IIBF CCP ANALYSIS OF FINANCIAL STATEMENTS

IIBF CCP ANALYSIS OF FINANCIAL STATEMENTS

INTRODUCTION

Financial statements: These include balance sheets, trading accounts in the case of manufacturing units, profit and loss account, cash flow statement, and fund flow statement. 

The process of analyzing a balance sheet can be articulated as making or presenting the financial position and the operating results into something which is simple and easy to understand. 

To clearly understand the financial position of a business, one at least needs the financial statements of 3 years through which we can get a treasure of new information.

The balance sheet shows the strength of the concern on a given date only. It does not reveal the state of affairs of the concern. The balance sheet has certain limitations because of the fact that some of the critical factors cannot be disclosed in financial or other measurable terms such as the efficiency of management, technical competence, market competition, and marketing capabilities.

It is normally said that analyzing the financial statements provide a ‘good backbone to lending’ in the terms that the parameters that need to be taken for this analysis should satisfy good lending criteria.

Because the phones which are used by a Banker loan further belongs to the depositors, therefore, singers of depositors should be the major factor to determine good lending criteria.

LENDING CRITERIA

A deposit or an investor looks for 2 things when he or she wants to invest money i.e safety and yield. Another aspect that is secondary but is as relevant as the main two aspects i.e. Liquidity & purpose (for it ensures depositors’ confidence)

Principles of good lending are stated as below: 

• Yield
• Safety of Funds
• Liquidity and
• Purpose

The main objective of analyzing the financial statements can be boiled down to 2 questions: 

1. How can we measure the liquidity of a business? 
2. What are the financial and non-financial criteria according to which we can judge the safety of loans?

There are two reasons by analyzing financial statements is important to a Banker:

1. Whether the advance should be extended or not 
2. If should be extended, then what should be the quantum of the advance.

This analysis is used to assess the working capital limits required for the Projected Balance Sheet method to decide where the large value advances are involved 

• Advances > Rs. 25,00,000.00 for industrial units in C&I segment and 
• Advances > Rs 5,00,00,000.00 in the SSI segment. 

JAIIB SYLLABUS PRIORITY:- 

CREDIT RISK ASSESSMENT

In the cases where the projected balance sheet method is not being used to access the credit requirement, it is important to determine the safety of advance and which is done by analyzing the financial statements. 

Credit risk assessment requires analyzing financial statements of the business and calculating various ratios before Bank can even start with its credit risk assessment.

In the cases such as for the loan products like SME Credit Card and SME Smart Score where credit rating assessment is not required. Do it is given for the financial ratios which represent the liquidity and gearing (current ratio and total outside liabilities to tangible net worth ratio).

DEFINITION OF FINANCIAL STATEMENT:-

Every business needs money to run its operations and this money in most cases is provided by the owners if there is a gap in the financial requirement then it can be fulfilled by taking finance from the outsiders i.e. creditors. 

Finance is constantly on the move through various financial transactions and keep altering its form and content. Therefore, a periodical assurance about their safety keeps the confidence of owners and creditors intact. 

Where the business unit is a limited company, the owners, shareholders, do not have direct control over the day-to-day administration of the company, which is entrusted to the management team or the board of directors. 

This is the reason why management is bound by the law as well as the contractual obligations to use the funds that have been made available to the company as per the regulations of the company and produce evidence having done the same after a period of time. 

This evidence is produced through financial accounting which enables the extraction of evidence as mentioned above. 

FINANCIAL ACCOUNTING

It is the art of recording, classifying, and summarising the transactions and events in terms of money and then interpreting the results thereof. 

It produces a significant summary of all the furniture transactions that have been recorded so as to produce the end results of the business operations. 

This summary is known as financial statements, which basically include a balance sheet and profit and loss statement. 

Financial statements are prepared to present a report on the progress that has been made by the management. It deals with the status of investment that has been made in the business as well as the results that have been achieved with the investment.

These statements reflect a combination of recorded facts as per the accounting conventions and personal judgments. These judgments and conventions affect the materiality of financial statements. 

