The Workings Of Equity Portfolio Management

The goal of virtually all investment analyses is to make investment decisions or advise others in
making their own investment decisions. Therefore, there is an inextricable link between the art
and science of equity analysis and equity portfolio management. As a result, most analysts have a
good educational background in both equity analysis and portfolio management subjects
like modern portfolio theory (MPT) early in their careers. Analysts frequently turn into portfolio
managers

over

time.

Even with a good understanding of equity analysis and MPT, there are certain mechanical
elements to portfolio management that must be addressed before actually constructing and
running equity portfolios. As is the case with many professions, the real-world application of
theoretical investment concepts can involve thinking beyond one's specialty and training.
Running a group of portfolios involves extensive attention to detail, computerization and the
need for administrative efficiency. In this article, we'll explain the mechanics of equity portfolio
management, and how this system can create a group of different portfolios that perform as a
homogeneous

element.

Investment Philosophy and the Investment Universe

Professional portfolio managers who work for an investment management company generally do
not have a choice about the general investment philosophy used to govern the portfolios they

manage. An investment firm may have strictly defined parameters for stock selection and
investment management. An example would be a firm defining a value investment selection style
using certain trading guidelines.
Therefore, the first step in portfolio management is to understand the universe from which
investments may be selected.
Another philosophical consideration is the analytical approach for the portfolio in question.
Some firms or portfolios use a bottom-up approach, where investment decisions are made
primarily by selecting stocks without consideration to sector selection or economic forecasts.
Other styles may be top-down oriented and portfolio managers pay primary attention to
analyzing entire sectors or macroeconomic trends as a starting point for analysis and stock
selection. Many styles use a combination of these approaches.
Professional portfolio managers follow the rigid policy with strictly defined parameters for
investment management and stock selection. These portfolio managers work for an investment
management company and do not have freedom to follow general investment philosophy for
governing the portfolios they manage. The portfolio managers are generally guarded by market
capitalization guidelines and thus, equity portfolio management involves understanding of the
investment universe for selecting the efficient investments.
Tax Sensitivity
A lot of institutional equity portfolios, such as pension funds, are not taxable. This gives portfolio
managers more managerial flexibility than taxable portfolios. Non-taxable portfolios may use
greater exposure to dividend income and short-term capital gains than their taxable counterparts.
Managers of taxable portfolios may need to pay special attention to stock holding periods, tax
lots, capital losses, tax selling and dividend income generated by portfolios. Taxable portfolios
may be more effective with a lower portfolio turnover rate, relative to non-taxable portfolios.
Understanding the tax consequences of - or lack thereof - portfolio management activity is of
primary importance in building and managing portfolios over time.
Portfolio managers of taxable portfolios take special care of following factors.
Stock holding periods

 Tax lots
Capital losses
Tax selling
Dividend income generated by portfolios
In comparison to non-taxable portfolio, the taxable portfolios are more successful with a lower
portfolio turnover rate. The portfolio management activity plays a major part in building and
managing portfolios over time.
Building the Portfolio Model
Whether running one portfolio or a thousand portfolios in one equity investment product or style,
building and maintaining a portfolio model is a common aspect of equity portfolio management.
A portfolio model is a standard against which individual portfolios are matched. Generally,
portfolio managers will assign a percentage weighting to every stock in the portfolio model, and
then individual portfolios are modified to match up against this weighting mix. Portfolio models
are usually computerized using software such as Microsoft Excel or specific portfolio
management software tools.
For example, after doing some mix of company analyses, sector analyses and macroeconomic
analyses, the portfolio manager may decide that he or she wants to own a relatively large weight
of a particular stock. Perhaps in the portfolio manager's style, a relatively large weighting is 4%
of the total portfolio value. By reducing the weighting of other stocks in the portfolio model, or
by reducing the overall cash weighting, the portfolio manager would buy enough stocks of a
particular company in each portfolio to match up against the 4% model weight. All of the
portfolios will look like each other (and the portfolio model), at least in terms of the 4%
weighting on that particular stock.
n this way, the portfolio manager runs all portfolios in a similar or identical fashion
given the specific style mandated by that portfolio group. He or she would expect all portfolios
in the group to generate returns in a standardized way, relative to each other. All of the portfolios

