Trend Analysis in Balance Sheet

Let us now consider the study of the Balance Sheet of a well known industrial enterprise for the past three years.

A study in trends could be most profitably be made by evaluation of the structural position. The evaluation of the structural position can be easily made, if the Balance Sheets are cast in the vertical form.

The above casting shows the position as it existed on 31.12.20 and ultimately how it moved and disclosed the position as at 31.12.22. The following inferences are possible :-

1. The Paid-up capital of the company between the periods 31.12.20 to 31.12.22 has remained unchanged at Rs. 817 lacs.

2. The reserves of the company have increased from Rs.327 lacs to Rs.581 lacs indicating by and large good profits possibly have been earned and retained in the business.

3. The company's gross block has increased from Rs. 1071 lacs to Rs. 2235 lacs between the period, an increase of Rs. 1164 lacs in two years. As the paid-up capital has not increased but has remained steady at Rs. 817 lacs, the expansion has been financed from sources other than own capital.

4. Current borrowings have remained without much change. But between 90 and 92 term borrowings have increased from a 'nil' position to Rs. 617 lacs. So this much of money has been brought in and utilised.

5. Reserves and Profits earned and retained in business have increased from Rs.327 to Rs. 581 lacs i.e. an increase of Rs. 254 lacs. This much of money has been brought in and utilised.

6. Depreciation was Rs. 528 lacs in 90 and Rs. 819 lacs in 92 i.e. in between the two dates depreciation of the order of Rs. 291 lacs has been further allowed. In other words, earned profits have been debited and investment in block has been credited to that extent. Eventhough by these internal entries profits and investment in block have been correspondingly reduced, but the cash that has been brought in by profits to the extent of depreciation charged has remained with the company and has been utilised.

7. Current liabilities have increased by Rs. 3 lacs indicating inflow of cash and current assets have increased by Rs. 1 lac resulting in outflow of cash. These two indicate a net inflow of Rs. 2 lacs.

8. It is thereafter possible to infer that in between the period 31.12.20 and 31.12.22 an outflow of cash to the extent of Rs. 1164 lacs for puchase of machinery has taken place which has been financed by the following :-

By this analysis, it is possible to answer the question how the Company has been able to enhance its investment in gross block from Rs. 1071 lacs in 2020 to Rs. 2235 lacs in 2022

Increase of gross block is an outstanding trend, calculated to increase production, profitability and ensure growth and how the other trends enumerated above have enabled cumulatively its happening should be particularly noted.

Let us consider the case of another company whose progressive figures are given below :- (Rs. in lacs)

The problem for determination is what is the basic trend if any, disclosed by the flow of Balance Sheet figures detailed above. Are these figures dead insentient entities, which have no story to tell, no life to reveal and no force to express ? Let us find out what the movement of figures indicate :-

1. The paid up capital at Rs. 450 lacs has been increased to Rs. 550 lacs in 2019 and to Rs. 600 lacs in 2021. A tendency to increase the capital may be noticed.

2. The Reserves of the company at Rs. 400 lacs have been depleted year by year so much so that in 2022 the figure is only Rs. 100 lacs. The trend is consistently falling.

3. Long-term borrowings from a 'nil' position in 2018 have increased year by year to Rs. 350 lacs in 2021 and then have regressed to Rs. 315 lacs in 2022.

4. Short term borrowings have consistently shown an increasing trend from Rs. 120 lacs to Rs. 290 lacs. So also the current liabilities and provisions have increased from Rs. 58 lacs to Rs. 165 lacs - in all total current liabilities have increased from Rs. 178 lacs to Rs. 455 lacs i.e. a rise of Rs. 277 lacs - an outstanding trend.

5. Gross block has been steadily increased from Rs. 850 lacs to Rs. 1200 lacs i.e. Rs. 350 lacs.

6. Current assets have recorded a significant and steady rise from Rs. 358 lacs to Rs. 615 lacs - a rise of Rs. 257 lacs.

7. Misc. assets have increased from Rs. 35 lacs to Rs. 80 lacs and remain steady at that figure from 90 onwards.

Each one of the above movements recording a rise or fall have exerted their influence on the Balance Sheet as a whole and have contributed their own share to increase or decrease the balance sheet strength. What is the net resultant strength that is disclosed ? An assessment of the resultant position may, perhaps, be easy if the Balance Sheets are cast in the vertical form which is being done herebelow :-

An analysis of the above break-up placed contiguously side by side enables drawing of firm financial inferences consequent to variations and trends in the tangible net worth of the company, the working capital, the size of total debt and the constitution of the tangible net worth. In particular, we may point out the following :

1. Between 18-19 Bonus shares have been issued by capitalising Reserves Rs. 100 lacs.

2. Between 19-20 - Rs. 50 lacs loss has occurred.

3. Between 21-22-Rs. 150 lacs loss has occurred. Why is there a loss and why is it increasing? Why inspite of greater investment of block between 2018 to 2022 of Rs. 350 lacs.

4. Tangible net worth has fallen from Rs. 850 lacs to Rs. 700 lacs a fall of Rs. 150 lacs. Total fall appears to be Rs. 200 lacs caused by losses in (2) and (3) above which has been reduced from bringing fresh capital Rs. 50 lacs in 21.

5. Inspite of earlier years appearing to be profitable as evidenced by the accumulation of reserves – the performance thereafter is erratic in spite of expansion.

6. A steady increase in current assets in the context of a similar increase in current liabilities cast doubts on assets, values, whether these are really current and whether there is no element of lock up somewhere, such as holding of obsolete stocks or irrecoverable debts.

7. Between 2021 and 2022 current assets have fallen from Rs. 680 lacs to Rs. 615 lacs but there is an opposite movement in current liabilities i.e. increase from Rs. 375 lacs to Rs. 455 lacs. Outflow of cash must have been financed by increase in current liabilities.

On the whole, it is possible to conclude that the trend is regressive and further investigation about the trends should be made. This should be done by a close analysis of the items consisting of the current assets and liabilities and also the Profit and Loss account and assess the pattern of their movement. We shall refer to this matter again, in our write-up relating to the analysis of the Profit and Loss Account.

A single Balance Sheet tells the story how a business stands at a particular point of time. A Profit and Loss statement sums up the results of operations over a period of time. A single Balance Sheet is like the opening chapter of a book. It enunciates a theme. It shows how the capital is distributed, how much of it is in various accounts and how much surplus exists of assets over liabilities.

When a series of Balance Sheets at regular intervals say at the end of each fiscal year are arranged in vertical columns and related items are compared, the changes in these items disclose trends. For example, if expansion is undertaken debt may remain high, and if losses are maintained the net worth declines.

The trend where did the money come from and where did it go, could be ascertainable by these trends. Similarly, from an examination of the Profit and Loss Statement, increase or decrease of sales, increase or decrease of cost of sales, increase or decrease of overheads and financing changes and whether these have remained in proper proportion or proper-balance to each other could be ascertained.

To conclude, a study in trends of Balance Sheet figures helps us to surmise the basic realities between the figures.