ACCO~ .. -- - .

,
~rnment
___:·_--rs-o-:f:-:R~a-:;tlo:7A;;;na;i;1y1I• ...
UU I. (i) Jtatio ~alys~s aid th~ goverrunent . .
· . la s a significant ro e ID ascertaini11 81
Ratio analysis P y of a concern. The following & ; Jitlancial hea_lt~ of different induatriltl sesaing the
.al performance its (Uture pohc1es. ea and prepare
the ~anc• f tio analysis .
. the various users o ra
With all the utilities to various USers .
(I) Management f serves as a powerful tool for 8SCerta. .' ratio ~lysis
. ·: help.s a management to reap lllAo. position of a concern. . llling the financial
Ratio ·anal~•S · .....
. ·at uses from it. They are, 1118
ge• of Ratio Analyala
managen 1,d"' Ratio ana1ys1s. s1mp
. l1'fi1es the u ·d
. h lpsamanagementassessthefinanc·
Ratio analysis e . till 1, finBDcial statements. . n erat_anding ~f
(a) . . . fth firm and making necessary decisio
pos1t1othn o . fi:rmation available in the flnanc,·nal oatio bring out, the inter relationsb·1Pamong ·
hm em a
stateme~t. . •, ,
z, -"'" •
financial figures and bring to light th . vanous
· significance and it is a device to anal eu- ~ancial
(b) It facilitates in financ~~ {orecasti~g and ~anciaJ the financial he,lth of the enterpriS:.C and mterpret
pl~g. Ratios contribute significantly towards fti .
It helps in communicating the financial strength and planning and forecasting. · e ective
(c)• wea1cness of a firm in a more easy and understandable Ratios facilitate .inter firm and intra firm com-J)anSODs.
.
4.
form. Ratios serve as effective control tools.
It heJps in the eoo~tj,on,of a~vities ;whic}l is the
s.
(d) . Ratio·s cater to the particular information need of a
most important functtons of busmess ~anage~~nt. 6. particurar person. .

(e)
It facilitates in effective control of the business i,f . Limitations of Ratio Aanlysis
revealing the loop boles in it. •.· Ratio may not prove to be the ideal tool for interfirm . 1
t.
I ' l comparisons. When two firms adopt different
(f)
Ratio analysis also ·serves ~any other P~.s~~:t~ accounting policies..
the management by .becommg an essential part ,in
budgetary coritrol and standard •costing. · · · '··l ' 2. A study of ratios in isolating, without the
actual figures may lead to wrong conclusions: ·
(ii) I Investors/Shareholders 3. Ratios can be calculated based on tlie data. If the
- j 1j •! .. ; ..., • '·'.), . " ., ' . •1<-
original data 'is not reliabl~, then ratios will be
!. , Ratio analysis helps an investors
or a sbare~~ld~M,o
_I
misleading.
assess the financial position ~f,the concern in wlµch he is
4. Ratio analysis suffers from lack of consistency.
going to ihvest. It warns him in making up bis mind w~ether
the present financial position ofthe-concern w~ts him ~or 5. In the absence ofwell accepted standards, interpretation ·
.~er investment 9r ~qt. -~~.1c;:alculation of vanous ratios of ratios become subjective.
1

