Basics of

Financial
Management

Prof. Kavita Pareek| Assistant Professor-Finance

Lexicon Management Institute of Leadership and Excellence (MILE)
Email: [email protected] | Mobile: 9560160676
https://www.linkedin.com/in/kavita-pareek-965aa514a/
 Syllabus
Unit – 1 - Fundamentals of Financial Management
 Introduction, Scope, and Significance of Finance and Finance Function
 Objectives of finance function – wealth vs. profit
 Organization of the Finance Function, and Various Forms of
Organizations
Unit – 2 - Financial Statement
 Understand the concept of Financial Statements, (Schedule VI of the
Companies Act),
 Vertical Form of Income Statement and Balance Sheet
 Financial reporting – Meaning and types
 Read and understand the Financial Statements of Various Organizations
Unit – 3 - Analysis and Interpretation of Financial Statements
• Horizontal Analysis of Financial Statements (Comparative Statements)
• Vertical Analysis of Financial Statements (Common Size Statements)
• Trend Analysis

Unit – 4 – Ratio Analysis

 Liquidity Ratios - current ratio, quick ratio, and Cash Ratio
 Solvency Ratios - debt-equity ratio, debt-assets ratio, proprietary Ratio, interest
coverage ratio, Dividend coverage ratio, and total fixed charges coverage ratio.
 Activity Ratios - Stock turnover ratio, Debtors turnover ratio, Creditors
turnover ratio,Working capital turnover Ratio, Fixed assets turnover ratio
 Profitability Ratios - Gross profit ratio, Net profit ratio, Expense ratio,
Operating profit ratio, Operating ratio, Return on investment, Return on Total
Assets, Earning per share, Price earning ratio, dividend payout ratio, Dividend
yield ratio, Retained earnings ratio
Unit – 5 - Working Capital Management
• Meaning and need of Working Capital, its components and types.
• Sources of Working Capital Finance
• Operating Cycle, Accounts Receivable Management, Accounts Payable
Management
• Inventory Management, Cash Management
• Factors affecting working capital, Estimation of working capital
requirement. (Total Cost Method & Cash Cost Method)
Syllabus:
 Introduction, Scope, and Significance of Finance and Finance
Function
 Objectives of finance function – wealth vs. profit
 Organization of the Finance Function, and Various Forms of
Organizations
 Functions of the Finance Manager

Course Objectives:
 To obtain in-depth knowledge of different fundamental
concepts of finance and understand the role of financial
management in a dynamic business environment.
 Meaning of Finance

Finance may be defined as the art and science of

managing money. It includes financial service and
financial instruments. Finance also is referred as the
provision of money at the time when it is needed.
Finance function is the procurement of funds and their
effective utilization in business concerns.
 Definition of Finance

According to Khan and Jain, “Finance is the art and

science of managing money”.

According to Oxford dictionary, the word ‘finance’

connotes ‘management of money’.
DECISION MAKING JOURNEY OF AN ENTREPRENEUR
 Financial management
(Meaning)

Financial management is concerned with optimal

procurement as well as usage of Finance.

It is the planning, organizing , controlling and monitoring of

the financial recourses of an organization.
 Financial Management
(Definition)

“Financial management deals with how the corporation obtains

the funds and how it uses them” -Hoagland

“Financial Management is the application of thee planning and

control functions to the finance functions, financial management
involves the application of general management principles to a
particular financial operation” -Howard and Upton
 Why Financial Management is Important

Good practice Financial Management will:

 Help Organizations make effective and efficient use of

resources to achieve objectives and fulfil commitment to
stakeholders.
 Help Organizations gain confidence of funding Agencies,
Partners and Beneficiaries.
 Give the advantage in competition for increasing scarce
resources.
 Help Organizations prepare themselves for long term
financial sustainability.
The diagram the demonstrates the day-to-day financial management
tasks delegated down through the line management structure. At the
same time, the accountability process comes back up through the
structure as people report back on progress.
 Scope of Finance Function/Financial Decisions

Investment Financing Dividend

Decision Decision Decision

Capital
Budgeting Working Capital
Management
Capital
Cost of capital Structure

Dividend Policy Retained

Earnings
 Major decisions
The financial management can be further classified into
three major decisions:

 The financing decision.

 The investment decision.
 The dividend decision.
 FINANCING DECISIONS
 The financing decisions are basically concerned with
the answers to the questions like-
a) What should be the amount of funds that should be
raised?
b) What should be the mix of equity and debt capital in
which the required amount of funds should be raised?
c) Proportion of internal and external sources of funds
d) What is the nature of capital market operations?
 Factors Affecting

 Cost
 Risk
 Floatation costs
 Cash flow position of the business
 Investment Decisions
1) Fixed Assets (Capital Budgeting): These are those
properties and infrastructural facilities which the
business is carried on and these are the assets which
yield the return over a period of time.
2) Current Assets (Working Capital Management):
These are those properties which are created during the
course of business and are capable of getting converted
into cash usually within a year.
These decisions relate to how the firm’s funds
are invested in different assets so that they are
able to earn the highest possible return for
their investors.
 Factors Affecting

 Cash flows of the project.

