MANAGEMENT ACCOUNTING:

1. Meaning of  Management Accounting:

The term Management Accounting consists of two words
“Management” and “Accounting”. It is the study of managerial
aspects of accounting. It is a tool in the hands of management to
exercise decision making. The emphasis of management
accounting is to redesign accounting in a manner which is helpful
to the management in framing the policies and control of their
execution.

Management accounting is of recent origin. The term was first

used in 1950 by a team of accountants visiting U.S.A. under the
auspices of Anglo-American Council on productivity. The
terminology of cost accounting had no reference to the word
‘management accountancy’ before the visit by this study group.
Intensive competitions, large scale production, dynamic
developments in technology, and complexities of modern
business have led to the development of management accounting-
to solve many of the problems.

“Management accounting is the presentation of accounting

information in such a way as to assist management in the
creation of policy and in the day-to-day operations of an
undertaking”. I.C.M.A. – the definition recently incorporated into
the terminology.

Management accounting provides information to the

management to use it as a base for decision making.

J. Batty defines Management Accounting as “the term used to

describe the accounting methods, systems and techniques which,
coupled with special knowledge and ability, assist management in
its task of maximising profits or minimising losses”.

Batty’s definition describes Management Accounting as a

combination of various accounting systems and techniques which
are designed to meet the needs of the management.
2. Nature of Management Accounting:
Though Management Accounting is the latest branch in the
accounting arena, it may be regarded partly as a Science and
partly as an Art. It is the science of ‘Quantifying and
summarising’ and Art of ‘Interpreting’ accounting data.

Management Accounts derives its conclusions through collection,

processing and objective analysis of data Quantified in figures.
Thus it depends upon “Objectivisation and Quantification of
progress and problems”. From this point of view Management
accounting may be regarded as a Science.

However Management Accounting also involves human

judgement, impulses, whims and prejudices as evidenced in
interpretation of data, deductions and conclusions drawn from
analysis. ‘Subjectivity’ is inevitable in ‘deriving the meaning of
data’. Deductions cannot be scientific with precision. Personal
judgement of Management accountant may influence the
interpretations and deductions significantly. From this point of
view, Management Accounting may be regarded as an Art.

We may conclude by saying that like all other social sciences,

Management Accounting is partly a Science and Partly an Art.
3. Characteristics of Management Accounting:
The objective of Management accounting is to record, analyse
and present financial data to the Management in such a way that
it becomes useful and helpful in planning and running business
operations systematically and effectively.

The following are the main characteristics of

management accounting:

(1) Providing Financial Information:

The main emphasis of management accounting is to provide

financial information to management. The information is
provided in a manner suitable to various levels of management
for reviewing policies and decision making.

(2) Cause and Effect Analysis:

Financial accounting confines itself to presentation of P&L

account and Balance Sheet. Management accounting analyses the
cause and effect of the facts and figures thereon. If there is loss
causes for the losses are investigated. If there is profit the
variable affecting the profit are also analysed. The amount of
profit is compared with expenditure, sales, capital employed, etc.,
to draw appropriate conclusions relating to the effect of those
items on profit.

(3) Use of Special Techniques and Concepts:

Management accounting employs special techniques like

standard costing, budgetary control, marginal costing, fund flow,
cash flow, ratio analysis, responsibility accounting, etc. to make
accounting data more useful and helpful to the management.
Each of these techniques or concepts is a useful tool for specific
purpose in analysis and interpretation of data, establishing
control over operations, etc.
(4) Decision Making:

Main objective of management accounting is to provide relevant

information-to management to take various important decisions.
Historical information provides a base on which the future
impact is predicted, alternatives are developed and decisions are
made to select to select the most beneficial course of action.

(5) No Fixed Conventions:

Financial accounting has various established principles and rules

in preparing the financial accounts. Management accounting has
no such fixed rules. The tools or techniques applied by the
management accounting are same but application of these
techniques various from concern to concern and situation to
situation.

Interpretation of analysed data depends on the person using it.

The conclusions derived from application of a technique depend
on the intelligence and experience of the management account.
The presentation of information depends on the requirements of
the concern. Every concern has its own was of application of the
techniques to suit its needs.

(6) Achievement of Objectives:

Management accounting is helpful in realising the enterprise

objectives. Based on the historical information and with
adjustments for predicate future changes, objectives are laid
down. Actual performance is recorded. Comparison of actual with
predetermined results is made. If there are deviations of actuals
from the predetermined results, corrective action is taken and
predicted objectives are achieved. This becomes possible with the
help of management accounting techniques of standard costing
and budgetary control.

