Introduction

The information contained in financial statements is used by various users for

decision making process. Users can know better about the financial strengths

and weaknesses of the firm if they properly analyze the information contained

in the financial statements. Financial analysis is the process of identifying the

financial strengths and weaknesses of the entity by properly establishing

relationships between the variables (items) of balance sheet and profit and loss

account. The purpose of "financial analysis" is to check the information given in

the financial statements in such a manner so as to judge the liquidity,

profitability and financial soundness of the entity. Just as a doctor examines a

patient similarly financial analyst examines the financial statements before

commenting upon financial health or weakness of an enterprise.

The term analysis includes interpretation also. Financial statement analysis is an

important function to determine the significance and meaning of the data

contained in the financial statements so that forecasting may be made regarding

the future earnings, ability to meet its liabilities and profitability of the business.

Analysis Involves re-grouping and re-arranging the data in a useful manner

whereas interpretation means explaining the meaning and importance of the

data so processed.
Introduction of Financial Statement: -

Finance is defined as the main provision of money when it is

required. Every enterprise needs money to start and carry out its operation.

Finance is the important aspect of an organization. So, finance should be

managed effectively and efficiently

Financial statements are prepared primarily for recording and decision

making. Financial Statement Analysis is process of determining important

factors like financial strength and weakness of the firm by properly establishing

planned relationship between the items of the balance sheet and profit and loss

account. There are various methods and tools used for analyze financial

statements, such as comparative statements, trend analysis, common size

statements, working capital and ratio analysis and other operative data. The

analysis of financial statement is used for decision making by various parties

related to business. The team financial statement includes at least two

statements which the organization prepares at the end of an accounting period.

The two statements are: -

• Balance Sheet

• Profit And Loss Account

Meaning of Financial Analysis

The first step of financial analysis is to choose the information relevant to the

decision under consideration to the available information contained in the

financial statement. The second step is to setup the information in a way to

show significant relationship. The last step is interpretation and drawing of

useful information and conclusions. Financial statement is the proper process of

selection, relation and evaluation.

Objective and Importance of Financial Statements

Analysis:

The first objective of financial statements analysis is to understand and diagnose

the information contained in financial statement with a view to see the

profitability financial soundness of the firm, and to make forecasting about

future growth and operations of the firm. The work of analysis depends upon

the person interested in such analysis and his object which helps to give useful

results .The following are objectives of financial statements analysis may be

stated to bring out significance of such analysis:

1. For assess the earning capacity or profitability of the firm.

2. For assess the operational efficiency and managerial effectiveness.

3. For assess the short term as well as long term solvency of the firm.

4. For identify the reasons for change in profitability and financial position.

5. For make inter-firm comparisons.

6. For make forecasts about future prospects of the firm.

7. For assess the progress of the firm over a period of time.

8. For help in decision making and control.

9. For guide or determine the dividend action.

10. For provide important information for granting credit.

Types of Financial Analysis:

There are various types of financial analysis which are as follows;

1. On the basis of material used.

2. On the basis of modus operandi.

3. On the basis of entities used.

4. On the basis of time horizon.

Procedure of Financial Statements Analysis:

Basically there are three steps involved in the analysis of financial statements.
These are

(i) Selection

(ii) Classification

(iii) Interpretation
 The first step starts from selection of information or data relevant for the

purpose of analysis of financial statements. The second step involved is the

classification of the data and the third step includes drawing of useful aspects

and conclusions.

The following procedure is used for the analysis and interpretation of financial

statements of any organization.

1. The person should have proper knowledge of principles and postulates of

accounting. He should know the proper planned policies of the management so

that he may be able to find out whether these plans are properly made and

execute or not.

2. The area of analysis should be determined so that the sphere of work may be

decided. If the aim is to find out the earning capacity of the enterprise then

analysis of income statement will be undertaken. On the other hand, if the

financial position is to be studied then balance sheet analysis will be necessary.

3. Financial data given in the statements should be re- organised and re-

arranged. It will involve the grouping of similar data under same heads,

breaking down of individual components of statements according to nature. The

data is reduced to a standard form.

4. A relationship is established among financial statements with the help of

methods and techniques of analysis such as ratios, trends, common size, cash

flow etc.

5. The information is interpreted in a simple and understandable way. The

significance and utility of financial data is determine for helping decision-

taking.

6.The conclusions arise from interpretation are presented to the management in

the form of reports.

Methods or Techniques for Financial Analysis:

The following are the important techniques for financial analysis of

financial statements are generally used:

i. Ratio analysis

ii. Comparative statements

iii. Common –size statements

iv. Funds flow analysis

v. Cash flow analysis

vi. Trend analysis

vii. Change in working capital.

Main Application of Financial Analysis:

Following are the application of financial analysis:

1. For Assessing Corporate Excellence

2 .For Judging credit worthiness

3. For Forecasting bankruptcy

4. For Valuing equity shares

5. For Predicting bonds ratings

6. For Estimating market risk.