Chapter analysis-of-financial-statements: Analysis of Financial Statements Case Study Questions | accountancy Class 12 CBSE

Chapter analysis-of-financial-statements: Analysis of Financial Statements Case Study Questions | accountancy Class 12 CBSE | ByteNotes.in

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Case Set 1

Case Analysis

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Priya is the Finance Manager of Sunrise Textiles Ltd. She has been asked by the Board of Directors to analyse the company's financial performance for the years 2015-16 and 2016-17. She prepares the financial statements and uses various tools of financial analysis to assess the company's profitability, liquidity, and solvency. The company's revenue from operations increased from ₹40 lakhs to ₹52 lakhs. She notes that expenses rose from ₹28 lakhs to ₹34 lakhs. The Board also wants to understand the trend in the company's financial position. Priya decides to use comparative statements, common size statements, and ratio analysis to present a comprehensive picture of the company's financial health to the management.

Question 1: What is the primary purpose of Financial Statement Analysis as described in the chapter?

To critically evaluate financial information to understand and make decisions regarding the operations of the firm.
To assess the profitability, operational efficiency, and financial health of the firm.

Question 2: Which tool of financial analysis should Priya use if she wants to compare the revenue and expenses for 2015-16 and 2016-17 by showing absolute and percentage changes?

Priya should use Comparative Statements (also known as horizontal analysis).
Comparative statements show figures for two periods along with absolute increase/decrease and percentage change, making it easy to identify trends and direction of financial performance.

Question 3: Calculate the absolute change and percentage change in revenue from operations and expenses for Sunrise Textiles Ltd., and comment on the financial performance.

Revenue from operations: Absolute change = ₹52L – ₹40L = ₹12L (increase); Percentage change = (12/40) × 100 = 30%.
Expenses: Absolute change = ₹34L – ₹28L = ₹6L (increase); Percentage change = (6/28) × 100 = 21.43%.
Comment: Revenue grew by 30% while expenses grew by only 21.43%, indicating improved operational efficiency and better profitability for the firm.

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Case Set 2

Case Analysis

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Mr. Arjun is a trade creditor of Galaxy Electronics Ltd. He regularly supplies components worth several lakhs of rupees on credit. Before extending further credit, he wants to evaluate whether Galaxy Electronics can meet its short-term obligations. He obtains the company's balance sheet and statement of profit and loss for the past two years. The company's current liabilities stand at ₹15 lakhs and current assets at ₹22 lakhs. Long-term borrowings are ₹30 lakhs. A financial analyst friend of Arjun advises him to conduct a thorough analysis of the financial statements to gauge the firm's liquidity position before making any decision.

Question 1: Why is financial statement analysis particularly important for trade creditors like Mr. Arjun?

Trade creditors are interested in the firm's ability to meet their claims over a very short period of time.
Their analysis evaluates the firm's liquidity position to assess whether the firm can pay its short-term obligations.

Question 2: Distinguish between the interests of trade creditors and long-term lenders in financial statement analysis.

Trade creditors focus on short-term liquidity — the firm's ability to pay claims over a very short period; they evaluate the firm's current assets vs. current liabilities.
Long-term lenders are concerned with the firm's long-term solvency and survival; they analyse profitability, ability to generate cash, capacity to pay interest and repay principal, and capital structure relationships over a period of time.

Question 3: Explain the objectives of financial statement analysis that would be relevant to Mr. Arjun as a trade creditor, and identify two other stakeholders who would conduct financial analysis for different purposes.

Relevant objective for Mr. Arjun: To judge the ability of the firm to repay its debt and assess the short-term liquidity position of the firm.
Other stakeholders and their purposes: (i) Investors — they analyse the firm's present and future profitability, capital structure, and management efficiency to decide whether to buy, sell, or hold shares. (ii) Labour unions — they analyse whether the firm can afford a wage increase or absorb it through increased productivity or higher prices.
Additionally, the Finance Manager uses analysis for financial control and corrective actions, while the government uses it for price regulation and taxation purposes.

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Case Set

Case Set 3

Case Analysis

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Neha is preparing the common size statement of profit and loss for Omega Pharma Ltd. for the years 2015-16 and 2016-17. The revenue from operations for the two years is ₹25,00,000 and ₹20,00,000 respectively. Cost of goods sold is ₹12,00,000 and ₹10,00,000. Operating expenses are ₹1,20,000 and ₹80,000. She wants to express each item as a percentage of revenue from operations. Her teacher explains that common size statements help in both intra-firm and inter-firm comparisons, especially when companies differ in size. The technique is also known as vertical analysis.

Question 1: What is the common base used in a Common Size Statement of Profit and Loss, and why is it useful?

Revenue from operations is taken as the common base (100) in a Common Size Statement of Profit and Loss.
It is useful because all items are expressed as percentages of revenue, enabling easy intra-firm and inter-firm comparisons even for companies of different sizes.

Question 2: Calculate the percentage of cost of goods sold and operating expenses to revenue from operations for both years for Omega Pharma Ltd.

2015-16: Cost of goods sold % = (12,00,000/25,00,000) × 100 = 48%; Operating expenses % = (1,20,000/25,00,000) × 100 = 4.8%.
2016-17: Cost of goods sold % = (10,00,000/20,00,000) × 100 = 50%; Operating expenses % = (80,000/20,00,000) × 100 = 4%.

Question 3: Distinguish between Common Size Statements and Comparative Statements, and explain why common size analysis is described as 'vertical analysis'.

Comparative Statements show data for two periods with absolute and percentage changes; they compare financial data over time and are called 'horizontal analysis' because comparison runs across time (left to right).
Common Size Statements express each item as a percentage of a common base within the same period; they reveal the structural composition of financial statements.
Common size analysis is called 'vertical analysis' because each item is expressed as a proportion of a total within the same column/period, i.e., the analysis runs vertically down the statement rather than across periods.

