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Financial Statement Analysis

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Financial Statement

Financial Statement Analysis

A Financial Statement is an official document of the firm, which explores the entire financial information of the firm. The main aim of the financial statement is to provide information and understand the financial aspects of the firm. Hence, the preparation of the financial statement is important as much as financial decisions.

MEANING AND DEFINITION

According to Hamptors John, the financial statement is an organized collection of data according to logical and consistent accounting procedures.   Its purpose is to convey an understanding of the financial aspects of a business firm. It may show a position at a moment of time as in the case of a balance-sheet or may reveal a service of activities over a given period of time, as in the case of an income statement.

IMPORTANCE OF FINANCIAL MANAGEMENT

Financial statements are the summary of the accounting process, which, provides useful information to both internal and external parties.   John N. Nyer also defines it “Financial statements provide a summary of the accounting of a business enterprise, the balance-sheet reflecting the assets, liabilities, and capital as on a certain data and the income statement showing the results of operations during a certain period”.

Financial statements generally consist of two important statements:

  1. The income statement or profit and loss account.
  2. Balance sheet or the position statement.

Apart from that, the business concern also prepares some of the other parts of statements, which are very useful to the internal purpose such as:

  1. Statement of changes in owner’s equity.
  2. Statement of changes in financial position.

Financial Statement

Income Statement

The income statement is also called profit and loss account, which reflects the operational position of the firm during a particular period. Normally it consists of one accounting year. It determines the entire operational performance of the concern like total revenue generated and expenses incurred for earning that revenue.

Income statement helps to ascertain the gross profit and net profit of the concern. Gross profit is determined by the preparation of trading or manufacturing a/c and net profit is determined by the preparation of profit and loss account.

Position Statement

The position statement is also called a balance sheet, which reflects the financial position of the firm at the end of the financial year.

The position statement helps to ascertain and understand the total assets, liabilities, and capital of the firm. One can understand the strength and weaknesses of the concern with the help of the position statement.

Statement of Changes in Owner’s Equity

It is also called a statement of retained earnings.   This statement provides information about the changes or position of owner’s equity in the company.  How the retained earnings are employed in the business concern. Nowadays, the preparation of this statement is not popular and nobody is going to prepare the separate statement of changes in owner’s equity.

Statement of Changes in Financial Position

Income statement and position statement shows only about the position of the finance, hence it can’t measure the actual position of the financial statement.  A statement of changes in financial position helps to understand the changes in financial position from one period to another period.

Statement of changes in financial position involves two important areas such as fund flow statement which involves the changes in working capital position and cash flow statement which involves the changes in cash position.

TYPES OF FINANCIAL STATEMENT ANALYSIS

Analysis of Financial Statement is also necessary to understand the financial positions during a particular period. According to Myres, “Financial statement analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of statements and a study of the trend of these factors as shown in a series of statements”.

Analysis of financial statements may be broadly classified into two important types on the basis of material used and methods of operations

Types of Financial Statement Analysis

1. Based on Material Used

Based on the material used, financial statement analysis may be classified into two major types such as External analysis and internal analysis.

A. External Analysis

Outsiders of the business concern do normally external analyses but they are indirectly involved in business concern such as investors, creditors, government organizations and other credit agencies. External analysis is very much useful to understand the financial and operational position of the business concern. The external analysis mainly depends on the published financial statement of the concern. This analysis provides only limited information about the business concern.

B. Internal Analysis

The company itself does disclose some of the valuable information to the business concern in this type of analysis. This analysis is used to understand the operational performances of each and every department and unit of the business concern. The internal analysis helps to take decisions regarding achieving the goals of the business concern.

2. Based on Method of Operation

Based on the methods of operation, financial statement analysis may be classified into two major types such as horizontal analysis and vertical analysis.

A. Horizontal Analysis

Under the horizontal analysis, financial statements are compared with several years and based on that, a firm may take decisions. Normally, the current year’s figures are compared with the base year (base year is considered as 100) and how the financial information is changed from one year to another. This analysis is also called as dynamic analysis.

B. Vertical Analysis

Under the vertical analysis, financial statements measure the quantities relationship of the various items in the financial statement on a particular period. It is also called static analysis, because, this analysis helps to determine the relationship with various items appeared in the financial statement. For example, a sale is assumed as 100 and other items are converted into sales figures.

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Techniques of Financial Statement Analysis

 

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