Ch12 FINANCIAL STATEMENTS ANALYSIS

CHAPTER 12 

FINANCIAL STATEMENTS ANALYSIS

 

ONE WORD TO ONE SENTENCE QUESTIONS

Q.1. What is financial analysis?

Ans. Financial analysis is the process of evaluating and interpreting financial information to assess the financial performance, position, and prospects of a company. It involves examining financial statements, ratios, trends, and other financial data to gain insights into the company's profitability, liquidity, solvency, and efficiency. Financial analysis helps stakeholders, such as investors, creditors, and managers, make informed decisions about investing, lending, and managing the company. It provides valuable information for assessing the company's financial health, identifying strengths and weaknesses, and determining areas for improvement.

 

Q.2. What is analysis of financial statements?

Ans. Analysis of financial statements refers to the process of examining and interpreting financial information presented in the financial statements of a company. It involves assessing the financial performance, position, and trends of the company by analyzing various financial ratios, trends, and indicators. The objective of financial statement analysis is to gain insights into the company's profitability, liquidity, solvency, and operational efficiency. By analyzing financial statements, stakeholders can make informed decisions regarding investment, lending, and business strategies. Financial statement analysis helps identify strengths, weaknesses, opportunities, and threats, and assists in evaluating the overall financial health and performance of a company.

 

Q.3. Name any one purpose of analysis of financial statements?

Ans. One purpose of the analysis of financial statements is to assess the profitability of a company.

 

Q.4. Name any one limitation of analysis of financial statements?

Ans. One limitation of the analysis of financial statements is that it relies on historical data and may not accurately predict future performance.

 

Q.5. What is external analysis?
Ans. External analysis refers to the examination and evaluation of external factors that can impact the performance and operations of a company. It involves analyzing the industry, market conditions, competition, economic trends, regulatory environment, and other external factors to assess the opportunities and threats faced by the organization. The purpose of external analysis is to gain insights into the external influences that can affect the company's strategic decisions, performance, and overall success.

 

Q.6. What is internal analysis?

Ans. Internal analysis refers to the examination and evaluation of internal factors within a company that can influence its performance and competitiveness. It involves assessing the company's resources, capabilities, strengths, weaknesses, and other internal aspects to understand its internal dynamics and competitive advantage. Internal analysis typically focuses on areas such as the company's financial health, operational efficiency, management capabilities, marketing strategies, and technological capabilities. The purpose of internal analysis is to identify the company's core competencies, areas for improvement, and potential strategies for achieving sustainable growth and competitive advantage.

 

Q.7. What is Horizontal analysis?

Ans. Horizontal analysis, also known as trend analysis, is a financial analysis technique used to evaluate and compare financial data over a series of reporting periods. It involves the examination of financial statements, such as the income statement and balance sheet, to identify trends, patterns, and changes in financial performance over time. Horizontal analysis focuses on the percentage changes or variances between specific line items or financial ratios from one period to another. This analysis helps in understanding the growth or decline of key financial metrics, identifying areas of strength or weakness, and assessing the overall financial stability and performance of a company over time.

 

Q.8. What is vertical analysis?

Ans. Vertical analysis, also known as common-size analysis, is a financial analysis technique used to assess the relative proportion of different line items within a financial statement. It involves expressing each line item as a percentage of a base figure, typically the total assets for the balance sheet or the net sales for the income statement. By converting the values into percentages, vertical analysis allows for easier comparison and identification of the composition and significance of each line item. This analysis helps in understanding the relative importance of different components within a financial statement, identifying trends in the structure of the statement, and assessing the financial health and performance of a company in relation to its assets, liabilities, revenues, and expenses.

 

Q.9. Name any one tool of analysis of financial statements?

Ans. One tool of analysis of financial statements is the ratio analysis.

 

Q.10. Mention any one objective of comparative statements?

Ans. One objective of comparative statements is to identify trends and changes in financial performance over time.

 

Q.11. What is common size statement?

Ans. A common size statement is a financial statement where each line item is expressed as a percentage of a base amount, typically the total sales or revenue. It allows for easy comparison and analysis of the relative proportions of different elements within the financial statement.

