Introduction to Financial statements analysis
Financial Statements
Nature of Financial statements
Features of Financial statements
Objectives of Financial statements
What is a financial statement?
The term financial statement refers to statement of Changes in financial position, Statement of
Retained Earnings, Balance Sheet, Profit and Loss Account, etc. But, generally, the financial
statements include only two statements; they are profit and Loss Account and Balance Sheet. It is
observed that the mere presentation of these statements does not serve the purpose of anybody in
anyway. The importance of these statements lies in their analysis and interpretation. In the
beginning, analysis was done only for extending credit, but now it is being used as
most important function of Management Accountant for providing various useful information to
many persons.
Some of the schedules are prepared and submitted along with the financial statements for
meaningful presentation. Such schedules are schedule of fixed assets, schedule of debtors,
schedule of creditors, schedule of investments and the like.
Nature of Financial Statements
Generally, financial statements are prepared in order to disclose the financial position of business
concerns at a point of time and also operating results during the period under review. The
interested parties of the financial statements are thinking that the values shown in the financial
statements to be real and absolute. But, this is not correct understanding. The values shown in the
financial statements never convey the current or economic values. The data shown in the
financial statements are greatly affected by the following facts.
1. Recorded Facts: All the business transactions which are having financial character alone
recorded in the books of accounts (Journals, Ledger and other Subsidiary Books). Such recorded
information are used for preparing financial statements. After some gradual passage of time,
these recorded information become historical in nature. Besides, the financial statements are
showing results of the various transactions which are taken place at various dates.
There is no place for their current value in the financial statements which is neither justified nor
logical. For example: If a plant and machinery is purchased in 2005 and another plant and
machinery is purchased in 2010, then the total amount paid at both dates shall be shown under
“Plant and Machinery Account” in the books. The purchasing power of money in 2005 is not the
same in 2010. Hence, the recording the value of plant and machinery in the books of account is
not valid and correct. Besides, the assets are shown in the Balance Sheet either on Straight Line
Method or Written Down Value Method. Market value or replacement cost is not shown in the
financial statement.
2. Accounting Conventions: There are four types of accounting conventions. They are
convention of conservatism, convention of full disclosure, convention of consistency and
convention of materiality. These are used for valuation of raw materials, stock of finished goods,
,debtors and the like. Many companies does not follow same pattern of conventions throughout
its life. Hence, the financial statements fail to satisfy the essential elements of comparison.
3. Postulates: There are some postulates and assumptions just like accounting concepts and
conventions. Such postulates and assumptions are used for preparing. financial statements. In
other words, the conventions used in financial statements are based on certain postulates. It is
assumed that the purchasing power of money is constant for all the period. Hence, the
management accountants are recording all the business transactions in rupee value on different
dates without making any distinction between the rupee value of two dates.
4. Personal Judgement: Personal judgement plays a vital role in the preparation of financial
records and financial statements. The management accountants may use their judgement in
choosing the method of valuation of closing inventory, in calculating the provision for bad debts
and in choosing the method of charging the depreciation of fixed assets. Likewise, the
application of various accounting concepts and conventions depends upon the personal
judgement of the management accountant. Therefore, different meaning and results can be
obtained from the financial statements of the same company. Based on the different results,
different recommendations may be provided for the growth and development of a business
concern.
Features of Financial Statements
The important features of financial statements are as follows.
1. Financial Statements are prepared at the end of the accounting period.
2. Financial Statements disclose both facts and opinions.
3. Financial statements are prepared on the going concern value..
4. Financial statements are recorded facts of financial transactions based on historical cost.
5. Financial statements are greatly affected by personal judgement of the accountants.
Objectives of Financial Statements
The different types of people are using the financial statements. They need different types of
information. Hence, the main objective of financial statements is fulfilling the needs of such
people. Even though, some other objectives are briefly explained below.
1. To provide an accurate and reliable financial information about the resources and usage in a
business unit within the stipulated time.
2. To provide overall changes made in the financial information relating to resources and usage
for a particular period.
3. To provide accurate and reliable financial information relating to net changes made between
resources and usage for a particular period arising out of business activities.
, 4. To provide financial information which are helping the top management for estimating earning
potential of business.
Meaning of Analysis
Analysis means the process of splitting or broken up of the contents of financial statements into
many parts for getting meaningful information at the maximum.
Meaning of Interpretation
Interpretation means explaining the meaning and significance of the rearranged and/or modified
data of the financial statements.
Procedure for Analysis and Interpretation
To make an effective analysis and interpretation of financial statements, the following
groundwork are required to be completed.
1. The objectives of financial statement analysis is the basis for the selection of techniques of
analysis. Hence, the organization should decide the purpose of financial statement analysis.
2. The extent of interpretation is also decided to select right type of techniques of financial
statement analysis.
3. The financial statements are prepared on certain assumptions, principles and practices which
are ascertained to understand their significance.
4. Additional information required for the work of interpretation should be collected properly.
5. The collected data should be presented in a logical sequence by rearrangement of data.
6. Data should be analyzed for preparing comparative statement, common size statement, trend
percentage, calculation of ratios and the like.
7. General market conditions and economic conditions are taken into consideration for analyzing
and interpreting the collected facts.
8. Interpreted data and information should be presented in a suitable report form.
Objectives of Analysis and Interpretation
Many interested parties of financial statements are analyzed and interpreted according to their
varied objectives. In spite of the variations in the objectives of analysis and interpretation by
various classes of people, there are some common objectives of interpretation which are
presented below.
1. To examine the earning capacity and efficiency of various business activities with the help
of income statements.
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