National Institute of Business Management

Chennai - 020
FIRST SEMESTER EMBA/ MBA
Subject: Financial Management
Attend any 4 questions. Each question carries 25 marks
(Each answer should be of minimum 2 pages / of 300 words)

1.

What are the significant factors of Financial Statements? Discuss the various tools of financial
Analysis.

Answer:- The significant factors of Financial Statements

This objective introduces the four financial statements of a corporation (in order of preparation Income
Statement, Retained Earnings Statement, Balance Sheet, and the Statement of Cash Flows) and explains how
they interrelate. Financial statements are reports prepared by accountants that summarize the financial affairs
of a business.
Balance Sheet

Net Income

Financial Statements

Net Loss

Income Statement

Retained Earnings Statement

Matching Concept Principle

Statement of Cash Flows

This objective introduces the four financial statements of a corporation (in order of preparation Income
Statement, Retained Earnings Statement, Balance Sheet, and the Statement of Cash Flows) and explains how
they interrelate. Financial statements are reports prepared by accountants that summarize the financial affairs
of a business.
This objective also introduces the concept of matching, which is one of the most important concepts in
accounting. The matching concept principle states that the revenue for one time period is matched up or
compared with the related expenses for the same time period. If revenues and expenses are not properly
matched, then the amount reported for net income is incorrect, making every statement thereafter incorrect.

All statements have a three line heading. The first line of the heading is always the company name. The second
line of the heading is always the name of the statement being prepared. The third line is the date portion of the
heading and varies among the financial statements. The Income Statement and the Retained Earnings Statement
summarize transactions for a period of time, while the Balance Sheet shows a snapshot of the business as of a
particular date.
The income statement lists revenues earned and expenses incurred for a specific period of time resulting in net
income or net loss. The excess of the revenue over the expenses is called net income or net profit. If the
expenses exceed the revenue, the excess is a net loss. A sample income statement for XYZ Corporation would
look like the following:
XYZ Corporation
Income Statement
For the Month Ended November 30, 20xx
Revenue:
Fees Earned

$ x,xxx.xx

Expenses:
Wages Expense
Rent Expense

$ xxx.xx
xxx.xx

Supplies Expense

xxx.xx

Utilities Expense

xxx.xx

Miscellaneous Expense
Total expenses
Net income (loss)

xx.xx
x,xxx.xx
$ x,xxx.xx

The net income (loss) from the Income Statement and any dividends paid to the owners of the business is used
in calculating the ending retained earnings balance on the Retained Earnings Statement. A sample Retained
Earnings Statement for XYZ Corporation would look like the following:
XYZ Corporation
Retained Earnings Statement
For the Month Ended November 30, 20xx
Retained earnings, November 1, 20xx
Net income for November

$
$ x,xxx.xx

.xx

Less dividends

xxx.xx

xxxx.xx

Retained earnings, November 30,20xx

$ xxxx.xx

The Balance Sheet lists the ending balances for assets, liabilities, and owners equity, which is made up of the
capital stock (owners investments) plus the ending retained earnings balance from the Retained Earnings
Statement. As a result, the balance sheet balances. A sample Balance Sheet for XYZ Corporation would look
like the following:
XYZ Corporation
Balance Sheet
November 30, 20xx
Assets

Liabilities

Cash

$ x,xxx.xx

Supplies
Land

Accounts Payable

x,xxx.xx

$ x,xxx.xx

Stockholders Equity

x,xxx.xx

Capital Stock

$ x,xxx.xx

Retained Earnings x,xxx.xx

Total Stockholders
Equity

x,xxx.xx
Total Liabilities and

Total Assets

$ x,xxx.xx

Stockholders Equity

$ x,xxx.xx

The various tools of financial Analysis are follow as;

Financial statement analysis is an exceptionally powerful tool for a variety of users of financial statements, each
having different objectives in learning about the financial circumstances of the entity.

There are a number of various tools of financial statement analysis. They are:

Creditors. Anyone who has lent funds to a company is interested in its ability to pay back the debt, and
so will focus on various cash flow measures.

Investors. Both current and prospective investors examine financial statements to learn about a
company's ability to continue issuing dividends, or to generate cash flow, or to continue growing at its
historical rate (depending upon their investment philisophies).

