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1.INTRODUCTION
Financial analysis is the process of examining a company’s performance in the context of its industry and economic
environment in order to arrive at a decision or recommendation. Often, the decisions and recommendations addressed
by financial analysts pertain to providing capital to companies—specifically, whether to invest in the company’s debt
or equity securities and at what price. An investor in debt securities is concerned about the company’s ability to pay
interest and to repay the principal lent. An investor in equity securities is an owner with a residual interest in the
company and is concerned about the company’s ability to pay dividends and the likelihood that its share price will
increase.

Overall, a central focus of financial analysis is evaluating the company’s ability to earn a return on its capital that is
at least equal to the cost of that capital, to profitably grow its operations, and to generate enough cash to meet
obligations and pursue opportunities.

Fundamental financial analysis starts with the information found in a company’s financial reports. These financial
reports include audited financial statements, additional disclosures required by regulatory authorities, and any
accompanying (unaudited) commentary by management. Basic financial statement analysis—as presented in this
reading—provides a foundation that enables the analyst to better understand

other information gathered from research beyond the financial reportsThis reading is organized as follows: Section 2
discusses the scope of financial statement analysis. Section 3 describes the sources of information used in financial
statement analysis, including the primary financial statements (statement of financial position or balance sheet,
statement of comprehensive income, statement of changes in equity, and cash flow statement). Section 4 provides a
framework for guiding the financial statement analysis process. A summary of the key points conclude the reading.

The member should be able to:

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 a. describe the roles of financial reporting and financial statement analysis;

b. describe the roles of the statement of financial position, statement of comprehensive income,
statement of changes in equity, and statement of cash flows in evaluating a company’s
performance and financial position;

c. describe the importance of financial statement notes and supplementary information—including

disclosures of accounting policies, methods, and estimates—and management’s commentary;

d. describe the objective of audits of financial statements, the types of audit reports, and the
importance of effective internal controls;

e. identify and describe information sources that analysts use in financial statement analysis
besides annual financial statements and supplementary information;

f. describe the steps in the financial statement analysis framework.

SUMMARY
The information presented in financial and other reports, including the financial statements, notes, and
management’s commentary, help the financial analyst to assess a company’s performance and financial position. An
analyst may be called on to perform a financial analysis for a variety of reasons, including the valuation of equity
securities, the assessment of credit risk, the performance of due diligence on an acquisition, and the evaluation of a
subsidiary’s performance relative to other business units. Major considerations in both equity analysis and credit
analysis are evaluating a company’s financial position, its ability to generate profits and cash flow, and its potential
to generate future growth in profits and cash flow.

This reading has presented an overview of financial statement analysis. Among the major points covered are the
following The primary purpose of financial reports is to provide information and data about a company’s financial
position and performance, including profitability and cash flows. The information presented in the reports —including
the financial statements and notes and management’s commentary or management’s discussion and analysis—
allows the financial analyst to assess a company’s financial position and performance and trends in that performance.

 The primary financial statements are the statement of financial position (i.e., the balance sheet), the
statement of comprehensive income (or two statements consisting of an income statement and a statement
of comprehensive income), the statement of changes in equity, and the statement of cash flows.

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 The balance sheet discloses what resources a company controls (assets) and what it

 L owes (liabilities) at a specific point in time. Owners’ equity represents the net assets of the company; it is the
owners’ residual interest in, or residual claim on, the company’s assets after deducting its liabilities. The
relationship among the three parts of the balance sheet (assets, liabilities, and owners’ equity) may be shown
in equation form as follows: Assets = Liabilities + Owners’ equity.

 The income statement presents information on the financial results of a company’s business activities over a
period of time. The income statement communicates how much revenue and other income the company
generated during a period and what expenses, including losses, it incurred in connection with generating that
revenue and other income. The basic equation underlying the income statement is Revenue + Other income –
Expenses = Net income.

 The statement of comprehensive income includes all items that change owners’ equity except transactions
with owners. Some of these items are included as part of net income, and some are reported as other
comprehensive income (OCI).

 The statement of changes in equity provides information about increases or decreases in the various
components of owners’ equity.

 Although the income statement and balance sheet provide measures of a company’s success, cash

 Hu and cash flow are also vital to a company’s long-term success. Disclosing the sources and uses of cash
helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial
flexibility.

