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Chapter -3
Introduction to Financial Statement Analysis
Statement?
What is a Financial an
the financial facts of make
financial statement may mean any formal expression of
Ans: A and creditors to
organization. The purpose of financial statements is to help investors collecting, processing
moreinformed economic
decisions. The major accounting functions are fluent inthe
analyst of financial statements must befinancial statements.
and reporting. Hence, the user or their
accountingstandards followed by the companiesin preparation of
statements are:
Themajor financial
firm's financial condition.
Balance sheet: It providesa 'snapshot' of the reports on the 'performance' of the firm.
loss account): It
h. Income statement (Profitand the cash receipts and cash outflows
classified according
tlows: It reports
c. Statement of cash
tooperating, investment
andfinancial activities. changes in
stockholder's equity: It reports the amounts and sources of
A. The statement of
owners.
eguity from transactions with They allow users to improve
assessment or tne
financial statements:
e. The footnotes of the estimates reported inthe financial
statements
uncertainty of the
amount, timing and

2. Uses of financial
statement regarding the finanCial
financial statement are to provide information
Ans: The uses of need of these statements.
financial position of a business to the different users of
result and
statement is:
The analysis of financial
a. Investment decision
excellence
b.Assessment of operating
c. Liquidity measure
d. Profitability measure
position
e. Assessment of
f.Managerial decision w
g. Allocation of resources
Future forecasting
Modern approach to financial statementT
3. Distinguish between Traditional approach and
analysis. is largely a study of
relationship among the various financial
Ans: "Financial statement analysis byasingle set of statements, and a study of trends of
these
factors in a business, as disclosed
statements"-Myer
as shown in aseries of Traditional approach
Modern approach
Basis
It includes profit and loss account
Apart from profit and loss account
1. Coverage cash flow and balance sheet only.
and balance sheet, it covers
ratio
statement, fund flow statement,
analysis etc.

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 Cash movement of the firm during the Such movement cannot be
k. Cash movement analysed.
year can be analysed in modern
approach.
Fund movement of the firm during Such movement can be analysed.
3. Fund
movement the year can be analysed in modern
approach.
Such information is not derived.
4. Human factor In the recent trend, human factors are
given due importance and various
information are disclosed on the basis
of employees e.g., average earning
per employee, turnover per
employee, value added per employee
etc.
5. Price level The historical data are adjusted with Such adjustment is not made.
changes the change in price level to give better
information.
6. Graphical Application of graph, chart,etc is No pictorial presentation is
presentation exercised to provide pictorial made.
information.
7. Nature of data Absolute as wellas relative data are Only absolute dataare available.
available in modern approach.
8. Lineage This statement is new and applied by These statements are old &
modern organizations. traditional and applied by all
organizations.
9. Reflection It reflects more information regarding It reflects information regarding
financial position of the company. financial position of the
company.
10. Dependability More reliable a dependable than, These statements are not sO
income statement & balance sheet. reliable ordependable.
11. Preparation Generally, big business houses Alltypes of business houses
prepare these statements. prepare these statements.
12. Mandatory Preparations of these statement are Preparations of these statements
not mandatory by law. are mandatory by law.
Different types of financial statement analysis.
Ans: Analysis of financial statements may be of five
a. Horízontal analysis: It compares the different types:
current year.
financial statements of previous year along with the
b. Trend analysis: It compares ratios of
related to different period to those of adifferent
base
components of the financial statements
c. Vertical analysis: It year.
converts each
amount of statement to establish element of the information into apercent of the total
relationship with other components of the same
statement.

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d. CrosS sectional analysis: The accounting ratios calculated taking figures of balance sheet and
income statement are used to compare performance of a Company with that of competitors or
industry as a whole. This method does neither compare the absolute figures, nor the
percentages.
e. Ratio analysis: It establishes the numerical relationship between two variables of financial
statement to judge the historical performance and current financial position.
5. Parties interested in financial statement analysis.
the
statements is the most useful statements for different users. It informns to all
Ans: Firnancial
Rnancial position; performance of the enterprise. It also indicates the trend of business. Ihe
financial statements help creditors to know the financial strength or weakness of business. SO,
parties interested are:
a. Management
b. Investors
c. Lenders
d. Suppliers and trade creditors
e. Employees
f. Customers
g. Generalpublic
h.Government department and agencies

biscuss the limitation of financial statements analysis.

Ans: The limitations of financial statement analysis:
statement depends on the intention of its user. Its
(a) Effectiveness of analysis of financial
adjustment, window dressing, etc.
utility may be diluted by year end
the marker.
(b) It is influenced by personal bias of
business.
(c) It ignores qualitative aspect of
resource of the firm.
(d) It does not account for human
(e) It ignores non-monetary factor. accommodation to various other aspects of accounting such
complete
() It does not provide a accounting, human resource accounting, inflation
accounting
accounting, cost
as management
data
etc.
and vouching of accounts does not ensure correctness of
verification
g) A sample check,
generated by accounts.
result, worth fullfuture plan can be made. A better future
years true conventional
(h) On the basis of past made on disguised past results as shown in
never be
plan and proper decision can
accounting.
each other.
balance sheet and the income statement related to
7. Explainhow are the 2013, Final account (Financial
statements) are:
of companies Act,
Ans: As per schedule Ill statement. Income statement discloses financial
sheet
income statement & (ii) Balance financialposition. They are inter-related. Without
performance and balance sheet discloses
be good.
performance, the position will not

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 The following are the relations between them:
(a)There are complementary to each other.
(b) Relation of profit & capital
(c) Stock &flow relation
(d) True & fair view
(e) Cyclical relation

8. Objectives and needs of financial statements.

Ans: FSAis aprocess of evaluating relationship between components of the financial
statements:
(a) To obtain a better understanding of the firm performance and position by simplifying
monotonous figures through which the user can drawconclusions.
(b) Toidentify the financial strength and weakness of the firm.
(c) To measure inter-relationship of the data of financial statement.
(d) To check the movement of funds of the firm.
(e) To measure operationalefficiency.
(f) To know business solvency position.
(e) Tosafeguard interested parties.
(h) To know the growth potentialof the firm.
(6) To check the movements of cash of the firm.
G)To check the short-term liquidity of the firm.
(k) To have inter firm comparisons