Financial Analysis

Financial analysis is the process of identifying the financial strengths and weaknesses of the
firm by property establishing relationships between the item of the balance sheet and the profit
and loss account. There are many users of a company’s financial statement like Trade
creditors, lender, Investor and management. They analyse the financial statement according to
their need.

The first task of the financial analyst is to select the relevant information to the decision under
consideration from the total information contained in financial statement. The second step is to
arrange the information in a way to highlight significant relationship. The final step is to
interpretation and drawing of inferences and conclusions.

In brief, financial analysis is the process of selection, relation and evaluation.

The financial statement provides a summarised view of financial position and operation of a
firm. Therefore, much can be learnt about a firm from a careful study of its financial
statements. The analysis of financial statements is an important aid to financial analysis. The
analysis of financial statements is a process of evaluating the relationship between component
pats of financial statements to obtain a better understanding of the firm’s position and
performance.

The traditional financial statements comprising the balance sheet and profit and loss account is
that they do not give all the information related to the financial operation of a firm.
Nevertheless, they provide some extremely useful information to the extent that the balance
sheet mirrors the financial position on a particulars date in terms of the structure of assets,
liabilities and owner’s equity, and so on profit and loss account show the result of operations
during a certain period of time in terms of the revenue obtained and the cost incurred during
the year.

Financial statements are the main and often the only source of information to the lenders and
the outside investors regarding a business’s financial performance and condition. In addition to
reading through the financial statements, they use certain ratios calculated from the figures in
the financial Statement to evaluate the profit performance and financial position of the
business. These key ratios are very important to managers as well, to say the least. The ratios
are part of the language of business. It would be embarrassing to a manager to display his or
her ignorance of any of these financial specifications for a business.
FINANCIAL STATEMENT ANALYSIS

Financial statement is an organised collection of data. Its purpose is to convey an

understanding of various financial aspects of business firm. It may show a position at a
moment as in the case of activities over a given period of time in the of an income statements.

Balance sheet:

The balance sheet summarizes assets & liabilities owned by a firm – value of assets and mix of
financing debt & equity to finance these assets up to a point of time. It some time, called
“Statement of financial position” or “A statement of financial position of an enterprise as on a
particular date.

In theory the balance sheet of a private limited company or a public limited company should be
able to tell us all about the company’s financial structure, and liquidity, the extent to which its
assets and liabilities are held in cash or in a near cash form (for example, bank accounts and
deposits).

It should also tell us about the assets held by the company, the proportion of current assets and
the extent to which they may be used to meet current obligations. An element of caution should
be noted in analyzing balance sheet information. The balance sheet is an historical document.
It may have looked entirely different six months or a year ago, or even one week ago. There is
not always consistency between the information included in one company’s balance sheet with
that.

Balance Sheet Terminology

Fixed Assets – Assets held for more than one year. Typically Include:
Machinery and equipment
Buildings
Land
Other Assets – Assets that are not current assets or fixed assets
Patents
Copyrights
Goodwill
Current assets typically include:
Cash
Accounts Receivable
(Payments due from customers who buy on credit)
Inventory
(Raw materials, work in process, and finished goods held for eventual sale)
Other expenses
(Prepaid expenses are those items paid for in advance)
Debt (Liabilities)

Money that has been borrowed and must be repaid at some predetermined date
Debt Capital
Financing provided by a creditor
Current or short-term debt and long-term debt
Current or short-term must be repaid within the next 12 months
Current Liabilities:
Accounts payable
Credit extended by suppliers to a firm when it purchases inventories
Accrued expenses
Short term liabilities incurred in the firm’s operations but not yet paid for
Short-term notes
Borrowings from a bank or lending institution due and payable within 12 months
Long-Term Debt
Loans from banks or other institutions for longer than 12 months
Equity
Includes the shareholder’s investment
Preferred stock
Common stock
Treasury Stock
stock that was once outstanding and has been re-purchased by the company
Retained Earnings
cumulative total of all the net income over the life of the firm, less common stock dividends
that have been paid out over the years
INCOME STATEMENT
Income Statement provides information regarding revenues and expenses of the firm and
resulting profit or loss during a particular period. This statement is extremely useful to the end
uses of business operations. While the balance represents the financial status of an enterprises
at a particular point of time, the income statement summaries the results of operations for the
given accounting period.
Income Statement Terminology
Revenue (Sales)
Money derived from selling the company’s product or service
Cost of Goods Sold (COGS)
The cost of producing or acquiring the goods or services to be sold
Operating Expenses
Expenses related to marketing and distributing the product or service and administering the
business
Financing Costs

The interest paid to creditors and the dividends paid to preferred stockholders
Tax Expenses
Amount of taxes owed, based upon taxable income
STATEMENT OF CASH FLOW

The statement of cash flows may be the most intuitive of all statements. We have already
shown that, in basic terms, a company raises capital in order to buy assets that generate a
profit. The statement of cash flows "follows the cash" according to these three core activities:

(1) Cash is raised from the capital suppliers - cash flow from financing,

(2) Cash is used to buy assets - cash flow from investing and

(3) Cash is used to create a profit - cash flow from operations.

Statement of Cash flow Projections for the New Project

(a comprehensive view)
Years
Total funds
Equity
Fixed assets
Working capital margin
Revenue
Operating costs
Depreciation

Interest on long term funds

Interest on short term borrowings

Profit before tax

Tax

Profit after tax and interest

Net Net Net salvage value of fixed

assets

Net recovery of working capital margin

Repayment of term-loans
Retirement of trade

creditors
Repayment of short- term borrowings
(i) Initial investment
- equity point of view
- long term funds
- total funds

(ii) Operating cash inflows - equity

vies

- long terms funds

- total funds
(iii) Terminal cash flows
- equity view
- long term funds
- total funds
Net cash flows from
-equity view

- the long term funds - the total funds view