Financial Statement Analysis Solved 2024 Question Paper [Dibrugarh University BCom 6th Sem.]

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Dibrugarh University
B.Com 6th Semester

(Honours & Non-Honours)
Paper: DSE-602 (GR-I) -

Financial Statement Analysis

2024
Full Marks: 80
Pass Marks: 32
Time: 3 Hours

The figures in the margin indicate full marks for the questions.

1. Write True or False: (1×4=4)

a) Comparative statement is an example of horizontal analysis.
Answer: True

b) Debt-equity ratio is a solvency ratio.
Answer: True

c) Corporate social responsibility reporting is not mandatory for any business in India.
Answer: False

d) IFRS 4 is associated with insurance contracts.
Answer: True

2. Fill in the Blanks: (1×4=4)

a) Common size statement is known as ______ analysis.
Answer: Vertical

b) ______ and ______ ratios are the main ratios to measure the liquidity position.
Answer: Current, Quick

c) CRR stands for ______.
Answer: Cash Reserve Ratio

d) IRDA was incorporated in the year ______.
Answer: 1999

3. Write short notes on (any four): (4×4=16)

a) Common size statement
Answer : A common size statement is a financial statement in which each item is expressed as a percentage of a base amount. In a common size income statement, each item is shown as a percentage of total revenue, whereas in a common size balance sheet, each item is presented as a percentage of total assets or liabilities. This type of statement helps in analyzing financial performance by making comparisons between companies of different sizes or tracking changes over time.

b) Trend analysis
Answer : Trend analysis is a financial analysis technique used to identify patterns or trends in financial data over a period of time. It involves examining historical financial statements and calculating percentage changes to determine the direction and magnitude of financial performance. This method is useful for forecasting future financial outcomes, identifying potential risks, and making informed business decisions.

c) Composite ratio
Answer : A composite ratio is a financial metric that combines two or more financial ratios to provide a comprehensive evaluation of a company's financial health. It is often used in financial analysis to assess multiple aspects of performance, such as liquidity, profitability, and solvency, within a single measure. Common examples include the return on investment (ROI) ratio and the debt service coverage ratio.

d) Corporate social responsibility
Answer : Corporate Social Responsibility (CSR) refers to the ethical and voluntary initiatives taken by businesses to contribute to social, economic, and environmental well-being. CSR activities include environmental sustainability efforts, community development programs, ethical labor practices, and philanthropy. In India, under Section 135 of the Companies Act, 2013, companies meeting certain criteria are required to spend a specified percentage of their profits on CSR activities.

e) Principle of indemnity in insurance
Answer : The principle of indemnity in insurance states that an insured person or entity should not gain financially from an insurance claim but should only be compensated to the extent of the actual loss suffered. This principle ensures that insurance serves as a protective measure rather than a profit-making mechanism. It prevents moral hazard and fraud by limiting compensation to the replacement or repair cost of the insured asset.

4. Answer the following questions: (14 Marks)

a) Write about the various techniques of financial statement analysis and explain the limitations of financial statement analysis.

Answer: Financial statement analysis is a process of evaluating a company's financial performance and position by examining its financial statements, such as the income statement, balance sheet, and cash flow statement. Various techniques are used to analyze financial statements, providing insights into profitability, liquidity, solvency, and efficiency.

Techniques of Financial Statement Analysis:

i) Comparative Statement Analysis: This technique involves comparing financial statements of different periods to analyze changes in financial performance. It helps in identifying trends in revenue, expenses, assets, and liabilities over time.

ii) Common Size Statement Analysis: In this method, each item in the financial statement is expressed as a percentage of a base figure. For example, in a common size income statement, each expense is shown as a percentage of total revenue. This helps in comparing companies of different sizes.

iii) Trend Analysis: Trend analysis examines financial data over multiple periods to identify patterns of growth or decline. It helps businesses predict future performance and make informed financial decisions.

iv) Ratio Analysis: This technique uses various financial ratios to evaluate a company’s performance. Some key ratios include:

