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LIMITATIONS LIMITATIONS The balance sheet analysis does not reflect The Reputation and creditworthiness of business Reputation

enterprise enterprise Efficiency of management Quality and morale of employees labour Reasons for improvement fall in various items in Reasons the financial statement the Sources and commitments for materials SIP and Sources supplies supplies Balance sheet figures are on a historical basis Accounting is done on the basis of certain Accounting conventions e g going concern concept conventions Balance sheet is prepared on a particular date Balance when window dressing can be done to depict a favourable picture favourable Non recognition of inflation ll corporate enterprises by law are required All to compile P L accounts and B S to Both compiled at annual intervals and under Both exceptional cases the time lag b w the two statements could be 15 months statements As per Income Tax all cos are required to As finalize their financial statements on 31st finalize March March Profit and Loss account Profit Indicates the working results of the Indicates company during specified period company No format prescribed by Companies Act No 1956 1956 Schedule VI part II of Companies Act 1956 Schedule VI lays down the requirement for the preparation and disclosures to be made in the P L account the Both statements looked together for the Both purpose of Credit Analysis Foll steps are involved in the analysis of P L account analysis Gross sales broken into domestic sales exports Gross and deferred sales and Net sales arrived at after deducting excise duty Net from gross sales from The cost of production is arrived at taking into The account RM consumption direct expenses and increase decrease in stock in progress increase The cost of sales is arrived at after adjusting in The the cost of production the increase decrease in the stock the Other operating expenses like admin selling Other financial i e interest are deducted out of gross profit to arrive at net profit profit Other non operative income is added other non Other operative expenses are deducted out of operating profit to arrive at PBT profit Non operative income arise from secondary Non activities like interest rent and dividend received by an enterprise whose main business is not to deal in finance property and investment deal Other expenses arise from incidental Other activities activities Net provision for income tax is deducted Net from PBT to arrive PAT from Profit appropriation i e dividend transfer Profit of a part full profit to various reserves of Balance remained after the appropriation Balance is carried to balance sheet Balance Sheet Balance Statement of balances depicting the Statement affairs position of a business enterprise on a GIVEN DATE on T shaped or vertical format Format for companies Companies Act Format 1956 1956 Grouped into Assets and liabilities

Liabilities Liabilities Obligation of the business to the others Sources of funds Business is a distinct entity capital invested Business by Owners S H is liability for business by Assets Assets Normally property of the business Certain items treated as assets though not Certain classified as property such as goodwill patents losses etc patents In accounting terms all debit balances are In assets and all credit balances are liabilities assets Balance sheet As prescribed by RBI as per CMA data format RBI Liabilities Current liabilities Term liabilities Net worth Assets Current assets Fixed assets Non current assets Intangible assets Analysis of Liabilities and Assets and Liabilities Liabilities Share Capital Paid up capital includes Equity and Preference Paid shares shares Equity capital only taken as share capital and Equity preference shares are given separate treatment preference RBI classifies redeemable pref shares which are RBI redeemable after 1 yr but before 12 yrs as Term Loans and not under Net worth Loans Principle redeemable pref shares have to be Principle redeemed and follows treatment accorded to such share capital by the All India term Lending Institutions AITLIs AITLIs Redeemable pref shares redeemed within 12 months Redeemable are classified as current liability are Reserves appropriation of profits and created for Redemption of a known liability Strengthen the liquidity resources for a definite amount Reserves and Surplus Reserves

Classified as Net worth Different from provisions Provisions Provisions Charge against profit for a specific purposes bad and doubtful debt Charge depreciation etc depreciation Necessity even when there is no profit While analysis classified as current liabilities as the provisions are While immediate liability to be settled by their nature immediate Secured and Unsecured loans Secured Banker concerned with the maturity of loan Loan repayable within 12 months from the date of Loan balance sheet current liabilities balance Loan repayable beyond 12 months from the date of Loan

