Financial Analysis deals with analysis of financial statements. it is one of the most important and useful tool to figure out a company's strenghts and weaknesses by establishing a proper relationship between the items of balance sheet and income statements.
For the purpose of adequate understanding and analysis of financial statements the following points are worth noting:
1. sound understanding of accounting procedures/pracitces.
2. understanding of tools of financial analysis.
3. knowledge of the business
4. knowledge of the economic conditions.
Financial analysis is preceded by accounting analysis and followed by prospective analysis.
Accounting Analysis: It is the analysis of past financial performance position and involves examining hoe generally accepted accounting principles and conventions have been applied.
Prospective Analysis: It involves developing projected/forecasted financial statements keeping in view the changes that are likely to take place and in what manner will they affect the functioning of a business.
Horizontal & Vertical Analysis
Horizontal analysis involves the comparison or establishment of relationship based on statments of two or more periods of the same or different businesses. wheveras vertical analysis is based on datas for one accounting period.
Objectives of financial Analysis:
1. To identify the magnitude and direction of changes in enterprise's performance and position financially.
2. to ascertain the strengths and weaknesses in terms of liquidity, solvency, profitability etc.
Tools of Financial Analysis:
In order to draw meaningful conclusions or to assess an enterprise's strengths and weaknesses, financial statements are subject to financial analysis and for this purpose the following are the most commonly used tools of financial analysis:
1. Ratio Analysis.
2. Comparative & Common size Statements Analysis.
3. Cash Flow Analysis.
4. Funds Flow Analysis.
5. Trend Analysis.
Contents of Company Financial Statements:
a. Board's Report.
b. Auditor's Report
c. Director's Responsibility Report.
d. Corporate Governance Report.
e. Balance Sheet(Position Statement)
f. Profit and Loss Account(Income Statement)
g. Cash Flow Statement
h. Segment Report.
Apart from the above mentioned statements and reports a company may make voluntary disclosures with regards to the following:
a. Human Resource Accounting
b. Inflation Accounting/ Accounting for price level changes.
c. Value Added Statements.
Limitations of Financial Analysis:
1. It ignores qualitative accepts or elements since they are confined to quantitative matters only.
2. Financial analysis also cannot be said to be free from bias.
3. It only reflects an estimated position and not the real position since the statements are prepared on a going concern basis as against liquidation basis.
4. Quality of accounting conventions, principles and practices also affect the quality of analysis.
5. Poor quality of auditing standards and professional ethics of chartered accountants also affects the quality of analysis.
6. Quality of enforcement of regulations also affect financial analysis.
Parties Interested in Financial Analysis:
b. Management & Stake Holders.
e. Bankers & Lenders or Creditors.
f. Regulatory Authorities.
Hope that this small piece of write up on "Financial Analysis" will provide the readers with a quick understanding of the subject matter.
Ashish Sharma B.Com.(Hons.)