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FS Analysis

The document discusses techniques for analyzing financial statements, including: 1. Comparative (horizontal) analysis compares line items over multiple years to analyze changes. 2. Common-size (vertical) analysis expresses line items as a percentage of a total (like revenue) for internal and external comparisons. 3. Ratio analysis calculates financial ratios that reveal a company's profitability, liquidity, leverage, and other financial characteristics. Key ratios are categorized according to the information they provide.

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Venz Karylle Capitan
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50 views

FS Analysis

The document discusses techniques for analyzing financial statements, including: 1. Comparative (horizontal) analysis compares line items over multiple years to analyze changes. 2. Common-size (vertical) analysis expresses line items as a percentage of a total (like revenue) for internal and external comparisons. 3. Ratio analysis calculates financial ratios that reveal a company's profitability, liquidity, leverage, and other financial characteristics. Key ratios are categorized according to the information they provide.

Uploaded by

Venz Karylle Capitan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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VENZ KARYLLE L.

CAPITAN
FINANCIAL STATEMENT
ANALYSIS OBJECTIVES
I - Knowing Profitability of Business
Financial statements are required to ascertain whether the enterprise is earning
adequate profit and to know whether the profits have increased or decreased as compared to
the previous year(s), so that corrective steps can be taken well in advance.

II - Knowing the Solvency of the Business


Financial statements help to analyse the position of the business as regards to the
capacity of the entity to repay its short as well as long term liabilities.
III - Judging the Growth of the Business
Through comparison of data of two or more years of business entity, we can draw a
meaningful conclusion as regard to growth of the business. For example, increase in sales with
simultaneous increase in the profits of the business, indicates a healthy sign for the growth of
the business.

IV - Judging Financial Strength of Business


Financial statements help the entity in determining solvency of the business and help to
answer various aspects viz., whether it is capable to purchase assets from its own resources
and/or whether the entity can repay its outside liabilities as and when they become due.
V - Making Comparison and Selection of Appropriate Policy
To make a comparative study of the profitability of the entity with other entities
engaged in the same trade, financial statements help the management to adopt sound business
policy by making intra firm comparison.

VI - Forecasting and Preparing Budgets


Financial statement provides information regarding the weak-spots of the business so
that the management can take corrective measures to remove these short comings. Financial
statements help the management to make forecast and prepare budgets.
VII - Communicating with Different Parties
Financial statements are prepared by the entities to communicate with different parties
about their financial position. Hence, it can be concluded that understanding the basic financial
statements is a necessary step towards the successful management of a commercial enterprise.
Limitations of Financial Statements
I - Manipulation or Window Dressing
Some business enterprises resort to manipulate the information contained in the
financial statements so as to cover up their bad or weak financial position. Thus, the analysis
based on such financial statements may be misleading due to window dressing.

II - Use of Diverse Procedures


There may be more than one way of treating a particular item and when two different
business enterprises adopt different accounting policies, it becomes very difficult to make a
comparison between such enterprises. For example, depreciation can be charged under straight
line method or written down value method. However, results provided by comparing the
financial statements of such business enterprises would be misleading.
III - Qualitative Aspect Ignored
The financial statements incorporate the information which can be expressed in
monetary terms. Thus, they fail to assimilate the transactions which cannot be converted into
monetary terms. For example, a conflict between the marketing manager and sales manager
cannot be recorded in the books of accounts due to its non-monetary nature, but it will certainly
affect the functioning of the activities adversely and consequently, the profits may suffer.

IV - Historical
Financial statements are historical in nature as they record past events and facts. Due to
continuous changes in the demand of the product, policies of the firm or government etc,
analysis based on past information does not serve any useful purpose and gives only post­
mortem report.
V - Price Level Changes
Figures contained in financial statements do not show the effects of changes in the price
level, i.e. price index in one year may differ from price index in other years. As a result,
misleading picture may be obtained by making a comparison of figures of past year with
current year figures.

VI - Subjectivity & Personal Bias


Conclusions drawn from the analysis of figures given in financial statements depend
upon the personal ability and knowledge of an analyst. For example, the term ‘Net profit’ may
be interpreted by an analyst as net profit before tax, while another analyst may take it as net
profit after tax.
VII - Lack of Regular Data/Information
Analysis of financial statements of a single year has limited uses. The analysis
assumes importance only when compared with financial statements, relating to different years
or different firm.
FINANCIAL STATEMENT ANALYSIS TECHNIQUES

I - Comparative Statement Analysis (Horizontal Analysis)

As the name suggests, comparative analysis provides a year-on-year review of the


various financial statements. For example, in the Income Statement, the Sales figure may be
compared over a period of consecutive years to understand how the sales figures have grown (or
declined) over the year. It should be noted that horizontal analysis compares the internal
performance of the company.
Below is an example of a Comparative Income Statement.
II - Common-size Financial Statement Analysis (Vertical Analysis)

Vertical analysis is applicable for internal performance review as well as for


comparison to peers and bench-marking. In vertical analysis all the items in a particular
statement are represented as a percentage of a particular item. For example, Operating
Expenses, Depreciation, Amortization, Profit before tax, Tax, Profit after tax, etc. may be
represented as a percentage of Sales in the Income Statement. Common standard base can
easily reveal the internal make-up of financial statements and any proportionate increase and
decrease of the same.

Vertical analysis is also put to use for comparison across companies as financial
statements are converted to common-size format, which can then be used to compare with
competitor or industry averages, highlighting key differences which can then be analyzed.
Below is an example of a Common Size Income Statement. Values are expressed as %age of
Revenue.
III - Ratio Analysis
Ratio analysis is the most widely used tool of financial statement analysis. A ratio
gives relationship between two numbers, in this case items in the financial statements. Ratios
are popular because they readily allow internal evaluation as well as comparison across firms.
The ratios are categorized according to activities or functions they perform or the information
they provide. For example, profitability ratios measure the profit making capability of the
company.

IV - Graphical Analysis
Graphs provide visual representation of the performance that can be easily compared
over time. The graphs may be line graphs, column graphs or pie charts
V - Trend Analysis
Trend analysis is used to reveal the trend of items with the passage of time and is
generally used as a statistical tool. Trend analysis is used in conjunction with ratio analysis,
horizontal and vertical analysis to spot a particular trend, explore the causes of the same and if
required prepare future projections.

VI - Regression Analysis
Regression analysis is a statistical tool used to establish and estimate relationship
among variables. Generally, the dependent variable is related to one or more independent
variables. In case of financial statement analysis, the dependent variable may be, say, sales, and
it is required to estimate its relationship with the independent variable, say, a macroeconomic
factor like Gross Domestic Product.
For example, in the Top Down approach of sales forecasting, an analyst would first
forecast GDP growth and then establish a relationship between GDP and industry growth rate
through regression analysis. He may then estimate the future sales growth based on the
industry growth. As such, regression analysis is widely used in forecasting models.
FINANCIAL
STATEMENT
ANALYSIS SAMPLE
COMPUTATIONS

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