Financial statement analysis

Financial statement analysis

1. Meaning of financial statement analysis

Financial statement analysis is comparison of the various items in the financial statements by establishing and evaluating relationships among them so that, it gives a better understanding of the performance and financial status of the business concern.

It involves rearrangement of data in accordance with the purpose of analysis, application of financial tools, evaluating the relationship among the component parts and drawing conclusion based on the analysis. Thus, financial statement analysis includes both analysis and interpretation.

Analysis refers to examination of the figures computed and comparison of the same to establish relationship among them and identifying the reasons for the performance or changes. Interpretation refers to elucidation and explanation of the results of analysis.

2. Objectives of financial statement analysis

Financial statement analysis may be done with any of the following objectives:

·        To analyse the profitability and earning capacity

·        To study the long term and short term solvency of the business

·        To determine the efficiency in operations and use of assets

·        To determine the efficiency of the management and employees

·        To determine the trend in sales, production, etc.

·        To forecast for future and prepare budgets

·        To make inter-firm and intra-firm comparisons.

3. Limitations of financial statement analysis

Following are the limitations of financial statement analysis:

·        All the limitations of financial statements such as ignoring non-monetary information, ignoring price level changes, etc., are applicable to financial statement analysis also.

·        Financial statement analysis is only the means and not an end, that is, it is only a tool in the hands of management and other shareholders. Interpretation of the results has to be done only by the financial analysts with due regard to the internal and external environmental factors.

·        Expert knowledge is required in analysing the financial statements.

·        Interpretation of the analysed data involves personal judgement as different experts may give different views.