 

Q,12. What is comparative financial statement?

Ans. A comparative financial statement is a financial statement that presents financial data for multiple periods, typically side by side, to facilitate comparison and analysis of the financial performance and position of a company over time. It helps in identifying trends, changes, and patterns in the financial data and evaluating the company's financial health and progress.

 

Q.13. What is comparative income statement?

Ans. A comparative income statement is a financial statement that presents the revenues, expenses, and net income of a company for multiple periods, usually side by side, to allow for comparison and analysis. It helps in understanding the changes in a company's financial performance over time, identifying trends, and assessing the company's ability to generate consistent profits.

 

VERY SHORT ANSWER TYPE QUESTIONS       

Q.1. What do you mean by financial statement analysis?

Ans. Financial statement analysis refers to the process of examining and interpreting a company's financial statements to assess its financial health, performance, and stability. It involves analyzing the information presented in financial statements, such as the balance sheet, income statement, and cash flow statement, to gain insights into the company's profitability, liquidity, solvency, and overall financial position. Financial statement analysis helps stakeholders, such as investors, creditors, and management, make informed decisions by evaluating the company's past performance, current financial condition, and future prospects.

 

Q.2. Name the different types of financial analysis?

Ans. The different types of financial analysis include:

Ratio Analysis: This involves calculating and interpreting various financial ratios to assess the company's liquidity, profitability, efficiency, and solvency. Examples of ratios include the current ratio, return on equity, and debt-to-equity ratio.

Trend Analysis: This involves analyzing financial data over a period of time to identify patterns, trends, and changes in the company's financial performance. It helps in understanding the company's growth rate and identifying areas of improvement or concern.

Vertical Analysis: Also known as common-size analysis, this involves expressing financial statement items as a percentage of a base value. It helps in comparing the relative importance of different components and assessing their contribution to the overall financial structure.

Horizontal Analysis: This involves comparing financial statement items across different periods to identify changes in financial performance and trends. It helps in assessing the company's growth or decline over time.

Comparative Analysis: This involves comparing the financial performance of a company with its industry peers or competitors. It helps in benchmarking the company's performance and identifying areas where it outperforms or lags behind its peers.

Cash Flow Analysis: This involves analyzing the company's cash flow statement to assess its ability to generate and manage cash. It helps in understanding the company's cash flow patterns, liquidity position, and ability to meet its financial obligations.

DuPont Analysis: This analysis breaks down the return on equity (ROE) into its components, such as profitability, asset turnover, and financial leverage. It helps in understanding the drivers of ROE and identifying areas for improvement.

These are some of the commonly used types of financial analysis. Each type provides different insights into the company's financial performance and helps in making informed decisions.

 

Q.3. Name the different tools of financial analysis?

Ans. The different tools of financial analysis include:

Ratio Analysis: It involves calculating and interpreting financial ratios to assess the company's performance and financial health.

Common Size Analysis: It involves expressing financial statement items as a percentage of a base value to compare the relative importance of different components.

Trend Analysis: It involves analyzing financial data over a period of time to identify patterns, trends, and changes in the company's financial performance.

Comparative Analysis: It involves comparing the financial performance of a company with its industry peers or competitors to benchmark its performance.

Cash Flow Analysis: It involves analyzing the company's cash flow statement to assess its cash generation, operating activities, investing activities, and financing activities.

DuPont Analysis: It breaks down the return on equity (ROE) into its components to analyze the profitability, efficiency, and leverage of the company.

SWOT Analysis: It assesses the company's strengths, weaknesses, opportunities, and threats to understand its competitive position and identify areas for improvement.

Financial Forecasting: It involves predicting future financial performance based on historical data, market trends, and other relevant factors.

Valuation Techniques: It includes methods such as discounted cash flow (DCF) analysis, price-earnings ratio (P/E ratio) analysis, and market-based valuation to determine the intrinsic value of the company.

These are some of the tools used in financial analysis. Each tool provides unique insights into the company's financial performance, position, and prospects, enabling informed decision-making.

 

Q.4. What is cash flow statement?

