A bank is approached by a company for a loan of ` 50 lakhs for working capital
purposes.

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.15

(ii) A long term creditor interested in determining whether his claim is adequately
secured.
(iii) A shareholder who is examining his portfolio and who is to decide whether he
should hold or sell his holding in the company.
(iv) A finance manager interested to know the effectiveness with which a firm uses its
available resources.
Answer
Important Ratios used in different situations
(i) Liquidity Ratios- Here Liquidity or short-term solvency ratios would be used by the
bank to check the ability of the company to pay its short-term liabilities. A bank may
use Current ratio and Quick ratio to judge short terms solvency of the firm.
(ii) Capital Structure/Leverage Ratios- Here the long-term creditor would use the capital
structure/leverage ratios to ensure the long term stability and structure of the firm. A
long term creditors interested in the determining whether his claim is adequately
secured may use Debt-service coverage and interest coverage ratio.
(iii) Profitability Ratios- The shareholder would use the profitability ratios to measure the
profitability or the operational efficiency of the firm to see the final results of business
operations. A shareholder may use return on equity, earning per share and dividend
per share.
(iv) Activity Ratios- The finance manager would use these ratios to evaluate the efficiency
with which the firm manages and utilises its assets. Some important ratios are (a)
Capital turnover ratio (b) Current and fixed assets turnover ratio (c) Stock, Debtors and
Creditors turnover ratio.
Question 13
From the following information, prepare a summarised Balance Sheet as at 31st March, 2002:

Working Capital ` 2,40,000

Bank overdraft ` 40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus ` 1,60,000
Current ratio 2.5
Liquid ratio 1.5

© The Institute of Chartered Accountants of India

 3.16 Financial Management

Answer
Working notes:
1. Current assets and Current liabilities computation:

Current assets 2.5 Current assets Current liabilities

= or = = k (say)
Current liabilities 1 2.5 1
Or Current assets = 2.5 k and Current liabilities = k
Or Working capital = ( Current assets − Current liabilities)
Or ` 2,40,000 = k (2.5 − 1) = 1.5 k
Or k = ` 1,60,000
∴ Current liabilities = ` 1,60,000
Current assets = ` 1,60,000 × 2.5 = ` 4,00,000
2. Computation of stock
Liquid assets
Liquid ratio =
Current liabilities
Current assets - Stock
Or 1.5 =
Rs.1,60,000
Or 1.5 × ` 1,60,000 = ` 4,00,000 − Stock
Or Stock = ` 1,60,000
3. Computation of Proprietary fund; Fixed assets; Capital and Sundry creditors
Fixed assets
Proprietary ratio = = 0.75
Proprietary fund

∴ Fixed assets = 0.75 Proprietary fund

and Net working capital = 0.25 Proprietary fund
Or ` 2,40,000/0.25 = Proprietary fund
Or Proprietary fund = ` 9,60,000
and Fixed assets = 0.75 proprietary fund
= 0.75 × ` 9,60,000
= ` 7,20,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.17

Capital = Proprietary fund − Reserves & Surplus

= ` 9,60,000 − ` 1,60,000 =` 8,00,000
Sundry creditors = (Current liabilities − Bank overdraft)
= (` 1,60,000 − ` 40,000)
= ` 1,20,000
Construction of Balance sheet
(Refer to working notes 1 to 3)
Balance Sheet
` `
Capital 8,00,000 Fixed assets 7,20,000
Reserves & Surplus 1,60,000 Stock 1,60,000
Bank overdraft 40,000 Current assets 2,40,000
Sundry creditors 1,20,000
11,20,000 11,20,000

Question 14
With the help of the following information complete the Balance Sheet of MNOP Ltd.:
Equity share capital ` 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt .40
Total debt to owner’s equity .60
Fixed assets to owner’s equity .60
Total assets turnover 2 Times
Inventory turnover 8 Times

Answer
MNOP Ltd
Balance Sheet
Liabilities ` Assets `
Owner equity 1,00,000 Fixed assets 60,000
Current debt 24,000 Cash 60,000
Long term debt 36,000 Inventory 40,000
1,60,000 1,60,000

© The Institute of Chartered Accountants of India

 3.18 Financial Management

Working Notes
1. Total debt = 0.60 × Owners equity = 0.60 × ` 1,00,000 =`60,000
Current debt to total debt = 0.40 , hence current debt = 0.40 × 60,000 = 24,000
2. Fixed assets = 0.60 × Owners equity = 0.60 × ` 1,00,000 = ` 60,000
3. Total equity = Total debt + Owners equity =` 60,000 + ` 1,00,000 = ` 1,60,000
4. Total assets consisting of fixed assets and current assets must be equal to Rs 1,60,000
(Assets = Liabilities + Owners equity). Since Fixed assets are Rs 60,000 , hence, current
assets should be ` 1,00,000
5. Total assets to turnover = 2 Times : Inventory turnover = 8 Times
Hence , Inventory /Total assets = 2/8=1/4, Total assets = 1,60,000
Therefore Inventory = 1,60,000/4 = 40,000 Balance on Asset side
Cash = 1,00,000 – 40,000 = 60,000
Question 15
Using the following data, complete the Balance Sheet given below:
Gross Profit ` 54,000
Shareholders’ Funds ` 6,00,000
Gross Profit margin 20%
Credit sales to Total sales 80%
Total Assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long-term Debt to Equity 40%
Balance Sheet
Creditors ………………….. Cash …………..
Long-term debt ………………….. Debtors …………..
Shareholders’ funds ………………….. Inventory …………..
Fixed assets …………..
Answer
Gross Profit ` 54,000
Gross Profit Margin 20%

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.19

Gross Profit
∴ Sales =
Gross Profit Margin
= ` 54,000 / 0.20 = ` 2,70,000
Credit Sales to Total Sales = 80%
∴ Credit Sales = ` 2,70,000×0.80 = ` 2,16,000
Total Assets Turnover = 0.3 times
Sales
∴ Total Assets =
Total Assets Turnover
R` 2,70,000
= = ` 9,00,000
0.3
Sales – Gross Profit = COGS
∴ COGS = ` 2, 70,000 – 54,000
= ` 2, 16,000
Inventory turnover = 4 times
COGS 2,16,000
Inventory = = = ` 54,000
Inventory turnover 4
Average Collection Period = 20 days
360
∴ Debtors turnover = = 360/20 = 18
Average Collection Period
Credit Sales R` 2,16,000
∴ Debtors = = = `12,000
Debtors turnover 18
Current ratio = 1.8
Debtors + Inventory + Cash
1.8 =
Creditors
1.8 Creditors = (` 12,000 + ` 54,000 + Cash)
1.8 Creditors = ` 66,000 + Cash
Long-term Debt to Equity = 40%
Shareholders’ Funds = ` 6, 00,000
∴ Long-term Debt= ` 6, 00,000 × 40% = ` 2, 40,000

© The Institute of Chartered Accountants of India

 3.20 Financial Management

Creditors (Balance figure) = 9, 00,000 – (6, 00,000 + 2, 40,000) = ` 60,000

∴ Cash = (60,000×1.8) – 66,000 = ` 42,000
Balance Sheet (in `)
Creditors (Bal. Fig) 60,000 Cash 42,000
Debtors 12,000
Long- term debt 2,40,000 Inventory 54,000
Shareholders’ funds 6,00,000 Fixed Assets (Bal fig.) 7,92,000
9,00,000 9,00,000
Question 16
JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:
Balance Sheet
` in lakhs
March 31, 2006 March 31, 2005
Sources of Funds:
Shareholders Funds 2,377 1,472
Loan Funds 3,570 3,083
5,947 4,555
Applications of Funds:
Fixed Assets 3,466 2,900
Cash and bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other Current Assets 1,567 1,404
Less: Current Liabilities (3,937) (3,794)
5,947 4,555

The Income Statement of the JKL Ltd. for the year ended is as follows:
` in lakhs
March 31, 2006 March 31, 2005
Sales 22,165 13,882
Less: Cost of Goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative expenses 1,135 752
Earnings before Interest and Tax (EBIT) 170 586

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.21

Interest Expense 113 105

Profits before Tax 57 481
Tax 23 192
Profits after Tax (PAT) 34 289

Required:
(i) Calculate for the year 2005-06:
(a) Inventory turnover ratio
(b) Financial Leverage
(c) Return on Investment (ROI)
(d) Return on Equity (ROE)
(e) Average Collection period.
(ii) Give a brief comment on the Financial Position of JKL Limited.
Answer
Ratios for the year 2005-2006
(i) (a) Inventory turnover ratio
COGS
=
Average Inventory

20,860
= = 7.91
(2,867 + 2,407)
2
(b) Financial leverage
2005-06 2004-05
EBIT 170 586
= = =
EBIT − I 57 481
= 2.98 = 1.22
(c) ROI
NOPAT Sales
= ×
Sales Average Capital employed

© The Institute of Chartered Accountants of India

 3.22 Financial Management

57 × (1 − .4) 22,165 34.2 22,165

= × = × = 0.65%
22,165 (5,947 + 4,555) 22,165 5,251
2

(d) ROE
PAT 34 34
= = = = 1.77%
Average shareholders' funds (2,377 + 1,472) 1,924.5
2

(e) Average Collection Period*

22,165
Average Sales per day = = ` 60.73 lakhs
365
(1,495 + 1,168)
Average Debtors 2
Average collection period = =
Average sales per day 60.73

1331.5
= = 22 days
60.73
*Note: In the above solution, 1 year = 365 days has been assumed. Alternatively, some
candidates may give the solution on the basis 1 year = 360 days.

(ii) Brief Comment on the financial position of JKL Ltd.

The profitability of operations of the company are showing sharp decline due to increase in
operating expenses. The financial and operating leverages are becoming adverse.
The liquidity of the company is under great stress.
Question 17
The Financial statements of Excel AMP Graphics Limited are as under:
Balance Sheet As at 31st December, 2001
(` in crores)
Sources of Funds: 2001 2000
Shareholders’ funds
Share Capital 1,121 931
Reserves & Surplus 8,950 10,071 7,999
8,930
Loan Funds:

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.23

Secured Loans − 259

Finance lease obligations 74 −
Unsecured loans 171 245 115
374
10,316 9,304
Applications of Funds:
Fixed Assets
Gross Block 6,667 5,747
Less: Depreciation 3,150 2,561
Net Block 3,517 3,186
Capital Work-in-progress 27 3,544 28
3,214
Investments 288 222
Current Assets, Loans & Advances:
Inventories 2,709 2,540
Sundry debtors 9,468 9,428
Cash & Bank Balances 3,206 662
Loans & Advances 2,043 1,712
17,426 14,342
Less: Current liabilities & Provisions
Current liabilities 10,109 7,902
Provisions 513 572
10,622 8,474
Net Current Assets 6,804 5,868
Net Deferred Tax Liabiliy (320) −
10,316 9,304
Profit and Loss Account
For the year ended 31 December, 2001
2001 2000
(` in crores)
Income:
Sales & Services 23,436 17,849
Other Income 320 306
23,756 18,155
Expenditure:
Cost of Materials 15,179 10,996
Personnel Expenses 2,543 2,293

© The Institute of Chartered Accountants of India

 3.24 Financial Management

Other Expenses 3,546 2,815

Depreciation 419 383
Less: Transfer from revaluation reserve 7 412 6 377
Interest 164 88
21,844 16,569
Profit Before Tax 1,912 1,586
Provision for Tax:
Current Tax 450 371
Deferred Tax (6) −
Profit after Tax 1,468 1,215
Required:
(a) Compute and analyse the return on capital employed (ROCE) in a Du-Pont control chart
framework.
(b) Compute and analyse the average inventory holding period and average collection period.
(c) Compute and analyse the return on equity (ROE) by bringing out clearly the impact of
financial leverage.
Answer
(a) Working note:
Computation of Cost of goods sold (COGS), Operating profit before depreciation, interest &
tax (OPBDIT), Operating profit before interest and tax (OPBIT), Profit before interest and tax
(PBIT), Profit before tax (PBT) and Profit after tax (PAT)
(` in crores)
Year 2001 2000
Cost of goods sold (COGS) 21,268 16,104
(Material consumed + Personnel expenses + Other expenses)
Operating profit before depreciation, interest and tax (OPBDIT) 2,168 1,745
(Income from sales & service – COGS)
Operating profit before interest and tax (OPBIT) 1,756 1,368
(OPBDIT – depreciation)
Profit before interest and tax (PBIT) 2,076 1,674
(OPBIT + Other incomes)
Profit before tax (PBT) 1,912 1,586

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.25

(PBIT – Interest)
Profit after tax (PAT) 1,468 1,215
(PBT – Tax)
Return on capital employed (ROCE): (Before interest & tax)
Operating profits before interest and tax Sales OPBIT
= × =
Sales Capital employed Capital employed
* Capital employed = (Balance sheet total − Capital WIP − Investments − Loans & advances)
Year
2001 2000
ROCE 22.07% 18.63%
(Refer to working note) ⎛ ` 1,756 ⎞ ⎛ ` 1,368 ⎞
⎜ ` 7,958 ×100 ⎟ ⎜ ` 7,342 ×100 ⎟
⎝ ⎠ ⎝ ⎠
Operating profit margin 7.49% 7.66%
(Refer to working note) ⎛ ` 1,756 ⎞ ⎛ ` 1,368 ⎞
⎜ ` 23,436 ×100 ⎟ ⎜ ` 17,849 ×100 ⎟
⎝ ⎠ ⎝ ⎠
Material consumed / Sales 64.77% 61.61%
Personnel expenses /Sales 10.85% 12.85%
Other expenses / Sales 15.13% 15.77%
Depreciation / Sales 1.76% 2.11%

(b) Computation and analysis of average inventory holding period and average collection
period:
(` ’ in crores)
Year 2001 2000
1. Inventory turnover ratio: 5.6 4.33
(Material consumed/ Closing inventory) (` 15,179/` 2,709) (` 10,996/` 2,540)
2. Average inventory turnover period: 64 days 83 days
(360 days / Inventory turnover ratio)
3. Receivables turnover ratio: 2.48 1.89
(Net credit sales/Closing Sundry debtors) (` 23,436/` 9,468) (` 17,849/` 9,428)
4. Average collection period: 145 days 190 days
(360 days / Receivables turnover ratio)

© The Institute of Chartered Accountants of India

 3.26 Financial Management

(c) ROE = PAT / Shareholders’ funds

2001 2000
1,468 Cr. 1,215 Cr.
=
10,071Cr. 8,930 Cr.
= 14.58 % 13.61%
D
ROE = ROA + { (ROA − i ∗ ( 1 − Tc)}
E
ROA (Post tax) 14.34% 12.11%
{(ROCE ∗ (1 − .35)}
Tax / PBT 23.22% 23.39%
Loan funds / Total funds 2.37% 4.02%
Shareholders’ Funds / Total funds 97.63% 95.98%

ROE is marginally better than ROA, as debt ratio employed by the company is minimal.
Question 18
The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st
December, 2006:
2006
I Accounting Information:
Gross Profit 15% of Sales
Net profit 8% of sales
Raw materials consumed 20% of works cost
Direct wages 10% of works cost
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of works cost
Debt collection period 60 days
All sales are on credit
II Financial Ratios:
Fixed assets to sales 1:3
Fixed assets to Current assets 13 : 11
Current ratio 2:1
Long-term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.27

