Introduction Vertical_Theory

CHAPTER \\\\newserver\\E\\Techmax\\Mumbai BAF\\Zeba Khan\\Cost accounting -II(Zeba Khan)\\Chap-1.docx Vertical Form of Financial Statem1stePronofts University Prescribed Syllabus Unit 3 :Meaning of financial Statement Analysis, steps, Objective and types of Analysis. Unit 2 : a)Vertical Forms of Balance Sheet and Profit and Loss Account suitable for analysis 2.1 Financial Statements and its Components 2.1.1 Meaning of term Financial Statements  What do you mean by the term Financial Statements?  All entities (profit making or non-profit making) closes its books of account every end of the year and prepares a summarised statements.  This summarised statements prepared at the end of every year are called as Financial Statements.  There are various users of this financial statement which analyse and evaluate the productivity, efficiency and financial stability of concern. 2.1.2 Components of Financial Statements  State the Main components of Financial Statements. The following are the main Components of Financial Statements. 1. Profit and Loss Account/ Income and Expenditure Account  Generally manufacturing and profit making concern prepare profit and loss account.  It indicates profit or loss made by the concern during the given period generally a year.  In case of non-profit making concern prepare income and expenditure account.  It indicates the earning capacity of entity and its dividend policy. 2. Cashflow Statement  Cashflow statement helps to explain how the funds inflow and outflow from different types of business activities. Fig. 2.1.1 : Components of Financial Statements  The three different types of activities are classified in to (i) Operating , (ii) Investing, (iii) Financial.

S. Y. B.Com Sem. III 2 Vertical form of Financial Statements  It indicates profit or loss made by the concern during the given period generally a year.  In case of non-profit making concern prepare income and expenditure account. 3. Balance Sheet  Balance Sheet shows financial position of entity as on that date.  It helps the reader of financial statement to evaluate short term and long term financial position of entity.  It indicates solvency position of an entity. 4. Notes forming part of Balance sheet  All entities prepare books of accounts and financial statements on basis of certain accounting policies and principles.  This principles and policies varies from concern to concern.  The decision of reader of financial statements may change on basis of which this it has been prepared.  Hence it is necessary for every entity to state its method of accounting, principles and policies adopted while preparing financial statements.  It includes social responsibility statement issued by an entity. 5. Additional Reports  Auditors and Directors report effect the decision making of reader of financial statements. Syllabus : Meaning of Financial Statements Analysis 2.1.3 Meaning and Defination of Term Financial Statements Analysis  Define and explain the term Financial Statement Analysis.  The Financial Statement are not easily understandable to a layman.  These statements are arranged in order do helps to conclusion.  It does not help to ascertain the efficiency, forecast the future and inform short term or long term financial position of the entity.  Therefore further analysis is done by establishing relationship of one variable with another variable. Definitions According to Definitions According to Lev. “Financial Statement Analysis is an information processing system designed to provide data for decision making models, such as the portfolio selection model, bank lending decision models, and corporate financial management models.’’ W.B Meig, “Financial Statements thus are organised summaries of detailed information and are thus a form of analysis. The type of statements accountants prepare, the way they arrange items on these statements and their standards of disclosure are all influenced by a desire to provide information in a convenient form.” Metcalf and Titard “Analysis of financial Statements is a process of evaluating the relationship between component parts of a Financial Statement of obtain a better understanding of a firm’s position and performance.” General Defination is on key figures contained in the Financial Statements and the significant relationship that exists between them.

S. Y. B.Com Sem. III 3 Vertical form of Financial Statements Syllabus : Financial Analysis Objectives 2.2 Objectives of Financial Statement Analysis  State the different objectives of Financial Statement Analysis.  The objectives of financial statement analysis is to him to understand analyse interpret and to provide information of business enterprise for decision-making.  It should analyse interpret and use information help them to evaluate. o The economic situation of the firm and predicting its future course. o Financial efficiency of the enterprise as a whole or of sub -units .  There are different users of analyse financial Statements for different purpose. Sr. Users Objectives No. 1 Shareholders Profitability, efficiency, Long term Solvency, risk factor. 2. Long term Financers Profitability, Financial viability, Long term solvency, Risk factor 3. Short term Financers Liquidity, and Short term solvency, risk factor. 4. Prospective investors Future return on investment, Comparison with other companies of same industries, risk factor. 4. Government departments Collection of revenues, and efficiency, Statistical department for macro studies. 5. Chamber of commerce and Study Strategic plans and method of facing competitions. other Associations, Researchers 6. Competitors Strategic plans like takeover, Merger and De-merger decisions cost efficiency and comparison of financial positions, risk factor. 7. Customers Fair pricing, and avoidance unnecessary making extravagant profit. 8. Trade union Staff/Workers Demand fair wages other facilities etc. 9. Company Management Framing Dividend, Debt financing, Bonus shares, preference shares policies and its impact thereon on market price. 10. Auditors and Investigators Check on errors and frauds and leakages, efficiency, efficiency in policies, etc. Interpretation of Financial Statements  The analysis of financial statements understanding and drawing fruitful conclusions means Interpretation of Financial Statement.  It is only an analytical study of statements which can help draw dependable conclusions. Syllabus : Financial Analysis Steps 2.3 Steps for Financial Statement Analysis  State the general steps involved in Financial Statement Analysis. 1. Selection of the Industry

