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Financial statement analysis

All business transactions have to record, classify and summarize various

business transactions, which should be presented in an effective and meaningful
Recording the various business transaction -

Preparation of Journal

Preparation of Ledgers

Preparation of Trial Balance

Financial statement
Financial statement refers to the two statements Profit and Loss A/c,
Balance sheet. In addition of the above two statements the following
statements such as Profit and Loss Appropriation Account and Statement of
Changes in financial position are also prepared.
1. Profit & Loss a/c or
reveals profit earned or loss
suffered due to business operation.


2. Profit & Loss Appropriation A/C

reveals the amount of fund
retained in
the business after the payment of tax
and dividend.
3. Balance Sheet

- reveals financial position as on the date

(about what the business owns & Owes)

4. Statement changes in Financial


- reveals the Sources and Applications of

Nature of Financial statement

Financial statements are generally prepared for every accounting year based
upon the recorded facts.
According to the American Institute of Certified Public Accountants
Financial Statements are prepared for the purpose of presenting periodical
review of report on progress by the management and deal with the status of
investment in the business and the results achieved during the period. Financial
statement reflect a combination of recorded facts, accounting principles and
personal judgement.
3 factors are
1. Recorded Facts
2. Accounting Principles
3. Personal Judgements

3 factors are
1. Recorded Facts- information available in financial statements show only
the recorded facts and do not show the information which are not recorded
in the books of accounts.
Eg. In the accounting records fixed assets are shown at cost price less
depreciation and do not record the market value of that assets.
2. Accounting Principles Accounting conventions such as consistency,
conservatism, full disclosure and materiality are followed while preparing
the financial statements.
3. Personal Judgements

Uses of Financial Statements

To the Share holders
To the Management
To the Creditors
To the Trade Creditors
To the Employees
To the Government
Stock Exchanges and Trade Associations

and trade

To the

To the
To the

Uses of

To the

To the

To the

Limitations of Financial Statements

It presents only Interim Reports
It ignores qualitative information
It ignores economic and social factors
It shows historical information only
It is influenced by personal judgements
It makes comparison difficult

Ratio refers to the numerical or quantitative relationship between two
According to Myers, ratio is define to study of relationship among the
various financial factors of the enterprise.
Ratio analysis is an important and age old technique of financial analysis.

Purpose of Ratio Analysis

To study the short term solvency of the firm liquidity
of the firm.
To study the long term solvency of the firm leverage
position of the firm.
To interpret the profitability of the firm Profit earning
capacity of the firm.
To identify the operating efficiency of the firm
turnover of the ratios.

Uses of Ratio Analysis

Easy to understand the financial position of the firm.
The ratio analysis helps the parties to read the change that have taken
place in the financial performance of the firm from one time period to another.
Measures of expressing the financial performance and position.
It acts as a measure of financial position through liquidity ratios and
leverage ratios and also a measure of financial performance through
profitability ratios and turnover ratios.
Intra firm analysis on the financial information over many number of years.

The financial performance and position of the firm can be analysed and
interpreted within the firm in between the available financial information
of many number of years, which portrays either increase or decrease in
the financial performance.

Inter firm analysis on the financial information within the industry.

The financial performance of the firm is studied and interpreted along
with the similar firms in the industry to identify the present status of the
respective firm among others.
Possibility for financial planning and control.
It not only guides the firm to earn in accordance with the financial
forecasting, but also helps the firm to identify the major source of
expenses which has got greater influence on the earnings.

Limitations of Ratio Analysis

It is a dependant tool of analysis
The perfection and effectiveness of the analysis mainly depends upon the
preparation of accurate and effectiveness of the financial statements. It is
subject to the availability of fair presentation of data in the financial
Ambiguity in the handling of terms
the tools of analysis taken for the study of inter-firm analysis on the
profitability of the firms lead to various complications.
For eg. For profitability analysis while considering of profit from different
firms will get differ because
one firm will take Profit After Taxes (PAT),
Another will consider Profit Before Interest and Taxes (PBIT)
Third approach Consider only Net profit

Qualitative factors are not considered

Only quantitative factors are taken into consideration rather than
qualitative factors of the enterprise, consumers and customers.
Not ideal for the future forecast
Ratio analysis is the outcome of analysis of historical transactions known
as postmortem analysis. So it is not possible to predict the future exactly with
past performance.
Time value of money is not considered
It does not give any room for time value of money for future planning or
forecasting of financial performance.