Question

Why do we need different tools for analyzing the financial statements? Don't the numbers in the financial statements speak for themselves?

Answer 1

Financial statements are usually the final output of a company’s accounting operations. These statements contain information relating to the revenues, expenses, assets, liabilities and retained earnings of the business. Business owners often pay close attention to this information since the statements can provide detailed information about the company’s operational performance. Many business owners and managers use specific analysis tools to closely review their company’s financial statements for decision-making purposes.

Financial statement analysis involves gaining an understanding of an organization's financial situation by reviewing its financial statements.

-->> the following items for a company's financial statements over a series of reporting periods

• Trends. Create trend lines for key items in the financial statements over multiple time periods, to see how the company is performing. Typical trend lines are for revenues, the gross margin, net profits, cash, accounts receivable, and debt.

• Proportion analysis. An array of ratios are available for discerning the relationship between the size of various accounts in the financial statements. For example, one can calculate a company's quick ratio to estimate its ability to pay its immediate liabilities, or its debt to equity ratio to see if it has taken on too much debt. These analyses are frequently between the revenues and expenses listed on the income statement and the assets, liabilities, and equity accounts listed on the balance sheet.

Financial statement analysis is an exceptionally powerful tool for a variety of users of financial statements, each having different objectives in learning about the financial circumstances of the entity.

Published accounts presented by a company in an annual general meeting do not serve the inherent purpose of every user of accounting information. The information contained in these financial statements does not give any instant suggestion or direction with regard to solvency, liquidity. operating efficiency. debt capacity. or future prospects of the company. It is believed that figures do not speak themselves, we have to make them speak. For this purpose the information contained in these financial statements is used (analysed) by the management, creditors, investors, bankers, employees, shareholders and others to form judgements and to get better insight about the financial strength and weakness of the company concerned. This analysis is done by means of various tools such as: Comparative Statements » Common size Statements o Trend Analysis, and Ratio Analysis. These tools of analysis help in estimating earning capacity of the enterprises, assessing the financial position of the company, ascertaining the future prospects of the firm, measuring the efficiency of operation. judging the solvency of an enterprise, determining the debt capacity of the company. assessing the financial performance of the business and to know the progress and take future course of action. The present chapter focuses only on last and the most reliable tool of analysis i.e.. "Ratio Analysis".