UNIT 5

SYLLABUS
Unit I Contact Hours:10
Financial Accounting: Introduction, Importance, Scope, and Limitations, Users of Accounting
Information, Branches of Accounting, Basic Terms, Generally Accepted Accounting Principles,
Accounting Equation. Introduction to International Financial Reporting Standards (IFRS).
Understanding Accounting Standards issued by the ICAI related to Disclosure of Accounting
Policies, Depreciation Accounting, and Revenue Recognition. Accounting Process, Nature of
Accounts and Rules of Debit and Credit, Recording Transactions in General Journal.
Unit II Contact Hours:12
Preparation of Ledger Accounts. An overview of Subsidiary books: Purchase Book, Purchase
Returns Book, Sales Book and Sales Returns Book. Recording Transactions in two column and
three column Cash Book. Preparation of Trial Balance, Bank Reconciliation Statement. Opening and
Closing Entries.
Unit III Contact Hours:12
Understanding Accounting Standards issued by the ICAI related to Disclosure of Accounting
Policies, Depreciation Accounting, and Revenue Recognition. Methods of charging Depreciation:
Straight-line Method, and Written-Down-Value Method. Change in Method as per AS-6, Adjustment
Entries. Post- adjusted Trial Balance. Preparation of Financial Statements: Preparing Trading
Account, Profit & Loss Account and Balance Sheet for a Sole Proprietor.

Unit IV Contact Hours:14
Understanding Contents of Financial Statements of a Joint Stock Company as per
Companies Act 2013. Understanding the Contents of a Corporate Annual Report. Preparation
of Cash Flow Statement as per AS-3 (Revised).
Unit V Contact Hours:12
Analyzing Financial Statements: Objectives of Financial Statement Analysis, Sources of
Information, Standards of Comparison, Techniques of Financial Statement Analysis:
Horizontal Analysis, Vertical Analysis, and Ratio Analysis. Meaning and Usefulness of
Financial Ratios, Analysis of Financial Ratios from the perspective of different Stakeholders
like Investors, Lenders, and Short-term Creditors. Profitability Ratios, Solvency Ratios,
Liquidity Ratios and Turnover Ratios, Limitations of Ratio Analysis.

4
ANALYSIS OF FINANCIAL STATEMENTS:
 Analysis of financial statements refers to the treatment
of information contained in the financial statement in a
way so as to afford a full diagnosis of the profitability
and financial position of the firm concerned.
 The process of analyzing financial statements involves
the rearranging, comparing and measuring the
significance of financial and operating data.
 Interpretation, which follows analysis of financial
statements, is an attempt to reach to logical conclusion
regarding the position and progress of the business on
the basis of analysis.

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OBJECTIVES OF FINANCIAL
STATEMENT ANALYSIS:
 The analysis would enable the present and the
future earning capacity and the profitability of the
concern.
 The operational efficiency of the concern as a
whole as well as department wise can be
assessed. Hence the management can easily
locate the areas of efficiency and inefficiency.

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 The solvency of the firm, both short-term and
long-term, can be determined with the help of
financial statement analysis which is beneficial
to trade creditors and debenture holders.
 The comparative study in regard to one firm
with another firm or one department with
another department is possible by the analysis
of financial statements.

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SOURCES OF INFORMATION ON
FINANCIAL STATEMENT ANALYSIS:
The three main sources of information for financial
analysis which we can easily access via the
annual report of the Company are:
 Balance Sheet,
 Income Statement, And
 Cash Flow Statement.

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STANDARD FOR COMPARISON IN
ANALYSIS:
Standards for comparisons in analysis of Financial
Statements include
 Intracompany—prior performance and relations between
financial items for the company under analysis;
 Competitor—one or more direct competitors of the
company;
 Industry—industry statistics; and
 Guidelines (rules of thumb)—general standards developed
from past experiences and personal judgments.

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TECHNIQUES OF FINANCIAL
STATEMENT ANALYSIS:
The most common techniques of financial statement
analysis are:
 Horizontal Analysis— comparing a company's
financial condition and performance across time;
 Vertical Analysis—comparing a company's financial
condition and performance to a base amount such as
revenues or total assets; and
 Ratio Analysis—using and quantifying key relations
among financial statement items.

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Horizontal Analysis:
 A horizontal analysis is a two-year comparison of
analysis of the financial statements and its
elements.
 It is also referred to as trend analysis, usually
expressed in monetary terms and percentages.
 This comparison provides analysts with insight into
the aspects that could contribute significantly to the
financial position or profitability of the organization.

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Vertical Analysis:
 Vertical analysis is a financial statement analysis
technique in which every line items of the financial
statements are listed as percentages, based on a
figure within the financial statement.
 The line items on the income statement could be
stated as percentages of the gross sales, while the
line items on the balance sheet could be stated as
percentages of the total assets or liabilities.
 And in case of cash flow, every inflow or outflow of
cash could be stated as a percentage of total cash
inflows.

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Ratio Analysis:
 A ratio between two quantities is used for
representing the relationships between different
figures on the profit and loss account, balance
sheet, cash flow statement or such other
accounting records.
 It is a form of Financial Statement Analysis, used
for obtaining a quick indication of the
organization’s financial performance in various key
areas.

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Users of Financial Ratios:
 Bankers and Lenders: Use profitability, liquidity and
investment because they want to know the ability of
the borrowing business in regular scheduled interest
payments and repayments of principal loan amount.
 Investors: Use profitability and investment because
they are more interested in profitability performance
of business and safety & security of their investment
and growth potential of their investment.

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 Government: Use profitability because
government may use profit as a basis for taxation,
grants and subsidies.
 Employees: Use profitability, liquidity and activity
because employees will be concerned with job
security, bonus and continuance of business and
wage bargaining.

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 Customers: Use liquidity because customers will seek
reassurance that the business can survive in the short
term and continue to supply.
 Suppliers: Use liquidity because suppliers are more
interested in knowing the ability of the business to
settle its short-term obligations as and when they are
due.
 Management: Use all ratios because management is
interested in all aspects i.e., both financial
performance and financial condition of the business.

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The importance and advantages of financial ratios are
given below:
 Ratios help in analyzing the performance trends over a long
period of time.
 They also help a business to compare the financial results to
those of competitors.
 Ratios assist the management in decision making. They also
point out problem and weak areas along with the strength areas.
 Ratios to help to develop relationships between different financial
statement items.
 Ratios have the advantage of controlling for differences in size.
For example, two businesses may be quite different in size but
can be compared in terms of profitability, liquidity, etc., by the
use of ratios.

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Profitability Ratios:
 Profitability ratios are financial metrics used by analysts
and investors to measure and evaluate the ability of a
company to generate income (profit) relative to revenue,
balance sheet assets, operating costs, and shareholders’
equity during a specific period of time.
 They show how well a company utilizes its assets to
produce profit and value to shareholders.
 A higher ratio or value is commonly sought-after by most
companies, as this usually means the business is
performing well by generating revenues, profits, and
cash flow.

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 Operating Profit = Net profit – Non operating Income
+ Non operating expenses
 Capital Employed = Shareholder’s fund
+ Non current Liabilities
OR
= Total Assets – Current liabilities

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 Working Capital = Current Assets – Current liabilities
 Total Assets = Non Current Assets + Current Assets
 Cost of Goods Sold= Opening Stock + Purchases
+ Direct expenses- Closing Stock
OR
= Sales – Gross Profit

UNIT 5

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