Management. The company controller prepares an ongoing analysis of the company's financial results,
particularly in relation to a number of operational metrics that are not seen by outside entities (such as
the cost per delivery, cost per distribution channel, profit by product, and so forth).

Regulatory authorities. If a company is publicly held, its financial statements are examined by the
Securities and Exchange Commission (if the company files in the United States) to see if its statements
conform to the various accounting standards and the rules of the SEC.

Methods of Financial Statement Analysis

There are two key methods for analyzing financial statements. The first method is the use of horizontal and
vertical analysis. Horizontal analysis is the comparison of financial information over a series of reporting
periods, while vertical analysis is the proportional analysis of a financial statement, where each line item on a
financial statement is listed as a percentage of another item. Typically, this means that every line item on an
income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a
percentage of total assets. Thus, horizontal analysis is the review of the results of multiple time periods, whiile
vertical analysis is the review of the proportion of accounts to each other within a single period. The following
links will direct you to more information about horizontal and vertical analyis:

Horizontal analysis

Vertical analysis

The second method for analyzing financial statements is the use of many kinds of ratios. You use ratios to
calculate the relative size of one number in relation to another. After you calculate a ratio, you can then compare
it to the same ratio calculated for a prior period, or that is based on an industry average, to see if the company is

performing in accordance with expectations. In a typical financial statement analysis, most ratios will be within
expectations, while a small number will flag potential problems that will attract the attention of the reviewer.

There are several general categories of ratios, each designed to examine a different aspect of a company's
performance. The general groups of ratios are:

1. Liquidity ratios. This is the most fundamentally important set of ratios, because they measure the ability of
a company to remain in business. Click the following links for a thorough review of each ratio.

Cash coverage ratio. Shows the amount of cash available to pay interest.

Current ratio. Measures the amount of liquidity available to pay for current liabilities.

Quick ratio. The same as the current ratio, but does not include inventory.

Liquidity index. Measures the amount of time required to convert assets into cash.

2. Activity ratios. These ratios are a strong indicator of the quality of management, since they reveal how well
management is utilizing company resources. Click the following links for a thorough review of each ratio.
Accounts payable turnover ratio. Measures the speed with which a company pays its suppliers.
Accounts receivable turnover ratio. Measures a company's ability to collect accounts receivable.
Fixed asset turnover ratio. Measures a company's ability to generate sales from a certain base of fixed
assets.
Inventory turnover ratio. Measures the amount of inventory needed to support a given level of sales.
Sales to working capital ratio. Shows the amount of working capital required to support a given amount
of sales.
Working capital turnover ratio. Measures a company's ability to generate sales from a certain base of
working capital.

3. Leverage ratios. These ratios reveal the extent to which a company is relying upon debt to fund its
operations, and its ability to pay back the debt. Click the following links for a thorough review of each ratio.
Debt to equity ratio. Shows the extent to which management is willing to fund operations with debt,
rather than equity.
Debt service coverage ratio. Reveals the ability of a company to pay its debt obligations.
Fixed charge coverage. Shows the ability of a company to pay for its fixed costs.

4. Profitability ratios. These ratios measure how well a company performs in generating a profit. Click the
following links for a thorough review of each ratio.
Breakeven point. Reveals the sales level at which a company breaks even.
Contribution margin ratio. Shows the profits left after variable costs are subtracted from sales.
Gross profit ratio. Shows revenues minus the cost of goods sold, as a proportion of sales.
Margin of safety. Calculates the amount by which sales must drop before a company reaches its
breakeven point.
Net profit ratio. Calculates the amount of profit after taxes and all expenses have been deducted from net
sales.
Return on equity. Shows company profit as a percentage of equity.
Return on net assets. Shows company profits as a percentage of fixed assets and working capital.
Return on operating assets. Shows company profit as percentage of assets utilized

2.

What is a Fund Flow Statement? Discuss the uses and preparation of Fund Flow Statements.