balance sheet term liabilities balance Even w r t long term loan portion of loan repayable Even within 12 months current liability and the remaining portion as term liability portion Secured and Unsecured loans contd contd Installment of loan due in next 12 months Installment are NOT classified as current liability for the limited purpose of arriving at MPBF limited However for the purpose of calculation of However ratios same would be treated as current liability liability Assets Assets Fixed Assets Gross block in the balance sheet include Gross intangibles like goodwill patents etc which should be classified as intangible assets and the remaining portion as gross block remaining If assets have been revalued upwards at any If time in the past the same amount should be deducted from gross block and shown as intangible asset intangible Investments Investments Includes Govt and other trustee securities Includes besides fixed deposits with banks besides Investment not expected to convert into cash Investment within a period of 1 year need not be put under current assets current Investment in shares in other cos associates Investment should be classified as non current assets except in case of pure investment cos where it should be classified as current assets at cost or market price whichever is lower price Miscellaneous Expenses Miscellaneous Entire miscellaneous expenditure will be Entire classified as intangible asset classified If debit balance in the P L account is shown If as miscellaneous expense the amount will be taken to the liabilities and shown as a deduction from the net worth deduction Short term borrowings from banks Current liability Current The outstanding balances of cash credit The overdraft export packing credit are classified under this head head Bills purchased discounted Normally shown as contingent liability as notes attached Normally to the balance sheet This item should be added to the bank borrowings on the liability side and receivables on the assets receivables on Deposits maturing within 12 months

The company normally shows all deposits together in the balance sheet While analysing deposits maturing within 12 months should be classified as current liabilities and those maturing beyond 12

months as term liabilities liabilities Current liability Current Sundry Creditors Trade Sundry A detailed break up of trade and other creditors should be detailed obtained and the creditors relating to trade should only be classified under this head classified Creditors for expenses and for purchase of capital goods are Creditors also classified under a separate head under current liabilities also Provision for taxation Provision Provision for income tax no other taxes such as sales tax less advance payment of tax is shown as current liability advance Dividend Payable Dividend Dividend declared for the year should be added to the figure of Dividend dividend payable in the balance sheet and the total figure should be shown under a separate head under the current liabilities

Current liability contd Current Instalments of term loan the instalment of term loan which has already fallen due and the due within 12 months from the date of balance sheet should be shown as current liability be It would also include deferred payment guarantee It Instalments debentures redeemable preference shares due within 1 year within This should be done only for the limited purpose of This calculation of current ratio however for arriving at MPBF these should not be classified as current liabilities as per RBI guidelines per Advance payments from customers Advance Where deposits are required in terms of regulations framed Where by the government to be invested in a particular manner the benefit of netting may be allowed to the extent of such investment in approved securities and only the balance amount need to be classified as current liability amount Current liability contd Current

Advance payments from customers Advance Advance payments received can be adjusted progressively from Advance the value of work completed as agreed in the contract the Outstanding advance payments are to be reckoned as current Outstanding liabilities or otherwise depending upon whether they are adjustable within a year within

Deposits from dealers selling agents Deposits These deposits may be treated as term liabilities irrespective of These their tenure if such deposits are accepted to be repayable only when the dealership agency is terminated the deposits which don t satisfy the above condition should continue to be classified as current liabilities current Current liability contd Current

Sales Tax Disputed Excise Liabilities shown as contingent Disputed liabilities or as a note to the balance sheet is not treated as a current liability for calculating MPBF provided it has been collected or shown in the accounts has Provision for disputed excise duty is taken as a current Provision liability unless the amount payable in installments is spread over a period of one year Where such provision is invested separately in fixed deposits with banks it can be setoff against the relative investment can Current liability contd Current Sales Tax Disputed liabilities with respect to income tax customs Disputed need not be treated as a current liability for the purpose of calculation of MPBF except the extent provided in the books books The amount of convertible debentures should be The classified as part of net worth if they are fully convertible If partly convertible only the convertible part should be taken as networth should Current Assets Current Current Assets Inventory It comprises of goods held for Inventory processing and conversion into saleable products goods and process and finished products Stores and spares used in the process of manufacturing and packaging is a part of inventory Stores and spares not exceeding 12 months consumption of imported items and exceeding 9 months consumption of indigenous items are taken as current assets current Slow moving or obsolete items should not be Slow treated as current assets treated Current Assets contd Current Current Assets Receivables It represents cash claims relating to sale of products or services by business enterprise Receivables of subsidiary firms or sister concerns would also be included if these have arisen in the normal course of business course The bad debts not provided for are to be classified as The intangible assets intangible Current Assets contd Current Other Current Assets Advances given to the suppliers material stores Advances towards future supplies towards Interest accrued in investments and other Interest accrued income accrued Prepaid expenses which relate to current Prepaid expenses and not future expenses expenses Investment in government securities and bank Investment deposits deposits Non Current Assets Non consumable stores and spares Deferred receivables Advances to group companies and capital Advances equipments supplier equipments Investment in subsidiary group companies Dues from directors officers and staff Security deposits of permanent nature with Security government authorities like electricity boards government

