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The term financial statement has been widely used to represent two statements prepared by accountants at the end of specific period. They are :
- Profit and loss a/c or income statement
- Balance sheet or statement of financial position
Limitation of Financial Statement:
- Information shown in financial statement is not precise since it is based on practical experience and the conventions and rules developed therefore
- Financial statements do not always disclose the correct financial position of the business concern as they are influenced by the personal opinions,judgement,subjective view and whims of accountant of each concern
- Balance sheet of a concern is a statics document it disclose the financial position of a concern on a particular date.
- Information disclosed by profit& loss a/c may not be the real profit as many items shown in the profit & loss a/c may not the real
- Financial statements are dumb, because they speak themselves. The statements require further detailed analysis and interpretation.
- Financial statement of the one period may not be comparable.
- Financial statement do not disclose the contribution of man towards the efficiency of the business.
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENT
The various tools of financial statement are used for decision-making process. The financial statement becomes a tool for future planning and forecasting. The analysis of these statements involves their division according to similar groups and arranged in desired form. The interpretation involves the explanation of financial facts in a simplifiers manner.
Objectives of Analysis and Interpretation:
The users of financial statement have definite objectives to analysis and interpret .Therefore; there are variations in the objectives of interpretation by various classes of people. However, there are certain specific and common objectives which are listed below:
- To interpret the profitability and efficiency of various business activities with the help of profit and loss account;
- To measure managerial 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 