If value of fixed assets as on 31st December, 2005 amounted to `26 lakhs, prepare a summarised
Profit and Loss Account of the company for the year ended 31st December, 2006 and also the
Balance Sheet as on 31st December, 2006.
Answer

(a) Working Notes:

(i) Calculation of Sales

Fixed Assets 1
=
Sales 3
26,00,000 1
∴ = ⇒ Sales = ` 78,00,000
Sales 3
(ii) Calculation of Current Assets
Fixed Assets 13
=
Current Assets 11
26,00,000 13
∴ = ⇒ Current Assets = ` 22,00,000
Current Assets 11
(iii) Calculation of Raw Material Consumption and Direct Wages
`
Sales 78,00,000
Less: Gross Profit 11,70,000
Works Cost 66,30,000

Raw Material Consumption (20% of Works Cost) `13,26,000

Direct Wages (10% of Works Cost) ` 6,63,000
(iv) Calculation of Stock of Raw Materials (= 3 months usage)
3
= 13,26,000 × = ` 3,31,500
12
(v) Calculation of Stock of Finished Goods (= 6% of Works Cost)
6
= 66,30,000 × = ` 3,97,800
100

© The Institute of Chartered Accountants of India

 3.28 Financial Management

(vi) Calculation of Current Liabilities

Current Assets
=2
Current Liabilities
22,00,000
= 2 ⇒ Current Liabilities = ` 11,00,000
Current Liabilities
(vii) Calculation of Debtors
Debtors
Average collection period = × 365
Credit Sales
Debtors
× 365 = 60 ⇒ Debtors = ` 12,82,191.78 or ` 12,82,192
78,00,000
(viii) Calculation of Long term Loan
Long term Loan 2
=
Current Liabilities 1
Long term loan 2
= ⇒ Long term loan = ` 22,00,000.
11,00,000 1
(ix) Calculation of Cash Balance
`
Current assets 22,00,000
Less: Debtors 12,82,192
Raw materials stock 3,31,500
Finished goods stock 3,97,800 20,11,492
Cash balance 1,88,508

(x) Calculation of Net worth

Fixed Assets 26,00,000
Current Assets 22,00,000
Total Assets 48,00,000
Less: Long term Loan 22,00,000
Current Liabilities 11,00,000 33,00,000
Net worth 15,00,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.29

Net worth = Share capital + Reserves = 15,00,000

Capital 1 1
= ⇒ Share Capital = 15,00,000 × = ` 3,00,000
Reserves and Surplus 4 5
4
Reserves and Surplus = 15,00,000 × = ` 12,00,000
5
Profit and Loss Account of PQR Ltd.
for the year ended 31st December, 2006
Particulars ` Particulars `
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,000
To Works (Overhead) 46,41,000
Balancing figure
To Gross Profit c/d
(15% of Sales) 11,70,000 ________
78,00,000 78,00,000
To Selling and Distribution 5,46,000 By Gross Profit b/d 11,70,000
Expenses (Balancing figure)

To Net Profit (8% of Sales) 6,24,000 ________

11,70,000 11,70,000

Balance Sheet of PQR Ltd.

as at 31st December, 2006
Liabilities ` Assets `
Share Capital 3,00,000 Fixed Assets 26,00,000
Reserves and Surplus 12,00,000 Current Assets:
Long term loans 22,00,000 Stock of Raw Material 3,31,500
Current liabilities 11,00,000 Stock of Finished Goods 3,97,800
Debtors 12,82,192
________ Cash 1,88,508
48,00,000 48,00,000
Question 19
Using the following information, complete the Balance Sheet given below:
(i) Total debt to net worth : 1:2

© The Institute of Chartered Accountants of India

 3.30 Financial Management

(ii) Total assets turnover : 2

(iii) Gross profit on sales : 30%
(iv) Average collection period : 40 days
(Assume 360 days in a year)
(v) Inventory turnover ratio based on cost of goods sold and year-end inventory : 3
(vi) Acid test ratio : 0.75
Balance Sheet
as on March 31, 2007
Liabilities ` Assets `
Equity Shares Capital 4,00,000 Plant and Machinery −
Reserves and Surplus 6,00,000 and other Fixed Assets
Total Debt: Current Assets:
Current Liabilities − Inventory −
Debtors −
Cash −
_______ _______

Answer
Networth = Capital + Reserves and surplus
= 4,00,000 + 6,00,000 = `10,00,000
Total Debt 1
=
Networth 2
∴ Total debt = `5,00,000
Total Liability side = 4,00,000 + 6,00,000 + 5,00,000
= `15,00,000
= Total Assets
Sales
Total Assets Turnover =
Total assets
Sales
2=
15,00,000
∴ Sales = ` 30,00,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.31

Gross Profit on Sales : 30% i.e. ` 9,00,000

∴ COGS = ` 30,00,000 – ` 9,00,000
= ` 21,00,000
COGS
Inventory turnover =
Inventory
21,00,000
3=
Inventory
∴ Inventory = `7,00,000
Average debtors
Average collection period =
Sales / day
Debtors
40 =
30,00,000 / 360
∴ Debtors = `3,33,333.
Current Assets − Stock
Acid test ratio =
Current liabilities
Current Assets − 7,00,000
0.75 =
5,00,000
∴ Current Assets = `10,75,000.
∴ Fixed Assets = Total Assets – Current Assets
= 15,00,000 – 10,75,000 = ` 4,25,000
Cash and Bank balance = Current Assets – Inventory – Debtors
= 10,75,000 – 7,00,000 – 3,33,333 = ` 41,667.
Balance Sheet as on March 31, 2007
Liabilities ` Assets `
Equity Share Capital 4,00,000 Plant and Machinery and other
Reserves & Surplus 6,00,000 Fixed Assets 4,25,000
Total Debt: Current Assets:
Current liabilities 5,00,000 Inventory 7,00,000
Debtors 3,33,333

© The Institute of Chartered Accountants of India

 3.32 Financial Management

________ Cash 41,667

15,00,000 15,00,000

Question 20
MN Limited gives you the following information related for the year ending 31st March, 2009:
(1) Current Ratio 2.5 : 1
(2) Debt-Equity Ratio 1 : 1.5
(3) Return on Total Assets 15%
(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7
(7) Current Market Price per Equity Share ` 16
(8) Net Working Capital ` 4,50,000
(9) Fixed Assets ` 10,00,000
(10) 60,000 Equity Shares of ` 10 each
(11) 20,000, 9% Preference Shares of ` 10 each
(12) Opening Stock ` 3,80,000
You are required to calculate:
(i) Quick Ratio
(ii) Fixed Assets Turnover Ratio
(iii) Proprietary Ratio
(iv) Earnings per Share
(v) Price-Earning Ratio.
Answer
(a) Workings Notes:
1. Net Working Capital = Current Assets – Current Liabilities
= 2.5 – 1=1.5
Net Working Capital × 2.5
Thus, Current Assets =
1.5
` 4,50,000 × 2.5
= = ` 7,50,000
1.5

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.33

Current Liabilities = ` 7,50,000 – ` 4,50,000 = ` 3,00,000

2. Sales = Total Assets Turnover × Total Assets
= 2 × (` 10,00,000 + ` 7,50,000) = ` 35,00,000
3. Cost of Goods Sold = 100 – 20 = 80% of Sales
= 80% of ` 35,00,000 = ` 28,00,000
Cost of Good Sold
4. Average Stock =
Stock Turnover Ratio
` 28,00,000
= = ` 4,00,000
7
Closing Stock = (Average Stock ×2) – Opening Stock
= (` 4,00,000 × 2) – ` 3,80,000 = ` 4,20,000
Quick Assets = Current Assets – Closing Stock
= ` 7,50,000 – ` 4,20,000 = ` 3,30,000
Total Assets (Debt + Equity) × 1.5
Net Worth =
(1 + 1.5)
` 17,50,000 × 1.5
= = `10,50,000
2.5
5. Profit after tax (PAT) = Total Assets × Return on Total Assets
= ` 17,50,000 × 15% = ` 2,62,500
(i) Calculation of Quick Ratio
Quick Assets
Quick Ratio =
Current Liabilities
` 3,30,000
= = 1.1:1
` 3,00,000
(ii) Calculation of Fixed Assets Turnover Ratio
Sales
Fixed Assets Turnover Ratio =
Fixed Assets
` 35,00,000
= = 3.5
` 10,00,000

© The Institute of Chartered Accountants of India

 3.34 Financial Management

(iii) Calculation of Proprietary Ratio

Network
Proprietary Ratio =
Total Assets
` 10,50, 000
= = 0.6 : 1
` 17,50,000
(iv) Calculation of Earnings per Equity Share (EPS)
PAT − Preference Share Dividend
Earnings per Equity Share (EPS) =
Number of Equity Shares
` 2,62,500 − ` 18,000
=
60,000
= ` 4.075 per share
(v) Calculation of Price-Earnings Ratio (P/E Ratio)
Market Price of Equity Share
P/E Ratio =
EPS
` 16
= = 3.926
` 4.075
Question 21
ABC Limited has an average cost of debt at 10 per cent and tax rate is 40 per cent. The
Financial leverage ratio for the company is 0.60. Calculate Return on Equity (ROE) if its
Return on Investment (ROI) is 20 per cent.
Answer
ROE = [ROI + {(ROI – r) × D/E}] (1 – t)
= [0.20 + {(0.20 – 0.10) × 0.60}] (1 – 0.40)
=[ 0.20 + 0.06] × 0.60 = 0.1560
ROE = 15.60%
Question 22
The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months then
sales may likely to increase by ` 1,20,000 per annum. Cost of sales amounted to 90% of
sales. The risk of non-payment is 5%. Income tax rate is 30%. The expected return on
investment is ` 3,375 (after tax). Should the company accept the suggestion of Sales
Manager?

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.35

Answer
Profitability on additional sales:
`
Increase in sales 1,20,000
Less: Cost of sales (90% sales) 1,08,000
Less: Bad debt losses (5% of sales) 6,000
Net profit before tax 6,000
Less: Income tax (30%) 1,800
4,200

Advise: Net profit after tax ` 4,200 on additional sales is higher than expected return. Hence,
proposal should be accepted.
Question 23
From the information given below calculate the amount of Fixed assets and Proprietor’s fund.
Ratio of fixed assets to proprietors fund = 0.75
Net Working Capital = ` 6,00,000
Answer
Calculation of Fixed Assets and Proprietor’s Fund
Since Ratio of Fixed Assets to Proprietor’s Fund = 0.75
Therefore, Fixed Assets = 0.75 Proprietor’s Fund
Net Working Capital = 0.25 Proprietor’s Fund
6,00,000 = 0.25 Proprietor’s Fund
` 6,00,000
Therefore, Proprietor’s Fund =
0.25
= ` 24,00,000
Proprietor’s Fund = ` 24,00,000
Since, Fixed Assets = 0.75 Proprietor’s Fund
Therefore, Fixed Assets = 0.75 × 24,00,000 = ` 18,00,000
Fixed Assets = ` 18,00,000

© The Institute of Chartered Accountants of India

 3.36 Financial Management

Question 24
MNP Limited has made plans for the next year 2010 -11. It is estimated that the company will
employ total assets of ` 25,00,000; 30% of assets being financed by debt at an interest cost of 9%
p.a. The direct costs for the year are estimated at ` 15,00,000 and all other operating expenses
are estimated at ` 2,40,000. The sales revenue are estimated at ` 22,50,000. Tax rate is assumed
to be 40%. Required to calculate:
(i) Net profit margin;
(ii) Return on Assets;
(iii) Asset turnover; and
(iv) Return on Equity.
Answer
The net profit is calculated as follows:
`
Sales Revenue 22,50,000
Less: Direct Costs 15,00,000
Gross Profits 7,50,000
Less: Operating Expense 2,40,000
EBIT 5,10,000
Less: Interest (9% × 7,50,000) 67,500
EBT 4,42,500
Less: Taxes (@ 40%) 1,77,000
PAT 2,65,500

(i) Net Profit Margin

EBIT (1 - t) 5,10,000 × (1 − 0.4)
Net Profit Margin = × 100 = = 13.6%
Sales 22,50,000
(ii) Return on Assets (ROA)
ROA = EBIT (1− t) ÷ Total Assets
= 5,10,000 (1− 0.4) ÷ 25,00,000 = 3,06,000 ÷ 25,00,000
= 0.1224 = 12.24%

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.37

(iii) Asset Turnover

Sales 22,50,000
Asset Turnover = = = 0.9
Assets 25,00,000
Asset Turnover = 0.9
(iv) Return on Equity (ROE)
PAT 2,65,500
ROE = = = 15.17%
Equity 17,50,000
ROE = 15.17%
Question 25
The financial statements of a company contain the following information for the year ending
31st March, 2011:
Particulars `
Cash 1,60,000
Sundry Debtors 4,00,000
Short-term Investment 3,20,000
Stock 21,60,000
Prepaid Expenses 10,000
Total Current Assets 30,50,000
Current Liabilities 10,00,000
10% Debentures 16,00,000
Equity Share Capital 20,00,000
Retained Earnings 8,00,000
Statement of Profit for the year ended 31st March, 2011
Sales (20% cash sales) 40,00,000
Less: Cost of goods sold 28,00,000
Profit before Interest & Tax 12,00,000
Less: Interest 1,60,000
Profit before tax 10,40,000
Less: Tax @ 30% 3,12,000
Profit After Tax 7,28,000
You are required to calculate:

© The Institute of Chartered Accountants of India

 3.38 Financial Management

(i) Quick Ratio

(ii) Debt-equity Ratio
(iii) Return on Capital Employed, and
(iv) Average collection period (Assuming 360 days in a year).
Answer
Quick Assets
(i) Quick Ratio =
Current Liabilities
Quick Assets = Current Assets – Stock – Prepaid Expenses
= 30,50,000 – 21,60,000 –10,000
Quick Assets = 8,80,000
Quick Ratio = 8,80,000/10,00,000
= 0.88 : 1
Long term debt
(ii) Debt-Equity Ratio =
Shareholders Funds
16,00,000
=
(20,00,000 + 8,00,000)
= 0.57:1
(iii) Return on Capital Employed (ROCE)
PBIT
ROCE = × 100
Capital Employed
12,00,000
= × 100
44,00,000
= 27.27%
(iv) Average Collection Period
Sundry Debtors
= × 360
Credit Sales
4,00,000
= × 360
32,00,000
= 45 days

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.39

Question 26
The following accounting information and financial ratios of M Limited relate to the year
ended 31st March, 2012 :
Inventory Turnover Ratio 6 Times
Creditors Turnover Ratio 10 Times
Debtors Turnover Ratio 8 Times
Current Ratio 2.4
Gross Profit Ratio 25%
Total sales ` 30,00,000; cash sales 25% of credit sales; cash purchases ` 2,30,000;
working capital ` 2,80,000; closing inventory is ` 80,000 more than opening inventory.
You are required to calculate:
(i) Average Inventory
(ii) Purchases
(iii) Average Debtors
(iv) Average Creditors
(v) Average Payment Period
(vi) Average Collection Period
(vii) Current Assets
(viii) Current Liabilities.
Answer
(i) Computation of Average Inventory
Gross Profit = 25% of 30,00,000
Gross Profit = 7,50,000
Cost of goods sold (COGS) = 30,00,000 – 7,50,000
COGS = 22,50,000
COGS 22,50,000
Inventory Turnover Ratio = 6=
Average Inventory Average inventory
Average inventory = 3,75,000
(ii) Computation of Purchases
Purchases = COGS + Increase in Stock = 22,50,000 + 80,000
Purchases = 23,30,000

