Explain various techniques used in financial statement analysis.

Financial statement analysis is interpreted mainly to determine the financial operational performances of the business concern. Following are the common techniques that are widely used −

Comparative statement analysis − These statements help to understand the comparative position of financial and operational period at different period of time. It is again classified into 2 types −

• Comparative balance sheet analysis − As the name suggests, it only concentrates on balance sheet at different period of time. This type of analysis helps to understand the real financial position over the years and how well the organisation utilises its assets, liabilities and capitals during a particular period.

• Comparative profit and loss account analysis − Under this, only profit and loss accounts are compared with previous years or compared within the statement. This analysis helps to understand the operational performances of the business concern in a given period. It can be analysed in both vertical and horizontal basis.

Trend analysis − It helps to understand the trends of various items, which appear in the financial statements. It can be analysed by computing trends of series of information.

Common size analysis − In this balance sheet, the total assets figures is assumed to be 100 and all figures are expressed as a percentage of this total.

Fund flow statement −These kind of statements tell about financial position between beginning and ending of financial statement dates. It is also called as statement of source and use of funds. The main use of these statements are to indicate the requirement of funds and how they are proposed to be raised and the utilisation and application of the same.

Cash flow statement − These statements will show inflow and outflow of cash in a particular period of time by providing a summary of operating, investment and financing cash flows and reconciles them with a change in its cash and its equivalents. Institute of chartered accountants of India issued the AS-3 (Accounting standards) to prepare cash flow statements in 1988.

Ratio analysis − Ratio analysis shows relationship between two numbers. Ratio analysis can be classified as following

• Liquidity Ratio − It explains the relationship between current assets to current liability. It is also called short-term ratio. Following are major liquidity ratios −

Formulas −

Current Ratio = current assets/current liability.

Quick Ratio = quick asset/quick (or) current liability.

• Activity Ratio − It measures the efficiency of current assets and liabilities during a particular period. Following are some of Activity Ratios −

Formulas −

Stock turnover Ratio = cost of sales / average inventory

Debtors turnover ratio = credit sales/average debtors

Creditors turnover ratio = credit purchase/average credit

Working capital turnover ratio = sales/net working capital

• Solvency Ratio − This Ratio helps to understand, how long term funds are used in an organisation. It is also called leverage ratios.

Formulas −

Debt-Equity Ratio − external equity/internal equity

Proprietary ratio − shareholders fund/total assets

Interest coverage Ratio − Earnings before interest and Taxes (EBIT)/fixed interest charges

• Profitability Ratio − As name suggest it tells about profitability position of an organisation.

Gross profit Ratio − (Gross profit/net sales)*100

Net profit Ratio = (Net profit after tax/net sales)*100

Operating profit Ratio = (operating net profit/sales)*100

Return in investment = (Net profit after tax/shareholder fund)*100