The various tools used for financial analysis are:
- Fund flow Statement
- Ratio Analysis
- Common Size Statements
- Comparative Financial Statements
- Trend Analysis
- Cash Budget
- Working Capital
- Leverages
Fund Flow Statement
Fund flow statement also referred to as statement of “source and application of funds” provides insight into the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. The information required for the preparation of funds flow statement is drawn from the basic financial statements such as the Balance Sheet and Profit and loss account. “Funds Flow Statement” can be prepared on total resource basis, working capital basis and cash basis. The most commonly accepted form of fund flow is the one prepared on working capital basis.
Ratio Analysis
Ratio analysis is the method or process by which the relationship of items or groups of items in the financial statements are computed, determined and presented. Ratio analysis is an attempt to derive quantitative measures or guides concerning the financial health and profitability of the business enterprise. Ratio analysis can be used both in trend and static analysis. There are several ratios at the disposal of the analyst but the group of ratios he would prefer depends on the purpose and the objectives of the analysis.
Accounting ratios are effective tools of analysis. They are indicators of managerial and overall operational efficiency. Ratios, when properly used are capable of providing useful information. Ratio analysis is defined as the systematic use of ratios to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined the term ratio refers to the numerical or quantitative relationship between items/ variables. This relationship can be expressed as:
1. Fraction
2. Percentages
3. Proportion of numbers
These alternative methods of expressing items which are related to each other are, for purposes of financial analysis, referred to as ratio analysis. It should be noted that computing the ratio does not add any information in the figures of profit or sales. What the ratios do is that they reveal the relationship in a more meaningful way so as to enable us to draw conclusions from them.
Common Size Statements
It facilitates the comparison of two or more business entities with a common base. In case of balance sheet, Total assets or liabilities or capital can be taken as a common base. These statements are called “Common Measurement” or “Component Percentage” or “100 percent” statements. Since each statement is reduced to the total of 100 and each individual component of the statement is represented as a % of the total of 100 which invariably serves as the base.
Thus the statement prepared to bring out the ratio of each asset of liability to the total of the balance sheet and the ratio of each item of expense or revenues to net sales known as the Common Size statements.
Comparative Financial Statements
Comparative financial statements is statement of the financial position of a business so designed as to facilitate comparison of different accounting variables for drawing useful inferences. Financial statements of two or more business enterprises may be compared over period of years. This is known as “inter-firm comparison” Financial statements of particular business enterprise maybe compared over two periods of years. This is known as “inter-period comparison”.
Trend Analysis
Trend analysis is employed when it is required to analyze the trend of data shown in a series of financial statements of several successive years. The trend obtained by such an analysis is expressed as percentages. Trend percentage analysis moves in one direction either upwards or downwards, progression or regression. This method involves the calculation of percentages relationship that each statement bears to the same item in the base year. The base year maybe any one of the periods involved in the analysis but the earliest period id mostly taken as the base year. The trend percentage statement is an “analytical device for condensing the absolutely rupee data” by comparative statements.
Cash Budget
Cash budget is a forecast or expected cash receipts and payments for a future period. It consists of estimates of cash receipts, estimate of cash disbursements and cash balance over various time intervals. Seasonal factors must be taken into account while preparing cash budget. It is generally prepared for 1 year and then divided into monthly cash budgets.
Working Capital
Working capital is the amount of funds held in the business or incurring day to day expenses. It is also termed as short term funds held in the business. It is ascertained by finding out the differences between total current assets and total current liabilities. Working capital is a must for every organization. It is like a life blood in the body. It must be of sufficient amount and should be kept circulated in the different forms of current assets and current liabilities. The success of organization depends upon how successfully the circulation of short term fund is maintained smoothly and speedily. Working capital is also compared with the water flowing in the river as the water is always flowing it is pure water similarly working capital should be kept circulated in different short term assets.
Leverages
The employment of an asset or source of funds for which the first firm has to pay a fixed cost or fixed return may be termed as leverage.
Operating leverages: is determined by the relationship between firms, sales revenue and its earnings before interest and taxes (EBIT) which are generally called as Operating profits. Operating leverage results from the existence of fixed operating expenses in the firm’s income stream. the operating leverage may be defined as the firm’s ability to use fixed operating cost to magnify the affects of charges In sales on its earnings before interest and taxes.
Financial leverages: it relates to the financing activities of a firm. Financial leverage results from the presence of fixed financial charges in the firm’s income stream. Financial leverages concerned with the effects or changes in the EBIT in the earnings available to equity shareholders. It is defined as the ability of a firm to use fixed financial charges to magnify the effects or changes in EBIT on the earnings per share.
