FINANCIAL CONSIDERATION

MEANING AND CONCEPT :-

The term financial consideration is known as analysis and interpretation of financial statements . It refers to the process of determining financial strengths and weakness of the firm by establishing strategic relationship between the items of balance sheet , profit and loss account and other operative data.

DEFINITIONS:-

ACCORDING TO :- Metcalf and Titard “ Financial consideration is a process of

evaluating the relationship between components parts of a financial statement to obtain a better understanding of a firm’s position and performance.”

Thus, the financial consideration refers to the process of obtaining relevant economic information about a project in order to established its financial viability. It is undertaken as one of the feasibility analyses in project formulation.

OBJECTIVES :-THE MAIN OBJECTIVES ARE AS FOLLOWS :-

1. To assess the present and future earning capacity or profitability of the concern.

2. To assess the financial soundness and stability of business concern.

3. To assess the operational efficiency of the concern as a whole and its various departments .

4. To assess the short term and long term solvency of the concern for the benefits of the debentureholders and trade creditors.

5. To assess the possibility of developments in the future by making forecasts and preparing budgets.

6. To assess the long – term liquidity of the funds.

7. To undertake comparative study in regard to one firm with another firm or one department with another department.

USERS OF FINANCIAL CONSIDERATION

USERS

USERS :-

a) TRADE CREDITORS:- Trade creditors are interested in firm’s ability to meet

their claims over a very short period of time. They are interested in evaluating the firm’s liquidity position.

b) SUPPLIERS OF LONG TERM DEBT :- The providers of long term debt are concerned with

firm’s long term solvency and survival . They are interested in analysing the firm’s profitability over a period of time. They are equally concerned with the ability of the firm to generate cash to pay interest and principal amount to them on the stipulated period.

c) INVESTORS :- Investors who have invested their money in the company’s

shares are very much concerned about the firm’s earnings. They always prefer steady growth in earnings and they concentrate on the analysis of the firm’s present and future profitability.

d) MANAGEMENT OF THE FIRM:- Management of the firm is very much interested in the

financial analysis. It is because the financial analysis indicates as to how the resources of the firm are used most effectively and efficiently . It is also possible to assess the financial soundness and stability of the company which is highly useful for managerial decision making.

PROCEDURE :-

The following procedure is adopted for the consideration of financial statements :

i. The analyst should acquaint himself with the principles and postulates of accounting . He should know the plans and policies of the management so that he may be able to find out whether these plans are properly executed or not.

ii. The extent of analysis should be determined so that the sphere of work may be decided.

iii. The data given in the financial statements should be reorganised and rearranged .it involves the grouping of similar data under same heads and breaking down of individual components of statements according to their nature .

iv. A relationship is established among financial statements with the help of tools and techniques of analysis such as ratios , trends , common- size , funds flow , etc.

v. The information is interpreted in a simple and understandable way .

vi. The conclusions drawn from interpretation are presented to the management in the form of reports .

TYPES

TYPES

NATURE OF THE ANALYST

OBJECTIVE MODUS OPERANDI OF THE ANALYSIS

1. ACCORDING TO THE NATURE OF THE ANALYST :-

EXTERNAL ANALYSIS

THIS IS MADE BY THOSE PERSONS WHO ARE NOT CONNECTED WITH THE ENTERPRISE.

EXAMPLES:- INVESTORS , CREDIT AGENCIES , GOVERNMENTAL AGENCIES AND RESEARCH SCHOLARS.

INTERNAL ANALYSIS

THIS IS DONE BY THOSE PERSONS WHO HAVE ACCESS TO YHE BOOKS OF

ACCOUNTS.

THEY ARE MEMBERS OF THE ORGANISATION.

2.ACCORDING TO THE OBJECTIVES OF ANALYSIS :-

a) LONG TERM ANALYSIS – This analysis is made to study the long term financial position , profitability and earning capacity of a business concern . It helps the management in the long term financial planning of the business concern .

b) SHORT TERM ANALYSIS – This analysis helps in assessing the short term solvency , stability and liquidity and earning capacity of the business . It helps to know whether the firm meets its short term financial requirements or not .

3. ACCORDING TO MODUS-OPERANDI OF THE ANALYSIS :-

a) HORIZONTAL ANALYSIS – This analysis reviews and analyses financial statement of number of years . Hence, it is useful for long term trend analysis and planning. For eg – comparative financial statement .

b) VERTICAL ANALYSIS – This analysis reviews and analyses the financial statements of one particular year only . For eg – ratio analysis.

TECHNIQUES :-

1. COMPARATIVE STATEMENTS:- The comparative financial statements show the financial position at different periods of time. These are design to show :

i)absolute fig. ii)change in absolute figures

( increase or decrease in absolute figures )

iii) change in terms of percentage .