A sound judgment depends on the competence and integrity of the management and their adherence to the GAAP. 

Understanding financial accounting is very important because analysis of financial statements depends on the reliability and authenticity of the financial statements. 

This definition of the following characteristics of financial statements: 

• There is a periodical review of investment and the management progress. 

• Accounting is done on the basis of conventions and personal judgments. 
• The ultimate results that are furnished depend on the integrity and competence of the accountants who prepare the financial statements. 

WEAKNESS OF FINANCIAL STATEMENTS

Financial statements have one major weakness i.e lack of objectivity. It means that these statements can be influenced by the subjective exercise of judgments to a large extent. 

For example, when management intends to do fraudulent activities, many patients are possible by distortion of final results, thus, camouflaging the real picture. 

But if Accountants compile these statements intelligently and without exercising any personal bias and as per the generally accepted accounting conventions, the financial statements will reflect a ‘true & fair picture of the company affairs & final results. 

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The Auditor’s Report is, therefore, an independent professional guarantee for compliance

with the generally accepted accounting principles and to that extent takes care of lack of

objectivity, and intelligent scrutiny of the Annual Report is bound to bring out Auditors

reservations, if any, on this subject. To ensure the genuineness of the financial statements and that of the signatures of the

chartered accountants therein, in case of large borrowers, viz. borrowers whose fund

based limits are Rs.1 cr and above, a confirmation is to be obtained by sending a letter

by Post/ e-mail regarding certification of financial statements from the Chartered

Accountant who has signed the balance sheet / financial statements of the borrowers and

this confirmation will be kept with the files of correspondence pertaining to the borrower. 3. Criteria for Analysis

3.1 As mentioned earlier, the outsiders or creditors who provide funds to the enterprise, do

so on certain conditions to be fulfilled by the latter, the most important being the payment

of interest and repayment of principal in time. Liquidity, therefore, connotes the

availability of cash resources with the enterprise to liquidate such dues to the creditors

and other pressing liabilities. The analysis of the Financial Statements should be such as

to indicate or forecast the above performance capabilities on the part of the enterprise. 3.2 Safety of funds lent was, till recently, considered to be synonymous with security by way

of physical or tangible assets. But the events occurring not only in India but elsewhere

have conclusively proved that the banker can no longer look to encashment of the assets

through a sale for liquidation of his dues and such repayment can be expected only from

out of the surpluses generated by the enterprise in its operations. It will, therefore, be

noted that the viability of the enterprises is the primary and real security for the lender. 3.3 Like the proverbial blind men trying to describe an elephant, viability is such a general

term, lending itself to many different interpretations according to the perceptions and

even predilections of the persons. For the purpose of this discussion, it can broadly be

stated that viability connotes the ability of the enterprise basically to produce a product

and market it at a profit or carry on an activity with a profit that is sufficient to meet the

following ‘charges’ or ‘claims’ against it. i) Service and repay the external indebtedness incurred for setting up the factory as

well as carrying on its operations. ii) Service the paid-up share capital at a reasonable rate or yield, considered good on

market comparisons. iii) Leave a surplus, adequate to meet its own ‘growth’ needs. The accomplishment of the above objectives is the broad or the ultimate goal of the

enterprise but it involves a lot of many management policies and decision-factors as under:

1. i) Selection of the sources of funds or in other words the distribution of the

requirements of funds between share-holders and creditors in such a manner as to

(a) satisfy the various purveyors of funds on their expectation of return on their

investment (b) satisfy the norms on the desirable mix between owned funds and

borrowed funds. ii) The funds provided, by the share-holders/creditors must be ‘judiciously’ used to

create certain assets. Judicious use of funds denotes a careful evaluation of

various options available to it before an investment decision is taken. iii) The assets so created ought to generate a net surplus, through their use, which is

the highest or optimum return on investment after meeting all expenses and

charges. 3.4 In order to understand these issues better, let us look at a typical Balance Sheet of a

manufacturing enterprise. The monies it needs for initially setting up its factory and later

on carrying on its operations in the factory and the sources providing such funds can be

illustrated as under