Financial Statement

The financial statement is an organized collection of data according to logical and consistent
accounting procedures. Its purpose is to convey an understanding of financial aspects of a
business firm. It may show a position at a moment of time as in the case of a balance-sheet or
may reveal a service of activities over a given period of time, as in the case of an income
statement. Financial statements are the summary of the accounting of a business enterprise, the
balance-sheet reflecting the assets, liabilities and capital as on a certain data and the income
statement showing the results of operations during a certain period, it means, it provides useful
information to both internal and external parties.
So we can say A financial statement is an official document of the firm, which explores the
entire financial information of the firm. The main aim of the financial statement is to provide
information and understand the financial aspects of the firm. Hence, preparation of the financial
statement is important as much as the financial decisions.

Financial statements generally consist of two important statements:

(i) The income statement or profit and loss account.
(ii) Balance sheet or the position statement.
A part from that, the business concern also prepares some of the other parts of statements,
which are very useful to the internal purpose such as:
(i) Statement of changes in owner’s equity.
(ii) Statement of changes in financial position.

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Income Statement
Income statement is also called as profit and loss account, which reflects the operational
position of the firm during a particular period. Normally it consists of one accounting year. It
determines the entire operational performance of the concern like total revenue generated and
expenses incurred for earning that revenue. Income statement helps to ascertain the gross profit
and net profit of the concern. Gross profit is determined by preparation of Trading or
Manufacturing A/c and net profit is determined by preparation of Profit and Loss Account.

1. Income Statement - Trading Account

It is the first phase in the process of preparing final accounts. It is prepared to show the
results of manufacturing, buying and selling of goods.
Importance of Trading Account:
a. It provides information about the direct income and direct expenses
b. It provides information about gross profit or gross loss.
c. It compares closing stock with that of the previous year.
d. It provides safety against possible losses

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2. Income Statement - Profit and Loss Account
Trading account discloses the gross profit earned as a result of buying and selling of goods.
However, a businessman has to incur a number of indirect income and indirect expenses
which are not taken to trading account. Hence, a businessman is more interested in knowing
the net profit earned or net loss incurred during the year. As such, a Profit & Loss Account
is prepared which contains all the items of losses and gains pertaining to the accounting
period.

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Position Statement (Balance Sheet)
After calculating the Net Profit or Net Loss of the business enterprise, the businessman would
also like to know the exact financial position of his business. For this purpose, a statement is
prepared which contains all the Assets and Liabilities of the business enterprise. The statement
so prepared is called a Balance Sheet.
Balances of all the personal and real accounts are grouped as assets and liabilities. Liabilities
are shown on the left hand side of the Balance Sheet and Assets on the right hand side.
Position statement is also called as balance sheet, which reflects the financial position of the
firm at the end of the financial year. Position statement helps to ascertain and understand the
total assets, liabilities and capital of the firm. One can understand the strength and weakness of
the concern with the help of the position statement.
So we can say, “A Balance Sheet is a statement prepared with a view to measuring the exact
financial position of a business on a fixed date.”
Format of a Balance Sheet
Balance Sheet

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Statement of Retained Earnings (Changes in Owner’s Equity)
Retained Earnings - These funds may also be referred to as retained profit, accumulated
earnings, or accumulated retained earnings. Often, these retained funds are used to make a
payment on any debt obligations or are reinvested into the company to promote growth and
development.

Whenever a company generates surplus income, a portion of the long-term shareholders may
expect some regular income in the form of dividends as a reward for putting their money in the
company. Traders who look for short-term gains may also prefer getting dividend payments
that offer instant gains. Dividends are paid out from profits, and so reduce retained earnings
for the company.
The following options broadly cover some of the possibilities on how the surplus money
allocated to retained earnings and not paid out as dividends can be utilized:
• It can be invested to expand the existing business operations, like increasing the
production capacity of the existing products or hiring more sales representatives.
• It can be invested to launch a new product/variant.
• The money can be utilized for any possible merger, acquisition, or partnership that
leads to improved business prospects.
• It can also be used for share buybacks.
• The earnings can be used to repay any outstanding loan (debt) the business may have.

Retained earnings refer to any profits made by an organization that it keeps for internal use.

The Statement of Retained Earnings (retained earnings statement) is a financial statement

that outlines the changes in retained earnings for a company over a specified period. This
statement reconciles the beginning and ending retained earnings for the period, using
information such as net income from the other financial statements, and is used by analysts to
understand how corporate profits are utilized.

The statement of retained earnings is also known as a statement of owner's equity, an equity
statement, or a statement of shareholders' equity.

It is prepared in accordance with generally accepted accounting principles (GAAP).

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Benefits of a Statement of Retained Earnings

The purpose of releasing a statement of retained earnings is to improve market and investor
confidence in the organization. It is used as a marker to help analyze the health of a firm.
Retained earnings do not represent surplus funds. Instead, the retained earnings are redirected,
often as a reinvestment within the organization.
The retained earnings for a capital-intensive industry or a company in a growth period will
generally be higher than some less-intensive or stable companies. This is due to the larger
amount being redirected toward asset development. For example, a technology-based business
may have higher asset development needs than a simple t-shirt manufacturer, as a result of the
differences in the emphasis on new product development.

