⭐ PART – 1 : FINANCIAL STATEMENTS
📌 Meaning
Financial Statements are the final reports prepared at the end of accounting period to show profit/loss and financial position of the business.
Simple words:
Financial Statements tell how much business earned, spent, owns & owes.
📌 Objectives
| Objective | Explanation |
|---|---|
| Know Profit or Loss | From Trading A/c & P&L A/c |
| Know Financial Position | From Balance Sheet |
| Help in Decision Making | Expand, close, borrow etc. |
| Show Business Health | To owners, investors, banks |
| Legal Requirement | Must prepare annually |
📌 Uses
- Helps owners understand performance
- Investors check before investing
- Bank sees before giving loans
- Government checks taxation
- Managers use it for planning
📌 Limitations
- Based on historical data, not future
- Does not show non-financial factors (employee morale)
- Asset values sometimes not realistic due to depreciation
- Window dressing possible if management manipulates
📌 Types of Financial Statements
| Part | What it Shows |
|---|---|
| Trading Account | Gross Profit or Loss |
| Profit & Loss Account | Net Profit or Loss |
| Balance Sheet | Assets & Liabilities |
| Cash Flow Statement | Inflow/Outflow of cash |
| Fund Flow Statement | Movement of working capital |
🔶 Trading Account
Shows Gross Profit = Sales – Cost of Goods Sold
Format (Easy)
Dr. | Trading Account | Cr.
| Particulars | Amt | Particulars | Amt |
|---|---|---|---|
| Opening Stock | xx | Sales | xx |
| Purchases | xx | Closing Stock | xx |
| Direct Expenses | xx | ||
| To Gross Profit c/d | xx |
Example
Sales = 2,00,000
Opening Stock = 20,000
Purchases = 1,00,000
Closing Stock = 30,000
Direct Wages = 10,000
Gross Profit = Sales + Closing Stock − (Opening Stock + Purchases + Wages)
= 2,00,000 + 30,000 − (20,000+1,00,000+10,000)
= 2,30,000 − 1,30,000 = 1,00,000 GP
🔶 Profit & Loss Account
Shows Net Profit = Gross Profit – Indirect Expenses + Other Incomes
| Particulars | Amt | Particulars | Amt |
|---|---|---|---|
| Salaries | xx | Gross Profit b/d | xx |
| Rent | xx | Interest Received | xx |
| Electricity | xx | Commission Received | xx |
| To Net Profit | xx |
Example (continuation)
Gross Profit = 1,00,000
Rent 10,000; Salary 15,000; Electricity 5,000; Interest Received 2,000
Net Profit = Gross Profit – Indirect Exp + Incomes
= 1,00,000 – (10,000+15,000+5,000) + 2,000
= 1,00,000 – 30,000 + 2,000
= ₹72,000
🔶 Balance Sheet
Shows financial position:
Assets = Liabilities + Capital
| Liabilities | Amt | Assets | Amt |
|---|---|---|---|
| Capital | xx | Cash | xx |
| Creditors | xx | Debtors | xx |
| Loan | xx | Fixed Assets | xx |
| Closing Stock | xx |
Capital is adjusted:
Closing Capital = Opening Capital + Net Profit – Drawings
Example (final)
Capital (opening) = 5,00,000
Net Profit = 72,000
Drawings = 20,000
Closing Capital = 5,00,000 + 72,000 − 20,000 = 5,52,000
Balance Sheet
| Liabilities | Amt | Assets | Amt |
|---|---|---|---|
| Capital 5,52,000 | 5,52,000 | Cash 1,00,000 | 1,00,000 |
| Creditors 1,00,000 | Debtors 1,50,000 | 1,50,000 | |
| Loan 50,000 | Fixed Assets 3,52,000 | 3,52,000 |
Total = 7,02,000 both sides ✔
What you MUST prepare for exam from Part 1
| Topic | Expected questions |
|---|---|
| Financial Statement meaning/objectives | 5M theory |
| Trading/P&L/Balance sheet | 8-10M problem |
| Adjustments (Salary outstanding etc.) | practical |
Adjustment Examples (very important)
| Adjustment | Effect in Accounts |
|---|---|
| Closing stock | Credit Trading + shown in Assets |
| Outstanding Expenses | Add in P&L + shown as liability |
| Prepaid Expense | Deduct in P&L + shown in assets |
| Depreciation | Dr P&L + reduce asset value |
| Bad Debts | Dr P&L + reduce debtors |
PART – 2 : RATIO ANALYSIS
📌 Meaning
Ratio Analysis is a technique of analyzing financial statements using mathematical ratios to understand profitability, liquidity, solvency, efficiency and performance of the business.
Simple Words:
Ratios = Indicators which tell how strong or weak the business is financially.