© The Institute of Chartered Accountants of India

 3.40 Financial Management

(iii) Computation of Average Debtors

Let Credit Sales be ` 100
25
Cash sales = x 100 =` 25
100
Total Sales = 100 +25= 125
Total sales is ` 125 credit sales is ` 100
If total sales is 30,00,000, then credit sales is
30,00,000x100
=
125
Credit Sales = 24,00,000
Cash Sales = 6,00,000
Net Credit Sales
Debtors Turnover Ratio = =8
Average debtors
24,00,000
= =8
Average debtors
24,00,000
Average Debtors =
8
Average Debtors = 3,00,000
(iv) Computation of Average Creditors
Credit Purchases = Purchases – Cash Purchases
= 23,30,000 – 2,30,000
= 21,00,000
Credit Purchases
Creditors Turnover Ratio =
Average Creditors
21,00,000
10 =
Average Creditors
Average Creditors = 2,10,000
(v) Computation of Average Payment Period
Average Creditors
Average Payment Period =
Average Daily Credit Purchases

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.41

2,10,000 2,10,000
= =
⎛ Credit Purchases ⎞ ⎛ 21,00,000 ⎞
⎜ ⎟ ⎜ ⎟
⎝ 365 ⎠ ⎝ 365 ⎠
2,10,000
= x 365
21,00,000
= 36.5 days
OR
Average Payment Period = 365/Creditors Turnover Ratio
365
= = 36.5 days
10
(vi) Computation of Average Collection Period
Average Debtors
Average Collection Period = × 365
Net Credit Sales
3,00,000
= × 365 = 45.625 days
24,00,000
OR
Average collection period = 365/ Debtors Turnover Ratio
365
= = 45.625 days
8
(vii) Computation of Current Assets
Current Assets (CA)
Current Ratio =
Current Liabilities (CL)
2.4 Current Liabilities = Current Assets or CL = CA/2.4
Working capital = Current Assets – Current liabilities
2,80,000 = CA-CA/2.4
2,80,000 = 1.4 CA/2.4
CA = 4,80,000
(viii) Computation of Current Liabilities
4,80,000
Current liabilities = = 2,00,000
2.4

© The Institute of Chartered Accountants of India

 3.42 Financial Management

UNIT – II : CASH FLOW AND FUNDS FLOW ANALYSIS

Question 1
Distinguish between Cash Flow and Fund Flow statement.
Answer
The points of distinction between cash flow and funds flow statement are as below:

Cash flow statement Funds flow statement

(i) It ascertains the changes in balance of (i) It ascertains the changes in financial
cash in hand and bank. position between two accounting
periods.
(ii) It analyses the reasons for changes in (ii) It analyses the reasons for change in
balance of cash in hand and bank financial position between two balance
sheets
(iii) It shows the inflows and outflows of (iii) It reveals the sources and application of
cash. finds.
(iv) It is an important tool for short term (iv) It helps to test whether working capital
analysis. has been effectively used or not.
(v) The two significant areas of analysis
are cash generating efficiency and free
cash flow.

Question 2
The following are the Balance Sheets of Gama Limited for the year ending March 31, 2004 and
March 31, 2005:
Balance Sheet
as on March, 31
2004 2005
` `
Capital and Liabilities
Share Capital 6,75,000 7,87,500
General Reserves 2,25,000 2,81,250
Capital Reserve (Profit on Sale of investment) - 11,250
Profit & Loss Account 1,12,500 2,25,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.43

15% Debentures 3,37,500 2,25,000

Accrued Expenses 11,250 13,500
Creditors 1,80,000 2,81,250
Provision for Dividends 33,750 38,250
Provision for Taxation 78,750 85,500
Total 16,53,750 19,48,500
Assets
Fixed Assets 11,25,000 13,50,000
Less: Accumulated depreciation 2,25,000 2,81,250
Net Fixed Assets 9,00,000 10,68,750
Long-term Investments (at cost) 2,02,500 2,02,500
Stock (at cost) 2,25,000 3,03,750
Debtors (net of provision for doubtful debts of ` 45,000 and ` 2,53,125 2,75,625
56,250 respectively for 2004 and 2005 respectively)
Bills receivables 45,000 73,125
Prepaid Expenses 11,250 13,500
Miscellaneous Expenditure 16,875 11,250
16,53,750 19,48,500

Additional Information:
(i) During the year 2004-05, fixed assets with a net book value of `11,250 (accumulated
depreciation, `33,750) was sold for `9,000.
(ii) During the year 2004-05, Investments costing `90,000 were sold, and also Investments
costing `90,000 were purchased.
(iii) Debentures were retired at a Premium of 10%.
(iv) Tax of `61,875 was paid for 2003-04.
(v) During the year 2004-05, bad debts of `15,750 were written off against the provision for
Doubtful Debt account.
(vi) The proposed dividend for 2003-04 was paid in 2004-05.
Required:
Prepare a Funds Flow Statement (Statement of changes in Financial Position on working capital
basis) for the year ended March 31, 2005.

© The Institute of Chartered Accountants of India

 3.44 Financial Management

Answer
Computation of Funds from Operation
`
Profit and loss balance on March 31, 2005 2,25,000
Add: Depreciation 90,000
Loss on Sale of Asset 2,250
Misc. Expenditure written off 5,625
Transfer to Reserves 56,250
Premium on Redemption of debentures 11,250
Provision for Dividend 38,250
Provision for Taxation 68,625
4,97,250
Less: P/L balance on March 31, 2004 1,12,500
Funds from operations 3,84,750

Accumulated Depreciation A/c

To Fixed Asset A/c 33,750 By Bal. b/d 2,25,000
By P/L A/c 90,000
To Bal. c/d 2,81,250 (Pro (Prov. for dep.) (Bal. Fig.)
3,15,000 3,15,000
Fixed Assets A/c
To Bal. b/d 11,25,000 By Accumulated Depreciation A/c 33,750
By Cash 9,000
To Bank (Purchase of Fixed 2,70,000 By P/L (Loss on sale) 2,250
Asset) (Bal. fig.)
By Bal. c/d 13,50,000
13,95,000 13,95,000

Provision for Tax A/c

To Cash (tax paid) 61,875 By Bal. b/d 78,750
By P/L A/c (Prov.)
To Bal. c/d 85,500 (Bal. fig.) 68,625
1,47,375 1,47,375

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.45

Statement of Changes in Working Capital

March 31, 2004 March 31, 2005 Change in W/C
Current Assets
Stock 2,25,000 3,03,750 78,750
Debtors 2,53,125 2,75,625 22,500
Bills Receivables 45,000 73,125 28,125
Prepaid Expenses 11,250 13,500 2,250
5,34,375 6,66,000 1,31,625 -
Less: Current liabilities
Accrued Expenses 11,250 13,500 - 2,250
Creditors 1,80,000 2,81,250 - 1,01,250
1,91,250 2,94,750 1,31,625 1,03,500
Working Capital 3,43,125 3,71,250 - -
Increase in Working Capital 28,125
1,31,625 1,31,625

Funds Flow Statement for the year ended March 31, 2005
Sources `
Working Capital from Operations 3,84,750
Sale of Fixed Assets 9,000
Sale of Investments 1,01,250
Share Capital Issued 1,12,500
Total Funds Provided (A) `6,07,500
Uses `
Purchase of Fixed Assets 2,70,000
Purchase of Investments 90,000
Payment of Debentures (at a premium of 10%) 1,23,750
Payment of Dividends 33,750
Payment of Taxes 61,875
Total Funds Applied (B) 5,79,375
Increase in Working Capital (A-B) `28,125

© The Institute of Chartered Accountants of India

 3.46 Financial Management

Question 3
Following are the financial statements of Zed Ltd.:
Balance Sheet as on
March 31, 2007 March 31, 2006
` `
Capital and Liabilities:
Share capital, `10 par value 1,67,500 1,50,000
Share premium 3,35,000 2,37,500
Reserves and Surplus 1,74,300 1,23,250
Debentures 2,40,000 −
Long-term loans 40,000 50,000
Creditors 28,800 27,100
Bank Overdraft 7,500 6,250
Accrued expenses 4,350 4,600
Income-tax payable 48,250 16,850
10,45,700 6,15,550

March 31, 2007 March 31, 2006

` `
Assets:
Land 3,600 3,600
Building, net of depreciation 6,01,800 1,78,400
Machinery, net of depreciation 1,10,850 1,07,050
Investment in ‘A’ Ltd. 75,000 −
Stock 58,800 46,150
Prepaid expenses 1,900 2,300
Debtors 76,350 77,150
Trade Investments 40,000 1,05,000
Cash 77,400 95,900
10,45,700 6,15,550

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.47

Income Statement
for the year ended March 31, 2007
`
Net Sales 13,50,000
Less: Cost of goods sold and operating expenses (including depreciation on
buildings of `6,600 and depreciation on machinery of `11,400) 12,58,950
Net operating profit 91,050
Gain on sale of trade investments 6,400
Gain on sale of machinery 1,850
Profits before tax 99,300
Income-tax 48,250
Profits after tax 51,050

Additional information:
(i) Machinery with a net book value of `9,150 was sold during the year.
(ii) The shares of ‘A’ Ltd. were acquired by issue of debentures.
Required:
Prepare a Funds Flow Statement (Statement of changes in Financial position on Working capital
basis) for the year ended March 31, 2007.
Answer
Schedule of Changes in Working Capital
March 31, 2007 March 31, 2006 Impact on Working
Capital
Increase Decrease
Current Assets
Stock 58,800 46,150 12,650 −
Prepaid expenses 1,900 2,300 − 400
Debtors 76,350 77,150 − 800
Trade Investments 40,000 1,05,000 − 65,000
Cash 77,400 95,900 − 18,500
2,54,450 3,26,500 12,650 84,700

© The Institute of Chartered Accountants of India

 3.48 Financial Management

Current Liabilities
Creditors 28,800 27,100 − 1,700
Bank overdraft 7,500 6,250 − 1,250
Accrued expenses 4,350 4,600 250 −
Income tax payable 48,250 16,850 − 31,400
88,900 54,800 250 34,350

Net Working Capital 1,65,550 2,71,700 12,900 1,19,050

Decrease in net working
capital 1,06,150 − 1,06,150 −
2,71,700 2,71,700 1,19,050 1,19,050

Machinery Account
` `
Balance b/d 1,07,050 Sale of machinery (given) 9,150
Purchase of machinery (plug) 24,350 Depreciation (given) 11,400
Balance c/d 1,10,850
1,31,400 1,31,400

Trade Investments Account

` `
Balance b/d 1,05,000 Cash (sale of trade investments) 65,000
_______ Balance c/d 40,000
1,05,000 1,05,000

Estimation of Funds flow from Operations

`
Profits after tax 51,050
Add: Depreciation on Buildings 6,600
Depreciation on Machinery 11,400 18,000
69,050
Less: Gain on sale of machinery 1,850
Funds from Operations 67,200

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.49

Gain on sale of trade investments has been considered as an operating income. Trade
investments have been considered as part of current assets.
Statement of Changes in Financial Position (Working Capital basis)
for the year ended March 31, 2007
`
Sources:
Funds from operations 67,200
Sale of machinery on gain (9,150 + 1,850) 11,000
Debentures issued (`2,40,000 – 75,000) 1,65,000
Investment in ‘A’ Ltd. financial transaction and hence not affecting working capital
Issue of share capital (including share premium) 1,15,000
Financial Resources Provided 3,58,200
Uses:
Purchase of building (6,01,800 + 6,600 − 1,78,400) 4,30,000
Purchase of machinery 24,350
Payment of long-term loan 10,000
Financial Resources Applied 4,64,350
Net Decrease in Working Capital 1,06,150

Question 4
Balance Sheet of OP Ltd. as on 31st March, 2007 and 2008 are as follows:
Liabilities Amount Amount Assets Amount Amount
31.3.2007 31.3.2008 31.3.2007 31.3.2008
` ` ` `
Share capital 20,00,000 20,00,000 Land and Building 15,00,000 14,00,000
General Reserve 4,00,000 4,50,000 Plant and Machinery 18,00,000 17,50,000
Profit and Loss A/c 2,50,000 3,60,000 Investment 4,00,000 3,72,000
10% Debentures 10,00,000 8,00,000 Stock 4,80,000 8,50,000
Bank Loan (long-term) 5,00,000 6,00,000 Debtors 6,00,000 7,98,000
Creditors 4,00,000 5,80,000 Prepaid Expenses 50,000 40,000
Outstanding Expenses 20,000 25,000 Cash and Bank 1,40,000 85,000
Proposed Dividend 3,00,000 3,60,000
Provision for taxation 1,00,000 1,20,000
49,70,000 52,95,000 49,70,000 52,95,000

© The Institute of Chartered Accountants of India

 3.50 Financial Management

Additional information:
(i) New machinery for `3,00,000 was purchased but an old machinery costing `1,45,000 was
sold for `50,000 and accumulated depreciation thereon was `75,000.
(ii) 10% debentures were redeemed at 20% premium.
(iii) Investment were sold for `45,000, and its profit was transferred to general reserve.
(iv) Income-tax paid during the year 2007-08 was `80,000.
(v) An interim dividend of `1,20,000 has been paid during the year 2007-08.
(vi) Assume the provision for taxation as current liability and proposed dividend as non-current
liability.
(vii) Investment are non-trade investment.
You are required to prepare:
(i) Schedule of changes in working capital.
(ii) Funds flow statement.
Answer
(i) Schedule of Changes in Working Capital
Particulars 31st March Working Capital
2007 2008 Increase Decrease
` ` ` `
A. Current Assets:
Stock 4,80,000 8,50,000 3,70,000 −
Debtors 6,00,000 7,98,000 1,98,000 −
Prepaid Expenses 50,000 40,000 − 10,000
Cash and Bank 1,40,000 85,000 − 55,000
Total (A) 12,70,000 17,73,000
B. Current Liabilities:
Creditors 4,00,000 5,80,000 − 1,80,000
Outstanding Expenses 20,000 25,000 − 5,000
Provision for Taxation 1,00,000 1,20,000 − 20,000
Total (B) 5,20,000 7,25,000 ________ _______
Working Capital (A – B) 7,50,000 10,48,000 5,68,000 2,70,000
Increase in Working Capital _______ 2,98,000
Total 5,68,000 5,68,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.51

(ii) Funds Flow Statement

for the year ending 31st March, 2008
Sources of Funds Amount Application of Funds Amount
`` `
Funds from operations 10,63,000 Redemption of debentures 2,40,000
Bank loan taken 1,00,000 Purchase of machinery 3,00,000
Sale of Machinery 50,000 Dividend paid 3,00,000
Sale of Investment 45,000 Interim Dividend paid 1,20,000
Increase in working capital 2,98,000
12,58,000 12,58,000

Workings:
1. Funds from operations:
Adjusted Profit and Loss A/c
` ` `
To General Reserve 33,000 By Balance b/d 2,50,000
To Depreciation By Funds from
On Land and Building 1,00,000 operations 10,63,000
On Plant & Machinery 2,80,000 3,80,000 (Balancing figure)
To Loss on Sale of Machine 20,000
To Premium on Redemption of
Debentures 40,000
To Proposed Dividend 3,60,000
To Interim Dividend 1,20,000
To Balance c/d 3,60,000
13,13,000 13,13,000

