,ACCOUNTANCY Analysis of Financial Statements
Analysis of Financial Statements
Introduction to Financial Statement Analysis
Meaning and Definition:
Meaning:
o It is a systematic process of dividing the financial information into simple and valuable
elements, establishing relationships between inter-related elements and interpreting the same
to understand the working and financial position of an enterprise from its financial statements.
o It includes analysis of Statement of Profit and Loss, Balance Sheet and Cash Flow Statement
of an enterprise.
o It provides information to understand complex financial data and helps in taking appropriate
financial decisions.
Understanding Analysis and Interpretation: These two terms in understanding the meaning of
financial statement analysis are complementary to each other and therefore, analysis cannot be
complete without interpretation.
o Analysis: It is concerned with simplification of financial data by proper classification of given
in the financial statement.
o Interpretation: It is concerned with explaining the meaning and significance of the financial
data.
Definition of Financial Statement Analysis:
o As per Myer: Financial Statement Analysis is largely a study of relationships among the
various financial factors in a business, as disclosed by a single set of statements, and a study
of trends of these factors, as shown in a series of statements.
Objectives of Financial Analysis:
Following are the Purposes (Objectives) and Significance of Financial Analysis:
i. To Assess the Earning Capacity or Profitability: Earning Capacity and Profitability of the
enterprise can be assessed from the financial statement analysis. It also facilitates forecasting of
the same for the future years. External users are interested in earnings and hence, this is their
prime objective of analysing financial statement.
ii. To Assess the Managerial Efficiency: This assessment is possible because financial statement
analysis identifies the areas where managers have been efficient and where not. Favourable and
unfavourable variations can be identified to pinpoint the managerial inefficiency.
iii. To Assess the Short-term and Long-term Solvency of the Enterprise: This assessment is
possible by analysing the financial statements minutely. Creditors or suppliers are interested to
know the ability of the entity to meet the short-term liabilities and Debentureholders and lenders
are interested to know the long term and short term solvency of the enterprise to assess the ability
of the company to repay the principal and interest thereon.
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, ACCOUNTANCY Analysis of Financial Statements
iv. To facilitate Inter-firm Comparison: Inter-firm Comparison helps an enterprise to assess its own
performance as well as that of others if mergers and acquisitions are to be considered.
v. To Forecast and Prepare Budgets: Analysis of historical data in the financial statements helps in
assessing developments in future. It facilitates forecasting and preparing budgets for the future
years.
vi. To Understand Complicated Matter: Financial Statement analysis helps the users in
understanding the complicated matter. This can be facilitated by using charts, graphs and
diagrams which are easy to explain and understand.
Uses of Financial Analysis:
Financial Statements Analysis assists in making accurate decisions in various areas which are as follows:
i. Security Analysis: It is a process used by the investor to identify whether the firm is fulfilling his
expectations with regard to dividends, capital appreciation, etc. Such analysis is done by a security
analyst who is interested in cash generating ability, dividend pay-out policy and the behaviour of
share prices.
ii. Credit Analysis: It is useful when a firm or bank offers credit to a new customer or a dealer.
Management is always interested to know credit worthiness of client so as to take decisions
regarding whether to allow or extend credit to them or not.
iii. Debt Analysis: It is useful when a firm wants to know its borrowing capacity.
iv. Dividend Decision: It is useful in determining the rate of dividend in order to decide how much of
the earnings are to be distributed in the form of dividends and how much is to be retained.
Dividend decisions have a direct impact on profitability of the firm and behaviour of its share prices
so are to be taken wisely using Financial Statement Analysis.
v. General Business Analysis: It is useful in identifying the key profit drivers and business risks in
order to assess the profit potential of the firm and also assist in future growth scenarios.
Parties Interested in Financial Analysis:
Following are the parties interested in the analysis of Financial Statements:
i. Management: Financial analysis helps the management to ascertain overall as well as segment-
wise efficiency of the business. It also helps in decision making, controlling and self-evaluation.
ii. Employees and Trade Unions: Financial Analysis is considered helpful for employees to get a
clear idea of the emoluments, bonus, working conditions and security of their jobs by analysing
profitability, sustainability and financial position of the enterprise from its financial statements. In
order to take proper decisions and enter into beneficial wage agreements, trade unions also
analyse financial statements to determine the degree of profitability of the enterprise based on
which they can further negotiate.
iii. Shareholder or Owners or Investors: These are the investors who invest or contribute their
savings in the form of capital. Therefore, they are interested in the returns of the business which
can be ascertained from the profitability of the business. Also, growth potential helps in investment
appreciation.
iv. Potential Investors: These are those who are interested to know the present profitability and the
financial position as well as future prospects to make their mind on investment into business
concern.