help him to do this. '_· .<!11 ,. ,""" 6: · Ratios fail to reflect the impact ofprice level changes,
and hence can be misleading.
(Iii) Creditors/~uppljers • t
. . ' 7. • Ratios are only tools of quantitative analysis and
Ratio analysis helps tb:e: creditors or suppliers who fail to take into account the qualitative aspects of a
, e~tend sbort-tenn,credit to the.- concern, to know whether business.
i .the financial position of the concern warrants their payment 8· Ratios are based oii past data and h~ce cannot be
1
1at a specified time or not.. · ' reliable guide to future performance. ·
- 9. · Ratios are volatile and can be influenced by a single
(iv) Emplc,yees
' transaction with extreme value.
a
.
· ' Ratio. analysis also helps the employees who are IO. Ratios are only indicators. They need proper analysis
· ·,interested in knowing the financial.position of the conpefll. by a capable management, they are only tbffinem~i
V~~us .profitability ratios facilitate them to knoW for the and not an end, in the interpretatio~ ,o , ~~•a
h • . ·, !lit,,,
~ease oftheir·wages and other benefits.
T.;' ·I Tl'\' . • '
statements. _____ SlA Pl
 ~.. ·. . - ... . "" 11U ANALYSIS
~ln~nclal Sta-itement Analyala . ents are very useful to
,...-- . . , Comparative financial statenl . drawn from
fjnaDCtal ~ents play a Vital role for ,anal . the financial analyst since they cootam fi~e 5ormation for
pnanci~ ~•tio~ of th~ conce~ The J?rilnary O Y7.mg single statement and also provide necessarY inJ; .od of
tlJe ial statemt:°ts lS dec1S1on-making. A eed_of the study of financial and operating r_esults over a ~ f 1he
1.ccounttng Pnnc1ples Board (APB) 0 f ACCording time They only point out the direction or the trendresults
tbe
to ial statemen are n
ts eeded ,or the following merica movement · · . . and v
. posmon
as regards financial ...-ttng
i--
'd 1· bl ti
To prov1 e re 1a e nanc1al mformar
• .,
economic resources· and obligations of
·.
~o: Pllrposes, of the business concern.
b
a_out
.
Compansons will
.
usmess compared truly reflect the constancy m
.
effect· only if1he data
. iv:e application of
date
firlll· generally accepted accounting principles from date to
T~ provide oth~ needed information about changes or period to period.
in such economtc resources and obligations. The analyst ahould also keep in.mind the price level
changes that have taken place between the~ of cliff~
To provide ~~able informa~on about changes in net transactions and that of preparation of financial statements.
resources ansmg out of busmess activities. Where there is a substantial price fl~on, 1he analyst
must exercise great caution while interpreting the values'.
To provide finan~ial information that assists in
estiJDating the eammg ~tentials of business. 2. Trend Analysis ·
'
. .
The financial statements for a series of years may be
To disclose, to the possible extent other information analyzed to determine the trend of the data contained~ ·
related -~ the ~cial statements which is relevant 'in. The trend percentages are also referred to _as • ~ rati~ ·
to the needs of the users of these statements. This method ofanalysis is adopted to determine the direction,
upward or downward. This involves the computation of the
In this connection American .Institute of Certified
percentage re~onship that each item in the statement bears
public Accountants states that, "F~ancial ~~ments are
_to the.corresponding item contained in tbat_of the~ year.
fo~ the purpose of presentmg a.penodical review
For this pun,ose, the earliest year involved m comparison or
of report on rogress by ~e manag~ment ·and deal with any intervening year may be considered as the base year.
the status of mvestments m the busmess and the results
The trend percen~ges emphasize changes .in the
acbievetl during the period under revie~. They r~flect a financial data from year to year -and facilitate honzontal
com~inatio':1 ~f rCC?rded facts, accounting principles ~d
comparison.and study of ~e data. These trend ratio~ can~
pmonil judgem~ts". ·
considered as index-.numbers showing relative changes m
Techniques of Fln~ncial Analysis the financial data ~ver a period of years.
3. - Common Size Analysis
The different methods and tools used analysis of
. The comparative financial statements and the
financial ~ents ar~, calculations of trend percentages, as tools of financial
1. Compa~tive Analysis analysis, have a common shortcomiJ:ig in that they do not
enable the analyst understand changes that have taken place
_-As.the very term signifies, comparative financial from year to year in relation to total assets, total liabilities,
statements'.are statements of the financial position of a capital or'total net sales. This defect }?ecomes more glaring
business so formttlated as to focus on the elements ~ontained , when the analysis is made through comparison of two or
therein and pr9vide the necessary time persp'ective to it. more business units or of one unit with that ofthe iJ).dustry as
Nonilally, ft is the balance sheet and profit and loss ~co~t a whole, since there_is no common base of comparison when
whi~h alone are prepared in a comparative fo~, sm~e lit d~g with absolute figures. But when tJ:ie balance sheet and
is these two statements which are considered as important income statement items are shown in analytical percentages,
financiaf statements. Moreover, it is through these two i.e., the percentages that each item bears to the total of
statements the financial positional and the operational results the appropriate item s11:ch as total assets, total liabilities,
·of any business can be determined. capital and net sales, the common base for comparison is
provided. ~e statements compiled in this form are termed
Comparative financial statements are designed to
as "common-size statements". The common size statements
di$c_lose the following, - are also known as "component percentage" or "l 00 percent
'I

