Financial statement analysis

1. Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P.G. Dept. of Commerce
N A M College Kallikkandy
Kannur – Kerala - India

2. Analysis and Interpretation
• Financial statements provide valuable information to
different stakeholders
• Fail to provide adequate information for taking
decisions regarding several aspects by different users
of the accounting information
• To help different users of accounting information, the
financial statements are analyzed and interpreted
• Interpretation is the last stage in the accounting
process

3. Meaning and Definition
Analysis and interpretation of financial statements is
• “the process of identifying the financial strength and
weakness of the firm by properly establishing relationship
between the items of the balance sheet and the profit and
loss account and other operative data”.
• “Is the process of evaluating the relationship between
component parts of a financial statement to obtain a better
understanding of a firm’s position and performance” –
Metcalf
• “Financial statement analysis is largely a study of
relationship among the various financial factors in a
business as disclosed by a statement and a study of the
trend of these factors as shown in a series of statements”.

4. The term “financial statement analysis” includes both
- (1) ‘analysis’ and (2)‘interpretation’.
These two terms can be differentiated.
• ‘Analysis’ means ‘simplification of the financial data by
methodical classification of data given in the financial
statements’.
• ‘Interpretation’ means ‘explaining the meaning and
significance of the data to simplified”
• Both are interlinked and complementary to each other.
• Analysis is useless without interpretation and
interpretation is difficult without analysis
• Thus, the term financial statement analysis or financial
analysis covers both analysis and interpretation of
financial statements.

5. Objects of Analysis and Interpretation
 Different users have different objectives or purposes
 However, common objectives can be:-
1. To examine the earning capacity and efficiency of various
business activities with the help of income statement
2. To determine the performance efficiency and managerial
ability of the business
3. To determine the solvency and liquidity position of the
business with the help of balance sheet
4. To determine the profitability and future prospects of the
business
5. To determine the operational efficiency of similar firms

6. Procedure for Analysis and Interpretation (Steps)
1. Determine the objective
2. Study the financial data carefully
3. Collect additional information, if necessary
4. Arrange (present) the data
5. Analyze the data by using various
6. Interpret the data on the basis of the facts
disclosed in the analysis
7. Present the interpreted data in the form of reports
to appropriate authorities

7. Analysis
Material Used
External Internal
Modus Operandi
Horizo-
ntal
Vertical

8. Types of Financial Analysis
I. The information (materials) used for analysis
II. The method of operation followed for analysis or modus operandi of
analysis.
On the basis of materials used
a. External analysis and
b. Internal analysis
 I-a. External Analysis
External parties, the only available material for analysis and interpretation
is the published financial statements and other available data. No
access to the internal records and information.
Analysis conducted on the basis of published financial statements done by
outsiders is known as external analysis.
Due to data constraints (limited availability) such analysis serves only
limited purposes.
 I- b. Internal Analysis: Conducted by persons who have access to the
internal accounting records of a firm
• Conducted by management and employees of the organization and
government on the basis of statutory powers

9. II –a. Horizontal Analysis
• Analysis of financial data over a period of time
(5 /10 years etc).
• Comparison of financial data for several years
• Tries to examine what happened to the items
under study over the period
• Studies the trend of the items
• Data are arranged horizontally, thus, it is called
as horizontal analysis.
• Also known as ‘dynamic analysis and ‘trend
analysis’, because it studies the changes or
trend over the period under study

10. II – b. Vertical Analysis:
• Analysis made by analyzing the data contained in
the financial statements of a particular period
• Studies the quantitative relationship between
various items contained in a single statement or
items contained in different statements of a
single period
• Also known as ‘static analysis’
• Data are arranged vertically, thus, it is known as
vertical analysis

11. Tools and Techniques or Methods or Devices of Analysis
• Depending upon the purpose or objective of analysis
and data availability, different tools and techniques can
be used for analysis
Following are the important tools or techniques or
methods or devices used for financial analysis
– Comparative Statements
– Common-size Statements
– Trend Analysis
– Ratio Analysis
– Fund Flow Analysis
– Cash Flow Analysis
– Cost-volume Analysis

12. Comparative Statements:
• Statements which summaries and present related
accounting data for a number of years incorporating
there in the changes (absolute and relative or both) in
individual items of financial statements.
• Include comparative income statement, comparative
balance sheet, comparative statement showing total
assets, working capital etc.
Common-size Statements:
• Financial statements in which items reported are
converted into percentage to some common base.
• Income statement total sales
• Balance sheet, total assets or liabilities

13. Trend Analysis:
• Trend refers to the tendency
• Trend analysis refers to the review and appraisal of the
tendency in accounting variables (items in the financial
statements).
• Data over a period of time is taken and trend ratios are
calculated or trend lines are fitted with the help of graphs.
Ratio Analysis:
• Ratio shows the mathematical relationship between two
variables or items.
• Accounting ratio refers to the mathematical relationship
between two accounting variable.
• Analysis of financial statements through accounting ratios is
known as ratio analysis.

14. Fund Flow Analysis:
• Refers to the financial analysis by preparing fund
flow statement.
• Made to determine the changes in the working
capital position of the firm.
• Shows the sources of funds and application of funds
Cash Flow Analysis:
• Analysis conducted by preparing cash flow
statement.
• Conducted to determine the changes in the cash
position of the firm.
• shows the sources and application of cash.