 The rate of return.
 The investment criteria involved.
 Dividend Decisions
 Dividend is that portion of profits, which is distributed to
shareholders.
 The decision made here is how much of the profit is to be
distributed to the shareholders and how much of it
should be retained to meet the investment requirements.
 Dividend Payout Policies derive enormous importance
by virtue of being a bridge between the company and
shareholders for profit-sharing. Without an organized
dividend policy, it would be difficult for the investors to
judge the intentions of the management.
 Factors Affecting

 Earnings.
 Stability of earnings.
 Stability of dividend.
 Growth opportunities.
 Find out the names of Top 10
Dividend Paying Stocks in India.
 Objectives
Efficient financial management requires the existence
of some objectives which are as follows:

 Profit Maximisation
 Wealth Maximisation
 WEALTH

PROFIT

OBJECTIVES
 Profit Maximization
Main aim of any kind of economic activity is earning profit. A
business concern is also functioning mainly for the purpose of
earning profit. Profit is the measuring techniques to understand the
business efficiency of the concern. Profit maximization is also the
traditional and narrow approach, which aims at, maximizes the profit
of the concern. Profit maximization consists of the following
important features.

1. Profit maximization is also called as cashing per share

maximization. It leads to maximize the business operation for profit
maximization.
2. Ultimate aim of the business concern is earning profit, hence, it
considers all the possible ways to increase the profitability of the
concern.
3. Profit is the parameter of measuring the efficiency of the business
concern. So it shows the entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the
business.
How can we maximize the profits of
an organization?
 Profit Maximization

• By increasing the sales and there by increasing the revenues.

• By reducing the cost of production through efficient use
of the resources.
• By making judicious choice of funds.
• By minimizing risk
Returns from two proposals - Project A & Project B

A (Rs.) B (Rs.)

Year 1 70,000
Year 2 20,000
Year 3 10,000 1,00,000

Total Returns 1,00,000 1,00,000

 The arguments in favor

a) Profit is the prime motive which contributes to better and

more efficient performance.
b) It ensures maximum returns tothe shareholder.
c) If this object is not there, there would not be any place for
competition.
d) It plays important role in growth of a business.
e) It act asa protection against risk.
 It is vague: In this objective, profit is not defined precisely or correctly. It
creates some unnecessary opinion regarding earning habits of the business
concern.
 It ignores the time value of money: Profit maximization does not
consider the time value of money or the net present value of the cash inflow. It
leads certain differences between the actual cash inflow and net present cash
flow during a particular period.
 It ignores risk: Profit maximization does not consider risk of the business
concern. Risks may be internal or external which will affect the overall
operation of the business concern.
 2. Wealth maximization
The term wealth means shareholder wealth or the
wealth of the persons those who are involved in the
business concern. Wealth maximization is also
known as value maximization or net present worth
maximization. This objective is an universally
accepted concept in the field of business.
How can we maximize the wealth of
shareholder?
 Merits

• It helps in future cashflow

• It considered the time value of money.
• This concept allows the dividend policy of the company to
have its effect of the market value of the equity shares.
• It also contributes to the maximization of other objectives
of financial management.
• Cash flows from projects subject to greater risks are
discounted at a higher discount rate
Syllabus:
 Understand the concept of Financial Statements, (Schedule VI of
the Companies Act),
 Vertical Form of Income Statement and Balance Sheet
 Financial reporting – Meaning and types
 Read and understand the Financial Statements of Various
Organizations

Course Objectives:
 Gain a comprehensive understanding of financial statements as
per Schedule VI of the Companies Act.
 Explore the methods and considerations for preparing a
vertical Income Statement and Balance Sheet.
 Explore emerging trends and technologies in financial
reporting that impact the presentation of vertical financial
statements.
 Financial statements are written records that convey the business
activities and the financial performance of a company. Financial
statements are often audited by government agencies, accountants,
firms, etc. to ensure accuracy and for tax, financing, or investing
purposes.
 Schedule III to the Companies Act, 2013 (‘the Act’) provides the
manner in which every company registered under the Act shall
prepare its Balance Sheet, Statement of Profit and Loss and notes
thereto.

 In the light of various economic and regulatory reforms that have

taken place for companies over the last several years, there was a
need for enhancing the disclosure requirements under the Old
Schedule VI to the Act and harmonizing and synchronizing them with
the notified Accounting Standards as applicable (‘AS’/‘Accounting
Standard(s)’). Accordingly, the Ministry of Corporate Affairs (MCA)
had issued a revised form of Schedule VI on February 28, 2011 and
this has formed the basis for the Schedule III of Companies Act, 2013.
 (1) Where compliance with the requirements of the Act including
Accounting Standards as applicable to the companies require any change
in treatment or disclosure including addition, amendment, substitution or
deletion in the head or sub-head or any changes, in the financial
statements or statements forming part thereof, the same shall be made
and the requirements of this Schedule shall stand modified accordingly.
 (2) The disclosure requirements specified in this Schedule are in
addition to and not in substitution of the disclosure requirements
specified in the Accounting Standards prescribed under the Companies
Act, 2013. Additional disclosures specified in the Accounting Standards
shall be made in the notes to accounts or by way of additional statement
unless required to be disclosed on the face of the Financial Statements.
Similarly, all other disclosures as required by the Companies Act shall be
made in the notes to accounts in addition to the requirements set out in
this Schedule.
 (3) (i) Notes to accounts shall contain information in addition to that
presented in the Financial Statements and shall provide where required
 a) Narrative descriptions or disaggregation’s of items recognized in those
statements; and
 b) Information about items that do not qualify for recognition in those
statements.
 (ii) Each item on the face of the Balance Sheet and Statement of Profit and
Loss shall be cross-referenced to any related information in the notes to
accounts. In preparing the Financial Statements including the notes to
accounts, a balance shall be maintained between providing excessive detail
that may not assist users of financial statements and not providing important
information as a result of too much aggregation.
 (i) Depending upon the turnover of the company, the figures appearing
in the Financial Statements maybe rounded off as given below:—
Turnover Rounding off (a) less than one hundred’ crore rupees To the
nearest hundreds, thousands, lakhs or millions, or decimals thereof (b)
one hundred crore rupees or more To the nearest lakhs, millions or
crores, or decimals thereof.
 (ii) Once a unit of measurement is used, it shall be used uniformly in the
Financial Statements.
 (5)Except in the case of the first Financial Statements laid before the
Company (after its incorporation) the corresponding amounts
(comparatives) for the immediately preceding reporting period for all
items shown in the Financial Statements including notes shall also be
given.
 (6) For the purpose of this Schedule, the terms used herein shall be as
per the applicable.
 Aspect Schedule VI Schedule III

