ANALYSIS OF FINANCIAL STATEMENTS (3) | IIBF-CCP Module B CH-7 | JAIIB | CAIIB | Certificate in MSME

Introduction

This tutorial provides a comprehensive guide on analyzing financial statements, particularly useful for bankers preparing for IIBF Certified Credit Professional (CCP), JAIIB, and CAIIB examinations. Understanding financial statements is crucial for effective credit appraisal and financial analysis, making this tutorial relevant for professionals in the banking sector.

Step 1: Understand Financial Statements

Familiarize yourself with the four key financial statements:

• Balance Sheet

  • Shows the financial position of a company at a specific point in time.
  • Key components include assets, liabilities, and equity.

• Trading and Profit and Loss Account

  • Reflects a company’s operational performance over a period.
  • Summarizes revenues, costs, and expenses to determine profit or loss.

• Cash Flow Statement

  • Details cash inflows and outflows within the business.
  • Categorized into operating, investing, and financing activities.

• Fund Flow Statement

  • Illustrates the sources and uses of funds over a period.
  • Helps identify changes in financial position.

Step 2: Analyze the Balance Sheet

Conduct a thorough analysis of the balance sheet by focusing on:

• Types of Assets

  • Current Assets: Cash, inventory, receivables.
  • Fixed Assets: Property, machinery, long-term investments.

• Types of Liabilities

  • Current Liabilities: Short-term debts, payables.
  • Long-term Liabilities: Loans, mortgages.

• Equity Analysis

  • Assess retained earnings, common stock, and additional paid-in capital.

Tip: Calculate key ratios such as the current ratio and debt-to-equity ratio to evaluate liquidity and financial leverage.

Step 3: Review the Trading and Profit and Loss Account

Evaluate the trading and profit and loss account by examining:

• Revenue Streams

  • Identify major sources of income.

• Cost of Goods Sold (COGS)

  • Analyze direct costs associated with production.

• Operating Expenses

  • Review overheads, salaries, and administrative costs.

• Net Profit Margin

  • Calculate using the formula:

  Net Profit Margin = (Net Profit / Revenue) * 100 
  

Common Pitfall: Ensure you differentiate between gross profit and net profit for accurate performance assessment.

Step 4: Assess the Cash Flow Statement

Analyze the cash flow statement to understand liquidity trends:

• Operating Activities

  • Review cash generated from core business operations.

• Investing Activities

  • Examine cash flows related to asset purchases or sales.

• Financing Activities

  • Analyze cash flows from issuing debt or equity and repaying borrowings.

Practical Tip: A positive cash flow from operating activities is a strong indicator of financial health.

Step 5: Explore the Fund Flow Statement

Conduct a fund flow analysis to grasp the movement of funds:

• Sources of Funds

  • Identify where funds are coming from, such as loans, sales of assets, or equity financing.

• Uses of Funds

  • Determine how funds are being utilized, including investments and debt repayments.

Real-World Application: Use this statement to foresee potential liquidity issues or funding needs.

Step 6: Review Auditor Notes

Study the auditor's notes for insights on financial integrity:

• Quality of Financial Reporting

  • Assess any qualifications or concerns raised by auditors.

• Compliance with Accounting Standards

  • Ensure adherence to GAAP or IFRS, depending on jurisdiction.

Tip: Pay attention to any changes in accounting policies that may affect financial results.

Conclusion

Analyzing financial statements is a vital skill for bankers and finance professionals. By understanding and reviewing the balance sheet, profit and loss account, cash flow statement, fund flow statement, and auditor notes, you can gain valuable insights into a company's financial health. As you prepare for your IIBF exams or enhance your credit appraisal skills, focus on these steps to improve your analytical abilities and make informed financial decisions.