Tools of Analysis of Financial Statements

Meaning of Analysis of Financial Statements:

Financial statement analysis is the procedure of analysing an enterprise’s financial statements for making decisions for the purposes and to understand the comprehensive health of an organisation. Financial statements document financial information, which must be evaluated through financial statement analysis to become more helpful to shareholders, managers, investors and other interested parties. To put it in other words, the term ‘financial analysis’ comprises both ‘analysis and interpretation’.

Tools of Analysis of Financial Statements :

The most frequently used tools of financial analysis are as follows :

• Comparative Statements: These are the statements depicting the financial position and profitability of an enterprise for the distinct timeframe in a comparative form to give a notion about the position of 2 or more periods. It usually applies to the 2 important financial statements, namely, statement of profit and loss and balance sheet outlined in a comparative form. Comparative figures signify the direction and trend of financial position and operating outcomes. This type of analysis is also referred to as ‘horizontal analysis’.
• Common Size Statements: Common size statements are the statements which signify the association of distinct items of a financial statement with a generally known item by depicting each item as a % of that common item. Such statements allow an analyst to compare the financing and operating attributes of 2 enterprises of distinct sizes in a similar industry. This analysis is also referred to as ‘Vertical analysis’.
• Cash Flow Analysis: It refers to the analysis of the actual movement of cash into and out of an establishment. The flow of cash into the trading concern is called cash inflow or positive cash flow and the flow of cash out of the enterprise is known as negative cash flow or cash outflow. The difference between the outflow and inflow of cash is the net cash flow. Hence, it compiles the reasons for the changes in the cash position of a trading concern between dates of 2 balance sheets.
• Ratio Analysis: It characterizes the vital association which exists between several items of a B/S (balance sheet) and a statement of P&L of an enterprise. As a method of financial analysis, accounting ratios compute the comparative importance of the single items of the position and income statements. It is feasible to evaluate the solvency, efficiency, and profitability of an enterprise via the method of ratio analysis.

This concludes the article on the topic of Tools of Analysis of Financial Statements, which is an important topic for Class 12 Commerce students. For more such interesting articles, stay tuned to BYJU’S.