Intangible Assets This includes Goodwill Patent Trademark This Preliminary expenses not written off and deferred revenue expenditures revenue In certain cases it could also include accumulated In losses to the extent not wiped off and shown in the balance sheet balance Tangible Net Worth It includes paid up share capital preference It shares redeemable after 12 years reserves and surplus It is arrived at after deducting intangible assets assets Interpretation of Financial Interpretation Statements Statements It is done by the following methods Percentage Method In this all the figures of the balance sheet are reduced to percentage terms in relation to the grand total at the bottom of the balance sheet Relationship between various group of assets and liabilities can be computed from the percentage wise balance sheet This method has its own limitation and is not widely used in banks However it is useful in respect of operating statements where all items are expressed in percentage terms and increase or decrease in various costs expenses can be easily studied various Trend Method Under this financial statements for a number of years are studied This method involves calculation of percentage relationship that each item bears to the same item in the base year it discloses the changes in the financial and operating data between specified periods and helps to find out favorable and unfavorable tendencies This method is not very popular unfavorable Ratio Method They are expressed in various forms Pure ratio in terms of number of times and percentage terms terms Limitations of Ratios The ratios are worked out in the basis of past year s statements which gives only a fair idea about what will happen in the future idea Interpretation of Financial Statements Various types of Ratio Balance Sheet Ratios Operating Statement Ratios Inter statement Ratios Financial or Capitalization Ratios Debt Equity Ratio Funded Debt Equity Ratio Liquidity Ratios Current Ratios Acid Test Ratio Profitability Ratios Operating Profit Sales Net Profit Sales Net Profit Tangible Net Worth Retained Profit Net Profit Raw Material Consumed Sales Expense Sales Turn over Ratios Raw Material Consumption Stock in Process Cost of Production Finished Goods Cost of Sales Receivables Gross Sales Sundry Creditors Purchases Stores and Spares Consumption Net Sales Total Tangible Assets Financial or Capitalization Ratios Capitalization Debt Equity Ratio Debt Also called Total outside liabilities to TNW ratio Total outside liabilities Debt Tangible Net Worth Equity Total outside liabilities viz Current and term liabilities and Total TNW are compared TNW To ascertain the relative financial stakes of the creditors vis vis the owners of an enterprise vis Ratio differs from industry to industry Ratio

Debt Equity Ratio Debt Equity 0 16 0 14 0 12 0 10 0 08 0 06 0 04 0 02 Debt Equity Ratio 2004 05 0 14 2003 04 0 05 0 05 0 14 Funded debt equity ratio Funded Also called term liabilities TNW ratio Term Liabilities Funded debt Tangible Net Worth Equity Worked out with a view to ensure as to whether the Worked owner has a reasonable stake in financing the enterprise In medium sized projects a ratio of 2 is considered In acceptable In cases of large projects with long gestation periods In and a correspondingly long useful life a ratio of 3 or 4 acceptable acceptable Lease finance obtained by an enterprise should also Lease be considered as a term finance Funded Debt Equity Ratio Funded 0 16 0 14 0 12 0 10 0 08 0 06 0 04 0 02 Funded Debt Equity ratio 2004 05 0 13 2003 04 0 03 0 03 0 13 Liquidity Ratios Liquidity Current Ratio Current Current Assets Current Liabilities If the ratio is 1 or 1 value of current assets exceeds the If current liabilities As per Tandon Committee norms the acceptable minimum As current ratio for industrial concerns should be 1 33 i e the NWC should be 25 of the current assets Refers to the ability of the business enterprise to meet its Refers obligations within a time span of one year The quality of current assets is also an important factor The Seasonality peak and non peak season etc also affect the Seasonality current ratio in some industry current Current Ratio Current 3 95 3 90 3 85 3 80 3 75 3 70 3 65 3 60 Current Ratio 2004 05 3 73 2003 04 3 90 3 73 3 90 Acid Test or Quick Ratio Acid Ratio indicates quick or instant liquidity position Cash Receivables Temp Investments Current Liabilities minus Bank borrowings The quickly realisable current assets and immediate The liabilities are taken into account for working out this ratio Acid Test Ratio Acid 3 18 3 16 3 14 3 12 3 10 3 08 3 06 3 04 3 02 3 00 2 98 2 96 Acid test ratio 3 04 3 16 2004 05 3 04 2003 04 3 16 Profitability Ratios Profitability Operating Profit Sales Operating