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 The notes (also referred to as footnotes) that accompany the financial statements are an integral part of those
statements and provide information that is essential to understanding the statements. Analysts should
evaluate note disclosures regarding the use of alternative accounting methods, estimates, and assumptions.

 In addition to the financial statements, a company provides other sources of information that are useful to
the financial analyst. As part of his or her analysis, the financial analyst should read and assess this additional
information, particularly that presented in the management commentary (also called management
report[ing], operating and financial review, and management’s discussion and analysis [MD&A]).

 A publicly traded company must have an independent audit performed on its annual financial statements. The
auditor’s report expresses an opinion on the financial statements and provides some assurance about whether
the financial statements fairly present a company’s financial position, performance, and cash flows. In
addition, for US publicly traded companies, auditors must also express an opinion on the company’s internal
control systems.

 Information on the economy, industry, and peer companies is useful in putting the company’s financial
performance and position in perspective and in assessing the company’s future. In most cases, information
from sources apart from the company are crucial to an analyst’s effectiveness.

 The financial statement analysis framework provides steps that can be followed in any financial statement
analysis project. These steps are:

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 o Articulate the purpose and context of the analysis;
o Collect input data;
o Process data;
o interpret the processed data;
o Develop and communicate conclusions and recommendations; and
2.MEANING

The in-depth study and interpretation of the data provided in the ‘Financial Statement’ is known as ‘Financial Analysis’.

With the help of various items provided in the ‘Profit and Loss Account’, ‘Balance sheet’ and other operative data and
their strategies inter-relationships, it is possible to ascertain the financial strength and weaknesses of an organization,
through the process of ‘Financial Analysis
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ADVERTISEMENTS:

In the words of Myers, “Financial statement analysis is largely a study of relationship among the various financial
factors in a business as disclosed by a single set-of statements and a study of the trend of these factors as shown in a
series of statements.”

The purpose of financial analysis is to diagnose the information contained in financial statements so as to judge the
profitability and financial soundness of the firm. Just like a doctor examines his patient by recording his body
temperature, blood pressure, etc. before making his conclusion regarding the illness and before giving his treatment,
a financial analyst analysis the financial statements with various tools of analysis before commenting upon the
financial health or weaknesses of an enterprise.

The analysis and interpretation of financial statements is essential to bring out the mystery behind the figures in
financial statements. Financial statements analysis is an attempt to determine the significance and meaning of the
financial statement data so that forecast may be made of the future earnings, ability to pay interest and debt
maturities (both current and long-term) and profitability of a sound dividend policy.

The term ‘financial statement analysis’ includes both ‘analysis’, and ‘interpretation’. A distinction should, therefore,
be made between the two terms. While the term ‘analysis’ is used to mean the simplification of financial data by
methodical classification of the data given in the financial statements, ‘interpretation’ means, ‘explaining the meaning
and significance of the data so simplified.’

However, both’ analysis and interpretation’ are interlinked and complimentary to each other Analysis is useless
without interpretation and interpretation without analysis is difficult or even impossible.

Most of the authors have used the term ‘analysis’ only to cover the meanings of both analysis and interpretation as
the objective of analysis is to study the relationship between various items of financial statements by interpretation.
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We have also used the term ‘Financial statement Analysis or simply ‘Financial Analysis’ to cover the meaning of both
analysis and interpretation

2.DEFINITIONS
1) According to Myers :
"Financial Statement Analysis is largely a study of relationship among the various ffinancial

factors in a business as disclosed by single set of statements, and study of the trend of theselfactors as shown
in a series of statement".

2) According to Hampton :

"Analysis of Financial Statement is the process of determining the significant operating and

Financia characteristics of a firm from accounting data".

4.OBJECTIVES
Objectives of financial statement analysis are enumerated in a nutshell as follows :

1) Trend revealed through the various financial data, like Sales, Cost of Goods Sold, Operating Expenses, Net Income,
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Cash Flow etc. If an organization past performance may be a good pointer to it's future performance. Prospective
investors and current creditors rely on such past data to predict the future prospective of an organization. 10

2)Cash Flow Statement : A cash

tatementiss a financial statement, which shows how 'cash' and 'cash equivalents' in a business are affected by the
changes in various components of balance sheet and profit and loss account. It summarises the reasons behind the
changes in cash position of a business entity between the dates of two balance sheets.

