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Financial Analysis with reference to Ratio Analysis

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  1. Nature of financial statements
  2. Importance of financial statements
  3. Limitations of financial statements
  4. Meaning of analysis of financial statements
  5. Objectives of financial analysis
  6. Types of financial statements analysis
    1. The nature of the analyst and the material used by him
    2. The objective of the analysis
    3. The modus operandi of the analysis
  7. Limitations of financial statements analysis
    1. Historical nature of financial statements
    2. No substitute for judgment
    3. Reliability of figures
    4. Reliability of figures
    5. Single year analysis is not valuable and useful
    6. Results may have different interpretation
    7. Change in accounting methods
    8. Shortcoming of the tool of analysis
  8. Detailed information on financial analysis in respect with ratio analysis
  9. Importance of ratio analysis
    1. Useful in financial position analysis
    2. Useful in simplifying accounting figures
    3. Useful in assessing the operational efficiency
    4. Useful in forecasting purpose
    5. Useful in locating the weak spots of the business
    6. Useful in comparison of performance
  10. Classification of ratios
    1. Profitability ratios
    2. Financial ratios
    3. Stability ratios
    4. Solvency ratios
  11. Conclusion

Financial statements are prepared for the purpose of presenting a periodical review or report by the management and deal with state of investment in business and result achieved during the period under view. They reflect a combination of recorded facts, accounting conventions and personal judgments. From this it is clear that financial statements are affected by three things i.e. recorded facts, accounting conventions and personal judgments. Only those facts which are recorded in the business books will be reflected in the financial statements.

The following points reflect truly the nature of financial statements of business entities:
(i) These are reports or summarized reviews about the performance, achievements and weaknesses of the concern.
(ii) These are prepared at the end of the accounting period so that various parties may take decisions of their future actions in respect of the relationship with the concerns.
(iii) The reliability of financial statements depends on the reliability of the accounting data. These statements cannot be said to be true and fair representatives of the strengths or profitability of the concern if there are numerous frauds and defalcations in the accounts.

[...] The main objectives of analysis of financial statements are to assess: The present and future earning capacity or profitability of the concern, The operational efficiency of the concern as a whole and of its various parts or departments, (iii) The short term and long term solvency of the term for the benefit of the debenture holders and trade creditors, The comparative study in regard to one firm with another firm or one department with another department, The possibility of developments in the future by making forecast and preparing budgets, The financial stability of a business concern, (vii) The real meaning and significance of financial data, and (viii)The long-term liquidity of its funds. [...]

[...] Ratio is given as= Total expenditure X 100 Total income Financial Ratios: These ratios are calculated to judge the financial position of the concern from long term as well as short term solvency point of view Liquidity Ratios: If it is decided to study position of the concerns, in order to highlight the relative strength of the concerns in meeting their current obligations to maintain sound liquidity and pinpoint the difficulties if any in it, then liquidity ratios are calculated. [...]

[...] If 4,000 is divided by 10,000, then the ratio can be expressed as 0.4 or 2:5 or 40%. A ratio can be used as a yard stick for evaluating the financial position and performance of a concern, because the absolute according data cannot provide meaning full understanding and interpretation. A ratio is the relationship between two accounting items expressed mathematically. Ratio analysis helps the analysts to make quantitative judgments with regard to concern's financial position and performance. Absolute figures are valuable but standing alone conveys no meaning unless compared with another. [...]

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