Analysis of Financial Statements or Computerised Accounts - I

Financial statement analysis is the systematic process of reviewing, comparing, and evaluating a company's financial statements to understand its financial health, profitability, solvency, and operational efficiency. While financial statements prepared under Schedule III of the Companies Act 2013 report absolute monetary numbers, analysis converts these static figures into relative, dynamic relationships that facilitate sound managerial and investment decision-making.

Limitations of Financial Statement Analysis: Financial analysis reflects historical records and fails to capture future inflationary shifts (price-level changes). It ignores qualitative factors such as managerial competence, employee loyalty, and industrial goodwill. Furthermore, varying accounting practices across companies (e.g., straight-line vs. written down value depreciation) restrict direct comparability unless normalized.

Comparative Financial Statements present financial data for two or more consecutive accounting periods side-by-side. By placing previous year figures alongside current year figures, the analyst computes the absolute change in monetary value and the corresponding percentage rate of increase or decrease.

A Common-Size Statement is a financial analysis tool in which every individual accounting item is expressed as a percentage of a common base item. By converting absolute monetary quantities into uniform percentages (setting the chosen base equal to 100%), common-size statements facilitate cross-firm comparisons regardless of business size differences.

Accounting ratios express the arithmetical relationship between two interrelated accounting variables. They are classified into four key categories: Liquidity, Solvency, Activity, and Profitability.

Liquidity ratios measure the enterprise's ability to settle its current obligations promptly as they fall due.

• 1. Current Ratio (Working Capital Ratio):
  Current Ratio = Current Assets / Current Liabilities
  • Ideal Standard: 2 : 1.
  • Current Assets include: Current Investments, Inventories (excluding Loose Tools & Stores/Spares), Trade Receivables (less Provision for Doubtful Debts), Cash & Cash Equivalents, Short-Term Loans & Advances, and Other Current Assets.
  • Current Liabilities include: Short-Term Borrowings, Trade Payables (Creditors + Bills Payable), Other Current Liabilities, and Short-Term Provisions.
• 2. Quick Ratio (Liquid Ratio or Acid-Test Ratio):
  Quick Ratio = Quick Assets / Current Liabilities
  • Ideal Standard: 1 : 1.
  • Quick Assets: Current Assets minus (Inventories + Prepaid Expenses + Advance Tax).

Solvency ratios determine whether a firm possesses adequate asset strength and equity cushion to satisfy long-term debts, debentures, and loan interest.

Activity ratios quantify the operational velocity with which a business deploys its assets and inventories to generate sales. Profitability ratios gauge the overall earning power and commercial success of corporate operations.

• 1. Inventory Turnover Ratio (ITR):
  ITR = Cost of Revenue from Operations (COGS) / Average Inventory
  • COGS = Opening Inventory + Net Purchases + Direct Expenses - Closing Inventory (or Net Revenue from Operations - Gross Profit).
  • Average Inventory = (Opening Inventory + Closing Inventory) / 2.
  • Average Age of Inventory: 365 Days / ITR.
• 2. Trade Receivables Turnover Ratio (TRTR):
  TRTR = Net Credit Revenue from Operations / Average Trade Receivables
  • Average Collection Period: 365 Days (or 12 Months) / TRTR.
• 3. Trade Payables Turnover Ratio (TPTR):
  TPTR = Net Credit Purchases / Average Trade Payables
  • Average Payment Period: 365 Days (or 12 Months) / TPTR.
• 4. Working Capital Turnover Ratio:
  WCTR = Revenue from Operations (or COGS) / Working Capital (where Working Capital = Current Assets - Current Liabilities).

A Computerised Accounting System (CAS) is an integrated accounting software framework where financial transactions are captured, processed, and summarized digitally according to Generally Accepted Accounting Principles (GAAP) to generate ledgers, trial balances, and financial statements automatically.

An electronic spreadsheet consists of a two-dimensional grid of rows (numbered 1, 2, 3...) and columns (labeled A, B, C...). The intersection forms a cell with an address (e.g., A1, C14). Key features utilized in accounting include:

• Cell Referencing: Relative referencing (e.g., =A1+B1, which shifts when copied) versus Absolute referencing (e.g., =$C$1*0.12, locked with dollar signs for fixed tax rates).
• Mathematical & Statistical Functions: =SUM(range) for ledger totals, =AVERAGE(range) for mean sales, =ROUND(val, 2) for currency precision.
• Logical & Conditional Functions: =IF(test, true_val, false_val) used in salary grade determinations and tax brackets.
• Payroll Applications: Computing Gross Pay = Basic Pay + DA + HRA; Deductions = PF + Professional Tax; Net Pay = Gross Pay - Deductions.