3)Ratio analysis is a technique of quantitative analysis by establishing relationships between two or

combination of more than two items of financial statement. Viz. balance sheet, income statement and / or
cash flow statement. It is used to evaluate various aspects of a company operating a financial performance
such as its efficiency, liquidity, profitability and solvency which is helpful for the management in making
certain decisions

4)'Financial Statement Analysis' is a vital technique, through which the possibilities of an organization going
bankrupt in future or the chances of failure of a business can be prod

5)Assessment of the Operational Efficiency

‘Financial Statement Analysis’ facilitates the assessment of the Operational Efficiency of an organization
management. It can be done through setting standard of performance of a basis of certain parameter and
comparing them with the actual performance of the organization. Any deviation between the ‘Set Standards of
Performance’ and ‘Actual Performance’ may be used as an indicator of ‘Management Efficient

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5.IMPORTANCE
advantage of financial statement analysis is as follows :

1. Measurement of Short Term Solvency :An organisation ability to pay its short term liabilities, is refereed to as it
“short term solvency” , assessment of which can be made through the ‘financial statement analysis’. If an
organisation has a positive “short term solvency”, its creditors would not hesitate in leading funds to it. On the
other hand, if an organisation suffers from the lack of ‘short term solvency’ , the creditors would refrain from
leading funds to it.

2. Measurement of Long Term Solvency :An Organisation ability to repay its ‘ long-term liabilities ‘ e.g. bonds and
debentures issued by it and other secured liabilities, is referred to as its ‘long term solvency’. A company having
such capability is said to be “solvent”. Thus, status of an organisation in terms of long term solvency is revealed
through the analysis of financial statement.

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3. Measurement of Operating Efficiency :Through the analysis of ‘financial statement’ of an Organisation, the
position with regard to its profitability can easily be ascertained. If a business organisation is incurring losses, the
reason there of may also be found out

through such analysis and necessary corrective actions may be taken to curb losses and turn the loss incurring
organisation into a profit earning organisation.

4. Measurement of Profitability :
The existing earning capacity of an organisation as well as forecasting in respect of its future earning can be
gathered through the earning ratio analysis, inputs for which are provided by the 'financial statements'.
'Measurement of profitability' is an important indicator, which helps in taking decisions by the investor's and
lender's.

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 5 Comparison of Inter-Firm Position The comparison of the financial position of one organisation with that of
another organisation is an exercise undertaken through the 'financial analysis'. Such a comparative study is useful
in deciding the course of action to be taken by investors and other stakeholders.

6.LIMITATIONS
The Limitation/Disadvantages of financial statement analysis are as follows :

1)Absence of Standard Universally Accepted Terminology :

The financial statement analysis is part of accounting, which is not an exact science. The terminology used in it is,
therefore not the one which is standardised or universal accepted.

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2) Overlooking Qualitative Aspects :

Under the financial statement analysis there is no consideration for qualitative aspects of a business. The entire
exercise focused on the quantitative aspects of the business while the quantitative aspects, some of which may be
quite significant, are totally overlooked.

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3) Result in Absence of Absolute Data :

As there is lack of the Absolute Data, the conclusion arrived at through the financial statement analysis may not be
correct in absolute terms.

4 ) Overlooks Price Level Changes :

As the price of same commodity differ from one year to another, the cost of production, sales as well as the value of
asset are affected. Therefore the compatibility of ratios decided on the presumption that the prices of the commodities
is two different years remain the same, may not hold good

5) Suffering from Limitations of Financial Statement ;

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There are some inherent weaknesses prevailing in the financial statement, due to the fact that the books of accounts
are maintained on the basis of historical data. Analysis carried out on the basis of such financial statements may not
reflect the true pictures

7 .TYPES OF FINANCIAL STATEMENT ANALYSIS

Various Tools and techniques used for the analysis of financial statements are as under :

1Funds Flow Statement :

Fund flow statement is a statement, which depicts the sources and application of fund for a specific time period.
Through the fund flow statement an analysis with regard to the changein the financial position of an organisation
from the beginning of time period to its end is undertaken.

3 Ratio Analysis :

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Ratio analysis is a technique of quantitative analysis by establishing relationships between two or combination of

more than two items of financial statement. Viz. balance sheet, income statement and / or cash flow statement. It is
used to evaluate various aspects of a company operating a financial performance such as its efficiency, liquidity,
profitability and solvency which is helpful for the management in making certain decisions.