Liquidity Ratios (e.g., Current Ratio, Quick Ratio) to assess short-term financial stability.
Solvency Ratios (e.g., Debt-Equity Ratio, Interest Coverage Ratio) to measure long-term financial strength.
Profitability Ratios (e.g., Net Profit Margin, Return on Assets) to determine the company's ability to generate profits.
Efficiency Ratios (e.g., Inventory Turnover Ratio, Asset Turnover Ratio) to analyze operational effectiveness.

v) Cash Flow Analysis: This technique studies the cash inflows and outflows of a business, helping in understanding liquidity and cash management. It ensures that a company has enough cash to meet its obligations.

vi) Fund Flow Analysis: Fund flow analysis examines the sources and uses of funds during a particular period. It helps in understanding how a company raises and utilizes financial resources.

vii) DuPont Analysis: This is an advanced technique that breaks down return on equity (ROE) into multiple components, providing insights into profitability, asset efficiency, and financial leverage.

Limitations of Financial Statement Analysis:

i) Based on Historical Data: Financial statements reflect past performance, which may not always be a reliable indicator of future performance.

ii) Ignores Non-Financial Factors: Financial analysis does not consider qualitative factors such as management efficiency, brand reputation, or customer satisfaction, which can impact a company’s success.

iii) Differences in Accounting Policies: Companies may follow different accounting methods (e.g., depreciation methods, inventory valuation techniques), making it difficult to compare financial statements across companies.

iv) Influence of Inflation: Financial statements may not account for inflation, leading to distorted financial ratios and misinterpretation of data.

v) Window Dressing: Companies may manipulate financial statements to present a better financial position than reality, misleading investors and stakeholders.

vi) Limited Scope in Dynamic Markets: Rapid changes in market conditions, regulatory policies, and technological advancements are not always reflected in financial statements, making the analysis less effective.

vii) Dependency on Estimates: Some financial data is based on estimates (e.g., provisions for doubtful debts, depreciation), which may not always be accurate and can affect the reliability of the analysis.

In conclusion, financial statement analysis is a valuable tool for assessing a company's financial health, but it has limitations that should be considered while making business or investment decisions. A combination of financial and non-financial factors should be used for a more comprehensive evaluation.

b) What is financial statement analysis? Discuss the importance of financial statement analysis.

Answer: Financial statement analysis is the process of examining a company's financial statements to assess its financial health, performance, and stability. The primary financial statements analyzed include the balance sheet, income statement, and cash flow statement. This analysis helps stakeholders such as investors, creditors, management, and regulatory authorities in making informed decisions.

Importance of Financial Statement Analysis:

i) Helps in Decision-Making: Financial statement analysis provides essential insights that help management, investors, and creditors in making strategic decisions regarding investments, lending, and business operations.

ii) Evaluates Profitability: By analyzing financial statements, businesses can assess their profitability using ratios such as gross profit margin, operating profit margin, and net profit margin. This helps in understanding how efficiently a company is generating profits.

iii) Assesses Liquidity Position: Liquidity analysis helps in determining whether a company has sufficient short-term assets to cover its short-term liabilities. Ratios like the current ratio and quick ratio are used for this purpose.

iv) Determines Solvency and Financial Stability: Financial statement analysis helps in assessing a company’s ability to meet its long-term obligations. Solvency ratios such as the debt-equity ratio and interest coverage ratio are useful indicators of financial stability.

v) Facilitates Comparison: Financial analysis enables comparisons between companies in the same industry, as well as comparisons of a company’s financial performance over different periods. This helps investors and analysts in benchmarking performance.

vi) Identifies Strengths and Weaknesses: Analyzing financial statements highlights areas of strength (such as high profitability or strong cash flow) and areas that need improvement (such as excessive debt or declining revenues).

vii) Assists in Investment Decisions: Investors use financial analysis to determine whether a company is a good investment opportunity. By assessing profitability, liquidity, and growth potential, investors can make informed decisions about buying, holding, or selling shares.

viii) Supports Credit Decisions: Banks and financial institutions analyze financial statements before granting loans or credit to businesses. This helps in evaluating a company's creditworthiness and ability to repay loans.

ix) Helps in Forecasting and Planning: Businesses use financial statement analysis to forecast future financial performance, plan budgets, and set financial goals. Trend analysis and cash flow projections are particularly useful for long-term planning.