Operating Profit x 100 Sales Expressed in percentage terms Indicates trend of operating profit over the Indicates years If the operating profit is on declining lines then If efforts could be initiated for improvement efforts Operating Profit Sales Operating 14 00 12 00 10 00 8 00 6 00 4 00 2 00 2 00 4 00 Operating Profit Sales 1 62 2004 05 1 62 2003 04 13 08 13 08 Net Profit Sales Net Net Profit x 100 Sales Sales Expressed in percentage terms This ratio for different units of same industry This group should also be studied If the ratio is low than the industry average If then further enquiries should be made and reasons ascertained Net Profit Sales Net 20 00 18 00 16 00 14 00 12 00 10 00 8 00 6 00 4 00 2 00 Net Profit Sales 2004 05 2 85 2003 04 17 43 2 85 17 43 Net Profit TNW Ratio Net Also called return on networth ratio indicating yield to the owners to Net Profit x 100 TNW Indicates success of business in earning profit and Indicates overall efficiency Net Profit TNW Ratio Net 16 00 14 00 12 00 10 00 8 00 6 00 4 00 2 00 Net Profit TNW Ratio 2004 05 2 17 2003 04 15 10 2 17 15 10 Retained Profit Net Profit Retained Retained Profit x 100 Net Profit Net Expressed in percentage terms Expressed Retained profit is that portion of profit which has Retained been ploughed back in business after drawings payment of dividend etc Retention of profit is a must for future growth and Retention also for facing any eventuality in future Raw Material Consumed Sales Raw Expresses consumption of raw material per unit of Expresses finished goods sold finished Raw Material Consumed x 100 Sales Gives an idea about the decline in profitability of an Gives enterprise in case raw material cost is going up Effect thereof is not passed on to customers while Effect selling selling Raw Material Consumption Raw 23 50 23 00 22 50 22 00 21 50 21 00 20 50 Raw Material Consumed Sales 2004 05 21 69 2003 04 23 19 21 69 23 19 Expenses Sales Expenses Expenses x 100 Sales Sales Comparison of ratio over the years would give a Comparison fair idea about increase decrease in various expenses items in relation to sales expenses Management can chalk out its

future strategy in Management regard to various expenses whether some expenses are to be curtailed or some others are to be increased to obtain good or results results Turnover Ratios Turnover Raw Material Consumption Raw Worked out in terms of period Worked Raw Material inventory x 12 Raw Material Consumption during the year Should be compared for past years to ascertain the trend Should The inventory of raw material The during the peak season during at the year end and at The average holding during the year etc The should also be kept in view while drawing conclusions should Raw Material Consumption Raw 120 00 100 00 80 08 80 00 60 00 40 00 20 00 Raw Material Consumption 107 21 2004 05 107 21 2003 04 80 08 Stock in process Cost of production production Stock in process inventory x 12 Cost of production during the year Cost Cost of production Raw material and stores Cost consumption direct expenses Opening stock of SIP minus Closing stock of SIP Compared with the past trend and the reasons for Compared increase decrease ascertained Stock in process Cost of production production 29 00 28 00 27 00 26 00 25 00 24 00 23 00 Stock in process Cost of production 2004 05 28 13 2003 04 24 83 24 83 28 13 Finished Goods Cost of Sales Finished Inventory of finished goods x 12 Cost of sales during the year Cost Inventory of finished goods cost of production Inventory opening stock of finished goods minus closing stock of finished goods The inventory should neither be excessive nor low The A high level of finished goods would indicate low high demand for the product A llow stock level may result in the inability of the ow enterprise to effect regular supplies to customers for various reasons various Finished Goods Cost of Sales Finished 18 00 16 00 14 00 12 00 10 00 8 00 6 00 4 00 2 00 Finished Goods Cost of Sales 2004 05 16 87 2003 04 12 44 12 44 16 87 Receivables Sales Receivables Expressed in terms of period Expressed The level of receivable in an enterprise depend on The various