The comparative statement can be prepared for both income statement and balance sheet .

(a)COMPARATIVE INCOME

It gives an idea of the progress of a business over a period of time . The changes in absolute data in money values and percentage can be determined to analyses the profitability of the business. This statement has four columns . While the first two columns give figures of various items for two years , last two columns show increase or decrease in figures in absolute amounts and percentages respectively .

31 st march 2005 -2006 Rs .(‘000 ) Rs .(‘000)

Increase (+)Decrease (-) Amount Rs. (‘000)

Net SalesLess: cost of goods sold

AdministrativeExpenses selling exp.Total Operating exp.

Operating profit(---- ) Insterest paid

Increase (-) Decreas (-)Percentages

Gross profit

Operating expenses:

Net profit before taxLess (-) Income taxNet profit after tax

b) COMPARATIVE BALANCE SHEET :- the comparative balance sheet facilitates

the study of the trend of the same items, group of items in two or more balance sheets of the same firm on different dates . It has two columns for the data of original balance sheet. Third column is used to show increase or decrease in figures . The fourth is used for giving the % of increase or decrease .

Items Year ending 30th june 2005-2006

Increase/decrease (amount)

Assets:Current Ass.

Cash and bank Bills ReceivesSunday debtors Stocks debtors Stock Prepaired expenses

Total Fixed Assets

Land and buildingPlant and machineryFurniture Other Fixed Assets

Total Fixed Assets

Fixed assets

Increase/ decrease percentage

Total asset

Liabilities and Capital Current Liabilities Bills payableSundry creditorsOther current liabilities

Total Current Liabilities

DebenturesLong Term loans on Mortgage

Total LiabilitiesEquity share capital

Reserves and Surplus

Total

2. COMMON-SIZE STATEMENTS :-

This statements indicates the relationship of various items with some common items (expressed as percentage of common items ).

(a) common-size income statement – in this sales figure is taken as base and all other figures are expressed as % of sales .

J.S MEHANDIPUR CO.LTDCOMMON-SIZE INCOME STATEMENTFOR THE YEAR ENDING MARCH31,2006 AND 2007

2006

Rs. (‘000 )

%

Sales 1,000 100.00 .400 100.00 Less: Cost of goods sold 650 65.00 1,020 72.86 Operating expenses : 350 35.00 380 27.14Office expenses 40 4.00 50 3.58Selling expanses 60 6.00 90 6.42Total operating expenses 100 10.00 140 10.00Operating profit 250 25.00 240 17.14 Misc . Income 40 4.00 30 2.14 Total Income 290 29.00 270 19.28 Less : non-operating 50 5.00 60 4.28 Net profit 240 24.00 210 15.00

2007

Rs. (‘000 ) %

(B) COMMON SIZE BALANCE SHEET :-

A statement in which balance sheet items are expressed as the ratio of each assets to total assets the ratio of each liability is expressed as a ratio of total liabilities is called common balance sheet .

Current assets

Share capital reserves

CO. CO.

Assets

Fixed assets

Amount (Rs)

Amount (Rs) % %

Total fixed assets

Total assets

Total capital reserves

Long term loans

Current liabilities

Total of liability side

Total current liabilities

3. TREND ANALYSIS

Trend analysis is a technique with the help of which the financial statements can be analysed by computing trends for a series of information.

2000

2001

2002

2003

2004

Year Amt. Trend Amt. Trend Amt. Trend percentages (Rs.lakhs) percentages (Rs. Lakhs) percentages (Rs.lakhs)

1.881

2.340

2.655

3.021

3.768

Sales Stock Profit before tax

100

124

141

161

200

709

781

816

944

1154

100

110

115

133

162

321

435

458

527

672

100

136

143

164

209

INTERPRETATION

The sales have increased continuously in all the years

The figures of stock have also increased from 2000 to 2004.the increase in stock is more in 2003 and 2004 when compared to earlier years.

The profit before tax has also increased .

4.FUNDS FLOW STATEMENTS

This statement is prepared in order to reveal clearly the various sources where from the funds are procured to financed the activities of a business a concern during an accounting period. It also brings to highlight the uses to which these funds are put during the said period.

5.CASH FLOW STATEMENT

This statement is prepared to know clearly the various sources of cash inflows and cash outflows. It is helpful in valuating the current liquidity of a business concern. Thus ,it is useful in short term financial analysis . It also helps the executives in the efficient cash management and internal financial management.

6.RATIO ANALYSIS

The technique helps in the development of meaningful relationship between individual items or group of items usually shown in the periodical financial statements. An accounting ratio shows the relationship between the two interrelated accounting figures.

LIMITATIONS

1. Historical nature of financial statement2. No substitute for judgment3. Reliability of figures4. Single year analysis is not much useful5. Different interpretations6. Choice of tool of analysis