x) Ensures Regulatory Compliance: Regulatory bodies require companies to disclose their financial statements to ensure transparency and compliance with accounting standards and legal requirements. Financial analysis helps in ensuring that companies adhere to these standards.

xi) Assists in Cost Control: By analyzing cost structures and expense trends, businesses can identify areas where costs can be reduced, improving overall efficiency and profitability.

xii) Detects Fraud and Irregularities: Financial analysis can help detect anomalies in financial statements, such as unusual expense patterns, revenue recognition issues, or inflated asset values, which may indicate fraud or financial mismanagement.

In conclusion, financial statement analysis plays a crucial role in assessing a company’s financial health, guiding decision-making, and ensuring long-term sustainability. It is an essential tool for management, investors, creditors, and regulatory authorities to evaluate performance, mitigate risks, and capitalize on growth opportunities.

5. Solve the following: (14 Marks)

Prepare a Balance Sheet from the following information:

Gross profit (20% of sales) – ₹30,000
Equity share capital – ₹25,000
Credit sales to total sales – 80%
Total assets turnover – 3 times
Stock turnover – 8 times
Average collection period (360 days) – 18 days
Current ratio – 1.6:1
Long-term debt ratio – 40% to equity

Answer: [Download PDF]

Explain the following (any four): (3½×4=14)

a) Balance Sheet ratio
b) Solvency ratio
c) Return on investment
d) Stock turnover ratio
e) Gross profit ratio

Answer: a) Balance Sheet Ratio: A Balance Sheet Ratio is a financial ratio derived from the figures in a company's balance sheet. It helps assess the financial position of a company at a specific point in time. These ratios indicate the liquidity, solvency, and financial structure of a business. Some common balance sheet ratios include:

i) Current Ratio = Current Assets / Current Liabilities (Measures short-term liquidity)
ii) Debt-Equity Ratio = Total Debt / Shareholders’ Equity (Measures financial leverage)
iii) Working Capital Ratio = Current Assets - Current Liabilities (Indicates short-term financial health)

These ratios help stakeholders understand how well a company manages its resources and obligations.

b) Solvency Ratio: A Solvency Ratio measures a company’s ability to meet its long-term financial obligations. It indicates whether a business has enough assets to cover its debts in the long run. Some important solvency ratios include:

i) Debt-Equity Ratio = Total Debt / Shareholders’ Equity (Indicates financial leverage)
ii) Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense (Measures a company's ability to pay interest on debt)
iii) Total Assets to Debt Ratio = Total Assets / Total Debt (Shows the proportion of total assets financed by debt)

A higher solvency ratio indicates financial stability, while a lower ratio suggests higher financial risk.

c) Return on Investment (ROI): Return on Investment (ROI) is a profitability ratio that measures the efficiency of an investment in generating profits. It is used to evaluate the return earned from an investment relative to its cost. The formula for ROI is:

ROI = Net Profit/Investment Cost x 100

For example, if an investor spends ₹1,00,000 on a business and earns a net profit of ₹20,000, the ROI will be:

20,000/1,00,000 x 100 = 20%

A higher ROI indicates a more profitable investment, whereas a lower ROI suggests inefficiency in generating returns.

d) Stock Turnover Ratio: The Stock Turnover Ratio, also known as Inventory Turnover Ratio, measures how efficiently a company manages its inventory. It shows how many times inventory is sold and replaced during a given period. The formula is:

Stock Turnover Ratio = Cost of Goods Sold (COGS)/Average Inventory

For example, if a company has COGS of ₹2,00,000 and an average inventory of ₹40,000,

2,00,000/40,000 = 5

This means the inventory is sold and restocked five times in the period. A higher ratio indicates efficient inventory management, while a lower ratio suggests overstocking or slow sales.

e) Gross Profit Ratio: The Gross Profit Ratio measures the proportion of gross profit to total sales and indicates a company's ability to generate profit from its core business operations. The formula is:

Gross Profit Ratio = Gross Profit / Net Sales x 100

For example, if a company has Gross Profit of ₹50,000 and Net Sales of ₹2,00,000,

50,000/2,00,000 x 100 = 25%

A higher gross profit ratio means the company has better control over production costs, while a lower ratio indicates higher expenses or lower profitability.