Answer:Fund Flow Statement

It is a statement summarizing the significant financial changes in items of financial position which have
occurred between the two different balance sheet dates. This statement is prepared on the basis of "Working
Capital" concept of funds. Fund flow Statement helps to measure the different sources of funds and application
of funds from transactions involved during the course of business.
The fund flow statement also termed as Statement of Sources and Application of Fund, Where Got and Where
Gone Out Statement, Inflow of Fund or Outflow of Fund Statement
Importance or Uses of Fund Flow Statement
Fund Flow Statements are prepared for financial analysis in order to meet the needs of people serving the
following purposes:
(1) It highlights the different sources and applications or uses of funds between the two accounting period.
(2) It brings into light about financial strength and weakness of a concern.
(3) It acts as a effective tool to measure the causes of changes in working capital.
(4) It helps the management to take corrective actions while deviations between two balance sheet figure.
(5) It is an instrument used by the investors for effective decisions at the time of their investment proposals.
(6) It also presents detailed information about profitability, operational efficiency and financial affairs of a
concern.
(7) It serves as a guide to the management to formulate its dividend policy, retention policy and investment
policy etc.
(8) It helps to evaluate the financial consequences of business transactions involved in operational finance and
investment.
(9) It gives the detailed explanation about movement of funds from different sources or uses of funds during a
particular accounting period.

Preparation of Fund Flow Statements

The three statements prepared while making a fund flow analysis are:
A) Statement of changes in Working Capital.
B) Calculation of Funds from Operations
C) Calculation of the Sources and Applications of funds.

A) Statement of changes in Working Capital.

This statement is to explain the net change in Working Capital, as arrived in the Funds Flow Statement. All
Current Assets and Current Liabilities are individually listed. Against each account, the figure pertaining to that
account at the beginning and at the end of the accounting period is shown. The net change in its position is also
shown. The changes taking place with respect to each account should add up to equal the net change in working
capital.
Note1: Increase in current assets and decrease in current liabilities The acquisition of current assets and
repayment of current liabilities will result in funds outflow. The funds may be applied to finance an increase in
stock, debtors etc. or to reduce the amount owed to trade creditors, bank overdraft, bills payable.
Note2: Decrease in Current Assets and Increase in Current Liabilities: The reduction in current assets e.g. stocks
or debtors balanced will result in release of funds to be applied elsewhere.

B) Calculation of Funds from Operations

During the course of trading activity, a company generates revenue mainly in the form of sale proceeds and
pays for costs. The difference between these two items will be the amount of funds generated by the trading
operations.
C) Calculation of the Sources and Applications of funds.
1) Sources:
It includes:

Funds raised from Shares, Debentures and Long-term Loans:

The Long-term funds are injected into the business during the year by issue of any shares and debentures and by
raising long-term loans. In any premium is collected that is also form part of funds raised from the above said
sources of finance.
Sale off fixed assets and Long-term investments:
Any amount generated from sale of fixed assets or long-term investments is a source of funds. While
preparation of funds flow statement the gross sale proceeds from sale is taken as source of funds.
2) Application:
The use of funds in an organization takes place in the following forms:
Repayment of Preference Capital or Debentures or Long-term Debit:
This represents the application of organisations funds released from business through redemption of preference
shares or debentures, repayment of long-term loans previously made by the organization. Any reduction in
equity capital is also taken as application of funds.
Purchase of fixed assets or long-term investments:
The funds used to purchase long-term assets are usually the most significant application of funds during the
year. This group includes capital expenditure on land, buildings, plant and machinery, furniture and fittings,
vehicles and long-term investments outside the business.
Distribution of dividends and payment of taxes:
The dividends to the shareholders and tax paid during the year is the application of funds for the firm.
Loss from operations:
Losses made in the trading activities use up the funds. If costs exceed revenue, a cash outflow will be
experienced.
Example:
Following are the summarized Balance Sheet of X Ltd. As on 31st December 2004 and 2005. You are
required to prepare funds flow statement for the year ended 31st December, 2005

Additional Information:
(i) Dividend of Rs. 11,500 was paid.
(ii) Depreciation written off on plant Rs. 7,000 and on buildings Rs. 5,000.
(iii) Provision for tax was made during the year Rs. 16,500.
Schedule of changes in working capital (Rs.)

Funds Flow Statement

Working Notes:
Share Capital A/c

General Reserve A/c

Provision for Taxation A/c

Bank Loan A/c

Land and Building A/c

3.