Ans. A cash flow statement is a financial statement that provides information about the cash inflows and outflows of a company during a specific period. It tracks the sources and uses of cash and helps assess the company's ability to generate cash and its liquidity position.

The cash flow statement consists of three main sections:

Operating Activities: This section includes cash flows from the company's core business operations, such as cash received from customers, cash paid to suppliers and employees, and other operating expenses. It helps evaluate the company's ability to generate cash from its primary operations.

Investing Activities: This section includes cash flows related to the purchase or sale of long-term assets, such as property, plant, and equipment, investments in other companies, and proceeds from the sale of investments or assets. It provides insights into the company's investment decisions and capital expenditures.

Financing Activities: This section includes cash flows related to the company's financing activities, such as the issuance or repayment of debt, issuance or repurchase of equity shares, payment of dividends, and other financing-related transactions. It helps assess the company's sources of capital and its ability to meet its financial obligations.

The cash flow statement is an essential tool for investors, creditors, and other stakeholders to evaluate the company's cash-generating ability, assess its financial health, and make informed decisions. It complements the income statement and balance sheet by providing a comprehensive view of the company's financial performance and cash management.

 

Q.5. Why are bankers and lenders interested in financial statements?

Ans. Bankers and lenders are interested in financial statements because they provide crucial information about a company's financial position, performance, and ability to repay its debts. Here are a few reasons why bankers and lenders find financial statements important:

Creditworthiness Assessment: Financial statements help bankers and lenders evaluate the creditworthiness of a company. They analyze the company's financial ratios, liquidity position, profitability, and cash flow to determine the likelihood of the company being able to meet its financial obligations and repay the borrowed funds.

Risk Assessment: Financial statements provide insights into the financial risks associated with lending to a particular company. Bankers and lenders assess factors such as the company's leverage, debt-to-equity ratio, interest coverage ratio, and asset quality to gauge the level of risk involved in lending to the company.

Loan Structuring: Financial statements assist bankers and lenders in structuring loan terms and conditions. The analysis of financial statements helps determine the appropriate loan amount, interest rate, repayment period, and collateral requirements based on the company's financial health and risk profile.

Decision Making: Financial statements aid bankers and lenders in making informed lending decisions. They provide a comprehensive view of the company's financial performance, including revenue, expenses, profits, and losses. By analyzing financial statements, bankers can assess the company's ability to generate sufficient cash flow and earnings to service its debt obligations.

Monitoring Borrowed Funds: After lending funds to a company, bankers and lenders use financial statements to monitor the company's financial health and compliance with loan covenants. They compare actual financial performance with projected figures, track changes in key financial ratios, and identify any signs of financial distress or default risk.

In summary, financial statements play a vital role in enabling bankers and lenders to assess creditworthiness, evaluate risk, structure loans, make lending decisions, and monitor the financial health of borrowing companies.

 

Q.6. Why is management interested in financial analysis?

Ans. Management is interested in financial analysis for several reasons. Here are a few key reasons why management finds financial analysis important:

Performance Evaluation: Financial analysis helps management evaluate the financial performance of the company. By analyzing financial statements, they can assess key financial indicators, profitability ratios, efficiency ratios, and other performance metrics. This information allows them to identify strengths and weaknesses, measure progress towards financial goals, and make informed decisions to improve the company's performance.

Planning and Forecasting: Financial analysis provides valuable insights for planning and forecasting future financial outcomes. By analyzing historical financial data and trends, management can make informed projections and set realistic financial goals. This helps in budgeting, resource allocation, and decision-making processes.

Financial Decision Making: Financial analysis supports management in making sound financial decisions. Whether it's evaluating investment opportunities, assessing the feasibility of new projects, or determining the optimal financing mix, financial analysis provides the necessary information and insights to support decision-making processes. It helps management weigh the potential risks and returns associated with various options and make informed choices.

Strategic Planning: Financial analysis plays a crucial role in strategic planning. It helps management assess the financial implications of strategic initiatives and evaluate the financial feasibility of long-term goals. By understanding the financial impact of different strategies, management can align business objectives with financial capabilities and develop effective strategic plans.

