Common Size Statement, Comparative Satement and Trend Analysis Essay Example For Students

Common Size Statement, Comparative Satement and Trend Analysis Essay COMPARATIVE STATEMENT COMMON SIZE STATEMENT AND TREND ANALYSIS INTRODUCTION We know business is mainly concerned with the financial activities. In order to ascertain the financial status of the business every enterprise prepares certain statements, known as financial statements. Financial statements are mainly prepared for decision making purpose. But the information as is provided in the financial statements is not adequately helpful in drawing a meaningful conclusion. Thus, an effective analysis and interpretation of financial statements is required. Analysis means establishing a meaningful relationship between various items of the two financial statements with each other in such a way that a conclusion is drawn. By financial statements we mean two statements: (i) Profit and loss Account or Income Statement (ii) Balance Sheet or Position Statement These are prepared at the end of a given period of time. They are the indicators of profitability and financial soundness of the business concern. The term financial analysis is also known as analysis and interpretation of financial statements. It refers to the establishing meaningful relationship between various items of the two financial statements i. e. Income statement and position statement. It determines financial strength and weaknesses of the firm. Analysis of financial statements is an attempt to assess the efficiency and performance of an enterprise. Thus, the analysis and interpretation of financial statements is very essential to measure the efficiency, profitability, financial soundness and future prospects of the business units. Types of financial statement are: 1) Comparative statement 2) Common size statement ) Trend analysis Financial analysis serves the following purposes: 1. Measuring the profitability The main objective of a business is to earn a satisfactory return on the funds invested in it. Financial analysis helps in ascertaining whether adequate profits are being earned on the capital invested in the business or not. It also helps in knowing the capacity to pay the interest and dividend. 2. Indicat ing the trend of Achievements Financial statements of the previous years can be compared and the trend regarding various expenses, purchases, sales, gross profits and net profit etc. an be ascertained. Value of assets and liabilities can be compared and the future prospects of the business can be envisaged. Assessing the growth potential of the business. The trend and other analysis of the business provides sufficient information indicating the growth potential of the business. 3. Comparative position in relation to other firms The purpose of financial statements analysis is to help the management to make a comparative study of the profitability of various firms engaged in similar businesses. Such comparison also helps the management to study the position of their firm in respect of sales, expenses, profitability and utilising capital, etc. 4. Assess overall financial strength The purpose of financial analysis is to assess the financial strength of the business. Analysis also helps in taking decisions, whether funds required for the purchase of new machines and equipments are provided from internal sources of the business or not if yes, how much? And also to assess how much funds have been received from external sources. 5. Assess solvency of the firm The different tools of an analysis tell us whether the firm has sufficient funds to meet its short term and long term liabilities or not. PARTIES INTERESTED Analysis of financial statements has become very significant due to widespread interest of various parties in the financial results of a business unit. The various parties interested in the analysis of financial statements are: (i) Investors : Shareholders or proprietors of the business are interested in the well being of the business. They like to know the earning capacity of the business and its prospects of future growth. ii) Management : The management is interested in the financial position and performance of the enterprise as a whole and of its various divisions. It helps them in preparing budgets and assessing the performance of various departmental heads. (iii) Trade unions : They are interested in financial statements for negotiating the wages or salaries or bonus agreement with the management. (iv) Lenders : Lenders to the business like debenture holders, suppliers of loans and lease are interested to know short term as well as long term solvency position of the entity. v) Suppliers and trade creditors : The suppliers and other creditors are interested to know about the solvency of the business i. e. the ability of the company to meet the debts as and when they fall due. (vi) Tax authorities : Tax authorities are interested in financial statements for determining the tax liability. (vii) Researchers: They are interested in financial statements in undertaking research work in business affairs and practices. (viii) Employees : They are interested to know the growth of profit. As a result of which they can demand better remuneration and congenial working environment. (ix) Government and their agencies : Government and their agencies need financial information to regulate the activities of the enterprises/ industries and determine taxation policy. They suggest measures to formulate policies and regulations. (x) Stock exchange : The stock exchange members take interest in financial statements for the purpose of analysis because they provide useful financial information about companies. Thus, we find that different parties have interest in financial tatements for different reasons. COMPARATIVE STATEMENT Comparative statements are financial statements that cover a different time frame, but are formatted in a manner that makes comparing line items from one period to those of a different period an easy process. This quality means that the comparative statement is a financial statement that lends itself well to the process of comparative analysis. Many companies make use of standardized formats in accounting functions that make the generation of a comparative statement quick and