MBA 5 YEAR INTEGRATED FINANCE NOTES

1. UNIT-3
Financial statement analysis involves the identification of the following items for a
company's financial statements over a series of reporting periods:
 Trends. Create trend lines for key items in the financial statements over multiple time
periods, to see how the company is performing. Typical trend lines are for revenues,
the gross margin, net profits, cash, accounts receivable, and debt.
 Proportion analysis. An array of ratios are available for discerning the relationship
between the size of various accounts in the financial statements. For example, you can
calculate a company's quick ratio to estimate its ability to pay its immediate liabilities,
or its debt to equity ratio to see if it has taken on too much debt. These analyses are
frequently between the revenues and expenses listed on the income statement and the
assets, liabilities, and equity accounts listed on the balance sheet.
Financial statement analysis is an exceptionally powerful tool for a variety of users of
financial statements, each having different objectives in learning about the financial
circumstances of the entity.
Users of Financial Statement Analysis
There are a number of users of financial statement analysis. They are:
 Creditors. Anyone who has lent funds to a company is interested in its ability to pay
back the debt, and so will focus on various cash flow measures.
 Investors. Both current and prospective investors examine financial statements to
learn about a company's ability to continue issuing dividends, or to generate cash
flow, or to continue growing at its historical rate (depending upon their investment
philisophies).
 Management. The company controller prepares an ongoing analysis of the company's
financial results, particularly in relation to a number of operational metrics that are not
seen by outside entities (such as the cost per delivery, cost per distribution channel,
profit by product, and so forth).
 Regulatory authorities. If a company is publicly held, its financial statements are
examined by the Securities and Exchange Commission (if the company files in the
United States) to see if its statements conform to the various accounting standards and
the rules of the SEC.
Methods of Financial Statement Analysis
There are two key methods for analyzing financial statements. The first method is the use of
horizontal and vertical analysis. Horizontal analysis is the comparison of financial
information over a series of reporting periods, while vertical analysis is the proportional
analysis of a financial statement, where each line item on a financial statement is listed as a
percentage of another item. Typically, this means that every line item on an income statement

2. is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a
percentage of total assets. Thus, horizontal analysis is the review of the results of multiple
time periods, whiile vertical analysis is the review of the proportion of accounts to each other
within a single period. The following links will direct you to more information about
horizontal and vertical analyis:
 Horizontal analysis
 Vertical analysis
The second method for analyzing financial statements is the use of many kinds of ratios. You
use ratios to calculate the relative size of one number in relation to another. After you
calculate a ratio, you can then compare it to the same ratio calculated for a prior period, or
that is based on an industry average, to see if the company is performing in accordance with
expectations. In a typical financial statement analysis, most ratios will be within expectations,
while a small number will flag potential problems that will attract the attention of the
reviewer.
There are several general categories of ratios, each designed to examine a different aspect of
a company's performance. The general groups of ratios are:
1. Liquidity ratios. This is the most fundamentally important set of ratios, because they
measure the ability of a company to remain in business. Click the following links for a
thorough review of each ratio.
o Cash coverage ratio. Shows the amount of cash available to pay interest.
o Current ratio. Measures the amount of liquidity available to pay for current
liabilities.
o Quick ratio. The same as the current ratio, but does not include inventory.
o Liquidity index. Measures the amount of time required to convert assets into
cash.
2. Activity ratios. These ratios are a strong indicator of the quality of management, since
they reveal how well management is utilizing company resources. Click the following
links for a thorough review of each ratio.
o Accounts payable turnover ratio. Measures the speed with which a company
pays its suppliers.
o Accounts receivable turnover ratio. Measures a company's ability to collect
accounts receivable.
o Fixed asset turnover ratio. Measures a company's ability to generate sales from
a certain base of fixed assets.
o Inventory turnover ratio. Measures the amount of inventory needed to support
a given level of sales.
o Sales to working capital ratio. Shows the amount of working capital required
to support a given amount of sales.
o Working capital turnover ratio. Measures a company's ability to generate sales
from a certain base of working capital.

