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FINACIAL STATEMENT ANALYSIS
Financial statement as normally understood refers to a set of reports and Schedules that an accountant prepares at the end of a period of time for a business enterprise.
According to Smith and Ashburn: Financial statement are the end products of financial Accounting, prepared by the accountant that support to reveal the financial done with the earnings.
THE PUROSE OF FINANCIAL STATEMENTS
The preparation of profit and loss statement and balance sheet is a very valuable exercise for an organization. The purposes of these financial statements are as outlined below:
• To inform owners about the financial position of the organization.
• To inform managers the achievements/shortfalls in the performance of the business.
• To secure finance and maintain finance.
• To monitor performance of the business periodically.
• To fulfill statutory obligations.
• To assess tax liability.
• To determine liquidity, solvency and profitability of business.
THE USERS OF FINANCIAL STATEMENTS
The users of financial statements include-
OWNERS: they want to know whether their investments are safe or not. They are interested in the financial performance of the business in terms of profitability. They want to know whether the company is in a position to pay dividends, if yes, how much, and so on.
Management: they want to plan and control the activities of business and need guidance in forward planning. Mangers look at (a) procurement performance against forecast targets-sales, expenses, profit (b)ways in which they can improve their performance © control of money cycle- repaying loans and collecting debts as when they become due.
Lenders: they provide finance. They use these statements to assess the ability of the business to repay its debts on maturity. They would like to get assured that their funds are in the safe hands.
Tax authorities: they are interested to assess the taxes payable for a five period.
Employee: they would like to whether profits have gone up as a result of their hard work . they would like to seek justification for their demands for increase in bonus and other perquisites.
Analysts and Advisors: This is a significant group consisting of financial analysis, economists, researchers and stock brokers, insurance companies, and so on who would need to research and on various issues such as profits, investments, costs, impact of Government policies on a particular sector, and so on which are of specific or common interest to their clients. The financial statements provide a basis for their analysis.
Other Business Contacts: This includes the suppliers, competitors and so on the suppliers may wish to know the financial stability of the business. The competitors wish to know their market share and the growth rates.
GENERAL PUBLIC: There may be potential investors in this group. They would like to know whether it is safe to invest in a given company or not. They use financial analysis for their purpose.
LIMITATIONS OF FINANCIAL STATEMENTS:
1. Personal Judgment / Discretion: the preparation of financial statements involves degree of personal judgment or discretion, which may prevent presentation of facts in their true nature. Take the case of allocating the costs and incomes to a given accounting period. Income and cost transactions take place continuously through out the life of the business and they have to be cut off at each balance sheet dates. It is very difficult to set a uniform policy to cut off income and cost. It is true that the accounting department has considerable discretion in this regard. The cost allocated to the period must have a logical relationship to the income allocated to the period. The data presented in financial statement cannot be exact thought, given theses conditions.
2. Replacement cost is not Emphasized: The finance statements show the assets as per the book value and these seldom have relevance to replacement costs. The financial statements are based on the historic cost prices but not on the current prices.
3. Current Economic Realities Ignored: The financial statements present the accounts on cost concept. The cost of acquisition of the assets is taken as the basis to present the asset accounts. These may be far less than the current level of prices, particularly when there is a market decline in the value of currency and the economy shows up inflationary trends. In other words, an increase in sales revenue may be in consequence to the fall in the rupee value and increase in the selling price. It may not be the direct result of improved performance of the firm.
4. Qualitative Factors Ignored: The financial statements do not reflect qualitative factors such as goodwill, credit rating, and so on. These factors have a profound impact on the financial conditions and operating results. How ever there are a few companies such as Reliance showing up the quality of human factor in their financial statements.
These limitations do not limit the use of financial statements. Financial statements continue to play a vital role in terms of their utility to different segments of the society. They from the primary basis for interpretation of statements of the society. They from the primary basis for interpretation of financial statements. They provide a basic understanding of the financial position of the firm.
TYPES OF FINANCIAL STATEMENT ANALYSIS
ANALYSIS OF FINANCIAL STATEMENTS
Analysis means examining something to know its contents in detail. It is the process of evaluating the relationship between different variables in the financial statements. For the purpose of analysis, it is necessary to identify the relevant data, group the data and identify the parameters to compare the groups to highlight the strong and weak points of the business the purpose is to identify the possible remedial measure to strengthen the weak areas of business.
Analysis of financial statements provides an understanding of the financial
Matters of business such as the following:
How is the firm mobilizing resources
How is the firm making profits/ losses
How is the firm maintaining its assets and liabilities
How is the firm taking care of liquidity, solvency and profitability of the business, and so on
In short, analysis facilitates decision making. Analysis of financial statements involves an art by itself. It is always desirable that the people involved in the analysis should be conversant with the nature and limitations of the industry. This knowledge will help to identify the right type or approach of analysis. There are different approaches for the study of the financial statements. The analysis of the study may range from time to time for the same firm or one firm to the other firm. The focus of the study varies depending upon the users: internal or external.
There are five basic financial statements of special importance. They are
• The Income Statement (or Profit and Loss account)
• The Position Statement (or Balance Sheet)
• The Fund Flow Statement (or the statement of source and application of funds)
• The Cash Flow Statement
• The Statement of Retained Earnings
The Income Statement: The Income Statement also called the Profit and Loss account is the accounting report that summarizes the revenues, expenses and the difference between them for an accounting period, matching materiality and realization. There is no statutory format in which the income statement is to be presented, except for banking and insurance companies. However sec 211of the companies act 1956 prescribes the consents to be disclosed in this statement.
The Position Statement: The position statement or balance statement shows the financial status of business at a given point of time. All the assets owned by the business and all the liabilities and claims it owes to outsiders and owners are listed. The balance sheet must always be in balance i.e. the total assets should always be equal to total liabilities.
The Funds Flow Statement: The term fund from normally means working capital. The funds flow statement reveals the sources from which are received and the uses to which these have been put. It is a valuable tool to analyze the changes in the financial condition of the business between two periods two and helps the management formulation and performance appraisal.
The Cash Flow Statement: The cash flow statement of changes in the financial position of a firm on cash basis. It is very much similar to the funds flow statement except that the cash flow statement lays emphasis on cash changes only.
The Statement of Retained Earnings: The statement of retained earning also known, as the profit and loss Appropriation account is a continuation of the income statement . It reveals the profit freely available after deduction of all expense including tax and how it has been appropriated. The balance after all appropriation s is shown in the liabilities side the balance sheet. Thus the statement of retained earnings is the link between the income statement the balance sheet.
The significance of financial statement lies not in their analysis an interpretation. Analysis and interpretation of financial statement involves a study of relationship among various financial factors and to judge their meaning and significance. The financial analyst must understood the plans and policies of management determine the extent of analysis reorganize data available as per requirement, establish relationship among financial figures and make interpretations in a simple and unbiased way.