Quick Revision: GS1;PART III;PART C Technique of Analysis of financial statement

GS1;PART III;PART C

Technique of Analysis of financial statement

Financial statement:

They are written records that convey the financial activities and condition of business or entity . It has four major components i.e.

Income statement
Balance sheets
Statement of retained earnings
Cash flows

Financial statement analysis:

It is a systematic process of analysis the financial information in the financial statement to understand and take financial decision.

Goals of FSA:

To find out about the financial Health of a firm.
To measure the current profitability
To measure operational efficiency of the firm.
To determine the power of firm to pay its debt on time

Techniques of analysis:

Comparative statement: They are financial statement that cover a different time frame. Comparative statement lines up section of balance sheet and income statement for different period and the absolute change and Percentage change is observed and noted.

Particulars	Year 2017	Year 2018	Absolute change	Percentage change
Sales	1000	2000	1000	100%
Revenue	5000	6000	1000	40%
Assets	200	500	300	150%
Liabilities	400	500	100	25%

Common size: It used to compare financial statement of different size of companies or of the same company over different periods. The structure of the common size statement uses a common figure as the base and the other line items are calculated on that basis.

Ratio analysis: A ratio analysis is a quantitative analysis of the information of the financial statement. It is used to calculate various aspects of company operating and financial performance such as its efficiency, liquidity, profitability and solvency.

Current ratio= current assets/ current liability
Quick ratio= (cash and cash equivalents + asset receivables)/ current liabilities
Cash ratio= ( cash + cash equivalents)/ current liabilities

Horizontal analysis: Horizontal analysis (also known as trend analysis) is a financial statement analysis technique that shows changes in the amounts of corresponding financial statement items over a period of time. It is a useful tool to evaluate the trend situations.The statements for two or more periods are used in horizontal analysis. The earliest period is usually used as the base period and the items on the statements for all later periods are compared with items on the statements of the base period. The changes are generally shown both in dollars and percentage.

Some related terms:

There are various types of Financial analysis. They are briefly mentioned herein:

External analysis: The external analysis is done on the basis of published financial statements by those who do not have access to the accounting information, such as, stockholders, banks, creditors, and the general public.

Internal Analysis: This type of analysis is done by finance and accounting department. The objective of such analysis is to provide the information to the top management, while assisting in the DECISION MAKING process.

Short term Analysis: It is concerned with the WORKING CAPITAL analysis. It involves the analysis of both current assets and current liabilities, so that the cash position (liquidity) may be determined.

Horizontal Analysis: The comparative financial statements are an example of horizontal analysis, as it involves analysis of financial statements for a number of years. Horizontal analysis is also regarded as Dynamic Analysis.

Vertical Analysis: it is performed when financial ratios are to be calculated for one year only. It is also called as static analysis.

Expected questions:

What is financial statement?
Write name of technique of analysis of financial statement?
Forms of financial statement.
Concept of financial system analysis
Goals of financial system of analysis.

Financial statement analysis is the process of evaluating a company’s financial statements to understand its financial health and performance. This analysis can be used to make Investment decisions, assess credit risk, or simply track a company’s progress over time.

There are many different techniques that can be used for financial statement analysis. Some of the most common include:

Horizontal analysis: This involves comparing a company’s financial statements from one period to another to see how its performance has changed.
Vertical analysis: This involves comparing a company’s financial statements to its own historical data or to Industry Averages.
Common-size analysis: This involves expressing all of a company’s financial statement items as a percentage of a common base, such as total assets or net sales.
Trend analysis: This involves tracking a company’s financial performance over time to see how it has changed.
Ratio analysis: This involves calculating ratios of different financial statement items to get a better understanding of a company’s financial health and performance.

Each of these techniques can provide valuable insights into a company’s financial condition. However, it is important to use multiple techniques and to consider the company’s specific circumstances before making any decisions based on the analysis.

One of the most important things to remember when analyzing financial statements is that they are historical documents. They provide information about a company’s past performance, but they cannot tell you what the company will do in the future. As a result, it is important to use financial statement analysis in Conjunction with other information, such as market research and industry analysis, to make informed decisions.

Another important consideration is that financial statements can be manipulated. Companies can use accounting techniques to make their financial statements look better than they actually are. As a result, it is important to be aware of the potential for accounting fraud when analyzing financial statements.

Despite these limitations, financial statement analysis can be a valuable tool for investors, creditors, and other stakeholders. By understanding how to analyze financial statements, you can gain valuable insights into a company’s financial health and performance.

Here are some additional techniques that can be used for financial statement analysis:

DuPont analysis: This is a technique that breaks down a company’s return on Equity (ROE) into three components: return on assets (ROA), asset turnover, and financial leverage.
Liquidity analysis: This involves assessing a company’s ability to meet its short-term obligations.
Solvency analysis: This involves assessing a company’s ability to meet its long-term obligations.
Profitability analysis: This involves assessing a company’s ability to generate profits.
Activity analysis: This involves assessing how efficiently a company uses its assets.
Market analysis: This involves assessing a company’s performance in the stock market.

