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Analysis and Interpretation of Financial Statements

Updated on April 2, 2013


Analysis and interpretation of financial statements are an attempt to determine the significance and meaning of the financial statement data. so that a forecast can be made of the prospects for future earnings ability to pay interest, debt maturities (current and long-term) and probability of a sound dividend policy.. To quote Myers "Financial statement analysis is largely a study of the relationship among the various financial factors in a business as disposed by a single set of statement and study of the trend of these factors as shown in a series of statements. So financial .analysis. main function is .the pinpointing of the strengths and weaknesses of a business concern by regrouping and analysis of figures contained in financial statements by making. comparisons of various components and by examining their content. The financial manager uses this as the basis to plan future financial requirements by means of forecasting and budgeting procedures.

The analysis. and interpretation of financial statements represent the last of the four major steps of accounting viz.

1. Analysis of each transaction to determine the accounts to be debited and credited and the measurement and valuation of each transaction to determine the amounts involved.

2. Recording of the information in the journals. summarisation in ledgers and preparation of a work sheet.

3. Preparation of financial statements.

4. Analysis and interpretation of financial statements results in the. presentation of information that assists business managers, creditors and investors. They require a clear understanding of monetary valuation of the items.

Types of Financial Analysis

1. External Analysis.

2. Internal Analysis.

3. Horizontal Analysis.

4. Vertical Analysis.

1.External Analysis:-This is made by those who do not, have access to the detailed records of the company. This group Includes credit agencies, investors and governmental agencies regulating: a business in a nominal way. They depend almost entirely on published financial statements. Now their position has been improved due to governmental information.regulations requiring business undertakings to make available:. detailed information schedules and explanatory footnotes to the public through audited accounts.

2. Internal Analysis:-This accomplished ,by those who have. access .to the books of accounts. and all-other information related to business. The internal analyst analyses for managerial purposes, It is an internal analysis and it is conducted by executives and employees of the enterprise as well as governmental and court agencies which may have major. regulatory and other jurisdiction over the business.

3. Horizontal Analysis: When Financial Statements for a number of years are reviewed and analysed . The analysis is called "Horizontal analysis" This is also known as " Dynamic Analysis" as it is based on data from the year to year rather than one data or period of time as a whole.

4. Vertical Analysis :- Itis often used for referring to ratios developed on on date or for the accounting period it as also called " Static Analysis. This is not very helpful for a proper analysis of the firms financial position and its interpretation as it does not enable to study the data in perspective . But this can be provided by a study conducted over a number of years. so that comparisons can be effected. Hence this is not very useful.

External Analysis and internal analysis are differentiated according to material used and Horizontal analysis and Vertical Analysis are classified according to method of Financial Analysis


Analysis And Interpretation

Analysis and Interpretation are interconnected because interpretation is impossible without analysis and short of interpretation, analysis is useless. Interpretation requires.proper analysis. It difficult to interpret financial statements figures which consist not only of account balances, which is usually are the results of a number of debit and credit entries for a variety of transactions, but also combinations of account balances, because the figures do not represent homogeneous data.So this needs ` an -analysis of the totals in statements into their components so as to restore some sort of homogeneity to the statement data. For example, though current liabilities, in a company's balance- sheet. are shown separately from other liabilities it would be better from the -point of -view of -the financial manager to have information regarding debts due within a month or six months or-for long periods. This information has to be obtained by aging the accounts as it is not available in statements.Interpretation further requires comparison.The Financial statement has to be -dissected into, its constituents in order to measure the relative: magnitudes of the vicious entities. For example, if current liabilities on a particular date. are stated at a certain figure and' if it is desired to know whether the business would be in a position to meet these obligations, the value of liabilities will be compared- with that of - assets' such as cash, readily convertible assets, etc., which are available to pay off liabilities.

Unlike in the earlier days, now accountants play a vital role in the analysis and interpretation of financial and operating data due to the pressing demand for analytical information by business executives. bankers and others. Now-a-days the work of an accountant is incomplete. if he has not analysed and interpreted the data presented in the,statements..


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