Thus, these financial ratios play a crucial role in analyzing a company's financial performance and stability.

6. Answer the following: (14 Marks)

a) "Financial reporting is intended to supply information useful to various groups in making decisions." Explain.

Answer: Financial reporting is the process of presenting financial information about a company's performance, position, and cash flows to various stakeholders. The primary objective of financial reporting is to provide useful financial information to assist different groups in making informed decisions. The key aspects of financial reporting and its usefulness to various stakeholders are discussed below:

1. Importance of Financial Reporting:

i) Provides Transparency: It ensures that financial data is available to investors, regulators, and other stakeholders, helping them assess a company’s financial health.

ii) Assists in Decision-Making: It helps different groups, such as investors, creditors, and management, make informed decisions about investments, lending, and business strategies.

iii) Ensures Compliance: Companies must follow accounting standards (such as GAAP and IFRS) to maintain uniformity and accuracy in financial reporting.

iv) Helps in Performance Evaluation: It allows stakeholders to analyze a company’s profitability, solvency, and overall performance over time.

2. Users of Financial Reports and Their Decision-Making:

i) Investors and Shareholders: Investors use financial statements to assess the profitability, risks, and potential returns of a company before making investment decisions.

ii) Creditors and Lenders: Banks and financial institutions analyze financial reports to determine a company’s creditworthiness before granting loans.

iii) Management and Employees: Internal management uses financial data for strategic planning, budgeting, and evaluating business performance. Employees may also be interested in financial stability for job security.

iv) Government and Regulatory Authorities: Tax authorities and regulators use financial reports to ensure companies comply with tax laws, financial regulations, and corporate governance standards.

v) Suppliers and Customers: Suppliers analyze financial reports to assess a company’s ability to make timely payments, while customers use them to determine long-term business viability.

3. Key Components of Financial Reporting:

i) Balance Sheet: Shows a company’s financial position, including assets, liabilities, and shareholders' equity.

ii) Income Statement: Provides information on revenues, expenses, and net profit or loss over a specific period.

iii) Cash Flow Statement: Reflects the company’s liquidity position by showing cash inflows and outflows.

iv) Notes to Financial Statements: Includes additional details on accounting policies, contingent liabilities, and other essential financial information.

4. Conclusion: Financial reporting plays a vital role in providing accurate, reliable, and transparent information to various stakeholders. It helps them assess a company’s financial health, make investment or lending decisions, and ensure regulatory compliance. Thus, financial reporting is a crucial tool for financial decision-making in the corporate world.

Or

b) Give a brief note on mandatory and voluntary disclosures in corporate social responsibility (CSR) reporting.

Answer: Corporate Social Responsibility (CSR) reporting refers to the disclosure of a company’s social, environmental, and ethical initiatives and their impact on stakeholders. It provides transparency regarding a company’s efforts to contribute to sustainable development. CSR reporting includes mandatory disclosures (as required by law) and voluntary disclosures (provided at the company’s discretion).

1. Mandatory Disclosures in CSR Reporting:

Certain companies are legally required to disclose their CSR activities under laws and regulations. In India, Section 135 of the Companies Act, 2013 mandates CSR reporting for companies meeting specific financial criteria. Key mandatory disclosures include:

i) CSR Policy Statement: Companies must disclose their CSR policies, objectives, and implementation strategies.

ii) CSR Expenditure: Companies with a net profit of ₹5 crore or more, revenue of ₹1,000 crore, or net worth of ₹500 crore must spend at least 2% of their average net profits on CSR activities.

iii) CSR Committee Details: Companies must disclose the composition of their CSR committee, including names of directors and their responsibilities.

iv) Annual CSR Report: The company must provide details of CSR activities, including funds allocated, projects undertaken, and their outcomes.

v) Reasons for Non-Spending: If a company fails to spend the required CSR amount, it must provide valid reasons in its annual report.

