This Project has been very useful to me because I learned how to prepare cash flow statements and ratio analysis. This has improved my knowledge on financial statements which is very useful in business and commerce ever day. The work I did in this project has helped me to understand the techniques, applications and usefulness of financial statements to understand the performance of a particular company or enterprise without much difficulty and also understand how to prepare them in future. I came to the following conclusion while preparing this project.
Purposes of Financial Analysis
Judging The Earning Capacity
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On the basis of the financial analysis, the earning capacity of the business concern may be computed. In addition to this, the future earning capacity of the concern may also be forecasted. All the external users of accounts, specially the investors and potential investors are interested in this.
Judging The Managerial Efficiency
The financial statement analysis helps to pinpoint the areas where in the managers have shown better efficiency and the areas of inefficiency. For example, using financial ratios, it is possible to analyze relative proportion of production, administrative and marketing expenses.
Any favorable or unfavorable variations can be identified and reasons thereof can be ascertained to pinpoint managerial efficiency and deficiency Judging The Short-term & Long-term Efficiency Of The Enterprise On the basis of financial analysis, long-term as well as short-term solvency of the concern may be judged.
Creditors or suppliers are interested to know the short-term solvency/liquidity of the concern i.e. ability to meet short-term liabilities. Debenture holders and lenders judge the ability of the company to pay the principal amount and interest on the basis of financial analysis
Inter-firm comparison becomes easy with the help of financial analysis. It
helps in assessing own performance as well as that of others, if merges and acquisitions are to be considered. Making Forecasts & Preparing Budgets
Past financial statement analysis helps a great deal in assessing developments in the future, especially the next year. For example, given a certain investment, it may be possible to forecast the next year’s profit on the basis of earning capacity shown in the past. Analysis thus helps in preparing the budgets.
Financial analysis helps the users of the financial statements to understand the complicated matter in simplified manner. Different date can be made more attractive by charts and diagrams which can be easily understood Uses of Financial Statement
It is a process by which the investor comes to know whether the firm is fulfilling hi expectation with regard to payment of dividend, capital appreciation and security of money. Such analysis is done by a security analyst who is interested in cash-generating ability, dividend payout policy and the behavior of share prices
Such analysis is useful when a firm offers credit to a new customer or a dealer. The manager of the firm would like to know whether to extend credit to them or not. Such analysis is also useful for a bank before granting loan to the public.
Such analysis is done by the firm to know the borrowing capacity of a prospective borrower.
Financial analysis helps the firm in deciding about the rate of dividend. Management would have to decide about how much portion of earnings to distribute and how much to retain. Such decisions indicate the profitability of the firm and hence to some extent affect the behavior of share prices
General Business Analysis
Financial analysis can be used to identify the profit drivers and business risks in order to assess the profit potential of the firm. It helps in the future growth scenarios of the firm Limitations Of Financial Statement
Financial statement analysis is a historical analysis. It analysis what has happened till date. It does not reflect the future. Person like shareholders, investors, etc are more interested in knowing the likely position in the future.
Ignore Price Level Changes
Price level changes and purchasing power of money are inversely related. A change in the price level makes analysis of financial statements of different accounting years invalid because accounting records ignore change in the value of money
Qualitative Aspects Ignored
Since the financial statements are confined to the monetary matters alone, the qualitative aspects like the quality of management, quality of labor force, public relations are ignored while carrying out the analysis of financial statement
Not Free From Bias
In many situations, the accountant has to make a choice out of alternative available, e.g. choice in the method of inventory valuation or choice in the method of depreciation. Since the subjectively is inherent in personal judgment, the financial statements are, therefore, not free from bias
Variation In Account Practices
For inter-firm comparison, it is necessary that accounting practices followed by the firms don’t vary significantly. As there may be variations in accounting practices followed by different firms, a meaningful comparison of their financial statements is not possible
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