will also be very similar to each other in terms of the risk/reward profile. In effect, all of the
analytical and security evaluation that the portfolio manager does is run on a model, and not on
the individual portfolios.
Achieving Portfolio Efficiency
Running all of his or her portfolios in a similar way, allows a portfolio manager to achieve
a remarkable analytical efficiency. The portfolio manager only needs to have an understanding of
perhaps 30 or 40 stocks owned in similar proportions in all portfolios, rather than 100 or 200
stocks owned in various proportions in 1,000 different portfolio accounts. Analysis on the 30 or
40 stocks can be applied to all portfolios easily by changing model weights in the portfolio
model over time. As the outlook on individual stocks changes over time, the portfolio manager
only needs to change his or her model weightings to reflect the investment decision in
all portfolios simultaneously.
The portfolio model can also be used to handle all day-to-day transactions at the
individual portfolio level. New accounts can be set up quickly and efficiently by simply "buying
against the model." Cash deposits and withdrawals can be handled in a similar way. If the
portfolio is large enough, the model only really needs to be applied to the change in asset size to
build a portfolio that looks just like the portfolio model. Smaller portfolios may be limited by
stock board lot constraints, which may affect the portfolio manager's ability to accurately buy or
sell to certain percentage weightings.
An equity portfolio manager can achieve analytical efficiency by running all the portfolios in a
similar way. The portfolio manager is required to have the knowledge and understanding of 30 or
40 stocks that are owned in comparable proportions in all portfolios instead of 100 or 200 stocks.
The analysis of 30 or 40 stocks is easily applied to other portfolios by modifying the model
weights in the portfolio model with passage of time. The dynamic market causes the rise and fall
of individual stocks over time and the portfolio manager is required to change the model
weightings that for reflecting the investment decision in all portfolios.
Equity portfolio management involves the portfolio modelling as an effective way for evaluating
the key set of stocks to a set of portfolios in one group. It acts as an efficient link between

portfolio management and equity analysis. With the rise and fall in outlook of individual stocks,
the weightings of these stocks needs to be changed accordingly in the portfolio model for
optimizing the return of all portfolios in the group.

Investment management
Investment management is the professional asset management of various securities (shares,
bonds and other securities) and other assets (e.g., real estate) in order to meet specified
investment goals for the benefit of the investors. Investors may be institutions (insurance
companies, pension funds, corporations, charities, educational establishments etc.) or private
investors (both directly via investment contracts and more commonly via collective investment
schemes e.g. mutual funds or exchange-traded funds).
The term asset management is often used to refer to the investment management of collective
investments, while the more generic fund management may refer to all forms of institutional
investment as well as investment management for private investors. Investment managers who
specialize in advisory or discretionary management on behalf of (normally wealthy) private
investors may often refer to their services as money management or portfolio management often
within the context of so-called "private banking".
The provision of investment management services includes elements of financial statement
analysis, asset selection, stock selection, plan implementation and ongoing monitoring of
investments. Coming under the remit of financial services many of the world's largest companies
are at least in part investment managers and employ millions of staff.
The term fund manager refers to both a firm that provides investment management services and
an individual who directs fund management decisions.
The business of investment has several facets, the employment of professional fund managers,
research (of individual assets and asset classes), dealing, settlement, marketing, internal auditing,
and the preparation of reports for clients. The largest financial fund managers are firms that

exhibit all the complexity their size demands. Apart from the people who bring in the money
(marketers) and the people who direct investment (the fund managers), there are compliance staff
(to ensure accord with legislative and regulatory constraints), internal auditors of various kinds
(to examine internal systems and controls), financial controllers (to account for the institutions'
own money and costs), computer experts, and "back office" employees (to track and record
transactions and fund valuations for up to thousands of clients per institution).
Key problems of running such businesses
Key problems include:

revenue is directly linked to market valuations, so a major fall in asset prices can cause a
precipitous decline in revenues relative to costs;

above-average fund performance is difficult to sustain, and clients may not be patient
during times of poor performance;

successful fund managers are expensive and may be headhunted by competitors;

above-average fund performance appears to be dependent on the unique skills of the fund
manager; however, clients are loath to stake their investments on the ability of a few
individuals- they would rather see firm-wide success, attributable to a single philosophy and
internal discipline;

analysts who generate above-average returns often become sufficiently wealthy that they
avoid corporate employment in favor of managing their personal portfolios.

