Financial Statement Analysis | Crash Course of Accountancy - Class 12 - Commerce PDF Download

Q1. What do you mean by 'Financial Analysis'?

Ans:Financial analysis is a process of studying the relationship between the various components of the financial statements to obtain a better understanding of the firm's financial position and performance.

Q2. What is the purpose of financial analysis? 

or
Briefly explain any three objectives of 'Financial Statement Analysis'.

Ans: Purpose or Objectives of Financial Analysis:
The following are the main purposes / objectives of financial analysis:
1. To judge the operational efficiency of the business.
2. To measure short-term and long-term financial position of the business.
3. To ascertain whether adequate profits are being earned on the capital invested in the business.
4. To determine the administrative efficiency of the management.
5. To predict the growth potential of the business.
6. To find out the weaknesses / shortcomings of the business and timely reporting of the same to the management so that it can take remedial measures to remove those shortcomings.
7. To make inter-firm comparison.

Q3. Name any six parties which are interested in financial analysis.

Ans: The various parties interested in financial analysis are named below:
(i) Shareholders
(ii) Debenture-holders
(iii) Creditors
(iv) Banks and Financial Institutions
(v) Management
(vi) Employees 

Q4. What is 'Horizontal' and 'Vertical' Analysis'?
Ans: Horizontal Analysis: A comparison of two or more year's financial statements is known as horizontal analysis. Trend analysis is the main tool of horizontal analysis. Vertical Analysis: The presentation of financial statements in common size form is known as vertical analysis. Vertical analysis is based on the data of one year only. Common size statements are those in which individual figures of financial statements are converted into percentages to some common base. For example, in a common size income statement, sales are taken as the base i.e. 100 and all other items are expressed as percentages of this base. 

Q5. What is meant by (i) intra-firm analysis and (ii) inter-firm analysis?

Ans: Intra-firm analysis means comparison of two or more years' financial data of a firm.
Inter-firm analysis means comparison of financial data of two or more firms.

Q6. Distinguish between internal and external analysis?
Ans:

Q7. Discuss briefly the significance/advantages of financial analysis ?
Ans: Significance/ Advantages of Financial Analysis: The following are the main advantages of financial analysis:
1. It helps in ascertaining whether the firm is earning adequate profits or not on the capital invested in the business.
2. It measures the short-term and long-term financial position of the business.
3. It helps in determining the administrative efficiency of the management.
4. It helps the firm in detecting its weaknesses or shortcomings.
5. It helps in making inter-firm and intra-firm comparisons.

Q8. What is the importance of financial analysis to the following parties: 
Ans: Importance of Financial Analysis: The importance of financial analysis to various parties is discussed below:
(a) Shareholders: Shareholders are concerned about the safety of their investment in company's shares. They want to know the rate of return on their investment. They are also interested in knowing the financial position of the company and the future prospects of the company. Financial analysis provides all the necessary information in this regard and recommends to shareholders whether they should hold or sell their shares.
(b) Management: Analysis of financial statements is of utmost importance for management. It measures the overall performance of the business. It helps the management in checking the results of its own policies and decisions. It pinpoints the areas where the managers have shown better efficiency and the areas of inefficiency. It predicts the future by analyzing the past data and provides adequate information to the management for planning and control.
(c) Creditors: Creditors are those who sell goods or provide services on credit and to whom the business owes money. They want to know whether or not the business would be in a position to pay their debts on time. Thus, they are more interested in working capital/short-term financial position of the business. Hence an analysis of financial statements is also important from the creditors point of view.
(d) Investors: Investors are concerned about the safety of their investment in company. They want to know whether the company will be able to give adequate return on their investments. They are also interested in knowing the financial position of the company and the future prospects of the company. Financial analysis provides all the necessary information in this regard and recommends to the prospective investors whether they should invest in company's securities or not.

Q9. State any five limitations of financial analysis 
Ans: Limitations of Financial Analysis: Following are main limitations of financial analysis:
(1) Suffering from the limitations of financial statements: Financial statements suffer from a number of limitations. As the financial analysis is based upon the information contained in the financial statements, so it suffers from the same limitations as that of the financial statements.
(2) Ignoring qualitative aspect: Financial statements contain only financial data and ignore the qualitative information like, quality of the product, efficiency of the management, management _ labour relations etc. Thus, financial analysis, which is based upon the information contained in the financial statements, does not measure the qualitative aspects of the business.
(3) Ignoring price level changes: The results shown by analysis of financial statements may be misleading, if the price level changes have not been accounted for.
(4) Different tools of analysis: The existence of different tools of financial analysis viz., common size statements, comparative statements, trend analysis, ratio analysis etc, may sometimes create confusion in the mind of the analyser.
(5) Affected by manipulation & window dressing: The results obtained from the financial analysis will be misleading, if the information contained in the financial statements is manipulated.

Q10. "Financial analysis suffers from lack of qualitative analysis and difficulty in forecasting". Comment.
Ans: "Financial analysis suffers from lack of qualitative analysis and difficulty in forecasting". This statement focuses on the two main limitations of analysis of financial statements. These limitations are discussed below:
(i) Financial analysis suffers from lack of qualitative analysis: Financial statements contain only financial data and ignore the qualitative information like, quality of the product, efficiency of the management, management - labour relations etc. Thus, financial analysis, which is based upon the information contained in the financial statements, does not measure the qualitative aspects of the business.
(ii) Financial analysis suffers from difficulty in forecasting: Financial analysis is based upon the data contained in the financial statements which is historical in nature. It analysis what has happened in the past. It does not reflect the future.

Q11. "Financial analysis is affected by window dressing and personal ability and bias of the analyst". Comment.
Ans: "Financial analysis is affected by window dressing and personal ability and bias of the analyst". This statement points towards the limitations of financial analysis and can be discussed in two parts as follows:
· Financial analysis is affected by window dressing: If the management is dishonest, it may indulge in window dressing. Window dressing means manipulation of accounts in a way as to show a better picture than what it actually is. Thus, financial analysis based on manipulated figures will not only be false but also misleading.
· Financial analysis is affected by personal ability and bias of the analyst: Financial analysis is dependent on the personal ability and judgment of the analyst. For example, an analyst may calculate net profit ratio on the basis of net profit before tax whereas the other may calculate on the basis of net profit after tax. In both the cases the results are bound to differ and the conclusion based on such analysis will be misleading.

Q12. What are the different tools of financial statement analysis ?

Ans: Tools of financial statement analysis are –
⇒ Cash flow statement
⇒ Fund flow statement
⇒ Ratio analysis
⇒ Comparative analysis
⇒ Commomsize analysis
⇒ Trend analysis