2. Voluntary Disclosures in CSR Reporting:

In addition to mandatory requirements, many companies choose to disclose additional CSR initiatives voluntarily to enhance transparency and reputation. Voluntary disclosures include:

i) Environmental Sustainability Initiatives: Details on efforts to reduce carbon footprint, renewable energy usage, and waste management.

ii) Employee Welfare and Diversity Programs: Information about employee benefits, workplace safety, gender diversity, and inclusion policies.

iii) Community Development Activities: Initiatives like education programs, healthcare support, rural development projects, and disaster relief contributions.

iv) Ethical Business Practices: Information on corporate governance, anti-corruption measures, fair trade practices, and ethical sourcing of materials.

v) Stakeholder Engagement: Companies often disclose how they engage with communities, NGOs, investors, and policymakers to address social and environmental concerns.

3. Benefits of CSR Reporting:

i) Enhances Corporate Reputation: Transparent CSR reporting improves the company’s image among stakeholders.

ii) Attracts Investors and Customers: Ethical and socially responsible businesses attract more investors and customer trust.

iii) Ensures Compliance and Reduces Legal Risks: Proper CSR reporting ensures compliance with legal requirements, avoiding penalties.

iv) Encourages Sustainable Business Practices: Helps companies adopt long-term sustainability goals and social responsibility.

4. Conclusion: CSR reporting is an essential aspect of corporate governance, ensuring accountability and transparency in business operations. While some CSR disclosures are mandatory under legal provisions, many companies voluntarily report additional initiatives to build trust and strengthen their brand image. Proper CSR disclosure benefits not only businesses but also society and the environment.

7. Answer the following: (14 Marks)

a) Discuss the impact of IFRS on Indian banking companies.

Answer: International Financial Reporting Standards (IFRS) are a set of global accounting principles designed to bring uniformity and transparency in financial reporting across different countries. In India, the banking sector has been significantly impacted by the convergence of Indian Accounting Standards (Ind AS) with IFRS. The Reserve Bank of India (RBI) has mandated that banks follow Ind AS, which is aligned with IFRS, to improve the quality and comparability of financial statements.

The impact of IFRS on Indian banking companies is discussed below:

Standardization of Financial Reporting
IFRS ensures uniformity in financial statements, making it easier for investors, regulators, and stakeholders to compare the performance of Indian banks with global banks. This enhances investor confidence and attracts foreign investments in the Indian banking sector.
Changes in Loan Loss Provisioning
Under IFRS 9, banks are required to follow the Expected Credit Loss (ECL) model instead of the Incurred Loss Model. This means banks have to recognize and provide for expected future credit losses in advance, rather than waiting for a default to occur. This improves risk management but increases the provisioning burden on banks, affecting profitability.
Fair Value Accounting
IFRS mandates fair value accounting for financial instruments instead of the historical cost method. This affects asset valuation in banks, as financial instruments such as loans, investments, and derivatives must be recorded at their fair market value. While this increases transparency, it also makes earnings more volatile due to frequent market fluctuations.
Improved Transparency and Disclosure Requirements
IFRS requires banks to provide detailed disclosures on financial instruments, risk management policies, and liquidity positions. This helps regulators and stakeholders assess the financial health of banks more effectively. It also ensures that banks follow ethical practices in financial reporting.
Revenue Recognition
IFRS introduces strict guidelines on revenue recognition, ensuring that income from loans, investments, and banking services is recorded accurately. This reduces the chances of manipulation and provides a clearer picture of a bank’s financial performance.
Impact on Financial Ratios and Capital Requirements
The implementation of IFRS affects key financial ratios such as the debt-equity ratio, return on assets, and capital adequacy ratio. Banks may need to adjust their capital structure and provisioning methods to comply with the new accounting standards.
Challenges in Implementation
The transition to IFRS requires banks to upgrade their accounting systems, train employees, and ensure compliance with new reporting standards. This involves significant costs and operational challenges, especially for smaller banks that may lack adequate resources.
Better Risk Management and Decision-Making
With detailed financial disclosures and early recognition of credit risks, IFRS helps banks in better risk assessment and strategic decision-making. It enables banks to identify potential financial risks in advance and take necessary measures to mitigate them.

