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Chapter 4: Analysis Of Financial Statements
4.1 Meaning of Analysis of Financial Statements
The process of critical evaluation of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm is called ‘Financial Statement Analysis’.
It is basically a study of the relationship among various financial facts and figures as given in a set of financial statements, and the interpretation thereof to gain an insight into the profitability and operational efficiency of the firm to assess its financial health and future prospects.
The term ‘financial analysis’ includes both ‘analysis and interpretation’. The term analysis
means the simplification of financial data by the methodical classification given in the financial statements.
Interpretation means explaining the meaning and significance of the data. These two are complementary to each other. The analysis is useless without interpretation, and interpretation without analysis is difficult or even impossible.
4.2 Significance of Analysis of Financial Statements
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by properly establishing relationships between the various items of the balance sheet and the statement of profit and loss.
Financial analysis can be undertaken by the management of the firm, or by parties outside the firm, viz., owners, trade creditors, lenders, investors, labor unions, analysts, and others.
The nature of the analysis will differ depending on the purpose of the analyst. A technique frequently used by an analyst need not necessarily serve the purpose of other analysts because of the difference in the interests of the analysts.
4.3 Objectives of Analysis of Financial Statements
Analysis of financial statements reveals important facts concerning managerial performance and the efficiency of the firm.
Broadly speaking, the objectives of the analysis are to apprehend the information contained in financial statements with a view to knowing the weaknesses and strengths of the firm and to make a forecast about the future prospects of the firm thereby, enabling the analysts to make decisions regarding the operation of and further investment in the firm.
4.5 Comparative Statements
As stated earlier, these statements refer to the statement of profit and loss and the balance sheet prepared by providing columns for the figures for both the current year as well as for the previous year and for the changes during the year, both in absolute and relative terms.
As a result, it is possible to find out not only the balances of accounts on different dates and summaries of different operational activities of different periods but also the extent of their
increase or decrease between these dates.
The figures in the comparative statements can be used for identifying the direction of changes and also the trends in different indicators of the performance of an organization.
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NCERT Solutions Class 12 Accountancy Chapter 4 Analysis Of Financial Statements
3. State the meaning of Analysis and Interpretation.
It is a critical and systematic examination of the financial statement. It presents the financial data in a systematic manner and also establishes a cause and effect relationship with all the items of financial statements.
Analysis and interpretation are all about presenting financial data which is self-explanatory and easy to understand.
It helps users of accounting information in assessing the status of the financial performance of the business for a time period and enables them to make proper decisions regarding the fiscal policy of the firm.
4. State the importance of Financial Analysis?
Financial analysis is of great importance for the various users of accounting information. Financial statements such as Balance Sheets, Income sheets, and other sources of financial data provide ample information on the various expenses and sources of profit, loss, and income which is helpful in determining the financial status of a business.
Financial data is not making any meaningful contribution until it is analyzed. There are various methods that help in analyzing financial statements and make them useful for various accounting users.
The following reasons are essential for performing financial analysis:
1. It is very helpful in determining the financial viability and profit earning capacity of the firm.
2. It is helpful in evaluating the business solvency in the long term
3. It is useful in comparing the financial status of a firm in comparison to other competitor firms
4. It helps management in decision making, drafting plans,s and also establishing a robust and effective control mechanism
5. What are Comparative Financial Statements?
Comparative financial statements refer to statements that enable comparison that is both intra and inter-firm and is based over a period of time.
These statements help various users of accounting information in evaluating the financial progress of a firm in relative terms.
These statements express the data in absolute figures or as percentage change and absolute change that occurs in the item of the financial statement over a period of time. The data presented in financial statements are self-explanatory and easy to understand.
When items of the financial statement are treated with the same accounting policies and practices over a fixed period of time, then the comparative data derived from such statements bear meaningful comparisons.
Two common types are:
1. Comparative Income Statement
2. Comparative Balance Sheet
6. What do you mean by Common Size Statements?
Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures.
It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison).
In these statements, the relationship between items present in financial statements and common items like balance sheet total and net sales are highlighted in percentages. The analysis based on these statements is called Vertical Analysis.
Two types are:
1. Common Size Income Statements
2. Common Size Balance Sheet
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