CBSE Book Class 11 Financial Markets Financial Statement Analysis

Financial Statement Analysis

4.1 Financial Statements

Financial statements, as used in corporate business houses, refer to a set of reports and schedules, which an accountant prepares at the end of a period of time for a business enterprise. The financial statements are the means with the help of which the accounting system performs its main function of providing summarized information about the financial affairs of the business. These statements comprise Balance Sheet or Position Statement and Profit and Loss Account or Income Statement. Of course to give a full view of the financial affairs of an undertaking, in addition to the above, the business may also prepare a Statement of Retained Earnings and a Statement of Changes in Financial position. In India, every company has to present its financial statements in the form and contents as prescribed under Section 211 of the Companies Act 1956. The significance of these statements is given below:

4.1.1 Balance Sheet or Position Statement

Balance sheet is a statement showing the nature and amount of a company's assets on one side and liabilities and capital on the other. In other words, the balance sheet shows the financial conditions or state of affairs of a company at the end of a given period usually at the end of one-year period. Balance sheet shows how the money has been made available to the business of the company and how the money is employed in the business.

4.1.2 Profit and Loss Account or Income Statement

Earning profit is the principal objective of all business enterprises and Profit and Loss account or Income statement is the document, which indicates the extent of success achieved by a business in meeting this objective. Profits are of primary importance to the Board of directors in evaluating the management of a company, to shareholders or potential shareholders in making investment decisions and to banks and other creditors in judging the loan repayment capacities and abilities of the company. It is because of this that the profit and loss or income statement is regarded as the primary statement and commands a careful scrutiny by all interested parties. It is prepared for a particular period, which is mentioned along with the title of these statements, which includes the name of the business firm also.

4.1.3 Statement of Retained Earnings

This statement is also known as Profit and Loss Appropriation Account and is generally a part of the Profit and Loss Account. This statement shows how the profits of the business for the accounting period have utilized or appropriated towards reserves and dividend and how much of the same is carried forward to the next period. The term 'retained earnings' means the accumulated excess of earnings over losses and dividends. The balance shown by Profit and Loss Account is to be transferred to the Balance Sheet through this statement after making necessary appropriations.

4.1.4 Statement of Changes in Financial Position

This is a statement, which summarizes for the period, the cash made available to finance the activities of an organization and the uses to which such cash have been put. This statement is also known as Cash Flow Statement, which summarizes the changes in cash inflows and outflows, by showing the various sources and applications of cash.

4.2 Analysis of Financial Statements

Published financial statements are the only source of information about the activities and affairs of a business entity available to the public, shareholders, investors and creditors and the governments. These various groups are interested in the progress, position and prospects of such entity in various ways. But these statements howsoever, correctly and objectively prepared, by themselves do not reveal the significance, meaning and relationship of the information contained therein. For this purpose, financial statements have to be carefully studied, dispassionately analyzed and intelligently interpreted. This enables a forecasting of the prospects for future earnings, ability to pay interest, debt maturities both current as well as long-term and probability of sound financial and dividend policies. According to Myers, "financial statement analysis is largely a study of relationship among the various financial factors in business as disclosed by a single set of statements and a study of the trend of these factors as shown in a series of statements".

Thus, analysis of financial statements refers to the treatment of information contained in the financial statement in a way so as to afford a full diagnosis of the profitability and financial position of the firm concerned.

The process of analyzing financial statements involves the rearranging, comparing and measuring the significance of financial and operating data. Such a step helps to reveal the relative significance and effect of items of the data in relation to the time period and/or between two organizations.

Interpretation, which follows analysis of financial statements, is an attempt to reach to logical conclusion regarding the position and progress of the business on the basis of analysis. Thus, analysis and interpretation of financial statements are regarded as complimentary to each other.

Please refer to the link below - CBSE Class 11 Financial Markets-Financial Statement Analysis