Investor Relations: Management uses financial analysis to communicate the company's financial performance and prospects to investors, shareholders, and other stakeholders. It helps them prepare accurate and reliable financial reports, such as annual reports and quarterly statements, that provide a clear picture of the company's financial health. This transparency and effective communication contribute to building trust and attracting potential investors.

Risk Management: Financial analysis helps management identify and manage financial risks. By examining financial statements and analyzing key risk indicators, management can proactively identify potential risks, such as liquidity risks, market risks, or credit risks. This allows them to implement appropriate risk mitigation strategies and take necessary actions to safeguard the company's financial stability.

In summary, financial analysis is crucial for management as it enables performance evaluation, aids in planning and decision making, supports strategic initiatives, facilitates investor relations, and contributes to effective risk management. By leveraging financial analysis, management can make informed and data-driven decisions to drive the company's financial success.

 

Q.7. What do you understand by comparative financial statement? Give its two objectives?

Ans. A comparative financial statement is a financial statement that presents financial data for multiple periods side by side, allowing for easy comparison and analysis of financial performance over time. It typically includes the financial statements for two or more consecutive periods, such as years, quarters, or months. The main objective of comparative financial statements is to provide insights into the changes and trends in a company's financial position and performance over time. Two key objectives of comparative financial statements are:

Performance Analysis: Comparative financial statements help in evaluating the performance of a company over different periods. By comparing financial data from one period to another, such as comparing current year results with the previous year or comparing multiple years, analysts can identify trends, patterns, and changes in key financial indicators. This analysis provides a deeper understanding of the company's financial performance, highlighting areas of improvement or concern.

Trend Analysis: Comparative financial statements facilitate trend analysis, which involves studying the direction and magnitude of financial changes over time. By examining the changes in financial figures, such as revenues, expenses, assets, and liabilities, analysts can identify patterns and assess the company's financial health. Trend analysis helps in identifying growth or decline trends, evaluating the effectiveness of financial strategies, and making informed projections for the future.

Overall, comparative financial statements serve as a valuable tool for assessing performance, tracking financial trends, and gaining insights into the financial position of a company over time. They provide a basis for meaningful analysis and decision-making by highlighting changes, trends, and patterns in financial data.

 

Q.8. Explain any four advantages of comparative statements?

Ans. Comparative financial statements offer several advantages that aid in analyzing a company's financial performance and making informed decisions. Four key advantages of comparative statements are:

Identification of Financial Trends: Comparative statements allow for the identification of financial trends over multiple periods. By comparing financial data from different periods, such as year-to-year or quarter-to-quarter, analysts can detect patterns, changes, and trends in key financial metrics. This helps in understanding the company's financial performance and evaluating its growth or decline over time.

Evaluation of Financial Performance: Comparative statements enable the evaluation of a company's financial performance over different periods. By comparing financial figures, such as revenues, expenses, and net income, analysts can assess the company's progress and identify areas of strength or weakness. This evaluation provides insights into the effectiveness of financial strategies and helps in making informed decisions for future planning.

Assessment of Financial Position: Comparative statements assist in assessing the financial position of a company over time. By comparing the balance sheet items, such as assets, liabilities, and equity, from different periods, analysts can evaluate changes in the company's financial structure and solvency. This assessment aids in understanding the company's ability to meet its short-term and long-term obligations.

Support for Decision-making: Comparative statements provide valuable information for decision-making. By analyzing financial data across different periods, decision-makers can assess the impact of past decisions, identify areas requiring attention or improvement, and make informed choices for the future. Comparative statements help in setting financial goals, evaluating the feasibility of projects, and monitoring the progress of financial objectives.

Overall, comparative financial statements offer advantages such as trend identification, performance evaluation, financial position assessment, and decision-making support. They enhance the understanding of a company's financial performance and provide a basis for effective financial analysis and strategic planning.

 

Q.9. What is ‘’Common size statement?

Ans. A common size statement, also known as a common size financial statement or vertical analysis, is a financial statement presentation format that expresses each line item as a percentage of a base amount. In a common size statement, all the items in the financial statement are presented in a standardized format, making it easier to compare and analyze the relative proportions of different components.

