SHIVCHHATRAPATI COLLEGE
BBA THIRD YEAR
MANAGEMENT ACCOUNTING
Asst. Prof. Krushna Lagad Sir
2. Analysis and Interpretation of Financial Statement
Meaning of Analysis and Interpretation of Financial Statement
Analysis and Interpretation refers to a systematic and critical examination of the
financial statements. It not only establishes cause and effect relationship among the
various items of the financial statements but also presents the financial data in a
proper manner.
The main purpose of Analysis and Interpretation is to present the financial data in
such a manner that is easily understandable and self explanatory. This not only
helps the accounting users to assess the financial performance of the business over
a period of time but also enables them in decision making and policy and financial
designing process.
Objectives and Importance of Financial Statement Analysis:
The primary objective of financial statement analysis is to understand and diagnose
the information contained in financial statement with a view to judge the
profitability and financial soundness of the firm, and to make forecast about future
prospects of the firm. The purpose of analysis depends upon the person interested
in such analysis and his object.
However, the following purposes or objectives of financial statements analysis
may be stated to bring out the significance of such analysis:
(i) To assess the earning capacity or profitability of the firm.
(ii) To assess the operational efficiency and managerial effectiveness.
(iii) To assess the short term as well as long term solvency position of the firm.
(iv) To identify the reasons for change in profitability and financial position of the
firm.
(v) To make inter-firm comparison.
(vi) To make forecasts about future prospects of the firm.
(vii) To assess the progress of the firm over a period of time.
(viii) To help in decision making and control.
(ix) To guide or determine the dividend action.
(x) To provide important information for granting credit.
Scope of Financial Statement Analysis
The key financial statements that are the focus of analysis are the income
statements, balance sheet, statement of cash flows and owner’s equity. The income
statement and statement of cash flows portray different aspects of a company’s
performance over a period of time.
FINANCIAL STATEMENT ANALYSIS?
Financial statement analysis is the process an individual goes through to analyze a
company’s various financial documents in order to make an informed decision
about that business.
While the specific data contained within each financial statement will vary from
company to company, each of these documents is designed to offer insight into the
health of the company. They are also essential to monitoring a company’s
performance over time, as well as understanding how a company is progressing
toward key strategic initiatives.
Tools of Analysis of Financial Statements :
The most frequently used tools of financial analysis are as follows :
Comparative Statements: These are the statements depicting the financial
position and profitability of an enterprise for the distinct timeframe in a
comparative form to give a notion about the position of 2 or more periods. It
usually applies to the 2 important financial statements, namely, statement of
profit and loss and balance sheet outlined in a comparative form.
Comparative figures signify the direction and trend of financial position and
operating outcomes. This type of analysis is also referred to as ‘horizontal
analysis’.
Common Size Statements: Common size statements are the statements
which signify the association of distinct items of a financial statement with a
generally known item by depicting each item as a % of that common item.
Such statements allow an analyst to compare the financing and operating
attributes of 2 enterprises of distinct sizes in a similar industry. This analysis
is also referred to as ‘Vertical analysis’.
Cash Flow Analysis: It refers to the analysis of the actual movement of cash
into and out of an establishment. The flow of cash into the trading concern is
called cash inflow or positive cash flow and the flow of cash out of the
enterprise is known as negative cash flow or cash outflow. The difference
between the outflow and inflow of cash is the net cash flow. Hence, it
compiles the reasons for the changes in the cash position of a trading
concern between dates of 2 balance sheets.
Ratio Analysis: It characterizes the vital association which exists between
several items of a B/S (balance sheet) and a statement of P&L of an
enterprise. As a method of financial analysis, accounting ratios compute the
comparative importance of the single items of the position and income
statements. It is feasible to evaluate the solvency, efficiency, and
profitability of an enterprise via the method of ratio analysis.
Comparative Statement
Comparative statements or comparative financial statements are statements of
financial position of a business at different periods. These statements help in
determining the profitability of the business by comparing financial data from two
or more accounting periods.
The data from two or more periods are updated side by side, which is why it is also
known as Horizontal Analysis. The advantage of such an analysis is that it helps
investors to identify the trends of business, check a company’s progress and also
compare it with that of its competitors.
The financial data will be considered to be comparative only when the same set
of accounting principles are being used for preparing the statements.
Types of Comparative Statements
There are two types of comparative statements which are as follows
1. Comparative income statement
2. Comparative balance sheet