easy. IMPORTANCE AND USES The benefits of a comparative statement are varied for a corporation. Because of the uniform format of the statement, it is a simple process to compare the gross sales of a given product or all products of the company with the gross sales generated in a previous month, quarter, or year. Comparing generated revenue from one period to a different period can add another dimension to analyzing the effectiveness of the sales effort, as the process makes it possible to identify trends such as a drop in revenue in spite of an increase in units sold. Fraternities Are Not All Bad EssayIn case of common size statement analysis the absolute figures are converted to proportions for the purpose of inter-firm as well as intra-firm analysis. . Limitations As with financial statements in general, the interpretation of common size statements is subject to many of the limitations in the accounting data used to construct them. For example: 1. Different accounting policies may be used by different firms or within the same firm at different points in time. Adjustments should be made for such differences. 2. Different firms may use different accounting calendars, so the accounting periods may not be directly comparable. TREND STATEMENT Trend analysis calculates the percentage change for one account over a period of time of two years or more. Percentage change To calculate the percentage change between two periods: Calculate the amount of the increase/ (decrease) for the period by subtracting the earlier year from the later year. If the difference is negative, the change is a decrease and if the difference is positive, it is an increase. Divide the change by the earlier years balance. The result is the percentage change. Calculation of Percentage Change : amount in 000 rupees) (N/M: not meaningful) | 2001| 2000| Increase/(Decrease) | Percent Change | Cash| 6,950| 6,330| 620| 9. 8%| Accounts Receivable, net| 18,567| 19,330| (763)| (3. 9%)| | | | | | Sales| 129,000| 103,000| 26,000| 25. 2%| Rent Expense| 10,000| 0| 10,000| N/M| Net Income (Loss)| 8,130| (1,400)| 9,530| N/M| | Calculation notes: 1. 2000 is the earlier year so the amount in the 20X0 column is subtracted from the amount in the 2001 colum n. 2. The percent change is the increase or decrease divided by the earlier amount (2000 in this example) times 100. Written as a formula, the percent change is: | | | | 3. If the earliest year is zero or negative, the percent calculated will not be meaningful. N/M is used in the above table for not meaningful. 4. Most percents are rounded to one decimal place unless more are meaningful. 5. A small absolute rupee item may have a large percentage change and be considered misleading. Trend percentages To calculate the change over a longer period of time—for example, to develop a sales trend—follow the steps below: 1. Select the base year. 2. For each line item, divide the amount in each non base year by the amount in the base year and multiply by 100. 3. In the following example, 2007 is the base year, so its percentages (see bottom half of the following table) are all 100. 0. The percentages in the other years were calculated by dividing each amount in a particular year by the corresponding amount in the base year and multiply by 100. Calculation of Trend Percentages (amount in rupees) | 2001 | 2000 | 2009 | 2008 | 2007 | Historical Data | | | | | | Inventory| 12,309| 12,202| 12,102| 11,973| 11,743| Property ; equipment| 74,422| 78,938| 64,203| 65,239| 68,450| Current liabilities| 27,945| 30,347| 27,670| 28,259| 26,737| Sales| 129,000| 97,000| 95,000| 87,000| 81,000| Cost of goods sold| 70,950| 59,740| 48,100| 47,200| 45,500| Operating expenses| 42,600| 38,055| 32,990| 29,690| 27,050| Net income (loss)| 8,130| (1,400)| 7,869| 5,093| 3,812| Trend Percentages | | | | | | Inventory| 104. 8| 103. 9| 103. 1| 102. 0| 100. 0| Property ; equipment| 108. 7| 115. 3| 93. 8| 95. 3| 100. 0| Current liabilities| 104. 5| 113. 5| 103. 5| 105. 7| 100. 0| Sales| 159. | 119. 8| 117. 3| 107. 4| 100. 0| Cost of goods sold| 155. 9| 131. 3| 105. 7| 103. 7| 100. 0| Operating expenses| 157. 5| 140. 7| 122. 0| 109. 8| 100. 0| Net income (loss)| 213. 3| (36. 7)| 206. 4| 133. 6| 100. 0| | Calculation notes: 1. The base year trend percentage is always 100. 0%. A trend percentage of less than 100. 0% means the balance has decreased below the base year level in that particular year. A trend percentage greater than 100. 0% means the balance in that year has increased over the base year. A negative trend percentage represents a negative number. 2. If the base year is zero or negative, the trend percentage calculated will not be meaningful. 3. In this example, the sales have increased 59. 3% over the five-year period while the cost of goods sold has increased only 55. 9% and the operating expenses have increased only 57. 5%. The trends look different if evaluated after four years. At the end of 2000, the sales had increased almost 20%, but the cost of goods sold had increased 31%, and the operating expenses had increased almost 41%. These 2000 trend percentages reflect an unfavourable impact on net income because costs increased at a faster rate than sales. The trend percentages for net income appear to be higher because the base year amount is much smaller than the other balances. FEATURES OF TREND ANALYSIS 1) In case of a trend analysis all the given years are arranged in an ascending order. 2) The first year is termed as the â€Å"Base year† and all figures of the base year are taken as 100%. 3) Item in the subsequent years are compared with that of the base year. 4) If the percentages in the following years is above 100% it indicates an increase over the base year and if the percentages are below 100% it indicates a decrease over the base year. ) A trend analysis gives a better picture of the overall performance of the business. 6) A trend analysis helps in analysing the financial performance over a period of time. 7) A trend analysis indicates in which direction a business is moving i. e. upward or downwards. 8) A trend analysis facilitates effective comparative study of the financial performance over a period of time. 9) Fo r trend analysis at least three years financial data is essential. Broader the base the more reliable is the data and analysis.