(Q Absol~te data statement". Each statement is reduced to the total of 100

and each individual item contained there in is expressed as
(ii) Increase or decrease in absolute data a percentage to the total 100. Thus, each percentage in the
...)
(IU · t nns of statement shows the relationship ·of individual item to its
Increase or decrease in absolute data ID e _
representative total.
. percentage.
111!!.l.A . DI IAI •~MFR~ 4.Nn nac~TDIDI ITnDC! D\IT. I Tl'\
 . .' A\;\,U~•,.·~-~-~ • 1
•• '"' 'flo\~El\n~
1

common Size Balanc; Sh~li . . -~

The common~size balance sheet represents ·
Q15. What dQ you mean by common size statement
relation of each asset item to total assets and each liabj~
analysis? Write about common ~lze balance and cattital item to total liabilities and capital re8Pect•
sheet and.common size Income.statement. :I:' · • •• th 1·. 1Ve~
As these percentages mdicate e re ati?nship to ha] . ·
Answer: ,sheet totals, variations from year to year do not necess:;
· _indicate changes in money amounts. The ratios exprCSst(j
Common Size Statement Analysis in the common-size balance sheet would reflect a change.
The ~omparative financial statements and the the individual i~em, total or both. · 111 .
calculations of tr~nd percentages, ·as tools of financial . the
commo~-~ize balance sheet percentages facilitate
analysis, have a common shortcoming in that they 40 not a horizontal companson from year to year and a ·study Of
. enable the analyst understand changes that have taken place the trends of relationships. They do not throw light the
00
from year to year in relation to total assets, total liabilities, trends of the ~divi~ual ite~s from ye~ to year, As the
capital or total net sales. This defe<.!t becomes mor~ glaring . trends of relati~ns?ip are difficult ~or. mt~retation the
when the analysis is made through comparison of two or value of common.:.size balance sheet mdicating the trend or
more business Wlits or of one unit with that ofthe industry as relationship is very ~uch reduced._But the usefulness of~
a whole, since there is no common base of comparison when ·c ommon size balance sheet can be improved by establishing
dealing with absolute figures. But when the balance sheet ~d norms of percentages for each _item to the relative total. _
income sta~ment items are shown in analytical percentages, · Common Size Income Statement
i.e., the percentages that. each item bears to the total of Common-size income statement show the per-centage
the appropriate item .such as total assets, total liabilities, of net sales that has been, absorbed by each individual item.
capital and net sales, the common base for comparison is representing cost or expense,.in the income statement The
provided. The statements compiled .in.this form are termed ·comparison of the common-size income statement ratios is
as "common-siz.estatements". The common size statements · significant since they indicate whether a larger or smaller
are also known as "com~nent percentage" or" 1oo per cent · amounf of net sales figure was used in meeting a particular
statement". Each statement is reduced to the total of 100 cost or expenses. ._
·and each individual -i tem contained there in is expressed -as .. ..Q16._ What Is a common size balance sheet? How
a percentage to the !otal 100. Thus~ each percentage in the It Is prepared? State Its usefulness to the
statement shows the relatjonship of individual 'item to its . · management.
representative total. ·Answer:
Model Paper-III, Q4(a) IJuly.-10, Q4(,} .
Computation of Common 'Size Statem~nt Common Size Balance Sheet ·
. (i) The total ass~. total liabilities capital and total net • r,' For answer refer Unit-III, Page. No. 3.34, Q.No.15,
sales are taken as 100. · Topic: Common Size Balance Sheet. ·
(ii) .
The ratio that each i ~ bears to the total',is ascertained Significance of Common Size Balance Sheet
1
by dividing the i~dividual amounts by the total · When common size balance sheets ofdifferent period1
amount as contained in the statement. For instance if are compared, it helps to identify the changes and their
selling and d~bution e x ~ amount to f J,OO,o6o tre~ds in case of different items. .
out of a ~et sa_les off 30 lakbs for a company in 1999 2.- When common size balance sheets are prepared for
th th
en e ratio that this item bears to the total cart b; different firms in a specific industry then it helps
calculated as follows : evaluate the relative soundness of a firm and thetJ'
= Sellinganddistributionexpenses · · financial strategies over a period of time.
Net sales XlOO . Objec~~ves of Common Size Balance Sheets
_ ? 3,00,000
- f 3,op,ooo l00 = IO%.
l. To e~amine the fluctuations in each and every itelll
l(
of bal~ce sheet. ·
2
• This ratio of 10% denotes that th . · ·: 0 c~nduct ~end analysis for determining the c ~
11
distributionexpensesofthecompanyare 10'¾.efsthe tng and m different items of assets 3.1\d liabilities.
fi 1996 In . oo e net sales 3. Ti 1 , fiJ1ll5
l ~oor rth
~ other words, th~,apiount to Rs. 10 for every Rs boleva ~ate _the financial pos!tion of different . of
_ w~ : o!net sales. - -~·~. . . _ · · , e on_g mg. to the same industry on the basts
·Cl4- i.lSHER-S ~~-D(Dl$TRIBUTGRs~~~ '*Tn common size balance sheets.