Analysis of Financial Statements: Caiib Paper 1 (Module D), Unit 2

Analysis of Financial Statements: Caiib Paper 1 (Module D), Unit 2

Dear Bankers,
We all know that CAIIB exams are conducted by the Indian Institute of Banking and Finance (IIBF).  CAIIB is said to be one of the difficult courses to be cleared for the bankers. But we assure you that with the help of our “CAIIB study material”, you will definitely clear the CAIIB exam.
CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 2: Analysis of Financial Statements” of “Module D: Credit Management” from “Paper 1: Advanced Bank Management (ABM)”.

Financial Statements

There are basically two financial statements which every business enterprise is required to prepare. These are:

• Balance sheet
• Profit & Loss account (Income & Expenditure statement in case of non-profit organizations)

Apart from these, the auditors’ report, explanatory schedules and notes on accounts, if applicable, provide useful information to the bankers.

A funds flow statement also provides useful information but, this is only a mathematical analysis of changes in the structure of two consecutive balance sheets and can be easily prepared by the banker/ analyst himself if the basic statements, i.e. the balance sheets, are available. Accounting Standard-3 makes it mandatory for some enterprises to prepare Cash Flow statement for the accounting period (these enterprises are those whose equity or debt is listed or is in the process of being listed on a recognized stock exchange and also all other commercial, industrial and business enterprises whose turnover for the accounting period exceeds Rs.50 crore. These enterprises are also required to do segment-wise reporting as per A S -1 7.

Users of Financial Statements

Apart from bankers, the other users of financial statements are:

• Other creditors and lenders
• Investors
• Government agencies
• Rating agencies
• Customers
• Employees
• General public
• Analysts

Basic Concepts Used in Preparation of Financial Statements

The important concepts are as under:

• Entity Concept
• Money Measurement Concept
• Stable Monetary Unit Concept
• Going Concern Concept
• Cost Concept
• Conservatism Concept
• Dual Aspect Concept
• Accounting Period Concept
• Accrual Concept
• Realization Concept
• Matching Concept

The format of balance sheet can be either Vertical or Horizontal  as  illustrated below (activities like banking, insurance, electricity generation etc, which are governed   by acts other than Companies Act, need not follow these formats)

Horizontal Form: Horizontal form is maintained in two columns. The first column shows the Liabilities and the second one shows the Assets.

The items shown in the first column against Liabilities are:

• Share Capital Reserves
• Surplus Secured loans
• Unsecured loans
• Current liabilities
• Provisions

The items shown in the second column against Assets are:

• Fixed assets
• Investments
• Current assets
• Loans and advances
• Miscellaneous expenditure

Vertical Form: In the Vertical Form, the different items are shown one below the other.

(A)Sources of funds

1. Shareholders’ funds

(a)Share capital

(b)Reserves and surplus

2. Loan funds

(a)Secured loans

(b)Unsecured loans

(B)Application of funds

1.Fixed assets

2.Investments

3.Current assets, loans and advances

Less: Current liabilities and provisions Net current assets

4.Miscellaneous expenditures

1.Equity and Liabilities

Shareholder’s funds

• Share capital
• Reserve and Surplus
• Money received against share warrants

Share application money pending allotment

Non-current liabilities

• Long-term borrowings
• Deferred tax liabilities (Net)
• Other long term liabilities
• Long term provisions

Current liabilities

• Short-term borrowings
• Trade payables
• Other current liabilities
• Short-term provisions

Total-

2.Assets

Non-current assets

• Fixed assets

(i)Tangible assets

(ii)Intangible assets

(iii)Capital work-in-progress

(iv)Intangible assets under development

• Non-current investments
• Deferred tax assets (net)
• Long-term loans and advances
• Other non-current assets

Current Assets

• Current investments
• Inventories
• Trade receivables
• Cash and cash equivalents
• Short-term loans and advances
• Other current assets

Total-

Accounting

• As per Income Tax rules, April to March is considered as the financial year for tax purposes. However, as per Companies Act, this can be different. Only restriction, as per Companies Act, is that the maximum duration of the financial year can be 15 months, and can be extended up to 18 months with the permission of Registrar of Companies (ROC).

Profit And Loss Account

It is a statement of income and expenditure of an entity for the accounting period. Every P and L account must indicate the accounting period for which it is prepared The items of a P & L account are:

• Gross and Net sale
• Cost of goods sold
• Gross profit
• Operating expenses
• Operating profit
• Non-operating surplus/deficit
• Profit before interest and tax
• Interest
• Profit before tax
• Tax
• Profit after tax (Net Profit)

Analysis of financial statements

• Ast. of fin position/performance
• Projections of future performance
• Warning signals
• Credit requirement assessment
• Exam fund flow
• Cross checking
• Fund flow analysis : diversionidle funds
• Trend analysis : trends/op.efficiency
• Ratio analysis : profitability, liquidity, capital structure(der), ability to service debt/int, inventory/debtor turnover

 Bankers mostly use three methods for analysis of financial statements

• Funds Flow Analysis
• Trend Analysis
• Ratio Analysis

While different users of financial statements are interested in different ratios, the ratios which interest a banker most, are the following:

• Profitability Ratios
• Liquidity Ratios
• Capital Structure Ratios
• Ratio Indicating Ability to Service Interest and Instalments
• Turnover Ratios
• Inventory Turnover Ratio
• Debtors’ Turnover Ratio

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