Analysis of Financial Statements

Financial Statements

• A FS is an organised collection of information.

✓A Balance sheet

✓A profit and loss account

✓A fund flow statement

✓A cash flow statement

Balance sheet and Banker

➢Analysis of financial statements is an important tool in the hands of a bank for taking a credit decision.

➢A bank will not approve credit unless the balance sheet and financial statement reveal that the company has:

✓A sound financial position(Solvency test)

✓Good liquidity(cash flows)

✓A good earning capacity(profitability)

BALANCE SHEET

BS is money value of company’s assets, liabilities and owners’ equity(net worth) on a particular day

Statement of

financial position

Profit and Loss account

Statement of the sum of expenses and income of a particular year

Performance of the firm over the year ending with the balance sheet

date

Assets➢Current assets-sale or conversion into cash within

a period of 12 months( Raw material, work in progress, finished goods)

➢Fixed assets-Movable,Immovable,Tangible (Land building, Machinery, Furniture)

➢Non current assets-investment or advances to subsidiary or sister companies, book debts more than 180 days, non consumable stores,spares,

➢ Intangible assets- patents, goodwill, trade mark, copyright

➢Liquid Assets –Current Assists (Stock Prepaid Exps) Preliminary Expenses Show Assets side (Non Current Assets)

➢All fictitious assets are intangibles, but all intangible assets are not fictitious.

❖Goodwill, patent, trademark, copy rights are intangibles but not fictitious.

❖Fictitious assets are preliminary expenses, discount on issue of debentures/shares, underwriting commission, miscellaneous expenditure etc.

Liabilities

• Current liabilities - Asserts which can converted in paid in 12 months in C.C. –Sunday Creditors , proposed dividend, outstanding Expenses, Bills payable

• Medium and long term liabilities- payable back in more than one year

• Capital and reserve-

• Net worth – Share capital, Reverse & Surplus ( total assets –Total liabilities)

• Total Liabilities =Term loan +Current liabilities

• Contingent Liability – Show in foot note.

➢Gross profit(operating profit)= profit before depreciation, tax and other appropriations

➢Net profit= profit after depreciation, tax and other appropriations

➢Return on equity= Net profit/Equity

It gives an indications of how much return the owners equity is getting

➢Net worth= paid up capital + general reserve+surplus-Intangible assets

➢Net working capital= Current assets –current liabilities

➢Working capital Gap=Current assets- current liabilities other than bank borrowings(short term)

• Cash Profit =Net profit + Depreciation(Net profit-50 lac and depreciation is 20lac)

• Cash profit = 50 lac+ 20 lac=70 lac

• Cash loss-Amount of depreciation is reduced from the amount of net loss(after depreciation)

Ratio Analysis

❖FS is adequate to know:

✓Is the sales showing an increasing trend?

✓Is the unit making profits?

✓Is the net worth stable? Is it increasing?

✓Has provision been made for bad & doubtful debts?

✓What are the auditor’s reports? Is the report qualified? Or is it clean?

Ratio Analysis

Ratios are the relationship between two or more variables.

These variables are taken from balance sheet or profit & loss account.

❖Types of ratios for bankers:

✓Liquidity ratio

✓Leverage ratio

✓Activity ratio

✓Profitability ratio

Profit

• 1.Liqudity Ratio

• Current Ratio = current assets/current liabilities-ideal current ratio=1.33

• Acid test ratio=(Current assets-inventory)/(Current liabilities-short term bank borrowings)

➢Liquid Ratio =Liquid assets/current liabilities:-Ideal liquid ratio=1:1

• Breakeven point – No profit no loss

➢Solvency Ratio – Debt/equity ratio = debt/equity

➢A debt equity ratio of 2:1 is considered desirable by the banks and Reserve Bank.

➢ Higher the ratio, more the pressure on the liquidity of the organizations, when repayment of liabilities falls due. Lower the debt equity of a firm compared to another firm, the better it is.

Turnovers ratio= cost of goods sold /average stock

➢Gross Profit ratio = GP/sales*100

➢Net Profit ratio = NP/sales*100

➢Debtor turnover ratio = credit sales/average debtor

➢Net Profit show – Liabilities side and net loss –asset side.

DSCR

➢Debt service coverage ratio(DSCR)=Net profit+depreciation+interest on term loan/interest on term loan+instalment

This ratio is used for judging repayment capacity and fixing the repayment schedule for term loans in banks.

❖Generally banks and FI consider a DSCR at 2 as comfirtable

• Q.- If a firms net profits are Rs. 3 lac and depreciation Rs. 2 lac, Interest payment Rs. 1 lac and the annual instalment Rs. 2 lac, the DSCR would be?

• Q.- If a firms net profits are Rs. 3 lac and depreciation Rs. 2 lac, Interest payment Rs. 1 lac and the annual statement Rs. 2 lac, the DSCR would be?

• Ans-Debt service coverage ratio(DSCR)=Net

profit+depreciation+interest on term loan/interest on term loan+instalment.

• DSCR=(3+2+1)/(1+2)=2

➢Debt equity ratio=Total outside liabilities /tangible net worth-2:1

➢Tangible net worth – capital+free reserve-intangible assets

➢Funded debt equity ratio= total term liabilities/net worth

➢Inventory turnover ratio=cost of goods sold/average inventory

➢Interest coverage ratio(ICR)=EBIT/Interest obligation

➢EBIT-earning before interest and tax

Q. An account showing outstanding amount of Rs. 42 lacs has been classified as D1 on 31-3-2014. The realizable value of security is Rs. 20 lacs. The account is covered under CGTMSE upto75% with max upto Rs. 37.50 lacs. What will be the provision as on 31-03-2016?

A. 6 lacs C. 11.5 lacs

B. 5.5 lacs D. 13.5 lacs

Q. An account become out of order on 22 January 2014. For a balance of Rs. 10 lac, What will be amount of provision as on 31 March 2015,If the value of security is Rs. 7 lac

A. Rs. 2 lac

B. Rs. 1.50 lac

C. Rs. 3.70 lac

D. None of the above

Out of order 22-01-2014 21-04-2014

Sub-stan. 22-04-2014 21-04-2015

D-1 22-04-2015 21-04-2016

D-2 22-04-2016 21-04-2018

D-3 22-04-2018

Q. Bank passed a cheque in the account of Mr. X by creating overdraft in the saving bank account, without consent of the customer, as the cheque was in favourof an insurance company and customer was an old customer. The customer sent a thanks letter to the bank for passing the cheque but refused to pay the overdraft when demanded by the bank, claiming that he did not make such request. An FDR is maturing in the name of the customer and bank wants to recover the amount from proceeds of FDR.

a. Bank can recover amount along with interestb. Bank can recover the principal and not interestc. Bank cannot recover the amountd. Bank cannot recover the amount from FDR but can recover the amount through court only

Answer-

Fund Flow Statement

Cash flow Statement