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Practice each question, then open the answer or worked solution.
List the techniques of Financial Statement Analysis.
The most commonly used techniques of Financial Statement Analysis are as listed below:
1. Common Size Financial Statements
2. Trend Analysis
3. Comparative Financial Statements
4. Cash Flow Statement
5. Fund Flow Statement
6. Ratio Analysis
Distinguish between Vertical and Horizontal Analysis of financial data.
| Basis of Comparison | Horizontal Analysis | Vertical Analysis |
| Meaning | It is the comparative evaluation of a financial statement of two or more periods for calculating relative and absolute variances for every line of the item | It is the analysis of financial data, which is independent of time and items relating to the financial information of the company and its impact on the performance of the company. |
| Purpose | To specify changes in financial performance between two comparable accounting periods | To compare a financial item as a percentage of the base figure |
| Comparison of | Intra-firm comparison | Both intra and inter-firm comparison |
| Usefulness | The growth or decline of an item is represented here | It is useful in predicting and determining the relative proportion of an item in the financial statement to a common item in the financial statement |
State the meaning of Analysis and Interpretation.
Analysis and interpretation is a critical and systematic examination of the financial statement. It presents the financial data in a systematic manner and also establishes a cause-and-effect relationship with all the items of financial statements. Analysis and interpretation is all about presenting financial data which is self-explanatory and easy to understand. It helps users of accounting information in assessing the status of the financial performance of the business for a time period, and enables them to take proper decisions regarding the finance policy of the firm.
State the importance of Financial Analysis.
Financial analysis is of great importance for the various users of accounting information. Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income, which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analysed. There are various methods which help in analysing financial statements and make them useful for various accounting users.
The following are the essential reasons for performing financial analysis:
1. It is very helpful in determining the financial viability and profit-earning capacity of the firm.
2. It is helpful in evaluating the business solvency in the long term
3. It is useful in comparing the financial status of a firm in comparison to other competitor firms
4. It helps management in decision-making and drafting plans and also establishes a robust and effective control mechanism
What are Comparative Financial Statements?
Comparative financial statements refer to statements which enable comparison that is both intra and inter-firm and is based on a period of time. These statements help various users of accounting information in evaluating the financial progress of a firm in relative terms. These statements express the data in absolute figures or as percentage change and absolute change that occurs in the item of the financial statement over a period of time. The data presented in financial statements are self-explanatory and easy to understand. When items of the financial statement are treated with the same accounting policies and practices over a fixed period of time, then the comparative data derived from such statements bear meaningful comparisons.
Two common types are as follows::
1. Comparative Income Statement
2. Comparative Balance Sheet
What do you mean by Common Size Statements?
Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet, total and net sales are highlighted in percentage. The analysis based on these statements is called Vertical Analysis.
Two types of Common Size Statements are as follows:
1. Common Size Income Statements
2. Common Size Balance Sheet