FINANCIAL ANALYSIS :
Financial analysis is an assessment of the viability, stability and profitability of unit, project or company. A careful analysis of the financial data has a great importance in the process of decision making by banks as it is based upon the concrete results of the company’s strategy and structure. Financial analysis assists in determining a company’s performance, health and stability using its balance sheet, profit and loss (P&L) account, cash flow statement etc.
The performance of a company or business enterprise can be measured by looking into the financial results of the company over a period of time. A comparative study of the financial statements assist the analyst in assessing the results. Two important financial statements commonly used for financial analysis are P & L account, and balance sheet.
The financial statements are analyzed and interpreted by different classes of persons, such as individual and institutional investors, bankers, financial institutions, credit analysts, credit rating agencies, research, management students and institutional investors.
P & L and Balance sheet analysis:
(i) The balance sheet shows the financial position of the business as at the end of a particular period (month, quarter or year). It shows the asset and liability position for a company on a particular date on which the balance sheet was drawn.
(ii) The profit and loss account shows the financial results of the working of an enterprise over a period of time. For example, 1st of April 2012 to 31st March 2013. This statement shows the profit or loss of the company during the span of the period covered.
(iii) A comparative analysis of these statements for a number of years gives a better view about the financial performance of the business unit over a period of time. This indicates growth or decline of past performance usually termed as trend analysis.
(iv) Financial analysis and interpretation of financial statements have now become important decision making tools, and is successfully used by banks, entrepreneurs, consultants and auditors. In developed countries even the investors carryout such analysis before putting in their fund.
Advantages of analysis of financial statements:
(a) The financial results in the form of P&L accounts and balance sheets are readily available. Further, there are statutory requirements regarding the certification of these statements which increase the credibility of financial statements. Statutory requirement for the companies, in case of Pvt. Limited company and limited companies getting it Certified is also compulsory as such these financial statements are true and accurate and provides genuine result when analysed.
(b) These financial statements are drawn as per the accounting standards and as per the regulatory and legal frame work. Thus, these statements provide a homogenous presentation which makes the analysis comparable.
(c) Depending upon the requirement of the analyst (investors, bankers, credit rating agencies etc.) the figures and data available on these statements can be easily grouped and interpreted.
(d) The financial statements can be used for ratio analysis, trend analysis etc.
While using the financial statements, the limitations are:
(i) The balance sheet numbers are available as at a particular date hence may not reveal the correct position of the financial health for over a period of year.
(ii) Since both profit and loss account and balance sheet are in the form of numerical statements, these statements may not reveal the overall picture about the performance of the concern or business unit. This means the productivity, moral status; motivated management and staff are not indicated. Also to cover it a management audit is carried out independently.
(iii) The methods of valuation of assets, writing off depreciation, amortization of costs, large expenses etc. may vary from one business unit to another. Therefore, a comparison of these numbers and ratios may not give desired results and calls for further detailed investigations.
(iv) Further, these financial statements depict the performance of the business enterprise. Therefore, any meaningful interpretation of these statements, will depend upon the projections of the future trend. But no doubt, it provides a basis to think ahead.