What is Analysis of financial statements?

 Analysis of financial statements

Introduction
The main objective of a company is to earn profit. It prefers a number of activities and transaction to achieve its objective. The transactions are recorded systematically and scientifically to assess the result of business operation and financial condition. A business organization prepares profit and loss account and balances sheet to known the profit or loss and financial position respectively. Profit and loss account is prepared to ascertain profit or loss and balance sheet to reveal the financial position. Similarly, it also prepares cash flow statements. They are further analyzed in terms of profitability, liquidity, solvency, operational efficiency and growth potentially.
Financial statement
Meaning of financial statement
Financial statements are the summary reports of company financial transaction. They report the end result of accounting activities during a given period of time. They provide the income/ profit or loss and financial position of a company. Financial statements are end of the period accounts prepared to show the profit or loss situation for a period of time and to assess the financial position and cash flow situation on a particulars date. Finical statement reports the result of past activities. Therefore, they are also called as the historical records of a company. Financial statements included:

Income statement
The income statement, sometimes called as the training and profit and loss account or an earnings statement, reports the profitability of a business organization for a stated period of time. In accounting, we measure profitability for a period, such as a month or year by comparing the revenues generated with the expenses incurred to produce these revenues.
Statement of retained earnings
The statement of retained earnings is also called as profit and loss appropriation account. One purpose of this statement is to connect the income statement and the balance sheet. The statement of retained earnings explains the changes in retained earning between two balances sheet dates these change usually consist of the addition of net income and the deduction of dividend.
Balance sheet
The balance sheet, sometimes called called the statement of financial position, list the company's assets, liabilities and stockholders' equity as on a particular date. A balance sheet is like a snap shot threat captured the financial position of a company at a particular point in time.
Statement of cash flow
Management is interested in the cash in flower to the company and the cash outflows from the management, because they determine the company's liquidity to pay its bills when due, the statement of cash flows shows the inflows and outflow from operating, investing and financing activities.
Features of financial statements
The following are the features of financial statements.
i.    They are always expressed in monetary terms. They ignore the qualitative aspects. In other words, tne non-monetary events do not come under the scope of financial statements.
ii.    They are always prepared for a certain period of time. They generally cover te period of one year.
iii.    They are historical in nature since the always present the past performance. Hence, they do not carry the futuristic approach.

Objective of financial statements
Financial statements of a company are the result of management's past action and decisions. They are the end of products of the accounting process. They give a picture of solvency and profitability of a company. The major objective of the financial statement can be listed as follows:
i.    To provide the financial information to the internal and external users.
ii.    To provide the information, which are useful in the decision making process.
iii.    To reveal the profitability and solvency of the company.
iv.    To help to evaluate the financial position and efficiency of the management.
v.    To facility the infra company an inter company comparison of the financial performance.
vi.    To show the financial statement health of the company.

Importance of financial statement
Financial statement are the importance sources of information to all the users of accounting information like; management, owners, debtors, creditors, employees, government agencies, financial analysis, etc. The following are the points which highlight the importance of financial statements:
i.    Financial statements are the summary of information relating to profitability, and resources owners by the form.
ii.    Financial statement provided the information which can be compared with those of other firms.
iii.    Employees can use them to demand for increment in salary and other benefits.
iv.    Bankers and other financial statement of the make the lending decision.
v.    Government bases on financial statement of the companies for the calculating of tax revenue from the firms.
vi.    Financial statements can be used as the basis for management decision-making purpose like planning, promotion, research and development decisions, etc.
vii.    Existing investment can use them to assess how efficiently the firm is using their funds.
viii.    Potential investment can obtain information which can be useful to take the investment decision.
ix.    Financial statements reveal the history of the firm.
x.    They can be used to assess the forms liquidity and solvency position.


Limitation of financial statements
The financial statement suffers from the following limitations:
i.    They included the quantities information which is expressed in monetary units. They do not provide any qualitative information which may have greater impact upon the decision makers.
ii.    They record and reveal only the historical date in nature. They do not include any feature possible result.
iii.    Financial statements are strictly within the boundary of some accounting principles hey are used as the guidance's in recording and reporting the financial transaction.
iv.    Financial statements are just the summary reports of the company's financial transactions. All too detailed information regarding to such transaction cannot be disclosed in the financial statement.
v.    Financial statement show the information on cost basis i.e. the price paid on the transaction's date. The effect of price level changes (inflation) is not shown in the financial statements. In another words, the information are not given in the current value.


Objectives of financial statement analysis
Meaning of financial statement analysis
Financial statement analysis is an analysis that highlights the importance relationship in the financial statement. It focuses on evaluation of past performance of the business firms in terms of profitability, liquidity, solvency, operational efficiency and growth potentiality. Financial statement analysis includes the methods uses in assessing and interpreting the result of past performance and current financial position as they relate to particular factors of interest in investment decision. Thus, it is an importance means of assessing past performance and in fore casting and planning futures performance.

