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Chapter 4

Chapter 4

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Published by Tinku Kumar

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Published by: Tinku Kumar on Jul 15, 2012
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Financial Statements Analysis is an analysis which critically examines the relationshipbetween various elements of the Financial Statements. It focuses on the evaluation of pastoperations as revealed by the analysis of basic statements. It is a process of scanningFinancial Statements for evaluating the relationship between the items as disclosed inthese. It is an important means of assessing past performance and forecasting and planningfuture performance. The analysis simplifies, summarizes and systematizes the monotonousfigures.
Analysis of 
Financial Statements with the help of ‘Ratio’ is termed as ‘Ratio Analysis’.
RatioAnalysis is a widely used tool of Financial Analysis. It can be used to compare the risk andreturn relationships of firms of different sizes. It is defined as the systematic use of ratio tointerpret the Financial Statements so that the strengths and weaknesses of a firm as well asits historical performance and current financial condition can be determined.
Following are the important objectives of Ratio Analysis1) To provide the necessary basis for Inter-period and Inter-firm Comparison.2) To help in providing a part of information needed in the process of decision-making.
3) To focus on facts on a comparative basis and facilitate drawing of conclusions relating tothe performance of a firm.4) To evaluate the performance of a firm in determining the important aspects of a businesssuch as liquidity, solvency, operational efficiency, overall profitability capital gearing, etc.5) To throw light on the degree of efficiency in the management and the effectiveness in theutilization of its assets.6) To provide the way for effective control of the enterprise in the matter of achievingthephysical and monetary targets.7) To help management in discharging its basic functions like forecasting, planning, co-ordination, communication, control, etc.8) To promote co-ordination among the departments and the staff by the study of performance and efficiency of each department.9) To point out the financial condition of business whether it is strong, questionable, or poorand enables the management to take necessary steps.10)To act as an index of the efficiencyof an enterprise.
Accounting Ratios may be classified as under:1) Traditional Ratios2) Functional Ratios
4.4.1 Traditional Ratios
Traditional Accounting Ratios are classified on the basis of the origin of the figures used inthe accounting ratios, i.e. on the basis of the Financial Statements from which ratios arederived. The following ratios are usually included in this type of classification. Balance Sheet Ratios or Financial Ratios
Ratios calculated from the different items as appearing in the Balance Sheet of a concernare called Balance Sheet Ratios, e.g. Current Ratio, Liquid Ratio, Proprietary Ratio, Debt-equity Ratio, and so on. Profit & Loss Account Ratios or Operating Ratios
Ratios calculated from the different items as appearing in the Profit & Loss Account of aconcern are called Profit & Loss Account Ratios or operating Ratio, e.g. Gross Profit Ratio,Net Profit Ratio, Operating Ratio. Mixed Ratios or Composite Ratios
Ratios calculated, taking some items as appearing in the Balance Sheet and taking someitems as appearing in Profit & Loss Account are called Mixed Ratios or Composite Ratios, e.g.Return on Net Worth, Return on Investment (ROI), Capital Turnover Ratio, etc.
The other way of classifying the ratios in on the basis of functions they perform, what theyindicate, symptoms or characteristics, namely, liquidity, profitability, financial stability andturnover relationship, etc. This classification assumes greater significance because itdistinctly the different aspects of business performance and helps the various users of Financial Statements to take guard of their interest. For instance, short-term creditors areinterested to evaluate the liquidity position by analyzing the liquidity ratios, while long-termcreditors and investors are interested in the solvency and profitability position of the

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