The common size statement is created by dividing each line item by a specific base amount, which is typically the total assets for the balance sheet or the net sales for the income statement. This converts the absolute values of each line item into percentages, representing their relative contribution to the total.

The primary objective of a common size statement is to facilitate the comparison of financial data across different companies, industries, or periods. By expressing financial figures as percentages, it allows for a better understanding of the composition and structure of a company's financial statement.

Some of the benefits of using a common size statement include:

Comparison: It enables easy comparison of financial statements of different companies, as well as the comparison of financial data from different periods for the same company. This helps in identifying trends, patterns, and differences in the financial performance of entities.

Analysis: It aids in the analysis of the relative importance of different components within a financial statement. By focusing on percentages rather than absolute values, analysts can identify areas of strength or weakness and assess the impact of changes in specific line items.

Benchmarking: It facilitates benchmarking by providing a standardized format for financial data. Companies can compare their financial ratios and percentages against industry averages or competitors, enabling them to evaluate their performance and identify areas for improvement.

Decision-making: It supports decision-making by providing a clearer understanding of the financial structure and composition of a company. It allows for better identification of key areas that require attention, such as high operating expenses or an excessive reliance on debt.

In summary, a common size statement is a presentation format that expresses each line item as a percentage of a base amount. It enhances the comparability, analysis, benchmarking, and decision-making process in financial statement analysis.

 

Q.10. Why common size statements are prepared?

Ans. Common size statements are prepared to facilitate financial analysis and comparison. The main reasons for preparing common size statements include:

Comparison: Common size statements allow for easy comparison of financial data across different companies, industries, or periods. By expressing each line item as a percentage of a base amount, such as total assets or net sales, it standardizes the presentation and makes it easier to identify trends, patterns, and differences in financial performance. This enables analysts to assess the relative importance of different components within the financial statement.

Analysis: Common size statements aid in the analysis of the relative proportions and structure of a company's financial statement. By focusing on percentages rather than absolute values, analysts can gain insights into the composition of the statement and identify areas of strength or weakness. For example, they can assess the proportion of sales revenue allocated to different expense categories or the percentage of assets financed by debt. This analysis helps in identifying areas for improvement and making informed financial decisions.

Benchmarking: Common size statements provide a standardized format for financial data, facilitating benchmarking. Companies can compare their financial ratios and percentages against industry averages or competitors to evaluate their performance and identify areas of strength or areas that need improvement. It allows for a better understanding of how a company's financials stack up against its peers and industry norms.

Trend Analysis: Common size statements are useful for trend analysis. By comparing common size statements of the same company over different periods, analysts can observe changes in the proportions of various components. This helps in assessing the direction and magnitude of changes in financial performance and identifying areas that require attention.

Overall, common size statements are prepared to enhance the comparability, analysis, benchmarking, and trend analysis of financial data. They provide a standardized format that aids in understanding the relative importance of different components within the financial statement, making it easier to identify trends, patterns, and areas for improvement.

 

Q.11. What is tread analysis?

Ans. I apologize, but I'm not familiar with the term "tread analysis" in the context of financial analysis. It's possible that it may be a typographical error or an uncommon term. If you intended to ask about another financial analysis concept or have any other questions related to financial analysis, please let me know and I'll be happy to assist you.

 

Q.12. Give two utilities of tread analysis?

Ans. Apologies, but I'm not familiar with the term "tread analysis" in the context of financial analysis. It's possible that you may be referring to a different concept or methodology. If you could provide more information or clarify your question, I'll do my best to assist you.

 

Q.13. Explain any four limitations of tread analysis?

Ans. Apologies, but I'm not familiar with the term "tread analysis" in the context of financial analysis. It's possible that you may be referring to a different concept or methodology. If you could provide more information or clarify your question, I'll do my best to assist you.

 

SHORT ANSWER TYPE QUESTIONS

Q.1. What do you mean by analysis of financial statements?

Ans. Analysis of financial statements refers to the process of evaluating and interpreting the financial information contained in the financial statements of a company. It involves examining various financial ratios, trends, and other metrics to assess the financial health, performance, and position of a business.