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Case Set 4

Case Analysis

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The management of Bharat Steel Ltd. is concerned about declining profitability. The company's profit before tax was ₹17,50,000 in 2015-16 and rose to ₹25,60,000 in 2016-17. Total revenue increased from ₹61,50,000 to ₹76,20,000. The CFO prepared a comparative statement of profit and loss and noted that while revenue grew by 23.90%, profit before tax grew by 46.29%. The tax rate changed from 35% to 40% between the two years. The management team uses this data to evaluate operational efficiency and make decisions for future investments.

Question 1: What does the comparative statement of profit and loss reveal about Bharat Steel Ltd.'s performance?

Revenue grew by 23.90% while profit before tax grew by 46.29%, indicating that expenses grew at a slower rate than revenue.
This reveals improved operational efficiency — the company controlled its costs effectively, leading to a disproportionately higher growth in profitability.

Question 2: What is the impact of a change in tax rate from 35% to 40% on the comparative statement, and how should this be handled?

The change in tax rate affects the profit after tax figure and makes direct comparison of net profit less meaningful unless the tax effect is separately noted.
The chapter notes that financial data is comparative only when the same accounting principles are used; any deviation (including tax rate changes) should be mentioned as a footnote to the comparative statement.

Question 3: How does comparative statement analysis help the top management of Bharat Steel Ltd. in decision-making? Explain with reference to at least three specific uses.

Measuring operational success: The comparative figures show that revenue grew 23.90% and profit before tax grew 46.29%, helping management assess whether operating policies are effective.
Identifying trends and direction: Comparative figures indicate the trend and direction of financial position; management can see if the firm is progressing or declining over time.
Resource allocation and financial control: Management can identify causes of major deviations (e.g., if expenses had grown faster than revenue) and take corrective action, ensuring resources are used most efficiently and financial condition remains sound.

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Case Set

Case Set 5

Case Analysis

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A research economist, Dr. Sharma, is studying the financial concentration of corporate power in the Indian pharmaceutical industry. She collects annual reports of five major pharmaceutical companies and uses financial statement analysis tools to compare their performance. She uses common size balance sheets to compare companies of very different sizes. She also examines comparative statements to track changes over time. Additionally, she notes that financial analysis helps the government in regulating prices, setting tax policies, and offering subsidies to the corporate sector.

Question 1: Why is common size statement particularly useful for Dr. Sharma's inter-firm comparison of pharmaceutical companies?

Common size statements express each item as a percentage of a common base (total assets for balance sheet), allowing comparison of companies of substantially different sizes.
Since numbers are brought to a common base, they facilitate inter-firm comparison for the same year or for several years without being distorted by absolute size differences.

Question 2: How does financial statement analysis serve purposes beyond individual firm decision-making, as seen in Dr. Sharma's work?

Through analysis of financial statements of various firms, an economist can judge the extent of concentration of economic power and pitfalls in financial policies pursued.
The analysis provides the basis for governmental actions relating to licensing, controls, fixing of prices, ceiling on profits, dividend freeze, tax subsidy, and other concessions to the corporate sector.

Question 3: Differentiate between cross-sectional analysis and time series analysis, and explain how both types of analysis are used in Dr. Sharma's study.

Cross-sectional analysis (inter-firm comparison) involves comparing the financial statements of different firms at the same point in time. Dr. Sharma uses this when comparing five pharmaceutical companies using common size balance sheets.
Time series analysis (intra-firm comparison) involves comparing a firm's own performance over different time periods. Dr. Sharma uses this when she tracks changes in each company using comparative statements over multiple years.
Financial statement analysis involves regrouping and analysis of information to establish relationships and throw light on strengths and weaknesses, which can be useful in decision-making involving both types of comparison.

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Chapter analysis-of-financial-statements: Analysis of Financial Statements | Case Study Questions

Passage

Question 1: What is the primary purpose of Financial Statement Analysis as described in the chapter?

Question 2: Which tool of financial analysis should Priya use if she wants to compare the revenue and expenses for 2015-16 and 2016-17 by showing absolute and percentage changes?

Question 3: Calculate the absolute change and percentage change in revenue from operations and expenses for Sunrise Textiles Ltd., and comment on the financial performance.

Passage

Question 1: Why is financial statement analysis particularly important for trade creditors like Mr. Arjun?

Question 2: Distinguish between the interests of trade creditors and long-term lenders in financial statement analysis.

Question 3: Explain the objectives of financial statement analysis that would be relevant to Mr. Arjun as a trade creditor, and identify two other stakeholders who would conduct financial analysis for different purposes.

Passage

Question 1: What is the common base used in a Common Size Statement of Profit and Loss, and why is it useful?

Question 2: Calculate the percentage of cost of goods sold and operating expenses to revenue from operations for both years for Omega Pharma Ltd.

Question 3: Distinguish between Common Size Statements and Comparative Statements, and explain why common size analysis is described as 'vertical analysis'.

Passage

Question 1: What does the comparative statement of profit and loss reveal about Bharat Steel Ltd.'s performance?

Question 2: What is the impact of a change in tax rate from 35% to 40% on the comparative statement, and how should this be handled?

Question 3: How does comparative statement analysis help the top management of Bharat Steel Ltd. in decision-making? Explain with reference to at least three specific uses.

Passage

Question 1: Why is common size statement particularly useful for Dr. Sharma's inter-firm comparison of pharmaceutical companies?

Question 2: How does financial statement analysis serve purposes beyond individual firm decision-making, as seen in Dr. Sharma's work?

Question 3: Differentiate between cross-sectional analysis and time series analysis, and explain how both types of analysis are used in Dr. Sharma's study.

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