Learning Objectives:

 Interpret financial statements in comparative

and common-size form.
 Compute and interpret financial ratios that
would be most useful to the owner.
 Compute and interpret financial ratios that
would be most useful to a short-term
creditors.
 Compute and interpret financial ratios that
would be most useful to long -term
creditors.
Balance Sheet
A summary of a firm’s financial position on a
given date that shows total assets = total
liabilities + owners’ equity.
Income Statement
◦ A summary of a firm’s revenues and
expenses over a specified period, ending
with net income or loss for the period.
 It is the process of critical evaluation about
financial information contained in the
financial statements in order to understand
and make decisions regarding the
operations of the firm.

 It is defined as the process of identifying

financial strengths and weaknesses of the
firm by properly establishing relationship
between the items of the balance sheet and
the profit and loss account.
 Financial statements are prepared to
meet external reporting obligations
and also for decision making
purposes.

 But the information provided in the

financial statements is not an end in
itself as no meaningful conclusions
can be drawn from these statements
alone.
1) Industry Averages
2) Intercompany basis or
Competitor’s results
3) Intracompany basis or
Company’s standard and policies
 The term analysis is nothing but
simplification of financial data by
classification methods given in the financial
statements. Interpretation means explaining
the significance and meaning of the data.
These two are complimentary to each other.

 Analysis is useless without interpretation, and

interpretation without analysis is difficult or
even impossible.
 Trade Creditors -- Focus on the
liquidity of the firm.
 Bondholders -- Focus on the long-
term cash flow of the firm.
 Shareholders -- Focus on the
profitability and long-term health of
the firm.
 Plan -- Focus on assessing the current
financial position and evaluating
potential firm opportunities.
 Control -- Focus on return on
investment for various assets and asset
efficiency.
 Understand -- Focus on understanding
how suppliers of funds analyze the firm.
1. Common-size Financial Statements -
comparing individual line items to a baseline.
2. Ratio Analysis – understanding the financial
health of a company.
a. Activity ratios
b. Liquidity ratios
c. Solvency ratios
d. Profitability ratios