Representing the owners of shares

Institutions often control huge shareholdings. In most cases they are acting as fiduciary agents
rather than principals (direct owners). The owners of shares theoretically have great power to
alter the companies via the voting rights the shares carry and the consequent ability to pressure
managements, and if necessary out-vote them at annual and other meetings.
In practice, the ultimate owners of shares often do not exercise the power they collectively hold
(because the owners are many, each with small holdings); financial institutions (as agents)

sometimes do. There is a general belief[ that shareholders in this case, the institutions acting as
agentscould and should exercise more active influence over the companies in which they hold
shares (e.g., to hold managers to account, to ensure Board's effective functioning). Such action
would add a pressure group to those (the regulators and the Board) overseeing management.
However, there is the problem of how the institution should exercise this power. One way is for
the institution to decide, the other is for the institution to poll its beneficiaries. Assuming that the
institution polls, should it then:
(i)
(ii)
(iii)

Vote the entire holding as directed by the majority of votes cast?

Split the vote (where this is allowed) according to the proportions of the vote?
Or respect the abstainers and only vote the respondents' holdings?

The price signals generated by large active managers holding or not holding the stock may
contribute to management change. For example, this is the case when a large active manager
sells his position in a company, leading to (possibly) a decline in the stock price, but more
importantly a loss of confidence by the markets in the management of the company, thus
precipitating changes in the management team.
Some institutions have been more vocal and active in pursuing such matters; for instance, some
firms believe that there are investment advantages to accumulating substantial minority
shareholdings (i.e. 10% or more) and putting pressure on management to implement significant
changes in the business. In some cases, institutions with minority holdings work together to force
management change. Perhaps more frequent is the sustained pressure that large institutions bring
to bear on management teams through persuasive discourse and PR. On the other hand, some of
the largest investment managerssuch as BlackRock and Vanguardadvocate simply owning
every company, reducing the incentive to influence management teams. A reason for this last
strategy is that the investment manager prefers a closer, more open and honest relationship with a
company's management team than would exist if they exercised control; allowing them to make a
better investment decision.
Philosophy, process and people
The 3-P's (Philosophy, Process and People) are often used to describe the reasons why the
manager is able to produce above average results.

Philosophy refers to the overarching beliefs of the investment organization. For example:

Does the manager buy growth or value shares, or a combination of the two (and
why)?

Do they believe in market timing (and on what evidence)?

Do they rely on external research or do they employ a team of researchers? It is

helpful if any and all of such fundamental beliefs are supported by proofstatements.

Process refers to the way in which the overall philosophy is implemented. For example:

Which universe of assets is explored before particular assets are chosen as

suitable investments?

How does the manager decide what to buy and when?

How does the manager decide what to sell and when?

Who takes the decisions and are they taken by committee?

What controls are in place to ensure that a rogue fund (one very different from
others and from what is intended) cannot arise?

People refers to the staff, especially the fund managers. The questions are, Who are they?
How are they selected? How old are they? Who reports to whom? How deep is the team (and
do all the members understand the philosophy and process they are supposed to be using)?
And most important of all, How long has the team been working together? This last question
is vital because whatever performance record was presented at the outset of the relationship
with the client may or may not relate to (have been produced by) a team that is still in place.
If the team has changed greatly (high staff turnover or changes to the team), then arguably
the performance record is completely unrelated to the existing team (of fund managers).