Objective of financial statement analysis
The major objective statement analyses are as follows:
Assessment of past performance: past performance is often a good indicator of future performance. Therefore, an investment or creditor is interested in the trend of past sales, cost of goods sold, operating expenses, net income, cash flows and return on investment. These trenches offer a means for judging management's past performance and are possible indicators of future performance.
Prediction of profitability and growth prospects: the financial statement analysis help in assessing and predicting the earning prospects and growth rates in earning which are used by investors while comparing investment alternatives and other users in judging the earnings the expected return. The decision makers are futuristic and are always concerned with the future. Financial statement which contain the information on past performance with the interpreted and uses as the basis for forecasting the futures return and risk.
Prediction of bankruptcy and failure: financial statement analysis is a significant tool in assessing and predicting the bankruptcy and prosperity of business failure. Through the greater extent. After such predication, the profanity failure can be predicated to the measure to avoid or minimize losses.
Loan decisions by banker and financial initiations: financial statement analysis is used by banker, fiance companies, lending agencies, and other to make sound loan or credit decision. With the help of financial statement analysis they can make proper allocation of credit among the difference borrowers. Because it helps in determining credit risks, deciding ergs and conditions of loan, interest rates, maturity date, etc.
Assessment of the operational efficiency: financial statement analysis is the tools that help to assess the operation efficiency of the management of a company. The actual performance of the firm which is revealed in the financial can be compared with some standards the indicators of efficiency of the management.
Simplifying the information: basically, the financial statement analysis further interprets the information disclosed in the financial statement. It attempts the tools that make the information readable and unbend-able even by average types of user for thesis purpose, the information is analyzed in rations, trend percentages, graphs, diagrams, etc.


Techniques of financial statement analysis
Variable techniques are used in the analysis of financial data to emphasize the comparative and relative importance of data presented and to evaluate the position of the firm. These techniques of analysis are intended to show relationship and change, among several techniques; the following are some of the most widely uses techniques:

Horizontal analysis: the percentage analysis of increases or decrease in corresponding items in comparative financial statement is called horizontal analysis. It involves the computation of amount changes and percentage changes from the current year. The amount of each item in the most recent statement is compared with the corresponding items of the earlier statements. The increase or decreased in the amount of the item is them listed other with the percent of increase or decrease end the comparison is made between two statement, the earlier statement is used as the base.

Vertical analysis: vertical analysis uses percentages to show the relationship of the difference parts to the total in a single statement. Vertical analysis sets a total figure in the statement equal to 100 percentages will be total assets or total liabilities and equity capital in the case of balance sheet and revenues or sales in the case of the profit and loss account.
Trend analysis: using the previous years' date of a business enterprise, trend analysis can be done to observe percentage changes over time in selected data. In trend analysis, percentage changes are calculated for several successive years instead of between two hears. Trend analysis is importance by looking at a trend in a particular ratio, one may find whether that ratio is falling rising or remaining relatively constant.

Ratio analysis: ratio analysis is an importance Menadue of expressing the relationship between two numbers. A ratio can be computer from any pair of number. To be useful a ratio must repress a meaningful relationship. Rations are useful in evaluating the financial position and operations of a company and in comparing them to previous years or to other companies.

Importance of financial statement analysis
Financial statement analysis is equally important to the management, shareholder, creditors, debtors, potential investors, government agencies, bankers, general public, etc. the importance of financial statement analysis can be summarized as follows:
i.    Helpful in paling and decision making.
ii.    Helps in the evaluation of performance.
iii.    Helps in the diagnosis of managerial and operating problems.
iv.    Helpful to the bankers for credit decision.
v.    Basis for tax calculations.
vi.    Helps the government to formulate policies.
vii.    Basis of controlling.
Limitation of the financial statement analysis
The following are the limitation of financial statement analysis:
i.    It ignores to qualities aspects of the business.
ii.    The analysis is not free from the brassiness of the analysis.
iii.    Accurate comparison may not be possible if the companies have followed difference accounting principle.
iv.    Financial statement analysis only identifies/ diagrams the problems but cannot suggest the solutions.
v.    It is not possible to adjust the effect of the price level ca ages in the analysis of financial statement.
vi.    There is the chance of wrong analysis and misleading to the users.


Users interest in financial statement analysis
The users of accounting information can be divided into two types of users namely interest and external users.
Internal users: the internal parties of the accounting information are concerned with the management of the concern. They need financial statement so as to perform the difference organization activities properly and smooth and achieves the objective. Such activities are planning, policy making, and implementing, controlling etc. the internal users of accounting information might be:
a.    Directors
b.    Partners
c.    Managers
d.    Officer Etc.


External users: the external parties are not directly involved in the management and operation of concern and they are external to the organization. They are closely associated with the concern. They are:
a.    Present as well as potential stockholder: the present stockholder needs accounting information so that he/she decided whether to continue to hold the stock or sell it. On the other hand a potential stockholder needs the financial information to choose among competing alternative investment.
b.    Bondholders, bankers and other creditors: A penitential bondholder wants to be ensured that the company will be able to pay back the amount owed at maturity and the periodic interest payment similarly, a bank needs financial information that will help it to determine the company's ability to pay the principle as well as interest. Other creditors also want the assurance of their claims on due date and make them interested on the financial information.
c.    Government agencies: the government needs financial information to decide on permitting contraction or expansion of business, import/export etc. in many cases, it becomes mandatory for the business to submit its financial information to different government agencies as presencribed by law.
d.    Other external users: many other individuals and group rely on financial information provided by business. They are:
e.    Public: the public needs financial information to know about the employment opportunities, discharge of responsibility toward the society etc.
f.    Employees: the employees are interested in financial information since their present as well as future is associated with the concern.
g.    Suppliers: when the suppliers sell the goods in credit, they want the payment on time.
h.    Customers: the customers want to know whether the concern is able to supply goods continuously or not.