Download analysis of financial statements

Chapter - 4
ANALYSIS OF FINANCIAL
STATEMENTS
Dr. BALAMURUGAN MUTHURAMAN
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NATURE OF FINANCIAL STATEMENT
• The data exhibited by financial statements are
affected by
• a) Recorded facts
• b) Accounting Concepts, Conventions &
Principles
• c) Personal Judgment
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ACCOUNTING PRINCIPLES
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Accounting concepts
Accounting Conventions
a) Entity Concept
a)
Disclosure
b) Going Concern Concept
b)
Materiality
c) Accounting period concept
c)
Consistency
d) Money Measurement Concept
d)
Conservatism
e) Cost Concept
f)
Cost Attach Concept
g) Dual Aspect Concept
h) Accrual concept
i)
Periodic Matching of cost and
Revenue Concept
j)
Realisation Concept
k) Verifiable Objective Evidence Concept
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ESSENTIAL QUALITIES OF
FINANCIAL STATMENTS
1.Relevance
2.Understandability :
3.Reliability and Accuracy
4.Comparability
5.Completeness
6.Timeliness
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LIMITATIONS OF FINANCIAL
STATEMENTS
1. Lack of Precision
2. Lack of Exactness
3. Incomplete Information
4. Interim Reports
5. Hiding of Real Position or Window Dressing
6. Lack of Comparability
7. Historical Costs
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ANALYSIS
• Analysis – To Analyse – to cut into pieces
• But only analyse – No – It means also Interpretation.
• Financial Statement Analysis means “Analysis,
comparisons and interpretation of Financial data to
achieve the desired result”
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TOOLS OF FINANCIAL STATEMENT
ANALYSIS
1. Comparative Statements
2. Common Size Statements
3. Trend Analysis
4. Ratio Analysis
5. Fund Flow Statement
6. Cash Flow Statement
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TYPES OF FINANCIAL ANALYSIS
1.Intra-Firm Comparison
2.Inter-firm Comparison
3.Industry Average or Standard Analysis:
4.Horizontal Analysis
5.Vertical Analysis
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INTERPRETATION
The Analysis is of no use without interpretation The
Company has to interpret the financial statement which it has
analysed.
The Analysis is made to serve the following purpose
1. Profitability Analysis
2. Liquidity Analysis
3. Solvency Analysis (To know the financial structure)
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Interested Parties in Analysis of
Financial Statements
1. Management
2. Investors (In the form of Shareholders or Debentureholders)
3. Banks and Financial Institution
4. Trade Creditors
5. Government and their Agencies
6. Employees
7. Customers
8. Public
9. Trade Association
10.Stock Exchange
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COMPARATIVE FINANCIAL
STATEMENTS
• Comparative Financial Statements is a
statement of Financial Position of a business
designed in such a way where a comparative
study is undertaken of different accounting
items, to measure the performance of a
Business Activity.
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TYPES OF COMPARISON
There are 3 types of Comparison
1) Inter Firm Comparison
2) Intra Firm Comparison
3) Inter Period Comparison
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MERITS OF COMPARISON
1) Indicate the Direction
Position
2) Reveal Nature & Trend
3) Identifying Trouble Spots
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DISADVANTAGES OF COMPARISON
1) Misleading picture, if consistency in accounting principle not
followed.
2) Constant change in price level tender accounting statement
useless for comparison.
3) Inter firm comparison is useless, unless all the firms are of the
same age, size and follow the same principles.
4) If there exists any Abnormal Period between 2 successive
accounting period then it will prove to be a pointless analysis.
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COMMON SIZE STATEMENTS
It is a Statement in Vertical Form in which
every item of the Financial Statement is
reduced to a common base. This was
introduced with a view to overcome the
limitation of Comparative Statement.
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TYPES OF COMMON SIZE
STATEMENTS.
(1) Common Size Balance Sheet
(2) Common Size Income Statement:
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ADVANTAGES OF COMMON SIZE
STATEMENT
1) It reveals Sources and Application of Funds in a
nutshell which help in taking decision.
(2) If common size statements of 2 or more years are
compared it indicate the changing proportion of
various components of Assets, Liabilities, Cost, Net
Sale & Profit.
(3) When Inter Firm Comparison is made with the help
of Common size statement it helps in doing corporate
evaluation and Ranking.
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DISADVANTAGES OF COMMON
SIZE STATEMENT
(1)
No Established Standard Proportion:
Common Size Statements are regarded as useless as there
is no established standard proportion of an asset to the total
asset or an item of expense to the net sales.
(2)
Consistency Required:If Financial Statement of a Particular business
organization are not prepared year after year on a consistent
basis comparative study of common size statement will be
misleading
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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 percentage where value of
each item in base year will be considered as
100. Trend percentage analysis move in one
directions either upward or downward
progression or regression.
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