Investment managers and portfolio structures

At the heart of the investment management industry are the managers who invest and divest
client investments.
A certified company investment advisor should conduct an assessment of each client's individual
needs and risk profile. The advisor then recommends appropriate investments.
Asset allocation
The different asset class definitions are widely debated, but four common divisions
are stocks, bonds, real estate and commodities. The exercise of allocating funds among these
assets (and among individual securities within each asset class) is what investment management
firms are paid for. Asset classes exhibit different market dynamics, and different interaction
effects; thus, the allocation of money among asset classes will have a significant effect on the
performance of the fund. Some research suggests that allocation among asset classes has more
predictive power than the choice of individual holdings in determining portfolio return.
Arguably, the skill of a successful investment manager resides in constructing the asset
allocation, and separately the individual holdings, so as to outperform certain benchmarks (e.g.,
the peer group of competing funds, bond and stock indices).
Long-term returns
It is important to look at the evidence on the long-term returns to different assets, and to holding
period returns (the returns that accrue on average over different lengths of investment). For
example, over very long holding periods (e.g. 10+ years) in most countries, equities have
generated higher returns than bonds, and bonds have generated higher returns than cash.
According to financial theory, this is because equities are riskier (more volatile) than bonds
which are themselves more risky than cash.
Diversification

Against the background of the asset allocation, fund managers consider the degree
of diversification that makes sense for a given client (given its risk preferences) and construct a
list of planned holdings accordingly. The list will indicate what percentage of the fund should be
invested in each particular stock or bond. The theory of portfolio diversification was originated
by Markowitz (and many others). Effective diversification requires management of the
correlation between the asset returns and the liability returns, issues internal to the portfolio
(individual holdings volatility), and cross-correlations between the returns.
Investment styles
There are a range of different styles of fund management that the institution can implement. For
example, growth, value, growth at a reasonable price (GARP), market neutral, small
capitalisation, indexed, etc. Each of these approaches has its distinctive features, adherents and,
in any particular financial environment, distinctive risk characteristics. For example, there is
evidence that growth styles (buying rapidly growing earnings) are especially effective when the
companies able to generate such growth are scarce; conversely, when such growth is plentiful,
then there is evidence that value styles tend to outperform the indices particularly successfully.
Large asset managers are increasingly profiling their equity portfolio managers to trade their
orders more effectively. While this strategy is less effective with small-cap trades, it has been
effective for portfolios with large-cap companies.

Performance measurement
Fund performance is often thought to be the acid test of fund management, and in the
institutional context, accurate measurement is a necessity. For that purpose, institutions measure
the performance of each fund (and usually for internal purposes components of each fund) under
their management, and performance is also measured by external firms that specialize in
performance measurement. The leading performance measurement firms compile aggregate
industry data, e.g., showing how funds in general performed against given indices and peer
groups over various time periods.

In a typical case (let us say an equity fund), then the calculation would be made (as far as the
client is concerned) every quarter and would show a percentage change compared with the prior
quarter (e.g., +4.6% total return ). This figure would be compared with other similar funds
managed within the institution (for purposes of monitoring internal controls), with performance
data for peer group funds, and with relevant indices (where available) or tailor-made
performance benchmarks where appropriate. The specialist performance measurement firms
calculate quartile and decile data and close attention would be paid to the (percentile) ranking of
any fund.
Generally speaking, it is probably appropriate for an investment firm to persuade its clients to
assess performance over longer periods (e.g., 3 to 5 years) to smooth out very short-term
fluctuations in performance and the influence of the business cycle. This can be difficult however
and, industry wide, there is a serious preoccupation with short-term numbers and the effect on
the relationship with clients (and resultant business risks for the institutions).
An enduring problem is whether to measure before-tax or after-tax performance. After-tax
measurement represents the benefit to the investor, but investors' tax positions may vary. Beforetax measurement can be misleading, especially in regimens that tax realised capital gains (and
not unrealised). It is thus possible that successful active managers (measured before tax) may
produce miserable after-tax results. One possible solution is to report the after-tax position of
some standard taxpayer.
Risk-adjusted performance measurement
Performance measurement should not be reduced to the evaluation of fund
returns alone, but must also integrate other fund elements that would be of
interest to investors, such as the measure of risk taken. Several other
aspects are also part of performance measurement: evaluating if managers
have succeeded in reaching their objective, i.e. if their return was sufficiently
high to reward the risks taken; how they compare to their peers; and finally
whether the portfolio management results were due to luck or the managers
skill. The need to answer all these questions has led to the development of

more sophisticated performance measures, many of which originate

in modern

portfolio

theory.