(7) Improving Efficiency:

The purpose of accounting is to provide information to increase
efficiency. The efficiency of departments, and divisions can be
improved by fixation of targets or goals for a specific period. The
actual performance is compared with that of targets. Positive
deviations are reviewed. The negative deviations are probed to
ascertain the causes. The ways and means to tackle the causes are
analysed and targets are achieved. The process of fixing and
achieving the targets leads to gradual improvement in overall
efficiency.

(8) Forecasting:

Management accounting is concerned with taking decisions for

future implementation. This involves prediction and forecasting
of future. It is helpful in planning and laying down of objectives.

(9) Providing of Information and not Decisions:

Management accounting provides financial information and not

the decisions. That is why it is said that management accounting
depends on the efficiency of the management in using
information and taking effective decisions.
4. Objectives and Functions of Management
Accounting:
Main objective of management accounting is to help the
management in performing its functions efficiently. The major
functions of management are planning, organising, directing and
controlling. Management accounting helps the management in
performing these functions effectively.

(1) Presentation of Data:

Traditional Profit and Loss Account and the Balance Sheet are
not analytical for decision making. Management accounting
modifies and rearranges data as per the requirements for decision
making through various techniques.

(2) Aid of Planning and Forecasting:

Management accounting is helpful to the management in the

process of planning through the techniques of budgetary control
and standard costing. Forecasting is extensively used in
preparing budgets and setting standards.

(3) Help in Organising:

Organising is concerned with establishment of relationships

among different individuals in the firm. It includes delegation of
authority and fixing responsibility. Management Accounting aims
at aiding the Management in organising through establishment of
cost centres, profit centres, responsibility centres, Budget
preparation etc. AH these activities are helpful in setting up an
effective organisational frame work.

(4) Decision Making:

Management accounting provides comparative data for analysis
and interpretation for effective decision making and policy
formulation.

(5) Reporting to Management of Different levels:

One of the Major objectives of Management accounting is to keep

the Management informed about the performance, adherence to
plans and progress of various sections of the organisation.

Top Management needs feed-back about implementation of its

plans policies and programmes. Middle level Management and
even junior executives need data for day to day operating
decisions. Periodical and frequent reports are prepared and sent
in time by Management Accountant to cater to the needs of all the
levels of Management.

(6) Communication of Management Policies:

Management accounting conveys the policies of the management

downward to the personal effectively for proper implementation.

(7) Effective Control:

Standard costing and budgetary control are integral part of

management accounting. These techniques lay-down targets,
compare actuals will standards and budgets to evaluate the
performance and control the deviations.

(8) Incorporation of Non-Financial Information:

Management accounting considers both financial and non-

financial information for developing alternative courses of action
which leads to effective and accurate decisions.

(9) Coordination:

The targets of different departments are communicated to them

and their performance is reported to the management from time
to time. This continual reporting helps the management in
coordinating various activities to improve the overall
performance.
(10) Motivating Employees:

Budgets, standards and other programmers are to be

implemented in practice by the employees. A major objective of
Management accounting is to determine the targets in the form of
budgets, standards and programmer in such a way that the
employees feel motivated to achieve them. This is usually
accomplished by making the targets practicable and offering
suitable monetary and Non-Monetary incentives to achieve them.
5. Tools and Techniques of Management Accounting:
The tools and techniques used in management
accounting are explained below:

1.Financial Policy and Accounting:

Every business concern ha sot plan for its sources of funds. The
fund can be raised out of different sources. Utilising a particular
source depends on cost of servicing the source, terms of
repayment in case of borrowings, etc. The amount of share capital
raised, the statutory obligations for repayment are to be
considered. The capital mix, i.e., the proportion of share capital
and borrowing has to be decided to have an optimum capital
structure. Management accounting provides capital budgeting
techniques for financial planning.

(2) Analysis of Financial Statement:

Analysis of financial statements is means to classify and present

the data in a manner useful to the management. The significance
of information provided is explained in a nontechnical language
in the form of ratio analysis, funds flow and cash flow techniques.

(3) Historical Cost Accounting:

Costs are recorded after being incurred for comparison with

predetermined targets to evaluate performance.

(4) Budgetary Control:

Budgets are used as a tool for planning and control. The

expenditure and revenue are predetermined. The actuals are
compared with budgets to reveal deviations and individuals
responsible for the same. Corrective actions are initiated to
eliminate the negative deviations in future.

