Financial Statement Includes:
1. Trading & Profit & Loss Account; which gives the result of year’s working.
2. Profit & Loss Appropriation Account; which gives details about the disposal of the retained earning.
3. Balance Sheet; which gives the financial position of the undertaking as on the accounting date.
“The most important function of financial statements is to serve those who control and direct the business and may be answered the questions, how efficiently the capital of the business is being utilized, how well credit standards are being observed, and whether the financial condition is being improved.”
The Meaning of Analysis and Interpretation
The financial statements are of much interest to number of groups of persons. Apart from the management there are other interested parties like shareholders, debenture holders, potential investors, bankers, trade creditors and legislature.
Interpret means to put the meaning of a statement into simple terms for the benefit of a person.
Analysis comprise resolving the statements by breaking them into simpler statements by a process or rearranging, regrouping and the calculation of ratios, interpretation is the mental process of understanding the terms of such statements and forming opinions or inferences about the financial health, profitability, efficiency and such other aspects of the understanding.
Objectives of Analysis and Interpretation
1. To evaluate the financial health of the understanding.
2. To evaluate the earning performance of the undertaking.
3. To evaluate the ability of the undertaking to pay interest, amortized debt and other outside liability.
4. To evaluate the solvency of the undertaking. By the understating of solvency of the undertaking above points can be well understand.
- Whether current assets are sufficient to pay off the current liabilities.
- Proportion of liquid assets (cash and book debts) to current assets.
- Whether the debenture holders are secured by a floating charge of the currents assets.
- Future growth of undertaking and earning.
Example: Bankers who provide short term working capital loan and medium term credit they generally look into the following matter:
i. The purpose of loan.
ii. The manner in which the borrower proposes to repay the loan.
iii. The capacity of company to repay as evaluated by trends of profits.
iv. Banker’s position in the event of forced liquidation.
v. The quality of management.
vi. History of accounts in the history.
Types of Analysis:
1. Trend Analysis: which is made by analyzing the financial statements over a period of years. This indicates of such variable, as sales cost of production profits, assets and liabilities. For this it is better to prepare financial statements horizontally.
2. Structural Analysis: which is made by analysis of single set of financial statements as are prepared on a particular date. Under this analysis relationship between different accounting variables is studied as for example, the ratio of net profit on sales or the ratio of current assets over current liabilities.
Tools of Financial Analysis:
1. Comparative Balance Sheet and Income Statements.
2. Common Size Percentage: it is used for big balance sheet when it is very difficult to understand the figures. Generally Income Statement is converted into % statement on some common base. Sales figures assumed 100 and other figures are analyzed on % of sales. In case of balance sheet total of assets and liabilities considered as 100 and all other figures are expressed as % of total.
3. Trend Ratios.
4. Ratio Analysis:
i. Balance Sheet Ratio:
a. Current Ratio or Working Capital Ratio.
b. Liquid Ratio or Acid Test Ratio.
c. Proprietary Ratio.
d. Assets Proprietorship Ratio.
ii. Profit & Loss Statement Ratio:
a. Gross Profit Ratio.
b. Operating Ratio.
c. Expenses Ratio.
d. Net Profit Ratio.
e. Stock Turnover Ratio.
iii. Balance Sheet and Profit & Loss Statement Ratio:
a. Return on total resources.
b. Return on Own Funds.
c. Turnover of Fixed Assets.
d. Turnover of Debenture.
e. Earning Per Share.