Question

The topic is: Tools for Financial Statement Analysis - What are the tools used to analyze financial statements ?

1. Identification: Identify the topic and explain why you believe the topic is important.
2. Explanation: Explain the calculations or concepts, and how it can be used in decision-making.
3. Application: Assuming your audience knows nothing about the topic, explain how to apply it:
   1. As an entry-level professional.
   2. As a mid-level professional.
   3. As an executive-level professional.
4. Ethics: Identify 1 ethical issue related to this topic and explain how you would address it.

Answer 1

Tools for Financial Statement Analysis:

1) Identification: Tools for Financial statement analysis refers to different methods with which financial statement analysis is carried out, depending on the purpose for which financial statement analysis is carried out.This may include ratio analytics, comparative study, analysis of presentation and disclosure methods, analysis of notes to accounts.

2) Explanation of calculations and concepts:

Calculations used in carrying out financial statement analysis vary depending on users and cover a wide range of analytics. Take an example, gross profit ratio i.e. Gross profit/Turnover, Net Profit Ratio i.e. Net Profit / Turnover.

Once we calculate these ratios for a particular organisation for one period these can be used in a comparative manner i.e. comparing organisation's own ratios with its previous period's ratios or comparing organisation's ratios with the competitors in the industry if the data of compititors business is easily available.

There are various other ratios which can be used in Financial analytics viz., Debtors turnover ratio, Debt Equity ratio, operating income to Non operating income ratio.

Other than ratio analytics simple scrutiny of Financial statements gives insights into financial analytics of the company.

For e.g. while analysing financial statement it comes to our notice that Turover has decreased still the debtors i.e.trade receivables have increased and there are no bad debts written off. This shows anomaly in financial statement.

3) Application of tools for financial analytics:

1. As an entry level professional - calculating simple ratios like gross profit ratio, net profit ratio, debtors turnover ratio will help entry level professional to make an insightful decision and further to take an informative decision or to reach an appropriate conclusion.

2. Mid-level professional - Mid level professional shall go on to calculate these ratios and compare them with industry ratios, organisation's own ratios for previous periods comparing them with budgeted financial statements if any.

3. Expert level professional - While carrying out financial analytics at expert level, not only ratios are looked into but other factors are also looked upon viz., how much part of entity's profits comes from normal business operations how much comes from exceptional items or one time items. Are there any contingent claims mentioned in notes to accounts which if materialise will result in severe impact on the organisation. What are the loan repayment schedules of the organisation how have they been paid.

Whether there are regular late payments or penalties incurred indicating that financial health of the organisation is dismal. What is the current ratio of the organisation i.e. Current Asset to Current Liabilities ratio. What is the composition of assets as compared to liabilities i.e. whether fixed assets are financed through term loan or long term borrowings or are they financed through short term borrowing.

Composition of sales & service revenue - how much organisation earns through sale of products and how much it has earned through provision of services. Are there regular warranty claims materialising suggesting that quality of the products is in question.

There are so many ways in which financial analytics is carried out.

Ethical Issue with carrying out financial analytics:

Financial analytics is always calculated in terms of % or times ratios. When things come to % terms they may be fugged and put in such fashion as if the performance is very great.

Addressing the issue: Wherever possible, mention absolute numbers along with ratios or percentage terms.

For e.g. many times organisations write in their financial results 100% dividend payout, which looks quite lucrative to any layman but when numbers are mentioned as absolute figure this problem gets addressed i.e. users come to know how much dividend is paid in absolute terms.