Conclusion
This Project has provided me with valuable skills in generating cash flow statements and conducting ratio analysis. The knowledge I have gained about financial statements is applicable to daily business and commerce activities. Completing the tasks for this project has not only improved my understanding of the methods, usefulness, and importance of financial statements for evaluating a company’s performance but also equipped me to prepare them in future situations. Based on my experience with this project, I have reached the following conclusion.
There are various purposes for Financial Analysis.
Judging the Earning Capacity and Managerial Efficiency:
The financial analysis allows for the calculation of the business concern’s earning capacity. Furthermore, it enables the forecast of the concern’s future earning capacity. This is of particular interest to external users of accounts, specifically investors and potential investors. Assessing the managerial efficiency is also a crucial aspect.
The financial statement analysis is essential for identifying areas of managerial efficiency and inefficiency. It involves using financial ratios to analyze the relative proportion of production, administrative, and marketing expenses. This allows for the identification of favorable or unfavorable variations and determining the reasons behind them, thereby pinpointing managerial efficiency and deficiency.
In addition, financial analysis assesses both the long-term and short-term solvency of the enterprise. Short-term solvency, also known as liquidity, refers to the company’s ability to meet its short-term liabilities. Creditors and suppliers are particularly interested in this aspect.
Furthermore, debenture holders and lenders use financial analysis to evaluate the company’s ability to repay both the principal amount and interest.
Inter-Firm Comparison
Inter-firm comparison is facilitated with the aid of financial analysis, which assists in evaluating both one’s own performance and that of others, particularly in the context of potential merges and acquisitions. Additionally, financial analysis is useful in making forecasts and preparing budgets.
Past financial statement analysis is helpful for evaluating future developments, specifically those expected in the next year. For instance, by examining historical earning capacity, it becomes possible to anticipate the profit for the upcoming year in relation to a particular investment. Consequently, this analysis aids in budget preparation.
Financial analysis assists financial statement users in comprehending complex information in a simplified manner. Utilizing charts and diagrams, it is possible to make various data more visually appealing and easily understood. Financial statements serve the following purposes:
Security Analysis is the process in which an investor determines if a firm is meeting their expectations in terms of dividend payments, capital appreciation, and the safety of their investment. This analysis is conducted by a security analyst who assesses the firm’s cash-generating ability, dividend payout policy, and the behavior of share prices. Credit Analysis.
Debt analysis is valuable when a company is deciding whether to offer credit to a new customer or dealer, as well as when a bank is considering granting loans to the public. The manager of the firm or the bank can use this analysis to determine whether or not to extend credit.
The firm conducts this analysis to determine the borrowing capacity of a potential borrower. It also assists in making decisions about the dividend rate. Management must decide how much of the earnings to distribute and how much to retain, which reflects the firm’s profitability and can impact the behavior of share prices. This analysis also contributes to general business analysis.
Financial analysis is an important tool for assessing a company’s profit drivers, business risks, and profit potential. It also helps in predicting future growth scenarios. Nevertheless, it is crucial to acknowledge the constraints of financial statements.
Historical Analysis
Financial statement analysis is a retrospective analysis, assessing past events rather than forecasting the future. Shareholders, investors, and others are primarily concerned with understanding the anticipated future position.
Ignore any changes in the price level.
Price level changes and purchasing power of money have an inverse relationship. The analysis of financial statements from different accounting years becomes invalid due to a change in the price level because accounting records do not consider the change in the value of money.
Qualitative Aspects Ignored
Financial statements focus exclusively on monetary matters and do not consider qualitative aspects such as management quality, labor force quality, and public relations when analyzing them.
Not devoid of prejudice
When faced with various options, such as deciding on inventory valuation or depreciation methods, accountants often have to make choices. As personal judgment is subjective, the resulting financial statements may consequently contain bias.
Variations in Account Practices
It is important for inter-firm comparison that accounting practices do not differ significantly among the firms. If there are variations in accounting practices among different firms, it is not possible to make a meaningful comparison of their financial statements.
