LINGAYAS VIDYAPEETH

NAME :- AAKANSHA PAL

CLASS :- MBA 1ST YEAR
ROLL. NO. :- 21MBA06
SUBJECT :- ACCOUNTING FOR MANAGERS
SUBMITTED TO :- MISS PRIYANKA CHAUHAN

Q.1 What is meant by Financial Statement

Analysis? What are the objectives of Financial
Analysis?
Ans. Definition: Financial statement analysis is the use of
analytical or financial tools to examine and compare financial
statements in order to make business decisions. In other
words, financial statement analysis is a way for investors and
creditors to examine financial statements and see if the
business is healthy enough to invest in or loan to.
Financial statement analysis takes the raw financial
information from the financial statements and turns it into
usable information the can be used to make decisions. The
three types of analysis are horizontal analysis, vertical
analysis, and ratio analysis. Each one of these tools gives
decision makers a little more insight into how well the
company is performing.
The term ‘financial analysis’, also known as analysis and
interpretation of financial statements’, refers to the process of
determining financial strengths and weaknesses of the firm by
establishing strategic relationship between the items of the
balance sheet, profit and loss account and other operative
data.

“Analyzing financial statements,” according to Metcalf and

Titard, “is a process of evaluating the relationship between
component parts of a financial statement to obtain a better
understanding of a firm’s position and performance.”

Objectives and Importance of Financial

Statement Analysis:
The primary objective of financial statement analysis is to
understand and diagnose the information contained in
financial statement with a view to judge the profitability and
financial soundness of the firm, and to make forecast about
future prospects of the firm. The purpose of analysis depends
upon the person interested in such analysis and his object.

However, the following purposes or objectives of financial

statements analysis may be stated to bring out the
significance of such analysis:

(i) To assess the earning capacity or profitability of the firm.

(ii) To assess the operational efficiency and managerial

effectiveness.

(iii) To assess the short term as well as long term solvency position
of the firm.
(iv) To identify the reasons for change in profitability and financial
position of the firm.

(v) To make inter-firm comparison.

(vi) To make forecasts about future prospects of the firm.

(vii) To assess the progress of the firm over a period of time.

(viii) To help in decision making and control.

(ix) To guide or determine the dividend action.

(x) To provide important information for granting credit.

Q.2 Elaborate the tools for Financial

Analysis?
1. Comparative Statement or Comparative Financial and
Operating Statements.
2. Common Size Statements.
3. Trend Ratios or Trend Analysis.
4. Average Analysis.
5. Statement of Changes in Working Capital.
6. Fund Flow Analysis.
7. Cash Flow Analysis.
8. Ratio Analysis.
9. Cost Volume Profit Analysis
10. A brief explanation of the tools or techniques of financial
statement analysis presented below.
1. Comparative Statements

Comparative statements deal with the comparison of

different items of the Profit and Loss Account and Balance
Sheets of two or more periods. Separate comparative
statements are prepared for Profit and Loss Account as
Comparative Income Statement and for Balance Sheets.
As a rule, any financial statement can be presented in the
form of comparative statement such as comparative balance
sheet, comparative profit and loss account, comparative cost
of production statement, comparative statement of working
capital and the like.

2. Comparative Income Statement

Three important information are obtained from the

Comparative Income Statement. They are Gross Profit,
Operating Profit and Net Profit. The changes or the
improvement in the profitability of the business concern is
find out over a period of time. If the changes or
improvement is not satisfactory, the management can find
out the reasons for it and some corrective action can be
taken.

3. Comparative Balance Sheet

The financial condition of the business concern can be find

out by preparing comparative balance sheet. The various
items of Balance sheet for two different periods are used.
The assets are classified as current assets and fixed assets
for comparison. Likewise, the liabilities are classified as
current liabilities, long term liabilities and shareholders’
net worth. The term shareholders’ net worth includes
Equity Share Capital, Preference Share Capital, Reserves
and Surplus and the like.

4. Common Size Statements

A vertical presentation of financial information is

followed for preparing common-size statements. Besides,
the rupee value of financial statement contents are not
taken into consideration. But, only percentage is
considered for preparing common size statement.
The total assets or total liabilities or sales is taken as 100
and the balance items are compared to the total assets, total
liabilities or sales in terms of percentage. Thus, a common
size statement shows the relation of each component to the
whole. Separate common size statement is prepared for
profit and loss account as Common Size Income
Statement and for balance sheet as Common Size Balance
Sheet.

5. Trend Analysis

The ratios of different items for various periods are find

out and then compared under this analysis. The analysis of
the ratios over a period of years gives an idea of whether
the business concern is trending upward or downward.
This analysis is otherwise called as Pyramid Method.
6. Average Analysis

Whenever, the trend ratios are calculated for a business

concern, such ratios are compared with industry average.
These both trends can be presented on the graph paper also
in the shape of curves. This presentation of facts in the
shape of pictures makes the analysis and comparison more
comprehensive and impressive.

7. Statement of Changes in Working Capital

The extent of increase or decrease of working capital is

identified by preparing the statement of changes in
working capital. The amount of net working capital is
calculated by subtracting the sum of current liabilities
from the sum of current assets. It does not detail the
reasons for changes in working capital.

8. Fund Flow Analysis

Fund flow analysis deals with detailed sources and

application of funds of the business concern for a specific
period. It indicates where funds come from and how they
are used during the period under review. It highlights the
changes in the financial structure of the company.

9. Cash Flow Analysis

Cash flow analysis is based on the movement of cash and

bank balances. In other words, the movement of cash
instead of movement of working capital would be
considered in the cash flow analysis. There are two types
of cash flows. They are actual cash flows and notional
cash flows.

10. Ratio Analysis

Ratio analysis is an attempt of developing meaningful

relationship between individual items (or group of items)
in the balance sheet or profit and loss account. Ratio
analysis is not only useful to internal parties of business
concern but also useful to external parties. Ratio analysis
highlights the liquidity, solvency, profitability and capital
gearing.

11. Cost Volume Profit Analysis

This analysis discloses the prevailing relationship among

sales, cost and profit. The cost is divided into two. They
are fixed cost and variable cost. There is a constant
relationship between sales and variable cost. Cost analysis
enables the management for better profit planning.

THE
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