ACCOUNTANCY
B
UNIT -4
ANALYSIS OF
FINANCIAL STATEMENT
1. What is Financial Statement
Analysis?
Ans: The term financial analysis also known as
analysis and interpretation of financial statements, refers to the process of
determining financial strengths and weakness of the firm by establishing
strategic relationship between the items of the balance sheet, profit and loss
account and other operative data.
2. Define financial statement
analysis?
Ans: According to John N. Myre, “Financial statement
analysis is largely a study of relationship among the various financial factors
in a business as disclosed by a single set of statements and a study of the
trend of these factors as shown in a series of statements”.
3. What are the different types
of financial statement analysis?
Ans: Following are the different types of financial
statement analysis
A. On the basis of material used:-
(i). External analysis
(ii). Internal analysis
B. On the basis of modus operandi:-
(i). Horizontal analysis
(ii). Vertical
analysis
C. On the
basis of objectives:-
(i). Long term analysis
(ii). Short term analysis
4. What are the objectives and importance
of financial statement analysis?
Ans: The primary objectives 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.
Followings are
the purposes or objectives of financial statement analysis to bring out the
importance of such analysis:
(i) Assessing the creditability: The business may have to offer credit to
prospective dealers and buyers therefore it is essential to analysis their
credit worthiness.
(ii) Assessing the profitability: Analysing of financial statement helps in
getting the view of profitability of business. The profits can be matched with
sales, capital employed, total assets etc.
(iii) Progress of the business: It is very essential to measure the progress
and growth of business.
(iv) Inter firm comparison: In the competitive age one business cannot
afford to close eyes from the business activities of its competitors. Analysis
also helps in gathering information about the activities of other business.
(v) Intra firm comparison: A
business can have the comparison of its own performance of one period with
another period of time. It helps in knowing the strength and weakness at different
period of time.
5. What are the limitations of
financial statement analysis?
Ans: Following are the limitations of financial
statement analysis:
a. Financial statements are historical in nature.
b. Price level changes reduce the validity of analysis.
c. Perceptions of the users are different.
6. What are the tools and
techniques of financial statement analysis?
Ans: Following are tools and techniques of financial
statement analysis:
a. Comparative statement
b. Common size statement
c. Trend analysis
d. Ratio analysis
e. Cash flow statement
f. Fund flow statement
g. Cost-volume-profit analysis
7. What is inter firm and inter firm analysis?
Ans:-
(i) Inter firm
analysis: When financial statement of two or more firms
are compared over a number of years, then it is called inter firm analysis. In
the competitive age one business cannot afford to close eyes from the business
activities of its competitors. Analysis also helps in gathering information
about the activities of other business.
(ii) Intra
firm analysis: When the financial statements of two or
more years of a firm are compared for drawing conclusions it is called intra
firm analysis. A business can have the comparison of its own performance of one
period with another period of time. It helps in knowing the strength and
weakness at different period of time.
8. What is comparative statement?
Mention two objectives or uses of comparative statement.
Ans: The comparative financial statements are
statements of the financial position at different periods of time. The elements
of financial position are shown in a comparative form so as to give an idea of
financial position at two or more periods. There are two types of common size
statement:
i. Comparative income statement.
ii. Comparative balance sheet.
Uses of Comparative statements:
a. Comparative statements help to identify the size and direction of
changes in financial position of an enterprise.
b. Comparative statements help to ascertain weakness and strength about
liquidity, profitability and solvency of an enterprise.
c. Comparative statements help the management for making forecasts for
the future.
9. What is common size statement?
Mention its two uses.
Ans: Common size statement is a statement where the
items of income statement and balance sheet of one or more years are expressed
in terms of percentage of a common base. Each item shows the relationship with
the base item. There are two types of common size statement:-
i. Common size income statement.
ii. Common size balance sheet.
Uses of Common
size statements:
a. It is used for vertical analysis, in which each line item in a
financial statement is represented as a percentage of a base figure within the
statement.
b. Common size financial statements help to analyze and compare a
company’s performance over several periods with varying sales figures.
10. What is trend analysis? Mention its two uses.
Ans: Trend analysis is
also an important tool of horizontal financial analysis. Under this technique
of financial analysis, the ratios of different items for various periods are
calculated and than a comparison are made. The information for a number of
years is taken up and one year, generally the first year, is taken as a base
year. The figures of the base year are taken as 100 and trend ratios for other
years are calculated on the basis of base year.
Uses of Trend
analysis:
a. Trend analysis is a technique used in
technical analysis that attempts to predict the future stock price movements
based on recently observed trend data.
b. Trend analysis is based on the idea that what
has happened in the past gives traders an idea of what will happen in the
future.
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