What is financial Forecasting? Explain.

Answer:- Financial Forecasting describes the process by which firms think about and prepare for the future.
The forecasting process provides the means for a firm to express its goals and priorities and to ensure that they
are internally consistent. It also assists the firm in identifying the asset requirements and needs for external
financing.

For example, the principal driver of the forecasting process is generally the sales forecast. Since most Balance
Sheet and Income Statement accounts are related to sales, the forecasting process can help the firm assess the
increase in Current and Fixed Assets which will be needed to support the forecasted sales level. Similarly, the
external financing which will be needed to pay for the forecasted increase in assets can be determined.
Financial Forecasting Methods
Financial forecasting methods are used to predict the success of a company in the coming year. This method of
forecasting is not only used for planning and budgeting, but may be a tool for outsiders to use when determining
whether to invest in a company. Financial forecasting can also be used when determining predictions for
currency markets of other countries. These methods can be used independently or together to give a more
accurate prediction.

The Bayesian Method

The Bayesian Method is one of the many methods of financial forecasting used in corporate America. However,
this method is far more dependent on belief than history, as other methods are based. It involves using a
complex formula based upon the outcome of historical events to create forecast of future events. The formula
also includes factors of probability in regards to stock indexes and interest rates decreasing or increasing. By
taking into account both interest rates and stock indexes, one can make better financial forecast than just basing
a theory off simplified guessing.

Reference Class Forecasting

Reference Class Forecasting is another method used in financial forecasting methods. This method involves
forecasting or predicting the outcome of a planned action based on similar scenarios in other times or places.
Reference class forecasting is used to counter predictions that are made based off simple human judgment.
Forecasting methods using judgement have been known to be inaccurate because most judgment underestimates
work and overestimates rewards of that work. Using similar scenarios that have already occurred provides a
more factual basis of forecasting.

Proforma Financial Statements

Proforma Financial Statements is a forecasting method that uses sales figures and costs from the previous two to
three years. This method of forecasting is typically used in situations such as mergers and acquisitions. It
provides a good basis of the financial statements of a company while eliminating certain costs that are not
reoccurring or not typical for the organization or company. The Proforma Financial Statements are also used in
cases where a new company is forming and statements are needed to request capital from investors.

Budget Expense Method

The budget expense method bases its amounts for sales and company costs on the expected growth in the future.
This method is not as dependable because it does require those within the company to make judgements without
the basis of history. Typically, when the Proforma Financial Statements method is used, the budget expense

method is used in conjunction with Proforma. These two forecasting methods were not created or meant to be
used independent of each other. Using both methods together is called the Combination Method.

Financial forecasting can be difficult for businesses when based upon judgements or subjective opinions.
However, using different forecasting methods with each other can yield results that are more substantial and
accurate. Financial forecasting can assist companies and investors when first starting out or attempting to
predict the success of fiscal performance in the coming year. In any case, financial forecasting aids those who
are making decisions of investment.

4.

Examine the various tools of Financial Analysis.

Answer:- Financial analysis tools are one of the most efficient ways that can be used for ensuring good profit
from your investments. These financial analysis tools are highly helpful in evaluating the market and investing
in a way so as to maximize the profit from the investments made. These financial analysis tools are useful for
deciphering both internal and external information related to a specific business organization.

Financial Analysis is defined as being the process of identifying financial strength and weakness of a business
by establishing relationship between the elements of balance sheet and income statement. The information
pertaining to the financial statements is of great importance through which interpretation and analysis is made.
It is through the process of financial analysis that the key performance indicators, such as, liquidity solvency,
profitability as well as the efficiency of operations of a business entity may be ascertained, while short term and
long term prospects of a business may be evaluated. Thus, identifying the weakness, the intent is to arrive at
recommendations as well as forecasts for the future of a business entity.

Financial analysis focuses on the financial statements, as they are a disclosure of a financial performance of a
business entity. A Financial Statement is an organized collection of data according to logical and consistent
accounting procedures. Its purpose is to convey an understanding of some financial aspects of a business firm. It
may show assets position at a moment of time as in the case of balance sheet, or may reveal a series of activities
over a given period of times, as in the case of an income statement.