3. 3. Leverage ratios. These ratios reveal the extent to which a company is relying upon
debt to fund its operations, and its ability to pay back the debt. Click the following
links for a thorough review of each ratio.
o Debt to equity ratio. Shows the extent to which management is willing to fund
operations with debt, rather than equity.
o Debt service coverage ratio. Reveals the ability of a company to pay its debt
obligations.
o Fixed charge coverage. Shows the ability of a company to pay for its fixed
costs.
4. Profitability ratios. These ratios measure how well a company performs in generating
a profit. Click the following links for a thorough review of each ratio.
o Breakeven point. Reveals the sales level at which a company breaks even.
o Contribution margin ratio. Shows the profits left after variable costs are
subtracted from sales.
o Gross profit ratio. Shows revenues minus the cost of goods sold, as a
proportion of sales.
o Margin of safety. Calculates the amount by which sales must drop before a
company reaches its breakeven point.
o Net profit ratio. Calculates the amount of profit after taxes and all expenses
have been deducted from net sales.
o Return on equity. Shows company profit as a percentage of equity.
o Return on net assets. Shows company profits as a percentage of fixed assets
and working capital.
o Return on operating assets. Shows company profit as percentage of assets
utilized.
Problems with Financial Statement Analysis
While financial statement analysis is an excellent tool, there are several issues to be aware of
that can interfere with your interpretation of the analysis results. These issues are:
 Comparability between periods. The company preparing the financial statements may
have changed the accounts in which it stores financial information, so that results may
differ from period to period. For example, an expense may appear in the cost of goods
sold in one period, and in administrative expenses in another period.
 Comparability between companies. An analyst frequently compares the financial
ratios of different companies in order to see how they match up against each other.
However, each company may aggregate financial information differently, so that the
results of their ratios are not really comparable. This can lead an analyst to draw
incorrect conclusions about the results of a company in comparison to its competitors.
 Operational information. Financial analysis only reviews a company's financial
information, not its operational information, so you cannot see a variety of key
indicators of future performance, such as the size of the order backlog, or changes in
warranty claims. Thus, financial analysis only presents part of the total picture.

4. What is a Financial Analysis Report?
 Comprehensive financial analysis reports accentuate the strengths and
weaknesses of a company. Communicating the company’s strengths and
weaknesses in an accurate and honest manner is helpful in convincing the investors
to invest in your business. A financial analysis report is, basically, a document that
attracts high interest of investors as it contains a detailed appraisal of a company’s
financial health.
How to write a Financial Analysis Report
1. Start the report with an “Executive Summary” of important findings from the financial
analysis. Also state the time period focused by the study in addition to identifying the firm
requesting the report.
2. Set up an introduction emphasizing the objectives of the report. Also define financial
terms necessary for understanding those objectives.
3. Move on to a section with “Resources” title. Give a general description of the analyzed
data and where has it been sourced from. Some examples of resource include balance
sheets, income statements, operating costs, inventory ratios, and warehouse statistics.
4. Further describe the resources under the heading “Method of Collecting Data”. Mention
whether the data was received from different sources, like government agencies or
departments within the firm. Also explain each source’s method for reporting data.
Explain about the method of accounting analysis for these distinct reporting methods.
5. Title the next section as “Significant Financial Events” and under this section, enlist the
events which occurred during the studied time period and which altered results.
6. Proceed with a section titled “Detailed Results” which includes a comprehensive
analysis about the investment returns, balance sheets, income statement, and productivity
ratios. Also comment on each of these factors in addition to providing support for your
statements with graphs and tables.
7. Evaluate results from various quarters in a section titled “Analysis of Variance”.
8. Prepare an appendix for “Financial Revenues” defining how that term was used for
preparing the report. Tabulate the revenues over the analysis’ time period.
9. End the report with an appendix for “Observations” discussing any problems faced
while performing analysis and thereafter explaining about how research method handled
problems. Conclude the report with a statement projecting future performance on the basis
of past years’ performance.

5. The balanced scorecard (BSC) is a strategy performance management tool – a semi-
standard structured report, supported by design methods and automation tools, that can be
used by managers to keep track of the execution of activities by the staff within their control
and to monitor the consequences arising from these actions.[1]
The phrase 'balanced scorecard' is commonly used in two broad forms:
1. As individual scorecardsthatcontainmeasurestomanage performance,those scorecards
may be operational orhave a more strategicintent;and
2. As a StrategicManagementSystem, asoriginallydefinedbyKaplan&Norton.
The critical characteristics that define a balanced scorecard are:[2]
 itsfocus onthe strategicagendaof the organizationconcerned
 the selectionof asmall numberof data itemstomonitor
 a mix of financial andnon-financialdataitems.
The Balanced Scorecard (BSC) is a business framework used for tracking and managing an
organization’s strategy.
The BSC framework is based on the balance between leading and lagging indicators, which
can respectively be thought of as the drivers and outcomes of your company goals. When
used in the Balanced Scorecard framework, these key indicators tell you whether or not
you’re accomplishing your goals and whether you’re on the right track to accomplish future
goals.
With a Balanced Scorecard, you have the capability to:
The Origin Of The Balanced Scorecard
In 1992, Drs. David P. Norton and Robert S. Kaplan started a working group to examine the
challenge of reporting only on financial measures. In for-profit organizations, financial
measures provided a lagging report (i.e. they told you what happened last month, quarter, or