Conclusion The implementation of IFRS in Indian banking companies has significantly improved transparency, financial discipline, and risk management. It has brought Indian banks in line with global financial reporting standards, making them more competitive in international markets. However, the transition to IFRS also presents challenges such as earnings volatility, increased compliance costs, and complex accounting adjustments. Despite these difficulties, IFRS is a crucial step toward strengthening the financial stability and credibility of the Indian banking sector.

Or

b) What is a Non-Banking Financial Company? Discuss the RBI guidelines on the regulatory framework of NBFCs.

Answer: A Non-Banking Financial Company (NBFC) is a financial institution that provides banking-like services without holding a banking license. NBFCs are regulated by the Reserve Bank of India (RBI) and play a crucial role in credit expansion by offering loans, asset financing, investment services, and microfinance. Unlike banks, NBFCs cannot accept demand deposits, meaning they cannot allow withdrawals through cheques or savings accounts.

Definition of NBFC

According to the Reserve Bank of India Act, 1934, an NBFC is a company engaged in the business of:

Providing loans and advances
Acquiring shares, stocks, bonds, or securities
Leasing and hire-purchase financing
Insurance and chit fund businesses

NBFCs do not form part of the payment and settlement system, which means they cannot issue cheques or provide overdraft facilities like banks.

Classification of NBFCs

The RBI classifies NBFCs into different types based on their activities:

Deposit-taking NBFCs (NBFC-D) – These NBFCs accept fixed deposits under strict RBI regulations.
Non-Deposit Taking NBFCs (NBFC-ND) – These NBFCs provide loans and financial services but do not accept public deposits.
Systemically Important NBFCs (NBFC-ND-SI) – Large NBFCs with asset size above ₹500 crore, which are subject to additional regulatory requirements.
Microfinance NBFCs (NBFC-MFI) – Provide small loans to low-income groups without collateral.
Housing Finance Companies (HFCs) – Specialize in providing home loans and financing for real estate projects.

RBI Guidelines on the Regulatory Framework of NBFCs

Minimum Capital Requirements
The RBI mandates that NBFCs must have a minimum Net Owned Fund (NOF) of ₹2 crore to operate legally. Systemically important NBFCs must maintain a higher capital adequacy ratio to ensure financial stability.
Asset Classification and Provisioning Norms
NBFCs are required to classify their assets into four categories:

Standard Assets
Substandard Assets
Doubtful Assets
Loss Assets

NBFCs must maintain provisions against non-performing assets (NPAs) to safeguard financial stability.

Liquidity Coverage Ratio (LCR)
The RBI has made it mandatory for large NBFCs to maintain sufficient high-quality liquid assets to meet short-term obligations. This prevents liquidity crises and ensures smooth operations.
Borrowing Limits
To prevent over-reliance on debt, NBFCs must diversify their funding sources. The RBI imposes restrictions on short-term borrowings to reduce financial risks.
Corporate Governance and Risk Management
NBFCs with assets of ₹500 crore or more must establish risk management committees, appoint independent directors, and follow strict corporate governance guidelines. They must also conduct stress testing to evaluate financial risks.
Restrictions on Public Deposits
Only NBFCs that have received special approval from the RBI can accept public deposits. The maximum deposit tenure is five years, and the interest rate cannot exceed the RBI’s prescribed limit.
Mandatory Credit Rating
NBFCs that accept public deposits must obtain a credit rating from an approved credit rating agency. This ensures transparency and protects depositors from financial fraud.
Foreign Investment in NBFCs
The RBI allows up to 100% Foreign Direct Investment (FDI) in NBFCs under the automatic route, provided they comply with the capital adequacy and prudential norms.

Conclusion Non-Banking Financial Companies play a crucial role in financial inclusion by providing credit to individuals, small businesses, and rural sectors that may not have access to traditional banking services. The RBI’s regulatory framework ensures that NBFCs operate in a safe and transparent manner, protecting investors and depositors from financial risks. With the rise of digital lending and fintech-based NBFCs, RBI regulations continue to evolve to maintain stability and prevent financial fraud in the sector.

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