2. Depreciation on Land and Building = `15,00,000 – `14,00,000

= `1,00,000.
3. Loss on Sale of Old Machine = Cost `1,45,000 – `75,000 (Cum-Dep.) –
` 50,000 (Sales value) = `20,000

© The Institute of Chartered Accountants of India

 3.52 Financial Management

4. Depreciation on Plant and Machinery:

Plant and Machinery A/c
Dr. Cr.
` `
To Balance b/d 18,00,000 By Bank A/c (Sold) 50,000
To Bank A/c (Purchases) 3,00,000 By Profit and Loss A/c 20,000
(Loss on Sales)
By Depreciation 2,80,000
(Balancing figure)
________ By Balance c/d 17,50,000
21,00,000 21,00,000

5. Premium on Redemption of Debentures:

Amount of Debenture Redeemed = `10,00,000 – `8,00,000
= `2,00,000
Premium = `2,00,000 × 20/100 = `40,000
6. Profit on sale of investment:
Investment A/c
Dr. Cr.
` `
To Balance b/d 4,00,000 By Bank A/c (Sales) 45,000
To General Reserve 17,000 By Balance c/d 3,72,000
(Profit on Sales)
4,17,000 4,17,000
7. Amount transferred to General Reserve from Profit and Loss A/c:
General Reserve A/c
Dr. Cr.
` `
To Balance c/d 4,50,000 By Balance b/d 4,00,000
By Investment A/c 17,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.53

_______ By Profit and Loss A/c 33,000

4,50,000 4,50,000
Question 5
XYZ Ltd. Company’s Comparative Balance Sheet for 2002 and the Company’s Income Statement
for the year are as follows:
XYZ Ltd.
Comparative Balance Sheet
December 31, 2002 and 2001
(` in crores) 2002 2001
Sources of funds:
Shareholder’s funds
Share Capital 140 140
110 232
Retained earnings 250 92
Loan funds
40
Bonus payable 135 272
385
Application of funds
Fixed Assets
Plant and Equipment 430 309
Less: Accumulated depreciation (218) 212 (194) 115
Investments 60 75
Current Assets
Inventory 205 160
Accounts receivable 180 270
Pre-paid expenses 17 20
Cash 26 428 10 460
Less : Current liabilities and provisions
Accounts payable 230 310
Accrued liabilities 70 60
Deferred income-tax provision 15 315 113 8 378 82
385 272

© The Institute of Chartered Accountants of India

 3.54 Financial Management

XYZ Ltd.
Income Statement
For the year ended December 31, 2002
(` in crores)
Sales ` 1,000
Less : Cost of goods sold 530
Gross margin 470
Less : Operating expenses 352
Net operating income 118
Non-operating items:
Loss on sale of equipment (4)
Income before taxes 114
Less : Income-taxes 48
Net income 66

Additional information:
(i) Dividends of ` 48 crores were paid in 2002.
(ii) The loss on sale of equipment of ` 4 crore reflects a transaction in which equipment with an
original cost of ` 12 crore and accumulated depreciation of ` 5 crore were sold for ` 3 crore
in cash.
Required:
Using the indirect method, determine the net cash provided by operating activities for 2002 and
construct a statement of cash flows.
Answer
Statement of net cash flows provided by operating activities
by using indirect method for the year ended December 31, 2002
(` in crores)
Operating Activities
Net Income 66
Adjustment to convert net income to a cash basis
Depreciation and amortization charges 29
Decrease in accounts receivable 90

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.55

Increase in inventory (45)

Decrease in pre-paid expenses 3
Decrease in accounts payable (80)
Increase in accrued liabilities 10
Increase in deferred income tax 7
Loss on sale of equipment 4
Net cash provided by operating activities 84
Cash Flow from Investing Activities
Additions to property, building & equipment (133)
Decrease in long term investments 15
Proceeds from sale of equipment 3
Net cash used in investing activities (115)
Cash Flows from Financing Activities
Increase in bonds payable 95
Cash dividends paid (48)
Net cash used in financing activities 47
Net increase in cash & cash equivalents 16
Cash & cash equivalents at the beginning of year 10
Cash & cash equivalents at the end of year 26

Question 6
The following is the income statement XYZ Company for the year 2004:
(` )
Sales 1,62,700
Add.: Equity In ABC Company’s earning 6,000
1,68,700
Expenses `
Cost of goods sold 89,300
Salaries 34,400
Depreciation 7,450
Insurance 500
Research and 1,250

© The Institute of Chartered Accountants of India

 3.56 Financial Management

development
Patent amortisation 900
Interest 10,650
Bad debts 2,050
Income tax:
Current 6,600
Deferred 1,550 8,150
Total expenses 1,54,650
Net income 14,050

Additional information’s are:

(i) 70% of gross revenue from sales were on credit.
(ii) Merchandise purchases amounting to `92,000 were on credit.
(iii) Salaries payable totaled `1,600 at the end of the year.
(iv) Amortisation of premium on bonds payable was `1,350.
(v) No dividends were received from the other company.
(vi) XYZ Company declared cash dividend of `4,000.
(vii) Changes in Current Assets and Current Liabilities were as follows:
Increase
(Decrease)
`
Cash 500
Marketable securities 1,600
Accounts receivable (7,150)
Allowance for bad debt (1,900)
Inventory 2,700
Prepaid insurance 700
Accounts payable (for merchandise) 5,650
Salaries payable (2,050)
Dividends payable (3,000)
Prepare a statement showing the amount of cash flow from operations. )

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.57

Answer
Statement showing cash flow from Operations
` `
Cash flow from operations
Cash sales (30% × 1,62,700) 48,810
Collection from debtors 1,20,890
Total cash from operations 1,69,700
Uses of cash from operations
Payment to suppliers 86,350
Salaries expense 36,450
Payment for insurance 1,200
Research and development 1,250
Interest payment 12,000
Income tax payment 6,600
Total operating cash payment 1,43,850
Net cash flow from operations 25,850

Notes
(1)
Collection from debtors `
Credit sales (70% × 1,62,700) 1,13,890
Less : Bad debts (2,050 less 1,900) 150
1,13,740
Add : decrease in accounts receivables 7,150
Collection from debtors on credit sales 1,20,890

(2) Dividends earned ` 6,000 on equity of ABC Company has not been considered as it has not
been received in cash.
(3) Payment to suppliers
Cost of goods sold ` 89,300
Add: Increase in inventory 2,700
Purchases 9,200
Less: increase in accounts payable 5,650

© The Institute of Chartered Accountants of India

 3.58 Financial Management

Payment to suppliers 86,350

(4) Calculation of salaries payment
Salary expense ` 34,400
Add : decrease in salary payable 2,050
Payment of salaries ` 36,450
(5) Insurance payments
Insurance ` 500
Add : increase in prepaid insurance 700
Payment for insurance ` 1,200
(6) Interest payment
Interest expenses ` 10,650
Add : Amortisation of bond premium 1,350
Interest payments ` 12,000
(7) Income tax payments
Income tax expense ` 8,150
Less: deferred tax 1,550
` 6,600
Changes in current tax payable Nil
Income tax payments ` 6,600
Question 7
From the information contained in Income Statement and Balance Sheet of ‘A’ Ltd., prepare Cash
Flow Statement:
Income Statement for the year ended March 31, 2006
`
Net Sales (A) 2,52,00,000
Less:
Cash Cost of Sales 1,98,00,000
Depreciation 6,00,000
Salaries and Wages 24,00,000
Operating Expenses 8,00,000
Provision for Taxation 8,80,000
(B) 2,44,80,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.59

Net Operating Profit (A – B) 7,20,000

Non-recurring Income – Profits on sale of equipment 1,20,000
8,40,000
Retained earnings and profits brought forward 15,18,000
23,58,000
Dividends declared and paid during the year 7,20,000
Profit and Loss Account balance as on March 31, 2006 16,38,000

Balance Sheet as on
Assets March 31, 2005 March 31, 2006
(` ) (` )
Fixed Assets:
Land 4,80,000 9,60,000
Buildings and Equipment 36,00,000 57,60,000
Current Assets:
Cash 6,00,000 7,20,000
Debtors 16,80,000 18,60,000
Stock 26,40,000 9,60,000
Advances 78,000 90,000
90,78,000 1,03,50,000

Balance Sheet as on
Liabilities and Equity March 31, 2005 March 31, 2006
(` ) (` )
Share Capital 36,00,000 44,40,000
Surplus in Profit and Loss Account 15,18,000 16,38,000
Sundry Creditors 24,00,000 23,40,000
Outstanding Expenses 2,40,000 4,80,000
Income-tax payable 1,20,000 1,32,000
Accumulated Depreciation
on Buildings and Equipment 12,00,000 13,20,000
90,78,000 1,03,50,000
The original cost of equipment sold during the year 2005-06 was ` 7,20,000.

© The Institute of Chartered Accountants of India

 3.60 Financial Management

Answer
Cash Flow Statement of Company A Ltd.
for the year ending March 31, 2006
Cash flows from Operating Activities
`
Net Profits before Tax and Extra-ordinary Item 16,00,000
Add: Depreciation 6,00,000
Operating Profits before Working Capital Changes 22,00,000
Increase in Debtors (1,80,000)
Decrease in Stock 16,80,000
Increase in Advances (12,000)
Decrease in Sundry Creditors (60,000)
Increase in Outstanding Expenses 2,40,000
Cash Generated from Operations 38,68,000
Income tax Paid 8,68,000
Net Cash from Operations 30,00,000

Cash flows from Investment Activities

`
Purchase of Land (4,80,000)
Purchase of Buildings and Equipment (28,80,000)
Sale of Equipment 3,60,000
Net Cash used in Investment Activities (30,00,000)

Cash flows from Financing Activities

`
Issue of Share Capital 8,40,000
Dividends Paid (7,20,000)
Net Cash from Financing Activities 1,20,000
Net increase in Cash and Cash Equivalents 1,20,000
Cash and Cash Equivalents at the beginning 6,00,000
Cash and Cash Equivalents at the end 7,20,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.61

Buildings and Equipment Account

` `
Balance b/d 36,00,000 Sale of Asset 7,20,000
Cash/Bank (purchase) Balance c/d 57,60,000
(Balancing figure) 28,80,000 ________
64,80,000 64,80,000

Accumulated Depreciation on
Buildings and Equipment Account
` `
Sale of Asset Balance b/d 12,00,000
(Accumulated depreciation) 4,80,000 Profit and Loss (Provisional) 6,00,000
Balance c/d 13,20,000 ________
18,00,000 18,00,000

Sale of Asset Account

`
Original Cost 7,20,000
Less: Accumulated Depreciation 4,80,000
Net Cost 2,40,000
Profit on Sale of Asset 1,20,000
Sale Proceeds from Asset Sales 3,60,000

Question 8
X Ltd. has the following balances as on 1st April 2007:
`
Fixed Assets 11,40,000
Less; Depreciation 3,99,000
7,41,000
Stocks and Debtors 4,75,000
Bank Balance 66,500
Creditors 1,14,000
Bills payable 76,000
Capital (Shares of `100 each) 5,70,000

© The Institute of Chartered Accountants of India

 3.62 Financial Management

The Company made the following estimates for financial year 2007-08:
(i) The company will pay a free of tax dividend of 10% the rate of tax being 25%.
(ii) The company will acquire fixed assets costing ` 1,90,000 after selling one machine for
` 38,000 costing ` 95,000 and on which depreciation provided amounted to `66,500.
(iii) Stocks and Debtors, Creditors and Bills payables at the end of financial year are expected to
be ` 5,60,500, ` 1,48,200 and ` 98,800 respectively.
(iv) The profit would be ` 1,04,500 after depreciation of ` 1,14,000.
Prepare the projected cash flow statement and ascertain the bank balance of X Ltd. at the
end of Financial year 2007-08.
Answer
Working:
(i) Cash Flow from operations
`
Profit for the year 1,04,500
Add: Depreciation (non cash item) 1,14,000
2,18,500
Less: Profit on sale of machine 9,500
2,09,000
Add increase in:
Creditors (`1,48,200 – `1,14,000) = `34,200
Bills payable (`98,800 – `76,000) = `22,800 57,000
2,66,000
Less: Increase in stocks & debtors (`5,60,500 – `4,75,000) 85,500
Cash from operations 1,80,500

(ii) Payment of Dividend

10% on capital `5,70,000 = `57,000
⎛ Rs.57,000 ⎞
Gross up Amount = ⎜ × 100 ⎟ = Rs.76,000
⎝ 75 ⎠
Total Dividend ` 76,000
Tax 25% ` 19,000
Payment of Dividend ` 57,000
Note: Income Tax on Company’s Profit Ignored

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.63

Projected Cash Flow Statement

for the Year ending on 31st March, 2008
`
Bank Balance as on 1st April, 2007 66,500
Add: Inflow of Cash
Sale of Machine `38,000
Cash From operation `1,80,500 2,18,500
Less: Outflow of Cash 2,85,000
Purchase of Fixed Assets `1,90,000
Payment of Dividend `57,000
Tax Paid `19,000 2,66,000
Bank Balance on 31st March, 2008 19,000

Question 9

The following are the summarised Balance Sheet of XYZ Ltd. as on 31 st March, 2008 and
2009:
(` in 000’)
Liabilities 31.3.08 31.3.09 Assets 31.3.08 31.3.09
Share capital 3,900 5,200 Plant & machinery 3,978 5,525
Reserve and surplus 1,690 2,600 Land & building 1,040 1,040
12% debenture - 1,300 Investment 130 130
Sundry creditors 936 1,222 Inventories 676 975
Outstanding rent 52 65 Sundry debtors 728 1,131
Income-tax payable 520 195 Prepaid selling expenses 26 52
Cash at bank 494 1,677
Cash in hand 26 52
7,098 10,582 7,098 10,582

Profit & Loss account for the year ended 31st March, 2009
(`in 000’)
` `
To Opening stock 806 By Sales 6,331
To Purchases 2,080 By Closing stock 1,105
To Wages 650

© The Institute of Chartered Accountants of India

 3.64 Financial Management

To Gross profit C/d 3,900

7,436 7,436
To Depreciation 390 By Gross profit B/d 3,900
To Office expenses 390 By Discount 39
To Rent 130 By Commission 91
To Selling & distribution expenses 780 By Dividend 260
To Income – tax 1,040
To Net profit C/d 1,560
4,290 4,290
To Dividend 650 By Balance B/d 1,690
To Balance C/d 2,600 By Net profit B/d 1,560
3,250 3,250

You are required to prepare a Cash flow statement as per AS-3 (revised).