S. Y. B.Com Sem. III 4 Vertical form of Financial Statements  It expected for analyser first to decide the type of industries it requires to study for ex. Cement Industries, FMCG (fast Moving consumer group) companies, Steel Industries, Petroleum and gas, etc. 2. Collection of data  The decision is based on internal and external forces, hence it necessary to collect internal and external related information.  It includes collections at least of past five year’s annual reports.  Each company’s strategic plans and milestones. Fig. 2.3.1 : Steps for Financial Statement Analysis  Company’s charter document i.e. Memorandum and Articles of Association etc.  Generally it can be collected from registrar of companies or its respective website. 3. Critical examine financial statements  Examine financial statements, Accounting standards conventions and principles followed while preparing books of accounts and financial Statements.  Study contingent liabilities and other notes evaluate its future impact.  Evaluation of the statement of cash flows helps in understanding the impact of the firm’s liquidity position from its operations, investments and financial activities over the period.  Also judge the quality of financial statements to measure its reliability and assurance. 4. Calculation of various parameters and indicators  This step will divide the analyser take the road as per its objectives.  The most common analysis tools are key financial statement ratios. 5. Interpretations of analysis  This is most challenging step.  It requires to make suitable and logical assumptions.  This step requires a high degree of cautions and skill.  The professional advices and experiences also play important role. 6. Conclusion / Decisions making  The decision of analyser cannot be predefined as it is subjective matter.  It depends on decision maker whether he is risk taker or risk averse. Syllabus : Financial Analysis Types of Analysis 2.4 Types of Financial Statement Analysis  State different types of Financial Statement Analysis.  Analysis depends on the objectives of analyst as discussed in above paragraph.  Hence analysis done by analyser differs from depths and directions.  The analysis when done with one year to another in horizontal direction is called Horizontal analysis.

S. Y. B.Com Sem. III 5 Vertical form of Financial Statements  The analysis done for the same year from top down approach is called vertical analysis.  For both analysis we need the statement to be formatted in vertical form hence we will first learn vertical form of financial statement. Fig. 2.4.1 : Methods of Analysis of Financial Statements 1. Verticals Analysis :  The method of analysis in which the figure are analysed vertically of the given financial statement.  It is also called as Vertical form statement. 2. Horizontal Analysis  It is the method under which the figures of an item of financial statement of one year are compared with same item of another year.  Hence under this method we require at least two years financial statements. There are two methods of analysis under this which are as follows : a. Vertical form of Method of Analysis : It is one of the Method of horizontal Analysis under which the figures of an item of one year are either compared to other firm’s items or with same enterprise financial statement. b. Trend Analysis : Under this method the figures of an item of One year is compared with the same item of consecutive three or more year’s financial statements. This method cannot be used for inter- firm Comparison. 2.5 Terminologies 1. Intra-Firm Comparison  When a financial data of a firms division is compared with its own another division or department is called intra firm comparison.

S. Y. B.Com Sem. III 6 Vertical form of Financial Statements 2. Inter-Firm Comparison  When the financial data of a firm is compared with another firm in same line of business is called Inter firm comparison. 3. Gross profit/margin  It is profit before deduction of Operating expenses or Sales less cost of goods sold. Gross Profit = Net Sales – Cost of Goods Sold. Net Sales = Gross Sales Less Returns and taxes on sales. 4. Cost of Goods sold(COGS)  It indicated the cost of goods sold after adjustment of profit. COGS = Opening Stock + Purchases + Direct Expenses – Closing Stock. 5. Stock/ Inventory  It includes Raw material, Work in progress and finished goods. 6. Direct expenses  It includes all direct expenses incurred for purchase of material and factory expenses to manufacture goods. 7. Factory expenses  It includes all expenses incurred in factory the place where goods are manufactured, it also includes depreciation on machinery and factory assets. 8. Net Operating Profit  It is derived after deducting Operating expenses. Net Operating profit. = Gross Profit – Operating Expenses. 9. Operating Expenses The features of Operating expenses are Fig. 2.5.1 : Terminologies i ) Recurring in Nature. ii) This expenses are incurred to earn short term profit. iii) It is incurred to maintain day to day running of business. iv) All expenses incurred are directly related to business only. v) Segregated further functionally in to Administrative, Selling and Distribution and Financial expenses. a) Administrative Expenses It includes all expenses which are incurred in office conveyance, printing and stationery, depreciation on office assets. b) Selling and distribution Expenses It includes all expenses for sales and promotions advertisement, delivery expenses, showroom expenses, depreciation on showroom assets, delivery van expenses. c) Financial Expenses

