financial statement

1. Financial statement analysis
Kulbir Singh

2. Introduction
Financial statements are reports prepared by a
company’s management to present the financial
performance and position at a point in time. A general-
purpose set of financial statements usually includes a
balance sheet, income statements, statement of owner’s
equity, and statement of cash flows. These statements
are prepared to give users outside of the company, like
investors and creditors, more information about the
company’s financial positions. Publicly traded
companies are also required to present these statements
along with others to regulator agencies in a timely
manner.

3. Financial statement analysis is the process of
reviewing and analysing a company’s financial
statements to make better economic decisions to
earn income in future. These statements include the
income statement, balance sheet, statement of cash
flow. Financial statement analysis is a method or
process involving specific techniques for evaluating
risks, performance, financial health and future
prospects of an organization

4. Nature of financial statement
• Recorded facts: The term ‘recorded facts’ refers to the
data taken out from the accounting records. The records
are maintained on the basis of actual cost data. The
original cost or historical cost is the basis of recording
various transactions. The figures of various accounts
such as cash in hand, cash in bank, bills receivables,
sundry debtors, fixed assets etc. are taken as per the
figures recorded in the accounting books.

5. Accounting conventions: Accounting Standards prescribe
certain conventions applicable in the process of accounting.
We have to apply these conventions while preparing these
statements. For example, the valuation of inventory at cost
price or market price, depending on whichever is lower.
Personal judgments: Even though certain standard
accounting conventions are followed in preparing financial
statements but still personal judgment of the accountant plays
an important part. For example, in applying the cost or market
value whichever is less to inventory valuation the accountant
will have to use his judgment in computing the cost in a
particular case. Even personal opinions and judgments play a
big role in the preparation of these statements. Thus, we have
to rely on our own estimates while calculating things like
depreciation.

6. Postulates: The accountant makes certain assumptions while
making accounting records. One of these assumptions is that
the enterprise is treated as a going concern. The other
alternative to this postulate is that the concern is to be
liquidated, this, is untenable if management shows an
intention to liquidate the concern. So the assets are shown on
a going concern basis. Another important assumption is to
presume that the value of money will remain the same in
different periods.
Accounting Standards and Guidance Notes: Accountants are
guided by various accounting standards and guidance notes in
preparing the financial statement.

7. Objectives of financial statement
• Knowing Profitability of Business
• Knowing the Solvency of the Business
• Judging the Growth of the Business
• Judging Financial Strength of Business
• Making Comparison and Selection of
Appropriate Policy
• Forecasting and Preparing Budgets
• Communicating with Different Parties

8. ATTRIBUTES OF FINANCIAL STATEMENTS
• Relevance: The financial statements prepared must
be relevant for the purpose they are supposed to
serve. While irrelevant and confusing disclosures
should be avoided, nothing relevant and material
should be held back from the public.
• Accuracy and Freedom from Bias: Financial
Statements should convey a full and correct idea
about the progress, position and prospects of an
enterprise. For this purpose they must be accurately
prepared.

9. Comparability: Comparability increases the utility of
financial statements. Comparison with previous statements
helps in assessing the performance and in localising the trends
in the progress and position of the business enterprise.
Analytical Presentation: The financial statements should be
prepared in a classified form so that a better and meaningful
analysis can be made. Proper classification helps in tracing
and understanding in causes of the results as shown in these
statements.
Promptness: No doubt, that the preparation of financial
statement is somewhat complicated, but an undue delay in
their preparation would reduce the significance and utility of
these statements. They should be prepared as soon as possible,
after the end of the period for which they are meant.

10. Generally Accepted Principles: Since the financial
statements are meant for the use of a wider clientele, they must
have general acceptability and understandability.
Consistency: The financial statements for a certain period are
affected by the judgment and procedural choices exercised by
the accountant. Consistency has a direct bearing upon
comparability. If inventories are valued on different basis in
different periods (LIFO to FIFO to Replacement Cost) the
results disclosed, generate doubt and comparison becomes
difficult.
Authenticity: The financial statements in order to be accepted
as reliable must be reviewed and authenticated by an
independent and capable person, generally known as auditor

11. IMPORTANCE OF FINANCIAL STATEMENTS
Management Labour and trade union
Public Government
Shareholder Tax authority
Stakeholder
Researcher
Public
Debtors
creditors

12. Limitations of Financial Statement
• Inflation: financial statements do not consider the effects
of inflation on the assets and liabilities shown in the
balance sheet. In a period when the inflation rate is too
high, the balance sheet misleads by showing substantially
low values.
• Specific time period: Financial statements are prepared for
a specific time period normally a year. Looking at one such
period could be misleading because of seasonal impact on
businesses, economic ups and downs etc.
• Not comparable: For checking the performance of one
company, it is a common practice to compare it with other
similar company in the same sector. A financial statement
just gives an indication and does not facilitate true
comparison between the two companies

13. Chances of Frauds: There are many situations when the
financial statement becomes a tool to commit fraud. There are
a lot of agencies who base their decisions on funding, rating
etc on financial statements.
Ignores non-financial matters: Successfully running a
business is not limited to sales, expenses, and profits. A lot of
other environmental, sociological, political factors,
competitive position, contribution towards local communities
etc impact the business. These factors are ignored in the
financial statements.
Not futuristic: There is no express indication by the financial
statements about the future.

14. Errors and omissions: The basic recording of transactions is
carried out by the accounting executive who is normally not
highly qualified. So there are always chances of errors and
omissions.
Qualitative information: Financial statements highly focus
on quantitative data and thus misses out on qualitative
information which is very crucial in running the show.
Qualitative information could be the efficiency of
management, employees, customer satisfaction, the efficiency
of the supply chain, etc.
Required expert knowledge: Financial statements are not
self-explanatory which a layman can understand. Reading,
understanding and interpreting the financial statements
requires expert knowledge of accounting, finance etc.

15. Hide true profits: he true profitability of a business can be
hidden if there is a one-time income received from non-
operating activities of the company like profits from
Investments, etc.
Valuation of closing stock: Valuation of closing stock is it
tool for the wicked management. It is very easy to manipulate
the value of the stock.