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.
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Financial statement analysis is the process of evaluating a company’s financial statements to understand its financial health and performance. There are a number of techniques that can be used to analyze financial statements, including horizontal analysis, vertical analysis, common-size analysis, trend analysis, ratio analysis, DuPont analysis, cash flow analysis, solvency analysis, profitability analysis, and efficiency analysis.
Horizontal analysis is the comparison of financial statement items over time. This can be done by looking at the changes in individual items or by looking at the changes in totals. Horizontal analysis can be used to identify trends in a company’s financial performance.
Vertical analysis is the comparison of financial statement items to a single base amount. This base amount can be total assets, net sales, or any other common denominator. Vertical analysis can be used to identify the relative importance of different items on a financial statement.
Common-size analysis is a type of vertical analysis in which all of the items on a financial statement are expressed as a percentage of a single base amount. This makes it possible to compare the financial statements of different companies that have different sizes or structures.
Trend analysis is the comparison of financial statement items over time. This can be done by looking at the changes in individual items or by looking at the changes in totals. Trend analysis can be used to identify trends in a company’s financial performance over time.
Ratio analysis is the comparison of two or more financial statement items. Ratios can be used to measure a company’s liquidity, solvency, profitability, efficiency, and market value.
DuPont analysis is a type of ratio analysis that breaks down a company’s return on Equity (ROE) into three components: return on assets (ROA), asset turnover, and financial leverage. DuPont analysis can be used to identify the areas where a company can improve its ROE.
Cash flow analysis is the process of evaluating a company’s cash flows. Cash flow analysis can be used to identify the sources and uses of cash, to assess a company’s liquidity, and to project future cash flows.
Solvency analysis is the process of evaluating a company’s ability to pay its debts. Solvency analysis can be used to identify the risks of a company defaulting on its debts.
Profitability analysis is the process of evaluating a company’s ability to generate profits. Profitability analysis can be used to identify the strengths and weaknesses of a company’s business model.
Efficiency analysis is the process of evaluating a company’s use of its Resources. Efficiency analysis can be used to identify opportunities for a company to improve its profitability.
Market analysis is the process of evaluating a company’s position in the market. Market analysis can be used to identify the opportunities and threats facing a company.
Financial statement analysis is a valuable tool for investors, creditors, and other stakeholders. By understanding the techniques of financial statement analysis, you can gain valuable insights into a company’s financial health and performance.
What are the different techniques of financial statement analysis?
There are many different techniques of financial statement analysis, but some of the most common include:
Horizontal analysis: This involves comparing the financial statements of a company over time to see how its performance has changed.
Vertical analysis: This involves comparing the different items on a company’s financial statements to each other to see how they relate to each other.
Ratio analysis: This involves calculating ratios of different items on a company’s financial statements to get a better understanding of its financial health.
Trend analysis: This involves plotting the data from a company’s financial statements over time to see how its performance has changed over time.
What are the benefits of financial statement analysis?
Financial statement analysis can be used to:
Identify trends: By looking at a company’s financial statements over time, you can identify trends in its performance. This can help you to make better Investment decisions.
Compare companies: By comparing the financial statements of different companies, you can see how they compare to each other. This can help you to choose the best company to invest in.
Evaluate performance: Financial statement analysis can be used to evaluate the performance of a company. This can help you to determine whether the company is doing well or not.
Make predictions: By looking at a company’s financial statements, you can make predictions about its future performance. This can help you to make better investment decisions.
What are the limitations of financial statement analysis?
Financial statement analysis is not without its limitations. Some of the limitations of financial statement analysis include:
The data may be inaccurate: The data in a company’s financial statements may be inaccurate. This can make it difficult to make accurate predictions about the company’s future performance.
The data may be incomplete: The data in a company’s financial statements may be incomplete. This can make it difficult to get a complete picture of the company’s financial health.
The data may be misleading: The data in a company’s financial statements may be misleading. This can be done by companies that are trying to hide their true financial condition.
The data may be outdated: The data in a company’s financial statements may be outdated. This can make it difficult to make accurate predictions about the company’s future performance.
What are some tips for financial statement analysis?
Some tips for financial statement analysis include:
Use multiple techniques: It is important to use multiple techniques of financial statement analysis to get a complete picture of a company’s financial health.
Compare companies: It is important to compare the financial statements of different companies to see how they compare to each other.
Be aware of the limitations: It is important to be aware of the limitations of financial statement analysis.
Use common sense: It is important to use common sense when analyzing financial statements.
Seek professional help: If you are not comfortable analyzing financial statements, you should seek professional help.
Sure, here are some MCQs without mentioning the topic Techniques Of Analysis Of Financial Statement:
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
Trend analysis is a technique of financial statement analysis that compares financial statement items over time to identify trends. (A) True (B) False
Which of the following is a common ratio used in financial statement analysis? (A) Current ratio (B) Quick ratio (C) Debt-to-equity ratio (D) All of the above
The current ratio is a measure of a company’s ability to pay its short-term debts. (A) True (B) False
The quick ratio is a measure of a company’s ability to pay its short-term debts without relying on the sale of inventory. (A) True (B) False
The debt-to-equity ratio is a measure of a company’s financial leverage. (A) True (B) False
A high current ratio indicates that a company is able to pay its short-term debts. (A) True (B) False
A high quick ratio indicates that a company is able to pay its short-term debts without relying on the sale of inventory. (A) True (B) False
A high debt-to-equity ratio indicates that a company is using a lot of debt to finance its operations. (A) True (B) False
Which of the following is a limitation of ratio analysis? (A) Ratios can be manipulated by management. (B) Ratios can be affected by Industry factors. (C) Ratios can be affected by economic factors. (D) All of the above
Which of the following is a qualitative factor that should be considered when analyzing financial statements? (A) Management’s experience and expertise (B) The company’s industry (C) The company’s financial position (D) All of the above
Which of the following is a quantitative factor that should be considered when analyzing financial statements? (A) The company’s earnings per share (B) The company’s return on equity (C) The company’s debt-to-equity ratio (D) All of the above