Answer
Cash Flow Statement for the year ending 31st March, 2009
[as per AS 3 (revised)]
(` in ‘000’)
(A) Cash flow from Operating Activities
Cash from Sales 5,928
Commission Received ____91
6,019
Cash Payments
Cash Purchases 1,755
Wages 650
Office Expenses 390
Rent 117
Selling and Distribution Expenses 806
3,718
2,301
Less : Tax paid 1,365
Cash flow from Operating Activities (a) 936

(B) Cash flow from Investing Activities

Purchase of Plant & Machinery (5525+390-3978) (1,937)
Dividend Received 260
Net Cash used in Investing Activities (b) (1,677)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.65

(C) Cash flow from Financing Activities

Issue of Shares 1,300
Issue of 12% Debentures 1,300
Dividend Paid (650)
Net Cash flow from Financing Activities (c) 1,950
Net Increase in Cash and Cash Equivalents during the 1,209
year (a+b+c)
Add: Cash and Cash Equivalents at 1-4-2008 (26+494) 520
Cash and Cash Equivalents at 31-3-2009 1,729
Working Notes:
1. Cash Sales
Cash Sales = Total Sales – Increase in Debtors
= 6,331 – (1,131 – 728)
= 6,331 – 403 = `5,928
2. Cash Purchases
Cash Purchases = Total Purchases – Increase in Creditors
= 2,080 – (1,222+39 – 936)
= 2,080 – 325= `1,755
3. Rent
`
Rent 130
Add: Rent Outstanding as on 31-3-2008 52
182
Less: Rent Outstanding as on 31-3-2009 65
117
4. Tax Payable
Tax Payable A/c
` `
To Tax paid 1,365 By Balance b/d 520
To Balance c/d 195 By Profit and Loss A/c 1,040
1,560 1,560

© The Institute of Chartered Accountants of India

 3.66 Financial Management

5. Selling and Distribution Expenses

`
Selling and Distribution Expenses 780
Add: Prepaid Selling Expenses on 31-3-2009 52
832
Less: Prepaid Selling Expenses on 31-3-2008 26
806

Question 10
The following are the Balance Sheet of Peacock Limited as on 31st March, 2009 and
31st March, 2010.
Liabilities Rupees Rupees
31st March, 2009 31st March, 2010
Share capital 44,00,000 66,00,000
Reserves and Surplus 27,50,000 38,50,000
Depreciation 8,80,000 13,20,000
Bank Loan 17,60,000 8,80,000
Sundry Creditors 13,20,000 14,85,000
Proposed dividend 4,00,000 6,00,000
Provision for taxation 4,00,000 5,50,000
1,19,10,000 1,52,85,000
Assets
Land 33,00,000 44,00,000
Plant and Machinery 50,60,000 69,30,000
Inventories 19,80,000 22,00,000
Sundry Debtors 11,00,000 17,05,000
Cash and Bank Balances 4,70,000 50,000
1,19,10,000 1,52,85,000
Additional Information :
(a) The machine which was purchased earlier for ` 6,00,000 was sold during the financial
year 2009-2010 for ` 40,000. The book value of the machine was
` 60,000. A new machinery was purchased during the financial year.
(b) The company had issued new shares to the extent of `22,00,000.

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.67

You are required to prepare:

1. Statement showing changes in the Working Capital;
2. Statement of Sources and Application of funds.
Answer
(1) Statement Showing Changes in Working Capital
31st March, 2009 31st March, 2010 Increase Decrease
Current Assets
Inventories 19,80,000 22,00,000 2,20,000 -
Sundry Debtors 11,00,000 17,05,000 6,05,000 -
Cash and Bank Balances 4,70,000 50,000 - 4,20,000
35,50,000 39,55,000
Current Liabilities
Sundry Creditors 13,20,000 14,85,000 - 1,65,000
Provision for Taxation 4,00,000 5,50,000 - 1,50,000
17,20,000 20,35,000
Working Capital 18,30,000 19,20,000
Net Increase in Working
Capital 90,000 - - 90,000
19,20,000 19,20,000 8,25,000 8,25,000
(2) Sources and Application of Funds
Sources Amount (` ) Application Amount (` )
Issue of Shares 22,00,000 Payment of Dividend 4,00,000
Funds from Operation 27,00,000 Bank Loan Repaid 8,80,000
Sale of Machinery 40,000 Purchase of Land 11,00,000
Purchase of Machinery 24,70,000
Net Increase in Working Capital 90,000

49,40,000 49,40,000
Working Notes:
Reserves and Surplus A/c
Dr Cr
To Depreciation 9,80,000 By Balance b/f 27,50,000
To Proposed Dividend 6,00,000 By Profit & Loss A/c 27,00,000

© The Institute of Chartered Accountants of India

 3.68 Financial Management

To Loss on Sale of Machinery 20,000

To Balance C/d 38,50,000
54,50,000 54,50,000

Provision for Depreciation A/c

Dr Cr.
To Machinery A/c 5,40,000 By Balance b/f 8,80,000
To Balance C/d 13,20,000 By Profit & Loss A/c 9,80,000
18,60,000 18,60,000

Machinery A/c
Dr. Cr.
To Balance b/f 50,60,000 By Depreciation A/c 5,40,000
To Bank 24,70,000 By Cash 40,000
By Loss on Sale of Machinery 20,000
By Balance c/d 69,30,000
75,30,000 75,30,000

Question 11
The Balance Sheet of JK Limited as on 31st March, 2005 and 31st March, 2006 are given below:
Balance Sheet as on (`’000)
Liabilities 31.03.05 31.03.06 Assets 31.03.05 31.03.06
Share Capital 1,440 1,920 Fixed Assets 3,840 4,560
Capital Reserve − 48 Less: Depreciation 1,104 1,392
General Reserve 816 960 2,736 3,168
Profit and Loss 288 360 Investment 480 384
Account
9% Debenture 960 672 Cash 210 312
Current Liabilities 576 624 Other Current Assets
Proposed Dividend 144 174 (including Stock) 1,134 1,272
Provision for Tax 432 408 Preliminary Expenses 96 48
Unpaid Dividend − 18 _____ _____
4,656 5,184 4,656 5,184

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.69

Additional Information:
(i) During the year 2005-2006, Fixed Assets with a book value of ` 2,40,000 (accumulated
depreciation ` 84,000) was sold for `1,20,000.
(ii) Provided `4,20,000 as depreciation.
(iii) Some investments are sold at a profit of ` 48,000 and Profit was credited to Capital
Reserve.
(iv) It decided that stocks be valued at cost, whereas previously the practice was to value
stock at cost less 10 per cent. The stock was ` 2,59,200 as on 31.03.05. The stock as
on 31.03.06 was correctly valued at ` 3,60,000.
(v) It decided to write off Fixed Assets costing ` 60,000 on which depreciation amounting to
` 48,000 has been provided.
(vi) Debentures are redeemed at ` 105.
Required:
Prepare a Cash Flow Statement.
Answer
Cash flow Statement (31st March, 2006)
(A) Cashflows from Operating Activities
` `
Profit and Loss A/c
(3,60,000 – (2,88,000 + 28,800) 43,200
Adjustments:
Increase in General Reserve 1,44,000
Depreciation 4,20,000
Provision for Tax 4,08,000
Loss on Sale of Machine 36,000
Premium on Redemption of 14,400
Debenture
Proposed Dividend 1,74,000
Preliminary Exp. w/o 48,000
Fixed Assets w/o 12,000 12,56,400
Funds from Operation 12,99,600
Increase in Sundry Current Liabilities 48,000
Increase in Current Assets

© The Institute of Chartered Accountants of India

 3.70 Financial Management

12,72,000 – (11,34,000 + 28,800) (1,09,200)

Cash before Tax 12,38,400
Tax paid 4,32,000
Cash from Operating Activities 8,06,400

(B) Cash from Investing Activities

Purchases of fixed assets (10,20,000)
Sale of Investment 1,44,000
Sale of Fixed Assets 1,20,000 (7,56,000)

(C) Cash from Financing Activities

Issue of Share Capital 4,80,000
Redemption of Debenture (3,02,400)
Dividend paid (1,26,000) 51,600
Net increase in Cash and Cash equivalents 1,02,000
Opening Cash and Cash equivalents 2,10,000
Closing Cash 3,12,000

Fixed Assets Account

Particulars ` Particulars `
To Balance b/d 27,36,000 By Cash 1,20,000
To Purchases (Balance) 10,20,000 By Loss on sales 36,000
By Depreciation 4,20,000
By Assets w/o 12,000
________ By Balance 31,68,000
37,56,000 37,56,000

Depreciation Account
Particulars ` Particulars `
To Fixed Assets (on sales) 84,000 By Balance b/d 11,04,000
To Fixed Assets w/o 48,000 By Profit and Loss a/c 4,20,000
To Balance 13,92,000 ________
15,24,000 15,24,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.71

Question 12
The Balance Sheet of X Ltd. as on 31st March, 2007 is as follows:
Liabilities ` (’000) Assets ` (’000)
Equity share capital 6,000 Fixed Assets (at cost) 16,250
8% Preference share capital 3,250 Less: Depreciation written off 5,200 11,050
Reserves and Surplus 1,400 Stock 1,950
10% Debentures 1,950 Sundry debtors 2,600
Sundry Creditors 3,250 Cash 250
Total 15,850 15,850
The following additional information is available:
(i) The stock turnover ratio based on cost of goods sold would be 6 times.
(ii) The cost of fixed assets to sales ratio would be 1.4.
(iii) Fixed assets costing ` 30,00,000 to be installed on 1st April, 2007, payment would be
made on March 31, 2008.
(iv) In March, 2008, a dividend of 7 per cent on equity capital would be paid.
(v) ` 5,50,000, 11% Debentures would be issued on 1st April, 2007.
(vi) ` 30,00,000, Equity shares would be issued on 31st March, 2008.
(vii) Creditors would be 25% of materials consumed.
(viii) Debtors would be 10% of sales.
(ix) The cost of goods sold would be 90 per cent of sales including material 40 per cent and
depreciation 5 per cent of sales.
(x) The profit is subject to debenture interest and taxation @ 30 per cent.
Required:
(i) Prepare the projected Balance Sheet as on 31st March, 2008.
(ii) Prepare projected Cash Flow Statement in accordance with AS-3.
Answer
(i) Calculation of Sales
Fixed assets `(1,62,50,000 + 30,00,000) = 1,92,50,000

© The Institute of Chartered Accountants of India

 3.72 Financial Management

1,92,50,000
Sales = = 1,37,50,000
1.4
Cost of goods sold = 1,37,50,000 × .90 = 1,23,75,000
Material = 1,37,50,000 × .40 = 55,00,000
Depreciation = 1,37,50,000 × .05 = 6,87,500
Net profit = 1,37,50,000 × .10 = 13,75,000
Calculation of Net Fixed Assets
`
Opening balance 1,62,50,000
Add: Purchases 30,00,000
1,92,50,000
Less: Accumulated Depreciation 52,00,000
Additional Depreciation 6,87,500 58,87,500
Closing balance of fixed assets 1,33,62,500
Calculation of Closing Stock
Cost of goods sold
Average stock =
Stock turnover ratio
1,23,75,000
= = 20,62,500
6
(Opening stock + Closing stock)
Average stock =
2
(19,50,000 + Closing stock)
20,62,500 =
2
Closing stock = 41,25,000 – 19,50,000 = 21,75,000
Calculation of Debtors = 1,37,50,000 × .10 = 13,75,000
Calculation of Creditors = 55,00,000 × .25 = 13,75,000
Calculation of Interest and Provision for Taxation
Net profit 13,75,000
Less: Interest (19,50,000 × 10%) 2,55,500
(5,50,000 × 11%) 11,19,500

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.73

Less: Taxes 3,35,850

Net profit available for dividend 7,83,650
Less: Preference share dividend 2,60,000
Less: Equity dividend @ 7% 4,20,000
Transfer to reserves and surplus 1,03,650
Reserves and Surplus
Opening balance 14,00,000
Add: Current balance 1,03,650
15,03,650
Projected Cash Flow Statement
(i) Cash flow from Operating Activities
Profit after taxation 7,83,650
Depreciation added back 6,87,500
14,71,150
Add: Increase in current liabilities and decrease in current
assets
Provision for taxation 3,35,850
Debtors (26,00,000 – 13,75,000) 12,25,000
Less: Increase in current assets and decrease in current
liabilities
Stock (21,75,000 – 19,50,000) (2,25,000)
Creditors (13,75,000 – 32,50,000) (18,75,000) (21,00,000)
Net Cash from Operating Activities 9,32,000

(ii) Cash flow from Investing Activities

Purchase of Fixed Assets (30,00,000)

(iii) Cash flow from Financing Activities

Issue of Debenture 5,50,000
Issue of equity share capital 30,00,000
Dividend paid (6,80,000) 28,70,000
Net increase in cash 8,02,000

© The Institute of Chartered Accountants of India

 3.74 Financial Management

Opening balance of cash 2,50,000

Closing balance 10,52,000
Projected Balance Sheet as on 31st March, 2008
Liabilities `(’000) Assets `(’000)
Equity share capital 9,000 Fixed Assets (at cost) 19,250
8% Preference share capital 3,250 Less: Depreciation
Reserves & Surplus 1,503.65 written off 5,887.5 13,362.5
10% & 11% Debentures 2,500 Stock 2,175
Sundry Creditors 1,375 Sundry debtors 1,375
Provision for taxation 335.85 Cash 1,052
Total 17,964.5 Total 17,964.5
Question 13
The financial statement and operating results of PQR revealed the following position as on
31st March, 2006:
— Equity share capital (`10 fully paid share) ` 20,00,000
— Working capital ` 6,00,000
— Bank overdraft ` 1,00,000
— Current ratio 2.5 : 1
— Liquidity ratio 1.5 : 1
— Proprietary ratio (Net fixed assets/Proprietary fund) .75 : 1
— Cost of sales `14,40,000
— Debtors velocity 2 months
— Stock turnover based on cost of sales 4 times
— Gross profit ratio 20% of sales
— Net profit ratio 15% of sales
Closing stock was 25% higher than the opening stock. There were also free reserves brought
forward from earlier years. Current assets include stock, debtors and cash only. The current
liabilities expect bank overdraft treated as creditors.
Expenses include depreciation of `90,000.
The following information was collected from the records for the year ended 31st March, 2007:
— Total sales for the year were 20% higher as compared to previous year.
— Balances as on 31st March, 2007 were : Stock ` 5,20,000, Creditors ` 4,15,000,
Debtors ` 4,95,000 and Cash balance ` 3,10,000.
— Percentage of Gross profit on turnover has gone up from 20% to 25% and ratio of net
profit to sales from 15% to 16%.

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.75

— A portions of Fixed assets was very old (book values ` 1,80,000) disposed for
` 90,000. (No depreciations to be provided on this item).
— Long-term investments were purchased for ` 2,96,600.
— Bank overdraft fully discharged.
— Percentage of depreciation to Fixed assets to be provided at the rate in the previous year.