(5) Standard Costing:

Standard costing is an important technique of cost control. In
Standard costing the costs are determined in advance by
systematic analysis. The actual costs are compared with
standards. The variances are analysed to find the causes and
action is taken for removal of the same to increase efficiency.

Generally, standard costing is used along with budgetary control

for effective control of operations.

(6) Marginal Costing:

Under marginal costing, the cost of products is divided into fixed

and variable portions. While the variable costs are taken for
decision making, fixed costs are treated as period costs to be
charged to costing Profit and Loss account. Marginal costing is
helpful to management in taking various important decisions etc.

(7) Other Tools of Management Accounting are:

(a) Decision Accounting:

Here alternatives are evaluated for selection in decision situation.

(b) Revaluation Accounting:

This is applied in replacement of fixed assets whose prices go up

from period. The effect of inflation on the fixer assets is tackled
here.

(c) Control Accounting:

In control accounting, internal check, internal audit and statutory

audit are used.

(8) Management Information System:

An important function of management accounting is reporting.

This function has improved consider off with the developing of
electronic data processing systems. In the modern firms, the
process of making information available for management is
integrated and computer based, known as ‘Management
Information System'(MIS).
6. Installation of Management Accounting
System:
Installation of Management accounting system involves
the following steps:

(1) Organisation Manual:

The first step is to prepare an organisational manual. The manual

will clearly pin point the duties and responsibilities of each level
of management and the horizontal and vertical relationship
among the key personnel.

(2) Preparation of Various Forms and Reports:

The second step in the installation process is designing the

perform of various and reports. The objective should be to
minimise their under and simplify them to avoid
‘Bureaucratisation’.

(3) Requisite Staffing:

The staff required for implementing the system is to be recruited

and trained.

(4) Classification of Accounts:

Financial and cost accounts should be classified, confined and

integrated to the extent possible to suit the requirement of
management accounting.

(5) Setting Up of Cost Centres:

Investment centres, profit centres, cost centres and budget

centres are to be clearly set up so that information can be
collected and analysed in relation to each of them.

(6) Introducing Management Accounting Techniques:

Various techniques of management accounting are to be
introduced, based on the needs of the firm, and practicability.

(7) Providing for Usage of ‘Operations Research’ (O.R)

Techniques:

Everyday new challenges are faced because business is operated

under changing economic, political and social environment.
‘Operations Research Techniques’ will be essential to cope up
with the emerging problems.
7. Organisation for Management Accounting:
The organisation for management accounting system will depend
on the scale of operations, nature of business, nature of
organisation, etc. In a small concern, management accountant is
directly under the owner. In a big concern management
accounting may be assigned to financial controller.

A concern with a divisional set up will have a different

management organisation. The role of management accountant
has been emphasised by Anderson and Schmidt r management
accounting will be specifically concerned, about the problem of
cooperation with all other is no other functional element in the
whole organisation that has necessary relations with so many
different units.

Management account is concerned with various levels of

managers, supervisors and operators in all sections of business
operations.

An organisational chart for a large scale concern is given

below:
In the organisation chart, director finance is placed above chief
management accountant. The functions like budgeting, auditing,
O & M, credit control etc., are all placed under Chief Management
Accountant.
8. Advantages/ Merits/ Uses of Management
Accounting:
Management Accounting is of immense value and utility for the
management of any firm and it has been considered as
indispensable, particularly in large organisations where the task
of Management is complex.

The following can be listed as the benefits or uses of

Management Accounting:

(1) Increase in Efficiency:

Management accounting contributes significantly towards

increasing efficiency in operations of a firm. Budgets, standards,
reports etc., usually elevate the level of performance.

(2) Effective Planning:

Policy formulation and planning of operations become more

effective through the ‘decision data’ provided by Management
Accounting.

(3) Performance Evaluation:

Evaluating performance of employees, departments, etc., is

facilitated by Management accounting through Variance Analysis,
control ratios etc.

(4) Profit Maximisation:

Management accounting is helpful in profit planning to pursue

decisions which can optimise profits.

(5) Reliability:

The Tools used by Management accounting usually make the data

supplied to Management accurate and reliable.
(6) Elimination of Wastages:

Standard costs, Budgets, cost control techniques, etc., contribute

towards elimination of wastages, production of defectives etc.

(7) Effective Communication:

Regular and systematic reporting ensures constant flow of

information about operations to various levels of Management.