Applicable Legislation Companies Act, 1956 Companies Act, 2013

Separate sections for Assets and Liabilities with Simplified format with separate sections for
Balance Sheet Layout
detailed classifications. Assets and Liabilities, focusing on clarity.
Assets classified into Fixed Assets,
Assets classified into Non-Current Assets and
Asset Classification Investments, Current Assets, and Loans &
Current Assets, with further subdivisions.
Advances.
Liabilities classified into Share Capital, Liabilities classified into Non-Current
Liability Classification Reserves & Surplus, Secured Loans, Unsecured Liabilities and Current Liabilities, with clear
Loans, and Current Liabilities. breakdowns.

Combined presentation of Share Capital and

Presented under Share Capital and Reserves &
Presentation of Equity Reserves & Surplus in a more consolidated
Surplus with detailed headings.
format.
 Aspect Schedule VI Schedule III

Detailed schedules for various components such Detailed notes to accounts providing clarity
Schedule Attachments
as Fixed Assets and Investments. on asset and liability breakdowns.

More detailed and traditional format, potentially More streamlined and user-friendly format
Format Complexity
complex. with reduced complexity.

Specific and often lengthy disclosures with Focuses on key disclosures, enhancing
Disclosure Requirements
multiple line items. readability and relevance.

Historical figures and comparative statements Enhanced requirement for presenting

Comparative Figures
provided for analysis. comparative figures and changes.

Less aligned with International Financial More aligned with IFRS and global
Consistency with IFRS
Reporting Standards (IFRS). accounting practices.
 Aspect Schedule VI Schedule III

Applicable Legislation Companies Act, 1956 Companies Act, 2013

Detailed format with specific headings and sub- Simplified format with broader categories and
Format
headings for each item. fewer sub-headings.

Revenue classified into various detailed heads Revenue broadly classified under Revenue
Revenue Classification
such as Sales, Other Income, etc. from Operations and Other Income.

Expenses classified into detailed categories Expenses categorized under broader heads
Expense Classification such as Cost of Goods Sold, Administrative such as Cost of Materials Consumed,
Expenses, etc. Employee Benefits Expense, etc.

Gross Profit shown explicitly between Revenue Gross Profit included within the broader
Gross Profit Calculation
and Cost of Goods Sold. category of Revenue from Operations.
 Aspect Schedule VI Schedule III

Operating and Non- Detailed separation between operating and non- Integrated presentation of operating and non-
Operating Items operating items. operating items for clarity.

Generally included within expenses, with less

Income Tax Expense Shown separately with detailed breakdowns.
detailed breakdown.

Often included in a broader category, with less

Extraordinary Items Detailed disclosure of extraordinary items.
emphasis on detailed disclosure.

Requires presentation of comparative figures for Enhanced focus on presenting comparative

Comparative Figures
each item. figures and trends.

Specific disclosures for various items with Broader disclosures focusing on key items and
Disclosure Requirements
detailed explanations. overall performance.
 Financial reporting is a systematic process of recording and
representing a company’s financial data. The reports reflect
a firm’s financial health and performance in a given period.
Management, investors, shareholders, financiers,
government, and regulatory agencies rely on financial
reports for decision-making.
 ICSI Publication:
https://www.icsi.edu/media/filer_public/e5/60/e560791d-fc7b-4812-
ad27-071851ddb825/recent_amendments_in_ca_2013-gr-6.pdf
 ICAI publication:
https://kb.icai.org/pdfs/PDFFile5b27859a90bfc7.83429474.pdf
 https://www.ibef.org

 YouTube Video:
 You Tube Video: https://www.youtube.com/watch?v=XjA2LVRlcSE
Financial Reporting| Division II of Sch III to Companies Act
2013| CA Suraj Lakhotia
Syllabus:
 Horizontal Analysis of Financial Statements (Comparative
Statements)
 Vertical Analysis of Financial Statements (Common Size
Statements)
 Trend Analysis