📌 Objectives of Ratio Analysis
| Objective | Meaning |
|---|---|
| Measure profitability | How much profit firm earns from sales |
| Test liquidity | Ability to pay short-term obligations |
| Test solvency | Ability to pay long-term loans |
| Judge operational efficiency | Asset utilization, stock movement |
| Compare performance | Trend analysis over years |
| Assist in decision making | Credit, investment, management |
📌 Advantages
- Easy to understand business condition
- Helps compare current vs past performance
- Helps banks/investors judge creditworthiness
- Quick decision support tool
- Helps detect financial weakness early
📌 Limitations
- Based on historical data
- Window dressing may hide reality
- Different firms use different accounting methods
- Ratios alone cannot judge business health — need trends
🔥 Classification of Ratios (as per Syllabus)
| Category | Ratios Included |
|---|---|
| Liquidity Ratios | Current Ratio, Quick Ratio |
| Solvency Ratios | Debt-Equity Ratio, Proprietary Ratio |
| Activity Ratios | Inventory Turnover, Debtor Turnover, Creditor Turnover, Working Capital Turnover |
| Profitability Ratios | Gross Profit, Net Profit, Operating Ratio, ROCE, ROI, EPS |
Now each in detail with example.
🟦 1. LIQUIDITY RATIOS
Shows ability of business to pay short-term liabilities.
🔹 Current Ratio
Current Ratio = Current Assets / Current Liabilities
Ideal Ratio = 2 : 1
Example:
CA = 2,00,000
CL = 1,00,000
CR = 2,00,000 / 1,00,000 = 2 : 1 (Good position)
🔹 Quick Ratio (Acid Test Ratio)
Quick Ratio = Quick Assets / Current Liabilities
Quick Assets = Current Assets − Stock − Prepaid Expenses
Ideal = 1 : 1
Example:
CA = 2,00,000
Stock = 50,000
Prepaid = 10,000
CL = 1,00,000
Quick Assets = 2,00,000−50,000−10,000 = 1,40,000
Quick Ratio = 1,40,000 / 1,00,000 = 1.4 : 1 (Good)
🟥 2. SOLVENCY RATIOS
Ability of business to pay long-term debt.
🔹 Debt-Equity Ratio
Debt-Equity = Long term Debt / Shareholders’ Funds
Ideal = 1:1
Example:
Long term loan = 5,00,000
Equity = 10,00,000
Ratio = 5,00,000 / 10,00,000 = 0.5 : 1 (Safe)
🔹 Proprietary Ratio
Proprietary Ratio = Shareholders’ Funds / Total Assets
Shows ownership portion in assets.
Higher ratio = strong financially.
Example:
Shareholder fund = 10,00,000
Total assets = 15,00,000
Ratio = 10,00,000/15,00,000 = 0.67 or 67%
🟩 3. ACTIVITY RATIOS / TURNOVER RATIOS
Measure efficiency in using assets.
🔹 Inventory (Stock) Turnover Ratio
ITR = Cost of Goods Sold / Average Stock
Average Stock = (Opening + Closing Stock)/2
Example:
COGS = 3,00,000
Opening = 40,000
Closing = 60,000
Avg = 50,000
ITR = 3,00,000/50,000 = 6 times
Higher turnover = goods selling fast.
🔹 Debtors Turnover Ratio
Debtors Turnover = Credit Sales / Average Debtors
Example:
Credit sales = 2,40,000
Debtors = 30,000
Ratio = 2,40,000/30,000 = 8 times
Collection efficiency good.
🔹 Creditors Turnover Ratio
Credit Purchases / Average Creditors
Shows payment speed.
🔹 Working Capital Turnover Ratio
WCTR = Sales / Working Capital
Working Capital = Current Assets − Current Liabilities
Higher better.
🟨 4. PROFITABILITY RATIOS
🔹 Gross Profit Ratio
GP Ratio = (Gross Profit / Sales) × 100
Example: GP = 80,000, Sales = 2,00,000
= 80,000/2,00,000×100 = 40%
🔹 Net Profit Ratio
NP Ratio = (Net Profit / Sales) × 100
Shows actual earning capacity.
🔹 Operating Ratio
Operating Ratio = (COGS + Operating Expense) / Sales ×100
Lower better.
🔹 Return on Capital Employed (ROCE)
ROCE = (Net Profit / Capital Employed) ×100
Shows return business earns on investment.
🔹 Earnings Per Share (EPS)
EPS = Net Profit after tax / No. of Shares
Investors’ favorite.
Short Summary Sheet
| Ratio | Formula | Ideal |
|---|---|---|
| Current | CA/CL | 2:1 |
| Quick | (CA−Stock−Prepaid)/CL | 1:1 |
| Debt-Equity | Debt/Equity | 1:1 |
| Proprietary | Equity/Total Assets | Higher=better |
| Inventory Turnover | COGS/Avg Stock | Higher |
| Debtor Turnover | Credit Sales/Avg Debtor | Higher |
| GP Ratio | GP/Sales×100 | Higher |
| NP Ratio | NP/Sales×100 | Higher |
| ROCE | NP/Capital×100 | Higher |
| EPS | NP/No. of Shares | Higher |
What will be asked in Exam?
✔ Meaning/objectives of ratio analysis (5M theory)
✔ Liquidity ratio calculations (CR, QR)
✔ Profitability ratios numericals
✔ Turnover ratios numericals
Mostly paper gives Balance Sheet + P&L → Find Ratios.
