Analysis of Financial Statements

The process of evaluation which is critical about financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm is called 'Financial Statement Analysis'. It is basically a study of relationship among different financial facts and figures as given in a set of financial statements, and the interpretation thereof to gain an insight into the operational efficiency and profitability of the firm to assess its financial health and future prospects. The term analysis is nothing but simplification of financial data by classification methods given in the financial statements. Interpretation means explaining the significance and meaning of the data. These two are complimentary to each other.

Analysis is useless without interpretation, and interpretation without analysis is difficult or even impossible. Financial analysis is the process of identifying the financial weakness and strengths of the firm by properly establishing relationships between the different items of the profit and loss account and the balance sheet. Financial analysis can be undertaken by management of the firm, or by parties outside the firm, viz. owners, trade creditors, lenders, investors, labor unions, analysts and others. The nature of analysis will differ depending on the purpose of the analyst. A technique frequently used by an analyst need not necessarily serve the purpose of other analysts because of the difference in the interests of the analysts. Financial analysis is useful and significant to different users in the following ways:

Finance manager: Financial analysis focuses on the facts and relationships related to managerial performance, corporate efficiency, financial strengths and weaknesses and creditworthiness of the company. A finance manager must be well-equipped with various tools of analysis to make rational decisions for the firm. The tools for analysis help in studying accounting data so as to determine the continuity of the operating policies, investment value of the business, credit ratings and testing the efficiency of operations.

Top management: The importance of financial analysis is not limited to the finance manager alone. Its scope of importance is quite broad which includes top management in general and the other functional managers. Management of the firm would be interested in every aspect of the financial analysis. It is their overall responsibility to see that the resources of the firm are used most efficiently, and that the firm's financial condition is sound. Financial analysis helps the management in measuring the success or otherwise of the company's operations, appraising the individual's performance and evaluating the system of internal control.

Trade creditors: A trade creditor, through an analysis of financial statements calculates not only the urgent ability of the company to meet its obligations, but also judges the probability of its continued ability to meet all its financial obligations in future. Trade creditors are interested in the firm's ability to meet their claims over a short period of time. Their analysis will, therefore, confine to the evaluation of the firm's liquidity position.

Meanings and Importance of Financial Statement Analysis

All financial statements are essentially historically historical documents. They tell what has happened during a particular period of time. However most users of financial statements are concerned about what will happen in the future. Stockholders are concerned with future earnings and dividends. Creditors are concerned with the company's future ability to repay its debts. Managers are concerned with the company's ability to finance future expansion. Despite the fact that financial statements are historical documents, they can still provide valuable information bearing on all of these concerns.

Financial statement analysis involves careful selection of data from financial statements for the primary purpose of forecasting the financial health of the company. This is accomplished by examining trends in key financial data, comparing financial data across companies, and analyzing key financial ratios.

Managers are also widely concerned with the financial ratios. First the ratios provide indicators of how well the company and its business units are performing. Some of these ratios would ordinarily be used in a balanced scorecard approach. The specific ratios selected depend on the company's strategy. For example a company that wants to emphasize responsiveness to customers may closely monitor the inventory turnover ratio. Since managers must report to shareholders and may wish to raise funds from external sources, managers must pay attention to the financial ratios used by external inventories to evaluate the company's investment potential and creditworthiness.

Although financial statement analysis is a highly useful tool, it has two limitations. These two limitations involve the comparability of financial data between companies and the need to look beyond ratios. Comparison of one company with another can provide valuable clues about the financial health of an organization. Unfortunately, differences in accounting methods between companies sometime makes it difficult to compare the companies' financial data. For example if one company values its inventories by the LIFO method and another firm by average cost method, then direct comparisons of financial data such as inventory valuations are and cost of goods sold between the two firms may be misleading. Some times enough data are presented in foot notes to the financial statements to restate data to a comparable basis. Otherwise, the analyst should keep in mind the lack of comparability of the data before drawing any definite conclusion. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry averages often suggest avenues for further investigation.

An inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgment about the future. Nothing could be further from the truth. Conclusions based on ratio analysis must be regarded as tentative. Ratios should not be viewed as an end, but rather they should be viewed as a starting point, as indicators of what to pursue in greater depth. They raise may questions, but they rarely answer any question by themselves. In addition to ratios, other sources of data should be analyzed in order to make judgments about the future of an organization. They analyst should look, for example, at industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm itself. A recent change in a key management position, for example, might provide a basis for optimism about the future, even though the past performance of the firm may have been mediocre.

Few figures appearing on financial statements have much significance standing by themselves. It is the relationship of one figure to another and the amount and direction of change over time that are important in financial statement analysis. How does the analyst key in on significant relationship? How does the analyst dig out the important trends and changes in a company? Three analytical techniques are widely used; dollar and percentage changes on statements, common-size statements, and financial ratios formulas.

Analysis of Statement of Cash Flow - Vital Aspect In The Process Of Financial Planning

Analysis of Statement of Cash Flow - Vital Aspect In The Process Of Financial Planning

When one is done tallying one's assets against one's liabilities in work out to figure out one's net worth, the subsequent imperative step of the process financial planning should be to set up and scrutinize one statement of cash flow. The paragraphs which follow explain the reason behind the importance of analysis of statement of cash flow with respect to the process of financial planning.

The scrutiny and examining of one's cash flow as well as the classification of one's budget to make certain the positive position of cash flow will permit one to take what so ever surplus cash over one's expenditure in order to assign it to one's savings fund as well as the investment plan for achievement of improved net worth.

General daily expenditures can include one's utilities bills, the electricity bills, the water bills, the telephone bills, the groceries bills as well as the transportation bills and various others.

However the genuine bane to some financial map at early phase of economic planning of juvenile person would be in relation to monthly repayments in order to make up for housing loan, may be car loan or even in the worst cases scenario of the debits of credit cards which might came into existence as a result of lofty living lifestyle that is far beyond his/her resources and means.

If one is in a superior fortunate debt free pose, then one's priority should be the budget which embraces monthly allotment for a fund of emergency buffer. Such a fund is vital in order to take good care of around 6-9 months of expenditure in case one loses one's job or in scenario when any kind of unexpected event hits or unjustifiable event occurs. All through this kind of period, gratuitous expenses must be evaded and postponed gratification requires being regulation of the day.

Therefore, the preparation of cash flow statement chased by the scrutiny of one's statement of cash flow statement should aid one make a decision on move to next significant step with respect to the process of financial planning, i.e.

on the lookout for investment opportunities so as to improve one's net worth as well as to attain one's financial goals.

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