6. year), but they were not able to look forward. Norton and Kaplan wanted to specifically look
at what measures that look forward in time and act as leading indicators might look like and
how that could affect an organization’s strategy.
Scorecard Lingo 101
If you build a Balanced Scorecard, you’re going to hear the words “objective,” “measure,”
“initiative (or project),” and “action item” frequently. Here’s a quick cheat sheet to explain
what they all mean.
-level goal in mind, which is your objective.
know that I’m achieving the objective?” (In other words,
they allow you to see if you’re meeting your goals.)
accomplish the objective?” In theory, these are the places you’re spending money or putting
forth effort to improve your performance.
Keep in mind, you may have multiple initiatives focused on improving your measures and
achieving your objective. And if your projects are not helping you improve in these areas,
you may need to rethink your overall strategy.
A Simple Breakdown Of The Balanced Scorecard Framework
Throughout the process of creating the BSC, Norton and Kaplan realized an organization
must first begin with goals that can broken down into four distinct perspectives that are
uniquely connected:
1.Financial goals—“What financial goals do we have that will impact our organization?”
2.Customer goals—“What things are important to our customers, which will in turn impact
our financial standing?”

7. 3.Process goals—“What do we need to do well internally, in order to meet our customer
goals, that will impact our financial standing?”
4.People (or learning and growth) goals—“What skills, culture, and capabilities do we need
to have in our organization in order to execute on the process that would make our customers
happy and ultimately impact our financial standing?”
Over time, the concept of a strategy map was created. A Balanced Scorecard strategy map is
a one-page visual depiction of an organization’s scorecard. It has the ability to show the
connections between all four perspectives in a one-page picture. If you want some examples
in your industry, download one of our free ebooks:
Purpose Behind the Balanced Scorecard
The balanced scorecard is used to reinforce good behaviors in an organization by isolating
four separate areas that need to be analyzed. These four areas, also called legs, involve
learning and growth, business processes, customers, and finance. The balanced scorecard is
used to attain objectives, measurements, initiatives and goals that result from these four
primary functions of a business. Companies can easily identify factors hindering company
performance and outline strategic changes tracked by future scorecards. With the balanced
scorecard, they look at the company as a whole when viewing company objectives. An
organization may use the balanced scorecard to implement strategy mapping to see where
value is added within an organization. A company also utilizes the balanced scorecard to
develop strategic initiatives and strategy objectives
How is the Balanced Scorecard typically put to use?
A Balanced Scorecard is most often used in three ways:
1.To bring an organization’s strategy to life. Those in the company can then use this strategy
to make decisions company-wide.
2.To communicate the strategy across the organization. This is where the strategy map is
critical. Organizations print it and include it in interoffice communications, put it on their
intranet, communicate it with business partners, publish it on their website, and more.
3.To track strategic performance. That’s typically done through monthly, quarterly, and
annual reports.

8. Who should use the BSC?
The Balanced Scorecard has been proven to be applicable in all industries—for-profit,
nonprofit, government, healthcare, and more—and for organizations of all sizes.
Typically it’s used by leadership teams either at the executive level of the organization or at
the division or department level. One of the keys to an effective scorecard is having
leadership buy-in. That might seem obvious at first glance, but it’s easy to get enthusiastic
about the scorecarding concept, see that it is relatively simple to implement, and move
forward without the true buy-in and understanding from the leadership team you need.
The reason this can be such a struggle is because in order to make the BSC work in your
organization, you have to change the way you’re currently managing. You will have to stop
the weekly KPI reports or weekly leadership meetings and integrate any strategic
management tactics into your scorecard. Of course, if your leadership team doesn’t buy into
this concept, they’re not going to be obliged to change the way they handle their strategy and
management.
Understanding Variance analysis
The primary objective of variance analysis is to exercise cost control and cost reduction.
Under standard costing system, the management by exception principle is applied through
variance analysis. The variances are related to efficiency. The showing of efficiency leads to
favorable variance. In this case, the responsible persons are rewarded. On the other hand, the
showing of in efficiency leads to unfavorable variance. In this case, the responsible persons
are enquired and find the root causes for such unfavorable variances. This type of findings are
used for taking remedial action
Variance analysis is the resolution into constituent parts and explanation of variances”.
Types of Variances
There is a need of knowing types of variances before measuring the variances. Generally, the
variances are classified on the following basis.