Required:
(i) Prepare Balance Sheet as on 31st March, 2006 and 31st March, 2007.
(ii) Prepare the fund flow statement for the year ended 31st March, 2007.
Answer
Balance Sheets
` `
Liabilities 31 March 31 March Assets 31 March 31 March
2006 2007 2006 2007
Equity share capital 20,00,000 20,00,000 Fixed Assets
(`10 each fully paid) (` 18,90,000– ` 90,000) 18,00,000 15,39,000
Reserve and Surplus 1,30,000 1,30,000 Long term investment − 2,96,600
(balancing)
Profit & Loss A/c 2,70,000 6,15,600 Current Assets
(15% of sales) (`10,00,000)
Current Liabilities Stock 4,00,000 5,20,000
Bank Overdraft 1,00,000 − Sundry Debtors 3,00,000 4,95,000
Creditors 3,00,000 4,15,000 Cash at Bank (Balancing) 3,00,000 3,10,000
Total 28,00,000 31,60,600 Total 28,00,000 31,60,600

Calculation for 31 March, 2006

(i) Calculation of Current Liabilities
Suppose that Current Liabilities = x, then current assets will be 2.5 x
Working capital = Current Assets – Current Liabilities
6,00,000 = 2.5x – x
x = 6,00,000 / 1.5 = `4,00,000 (C.L.)
Other Current Liabilities = Current Liabilities – Bank Overdraft
(Creditors) 4,00,000 – 1,00,000 = `3,00,000
Current Assets = 2.5 x 4,00,000 = `10,00,000

© The Institute of Chartered Accountants of India

 3.76 Financial Management

(ii) Liquid Ratio = Liquid Assets / Current Liabilities or 1.5 = Liquid Assets / 4,00,000
= ` 6,00,000
Liquid assets = Current Assets – Stock
6,00,000 = 10,00,000 – Stock
So, Stock = `4,00,000
(iii) Calculation of fixed assets: Fixed assets to proprietary fund is 0.75, working capital is
therefore 0.25 of proprietary fund. So,
6,00,000 / 0.25 x 0.75 = `18,00,000
(iv) Debtors = 2 / × 12 Sales
2 / 12 × 18,00,000 = `3,00,000
(v) Sales = (14,40,000 / 80) × 100 = `18,00,000
(vi) Net profit = 15% of ` 18,00,000 = `2,70,000

Calculation for the year 31st March, 2007

(vii) Sales = 18,00,000 + (18,00,000 × 0.2) = 21,60,000
(viii) Calculation of fixed assets
` `
To Opening balance 18,00,000 By Banks (Sale) 90,000
By Loss on sales of Fixed asset 90,000
By P & L (Dep) (5% as in
previous year) 81,000
________ By Balance b/d 15,39,000
Total 18,00,000 18,00,000
(ix) Net profit for the year 2007, 16% × 21,60,000 = `3,45,600
Total Profit = 2,70,000 + 3,45,600 = `6,15,600
Calculation of fund from operation:
Net profit for the year 2007 = `3,45,600
Add: Depreciation `81,000
Loss on sale of assets `90,000 = `1,71,000
Total = `5,16,600

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.77

Fund Flow Statement

` `
Fund from operation 5,16,600 Increase in WC 3,10,000
Sales of fixed assets 90,000 Pur. of investment 2,96,600
6,06,600 6,06,600
Schedule of Changing Working Capital
31 March 31 March Increase Decrease
2006 2007 (+) (−)
A. Current Assets ` ` ` `
Stock 4,00,000 5,20,000 1,20,000
Sundry debtors 3,00,000 4,95,000 1,95,000
Cash at bank 3,00,000 3,10,000 10,000
10,00,000 13,25,000
B. Current Liabilities
Bank overdraft 1,00,000 − 1,00,000
Sundry creditors 3,00,000 4,15,000 1,15,000
4,00,000 4,15,000
Working capital 6,00,000 9,10,000 −
Increase in working capital 3,10,000 3,10,000
9,10,000 9,10,000 4,25,000 4,25,000
Question 14
Balance Sheets of a company as on 31st March, 2007 and 2008 were as follows:
Liabilities 31.3.07 31.3.08 Assets 31.3.07 31.3.08
` ` ` `
Equity Share Capital 10,00,000 10,00,000 Goodwill 1,00,000 80,000
8% P.S. Capital 2,00,000 3,00,000 Land and
General Reserve 1,20,000 1,45,000 Building 7,00,000 6,50,000
Securities Premium − 25,000 Plant and
Profit and Loss A/c 2,10,000 3,00,000 Machinery 6,00,000 6,60,000
11% Debentures 5,00,000 3,00,000 Investments
Creditors 1,85,000 2,15,000 (non-trading) 2,40,000 2,20,000
Provision for tax 80,000 1,05,000 Stock 4,00,000 3,85,000
Proposed Dividend 1,36,000 1,44,000 Debtors 2,88,000 4,15,000
Cash and Bank 88,000 93,000

© The Institute of Chartered Accountants of India

 3.78 Financial Management

Prepaid 15,000 11,000

Expenses
Premium on − 20,000
Redemption of
________ ________ Debentures ________ ________
24,31,000 25,34,000 24,31,000 25,34,000

Additional Information:
1. Investments were sold during the year at a profit of `15,000.
2. During the year an old machine costing ` 80,000 was sold for ` 36,000. Its written down
value was ` 45,000.
3. Depreciation charged on Plants and Machinery @ 20 per cent on the opening balance.
4. There was no purchase or sale of Land and Building.
5. Provision for tax made during the year was ` 96,000.
6. Preference shares were issued for consideration of cash during the year.
You are required to prepare:
(i) Cash flow statement as per AS 3.
(ii) Schedule of Changes in Working Capital.
Answer
(i) Cash Flow Statement
for the year ending 31st Mach, 2008
` `
A. Cash flow from Operating Activities
Profit and Loss A/c as on 31.3.2008 3,00,000
Less: Profit and Loss A/c as on 31.3.2007 2,10,000
90,000
Add: Transfer to General Reserve 25,000
Provision for Tax 96,000
Proposed Dividend 1,44,000 2,65,000
Profit before Tax 3,55,000
Adjustment for Depreciation:
Land and Building 50,000
Plant and Machinery 1,20,000 1,70,000
Profit on Sale of Investments (15,000)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.79

Loss on Sale of Plant and Machinery 9,000

Goodwill written off 20,000
Interest Expenses 33,000
Operating Profit before Working Capital Changes 5,72,000
Adjustment for Working Capital Changes:
Decrease in Prepaid Expenses 4,000
Decrease in Stock 15,000
Increase in Debtors (1,27,000)
Increase in Creditors 30,000
Cash generated from Operations 4,94,000
Income tax paid (71,000)
Net Cash Inflow from Operating Activities (a) 4,23,000
B. Cash flow from Investing Activities
Sale of Investment 35,000
Sale of Plant and Machinery 36,000
Purchase of Plant and Machinery (2,25,000)
Net Cash Outflow from Investing Activities (b) (1,54,000)
C. Cash Flow from Financing Activities
Issue of Preference Shares 1,00,000
Premium received on Issue of Securities 25,000
Redemption of Debentures at premium (2,20,000)
Dividend paid (1,36,000)
Interest paid to Debenture holders (33,000)
Net Cash Outflow from Financing Activities (c) (2,64,000)
Net increase in Cash and Cash Equivalents during the year (a + b + c) 5,000
Cash and Cash Equivalents at the beginning of the year 88,000
Cash and Cash Equivalents at the end of the year 93,000
Working Notes:
1. Provision for the Tax Account
` `
To Bank (paid) 71,000 By Balance b/d 80,000
To Balance c/d 1,05,000 By Profit and Loss a/c 96,000
1,76,000 1,76,000

© The Institute of Chartered Accountants of India

 3.80 Financial Management

2. Investment Account
` `
To Balance b/d 2,40,000 By Bank a/c (b/f) 35,000
To Profit and Loss (profit on sale) 15,000 By Balance c/d 2,20,000
2,55,000 2,55,000
3. Plant and Machinery Account
` `
To Balance b/d 6,00,000 By Bank (sale) 36,000
To Bank a/c (Purchase b/f) 2,25,000 By Profit and Loss a/c 9,000
(Loss on sale)
By Depreciation 1,20,000
_______ By Balance c/d 6,60,000
8,25,000 8,25,000

Note: Since the date of redemption of debentures is not mentioned in the question,
therefore, it is assumed that the debentures are redeemed at the beginning of the year.
(ii) Schedule of Changes in Working Capital
Particulars 31st March Change in Working
Capital
2007 2008 Increase Decrease
` ` ` `
Current Assets
Stock 4,00,000 3,85,000 − 15,000
Debtors 2,88,000 4,15,000 1,27,000 −
Prepaid Expenses 15,000 11,000 − 4,000
Cash and Bank 88,000 93,000 5,000 −
Total (A) 7,91,000 9,04,000
Current Liabilities
Creditors 1,85,000 2,15,000 − 30,000
Total (B) 1,85,000 2,15,000
Working Capital (A – B) 6,06,000 6,89,000
Increase in Working Capital 83,000 _______ _______ 83,000
6,89,000 6,89,000 1,32,000 1,32,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.81

Question 15
Balance Sheets of RST Limited as on March 31, 2008 and March 31, 2009 are as under:
Liabilities 31.3.2008 31.3.2009 Assets 31.3.2008 31.3.2009
` ` ` `
Equity Share Capital Land & Building 6,00,000 7,00,000
(`10 face value per
share) 10,00,000 12,00,000
General Reserve 3,50,000 2,00,000 Plant & Machinery 9,00,000 11,00,000
9% Preference Share Investments (Long- 2,50,000 2,50,000
Capital 3,00,000 5,00,000 term)
Share Premium A/c 25,000 4,000 Stock 3,60,000 3,50,000
Profit & Loss A/c 2,00,000 3,00,000 Debtors 3,00,000 3,90,000
8% Debentures 3,00,000 1,00,000 Cash & Bank 1,00,000 95,000
Creditors 2,05,000 3,00,000 Prepaid Expenses 15,000 20,000
Bills Payable 45,000 81,000 Advance Tax Payment 80,000 1,05,000
Provision for Tax 70,000 1,00,000 Preliminary Expenses 40,000 35,000
Proposed Dividend 1,50,000 2,60,000 _________ _________
26,45,000 30,45,000 26,45,000 30,45,000

Additional information:
(i) Depreciation charged on building and plant and machinery during the year 2008-09 were
` 50,000 and ` 1,20,000 respectively.
(ii) During the year an old machine costing ` 1,50,000 was sold for ` 32,000. Its written
down value was ` 40,000 on date of sale.
(iii) During the year, income tax for the year 2007-08 was assessed at ` 76,000. A cheque of
` 4,000 was received along with the assessment order towards refund of income tax paid
in excess, by way of advance tax in earlier years.
(iv) Proposed dividend for 2007-08 was paid during the year 2008-09.
(v) 9% Preference shares of ` 3,00,000, which were due for redemption, were redeemed
during the year 2008-09 at a premium of 5%, out of the proceeds of fresh issue of 9%
Preference shares.
(vi) Bonus shares were issued to the existing equity shareholders at the rate of one share for
every five shares held on 31.3.2008 out of general reserves.
(vii) Debentures were redeemed at the beginning of the year at a premium of 3%.
(viii) Interim dividend paid during the year 2008-09 was ` 50,000.

© The Institute of Chartered Accountants of India

 3.82 Financial Management

Required:
(a) Schedule of Changes in Working Capital; and
(b) Fund Flow Statement for the year ended March 31, 2009.
Answer
(a) Schedule of Changes in Working Capital
Particulars 31.3.08 31.3.09 Effect on Working Capital
Increase Decrease
` ` ` `
Current Assets:
Stock 3,60,000 3,50,000 - 10,000
Debtors 3,00,000 3,90,000 90,000 -
Cash and Bank 1,00,000 95,000 - 5,000
Prepaid Expenses 15,000 20,000 5,000 -
Total (A) 7,75,000 8,55,000
Current Liabilities:
Creditors 2,05,000 3,00,000 - 95,000
Bills Payable 45,000 81,000 - 36,000
Total (B) 2,50,000 3,81,000
Net Working Capital (A-B) 5,25,000 4,74,000 -
Net Decrease in Working Capital - 51,000 51,000 -
5,25,000 5,25,000 1,46,000 1,46,000
(b) Funds Flow Statement for the year ended 31st March, 2009
`
Sources of Fund
Funds from Operation 7,49,000
Issue of 9% Preference Shares 5,00,000
Sales of Plant & Machinery 32,000
Refund of Income Tax 4,000
Financial Resources Provided (A) 12,85,000

Applications of Fund
Purchase of Land and Building 1,50,000
Purchase of Plant and Machinery 3,60,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.83

Redemption of Debentures 2,06,000

Redemption of Preference Shares 3,15,000
Payment of Tax 1,05,000
Payment of Interim Dividend 50,000
Payment of Dividend (2007-08) 1,50,000
Financial Resources Applied (B) 13,36,000
Net Decrease in Working Capital (A - B) 51,000

Working Notes:
Estimation of Funds from Operation `
Profit and Loss A/c Balance on 31.3.2009 3,00,000
Add: Depreciation on Land and Building 50,000
Depreciation on Plant and Machinery 1,20,000
Loss on Sale of Plant and Machinery ( 40,000 – 32,000) 8,000
Preliminary Expenses written off (40,000 – 35,000) 5,000
Transfer to General Reserve 50,000
Proposed Dividend 2,60,000
Provision for Taxation 1,06,000
Interim Dividend paid 50,000
6,49,000
9,49,000
Less: Profit and Loss A/c balance on 31.3.08 2,00,000
Funds from Operation 7,49,000

Plant & Machinery A/c

` `
To Balance b/d 9,00,000 By Depreciation 1,20,000
To Bank [Purchase (Bal. Fig.)] 3,60,000 By Bank (Sale) 32,000
By P/L A/c (Loss on Sale) 8,000
_______ By Balance c/d 11,00,000
12,60,000 12,60,000

© The Institute of Chartered Accountants of India

 3.84 Financial Management

Provision for Taxation A/c

` `
To Advance tax payment A/c 76,000 By Balance b/d 70,000
To Balance c/d 1,00,000 By P/L A/c (additional provision for 6,000
2007-08)
By P/L A/c (Provision for
_______ 08-09) 1,00,000
1,76,000 1,76,000
Advance Tax Payment A/c
` `
To Balance b/d 80,000 By Provision for taxation A/c 76,000
To Bank (paid for 08-09) 1,05,000 By Bank (Refund of tax) 4,000
_______ By Balance c/d 1,05,000
1,85000 1,85,000
8% Debentures A/c
` `
To Bank ( 2,00,000 x 103%) 2,06,000 By Balance b/d 3,00,000
(redemption) By Premium on redemption
To Balance c/d 1,00,000 of Debentures A/c 6,000
3,06,000 3,06,000
9% Preference Share Capital A/c
` `
To Bank A/c (3,00,000 x 3,15,000 By Balance b/d 3,00,000
105%) (redemption) By Premium on redemption
To Balance c/d 5,00,000 of Preference shares A/c 15,000
_______ By Bank (Issue) 5,00,000
8,15,000 8,15,000

Securities Premium A/c

` `
To Premium on redemption of 6,000 By Balance b/d 25,000
debentures A/c
To Premium on redemption of
preference shares A/c 15,000
To Balance c/d 4,000
25,000 25,000

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.85

General Reserve A/c

` `
To Bonus to Shareholders A/c 2,00,000 By Balance b/d 3,50,000
To Balance c/d 2,00,000 By P/L A/c (transfer) b/f 50,000
4,00,000 4,00,000
Land and Building A/c
` `
To Balance b/d 6,00,000 By Depreciation 50,000
To Bank (Purchase) (Bal. Fig.) 1,50,000 By Balance c/d 7,00,000
7,50,000 7,50,000

Question 16
The Balance Sheets of a Company as on 31st March, 2008 and 2009 are given below:
Liabilities 31.3.08 31.3.09 Assets 31.3.08 31.3.09
` ` ` `
Equity share capital 14,40,000 19,20,000 Fixed assets 38,40,000 45,60,000
Capital reserve - 48,000 Less: depreciation 11,04,000 13,92,000
General reserve 8,16,000 9,60,000 27,36,000 31,68,000
Profit & Loss A/c 2,88,000 3,60,000 Investment 4,80,000 3,84,000
9% debentures 9,60,000 6,72,000 Sundry debtors 12,00,000 14,00,000
Sundry creditors 5,50,000 5,90,000 Stock 1,40,000 1,84,000
Bills payables 26,000 34,000 Cash in hand 4,000 -
Proposed dividend 1,44,000 1,72,800 Preliminary 96,000 48,000
Expenses
Provision for tax 4,32,000 4,08,000
Unpaid dividend - 19,200
46,56,000 51,84,000 46,56,000 51,84,000
Additional information:
During the year ended 31st March, 2009 the company:
(i) Sold a machine for ` 1,20,000; the cost of machine was `2,40,000 and depreciation provided
on it was `84,000.
(ii) Provided `4,20,000 as depreciation on fixed assets.
(iii) Sold some investment and profit credited to capital reserve.