4) Common-Size Statement :

A company financial statement, which displays all the items percentage of a common base figure (for example, total
assets, total liabilities and total sales ) is known as common size statement. It facilities comparative analysis between
two or more companies, or between two or more time period of a company.

5) Comparative Statement :

The financial statement of an organisation for different time periods are referred to as

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comparative financial statement. Various items of financial statement are presented in a comparative form, which
may be in the form of a table. This enables one to have a comparative view of various parameter for two or more time

period at a glance.

6) Trend Analysis :

Trend analysis is a technique based on the underlying premise that what was happened in the past gives an indication
as to what will happen in the future. It may be defined as a mathematical techniques that used historical data to
forecasts future outcome. Trend analysis may be undertaken in respect of two organisation for the same time period

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 of two Organisation for different time period ( two or more years). A trend is a series of information from the financial
statement, analysed to arrive at some meaningful conclusion.

8 .METHODS
There are five commonplace approaches to financial statement analysis: horizontal analysis, vertical analysis, ratio
analysis, trend analysis and cost-volume profit analysis. Each technique allows the building of a more detailed and
nuanced financial profile.

1) HORIZONTAL ANALYSIS

Horizontal analysis compares historical data (such as ratios and line items) and is usually depicted as a percentage
growth over the same line item in the base year. This allows

financiers to easily spot trends and growth patterns and forecast future projections. This type of analysis also
lends insight into the operational results of an organisation and

whether it is operating efficiently and profitably, and makes it easier to compare growth rates amongst sector
competitors.

2) VERTICAL ANALYSIS

Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial
statement is listed as a percentage of another item. For example, every line item on an income statement is stated
as a percentage of gross sales, while every line

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item on a balance sheet is stated as a percentage of total assets. This gives analysts an understanding of overall

performance in terms of revenue and expenses.

3) RATIO ANALYSIS

Ratio analysis allows for meaningful comparison between the different elements of a financial statement and is
used to reveal a general upward or downward trend. It’s a quick method to obtain an overview of a company’s
financial health, but also more granular relationships between data, such as debt and equity or price versus
earnings, in addition

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 to liability areas such as staff turnover. Once a ratio has been calculated, it can be compared against the previous
period, which is crucial for setting performance targets

4) TREND ANALYSIS
Trend analysis uses historical data (such as price movements and trade volume) to forecast the long-term
direction of market sentiment. It’s based on the idea that what has transpired in the past will occur again in
the future, which helps a business to better predict and prepare for upward trends and

5)reversals within particular market segments. Trend analysis is a useful technique as moving with trends (and not
against them) will result in profit for an investor COST VOLUME PROFIT ANALYS

This analysis technique helps businesses better understand the relationship between sales, costs, and business
profit. It examines the fixed cost and variable cost and establishes21

9 .CONCLUSION
No matter which type of business report you have written, you will need a good conclusion to sum up all the
critical information.

A business report conclusion is the last section of the document used for summarizing the most important
information, providing a final word to the readers
Through the conclusion, you are able to convey the main message of your business document. You use it to
outline the report as a whole, remind the readers of the main pain points, and present the key findings and
decisions.

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 Depending on whether you have written a shorter or longer business report, the conclusion length may vary,
but it should always be included. It is a sign of good organization and it can make the readers understand the
pain points much easier.

To put it simply, the conclusion is supposed to create the impression among the readers that

the purpose of the report has been achieved.

Business report conclusions have a lot of similarities to executive summaries, which is why a lot of people tend
to confuse these two.

However, there are some important things that differentiate them. These include:

Executive summaries are mainly focused on displaying what the report will be about, while conclusions are anoverview
of what was discussed in the report.

 Executive summaries provide readers with a broad overview of the business report, while the
conclusion summarizes the key pain points and most important data.

 Executive summaries should convince the readers to continue reading the report, while the conclusion
should persuade them to take certain action.

 Conclusions tend to include CTAs (Call to Action), which isn’t the case with executive summaries.

 10 .RECOMMENDATIN The most important recommendation for financial-statement preparation is

to conform to key accounting norms and industry standards. These include generally accepted
accounting principals (GAAP) and international financial reporting standards (IFRS). Besides GAAP
and IFRS, other edicts include U.S. Securities and Exchange Commission guidelines. By law,
accountants must display financial items in a specific way when presenting accoun

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