9. A brief explanation of the above mentioned variances are presented below
1. Material Cost Variance: It is the difference between actual cost of materials used and the
standard cost for the actual output.
2. Labour Cost Variance: It is the difference between the actual direct wages paid and the
direct labour cost allowed for the actual output to be achieved.
3. Overhead Variance: Overhead variance is the difference between the standard cost of
overhead allowed for actual output (in terms of production units or labour hours) and the
actual overhead cost incurred.
4. Controllable Variance: A variance is controllable whenever an individual or a department
or section or division may be held responsible for that variance.
According to ICMA, London,
“Controllable cost variance is a cost variance which can be identified as primary
responsibility of a specified person”.
5. Uncontrollable Variance: External factors are responsible for uncontrollable variances. The
management has no power or is unable to control the external factors. Variances for which a
particular person or a specific department or section or division cannot be held responsible
are known as uncontrollable variances.

10. 6. Favourable Variances: Whenever the actual costs are lower than the standard costs at per-
determined level of activity, such variances termed as favorable variances. The management
is concentrating to get actual results at costs lower than the standard costs. It shows the
efficiency of business operation.
7. Unfavorable Variances: Whenever the actual costs are more than the standard costs at
predetermined level of activity, such variances termed as unfavorable variances. These
variances indicate the inefficiency of business operation and need deeper analysis of these
variances.
8. Basic Variances: Basic variances are those variances which arise on account of monetary
rates (i.e. price of raw materials or labour rate) and also on account of non-monetary factors
(such as physical units in quantity or time). Basic variances due to monetary factors are
material price variance, labour rate variance and expenditure variance. Similarly, basic
variance due to non-monetary factors are material quantity variance, labour efficiency
variance and volume variance.
9. Sub Variance: Basic variances arising due to non-monetary factors are further analyzed
and classified into sub-variances taking into account the factors responsible for them. Such
sub variances are material usage variance and material mix variance of material quantity
variance. Likewise, labour efficiency variance is subdivided into labour mix variance and
labour yield variance. At the same time, variable overhead variance is sub-divided into
variable overhead efficiency variance and variable overhead expenditure variance.
Advantages of Variance analysis
The following are the merits of variance analysis.
1. The reasons for the overall variances can be easily find out for taking remedial action.

11. 2. The sub-division of variance analysis discloses the relationship prevailing between
different variances.
3. It is highly useful for fixing responsibility of an individual or department or section for
each variance separately.
4. It highlights all inefficient performances and the extent of inefficiency.
5. It is used for cost control.
6. The top management can follow the principle of management by exception. Only
unfavorable variances are reporting to management.
7. Sometimes, the variances can be classified as controllable and uncontrollable variances. In
this case, controllable variances are taken into consideration for further action.
8. Profit planning work can be properly carried on by the top management.
9. The results of managerial action can be a cost reduction.
10. It creates cost consciousness in the minds of the every employee of business organization.
Variance analysis, in budgeting (or management accounting in general), is a tool of
budgetary control by evaluation of performance by means of variances between budgeted
amount, planned amount or standard amount and the actual amount incurred/sold. Variance
analysis can be carried out for both costs and revenues.
Variance analysis is usually associated with explaining the difference (or variance) between
actual costs and the standard costs allowed for the good output. For example, the difference
in materials costs can be divided into a materials price variance and a materials usage
variance. The difference between the actual direct labor costs and the standard direct labor

12. costs can be divided into a rate variance and an efficiency variance. The difference in
manufacturing overhead can be divided into spending, efficiency, and volume variances. Mix
and yield variances can also be calculated.
Variance analysis helps management to understand the present costs and then to control
future costs.
Limitations of Variance Analysis
The variance analysis is been of large use to corporations; however it comes with its own set of
limitations as follows:
 Variance analysis as an activity is based on financial results which are released much
later after quarterly closing; there may be a time gap which may affect the remedial
action taking an ability to a certain extent. Also, not all sources of variance may be
available in accounting data which makes acting upon variances difficult.
 If the budgeting is not made taking into consideration the detailed analysis of each factor,
the budgeting exercise may be loosely done which is bound to deviate from the actual
numbers. Thereafter analysing variances may not be a useful activity.