The analysis of financial statements helps stakeholders, such as investors, creditors, and management, to make informed decisions and understand the financial implications of those decisions. It provides insights into the profitability, liquidity, solvency, and efficiency of a company, allowing stakeholders to assess its strengths, weaknesses, and overall financial performance.

The analysis of financial statements typically involves techniques such as ratio analysis, trend analysis, comparative analysis, and common-size analysis. These techniques help in benchmarking the company's performance against industry standards, identifying areas for improvement, and assessing the company's financial viability and stability.

Overall, the analysis of financial statements provides valuable information and insights that aid stakeholders in assessing the financial health and performance of a company and making well-informed decisions.

 

Q.2. What are the limitations of financial statements?

Ans. The limitations of financial statements are as follows:

Historical Information: Financial statements provide information about the past performance and financial position of a company. They do not provide insights into the future prospects or the potential risks that a company may face. Therefore, financial statements have limited predictive value.

Subjectivity and Estimates: Financial statements often involve judgments, estimates, and assumptions made by management. These subjective elements can introduce a level of uncertainty and variability in the reported financial figures. Additionally, accounting standards and policies can vary, leading to differences in financial reporting practices among companies.

Limited Scope: Financial statements only provide a summary of the financial aspects of a company's operations. They do not capture all the relevant non-financial information such as customer satisfaction, employee morale, or market reputation, which can significantly impact the company's performance and value.

Lack of Comparability: Financial statements of different companies may not be directly comparable due to variations in accounting methods, industry practices, or reporting standards. This can make it challenging to perform meaningful comparisons and benchmarking analysis.

Potential Manipulation: Financial statements can be subject to manipulation or misrepresentation, either intentionally or unintentionally. Companies may employ various accounting techniques or engage in creative financial reporting to present a more favorable picture of their financial performance. This can obscure the true financial health of the company.

Limited Disclosure: Financial statements have specific reporting requirements but may not provide detailed information about certain aspects of a company's operations, such as proprietary information, pending legal disputes, or undisclosed liabilities. This lack of comprehensive disclosure can limit the transparency and completeness of the financial statements.

It is important to consider these limitations and supplement the analysis of financial statements with other sources of information and qualitative factors to gain a more comprehensive understanding of a company's financial position and performance.

 

Q.3. Name the parties who are interest in financial statements analysis?

Ans. The parties who are interested in financial statement analysis include:

Investors and Shareholders: Investors and shareholders analyze financial statements to assess the financial health and performance of a company before making investment decisions. They use financial analysis to evaluate the profitability, solvency, and growth potential of the company.

Creditors and Lenders: Creditors and lenders, such as banks and financial institutions, analyze financial statements to evaluate the creditworthiness and repayment capacity of a company before extending loans or credit. They assess the company's financial ratios, cash flow position, and ability to meet debt obligations.

Management and Board of Directors: The management and board of directors analyze financial statements to monitor the company's financial performance, identify areas of improvement, and make strategic decisions. Financial analysis helps in evaluating the effectiveness of financial strategies, assessing profitability, and identifying potential risks.

Regulatory Authorities: Regulatory authorities, such as government agencies and tax authorities, analyze financial statements to ensure compliance with accounting standards, tax regulations, and other legal requirements. They use financial analysis to assess the accuracy and reliability of financial reporting.

Analysts and Financial Advisors: Financial analysts and advisors analyze financial statements to provide insights and recommendations to investors, clients, or the public. They assess the company's financial position, performance, and prospects to make informed investment decisions or provide financial guidance.

Competitors and Industry Peers: Competitors and industry peers analyze financial statements to benchmark their own performance against similar companies in the industry. Financial analysis helps in identifying areas of strength or weakness, evaluating market position, and identifying opportunities for improvement.

Overall, financial statement analysis is crucial for various stakeholders to make informed decisions, assess risk, allocate resources, and evaluate the financial health and performance of a company.

 

Q.4. Enumerate the purpose of financial statements analysis?

Ans. The purpose of financial statement analysis includes:

Assessing Financial Performance: Financial statement analysis helps in evaluating the financial performance of a company over a specific period. It provides insights into key financial ratios, profitability, liquidity, and efficiency measures, allowing stakeholders to assess the company's overall financial health and performance.

