agerial efficiency of the firm;
- To ascertain earning capacity in future period;
- To measure short-term and long -term solvency of the business;
- To determine future positional of the concern;
- To measure utilization of various assets during the period;
- To compare operational efficiency of similar concerns engaged in the same industry
Type of Analysis:
The process of financial statement analysis is of different types. The process of analysis is classified on the basis of information used and ‘modus operandi’ of analysis. The classification is as under:
Financial statement analysis
On the basis of information on basis of ‘modus operandi’ of
(a) External analysis (a) Horizontal analysis
(b) Internal analysis (b) Vertical analysis
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS
Financial statement analysis is a very important device but it has Certain limitation which are to be kept in mind. Following are the limitations of financial statement analysis.
- Based on past data:
The nature of financial statements is historical. Past cannot be the index of future estimation, forecasting, budgeting and planning.
- Financial statement analysis cannot be a substitute for judgment :
Analysis is a tools which can be utilized usefully by an expert may lead to erroneous conclusion by unskilled analysis. Thus the result analysis cannot be considered as judgment or conclusion.
- Reliability of figures:
The accuracy and reliability of analysis depends on reliability of figures derived from financial statement.
- Different interpretation:
Result of the analysis may be interpreted differently by different user
- Change in accounting methods:
Analysis will be effective if the figures taken from financial statements comparable. If there are frequent change in accounting policies and method, figures of different periods will be different and comparable.
- Price level change:
The ever rising inflation erodes the value of money in the present day economic situation, which reduces the validity of analysis.
- Limitations of the tools of analysis:
Different techniques of analysis are used by an analyst. These tools are suitable for different type of analysis. Application of a particular tool or technique depends on the skill and expertise of the analyst. If an unsuitable technique is used, it give misleading result. It may lead to wrong conclusions and prove harmful to the business concern.
METHODS OF ANALYSIS AND INTERPRETATION
The analysis and interpretation of financial statement is used to determine the financial position and result of operation as well. The following are the tools that are used for analyzing the financial position of the company:
- Ratio Analysis
- Comparative balance sheet
- Common size balance sheet
- Trend analysis
Ratio analysis is an important and age-old technique. It is a powerful tool of financial Analysis. It is defined as “The indicated quotient of two mathematical expressions” and as “the relationship between two or more things” .Systematic use of ratio is to interpret the financial statement so that the strength and weakness of a firm as well as its historical performance and current financial condition can be determined.
A ratio is only comparison of the numerator with the denominator .The term ratio refers to the numerical or quantitative relationship between two figures. Thus, ratio is the relationship between two figures and obtained by dividing a former by the latter. Ratios are designed show how one number is related to another.
The data given in the financial statements are in absolute form and are dumb and are unable to communicate anything. Ratios are relative form of financial data and are very useful technique to check upon the efficiency of a firm. Some ratios indicate the trend or progress or downfall of the firm.
In the view of the requirements of the various users of ratio, it is divided in to the following important categories.
- 1. Liquidity ratios
- 2. Activity ratios
- 3. Profitability ratios
- 4. Earning ratios
Liquidity ratios measure the ability of the firm to meet it’s a current obligation.