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Analysis of Financial Statements
Introduction to Financial Statement Analysis
Meaning and Definition:
Meaning:
o It is a systematic process of dividing the financial information into simple and valuable
elements, establishing relationships between inter-related elements and interpreting the same
to understand the working and financial position of an enterprise from its financial statements.
o It includes analysis of Statement of Profit and Loss, Balance Sheet and Cash Flow Statement
of an enterprise.
o It provides information to understand complex financial data and helps in taking appropriate
financial decisions.
Understanding Analysis and Interpretation: These two terms in understanding the meaning of
financial statement analysis are complementary to each other and therefore, analysis cannot be
complete without interpretation.
o Analysis: It is concerned with simplification of financial data by proper classification of given
in the financial statement.
o Interpretation: It is concerned with explaining the meaning and significance of the financial
data.
Definition of Financial Statement Analysis:
o As per Myer: Financial Statement Analysis is largely a study of relationships among the
various financial factors in a business, as disclosed by a single set of statements, and a study
of trends of these factors, as shown in a series of statements.
Objectives of Financial Analysis:
Following are the Purposes (Objectives) and Significance of Financial Analysis:
i. To Assess the Earning Capacity or Profitability: Earning Capacity and Profitability of the
enterprise can be assessed from the financial statement analysis. It also facilitates forecasting of
the same for the future years. External users are interested in earnings and hence, this is their
prime objective of analysing financial statement.
ii. To Assess the Managerial Efficiency: This assessment is possible because financial statement
analysis identifies the areas where managers have been efficient and where not. Favourable and
unfavourable variations can be identified to pinpoint the managerial inefficiency.
iii. To Assess the Short-term and Long-term Solvency of the Enterprise: This assessment is
possible by analysing the financial statements minutely. Creditors or suppliers are interested to
know the ability of the entity to meet the short-term liabilities and Debentureholders and lenders
are interested to know the long term and short term solvency of the enterprise to assess the ability
of the company to repay the principal and interest thereon.
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, ACCOUNTANCY Analysis of Financial Statements
iv. To facilitate Inter-firm Comparison: Inter-firm Comparison helps an enterprise to assess its own
performance as well as that of others if mergers and acquisitions are to be considered.
v. To Forecast and Prepare Budgets: Analysis of historical data in the financial statements helps in
assessing developments in future. It facilitates forecasting and preparing budgets for the future
years.
vi. To Understand Complicated Matter: Financial Statement analysis helps the users in
understanding the complicated matter. This can be facilitated by using charts, graphs and
diagrams which are easy to explain and understand.
Uses of Financial Analysis:
Financial Statements Analysis assists in making accurate decisions in various areas which are as follows:
i. Security Analysis: It is a process used by the investor to identify whether the firm is fulfilling his
expectations with regard to dividends, capital appreciation, etc. Such analysis is done by a security
analyst who is interested in cash generating ability, dividend pay-out policy and the behaviour of
share prices.
ii. Credit Analysis: It is useful when a firm or bank offers credit to a new customer or a dealer.
Management is always interested to know credit worthiness of client so as to take decisions
regarding whether to allow or extend credit to them or not.
iii. Debt Analysis: It is useful when a firm wants to know its borrowing capacity.
iv. Dividend Decision: It is useful in determining the rate of dividend in order to decide how much of
the earnings are to be distributed in the form of dividends and how much is to be retained.
Dividend decisions have a direct impact on profitability of the firm and behaviour of its share prices
so are to be taken wisely using Financial Statement Analysis.
v. General Business Analysis: It is useful in identifying the key profit drivers and business risks in
order to assess the profit potential of the firm and also assist in future growth scenarios.
Parties Interested in Financial Analysis:
Following are the parties interested in the analysis of Financial Statements:
i. Management: Financial analysis helps the management to ascertain overall as well as segment-
wise efficiency of the business. It also helps in decision making, controlling and self-evaluation.
ii. Employees and Trade Unions: Financial Analysis is considered helpful for employees to get a
clear idea of the emoluments, bonus, working conditions and security of their jobs by analysing
profitability, sustainability and financial position of the enterprise from its financial statements. In
order to take proper decisions and enter into beneficial wage agreements, trade unions also
analyse financial statements to determine the degree of profitability of the enterprise based on
which they can further negotiate.
iii. Shareholder or Owners or Investors: These are the investors who invest or contribute their
savings in the form of capital. Therefore, they are interested in the returns of the business which
can be ascertained from the profitability of the business. Also, growth potential helps in investment
appreciation.
iv. Potential Investors: These are those who are interested to know the present profitability and the
financial position as well as future prospects to make their mind on investment into business
concern.
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