Financial Statement analysis Assignment Help
Before discussing about the topic "Financial Statement Analysis", first we should get an overview of the basic financial statements:
a) Balance sheet: It summarizes what a firm owns and owes at a point in time.
b) Profit and loss account: It reports on how much a firm earned in the period of analysis. It is also known as income statement.
c) Cash flow statement: It reports on cash inflows and outflows to the firm during the period of analysis.
Financial statement analysis (or financial analysis) is a process of selecting, evaluating and interpreting financial data, along with other pertinent information, in order to formulate an assessment of a company’s present and future financial condition and performance. It is the process of understanding the risk and profitability of an entity through analysis of reported financial information, by using different accounting tools and techniques. It is an evaluative method of determining the past, current and projected performance of a company.
Following are the tools for financial statement analysis:
- Comparative statements: It is a statement of financial position of a business designed in such a way where a comparative study is undertaken for different accounting items, to measure the performance of business activity.
- Common size statements: It is a statement in vertical form in which every item of the financial statement is reduced to a common base.
- Trend analysis: Trend analysis is a statement in vertical form where the earliest year is taken as base year and the value of all the items in the financial statements will be related to the base year in terms of % where value of each item in base year will be considered as 100.
- Ratio analysis: Balance sheet ratios are calculated and compared with that of previous years.
- Proportion analysis: Arrays of ratios are available for discerning the relationship between the sizes of various accounts in the financial statements.
Following are the types of financial statement analysis:
- Intra-firm comparison
- Inter-firm comparison
- Industry average or standard analysis
- Horizontal analysis
- Vertical analysis
Advantages of financial statement analysis:
- It provides an idea to the investors about deciding on investing their funds in a particular company.
- Regulatory authorities can ensure the company following the required accounting standards.
- It is helpful to the government agencies in analyzing the Taxation owed to the firm.
- Above all, the company is able to analyze its own performance over a specific time period.
Limitations of financial statement analysis:
- Comparability between periods: An entity preparing the financial statements may have changed the accounts in which it stores financial information, so that results may differ from period to period.
- Comparability between companies: An analyst frequently compares the financial ratios of different companies in order to see how they match up against each other. However, each company may aggregate financial information differently, so that the results of their ratios are not really comparable. This can lead an analyst to draw incorrect conclusions about the results of a company in comparison to its competitors.
- Operational performance: Financial analysis only reviews a company's financial information, not its operational information.
Conclusion:
Financial statement analysis is concerned with analyzing the balance sheet and the income statement of a business to interpret the business and financial ratios of a business for financial representations, business evaluation, in addition to financial forecasting. It only presents part of the total picture.