Analysis and Interpretation of Financial Statements
The analysis and interpretation of financial statements are attempts to determine the significance and meaning of financial statement data so that a forecast can be made of the prospects for future earnings ability to pay interest, debt maturities and probability of a sound dividend policy.
Types of Financial Analysis:
1. External analysis: - This is made by those who do not have access to the detailed records of the company. This group includes credit agencies, investor and governmental agencies regulating a business in a nominal way.
2. Internal analysis: - This is accomplished by those who have access to the books of accounts and all other information related to business. The internal analyst analyses for managerial purposes.
3. Horizontal analysis:- When financial statements for a number of years are reviewed and analyzed, the analysis is called Horizontal analysis. This is also known as dynamic analysis as it is based on data from year to year rather than one data of a period of time as a whole.
4. Vertical analysis- It is often used for referring to ratios developed on one date or for one accounting period. It is also called as static analysis.
External and internal analyses are differentiated according to material used and horizontal analysis and vertical analysis are differentiated according to modus operandi of analysis.
Methods and devices used in analyzing financial statements:
1. Comparative financial and operating statements
2. Statement of changes in net working capital
3. Trend Ratios
4. Common size percentages and
5. Individual ratios.
Financial Troubles: - A concern may face the following financial troubles, the effect of which can be reduced by proper control established on the basis of management accounting information:
1. Failure to make a profit
2. Running out of money
3. Overtrading
4. Under trading
5. Over Capitalization
6. Under Capitalization
7. Capital gearing and
8. Earning capacity reduction.
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