Since there is recurring need to evaluate the past performance, present financial position, the position of
liquidity and to assist in forecasting the future prospects of the organization, various financial statements are to
be examined in order that the forecast on the earnings may be made and the progress of the company be
ascertained.
The financial statements are: Income statement, balance sheet, statement of earnings, statement of changes in
financial position and the cash flow statement. The income statement, having been termed as profit and loss
account is the most useful financial statement to enlighten what has happened to the business between the
specified time intervals while showing, revenues, expenses gains and losses. Balance sheet is a statement which
shows the financial position of a business at certain point of time. The distinction between income statement
and the balance sheet is that the former is for a period and the latter indicates the financial position on a
particular date. However, on the basis of financial statements, the objective of financial analysis is to draw
information to facilitate decision making, to evaluate the strength and the weakness of a business, to determine
the earning capacity, to provide insights on liquidity, solvency and profitability and to decide the future
prospects of a business entity.

There are various tools of Financial Analysis, They are briefly mentioned herein:

External analysis: The external analysis is done on the basis of published financial statements by those who do
not have access to the accounting information, such as, stock holders, banks, creditors, and the general public.

Internal Analysis: This type of analysis is done by finance and accounting department. The objective of such
analysis is to provide the information to the top management, while assisting in the decision making process.

Short term Analysis: It is concerned with the working capital analysis. It involves the analysis of both current
assets and current liabilities, so that the cash position (liquidity) may be determined.

Horizontal Analysis: The comparative financial statements are an example of horizontal analysis, as it involves
analysis of financial statements for a number of years. Horizontal analysis is also regarded as Dynamic
Analysis.

Vertical Analysis: it is performed when financial ratios are to be calculated for one year only. It is also called as
static analysis.

An assortment of techniques is employed in analyzing financial statements. They are: Comparative Financial
Statements, statement of changes in working capital, common size balance sheets and income statements, trend
analysis and ratio analysis.

Comparative Financial Statements: It is an important method of analysis which is used to make comparison
between two financial statements. Being a technique of horizontal analysis and applicable to both financial
statements, income statement and balance sheet, it provides meaningful information when compared to the
similar data of prior periods. The comparative statement of income statements enables to review the operational
performance and to draw conclusions, whereas the balance sheets, presenting a change in the financial position
during the period, show the effects of operations on the assets and liabilities. Thus, the absolute change from
one period to another may be determined.

Statement of Changes in Working Capital: The objective of this analysis is to extract the information relating to
working capital. The amount of net working capital is determined by deducting the total of current liabilities
from the total of current assets. The statement of changes in working capital provides the information in relation
to working capital between two financial periods.

Common Size Statements: The figures of financial statements are converted to percentages. It is performed by
taking the total balance sheet as 100. The balance sheet items are expressed as the ratio of each asset to total
assets and the ratio of each liability to total liabilities. Thus, it shows the relation of each component to the
whole - Hence, the name common size.

Trend Analysis: It is an important tool of horizontal analysis. Under this analysis, ratios of different items of the
financial statements for various periods are calculated and the comparison is made accordingly. The analysis
over the prior years indicates the trend or direction. Trend analysis is a useful tool to know whether the financial
health of a business entity is improving in the course of time or it is deteriorating.

Ratio Analysis: The most popular way to analyze the financial statements is computing ratios. It is an important
and widely used tool of analysis of financial statements. While developing a meaningful relationship between
the individual items or group of items of balance sheets and income statements, it highlights the key
performance indicators, such as, liquidity, solvency and profitability of a business entity. The tool of ratio
analysis performs in a way that it makes the process of comprehension of financial statements simpler, at the
same time, it reveals a lot about the changes in the financial condition of a business entity.

It must be noted that Financial analysis is a continuous process being applicable to every business to evaluate its
past performance and current financial position. It is useful in various situations to provide managers the
information that is needed for critical decisions. The process of financial analysis provides the information
about the ability of a business entity to earn income while sustaining both short term and long term growth.

5.

What is Zero Base Budgeting? Explain.

6.

Describe the various aspects of Zero Based Budgeting with its merits and demerits.

25 x 4=100 marksNIBM MBA solved Assignments

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