(8) Employee Morale:

Morale of employees can be created and sustained through

attainable standards, practical budgets and incentive schemes.

(9) Control and Co-ordination:

Control on costs and coordination in the efforts of different

segments of an organisation can be achieved through
performance reporting, variance analysis and follow up action
etc.

The greatest benefit of Management accounting is its advisory

role in making the Management to take the best possible
decisions on a day-to-day basis on routine matters and also vital
policy matters.
9. Limitations of Management Accounting:
Like any other discipline Management Accounting has its own
Limitations. Though it is considered as an indispensable tool for
Managerial decision making, its recent origin and several
external factors limit its effectiveness.

These factors are explained below:

(1) Dependence for Basic Records:

Management Accounting rarely maintains basic and primary

records of operations, expenses and revenues. It derives all of its
Primary data from Financial Accounting, cost Accounting and
other relevant records. So, the accuracy .and reliability of the
conclusions derived by Management Accounting is limited to the
reliability of its sources of data, so, it suffers from several of the
limitations of Finance Accounts and cost Accounts.

(2) Personal Bias:

Analysis and interpretation of financial information depends

upon the capability of the analyst and interpreter. Personal
Judgement and usage of discretion become necessary in several
areas of Management accounting. Personal ‘Prejudices’ and ‘Bias’
of individuals can affect the objectivity and effectiveness of the
conclusions and recommendations.

(3) Management Accounting is only a Tool:

Management accounting cannot be considered as an alternative

or substitute to Management. Management accountant acts as an
adviser and facilitator for decision making by management. The
actual decisions, their implementation and follow up action are
the prerogative of the Management.

(4) Management Accounting provides only Data:

The Main function of Management Accounting is to provide data

in the form of ‘Alternatives’ to the Management. It is for
Management to make suitable choice among the alternatives or
even discard all of them. So, Management Accounting can ‘only
Inform and not prescribe’.

(5) Broad Based Scope:

The scope of Management accounting is very wide and broad

based. It uses information from varied disciplines like Financial
Accounting, economics, Statistics, Cost Accounts, engineering
etc. It considers Monetary and Non-Monetary Transaction of the
firm. Limitations of the knowledge and experience of the
Management Accountant in such diverse fields can make the data
unreliable and undependable.

(6) Resistance to Change:

Installation of Management accounting involves basic changes in

the organisational set up and Traditional accounting practices.
The personnel concerned may resist such change unless they are
taken into confidence and convinced of the need for such
changes.

(7) Costly to Install:

Installation of Management Accounting involves huge

expenditure because of the elaborate organisation needed and the
large number of changes in procedures, forms and rules. So,
small firms may not be able to afford the cost. Only big
organisations can afford to Maintain Management accounting as
a department or aid to management.

(8) Evolutionary Stage:

Management accenting is of-recent-origin, as a discipline and it is

still in development stage. So, its concepts are fluid, Techniques
are still evolving and analytical tools imperfect. There are several
experts who are skeptical of the utility of Management accounting
because of such an important limitation.

Most of above limitations can be overcome with determined

efforts on the part of the Management and a skilled Management
Accountant.
10.The Role of Management Accounting in Decision
Making:

Management accounting is a field of accounting that focuses on

providing financial information and analysis to decision-makers
within a company. The role of management accounting in decision-
making is critical, as it helps management make informed decisions
that can lead to increased profitability, efficiency, and overall
success. In this article, we will explore the importance of
management accounting in decision-making and its various
applications.

Providing timely and accurate financial information

One of the primary functions of management accounting is to

provide timely and accurate financial information to decision-
makers. This information can include financial statements, budgets,
and forecasts, among other things. This information is crucial for
management to make informed decisions about the company's
finances, operations, and overall strategy. With timely and accurate
information, management can make more informed decisions about
investments, pricing, cost control, and other critical aspects of the
business.

Evaluating and managing costs

Another important role of management accounting is to evaluate

and manage costs. Management accountants work to identify areas
where costs can be reduced, and opportunities to increase
efficiency and profitability. This can involve analyzing production
processes, identifying waste, and determining the most cost-
effective way to allocate resources. By effectively managing costs,
companies can improve their profitability and stay competitive in
their respective markets.
Identifying and analyzing risks

Management accounting also plays a critical role in identifying and

analyzing risks. Management accountants work to identify potential
risks to the company, such as changes in the economic environment
or shifts in consumer behavior. They then analyze these risks to
determine their potential impact on the company and develop
strategies to mitigate them. By identifying and managing risks,
companies can protect themselves from financial losses and
maintain long-term sustainability.