By using these techniques, you can gain a more complete understanding of a company’s financial health and performance. However, it is important to remember that financial statement analysis is just one tool that you can use to make investment decisions. You should also consider other factors, such as the company’s management team, its industry, and the overall economy, before making any investment decisions.

Quick Revision: GS1;PART III;PART C Technique of Analysis of financial statement

1. What is financial statement analysis?

Financial statement analysis is the process of evaluating a company’s financial performance by examining its financial statements. This includes looking at the company’s income statement, balance sheet, and cash flow statement.

2. What are the different types of financial statement analysis?

There are two main types of financial statement analysis: horizontal analysis and vertical analysis. Horizontal analysis compares a company’s financial statements over time, while vertical analysis compares a company’s financial statements to its industry averages.

3. What are the different ratios used in financial statement analysis?

There are many different ratios used in financial statement analysis, but some of the most common include the following:

Profitability ratios: These ratios measure a company’s ability to generate profits. Examples include the return on assets (ROA) and the return on equity (ROE).
Liquidity ratios: These ratios measure a company’s ability to meet its short-term obligations. Examples include the current ratio and the quick ratio.
Solvency ratios: These ratios measure a company’s ability to meet its long-term obligations. Examples include the debt-to-equity ratio and the debt-to-assets ratio.
Activity ratios: These ratios measure how efficiently a company uses its assets. Examples include the inventory turnover ratio and the accounts receivable turnover ratio.

4. What are the benefits of financial statement analysis?

Financial statement analysis can provide you with valuable information about a company’s financial health. This information can help you make informed investment decisions, assess a company’s creditworthiness, and identify potential investment opportunities.

5. What are the limitations of financial statement analysis?

Financial statement analysis is not without its limitations. One limitation is that financial statements are historical documents, and they may not reflect the company’s current financial situation. Another limitation is that financial statements can be manipulated by management, making it difficult to get an accurate picture of the company’s financial health.

6. What are some tips for conducting financial statement analysis?

When conducting financial statement analysis, it is important to use a variety of ratios and to compare a company’s financial performance to its industry averages. It is also important to be aware of the limitations of financial statement analysis and to use caution when making investment decisions based on this information.

7. What are some common mistakes to avoid when conducting financial statement analysis?

Some common mistakes to avoid when conducting financial statement analysis include the following:

Not using a variety of ratios: It is important to use a variety of ratios to get a complete picture of a company’s financial health.
Not comparing a company’s financial performance to its industry averages: It is important to compare a company’s financial performance to its industry averages to get an accurate understanding of its performance.
Not being aware of the limitations of financial statement analysis: Financial statements are historical documents, and they may not reflect the company’s current financial situation. It is important to be aware of these limitations when making investment decisions.
Using financial statement analysis to make investment decisions without considering other factors: Financial statement analysis is just one tool that can be used to make investment decisions. It is important to consider other factors, such as the company’s management team, its industry, and the overall economy, when making investment decisions.

Which of the following is not a technique of financial statement analysis?
(A) Horizontal analysis
(B) Vertical analysis
(C) Ratio analysis
(D) Trend analysis
Horizontal analysis is a technique of financial statement analysis that compares financial statement items over time.
(A) True
(B) False
Vertical analysis is a technique of financial statement analysis that expresses each financial statement item as a percentage of a base amount.
(A) True
(B) False
Ratio analysis is a technique of financial statement analysis that uses financial statement items to calculate ratios that can be used to assess a company’s financial health.
(A) True
(B) False
Which of the following is not a type of ratio analysis?
(A) Liquidity ratios
(B) Solvency ratios
(C) Profitability ratios
(D) Efficiency ratios
Liquidity ratios measure a company’s ability to meet its short-term obligations.
(A) True
(B) False
Solvency ratios measure a company’s ability to meet its long-term obligations.
(A) True
(B) False
Profitability ratios measure a company’s ability to generate profits.
(A) True
(B) False
Efficiency ratios measure a company’s ability to use its Resources efficiently.
(A) True
(B) False
Which of the following is not a limitation of financial statement analysis?
(A) Historical data is used.
(B) Financial statements are prepared using generally accepted accounting principles (GAAP).
(C) Financial statements are not always accurate.
(D) Financial statements are not always complete.
One limitation of financial statement analysis is that historical data is used. This means that the analysis is based on past performance, which may not be indicative of future performance.
(A) True
(B) False
Another limitation of financial statement analysis is that financial statements are prepared using generally accepted accounting principles (GAAP). GAAP is a set of rules that companies must follow when preparing their financial statements. However, GAAP can be complex and difficult to understand, which can make it difficult to interpret financial statements.
(A) True
(B) False
Finally, financial statements are not always accurate. This is because companies can make mistakes when preparing their financial statements, or they may intentionally misstate their financial statements to deceive investors.
(A) True
(B) False
Financial statement analysis is a valuable tool that can be used to assess a company’s financial health. However, it is important to be aware of the limitations of financial statement analysis before using it.
(A) True
(B) False