Course Objectives:
 Basic understanding of business performance through
various techniques.
 Understand the Vertical and Horizontal analysis of financial
statement
 Identify the trend of Financial Statements
 The process of reviewing and analyzing a
company’s financial statements to make better economic
decisions is called analysis of financial statements. In
other words, the process of determining financial
strengths and weaknesses of the entity by establishing
the strategic relationship between the items of
the balance sheet, profit and loss account, and other
financial statements.
 The term ‘analysis’ means the simplification of financial
data by methodical classification of the data given in the
financial statements, ‘interpretation’ means, ‘explaining
the meaning and significance of the data so simplified.’
However, both’ analysis and interpretation’ are interlinked
and complementary to each other.
 According to Metcalf and Titard, “Analyzing
financial statements is a process of evaluating
the relationship between component parts of a
financial statement to obtain a better
understanding of a firm’s position and
performance.”
 In the words of Myers, “Financial statement
analysis is largely a study of relationship among
the various financial factors in a business as
disclosed by a single set-of statements and a
study of the trend of these factors as shown in a
series of statements.”
 Finance Manager
 Top Management
 Trade Payables
 Lenders
 Investors
 Trade Unions
Analysis of financial statements helps the finance manager in:
 Assessing the operational efficiency and managerial
effectiveness of the company.
 Analyzing the financial strengths and weaknesses and
creditworthiness of the company.
 Analyzing the current position of financial analysis,
 Assessing the types of assets owned by a business enterprise
and the liabilities which are due to the enterprise.
 Providing information about the cash position company is
holding and how much debt the company has in relation to
equity.
 Studying the reasonability of stock and debtors held by the
company.
Financial analysis helps the top management:
 To assess whether the resources of the firm are used
in the most efficient manner
 Whether the financial condition of the firm is sound
 To determine the success of the company’s
operations
 Appraising the individual’s performance
 Evaluating the system of internal control
 To investigate the future prospects of the enterprise.
Trade payables analyze the financial statements for:
 Appraising the ability of the company to meet its
short-term obligations
 Judging the probability of firm’s continued ability to
meet all its financial obligations in the future.
 Firm’s ability to meet claims of creditors over a very
short period of time.
 Evaluating the financial position and ability to pay off
the concerns.
 Suppliers of long-term debt are concerned with the
firm’s long-term solvency and survival. They analyze
the firm’s financial statements
 To ascertain the profitability of the company over a
period of time,
 For determining a company’s ability to generate
cash, to pay interest and repay the principal amount
 To assess the relationship between various sources
of funds (i.e. capital structure relationships)
 To assess financial statements which contain
information on past performances and interpret it as
a basis for forecasting future rates of return and for
assessing risk.
 For determining credit risk, deciding the terms and
conditions of a loan if sanctioned, interest rate, and
maturity date etc.
Investors, who have invested their money in the firm’s
shares, are interested in the firm’s earnings and
future profitability. Financial statement analysis helps
them in predicting the bankruptcy and failure
probability of business enterprises. After being
aware of the probable failure, investors can take
preventive measures to avoid/minimize losses.
Labour unions analyze the financial statements:
 To assess whether an enterprise can increase their
pay.
 To check whether an enterprise can increase
productivity or raise the prices of products/ services
to absorb a wage increase.
 Reviewing the performance of a company over the past periods
 Assessing the current position & operational efficiency
 Predicting growth & profitability prospects
 Loan Decision by Financial Institutions and Banks
 To estimate the earning capacity of the business concern.
 To find out the operating performance of a company.
 To examine efficiency of various business activities.
 To find out the financial performance of a company.
 To compare the performance of a company for different
periods.
 To assess the borrowing capacity of the business concern.

 To determine the long term liquidity and solvency of the
business concern.
 To decide about the future prospects of the business concern.
 To know the profitability and collection policy of the business
concern.
 To verify the correctness and accuracy of the decision taken by
the management already.
 To compare the overall performance of the company with other
similar companies.
 To examine the impact of past decision of the management on
financial aspect.
 To determine the debt capacity of the firm.
 To judge the managerial ability.
 It is only a study of interim reports
 Financial analysis is based upon only monetary
information and non-monetary factors are ignored.
 It does not consider changes in price levels.
 As the financial statements are prepared on the basis of a
going concern, it does not give exact position. Thus
accounting concepts and conventions cause a serious
limitation to financial analysis.
 Changes in accounting procedure by a firm may often
make financial analysis misleading.
 Analysis is only a means and not an end in itself. The
analyst has to make interpretation and draw his own
conclusions. Different people may interpret the same
analysis in different ways.
 Also known as ‘horizontal analysis, are financial
statements showing financial position & profitability
at different periods of time. These statements give an
idea of the enterprise financial position of two or
more periods. Comparison of financial statements is
possible only when same accounting principles are
used in preparing these statements.
 The progress of the company can be seen by
observing the different assets and liabilities of the
firm on different dates to make the comparison of
balances from one date to another. To understand the
comparative balance sheet, it must have two columns
for the data of original balance sheets. A third
column is used to show increases/decrease in
figures. The fourth column gives percentages of
increases or decreases.
 By comparing the balance sheets of different dates,
one can observe the following aspects
 Current financial position and Liquidity position
 Long-term financial position
 Profitability of the concern
 Traditionally known as trading and profit and loss A/c. Net sales,
cost of goods sold, selling expenses, office expenses etc are
important components of an income statement. To compare
the profitability, particulars of profit & loss are compared with the
corresponding figures of previous years individually. To analyze
the profitability of the business, the changes in money value and
percentage is determined.
 By comparing the profits of different dates, one can observe the
following aspects:
 The increase/decrease in gross profit.
 The study of operational profits.
 The increase or decrease in net profit
 Study of the overall profitability of the business.
 Common size statements are also known as ‘Vertical analysis’. Financial
statements, when read with absolute figures, can be misleading. Therefore,
a vertical analysis of financial information is done by considering the
percentage form. The balance sheet items are compared:
 to the total assets in terms of percentage by taking the total assets as 100.