Making Informed Investment Decisions: Investors and shareholders analyze financial statements to make informed investment decisions. They use financial analysis to assess the company's growth prospects, profitability, and stability, helping them determine whether to buy, hold, or sell their investments in the company.

Evaluating Creditworthiness: Lenders and creditors analyze financial statements to evaluate the creditworthiness of a company before extending loans or credit. They assess the company's ability to meet its financial obligations, analyze cash flow patterns, and review debt levels to determine the risk of lending money to the company.

Monitoring Business Operations: Financial statement analysis helps management and stakeholders monitor the company's business operations. It provides insights into revenue and expense trends, working capital management, and cash flow patterns, allowing them to identify areas of improvement, make strategic decisions, and assess the effectiveness of financial strategies.

Identifying Financial Strengths and Weaknesses: Financial analysis allows stakeholders to identify the financial strengths and weaknesses of a company. By analyzing financial ratios, trends, and benchmarks, they can identify areas where the company excels and areas that need improvement. This helps in formulating strategies to leverage strengths and address weaknesses.

Assessing Risk and Uncertainty: Financial statement analysis helps in assessing the risk and uncertainty associated with a company's financial position. It allows stakeholders to identify potential risks, such as excessive debt, poor liquidity, or reliance on a few key customers. This enables them to make informed decisions and take appropriate risk management measures.

Facilitating Comparison and Benchmarking: Financial statement analysis facilitates comparison and benchmarking of a company's financial performance against industry peers and competitors. It helps stakeholders understand how the company is performing relative to others in the same industry and identify areas where the company can improve its competitive position.

Overall, the purpose of financial statement analysis is to provide stakeholders with valuable insights into the financial performance, position, and prospects of a company. It helps in decision-making, risk assessment, performance evaluation, and strategic planning.

 

Q.5. What is meant by internal analysis and external analysis?
Ans. Internal analysis and external analysis are two approaches used in analyzing a company's business environment and performance:

Internal Analysis: Internal analysis focuses on assessing the internal factors and capabilities of a company. It involves examining the company's resources, strengths, weaknesses, and overall organizational effectiveness. The purpose of internal analysis is to understand the company's internal dynamics, identify areas of competitive advantage, and determine its ability to achieve its goals and objectives. Internal analysis typically involves evaluating aspects such as financial performance, operational efficiency, human resources, technology, and strategic capabilities. It helps in identifying opportunities for improvement, addressing weaknesses, and leveraging strengths to gain a competitive edge.

External Analysis: External analysis, on the other hand, focuses on examining the external factors and influences that impact a company's performance and competitiveness. It involves assessing the industry dynamics, market trends, competitive landscape, customer behavior, regulatory environment, and other external factors that can affect the company's operations and success. The purpose of external analysis is to understand the opportunities and threats present in the external environment and develop strategies to navigate them effectively. External analysis helps in identifying market opportunities, understanding customer preferences, anticipating competitive challenges, and adapting the company's strategies accordingly.

Both internal and external analysis are crucial for gaining a comprehensive understanding of a company's position, capabilities, and prospects. Internal analysis provides insights into the company's internal strengths and weaknesses, while external analysis helps in understanding the opportunities and threats present in the external business environment. Together, these analyses enable stakeholders to make informed decisions, develop effective strategies, and enhance the company's performance and competitiveness.

 

Q.6. What is comparative financial statements?

Ans. Comparative financial statements refer to the financial statements that present financial information for multiple periods side by side, allowing for easy comparison and analysis of financial performance over time. These statements typically include the income statement, balance sheet, and cash flow statement for two or more consecutive periods.

The comparative financial statements show the financial data for the current period and the corresponding data for one or more prior periods, usually in separate columns. This format allows stakeholders, such as investors, analysts, and management, to assess the company's financial performance, trends, and changes over time.

The main purpose of comparative financial statements is to provide a historical perspective and facilitate trend analysis. By comparing the financial figures of different periods, users can identify patterns, growth rates, and fluctuations in key financial metrics. This analysis helps in evaluating the company's financial health, assessing its performance relative to industry benchmarks, and making informed decisions about investment, lending, or strategic planning.