Statement of Changes in Financial Position

Income statement and position statement shows only about the position of the finance; hence
it can’t measure the actual position of the financial statement. Statement of changes in financial
position helps to understand the changes in financial position from one period to another period.
The Statement of change in financial position is a financial statement that outlines the
sources and uses of funds and explains any changes in cash or working capital.
It contains activities from operations that alter the cash of a company has on hand. Changes in
financial position include cash outflows, such as capital expenditures, and cash inflows, such
as revenue. It may also include certain non-cash changes, such as depreciation.
The use of this statement is to provide relevant and focused on a period, so that users of
financial statements with sufficient information to:
• Evaluate the company’s ability to generate resources.
• Assess the reasons for the differences between net income and funds generated or used
by the operation.
• To assess the ability of the company to meet its obligations to pay dividends, and if
necessary, to anticipate the need for funding.

• To assess the changes in the company’s financial situation arising from investing and
financing transactions that occurred during the period.

Statement of changes in financial position involves two important areas such as fund flow
statement which involves the changes in working capital position and cash flow statement
which involves the changes in cash position.
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FINANCIAL STATEMENT ANALYSIS
Analysis of Financial Statement is also necessary to understand the financial positions during
a particular period.
“Financial statement analysis is largely a study of the 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”.
Analysis of financial statement may be broadly classified into two important types on the basis
of material used and methods of operations.

FINANCIAL STATEMENT ANALYSIS - TYPES

1. Based on Material Used Based

Based on the material used, financial statement analysis may be classified into two
major types such as External analysis and internal analysis.
A. External Analysis
Outsiders of the business concern do normally external analyses but they are
indirectly involved in the business concern such as investors, creditors, government
organizations and other credit agencies. External analysis is very much useful to
understand the financial and operational position of the business concern. External
analysis mainly depends on the published financial statement of the concern. This
analysis provides only limited information about the business concern.

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 B. Internal Analysis
The company itself does disclose some of the valuable information’s to the business
concern in this type of analysis. This analysis is used to understand the operational
performances of each and every department and unit of the business concern.
Internal analysis helps to take decisions regarding achieving the goals of the
business concern.

2. Based on Method of Operation

Based on the methods of operation, financial statement analysis may be classified into
two major types such as horizontal analysis and vertical analysis.

A. Horizontal Analysis
Under the horizontal analysis, financial statements are compared with several years
and based on that, a firm may take decisions. Normally, the current year’s figures
are compared with the base year (base year is consider as 100) and how the financial
information are changed from one year to another. This analysis is also called as
dynamic analysis.
B. Vertical Analysis
Under the vertical analysis, financial statements measure the quantities relationship
of the various items in the financial statement on a particular period. It is also called
as static analysis, because, this analysis helps to determine the relationship with
various items appeared in the financial statement. For example, a sale is assumed
as 100 and other items are converted into sales figures.

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TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS
Financial statement analysis is interpreted mainly to determine the financial and operational
performance of the business concern. A number of methods or techniques are used to analyse
the financial statement of the business concern. The following are the common methods or
techniques, which are widely used by the business concern.

1. Comparative Statement Analysis

A. Comparative Position Statement Analysis
(Comparative Balance Sheet Analysis)
B. Comparative Income Statement Analysis
(Comparative Profit and Loss Account Analysis)

2. Trend Analysis
3. Common Size Analysis
4. Fund Flow Statement
5. Cash Flow Statement
6. Ratio Analysis

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1. Comparative Statement Analysis
Comparative statement analysis is an analysis of financial statement at different period of
time. This statement helps to understand the comparative position of financial and
operational performance at different period of time.

Comparative financial statements again classified into two major parts –

A. Comparative Position Statement Analysis
(Comparative Balance Sheet Analysis)
B. Comparative Income Statement Analysis
(Comparative Profit and Loss Account Analysis)

A. Comparative Balance Sheet Analysis

Comparative balance sheet analysis concentrates only the balance sheet of the concern
at different period of time. Under this analysis the balance sheets are compared with
previous year’s figures or one-year balance sheet figures are compared with other years.
Comparative balance sheet analysis may be horizontal or vertical basis. This type of
analysis helps to understand the real financial position of the concern as well as how
the assets, liabilities and capitals are placed during a particular period.

B. Comparative Income Statement Analysis (Comparative Profit and Loss Account

Analysis)
Comparative financial statement analysis is comparative profit and loss account
analysis. Under this analysis, only profit and loss account is taken to compare with
previous year’s figure or compare within the statement. This analysis helps to
understand the operational performance of the business concern in a given period. It
may be analyzed on horizontal basis or vertical basis.
Comparative Profit and Loss Account is prepared with the objective of –
a. To analyze the income and expenditure for two or more years.
b. To analyze the increase and decrease in the income and expenditure in terms of rupee
and percentage. Previous year figures are taken as the base year for calculating
percentage change.
c. To review the business operations of the last year and its likely effect on the current
year’s operation.

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2. Trend Analysis
The financial statements may be analysed by computing trends of series of information. It
may be upward or downward directions which involve the percentage relationship of each
and every item of the statement with the common value of 100%. Trend analysis helps to
understand the trend relationship with various items, which appear in the financial statements.
These percentages may also be taken as index number showing relative changes in the
financial information resulting with the various period of time. In this analysis, only major
items are considered for calculating the trend percentage.

3. Common Size Analysis

Another important financial statement analysis technique are common size analysis in which
figures reported are converted into percentage to some common base. In the balance sheet
the total assets figures is assumed to be 100 and all figures are expressed as a percentage of
this total. It is one of the simplest methods of financial statement analysis, which reflects
the relationship of each and every item with the base value of 100%.

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