Modern

portfolio

theory

established

the

quantitative link that exists between portfolio risk and return. The Capital
Asset Pricing Model (CAPM) developed by Sharpe (1964) highlighted the
notion of rewarding risk and produced the first performance indicators, be
they risk-adjusted ratios (Sharpe ratio, information ratio) or differential
returns compared to benchmarks (alphas). The Sharpe ratio is the simplest
and best known performance measure. It measures the return of a portfolio
in excess of the risk-free rate, compared to the total risk of the portfolio. This
measure is said to be absolute, as it does not refer to any benchmark,
avoiding drawbacks related to a poor choice of benchmark. Meanwhile, it
does not allow the separation of the performance of the market in which the
portfolio is invested from that of the manager. The information ratio is a
more general form of the Sharpe ratio in which the risk-free asset is replaced
by a benchmark portfolio. This measure is relative, as it evaluates portfolio
performance in reference to a benchmark, making the result strongly
dependent on this benchmark choice.
Portfolio alpha is obtained by measuring the difference between the return of the portfolio and
that of a benchmark portfolio. This measure appears to be the only reliable performance measure
to evaluate active management. In fact, we have to distinguish between normal returns, provided
by the fair reward for portfolio exposure to different risks, and obtained through passive
management, from abnormal performance (or outperformance) due to the managers skill (or
luck), whether through market timing, stock picking, or good fortune. The first component is
related to allocation and style investment choices, which may not be under the sole control of the
manager, and depends on the economic context, while the second component is an evaluation of
the success of the managers decisions. Only the latter, measured by alpha, allows the evaluation
of the managers true performance (but then, only if you assume that any outperformance is due
to skill and not luck).
Portfolio return may be evaluated using factor models. The first model, relies on the CAPM and
explains portfolio returns with the market index as the only factor. It quickly becomes clear,

however, that one factor is not enough to explain the returns very well and that other factors have
to be considered. Multi-factor models were developed as an alternative to the CAPM, allowing a
better description of portfolio risks and a more accurate evaluation of a portfolio's performance.
Financial Analysis
Financial statement analysis is an analysis that highlights the important relationship in the
financial statements. Financial statement analysis focuses on the evaluation of past performance
of the business firm in terms of liquidity, profitability, operational efficiency and growth
potentiality.

Financial statements

analysis

includes

the

method

use

in

assessing

and interpreting the result of past performance and current financial position as they relate to
particular factors of interest in investment decisions. Therefore financial statement analysis is an
important means of assessing past performance and in forecasting and planning future
performance.
Tools and techniques of Financial Analysis

Financial Analysis is defined as being the process of identifying financial strength and weakness
of a business by establishing relationship between the elements of balance sheet and income
statement. The information pertaining to the financial statements is of great importance through
which interpretation and analysis is made. It is through the process of financial analysis that the

key performance indicators, such as, liquidity solvency, profitability as well as the efficiency of
operations of a business entity may be ascertained, while short term and long term prospects of a
business may be evaluated. Thus, identifying the weakness, the intent is to arrive at
recommendations as well as forecasts for the future of a business entity.

Financial analysis focuses on the financial statements, as they are a disclosure of a financial
performance of a business entity. A Financial Statement is an organized collection of data
according to logical and consistent accounting procedures. Its purpose is to convey an
understanding of some financial aspects of a business firm. It may show assets position at
a moment of time as in the case of balance sheet, or may reveal a series of activities over a
given period of times, as in the case of an income statement.

Since there is recurring need to evaluate the past performance, present financial position, the
position of liquidity and to assist in forecasting the future prospects of the organization, various
financial statements are to be examined in order that the forecast on the earnings may be made
and the progress of the company be ascertained.