Assessing performance

Management accounting is also used to assess performance.

Management accountants can analyze financial statements and
other data to evaluate how the company is performing relative to its
goals and objectives. This information is crucial for management to
make decisions about future investments, operations, and strategy.
By assessing their performance, companies can make necessary
adjustments to ensure they are meeting their goals and maintaining
profitability.

Providing financial insights for decision making

Lastly, management accounting provides financial insights for

decision-making. Management accountants can use financial data
and analysis to provide insights and recommendations for strategic
decision-making. For example, they can analyze the financial impact
of different pricing strategies, production methods, or investments.
This information is valuable for management to make informed
decisions about the company's future direction and growth.
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information
11.Financial Statement Analysis:
Definition: Financial Statement Analysis is the assessment of the firm’s
financial well-being. It determines relations among various items of the
financial statements. Also, it helps in identifying strengths and specifying the
areas of concern persisting in the firm.
t aims to scrutinize, interpret, compare and depict useful relationships among
financial statements (Balance Sheet, Income Statement). However, managers
make these comparisons within and across the statements.

Financial Statement Analysis helps to determine the future course of action.

Besides, it involves decision-making about several aspects, some of which are
as follows:
  Financial Position
 Investing Decisions
 Profitability
 Strengths and Weakness

The information generated post-analysis is vital for internal and external parties.
These parties may include – Lenders, Investors, Security Analysts, Managers,
etc.

Tools of Financial Statement Analysis

One can use the following tools to perform financial statement analysis:
Comparative Statement Analysis

We perform this analysis to assess the financial position of the firm or one or
more firms over the years.

In this statement, we compare the current year’s financial statements with

previous years. Consequently, we can find out the percentage increase or
decrease over a period of time.

For Example– An investor wants to compare the percentage increase or

decrease in net profit in the past three years between XYZ ltd and ABC ltd.
Common Size Statement

It involves the vertical analysis of the financial data. It helps in converting

complex data into a concise and understandable form.

Besides, these statements depict the relationship of individual items with a

common base. The comparisons may take place between different years of the
same firm or more than one firm.

ote: We can prepare a common size statement both horizontally as well as

vertically. 
The common base differs in Income Statement and Balance Sheet. Therefore,
we can take Net Sales in the case of the Income Statement as a common base.
Whereas, Total Assets/Liabilities in the case of Balance Sheet.

The formulas for calculating the percentages are as follows:

Percentage in relation to Common Size Income Statement=

Percentage in relation to Common Size Balance Sheet=

RATIO ANALYSIS:
Ratio Analysis is an essential tool for financial statement analysis. It represents
a meaningful quantitative relationship between individual & interdependent
components of financial statements. However, the outputs are in the form
of ratios, percentages, rates and time.

We can use these ratios to determine:

 Firms Financial Position

 Profitability
 Evaluation
 Decision-making
Besides, the classification of the Ratios depends upon the purpose of their

evaluation. The heads listed below depict the grouping of ratios according to
their purpose:

1. Profitability Ratios (Gross profit, Net Profit, Operating Profit, etc.)

2. Liquidity Ratios (Current Ratio, Quick Ratio, etc.)
3. Activity/ Turnover Ratios (Stock, Debtors, Creditors Turnover
Ratios, etc.)

Trend Analysis
It evaluates the relative change in the behaviour of data over a series of years.
We can perform Trend analysis by using Trend Ratios or Index Numbers.

It is useful for making comparisons in the long run. Also, it

facilitates Forecasting and Budgeting for the upcoming fiscal year.

An essential part of the trend analysis is the indexing of the items. The indexing
process includes the comparison of each item with the base year. Generally, we
take the first year as a base in the series of years.
We can represent these Indexes in the form of percentages, ratios and graphs.
Thereafter, analyze the upward or downward trends of the data.

Trend Ratio/Index Number =

Cash Flow Statements

It depicts the movement of ‘cash and cash equivalents’ in the firm in an

accounting year. The analysis includes the evaluation of the net changes in cash
from inflow and outflow by:

 Operating Activity
 Financing Activity
 Investing Activity

Fund Flow Statements

A Fund Flow Statement is a tool of Financial Statement Analysis that
shows how the enterprise has been financed. This statement shows the
summary of sources and utilization of funds.