 to the total liabilities in terms of percentage by taking the total liabilities as

100.
 Therefore the whole Balance Sheet is converted into percentage form. And
such converted Balance Sheet is known as Common-Size Balance Sheet.
Similarly profit & loss items are compared:
 total sales will be taken as the base for conversion and all items in the
income statement are converted and expressed as percentage of sales.
 Therefore the whole Profit & loss account is converted into percentage
form. And such converted profit & loss account is known as Common-Size
Profit & Loss account. As the numbers are brought to a common base, the
percentage can be easily compared with the results of corresponding
percentages of the previous year or of some other firms.
 Also known as the Pyramid Method. Studying the
operational results and financial position over a
series of years is trend analysis. Calculations of
ratios of different items for various periods is done &
then compared under this analysis. Whether the
enterprise is trending upward or backward, the
analysis of the ratios over a period of years is done.
By observing this analysis, the sign of good or poor
management is detected.
Quantitative analysis of information contained in a company’s
financial statements is ratio analysis. It describes the significant
relationship which exists between various items of a balance
sheet and a statement of profit and loss of a firm.
To assess the profitability, solvency, and efficiency of a
business, management can go through the technique of ratio
analysis. It is an attempt at developing a meaningful
relationship between individual items (or group of items) in
the balance sheet or profit and loss account.
 The actual movement of cash into and out of a business is cash
flow analysis. The flow of cash into the business is called the
cash inflow. Similarly, the flow of cash out of the firm is called
cash outflow. The difference between the inflow and outflow of
cash is the net cash flow.
 Cash flow statement is prepared to project the manner in which
the cash has been received and has been utilized during
an accounting year. It is an important analytical tool. Analysis of
cash flow explains the reason for a change in cash. It helps in
assessing the liquidity of the enterprise and in evaluating the
operating, investment & financing decisions.
• Prepared to explain the changes which have taken
place in the working capital during the period under
consideration.
• It is a report on movement of funds explaining
wherefrom working capital originates and where into
the same goes during an accounting period.
• Essential tool for long-term financial analysis.
1. Comparative Income
Statement Format
Practice Questions –
Comparative Income
Statement
 COMPARATIVE INCOME STATEMENT
Values Change (+ / - )
Particulars CY PY Absolute Percentag
e
Net sales 120 100
Less Cost of Goods Sold 40 30
Gross Profit 80 70
Operating expenses 40 25
Operating Profit (EBIT) 40 45
Less Interest 10 10
Earning Before Tax 30 35
Less Tax 12 15
Earnings After Tax 18 20
Less Preference Share Dividend 8 8
Earnings available to Equity Share Holders 10 12
 COMPARATIVE INCOME STATEMENT
Values Change (+ / - )
Particulars CY PY Absolute Percentage
Net sales 120 100 +20 +20.00
Less Cost of Goods Sold 40 30 +10 +33.33
Gross Profit 80 70 +10 +14.30
Operating expenses 40 25 +15 +60.00
Operating Profit (EBIT) 40 45 -5 -11.10
Less Interest 10 10 0 0
Earning Before Tax 30 35 -5 -14.30
Less Tax 12 15 -3 -20.00
Earnings After Tax 18 20 -2 -10.00
Less Preference Share Dividend 8 8 0 0
Earnings available to Equity Share Holders 10 12 -2 -16.67
Prepare Comparative Income Statement for the following:
 Consider the following income statement for M/s Singhania for the years
ended December 31st, 2017 and December 31st, 2018.
Comparative Income Statement of M/s Singhania For The Years Ended
December 31, 2017, and December 31, 2018.
 Analysis

As is evident from the above comparative income statement, the sales of

M/s Singhania increased by Rs 20,400 during 2018 as against 2017.
However, the cost of goods sold for the company increased by just Rs
15,000 in the same period. If you see carefully, sales increased by 12%
whereas the cost of goods sold increased by 14.3%. Thus, the Gross
Profit for M/s Singhania did not increase significantly.
2. Comparative Balance Sheet
Format
 Practice Questions –
Comparative Balance Sheet
Prepare a Comparative Balance Sheet and study the
financial Position.
5,00,000
Consider the following balance sheets of M/s Kapoor and Co as on
December 31st, 2017 and December 31st, 2018
Comparative Balance Sheet of M/s Kapoor and Co. as on
December 31, 2017, and December 31, 2018.
 Analysis

As we can see in the comparative balance sheet above, the current assets
of Kapoor and Co. have decreased by Rs 35,200 in the year 2018 over
2017.

On the other hand, the current liabilities have decreased by Rs 27,000 only.
Now, such a change does not have a negative impact on the liquidity
position of M/s Kapoor and Co. This is because current assets have
decreased by 33.9% whereas current liabilities have declined by 51.5%.

