Financial statement analysis Class 12 Notes Accountancy
Financial Statement's Analysis
In the words of Finney and Miller, “Financial Analysis consists in separating facts According to certain circumstances and then presenting them in a convenient and easily read and understandable form”.
METHODS OF FINANCIAL ANALYSIS
1) Horizontal Analysis: This form of analysis is also known as Comparison Analysis. In such Analysis, Financial statement from different Periods/Years are placed side by side to facilitate comparison. The Change is presented both in Absolute form and percentage form. Horizontal Analysis is undertaken when Development is to be measured over a period of time.
2) Vertical Analysis: In such form of Analysis, Statements are reviewed on a particular date with help of percentages and ratios. It is also called as Static Analysis. It cannot be considered as a good measure to elucidate Development but is quite efficient to calculate performance of same group or Department. Common size statement is an example of such Analysis, where the sum total is assumed as whole (100%), and the items are expressed as a percentage to the total.
OBJECTIVES OR PURPOSE
1) Judge the efficiency of management
The Analysis keeps a check on the Policies undertaken by the management. If The Calculated Ratios vary with Standard Ratios, Management is at Fault.
2) Implementation of Growth
Horizontal Analysis can be used to Calculate the Growth/ Development of the Firm over a period of time. The analysis helps to Understand whether the Business is Profitable or not.
3) Measurement of Solvency
It can be ascertained Whether the business is able to pay its short term and long term Liabilities. Example - Quick ratio is used to ascertain whether the Business is able to pay its short term Liabilities or not.
4) Facilitates Comparison
Financial statement Analysis helps the Firm to Compare its growth with its Competitors and thus helps in Implementation of Policies.
5) Measurement of Financial Strength
One of the main Purposes of Financial Analysis is the ascertainment of Financial Strength, Such as Liquidity and the Availability of Funds.
USES OF FINANCIAL ANALYSIS
1) Taking Investment Decisions
The Analysis helps to Identify the Financial Strength, Such as the Availability of Funds. The analysis becomes very important from Investor's point of view as it helps him to understand whether the firm is worth investing or not.
2) Taking Credit Decisions
It helps the firm to Identify whether it is compatible for making Credit Sales Or Not.
3) Taking Dividend Decision
Analysis helps a Firm To Know what proportion of the profit shall be distributed ad Dividend and How Much shall Be put back as Retained Earnings.
4) Estimating Trend Of Business
Continuous Analysation of Financial Information helps a Firm Understand, The Future Growth Potentials.
5) Taking Managerial Decisions
The Policy Making Process is Undertaken only after The Financial Statement Analysis, This Helps the Firm to Tap on New Opportunities According to the Results of The Analysis.
SIGNIFICANCE OF FINANCIAL STATEMENT ANALYSIS
1) Significance For Management
As mentioned Earlier, Policy/Decision Making Process of The Management is Dependent upon the Financial Statement Analysis. It Helps the Management to Know Whether the Existing Policies Are Effective or Not.
2) Significance for Investors
The Investors Check the Analysis Results To Decide Whether The Firm has Growth Potentials and Would give Fruitful Results to Their Funds.
3) Significance For Creditors
The Analysis Also Brings About the Credit Rating of Any Firm and thus Helps the Lenders Decide Whether the Firm Should be Given Funds or Not.
4) Significance for Government
The Government keeps a Check on the Firms Through Financial Statement Analysis, To Decide The Tax Rate and to keep an eye on the Progress of Industries.
5) Significance for Stock Exchanges
The Stock Exchange needs the Financial Statement Analysis to Look up to The Dividend Rate and to Decide The Earning Per Share ( EPS ).
6) Significance For Outside Parties
The Financial Statement Analysis and Other Accounts are usually open for the Public to Investigate, hence can be used by any concerned Party.
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS
1) Affected by Window Dressing
Window Dressing refers to Unethical changes made in the Data to bring about Positive Changes in Results. Rounding Off Digits or change in decimal place changes the Ratios, Hence Delivering Fake Results.
2) Difficulty in Forecasting
Financial Statement Analysis just presents the Data In an Exhaustive Manner, these cannot be used to make Future Decisions or For Forecasting.
3) Lack Of Qualitative Analysis
Financial Statement Analysis involves all the Transactions expressed in Monetary Terms. Hence, Factors Such as Goodwill, Efficient Management and Work Environment Go Unnoticed.
4) Different Accounting Policies
Different Polices adopted by Different Firms makes it difficult to Facilitate Comparison of Financial Statements.
5) Effect Of Personal Ability of Analyst
The Different Methods taken up by Different Analysts would bring out Different Results, hence Making it Difficult to Compare.