DK Goel Solutions Class 12 Accountancy Chapter 2 Financial Statements Analysis

Question 1. State who may be interested in the analysis of financial statement and why?

Solution 1. The interested in the analysis of the financial statement ananlysis may be studies from the point of view of varioud parties as follows:-

1.) Significance for Management:- Management of a firm is always interested in the solvency, profitability and the capital structure of the firm.

2.) Significance for Creditors:- Creditiors want to know the liquidity of the business, i.e. to know whether the company will have sufficient current assets and cash to pay their debts or not.

3.) Siginificance for Government:- Government can judge on the basis of analysis of financial statements, which industry is progressing on the desired lines and which indsrty needs the financial help.

4.) Siginificance for Financial Insitutions:- All the financial institutions which provide finance to the industries such as Banks, Insurance companiesm, Units Trust etc.

5.) Siginificance for Investors:- Investors and shareholders of the business are interested in the longevity of the business enterprise enterprice and therefore, they want to know the earning capircity of the business and its prospectus for future growth and prosperity.

6.) Siginificance for Employees:- Analysis of financial statements helps the employees in determining the profitability of the business entriperise.

Question 2. What is meant by ‘Financial Analysis’? What is the interest of shareholders and prospective investors in such analysis?

Solution 2. “Financial analysis consists in separating facts according to some definite plan, arranging them in groups according to certain circumstances and then presenting them in a convenient and easily read and understandable form.”

Interest of shareholders and prospective inverstors:- Investors and shareholders of the business are interested in the longevity of the business enterprise enterprice and therefore, they want to know the earning capircity of the business and its prospectus for future growth and prosperity. Analysis of financial statement of an company helps them a great deal in assessing the capacity of the business to pay dividend at a higher rate ans also the safety of their investments.

Question 3. How is analysis of financial statement important to Government Authorities?

Solution 3. Government can judge on the basis of analysis of financial statement, which industry is progressing on the desired lines and which industry needs the financial help. Government can take a decision to reduce the GST in those industries where the profit margins are low in comparison to the cost of profuction. On the contrary, if the profit margins are too high in comparison to the cost of production, Government can increase the GST or can enforce the price regulations.

Question 4. Why is analysis of financial statements important to Creditors?

Solution 4. There are two types of crditors (i) Short-term creditors and (ii) Long-term creditors.

(i) Short term creditiors want to know the liquidity of the business, i.e. to know whether the company will have sufficient current assets and cash to pay their debts or not. Current ratio and quick ratio calaculated on the basis of financial statements help them in assessing this.

(ii) Long-term creditors want to know two things namely: (i) Whether the compay will be able to pay the interest consistently, and (2) Whether the company ratio they can ascertain whether the company will be able to pay the interest regularly or not and on the basis of debts-equity ratio they can ascertain whether the company will be able to pay their debts on maturity.

Question 5. “Financial Analysis is affected by window-dressing and the personal ability and bias of the analyst.” Comment.

Solution 5. Some firms resort to window-dressing their financial statements to cover up badfinancial position on the eve of accounting date. For example, they may not record the purchases made at the end of the year or they may overvalue their closing stock. In such cases, the results obtained by analysis of financial statements will be misleading.

Question 6. What is horizontal analysis of financial statements?

Solution 6. In such type of analysis, financial statements for a number of years are reviewed and analyse. Figures for two or more years are contained in such type of analysis and these figures are placed side-by-side to facilitate comparison. Such analysis indicates the increase or decrese in these items not only in absoulye figures but also in percentage form. Thus, it involves making comparisions and establishing relationship among related items of an enterprise for a number of years. Since such type of analysis is based on the date from year-to-year rather than only one year, it is also called ‘Dynamic Analysis’.

Question 7. What is vertical analysis of financial statements?

Solution 7. In such type of analysis, financial statements for a single year or on a particular date are reviews and analysed with the help of proper devices like ratios. It involves a study of the quantitive relationship among various itmes of Balance Sheet or Statement of Profit and Loss of a single period. The items in the financial statement are expressed as a percentage to total and the total is taken as equivalent to 100. Statements containing such analysis are termed as ‘Comman Size Statements’.

The Comman size Statement of Profit & Loss shows each element of Cost as a percentage of sales. It helps in analysing costs and operating results of the year. Similarly, in a comman size Balance Sheet various assets can be expressed as percentage to total assets.

Question 8. What is the importants of analysis of financial statements?

Solution 8. The analysis of financial statements has become of general interest. Various parties have become interested in the financial statements of a company due to various reasons. Different persons look at the same financial statement from different angles, i.e. there are different useds of finanacial statements, all of them usind the same statement but for a different purpse. For example, a share holder would be interestd in the profitability whereas a short-term creditor would be concerned about the liquidity, i,e the firm’s ability to pay its current liabilities.

Question 9. State any two objectives of analysis of financial statements.

Solution 9. The purpose of financial analysis depends on the needs of the person who is analysis these statements. These varying needs may be:

1.) To Measure the Earning Capicity of Profitabiliy:- According to Robert Anthony, “The overall objective of a business is to earn a satisfactory return on the funds invested in it, consistent with maintaining a sound financial position.”

2.) To Masure the Solution vency:- It can be ascertained from financial analysis whether the business is in a position to pay its short-term and long-term liabilities in time. For example, the liquidity ratio (current ratio and quick ratio) are calculated to ascertain whether the business enterprise has sufficient liquid funds to meet its short term liabilities and Debt Equity Ratio is calculated to ascertain whether the business enterprise has got the ability to repay the long term liabilities.

Question 10. State any two limitations of analysis of financial statements?

Solution 10. Some limitations of financial analysis are as follows:-

1.) Limitations of Financial Stetements:- Financial analysis is based on financial statements. But financial statements themselves suffer from cetain limitations; hence the limitations of financial statements are also the limitations of their analysis. For example, (i) Sometimes the informations given in financial statements are incomplete and unauthentic, (ii) Financial Statements are based on accounting concepts and conventions. As such the utility of financial ananlysis is decresed due to the shortcomings of financial statements.

2.) Affected by Window-dressing:- Some firms resort to windor-dreasing their financial statements to cover up bad financial position on the eve of accounting date. For example, they may not record the purhases made at the end of the year or they may overvalue their closing stock. In such cases, the results obtained by analysis of financial statements will be misleading.

Question 11. One of the objectives of ‘Financial Statement Analysis’ is to identify the reasons for change in the financial position of the enterprise. State two more objectives of this anlaysis.

Solution 11. Objectives of ‘Financial Statements Analysis’:

1. Assessing the earning capacity or profitability of the firm as whole as well as its different departments so as to judge the financial health of the firm.

2. Assessing the managerial efficiency by using financial ratios.

3. Assessing the short-term and the long-term solvency of the enterprise.

4. Assessing their own performance in comparison to other firms in the same business.