Secondly, the cash and bank balance of Kapoor and Co. have decreased
by 91.5%. This indicates a negative cash position of the company. It further
hints towards the fact that the company might find it challenging to meet its
short-term obligations.
 Analysis

Next, the long-term debt of M/s Kapoor and Co. has increased by 62.5%.
On the other hand, the owner’s equity has improved by only 34%. This
indicates that the company is way too dependent on the external lenders
thus leading to a great financial risk for the firm.

Finally, there is a considerable increase seen in the fixed assets of the

company. Accordingly, the fixed assets increased by Rs 79,000 or 64.9%
from the year 2017 to 2018. This was on account of the huge addition
made to the plant and machinery by the company in the given accounting
periods.

Plant and machinery increased by Rs 95,200 that is by 153.5%. Such

additional machinery leads to an incredible improvement in the production
capacity of the company during the year. This expenditure was provided for
by the company proprietors and the external lenders.
1. Common Size Income
Statement Format
Practice Questions – Common
Size Income Statement
 COMMON SIZE INCOME STATEMENT
2023 2024
Particulars
Rupees % Rupees %
Net sales 7,00,000 8,00,000
Less cost of goods sold 5,95,000 6,15,000
Gross profit 1,05,000 1,85,000
Operating expenses 35,700 36,500
Operating income 69,300 1,48,500
Add other Incomes 1,200 6,110
Total income (EBIT) 70,500 1,54,610
Less interest 10,500 8,750
Profit Before Tax 60,000 1,45,860
Less Tax 30,000 45,000
Profit after tax 30,000 1,00,860
 COMMON SIZE INCOME STATEMENT
2023 2024
Particulars
Rupees % Rupees %
Net sales 7,00,000 100.00 8,00,000 100.00
Less cost of goods sold 5,95,000 85.00 6,15,000 76.87
Gross profit 1,05,000 15.00 1,85,000 23.13
Operating expenses 35,700 5.10 36,500 4.56
Operating income 69,300 9.90 1,48,500 18.56
Add other Incomes 1,200 0.17 6,110 0.76
Total income (EBIT) 70,500 10.07 1,54,610 19.33
Less interest 10,500 1.50 8,750 1.09
Profit Before Tax 60,000 8.57 1,45,860 18.23
Less Tax 30,000 4.28 45,000 5.62
Profit after tax 30,000 4.29 1,00,860 12.61
25200 30000
2. Common Size Balance
Sheet Format
 Practice Questions –
Common Size Balance Sheet
 COMMON-SIZE BALANCE SHEET
X LTD Y LTD
ASSETS
Rupees % Rupees %
Current Assets :-
Cash in hand 8,000 10,000
Prepaid expenses 1,000 2,000
Debtors 4,000 8,000
Stock 10,000 25,000
Temporary investment 1,000 40,000
Total Current Assets 24,000 85,000
Fixed Assets :-
Land and building 3,30,000 6,00,000
Plant and machinery 84,000 1,23,000
Total Fixed Assets 4,14,000 7,23,000
TOTAL ASSETS 4,38,000 8,08,000
 COMMON-SIZE BALANCE SHEET
X LTD Y LTD
Liabilities
Rupees % Rupees %
Current Liabilities:-
Sundry creditors 14,000 4000
Outstanding expenses 15,000 6,000
Proposed dividend 10,000 90,000
Total current liabilities 39,000 1,00,000
Long-term Liabilities :-
Loans 15,000 30,000
Debentures 1,00,000 1,00,000
Total long term liabilities 1,15,000 1,30,000
Capital and Reserves :-
Share capital 2,70,000 5,60,000
Reserves 14,000 18,000
Total capital and reserves 2,84,000 5,78,000
Total Liabilities 4,38,000 8,08,000
 COMMON-SIZE BALANCE SHEET
X LTD Y LTD
ASSETS
Rupees % Rupees %
Current Assets :-
Cash in hand 8,000 1.83 10,000 1.25
Prepaid expenses 1,000 0.23 2,000 0.25
Debtors 4,000 0.91 8,000 0.99
Stock 10,000 2.28 25,000 3.08
Temporary investment 1,000 0.23 40,000 4.95
Total Current Assets 24,000 5.48 85,000 10.52
Fixed Assets :-
Land and building 3,30,000 75.34 6,00,000 74.26
Plant and machinery 84,000 19.18 1,23,000 15.22
Total Fixed Assets 4,14,000 94.52 7,23,000 89.48
TOTAL ASSETS 4,38,000 100.00 8,08,000 100.00
 COMMON-SIZE BALANCE SHEET
X LTD Y LTD
Liabilities
Rupees % Rupees %
Current Liabilities:-
Sundry creditors 14,000 3.20 4000 0.49
Outstanding expenses 15,000 3.44 6,000 0.74
Proposed dividend 10,000 2.28 90,000 11.15
Total current liabilities 39,000 8.92 1,00,000 12.38
Long-term Liabilities :-
Loans 15,000 3.44 30,000 3.71
Debentures 1,00,000 22.81 1,00,000 12.38
Total long term liabilities 1,15,000 26.25 1,30,000 16.09
Capital and Reserves :-
Share capital 2,70,000 61.64 5,60,000 69.31
Reserves 14,000 3.20 18,000 2.23
Total capital and reserves 2,84,000 64.84 5,78,000 71.53
Total Liabilities 4,38,000 100.00 8,08,000 100.00
 Another tool used for analysis and interpretation
 Trend means “tendency”
 Trend analysis means “review and appraisal of
tendency in accounting variables”
 Helps in analyzing long term trend of various
business factors – help in budgeting and
forecasting
 Helps in ascertaining favorable or unfavorable
trend in business
 Trend analysis can be performed through :- (a).
Trend ratios and (b). Graphs
 Ratio expresses mathematical relationship between two
figures. Expression of one figure in term of another one
 Trend ratios / percentages refer to the expression of
arithmetical relationship which each item of several years
bears to the same item of ‘base year’.
 For calculating trend ratios / percentages one year is taken as
the “base” and then ratios or percentages are calculated taking
the figure of the base year as “base”.