The financial statements are: Income statement, balance sheet, statement of earnings, statement
of changes in financial position and the cash flow statement. The income statement, having
been termed as profit and loss account is the most useful financial statement to enlighten what
has happened to the business between the specified time intervals while showing, revenues,
expenses gains and losses. Balance sheet is a statement which shows the financial position of a
business at certain point of time. The distinction between income statement and the balance sheet
is that the former is for a period and the latter indicates the financial position on a particular date.
However, on the basis of financial statements, the objective of financial analysis is to
draw information to facilitate decision making, to evaluate the strength and the weakness of a

business, to determine the earning capacity, to provide insights on liquidity, solvency and
profitability and to decide the future prospects of a business entity.

There are various types of Financial analysis. They are briefly mentioned herein:

External analysis: The external analysis is done on the basis of published financial statements
by those who do not have access to the accounting information, such as, stock holders, banks,
creditors, and the general public.

Internal Analysis: This type of analysis is done by finance and accounting department. The
objective of such analysis is to provide the information to the top management, while assisting in
the decision making process.

Short term Analysis: It is concerned with the working capital analysis. It involves the analysis
of both current assets and current liabilities, so that the cash position (liquidity) may be
determined.

Horizontal Analysis: The comparative financial statements are an example of horizontal

analysis, as it involves analysis of financial statements for a number of years. Horizontal analysis
is also regarded as Dynamic Analysis.

Vertical Analysis: it is performed when financial ratios are to be calculated for one year only. It
is also called as static analysis.

An assortment of techniques is employed in analyzing financial statements. They

are: Comparative Financial Statements, statement of changes in working capital, common size
balance sheets and income statements, trend analysis and ratio analysis.

Comparative Financial Statements: It is an important method of analysis which is used to

make comparison between two financial statements. Being a technique of horizontal analysis and
applicable to both financial statements, income statement and balance sheet, it provides
meaningful information when compared to the similar data of prior periods. The comparative
statement of income statements enables to review the operational performance and to draw
conclusions, whereas the balance sheets, presenting a change in the financial position during the
period, show the effects of operations on the assets and liabilities. Thus, the absolute change
from one period to another may be determined.

Statement of Changes in Working Capital: The objective of this analysis is to extract

the information relating to working capital. The amount of net working capital is determined by
deducting the total of current liabilities from the total of current assets. The statement of changes
in working capital provides the information in relation to working capital between two financial
periods.

Common Size Statements: The figures of financial statements are converted to percentages. It
is performed by taking the total balance sheet as 100. The balance sheet items are expressed as
the ratio of each asset to total assets and the ratio of each liability to total liabilities. Thus, it
shows the relation of each component to the whole - Hence, the name common size.

Trend Analysis: It is an important tool of horizontal analysis. Under this analysis, ratios of
different items of the financial statements for various periods are calculated and the comparison
is made accordingly. The analysis over the prior years indicates the trend or direction. Trend
analysis is a useful tool to know whether the financial health of a business entity is improving in
the course of time or it is deteriorating.

Ratio Analysis: The most popular way to analyze the financial statements is computing ratios. It
is an important and widely used tool of analysis of financial statements. While developing a
meaningful relationship between the individual items or group of items of balance sheets and
income statements, it highlights the key performance indicators, such as, liquidity, solvency and
profitability of a business entity. The tool of ratio analysis performs in a way that it makes the
process of comprehension of financial statements simpler, at the same time, it reveals a lot about
the changes in the financial condition of a business entity.

