1.CHAPTER 2 : FINANCIAL STATEMENT ANALYSIS

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Chapter 2

Financial Statements Analysis

Meaning of Analysis of Financial Statement

1. it is a process of identifying the financial strengths and weaknesses of the firm

2. It is a systematic process of the critical examination of the financial information in order to understand and make decisions regarding operations of the firm.

3. It involves regrouping and analysis of information provided by financial statements.

Objectives of Analysis of Financial Statements

1.Assessing the earning capacity or profitability of the firm.

2. Assessing the managerial efficiency by using financial ratios.

3. Assessing the short term and the long term solvency of the enterprise to assess the ability of the company to repay principal amount and interest.

4. To facilitate inter- firm and intra- firm comparisons.

5. Assessing development in future by forecasting and preparing budgets.

Importance/ Significance of Analysis of Financial Statements

Finance manager.. it helps in constant review of financial operations and to analyse causes of major deviation which further help in taking corrective actions.

Top management.. it helps the management in measuring the success of company's operations, appraising the individual's performance and evaluating the system of internal control.

Trade Creditors are particularly interested in the firm's ability to meet the claims over a very short period of time i.e. firm's liquidity position.

Lenders / Bankers.. to analyse the historical financial statements to assess the liquidity, solvency profitability and efficiency of the enterprise.

Investors/ Owners ..are interested in the firms present and future profitability.They evaluate the efficiency of the management and determine whether a change is needed or not.

Labour unions..it helps whether an enterprise can increase productivity or raise the prices of products/ services to absorb a wage increase.

Others 

a.Researchers ..helps them to study the present business and economic conditions.

b. Government agencies ..it helps them for price regulations taxation and other similar purposes.

c.Tax Authorities.. it helps them to know about the performance of the company and to collect various types of taxes.

Limitations of Financial Analysis

1. It is just a  Historical Analysis.. it doesn't reflect on current and future positions.

2. It ignores price level changes.

3. Money information alone is considered while non-monetary aspects/ qualitative aspects are ignored.

4. It suffers from the limitations of financial statements 

5. It is affected by the personal ability and bias of the analyst.

6. It may lead to window dressing i.e. showing better financial position by manipulating the books of accounts.

7. Meaningful inter -firm comparison may not be possible as there may be difference in accounting policies followed by different firms.