 Where
P₁ = Values of Current Year
P₀ = Values of Base Year
Practice Questions – Trend
Analysis
Interpretation:

The performance trend in sales and net profit are growth-oriented, given the
increasing trend. However, percentage growth in terms of net profit exceeded
sales percentage growth.
As such, in this example, the company is an attractive target for investment.
Comparing the growth of sales and net profit together, it is clear that net
profit growth is greater than sales growth. Specifically, over the five years, while
there was an increase of 100% in terms of sales, the net profit increased by
181%.

Vertical comparison of the yearly increase in sales and net profit indicates that:
•For the year 2015-16, if sales increased by 20%, net profit increased by 31%
•For the year 2016-17, if sales increased by 40%, net profit increased by 56%
•For the year 2017-18, if sales increased by 67%, net profit increased by 109%
•For the year 2018-19, if sales increased by 100%, net profit increased by 181%

This comparative growth clearly reflects the efficiency and effectiveness of the
company's management.
Solution:
 From the following data relating to the assets of Balance Sheet
of ABC Ltd., for the period ended March 31, 2011 to March 31,
2014, calculate trend percentages.
 Solution:
 In case of comparative statement, an item is compared with
itself in the previous year to know whether it has increased or
decreased or remained constant.
 Common size analysis is to ascertain whether the proportion
of an item (say cost of revenue from operations) is increasing
or decreasing in the common base (say revenue from
operations).
 In case of trend analysis, we learn about the behavior of the
same item over a given period, say, during the last 5 years.
UNIT – 4
RATIO ANALYSIS
Syllabus:
 Liquidity Ratios - current ratio, quick ratio, and Cash Ratio
 Solvency Ratios - debt-equity ratio, debt-assets ratio, proprietary Ratio,
interest coverage ratio, Dividend coverage ratio, and total fixed charges
coverage ratio.
 Activity Ratios - Stock turnover ratio, Debtors turnover ratio, Creditors
turnover ratio, Working capital turnover Ratio, Fixed assets turnover
ratio
 Profitability Ratios - Gross profit ratio, Net profit ratio, Expense ratio,
Operating profit ratio, Operating ratio, Return on investment, Return on
Total Assets, Earning per share, Price earning ratio, dividend payout ratio,
Dividend yield ratio, Retained earnings ratio
Course Objectives:
 To acquire application-oriented knowledge of various financial ratios for
financial analysis to assist the management in planning and decision-
making
 Understand the types of ratios in detail – Liquidity ratios, Solvency ratios,
Activity ratios, and Profitability ratios
 MEANING
 Mathematical relationship between two items
 Expressed in quantitative form

 Defined as:
“relationships expressed in quantitative terms, between
figures which have cause and effect relationships or
which are connected with each other in some manner
or the other”
 STEPS

 Selection of relevant information

 Comparison of calculated ratio

 Interpretation and reporting

 ADVANTAGES
1. Forecasting
2. Managerial control
3. Facilitates communication
4. Measuring efficiency
5. Inter firm comparisons
 LIMITATIONS
1. Practical knowledge
2. Inter-relationships
3. Accuracy of financial information
4. Consistency of preparation of
financial statements
5. Time log
 CLASSIFICATION OF RATIOS
Liquidity Activity Profitability Solvency Ratios
Ratios Ratios Ratios
• Current • Stock • Gross profit ratio • Debt-equity
ratio turnover • Net profit ratio ratio
• Liquidity • Debtors • Debt-assets
• Expense ratio Long term
ratio turnover ratio
• Operating profit solvency ratio
• Cash • Creditors • Proprietary
position ratio
turnover Ratio
ratio • Working • Operating ratio
• Interest
capital • Return on coverage ratio
turnover investment • Dividend
• Fixed • Return on Total
assets coverage ratio
turnover Assets • Total fixed
• Earning per share charges
• Price earning ratio coverage ratio
• Dividend payout
ratio
• Dividend yield ratio
• Retained earnings
ratio
Practice Questions –
Liquidity Ratios
A company had current assets ₹ 3,00,000 and current liabilities ₹
1,40,000. Afterwards, it purchased goods worth ₹ 20,000 on credit.
Calculate the current ratio after the purchase of goods. (All India
2019)
Compute current ratio, quick ratio and absolute liquid ratio from the
following are the current assets and current liabilities of a trading company:

Current assets:
Cash and Bank: $5,000
Marketable securities: $18,000
Accounts receivables, net: $8,000
Inventories: $10,000
Prepaid expenses: $500

Current liabilities:
Accounts payable: $15,000
Accrued payable: $5,000
Notes payable: $8,000

