<h5 id="41-meaning-of-analysis-of-financial-statements">4.1 Meaning of Analysis of Financial Statements</h5> <ul> <li>Financial Statement Analysis (FSA) is the critical evaluation of financial information in financial statements.</li> <li>FSA is a study of relationships among various financial facts and figures to understand and make decisions about a firm’s operations, profitability, and operational efficiency.</li> <li>It includes both analysis (simplification of financial data) and interpretation (explaining the meaning and significance of data).</li> <li>FSA is a judgemental process to estimate current and past financial positions, and predict future conditions, highlighting the enterprise’s strengths and weaknesses.</li> <li>It involves regrouping and analyzing information from financial statements for cross-sectional (comparison with other firms) and time-series analysis (comparison over time).</li> </ul> <p>======</p> <h5 id="42-significance-of-analysis-of-financial-statements">4.2 Significance of Analysis of Financial Statements</h5> <ul> <li>Financial analysis is the process of evaluating a firm’s financial strengths and weaknesses by analyzing its balance sheet and profit and loss statement.</li> <li>It is useful for various users such as finance managers, top management, trade payables, lenders, investors, labor unions, and others.</li> <li>Finance managers use financial analysis to make rational decisions for the firm, study accounting data, determine the continuity of operating policies, and evaluate the efficiency of operations.</li> <li>Lenders analyze the firm’s long-term solvency and survival by evaluating its profitability, ability to generate cash, and capital structure relationships.</li> <li>Investors are interested in the firm’s earnings, present and future profitability, and capital structure. They also evaluate the efficiency of the management.</li> <li>Labor unions analyze the financial statements to assess whether the firm can afford a wage increase and absorb it through increased productivity or by raising prices.</li> </ul> <p>======</p> <h5 id="43-objectives-of-analysis-of-financial-statements">4.3 Objectives of Analysis of Financial Statements</h5> <ul> <li>The analysis of financial statements aims to understand the information contained within, highlighting the strengths and weaknesses of the firm.</li> <li>It serves to assess the current profitability and operational efficiency of the firm and its departments, providing insights into the firm’s financial health.</li> <li>It helps identify the reasons for changes in the profitability/financial position of the firm and judge the firm’s ability to repay debt and assess short-term and long-term liquidity.</li> <li>The analysis identifies the relative importance of different components of the firm’s financial position and can reveal the economic concentration and financial policies of various firms.</li> <li>It provides a basis for governmental actions such as licensing, controls, price fixing, profit ceiling, dividend freeze, tax subsidies, and other concessions to the corporate sector.</li> </ul> <p>======</p> <h5 id="44-tools-of-analysis-of-financial-statements">4.4 Tools of Analysis of Financial Statements</h5> <ul> <li>Comparative Statements: A form of financial analysis that compares the profitability and financial position of a firm for different periods of time to give an idea about the position of two or more periods. Also known as ‘horizontal analysis’.</li> <li>Common Size Statements: A type of financial analysis that indicates the relationship of different items of a financial statement with a common item by expressing each item as a percentage of that common item. Also known as ‘vertical analysis’.</li> <li>Trend Analysis: A technique of studying the operational results and financial position over a series of years to observe the percentage changes over time in the selected data.</li> <li>Ratio Analysis: A technique that measures the comparative significance of the individual items of the income and position statements of a firm to assess the profitability, solvency and efficiency of an enterprise.</li> <li>Cash Flow Analysis: The analysis of actual movement of cash into and out of an organisation, summarising the causes for the changes in cash position of a business enterprise between dates of two balance sheets. Also known as ‘cash flow statement’.</li> </ul> <p>======</p> <h5 id="45-comparative-statements">4.5 Comparative Statements</h5> <ul> <li>The text provides financial information for two years.</li> <li>There are different components of revenue, costs, and expenses.</li> <li>The revenue from operations is 40,00,000 in 2016 and 35,00,000 in 2017.</li> <li>Other income and employee benefit expenses remain the same for both years.</li> <li>Cost of material consumed, other expenses, and depreciation and amortization change between the two years.</li> <li>The profit is 20,09,000 in 2016 and 14,27,000 in 2017.</li> <li>The text also includes instructions to prepare a comparative balance sheet, but no balance sheet data is provided for that task.</li> </ul> <p>======</p> <h5 id="46-common-size-statement">4.6 Common Size Statement</h5> <ul> <li>The text provides a Common Size Statement of Profit and Loss for the year ended March 31, 2016 and March 31, 2017.</li> <li>Revenue from operations, other income, employee benefit expenses, and other expenses are presented as a percentage of revenue from operations for both years.</li> <li>The income tax is presented as a percentage of profit before tax for both years.</li> <li>The Common Size Statement of Profit and Loss is used to compare the performance of different companies or the same company over different periods.</li> <li>The text also includes 3 multiple-choice questions and 6 true or false questions related to financial statements, financial analysis, and the common size statement.</li> </ul> <p>======</p> <h5 id="47-limitations-of-financial-analysis">4.7 Limitations of Financial Analysis</h5> <ul> <li>Financial analysis is limited by the information available in financial statements, which can be affected by price level changes, window dressing, and changes in accounting policies.</li> <li>Financial analysis may be misleading without understanding the changes in accounting procedures followed by a firm.</li> <li>Financial analysis is based solely on monetary information, ignoring non-monetary aspects.</li> <li>The preparation of financial statements on the basis of accounting concepts may not reflect the current position of the company.</li> <li>Financial analysis does not consider price level changes and is limited to studying reports of the company.</li> </ul> <p>======</p>