factors like trade credit practice market conditions demand for the product etc A llower level of receivable may indicate effective ower collection machinery and the good demand for the product product Receivables Sales Receivables 99 00 98 00 97 00 96 00 95 00 94 00 93 00 92 00 91 00 90 00 Receivables Sales 2004 05 97 86 2003 04 93 14 93 14 97 86 Sundry Creditors Purchases Sundry Expressed in terms of period Sundry creditors outstanding in B S x 12 Total purchases during the year The high level of creditors may mean that the enterprise The is unable to make payment to creditors in time due to liquidity strains and or procedural faults liquidity If the level is quite low it indicates that the enterprise is If not availing the minimum credit available as per market trends trends Sundry Creditors Purchases Sundry 100 00 95 00 90 00 85 00 79 89 80 00 75 00 70 00 Sundry Creditors Purchases 94 52 2004 05 94 52 2003 04 79 89 Expresses the turnover of assets Net Sales Total tangible assets assets How many times the tangible assets of the enterprise How have rotated in relation to sales have In the highly capital intensive industries this ratio may In be 1 which means the annual sales may be less than the total value of tangible assets than Ratio may be much more in trading concern Net Sales Total tangible assets assets 3 50 3 00 2 50 2 00 1 50 1 00 0 50 0 00 Net Sales Total tangible assets 2004 05 2 63 2003 04 3 32 2 63 3 32 Cash Flow Cash It is prepared to explain the changes in the It cash balance from one balance sheet to another another The cash flow starts with the opening cash The balance to which funds obtained during the year are added and from which funds applied during the year are subtracted The cash flow is useful in the cases of term The loan proposals whereas the funds flow is useful for working capital useful Cash Budget Cash An exercise for management of cash prepared at shorter intervals in advance say monthly prepared or for six months or Cash budget comprises of cash receipts and cash Cash payments during the given

future period payments No credit or transfer transactions in the cash budget bankers obtain cash budgets while issuing usance bankers letter of credit or in the cases of sick units in order to ensure that the enterprise would be able to meet its obligations on the due dates when the liabilities would occur Funds Flow Statement Funds In the balance sheet all liabilities are sources In and assets are uses and The sources and the uses can be further The classified into the following categories classified 1 Long Term a Sources 1 b Uses b 2 Short Term a Sources 2 b Uses The short term funds indicate the variations in The current assets and current liabilities Funds Flow Format RBI under CMA CMA 1 Reasons of increase in carry of various items of 1 inventory which is disproportionate to percentage rise in sales should be ascertained and explained sales 2 Similarly reasons for decrease in current liabilities which 2 is not commensurate will percentage rise or fall in sales should be ascertained and explained 3 In case the increase in working capital gap is not In commensurate with the increase in net sales the position should be ascertained and explained should 4 The projected funds flow would represent company s The intentions about the use of funds Any variance in actuals and projections should be enquired into and Useful Points while deriving conclusions conclusions Useful Points while deriving conclusions contd conclusions 5 The Net Working Capital i e difference between 5 total current assets and total current liabilities would increase decrease with the figure at item no 3 above during the year above 6 It is often useful to prepare funds flow statement 6 for shorter periods or over annual dates other than the fiscal year of the enterprise This will ensure greater and stricter control over the use of funds and any wrong flow into areas unwanted can be detected much earlier much