© The Institute of Chartered Accountants of India

 3.86 Financial Management

(iv) Redeemed 30% of the debentures @ 105.

(v) Decided to write off fixed assets costing `60,000 on which depreciation amounting to
`48,000 has been provided.
You are required to prepare Cash Flow Statement as per AS 3.
Answer
Cash Flow Statement for the year ending 31st March, 2009
(A) Cash Flows from Operating Activities
`
Profit and Loss A/c (3,60,000 – 2,88,000) 72,000
Adjustments:
Increase in General Reserve 1,44,000
Depreciation 4,20,000
Provision for Tax 4,08,000
Loss on Sale of Machine 36,000
Premium on Redemption of Debentures 14,400
Proposed Dividend 1,72,800
Preliminary Expenses written off 48,000
Fixed Assets written off 12,000
Interest on Debentures* 60,480 13,15,680
Funds from Operations 13,87,680
Increase in Sundry Creditors 40,000
Increase in Bills Payable 8,000
48,000
Increase in Sundry Debtors (2,00,000)
Increase in Stock (44,000) (1,96,000)
Cash before Tax 11,91,680
Less: Tax paid 4,32,000
Cash flows from Operating Activities 7,59,680
(B) Cash Flows from Investing Activities

Purchase of Fixed Assets (10,20,000)

Sale of Investment 1,44,000
Sale of Fixed Assets 1,20,000 (7,56,000)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.87

(C) Cash Flows from Financing Activities

Issue of Share Capital 4,80,000
Redemption of Debentures (3,02,400)
Dividend Paid (1,44,000 – 19,200) (1,24,800)
Interest on Debentures (60,480) (7,680)
Net increase in Cash and Cash Equivalents (4,000)
Cash and Cash Equivalents at the beginning of the year 4,000
Cash and Cash Equivalents at the end of the year NIL
* It is assumed that the 30 percent debentures have been redeemed at the beginning of the
year.
Fixed Assets Account
Particulars ` Particulars `
To Balance b/d 27,36,000 By Cash 1,20,000
To Purchases (Balance) 10,20,000 By Loss on Sales 36,000
By Depreciation 4,20,000
By Assets written off 12,000
________ By Balance c/d 31,68,000
37,56,000 37,56,000
Question 17
The summarized Balance Sheets of XYZ Limited as at 31st March, 2010 and 2011 are given
below:
Liabilities 2010 2011 Assets 2010 2011
(`) (`) (`) (`)
Preference share 4,00,000 2,00,000 Plant and 7,00,000 8,20,000
capital Machinery
Equity share capital 4,00,000 6,60,000 Long term 3,20,000 4,00,000
investment
Share premium A/c 40,000 30,000 Goodwill - 30,000
Capital redemption - 1,00,000 Current Assets 9,10,000 11,41,000
reserve
General reserve 2,00,000 1,20,000 Short term 50,000 84,000
investment (less
than 2 months)
P & L A/c 1,30,000 1,75,000 Cash and Bank 1,00,000 80,000

© The Institute of Chartered Accountants of India

 3.88 Financial Management

Current liabilities 6,40,000 9,00,000 Preliminary 40,000 20,000

expenses
Proposed dividend 1,60,000 2,10,000
Provision for tax 1,50,000 1,80,000
21,20,000 25,75,000 21,20,000 25,75,000
Additional information:
During the year 2011 the company:
(i) Preference share capital was redeemed at a premium of 10% partly out of proceeds
issue of 10,000 equity shares of ` 10 each issued at 10% premium and partly out of
profits otherwise available for dividends.
(ii) The company purchased plant and machinery for ` 95,000. It also acquired another
company stock ` 25,000 and plant and machinery ` 1,05,000 and paid
` 1,60,000 in Equity share capital for the acquisition.
(iii) Foreign exchange loss of ` 1,600 represents loss in value of short-term investment.
(iv) The company paid tax of ` 1,40,000.
You are required to prepare cash flow statement.
Answer
Preparation of Statement of Cash Flow for XYZ Limited
Cash flow statement as per AS 3 for the year ending 31st March, 2011
(a) Cash flow from Operating Activities ` `
Profit before tax (2,75,000 + 1,70,000) 4,45,000
Add: Depreciation on machinery 80,000
Foreign exchange loss 1,600
Preliminary expenses written off 20,000
Cash flow before working capital adjustment 5,46,600
Add: Stock obtained on acquisition 25,000
Increase in Current Liabilities 2,60,000
Less: Increase in current assets (2,31,000)
Cash flow before tax paid 6,00,600
Less: Tax paid (1,40,000)
Cash flow from operating activities 4,60,600
(b) Cash flow from Investing Activities
Purchase of Machinery (95,000)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.89

Purchase of investment (80,000) (1,75,000)

(c) Cash flow from Financing Activities
Issue of shares at premium 1,10,000
Payment of dividend (1,60,000)
Redemption of preference shares at premium (2,20,000) (2,70,000)
Net increase/decrease in cash and cash equivalent (a+b+c) 15,600
Cash and cash equivalent at the beginning of the year 1,50,000
Cash and cash equivalent at the end of the year 1,65,600
Working Notes:
1. Plant and Machinery Account
` `
To balance b/d 7,00,000 By depreciation 80,000
To bank 95,000
To acquired from other 1,05,000 By balance c/f 8,20,000
9,00,000 9,00,000
2. Provision for Tax Account
` `
To bank 1,40,000 By balance b/d 1,50,000
To balance c/f 1,80,000 By P & L 1,70,000
3,20,000 3,20,000

3. Profit for the year 2011

`
P&L Account (1,75,000-1,30,000) 45,000
Transfer to general reserve (1,20,000+1,00,000 for redemption-opening 20,000
2,00,000)
Proposed dividend 2,10,000
Net Profit 2,75,000
4. Cash and Cash Equivalent
Opening balance + short term investment =` 1,00,000 + ` 50,000 = ` 1,50,000
Closing balance = Closing cash + short term investment + foreign exchange loss
= ` 80,000+` 84,000+` 1,600=` 1,65,600

© The Institute of Chartered Accountants of India

 3.90 Financial Management

Question 18
The Balance Sheet of X Ltd. as on 31-3-2011 and 31-3-2012 are as under:
Liabilities 2011 2012 Assets 2011 2012
Equity Share 18,00,000 22,00,000 Fixed Assets 20,50,000 18,75,000
capital (` 10 each) (Including machine)
General Reserve 7,50,000 6,00,000 Stock 7,10,000 8,95,000
Security premium 50,000 45,000 Debtors 7,25,000 9,80,000
Profit & Loss A/c 4,50,000 5,30,000 Cash Balance 1,25,000 1,80,000
7% Debentures 3,00,000 2,00,000 Preliminary 35,000 25,000
Expense
Creditors 1,50,000 2,15,000
Provision for tax 1,45,000 1,65,000
36,45,000 39,55,000 36,45,000 39,55,000
Additional Information:
(i) Depreciation charged on fixed assets during the year was ` 2,05,000. An old
machine costing ` 2,00,000 (WDV` 80,000) was sold for ` 65,000 during the year.
(ii) Provisions for tax made during the year for ` 1,78,000.
(iii) On 1-4-2011 company redeemed debentures of ` 1,00,000 at a premium of 5%.
(iv) Company has issued fully paid bonus shares of ` 2,00,000 by capitalization of
profit.
Prepare Cash Flow Statement.
Answer
Cash flow Statement of X Ltd. for the year ending 31.03.2012
(A) Cash flow from Operating Activities : (`) (` )
Net Profit before Tax (80,000 + 50,000 + 1,78,000) 3,08,000
Add : Depreciation 2,05,000
Loss on Sale of Machine 15,000
Interest Paid on Debentures 14,000
Preliminary Expenses written off 10,000
Cash flow before working capital adjustments 5,52,000
(−) Increase in Stock (1,85,000)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.91

(−) Increase in Debtors (2,55,000)

(+) Increase in Creditors 65,000
Cash flow from Operating Activities 1,77,000
Less : Tax paid (1,58,000) 19,000
(B) Cash flow from Investing Activities
Sale of Machine 65,000
Purchase of Fixed Assets (1,10,000)
Net cash used in Investing activities (45,000)
(C) Cash flow from Financing activities
Issue of Equity Shares 2,00,000
Redemption of Debentures (1,05,000)
Interest paid on Debentures (14,000)
Net cash used in Financing Activities 81,000
Net Increase in Cash and Cash Equivalent during year 55,000
Add : Opening Balance of Cash 1,25,000
Closing Balance of Cash 1,80,000
Working Notes:
Fixed Assets Account
To Balance b/d 20,50,000 By Bank 65,000
To Bank 1,10,000 By P&L a/c 15,000
By Depreciation a/c 2,05,000
By Balance c/d 18,75,000
21,60,000 21,60,000

Provision for Tax

To Balance b/d 1,58,000 By balance c/d 1,45,000
To Bank 1,65,000 By P & L a/c 1,78,000
3,23,000 3,23,000
General Reserve A/c
To Equity share capital a/c 2,00,000 By Balance b/d 7,50,000
To Balance c/d 6,00,000 By P & L a/c 50,000
8,00,000 8,00,000

© The Institute of Chartered Accountants of India

 3.92 Financial Management

Question 19
Balance Sheets of ABC Ltd as on March 31, 2009 and March 31, 2010 are as under:
Liabilities 31.3.2009 31.3.2010 Assets 31.3.2009 31.3.2010
` ` ` `
Share Capital 40,00,000 40,00,000 Land and 30,00,000 28,00,000
Building
General Reserve 8,00,000 9,00,000 Plant and 36,00,000 35,00,000
Machinery
Profit and Loss A/c 5,00,000 7,20,000 Investments 8,00,000 7,44,000
(long-term)
10% Debentures 20,00,000 16,00,000 Stock 9,60,000 17,00,000
Bank Loan (long- 10,00,000 12,00,000 Debtors 12,00,000 15,96,000
term)
Creditors 8,00,000 11,60,000 Prepaid 1,00,000 80,000
Expenses
Outstanding 40,000 50,000 Cash and Bank 2,80,000 1,70,000
Expenses
Proposed Dividend 6,00,000 7,20,000
Provision for 2,00,000 2,40,000
Taxation
99,40,000 1,05,90,000 99,40,000 1,05,90,000
Additional Information:
(i) New machinery for ` 6,00,000 was purchased but an old machinery costing ` 2,90,000
was sold for ` 1,00,000 and accumulated depreciation thereon was ` 1,50,000.
(ii) 10% debentures were redeemed at 20% premium.
(iii) Investments (long term) were sold for ` 90,000 and its profit was transferred to general
reserve.
(iv) Income-tax paid during the year 2009-10 was ` 1,60,000.
(v) An interim dividend of ` 2,40,000 has been paid during the year 2009-10.
(vi) Assume the provision for taxation as current liability and proposed dividend as non-
current liability.
(vii) Investments (long-term) are non-trade investments.
Required:
(i) Schedule of changes in working capital

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.93

(ii) Funds flow from operations for the year ended March 31, 2010.
Answer
(i) Schedule of Changes in Working Capital:
Particulars 31st March Working Capital
2009 2010 Increase Decrease
` ` ` `
(A) Current Assets
Stock 9,60,000 17,00,000 7,40,000
Debtors 12,00,000 15,96,000 3,96,000
Prepaid Expenses 1,00,000 80,000 20,000
Cash and Bank 2,80,000 1,70,000 1,10,000
Total (A) 25,40,000 35,46,000
(B) Current Liabilities
Creditors 8,00,000 11,60,000 3,60,000
Outstanding Expenses 40,000 50,000 10,000
Provision for Taxation 2,00,000 2,40,000 40,000
Total (B) 10,40,000 14,50,000
Working Capital 15,00,000 20,96,000 11,36,000 5,40,000
(A) – (B)
Increase in Working
Capital 5,96,000 5,96,000
Total 20,96,000 20,96,000 11,36,000 11,36,000
(ii) Funds flow from Operations for the year ended March 31, 2010
Adjusted Profit and Loss A/C
Particulars ` Particulars `
To General Reserve 66,000 By Balance b/d 5,00,000
To Depreciation: By Funds from 21,26,000
Operations
(Balancing figure)
On Land & Building 2,00,000
On Plant & 5,60,000 7,60,000
Machinery
To Loss on Sale of 40,000
Machine

© The Institute of Chartered Accountants of India

 3.94 Financial Management

To Premium on 80,000
Redemption of
Debentures
To Proposed 7,20,000
Dividend
To Interim Dividend 2,40,000
To Balance c/d 7,40,000
26,26,000 26,26,000
Working Notes:
(i) Depreciation on Land and Building = `30,00,000 – 28,00,000 = `2,00,000
(ii) Loss on Sale of Old Machine = `2,90,000 (Cost) –1,50,000 (Cum. Dep.)
– 1,00,000 (Sale Value) = 40,000
(iii) Depreciation on Plant and Machinery
Dr. ` Cr. `
To Balance b/d 36,00,000 By Bank a/c (sold) 1,00,000
To Bank a/c (Purchases) 6,00,000 By Profit & Loss a/c 40,000
(Loss on Sales)
By Depreciation 5,60,000
(Balancing figure)
By Balance c/d 35,00,000
42,00,000 42,00,000
(iv) Premium on Redemption of Debentures
Amount of Debentures Redeemed = ` 20,00,000 − 16,00,000 = `4,00,000

Premium = 20% of 4,00,000= ` 80,000

Question 20

Following are the summarized Balance Sheets of JKM Limited as on 31st March, 2011
and 2012 :
(` in lakhs)
Liabilities 31st March Assets 31st March
2011 2012 2011 2012
` ` ` `
Equity Share Capital 50.00 55.00 Goodwill 5.00 4.20
Capital Reserve - 2.50 Land & Building 20.00 18.00

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.95

General Reserve 4.00 6.00 Plant & Machinery 22.00 31.00

Profit & Loss Account 5.30 6.70 Investment 2.00 3.50
Proposed Dividend 8.00 11.00 Stock 8.60 12.70
Bills Payable 2.00 1.80 Sundry Debtors 10.20 13.00
Sundry Creditors 3.50 4.60 Bills Receivables 1.00 0.70
Provision for Tax 4.00 5.00 Cash in hand & Bank 7.20 8.90
Share Issue Exp. 0.80 0.60
76.80 92.60 76.80 92.60
Additional Information:
(i) A machine (original cost ` 2,80,000; Book Value ` 1,70,000) was sold during the
year for ` 1,50,000.
(ii) Depreciation for 2011-12 was amounted to ` 3,00,000 on plant and machinery and
` 50,000 on land and building.
(iii) A piece of land had been sold out on 01-11-2011 and the profit on the sale has been
credited in capital reserve.
(iv) ` 40,000 is received as dividend including ` 15,000 pre-acquisition profit, which is
credited to investment account.
(v) An interim dividend of ` 2,50,000 has been paid during the year 2011-12.
(vi) Income tax paid during the year 2011-12, amounted to ` 3,80,000.
Required:
(A) Prepare a schedule of changes in the working capital.
(B) Prepare funds flow statement as on 31st March, 2012.