S. Y. B.Com Sem. III 7 Vertical form of Financial Statements It includes all expenses incurred for procure or maintain financial transaction, bank interest, bill discounting charges, debenture interest etc. Operating expenses = (Administrative + Selling and distribution + Financial)expenses. 10. Net Profit Before Tax.  It is Profit after adjustment of non-operating income and expenses.  Non-Operating Expenses 11. The Non-Operating income/ Expenses includes i) Non-recurring in Nature. ii) This expenses are incurred to earn long term profit. iii) It is not related to maintain day to day running of business. ii) All expenses incurred are indirectly related to business only. iii) Segregated further functionally in to Administrative, Selling and Distribution and Financial expenses. All Non-Operating incomes are added and non-operating expenses and losses are adjusted with operating profit to derive Net Profit. Net Profit before Tax = Operating Profit + Non-Operating (Income –Exp. /Losses.) 12. Net Profit After Tax.  Net profit before Tax less Income tax we derive Net profit after tax. 13. Appropriation  It means part of profit after tax set aside either for long term specific reserves or declaration of divided.  The term appropriation includes transfer to general or Revenue reserve, reserve transferred for specific purpose.  For e.g. Machinery Sinking fund reserve, Debenture sinking funds reserve, Provision for proposed Dividend to preference shareholder and equity shareholders. 14. Sources of Funds  The entities or accounts from where the entity has collected funds for ong term and Short term period. 15. Application of Funds  The funds received by the entity are applied/invested in different areas is called Application of Funds. 16. Proprietor’s Funds/Owner Funds/Equity/ Net worth  In case of Companies it is Equity Shareholders fund + Preference Share capital.  It indicates the amount invested by the owner in company. 17. Equity Shareholder fund  It is narrower term as compared to equity it does not includes preference share capital. Equity Shareholders fund = Equity share capital + Reserves and surplus – Miscellaneous expenditure/Fictitious assets – Profit and loss Dr. balance.

S. Y. B.Com Sem. III 8 Vertical form of Financial Statements 18. Loans  The term Loans includes Loans term loans taken from financial intuitions or public to be repaid within a period more than three years.  Whereas Short term loans includes loan taken from financial institutions or public to be repaid within period of more than one year and less than three years. 19. Fixed Assets  It includes all assets intended to generate long term profit.  They are purchased with not an intention for immediate sale.  They are non-recurring and incidental to acquisitions of such fixed assets.  It includes tangible, intangible assets and capital work in progress. 20. Investments  This are purchased for strategic (long term) investments.  This are invested to earn long term profit.  It includes Equity Shares, Debentures, non quoted listed in stock exchanges, government securities, bonds etc. 21. Working Capital  That part of total fund which is invested in routine business. It amount invested in day to day running of business. Working Capital = Current Assets – Current Liabilities. 22. Current assets  It includes all assets which are held to earn profit for the period less than one year.  It assets are held for the period less than one year.  This assets are acquired as a part of day to day business.  Marketable securities Quoted and listed in stock exchange are part of Current Assets.  For e.g. Cash and Bank Balance, Sundry debtors, Bills of exchange, Stock, Prepaid Expenses etc. 23. Current Liabilities  The liabilities repayment period is less than one year held in ordinary course of business are called current liabilities.  For e.g. Bank overdraft, Cash credit, Sundry creditors, outstanding expenses payable. Syllabus Topic : Vertical Form of Profit and Loss Account 2.6 Vertical Form of Financial Statements 2.6.1 Vertical Form of Profit and Loss Account Under this method we prepare vertical format (one below other in analytical manner grouped nature wise transactions. Format of Vertical for of Profit and Loss Account (Summarised Form) Particulars Amount ` Amount ` A Net sales x B Cost of goods sold x C Gross profit/ marginC = [ A – B ] x D Less : Operating expenses x x E Add: operating income +x F Net operating profit before taxF = [ C – D + E ] (NOPBT) x