Tools of 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 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.

Tools of Analysis of Financial Statements :

The most frequently used tools of financial analysis are as follows :

  • Comparative Statements: These are the statements depicting the financial position and profitability of an enterprise for the distinct timeframe in a comparative form to give a notion about the position of 2 or more periods. It usually applies to the 2 important financial statements, namely, statement of profit and loss and balance sheet outlined in a comparative form. Comparative figures signify the direction and trend of financial position and operating outcomes. This type of analysis is also referred to as ‘horizontal analysis’.
  • Trend Analysis: It is a method of analysing the operational outcomes and financial position over a period of time. Utilising the previous years’ data of a business firm, trend analysis can be done to notice the percentage changes over time in the picked information. The trend percentage is the percentage association, in which each item of different years delivers to the same item in the base year.
  • Common Size Statements: Common size statements are the statements which signify the association of distinct items of a financial statement with a generally known item by depicting each item as a % of that common item. Such statements allow an analyst to compare the financing and operating attributes of 2 enterprises of distinct sizes in a similar industry. This analysis is also referred to as ‘Vertical analysis’.
  • Cash Flow Analysis: It refers to the analysis of the actual movement of cash into and out of an establishment. The flow of cash into the trading concern is called cash inflow or positive cash flow and the flow of cash out of the enterprise is known as negative cash flow or cash outflow. The difference between the outflow and inflow of cash is the net cash flow. Hence, it compiles the reasons for the changes in the cash position of a trading concern between dates of 2 balance sheets.
  • Ratio Analysis: It characterizes the vital association which exists between several items of a B/S (balance sheet) and a statement of P&L of an enterprise. As a method of financial analysis, accounting ratios compute the comparative importance of the single items of the position and income statements. It is feasible to evaluate the solvency, efficiency and profitability of an enterprise via the method of ratio analysis.

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