Answer

(A) Schedule of Changes in the Working Capital

Particulars 31st March Changes in Working

Capital (in lakhs)
2011 2012 Increase Decrease
(` ) (` ) (` ) (` )
A. Current Assets
Stock 8.60 12.70 4.10
Sundry Debtors 10.20 13.00 2.80
Bills Receivables 1.00 0.70 0.30
Cash in Hand & Bank 7.20 8.90 1.70
Total (A) 27.00 35.3

© The Institute of Chartered Accountants of India

 3.96 Financial Management

B. Current Liabilities
Sundry Creditors 3.50 4.60 1.10
Bills Payable 2.00 1.80 0.20
Total (B) 5.5 6.4
C. Working Capital (A-B) 21.5 28.9
D. Increase in Working Capital 7.4 7.4
28.9 28.9 8.8 8.8
(B) Preparation of Funds Flow Statement
Working Notes:
Plant & Machinery A/c

Particulars ` Particulars `
To Balance b/d 22.00 By Depreciation 3.00
To Bank (Purchase ) 13.7 By Bank (Sale) 1.50
(Balancing figure) By Loss on Sale 0.20
By Balance c/d 31.00
35.7 35.7
Provision for Taxation A/c
Particulars ` Particulars `
To Balance c/d 5.00 By Balance b/d 4.00
To Bank A/c 3.80 By P&L A/c (balancing 8.80
figure)
8.80 8.80
Investment A/c
Particulars ` Particulars `
To Balance b/d 2.00 By Dividend A/c 0.15
To Bank (purchase b/d) 1.65
By Balance c/d 3.50
3.65 3.65
Land & Building A/c
Particulars ` Particulars `
To Balance b/d 20.00 By Bank A/c (Sale) 4.00
To Capital Reserve (Profit on 2.50 By Depreciation 0.50

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.97

Sale)
By Balance c/d 18.00
22.50 22.50
Adjusted Profit & Loss A/c
Particulars ` Particulars `
To Depreciation on: By Net Profit for 2011 5.30
Plant & Machinery 3.00 By Dividend on 0.25
Investment
Land & Building 0.50 By Funds from Operation 26.15
To Loss on Sale of Machinery 0.20
To Goodwill Written Off 0.80
To Share Issue Up Written Off 0.20
To Provision for Taxation 4.80
To Transfer to General Reserves 2.00
To Interim Dividend 2.50
To Proposed Dividend 11.00
By Net Profit for 2012 6.70
31.70 31.70
Funds Flow Statement as on 31st March 2012

Sources of Fund Rs. Application of Fund Rs.

Funds from Operation 26.15 Increase in Working 7.40
Capital
Dividend on Investment 0.40 Tax paid 3.80
Sale of Machinery 1.50 Interim Dividend 2.50
Issue of Shares 5.00 Dividend 8.00
Sale of Land 4.00 Purchase of Investments 1.65
Purchase of Plant 13.70
37.05 37.05
(Note: Schedule of changes in the working capital may be computed alternatively
by taking provision for tax as a current liability.)

© The Institute of Chartered Accountants of India

 3.98 Financial Management

EXERCISES

1. The following information is available in respect of ABC Ltd.:

(1) Materials are purchased and received one month before being used and payment is made to
suppliers two months after receipt of materials.

(2) Cash is received from customers three months after finished goods are sold and delivered to them.

(3) No time lag applies to payments of wages and expenses.

(4) The following figures apply to recent and future months:

Month Materials received Sales Wages and Expenses
` ` `
January 20,000 30,000 9,500
February 22,000 33,000 10,000
March 24,000 36,000 10,500
April 26,000 39,000 11,000
May 28,000 42,000 11,500
June 30,000 45,000 12,000
July 32,000 48,000 12,500
August 34,000 51,000 13,000
(5) Cash balance at the beginning of April is `10,000.
(6) All the products are sold immediately they have been made and that materials used and sums spent
on wages and expenses during any particular month relate strictly to the sales made during that
month.
Prepare cash flow forecast month by month from April to July, profit and loss forecast for four months (April-
July) and a movement of funds statement for the four months period (April-July).
(Answer: Cash forecast from April to July: Closing balance-7,000; 4,500; 2,500; 1,000 Profit and Loss
forecast for 4 months April-July-19,000 and Movement of Funds Statement- 1,000)

2. A newly established company manufacturing two products furnishes the Cost Sheets as under:
Products ` /unit
L B
Direct Materials 40 20
Direct Labour 30 15
Variable Overheads 14 7
Selling Price 100 50
Fixed overheads excluding bank interest amount to `6,00,000 per annum spread out evenly throughout the
year.

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.99

Sales forecast is as under:

Product July August Sept. Oct. November‘2013
L (Units) 4,200 4,600 3,600 4,000 4,500
B (Units) 2,100 2,300 1,800 2,000 1,900

Production: 75% of each month’s sales will be produced in the month of sale and 25% in the previous month.

Sales Pattern:
L: One-third of sales will be on cash basis on which a cash discount of 2% is allowed.

One-third will be on documents against payment basis.

The documents will be discounted by the bank in the month of sales itself.

Balance of one-third will be on documents against acceptance basis.

The payment under this scheme will be received in the third month.

For e.g. for sales made in September, payment will be received in November.

B.: 80% of the sales will be against cash to be received in the month of sales and the balance 20% will be
received next following month.

Direct materials: 50% of the direct materials required for each month’s production will be purchased in the previous
month and the balance in the month of production itself. The payment will be made in the month next following the
purchase.

Direct Wages: 80% of the direct wages will be paid in the month of use of direct labour for production and the
balance in the next following month.

Variable overheads: 50% to be paid in the month of incurrence and the balance in the next following month.

Fixed overheads: 40% will be paid in the month of incurrence and the other 40% in the next following month. The
balance of 20% represents depreciation.
The bill discounting charges payable to the bank in the month in which the bills are discounted amount to 50 paise
per `100 of bills discounted.

A cash balance of `1,00,000 will be maintained on 1st July, 2013.

Prepare a cash budget monthwise for July, August and September, 2013

(Answer: Closing Balance-1,03,062; 24,207; 40,894)

3. Given below are the Balance Sheets of Alpha Limited and Beta Limited as on 31st March, 2013 :

Balance Sheet
‘000
Liabilities Alpha Ltd. Beta Ltd. Assets Alpha Ltd. Beta Ltd.
Share capital Gross Block
Equity Shares of Less : Depreciation 812 917

© The Institute of Chartered Accountants of India

 3.100 Financial Management

`10 each 500 400 Investments 100 300

9-1/2% Pref. shares of Current Assets, Loans
`10 each 100 50 and Advances :
Reserve and Surplus Inventories 202 52
General Reserve 300 — Sundry Debtors 152 64
P&L A/c 100 50 Cash & Bank 42 32
Secured Loan Deposits 12 42
11% Term Loan 50 620 Advances — 40
10% Debentures 100 100
Unsecured Loan
15% Bank Loan 20 20
18% Short Term Loan 10 15
Current Liabilities &
Provisions :
Sundry Creditors 10 10
Outstanding Expenses 5 2
Provision for Taxation 50 40
Proposed Dividend 75 140
1320 1447 1320 1447
Find the capital structure ratios of the companies. Comment on their overall capital structure. Both the companies are willing
to raise 3.2 lakhs rupees by issue of debentures. How do you react if 2 : 1 debt-equity ratio norm is to be followed ?

(Answer: Alpha – 0.76; 0.17; 0.49 and Beta-0.35; 1.48; 2.12)

4. Profit and Loss Account for the period ended 31.3.2013

(‘000) (‘000)
Particulars Amount Particulars Amount
To Administrative Exp. 300 By Gross Profit (after charging
To Selling & Dis. Exp. 100 depreciation `1,00,000) 1250
To Interest 50 By Income from Investment 50
To Loss on sales of Fixed Assets 12 By Misc. Income 2
To Goodwill written off 15
To Tax provision 412
To Net profit 413
1302 1302
Calculate debt-service coverage ratio. Current instalment of long term loan is ` 5 lakhs.

(Answer: 1.07)

5. Given below is the Balance Sheet of Ahuja Company as on 31.12.2012

’000 ’000
Liabilities ` Assets `
Share Capital-Equity Net Block 180
shares of `10 each- 100 Inventories 100

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.101

General Reserve 10 Sundry Debtors 40

Capital Reserve 15 Cash and Bank Balances 40
Capital Redemption Reserve 50 Profit & Loss A/c 20
12% Convertible Debentures 55
(convertible into equity
shares by 31.3.2013 at a 10% premium)
14% Debentures 50
(25% Redeemable by 31.3.2013)
Current Liabilities 100
380 380
The company plans to issue 14% fresh debentures at the debt-equity ratio of 2 : 1 excluding capital
redemption reserve and capital reserve for which it has no cash backing. Tanuja Co. Ltd. wants to subscribe
fully the fresh debentures of Ahuja Co. Ltd. You are asked to calculate the amount needed to be set aside
for this purpose. Also you are asked by Ahuja Co Ltd. to determine the proprietary ratio after conversion of
debentures and fresh issue.

(Answer: `2,52,500; 0.35)

6. Cost Structure : for 10,000 units of product ‘X’

Raw Material ` 7,00,000

Wages ` 2,50,000
Manufacturing Exp. (70% fixed) ` 3,50,000
Admn. Exp. (100% fixed) ` 1,00,000
Selling Exp. (80% fixed) ` 2,00,000
` 16,00,000
The company expects annual sales of 9,600 units and wants to maintain 1/2 months’ sales in stock. It wants to
offer 2 months’ credit period and expects to receive 2 months’ credit. It has to give trade advance amounting to `
50,000. It wants to maintain 1 month’s cost of production in cash balance. Its fixed assets were ` 12 lakhs. It will
raise 16% short term loan from bank, but it has to maintain 2 : 1 current ratio. Also it will raise long term fund at the
2 : 1 debt equity ratio. It wants to earn 20% on sales. Draft the Balance Sheet of the Company.

(Answer: 20,50,334)
7. Given below are the Profit and Loss Statement of Om Limited for the year ended 31st March, 2013 and
Balance Sheet as on that date:

Profit and Loss Statement

` in lakhs ` in lakhs
Sales 7,850
Less : Cost of goods sold 5,232

© The Institute of Chartered Accountants of India

 3.102 Financial Management

Gross Profit 2,618

Less : Administrative Expenses 240
Selling & Distribution Expenses 545
Finance Charge 280
Depreciation 540 1,605
Profit Before Tax 1,013
Less : Tax Provision 500
Net Profit 513
Less : Proposed dividend 400
Retained Earnings 113

Balance Sheet
Liabilities ` in ` in Assets ` in ` in
Lakhs lakhs lakhs lakhs
Share Capital (`10 each) 4,000 Gross Block 6,550
Reserve & Surplus 2,000 Less: Accumu- 1,540
lated depn.
Add : Retained Earnings 113 2,113 Net Block 5,010
Secured loans 2,500
Unsecured loans 1,500 Investments 2,500
Current liabilities and provisions: Stock 1,500
Sundry Creditors 550 Debtors 1,800
Tax Provision 500 Cash at bank 700
Proposed dividend 400 1,450 Cash in hand 53 4,053
11,563 11,563
You are required to show the following ratios :

1. Gross yield percentage

2. Market value to book value per share

3. Price-earnings ratio

4. Market price to cash flow

Market price per share may be taken as `30 which was arrived at by taking average share price for the
month of March, 2013.

(Answer: 3.33%; 1.96; 23.39; 11.40)

© The Institute of Chartered Accountants of India

 Financial Analysis and Planning 3.103

8. The following are the changes in the account balances taken from the Balance Sheet of PQ Ltd. as at the
beginning and end of the year:

Changes in Rupees in
debit or [credit]
Equity share capital 30,000 shares of `10 each issued and fully paid —
Capital reserve [49,200]
8% debentures [50,000]
Debentures discount 1,000
Freehold property at cost/revaluation 43,000
Plant and machinery at cost 60,000
Depreciation on plant and machinery [14,400]
Debtors 50,000
Stock and work-in-progress 38,500
Creditors [11,800]
Net profit for the year [76,500]
Dividend paid in respect of earlier year 30,000
Provision for doubtful debts [3,300]
Trade investments at cost 47,000
Bank [64,300]
0

You are informed that:

(a) Capital reserve as at the end of the year represented realised profits on sale of one freehold property
together with surplus arising on the revaluation of balance of freehold proper- ties.
(b) During the year plant costing `18,000 against which depreciation provision of `13,500 was lying, was
sold for `7,000.

(c) During the middle of the year `50,000 debentures were issued for cash at a discount of `1,000.
(d) The net profit for the year was after crediting the profit on sale of plant and charging debenture
interest.
You are required to prepare a statement which will explain, why bank borrowing has in- creased by `64,300
during the year end. Ignore taxation.
(Answer: Cash flow from operating, investing and financing activities- 30,500; (1,11,800); 17,000)

© The Institute of Chartered Accountants of India

 3.104 Financial Management

9. Given below are the Balance Sheets of X Ltd. as on 31st March, 2011, 2012 and 2013.
31st March 31st March

Liabilities 2011 2012 2013 Assets 2011 2012 2013

(` in Lacs) (` in Lacs)
Share Capital 70,00 75,00 75,00 Plant & Machinery 80,00 110,00 130,00

Reserve 12,00 16,00 25,00 Investments 35,00 30,00 45,00

Profit & Loss A/c 6,00 7,00 9,00 Stock 15,00 15,00 20,00

12% Debentures 10,00 5,00 10,00 Debtors 5,00 5,50 5,00

Cash Credit 5,00 7,00 12,00 Cash at Bank 5,00 3,00 3,25

Creditors 12,00 14,00 18,00

Tax Provision 11,00 17,00 28,00

Proposed Div. 14,00 22,50 26,25

140,00 163,50 203,25 140,00 163,50 203,25

Other Information :
(i) Depreciation : 2010-2011 `500 lacs; 2011-12 `700 lacs; and 2012-13 `775 lacs.
(ii) In 2012-13 a part of the 12% debentures was converted into equity at par.

(iii) In the last three years there was no sale of fixed assets.
(iv) In 2012-13 investment costing `500 lacs was sold for `510 lacs. The management is confused on the
deteriorating liquidity position despite good profit earned by the enterprise.

Identify the reasons. Fund Flow Analysis may be adopted for this purpose.

(Answer: 2012-13-Sources: 56,50; 78,00 and Applications; 5,50; 4,25)

© The Institute of Chartered Accountants of India