Analysis of Financial Statements — Notes

Analysis of financial statements means studying the published statements critically: grouping related items, comparing them over time, with other firms or with a base, and interpreting the results to judge the profitability, solvency and efficiency of the business.

Kinds of analysis

• Horizontal (dynamic): the same item over two or more periods. Tool: comparative statements.
• Vertical (static): items of one period against a base of the same period. Tool: common-size statements.
• Intra-firm comparison: one firm against its own past. Inter-firm comparison: one firm against others in the industry.
• External analysis (by outsiders with published statements) and internal analysis (by management with full records).

Significance (users): management (planning, cost control, efficiency); investors (profitability, growth, safety); trade payables (payment within the credit period); lenders and debenture holders (interest and repayment over years); employees and unions (wages, bonus, job security); government and researchers (tax, regulation, industry studies).

Objectives

1. Assess profitability and earning capacity.
2. Assess short-term solvency (liquidity).
3. Assess long-term solvency.
4. Make intra-firm and inter-firm comparisons.
5. Find the reasons for changes in profit and financial position.
6. Help forecasting, budgeting and planning.

• Comparative statements: two or more years side by side with absolute and percentage changes.
• Common-size statements: every item as a percentage of a common base of the same period.
• Ratio analysis: relationships between related items (Chapter 10).
• Cash flow statement: inflows and outflows of cash from operating, investing and financing activities (Chapter 11).

• Historical: based on past figures; the future may be different.
• Price-level changes ignored: figures of different years are compared in rupees of different value.
• Qualitative aspects ignored: quality of management, industrial relations, reputation.
• Different accounting policies: methods of depreciation and inventory valuation differ between firms, which spoils inter-firm comparison.
• Window dressing: statements may present a better picture than the real one.
• Analyst’s bias and skill: analysis indicates symptoms; diagnosis needs judgement.

A single figure means little: relate it to others (worked example 1).

Columns: Particulars | previous year (₹) | current year (₹) | absolute change (₹) | percentage change (%).

Formulas

• Absolute change = current year − previous year.
• Percentage change = absolute change ÷ previous year × 100, rounded to two decimals.
• A fall is shown in brackets (or with a minus sign).

Order (2026–27 format): I. Revenue from operations; II. Other income; III. Total income; IV. Expenses (cost of materials consumed, purchases of stock-in-trade, change in inventories, employee benefits, finance costs, depreciation and amortisation, other expenses) and total expenses; V. Profit before tax; VI. Tax; VII. Profit after tax.

Work every total from rupees; the percentage change of a total is its own change ÷ its own previous figure. Exceptional and extraordinary items and discontinued operations are not in the 2026–27 syllabus.

Columns as for the statement of profit and loss, with the two balance sheet dates.

Steps: write both balance sheets in Schedule III order (heads and sub-heads); compute the absolute and percentage change of every sub-head and of the totals; check that total equity and liabilities and total assets change by the same amount.

Reading it: group the changes into sources (shareholders’ funds, borrowings, current liabilities) and uses (non-current and current assets). Long-term assets financed by long-term funds is a sound sign; a rise in current liabilities that outpaces current assets weakens liquidity.

Common-size statement of profit and loss: every item ÷ revenue from operations × 100. Revenue = 100.00; other income is also on this base, so total income may exceed 100.

Common-size balance sheet: every item ÷ balance sheet total × 100. Each part (equity and liabilities; assets) = 100.00.

Rounding rule (SOYL practice): round each percentage to two decimals (halves away from zero). If the rounded lines of a part come to 99.99 or 100.01, move the line with the largest rounding error by 0.01 and add a note, so every part of every column totals 100.00. Subtotals in a profit and loss statement are worked from rupees, not by adding rounded percentages.

Uses: shows the make-up of each statement; compares years by share; compares firms of different sizes (inter-firm).

• Compare the growth of each expense with the growth of revenue: costs growing faster squeeze profit.
• Track the share of each cost in revenue: a rising materials share means higher input costs or prices not raised.
• Watch finance costs and the share of borrowings: more debt, more risk.
• Check how fixed assets were financed: long-term funds are the sound source.
• Remember that a falling share does not mean a falling amount, and a large percentage change may be a small rupee change.
• Use both tools: comparative shows speed of change; common-size shows structure.