It depicts the financial health of an enterprise. For this purpose, we need to

evaluate changes in working capital during the year.

Types of Financial Statement Analysis

Following are the types of financial statement analysis:
Internal Analysis

In this, the internal management assesses the business’s performance and

financial soundness. They have access to all the records and detailed

information about the company. Internal management consists of:

1. Employees
2. Managers
3. Auditors
4. Top Level Management, etc.

External Analysis

The parties outside the business conduct external analysis. Such parties check
the company’s performance for different purposes. They use data published by
the company through financial statements in different years.

These outsiders can be:

1. Investors
2. Financial Institutions
3. Statutory bodies, etc

Horizontal Analysis

It helps compare the past year’s performance of the financial statements or

individual items. Thus, one can check the trend and patterns in the long run.

Tools used to perform this type of analysis are:

1. Comparative Financial Statement

2. Cash Flow Statement
3. Fund Flow Statement
4. Trend Analysis, etc.

Vertical Analysis

When we analyze different items of the same year, taking a common base,
then we use the vertical analysis. It is quantitative in nature. Moreover, it
indicates the relationship between different items for forecasting and decision
making.

Ratio Analysis and common size statements are tools used in the vertical
analysis.
Parties Involved in Financial Statement Analysis

The diagram below depicts various parties involved in carrying out financial
statement analysis.

Guidelines for Financial Statement Analysis

1. The choice of tools should be appropriate at the time of selection.

Use ratios for better interpretations.
2. Always refer to the notes provided at the end of the statements.
These notes contain information and calculation showing the
truthfulness of the published facts.
3. Comparison of ratios must depend on the average of the industry
benchmarks. Also, the benchmarks of the industry leaders or their
own historical ratios.
4. Financial Statement Analysis is a complex process. As it requires
expertise, logic and a correct approach to perform the analysis. It
does not have any mechanical substitute.
5. Try to choose those ratios which can provide you with the most
information for the analysis.
Importance of Financial Statement Analysis

 Management: For analyzing market trends, preparing managerial

reports, forecasting and decision making.
 Government: It is a major source of information for taxation and
policy formulation.
 Investors: Provides vital information for investment and
comparisons with other institutions.
 Creditors: It helps in ascertaining firms’ short-term and long-term
solvency.
 Financial Institutions: Institutions check the creditworthiness of
the firm through these statements.
 Employees: To know about the profitability and growth of the firm.

Limitations of Financial Statement Analysis

Following are the limitations of the financial statement analysis:

 The difference in Accounting policies, methods, and standards at

local and global levels.
 Continuous change in Technology, Trends, Techniques and Tools of
evaluation.
 Manipulation by the analyst or firm through unethical practices and
misleading facts representation.
  Less reliability and truthfulness due to the analyst’s wrong
interpretation or personal bias.
 Selection of the wrong tool of analysis while comparisons are being
made.
 Difficulty in analysing firms with a large or diversified product
range.
 The analysis is done quantitatively; non-monetary aspects are
entirely ignored.
 Many firms do not consider changes in price levels. Therefore, it
results in the wrong interpretation during analysis.
 The analysis depends only on the historical data. Many other factors
necessary for forecasting may not be taken into consideration.

Final Words

Internal and external beneficiaries carry out financial statement analysis for
many purposes. They use horizontal and vertical approaches to use different
tools like comparative statements, common-size statements, etc.
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information
Management Accounting
Financial Accounting Cost
Accounting
Objective Provides information to
help
managers make planning and
control decisions for the
organization
Provides information about
financial
performance and financial
position
of the business
Provides information of
ascertainments of costs to control
cost for decision making about
the
costs
Nature Deals with projection of
data for
the future (futuristic in nature)
Concerned with historical data
Concerned with both past and
present data (historical in nature)
Primary Users Internal External
Internal
Nature of Information More
subjective and judgemental,
valid, relevant and accurate
Objective, auditable, reliable,
consistent and precise
Time focus Future oriented;
formal use of
budgets as well as historical
records
Past oriented; historical
evaluation
Time span/period Flexible; from
hourly to yearly Less flexible;
usually 1 year or 1
quarter
Prepared when required
Restrictions GAAP does not
apply; restricted to
strategic and operational needs
GAAP
Presentation of
Information
Detailed reports; concerned about
details of parts of the entity,
products, departments, territories
Summary reports; concerned
primarily with the entity as a
whole
No set formats for presenting cost
information