PART – 3 FUND FLOW STATEMENT
📌 Meaning
Fund Flow Statement is a statement that shows changes in financial position between two balance sheet dates in terms of sources of funds and applications (uses) of funds.
Fund = Working Capital
Fund Flow = Movement of working capital
📌 Objectives
| Objective | Explanation |
|---|---|
| Know how funds were generated | Issue of shares, loan, profit |
| Know where funds were used | Asset purchase, loan repayment |
| Analyse financial position | Increase or decrease in working capital |
| Helps for planning & control | Long-term investment decisions |
📌 Sources of Funds (Inflow)
- Issue of shares or debentures
- Long-term loan raised
- Sale of fixed assets
- Operating profit
- Decrease in working capital
📌 Application of Funds (Outflow)
- Purchase of fixed assets
- Repayment of loan/debentures
- Payment of dividend/tax
- Loss from operations
- Increase in working capital
📌 Steps to Prepare Fund Flow Statement
- Prepare Schedule of Changes in Working Capital
Working Capital = Current Assets − Current Liabilities
- Find funds from operations (profit adjusted)
Add non-cash items (Depreciation, Loss on sale)
Less non-operating income (Profit on sale, interest received) - Prepare Fund Flow Statement
List sources → List applications → Balance = increase/decrease WC
📌 Format – Schedule of Changes in Working Capital
| Particulars | Yr-1 CA | Yr-2 CA | Increase | Decrease |
|---|---|---|---|---|
| Current Assets | xx | xx | ||
| Current Liabilities | xx | xx |
Increase in Working Capital = CA↑ or CL↓
Decrease in Working Capital = CA↓ or CL↑
📌 Example
Balance Sheets (Extract)
| Particulars | 2023 | 2024 |
|---|---|---|
| Debtors | 50,000 | 60,000 |
| Stock | 40,000 | 30,000 |
| Cash | 20,000 | 25,000 |
| Creditors | 30,000 | 20,000 |
Schedule of WC
| Particular | 2023 | 2024 | Increase | Decrease |
|---|---|---|---|---|
| Debtors | 50,000 | 60,000 | 10,000 | – |
| Stock | 40,000 | 30,000 | – | 10,000 |
| Cash | 20,000 | 25,000 | 5,000 | – |
| Creditors | 30,000 | 20,000 | – | 10,000↓ because CL decreased |
Working Capital Change:
Increase = 10,000 + 5,000 + 10,000 = 25,000
Decrease = 10,000
Net Increase = 15,000
📌 Fund Flow Statement Format
| Sources of Funds | Amt | Application of Funds | Amt |
|---|---|---|---|
| Issue of shares | xx | Purchase of machinery | xx |
| Fund from operations | xx | Repayment of loan | xx |
| Sale of asset | xx | Increase in WC | xx |
| ↓ | ↓ | ↓ | ↓ |
📘 CASH FLOW STATEMENT
📌 Meaning
Cash Flow Statement shows movement of cash & cash equivalents during a period under operating, investing & financing activities.
Cash Flow = Cash Inflows − Cash Outflows
It tells how cash came & where it went.
📌 Objectives
- Evaluate cash position & liquidity
- Helps in short-term planning & budgeting
- Useful for bankers, investors
- Shows capability to pay dividends/loans
- Measures real-time money movement
📌 Types of Activities
| Activity | Meaning | Examples |
|---|---|---|
| Operating | Cash from main business activity | Cash from sales, payment to supplier, wages |
| Investing | Cash spent/received on assets | Purchase/sale of machinery, land |
| Financing | Cash related to capital & loans | Issue of shares, repayment of loan |
📌 Cash Flow Statement Format
A. Cash Flow from Operating Activities
Net Profit
+ Non cash expenses (Depreciation)
- Non-operating incomes
+/- Changes in working capital
B. Cash Flow from Investing Activities
+ Sale of assets
- Purchase of assets
C. Cash Flow from Financing Activities
+ Issue of shares
- Loan repayment
Net Cash Flow = A + B + C
📌 Example
Additional information:
- Net Profit = ₹1,00,000
- Depreciation = ₹20,000
- Increase in Debtors = ₹10,000
- Decrease in Creditors = ₹5,000
- Machinery purchased = ₹50,000
- Loan raised = ₹30,000
Stepwise Solution
A. Operating Activities
Net Profit 1,00,000
Add: Depreciation 20,000
Less: Increase in Debtors (10,000)
Less: Decrease in Creditors (5,000)
---------------------------------------------
Cash from Operating Activities = 1,05,000
B. Investing Activities
Purchase of machinery (50,000)
C. Financing Activities
Loan taken 30,000
Net Cash Flow
= 1,05,000 - 50,000 + 30,000
= ₹85,000
Summary of Unit 2 – Final Revision Sheet
| Topic | Must Learn |
|---|---|
| Final Accounts | Trading + P&L + Balance Sheet format |
| Adjustments | Outstanding, prepaid, depreciation |
| Ratio Analysis | All formulas + examples |
| Fund Flow | Working capital schedule + FFS |
| Cash Flow | Operating/Investing/Financing method |