State any three advantages and three limitations of analysis of financial statements.
State any three advantages and three limitations of analysis of financial statements.
Advantages of analysis of financial statements are:
(i) Assessing the profitability: Analysis of financial statements help in assessing the present earning capacity of the business. It is also helpful in forecasting its future earning capacity.
(ii) Assessing the efficiency: Analysis of financial statements helps in assessing the efficiency as well as the inefficiencies of the management.
(iii) Assessing the liquidity: Liquidity means ability of the firm to meed its current liabilities. Creditors and suppliers are interested in liquidity (or short-term financial position). Liquidity can be assessed by comparing current assets with current liabilities.
Limitations of analysis of financial statements:
(i) Limitations of financial statements: Financial statements are used as a basis for analysis. Hence, the limitations of financial statements, such as influence of accounting concepts, disclosure of only monetary facts, are also the limitations of analysis of financial statements.
(ii) Not free from bias: Personal judgement and discretion of the accountant and the management play an important role in determining the figures of many items of financial statement. Provision for depreciation, provision for doubtful debts, stock valuation, etc., are based on personal judgement and therefore, financial statement are not free from bias.
(iii) Ignores price level changes: Financial analysis fails to disclose current worth of the enterprise since it is based on financial statements, which are merely a record of the historical facts.
Advantages of analysis of financial statements are:
(i) Assessing the profitability: Analysis of financial statements help in assessing the present earning capacity of the business. It is also helpful in forecasting its future earning capacity.
(ii) Assessing the efficiency: Analysis of financial statements helps in assessing the efficiency as well as the inefficiencies of the management.
(iii) Assessing the liquidity: Liquidity means ability of the firm to meed its current liabilities. Creditors and suppliers are interested in liquidity (or short-term financial position). Liquidity can be assessed by comparing current assets with current liabilities.
Limitations of analysis of financial statements:
(i) Limitations of financial statements: Financial statements are used as a basis for analysis. Hence, the limitations of financial statements, such as influence of accounting concepts, disclosure of only monetary facts, are also the limitations of analysis of financial statements.
(ii) Not free from bias: Personal judgement and discretion of the accountant and the management play an important role in determining the figures of many items of financial statement. Provision for depreciation, provision for doubtful debts, stock valuation, etc., are based on personal judgement and therefore, financial statement are not free from bias.
(iii) Ignores price level changes: Financial analysis fails to disclose current worth of the enterprise since it is based on financial statements, which are merely a record of the historical facts.