Some of the key advantages of using comparative financial statements include:

Trend Identification: Comparative statements allow for the identification of trends and changes in financial performance over time. Users can analyze revenue growth, expense patterns, profitability, liquidity, and other key metrics to assess the company's financial trajectory.

Performance Evaluation: By comparing financial data from different periods, stakeholders can evaluate the company's performance and assess its ability to meet financial objectives. This analysis helps in identifying areas of improvement or concern.

Benchmarking: Comparative statements facilitate benchmarking by comparing a company's financial performance with industry peers or competitors. This allows for a better understanding of the company's relative position and performance within the market.

Decision Making: Comparative financial statements provide valuable information for decision-making processes. Investors can assess the company's financial stability and growth potential, creditors can evaluate creditworthiness, and management can make strategic decisions based on historical trends and patterns.

Overall, comparative financial statements offer a comprehensive view of a company's financial performance over time, enabling stakeholders to assess trends, make informed decisions, and monitor the company's progress towards its financial goals.

 

Q.7. Explain in brief any two tools of analysis of financial statement?

Ans. Ratio Analysis: Ratio analysis is a powerful tool used to assess the financial performance, profitability, liquidity, and solvency of a company. It involves calculating various financial ratios by comparing different financial data from the company's financial statements. These ratios provide meaningful insights into the company's financial health and help in assessing its strengths and weaknesses. Some commonly used ratios include profitability ratios (such as gross profit margin, net profit margin), liquidity ratios (such as current ratio, quick ratio), and solvency ratios (such as debt-to-equity ratio, interest coverage ratio). By analyzing these ratios over time or comparing them with industry benchmarks, analysts can make informed judgments about the company's financial position.

Trend Analysis: Trend analysis involves examining the financial data of a company over multiple periods to identify patterns, tendencies, and changes in performance. It focuses on assessing the direction and magnitude of financial variables such as revenues, expenses, profitability, and asset values. By plotting and analyzing these trends, analysts can identify growth patterns, seasonality, cyclical fluctuations, and other significant changes. Trend analysis helps in understanding the company's historical performance, forecasting future outcomes, and making informed decisions based on the observed patterns. It can be performed using graphical representations, such as line charts or bar charts, or through statistical techniques like regression analysis.

Both ratio analysis and trend analysis provide valuable insights into the financial performance and position of a company. They help in understanding the company's profitability, efficiency, liquidity, solvency, and overall financial health. These tools assist investors, creditors, analysts, and management in assessing risks, making investment decisions, formulating strategies, and monitoring the company's performance over time.

 

Q.8. What do you mean by trend percentage analysis?

Ans. Trend percentage analysis, also known as trend analysis or horizontal analysis, is a method of financial statement analysis that compares the changes in financial statement items over multiple periods. It involves calculating the percentage change of each item from one period to another and analyzing the trends or patterns in these changes.

The trend percentage is calculated by dividing the difference between the current period and the base period by the base period amount and multiplying it by 100. The base period is usually the earliest period under consideration.

The main objective of trend percentage analysis is to identify the direction and magnitude of changes in financial statement items over time. It helps in assessing the growth or decline of specific items and understanding the overall performance of the company. By analyzing the trend percentages, analysts can identify patterns, outliers, and significant changes in financial data.

Trend percentage analysis provides several benefits, including:

Identifying growth or decline: It helps in identifying whether specific items have shown consistent growth or decline over time. This information is useful for assessing the company's performance and making informed decisions.

Comparing performance: Trend percentages allow for easy comparison of performance across different periods. It enables analysts to assess the relative performance of various financial statement items and identify areas of strength or weakness.

Forecasting future trends: By analyzing historical trends, analysts can make projections or forecasts about future trends. This can assist in financial planning, budgeting, and decision-making processes.

Detecting irregularities or anomalies: Trend percentage analysis can highlight any significant deviations from the expected or normal trend. It helps in identifying outliers or irregular patterns that may require further investigation.

Overall, trend percentage analysis provides valuable insights into the historical performance and trends of financial statement items. It aids in understanding the company's financial health, making comparisons, and forecasting future outcomes.