It must be noted that Financial analysis is a continuous process being applicable to every
business to evaluate its past performance and current financial position. It is useful in various
situations to provide managers the information that is needed for critical decisions. The process
of financial analysis provides the information about the ability of a business entity to earn
income while sustaining both short term and long term growth.
Objectives Of Financial Statement Analysis
Objectives of financial statement analysis are as follows
1.Assessment Of Past Performance
Past performance is a good indicator of future performance. Investors or creditors are interested
in the trend of past sales, cost of good sold, operating expenses, net income, cash flows and

return on investment. These trends offer a means for judging management's past performance
and are possible indicators of future performance.
2.Assessment of current position
Financial statement analysis shows the current position of the firm in terms of the types of assets
owned by a business firm and the different liabilities due against the enterprise.
3.Prediction of profitability and growth prospects
Financial statement analysis helps in assessing and predicting the earning prospects and growth
rates in earning which are used by investors while comparing investment alternatives and other
users in judging earning potential of business enterprise.
4.Prediction of bankruptcy and failure
Financial statement analysis is an important tool in assessing and predicting bankruptcy
andprobability of business failure.
5. Assessment of the operational efficiency

Financial statement analysis helps to assess the operational efficiency of the management of a
company. The actual performance of the firm which are revealed in the financial statements can
be compared with some standards set earlier and the deviation of any between standards and
actual performance can be used as the indicator of efficiency of the management.
Importance Of Financial Statement Analysis
The financial statement analysis is important for different reasons:
1. Holding Of Share

Shareholders are the owners of the company. Time and again, they may have to take decisions
whether they have to continue with the holdings of the company's share or sell them out. The
financial statement analysis is important as it provides meaningful information to the
shareholders in taking such decisions.
2. Decisions And Plans
The management of the company is responsible for taking decisions and formulating plans and
policies for the future. They, therefore, always need to evaluate its performance
and effectiveness of their action to realise the company's goal in the past. For that purpose,
financial statement analysis is important to the company's management.
3. Extension Of Credit
The creditors are the providers of loan capital to the company. Therefore they may have to take
decisions as to whether they have to extend their loans to the company and demand for higher
interest rates. The financial statement analysis provides important information to them for their
purpose.
4.Investment Decision
The prospective investors are those who have surplus capital to invest in some profitable
opportunities. Therefore, they often have to decide whether to invest their capital in the
company's share. The financial statement analysis is important to them because they can obtain
useful information for their investment decision making purpose.
2. Not useful for planning
Since financial statements are prepared by using historical financial data, therefore, the
information derived from such statements may not be effective in corporate planning, if the
previous situation does not prevail.
3. Qualitative aspects
Then financial statement analysis provides only quantitative information about the company's
financial affairs. However, it fails to provide qualitative information such as management labor

relation, customer's satisfaction, management's skills and so on which are also equally important
for decision making.
4. Comparison not possible
The financial statements are based on historical data. Therefore comparative analysis of financial
statements of different years can not be done as inflation distorts the view presented by the
statements of different years.
5. Wrong judgment
The skills used in the analysis without adequate knowledge of the subject matter may lead to
negative direction . Similarly, biased attitude of the analyst may also lead to wrong judgement
and

conclusion.

The limitations mentioned above about financial statement analysis make it clear that the
analysis is a means to an end and not an end to itself. The users and analysts must understand the
limitations before analyzing the financial statements of the company.
Parties Interested In Financial Statement Analysis
The analysis of financial figures contained in the company's profit and loss account and balance
sheet by employing appropriate technique is known a financial statement analysis. Financial
statement analysis is useful to different parties to obtain the required information about the
organization. Following are the parties interested in financial statement analysis.
1. Shareholders
Shareholders are interested in financial statement analysis to know the profitability of the
organization. Profitability shows the growth potentiality of an organization and safety of
investment of shareholders.
2. Investors And Lenders

Investors and lenders are interested to know the solvency position of an organization. They
analyze the financial statement position to know about the safety of their investment and ability
to pay interest and repayment of principle amount on due date.
3. Creditors
Creditors are interested in analyzing the financial statements in order to know the short term
liquidity position of an organization. Creditors analyse the financial statement to know either the
organization is enable to pay the amount of short term liabilities on due date.
4. Management
Management is interested to analyze the financial statement for measuring the effectiveness of its
policies and decisions. It analyze the financial statements to know short term and long term
solvency position, profitability, liquidity position and return on investment from the business.
5.Government
Government is interested to analyze the financial position in determining the amount of tax
liability. It also helps for formulating effective plans and policies for economic growth.