Analysis of Financial Statements

Meaning of Analysis of Financial Statements:

Financial statement analysis is the procedure of scrutinizing an enterprise’s financial statements for taking up the decisions for the purposes and to comprehend the comprehensive health of an establishment. Financial statements document financial information, which must be assessed through financial statement analysis to become more helpful to shareholders, managers, investors and other interested parties. To put it in other words, the term ‘financial analysis’ comprises both ‘analysis and interpretation’. The term analysis refers to the simplification of financial information by methodical categorisation furnished in the financial statements. Interpretation refers to elucidating the meaning and importance of the information. These 2 are integral to each other. The analysis is inoperative without interpretation and interpretation without analysis is complicated or often futile.

The significance of Analysis of Financial Statements:

Financial analysis is the procedure of recognising the financial strengths and weaknesses of the enterprise by accordingly chartering the relationships between several items of the balance sheet and the statement of P&L. Financial analysis can be initiated by the management of the enterprise or by parties outside the enterprise, viz., finance manager, trade payables, lenders, labour unions and others. Financial analysis is helpful and vital for distinct users in the below mentioned following ways :

Finance Manager:

Analysis of financial statements assists the finance manager in:

  • Evaluating the operational competence and managerial effectiveness of the enterprise
  • Scrutinizing the financial strengths and weaknesses and adherence of the enterprise
  • Analyzing the present position of the financial analysis
  • Evaluating the types of assets possessed by an enterprise and the liabilities which are due to the business concern
  • Furnishing data about the cash position enterprise is holding and how much debt the enterprise has in association to equity

Top Management:

Financial analysis assists the top management :

  • To evaluate whether the resources of the enterprise are utilised in the most effective way
  • Whether the financial condition of the enterprise is good
  • To ascertain the success of the enterprise’s functions
  • Computing the individual’s performance
  • Assessing the structure of internal control
  • To scrutinize the future aspects of the enterprise

Trade Payables:

Trade payables scrutinize the financial statements for:

  • Computing the capability of the enterprise to meet its short-term responsibilities
  • Judging the feasibility of the enterprise’s continued capability to meet all its financial responsibilities in the upcoming future
  • Enterprise’s capability to meet claims of payables over a short period of time
  • Assessing the financial position and capability to pay off the concerns

Lenders:

Suppliers of long-term debt are concerned with the enterprise’s long-term financial competence and survival. They inspect the enterprise’s financial statements :

  • To determine the profitability of the enterprise over a time frame
  • For ascertaining an enterprise’s capability to get cash, to repay the principal amount and pay interest
  • To evaluate the association between various sources of capital (i.e.capital structure associations)
  • To evaluate financial statements which comprise data on past performances and decipher it as a ground for anticipating the future rates of return and for evaluating risk factor
  • For ascertaining credit risk, ascertaining the terms and conditions of a loan if granted, maturity date and interest rate etc.,

Labour Unions:

Labour unions scrutinize the financial statements:

  • To evaluate whether a firm can raise their pay
  • To check whether a firm can raise productivity or increase the cost prices of services/products to absorb an increase in the wage

Objectives of Analysis of Financial Statements:

Analysis of financial statements discloses the significant facts concerning managerial performance and the effectuality of the enterprise. To be more particular, the inspection is undertaken to serve the following objectives :

  • To evaluate the current profitability and functional capability of the enterprise as comprehensive as well as its distinct departments so as to arbitrate the financial health of the enterprise
  • To determine the relative significance of distinct elements of the financial condition of the enterprise
  • To recognize the reasons for the change in the profitability/financial position of the enterprise
  • To judge the capability of the enterprise to repay its debt and evaluating the short-term as well as long-term liquidity position of the enterprise

The above mentioned is the concept, that is elucidated in detail about the Analysis of Financial Statements, its meaning, significance and objectives for the class 12 Commerce students. To know more, stay tuned to BYJU’S.