Financial Statement Analysis & Interpretation – [Part –I]
Financial Statement Includes:
“The most important function of financial statements is to serve those who control and direct the business and may be answered the questions, how efficiently the capital of the business is being utilized, how well credit standards are being observed, and whether the financial condition is being improved.”
The Meaning of Analysis and Interpretation
The financial statements are of much interest to number of groups of persons. Apart from the management there are other interested parties like shareholders, debenture holders, potential investors, bankers, trade creditors and legislature.
**Interpret means to put the meaning of a statement into simple terms for the benefit of a person.
** Analysis comprise resolving the statements by breaking them into simpler statements by a process or rearranging, regrouping and the calculation of ratios, interpretation is the mental process of understanding the terms of such statements and forming opinions or inferences about the financial health, profitability, efficiency and such other aspects of the understanding.
Objectives of Analysis and Interpretation
– To evaluate the financial health of the understanding.
– To evaluate the earning performance of the undertaking.
– To evaluate the ability of the undertaking to pay interest, amortized debt and other outside liability.
– To evaluate the solvency of the undertaking. By the understating of solvency of the undertaking above points can be well understand.
– Whether current assts are sufficient to pay off the current liabilities.
– Proportion of liquid assets (cash and book debts) to current assets.
– Whether the debenture holders are secured by a floating charge of the currents assets.
– Future growth of undertaking and earning.
Example: Bankers who provide short term working capital loan and medium term credit they generally look into the following matter:
– The purpose of loan.
– The manner in which the borrower proposes to repay the loan.
– The capacity of company to repay as evaluated by trends of profits.
– Banker’s position in the event of forced liquidation.
– The quality of management.
– History of accounts in the history.
Types of Analysis:
Tools of Financial Analysis:
(i) Balance Sheet Ratio:
(a) Current Ratio or Working Capital Ratio
(b) Liquid Ratio or Acid Test Ratio
(c) Proprietary Ratio
(d) Assets Proprietorship Ratio.
(ii) Profit & Loss Statement Ratio
(a) Gross Profit Ratio
(b) Operating Ratio
(c) Expenses Ratio
(d) Net Profit Ratio
(e) Stock Turnover Ratio
(iii) Balance Sheet and Profit & Loss Statement Ratio
(a) Return on total resources
(b) Return on Own Funds
(c) Turnover of Fixed Assets
(d) Turnover of Debenture
(e) Earning Per Share