Required: Compute current ratio, quick ratio and absolute liquid ratio from the
above data.
(1). Current ratio:
Current assets/Current liabilities
= $41,500 / $28,000
= 1.48 : 1

(2). Liquid ratio:

Liquid assets/Current liabilities
= $31,000* / $28,000
= 1.1 : 1

(3). Absolute liquid ratio:

Absolute liquid assets/Current liabilities
= $23,000** / $28,000
= 0.82 : 1

Working Notes:
*Liquid assets: $5,000 + $18,000 + $8,000 = $31,000
**Absolute liquid assets: $5,000 + $18,000 = $23,000
 TURNOVER RATIOS OR ACTIVITY RATIOS

1. Inventory turnover ratio/:

stock turnover ratio= cost of goods sold
average inventory

2. Inventory turnover period/:

stock turnover period= days/months in a year

inventory turnover ratio

3. Debtor’s turnover ratio/:
receivable's turnover= net credit sales

average receivables

4. Creditor’s turnover ratio/:

accounts payable turnover= net credit purchases

average accounts payable

5. Conversion period/:
Conversion period= days/month in a year

any turnover ratio

6. Working Capital Turnover Ratio
= Sale/Cost of Sales

Net working capital

7.Fixed Asset turnover ratio

= sales (or) cost of goods sold

net fixed assets

 Practice Questions –
Activity (or Turnover) Ratios
From the following information, calculate inventory turnover ratio :
 PROFITABILITY RATIOS
1.Return on investment / overall profitability ratio / Return on
Capital Employed

operating profit / EBIT

R.O.I = ------------------------ * 100
capital employed

2.Gross profit ratio

Gross profit ratio = gross profit

*100
net sales
3. OPERATING RATIO
= cost of sales + operating expenses *100
 net sales

 4.Operating profit ratio

Operating profit ratio= operating profit

 * 100
 net sales
5. Expenses ratio 1.Administrative
expenses ratio:
Admistrative expenses
*100
net sales

2. Selling and distribution expenses ratio:

selling and distribution expenses
* 100
net sales

3. Financial expenses ratio:

financial expenses
* 100
net sales
6. Net profit ratio
net profit ratio = net profit after tax
* 100
net sales

7. Earnings per share (EPS)

E.P.S= net profit after tax and preference dividend

no. of equity shares

8.Price earnings ratio (P/E)

P.E.R= market price per equity share

earnings per equity share

9.

Pay out ratio = dividend per equity share

* 100
earnings per equity share

Retained earning ratio=

retained earning per equity share
* 100
earning per equity share
10. Dividend yield ratio

Dividend yield = dividend per share

* 100
market price per share
Practice Questions –
Profitability Ratios
Case Study
Case Study
Case Study
 Case Study

Calculate Return on capital employed by three tech companies—Alphabet

Inc., Apple Inc., and Microsoft Corporation—for the fiscal year ending in 2021.

(in $millions) Alphabet Apple Microsoft

EBIT $41,047 $65,339 $69,916
Total Assets (TA) $319,616 $323,888 $333,779
Current
$56,834 $105,392 $88,657
Liabilities (CL)
 (in $millions) Alphabet Apple Microsoft
EBIT $41,047 $65,339 $69,916
Total Assets (TA) $319,616 $323,888 $333,779
Current
$56,834 $105,392 $88,657
Liabilities (CL)
Capital
Employed (TA – $262,782 $218,496 $245,122
CL)
Return on
Capital 0.1562 0.2990 0.2852
Employed

Interpretation: Of the three companies, Apple Inc. has the highest return on
capital employed of 29.9%. A return on capital employed of 29.9% means that
for every dollar invested in capital employed for 12 months ended September
30, 2021, the company made almost 30 cents in profits. Investors are
interested in the ratio to see how efficiently a company uses its capital
employed as well as its long-term financing strategies.
 SOLVENCY RATIOS
1. Fixed assets ratio= Net fixed assets

long term funds

2. Debt equity ratio= total long term debt

(or)
shareholder’s fund

= external equities

internal equities

3. Proprietary ratio = shareholder’s fund

total Assets
4. Capital gearing ratio:
= Common Stockholders’ Equity
Fixed Interest bearing funds

5. Debt Asset Ratio / Debt Ratio =

Total debts

Total assets
6. Interest cover or fixed charges Cover

Interest or fixed charges cover

= profit before interest and tax
fixed or interest charges

7. Dividend Coverage Ratio

Dividend Coverage Ratio

= Net profit after tax
Cash Dividend
Practice Questions –
Solvency Ratios
Calculate Total assets to Debt Ratio.
Total assets to Debt Ratio = Total assets/Long-term debts.
= Rs. 14,00,000/Rs. 1,50,000
= 9.33 : 1

The higher ratio indicates that assets have been mainly financed by
owners funds and the long-term loans is adequately covered by assets. It
is better to take the net assets (capital employed) instead of total assets
for computing this ratio also. It is observed that in that case, the ratio is
the reciprocal of the debt to capital employed ratio.

Significance: This ratio primarily indicates the rate of external funds in

financing the assets and the extent of coverage of their debts are covered
by assets.
Miscellaneous Questions
General Reserve
Profit & Loss A/c
Creditors
Bills Payable
O/s Expenses
Provident Fund
24
7