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    This document provides an introduction to financial statement analysis. It defines financial analysis and financial statement analysis. It describes the features of financial analysis as presenting complex financial data in a simple way, classifying items into rational groups, and allowing comparisons to draw conclusions. The purpose of analysis is to determine profitability, solvency, financial strengths, and efficiency. The procedure involves understanding accounting principles, determining the analysis scope, rearranging and standardizing financial data, interpreting it, and presenting conclusions. Advantages are that it allows investors to evaluate investments and companies/regulators to ensure compliance and evaluate taxes.

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    This document provides an introduction to financial statement analysis. It defines financial analysis and financial statement analysis. It describes the features of financial analysis as presenting complex financial data in a simple way, classifying items into rational groups, and allowing comparisons to draw conclusions. The purpose of analysis is to determine profitability, solvency, financial strengths, and efficiency. The procedure involves understanding accounting principles, determining the analysis scope, rearranging and standardizing financial data, interpreting it, and presenting conclusions. Advantages are that it allows investors to evaluate investments and companies/regulators to ensure compliance and evaluate taxes.

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    FSA 1

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    This document provides an introduction to financial statement analysis. It defines financial analysis and financial statement analysis. It describes the features of financial analysis as presenting complex financial data in a simple way, classifying items into rational groups, and allowing comparisons to draw conclusions. The purpose of analysis is to determine profitability, solvency, financial strengths, and efficiency. The procedure involves understanding accounting principles, determining the analysis scope, rearranging and standardizing financial data, interpreting it, and presenting conclusions. Advantages are that it allows investors to evaluate investments and companies/regulators to ensure compliance and evaluate taxes.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    7 views6 pages

    Fsa 1

    Uploaded by

    wambualucas74
    This document provides an introduction to financial statement analysis. It defines financial analysis and financial statement analysis. It describes the features of financial analysis as presenting complex financial data in a simple way, classifying items into rational groups, and allowing comparisons to draw conclusions. The purpose of analysis is to determine profitability, solvency, financial strengths, and efficiency. The procedure involves understanding accounting principles, determining the analysis scope, rearranging and standardizing financial data, interpreting it, and presenting conclusions. Advantages are that it allows investors to evaluate investments and companies/regulators to ensure compliance and evaluate taxes.

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    of 6

    FSA Chapter One: Introduction

    Learning Outcome

    At the end of this topic, the learner should be able


    Define financial analysis and Financial statement analysis
    Describe the Features of Financial Analysis
    Determine the Purpose of Analysis of financial statements
    Outline the Procedure of Financial Statement Analysis
    Appreciate the importance of Financial Statement Analysis:
    In order to make rational decisions in keeping with objectives of the firm the stakeholders

    especially the managers must have at their disposal certain analytical tools. These tools of

    financial analysis are important as they give a feedback as to the contents of the financial

    statements. These tools are also used by outside suppliers of capital, creditors, investors

    and by the firm itself. The firm uses financial analysis not only for internal controls but

    also for a better understanding of what capital suppliers seeks in the way of financial

    conditions and performance of it.

    The type of analysis names according to specific intensities


    of parties involved

    agriculture and trade creditor is interested pre-mainly on the liquidity of the firm this

    claim is in the short-term and the ability of the firm to pay this claim is best judged by

    means of through of its liquidity.

    The claim of a bond holder on the other hand is longer accordingly he would be more

    interested in the cash flow ability of the form to use debts over the long run. The bond

    holder thus may evaluate this ability by analyzing the capital structure of the form, the

    6
    major sources and use of the funds, its probability over time and projections of future

    profitability.

    1.1 Definition

    Financial analysis is a process by which finance identifies the company‟s financial

    performances by comparing the entities in the balance sheet and those in the profit and

    loss account (P&L). This is so because balance sheet entities are usually responsible for

    those to be found in the P&L i.e. assets shown in the balance sheet are responsible for

    sales, revenue and expenses to be found in the P&L. Financial statement analysis is

    defined as the process of identifying financial strengths and weaknesses of the firm by

    properly establishing relationship between the items of the balance sheet and the profit

    and loss account. Financial statement analysis (or financial analysis) is the process of

    understanding the risk and profitability of a firm (business, sub-business or project)

    through analysis of reported financial information, particularly annual and quarterly

    reports.

    Financial statement analysis consists of 1) reformulating reported financial statements, 2)

    analysis and adjustments of measurement errors, and 3) financial ratio analysis on the

    basis of reformulated and adjusted financial statements. The two first steps are often

    dropped in practice, meaning that financial ratios are just calculated on the basis of the

    reported numbers, perhaps with some adjustments. Financial statement analysis is the

    foundation for evaluating and pricing credit risk and for doing fundamental company

    valuation.
    There are various methods or techniques that are used in analyzing financial statements,

    such as comparative statements, schedule of changes in working capital, common size

    percentages, funds analysis, trend analysis, and ratios analysis.

    Financial statements are prepared to meet external reporting obligations and also for

    decision making purposes. They play a dominant role in setting the framework of

    managerial decisions. But the information provided in the financial statements is not an

    end in itself as no meaningful conclusions can be drawn from these statements alone.

    However, the information provided in the financial statements is of immense use in

    making decisions through analysis and interpretation of financial statements.

    1.2 Features of Financial Analysis


    To present a complex data contained in the financial statement in simple and

    understandable form.

    To classify the items contained in the financial statement inconvenient and rational

    groups.

    To make comparison between various groups to draw various conclusions.

    1.3 Purpose of Analysis of financial statements


    To know the earning capacity or profitability.

    To know the solvency.

    To know the financial strengths.

    To know the capability of payment of interest & dividends.

    To make comparative study with other firms.

    /To know the trend of business.

    To know the efficiency of mgt.

    To provide useful information to mgt


    1.4 Procedure of Financial Statement Analysis
    The following procedure is adopted for the analysis and interpretation of financial

    statements:-

    The analyst should acquaint himself with principles and postulates of accounting. He

    should know the plans and policies of the managements that he may be able to

    find out whether these plans are properly executed or not.

    The extent of analysis should be determined so that the sphere of work may be

    decided. If the aim is find out. Earning capacity of the enterprise then analysis of

    income statement will be undertaken. On the other hand, if financial position is to

    be studied then balance sheet analysis will be necessary.

    The financial data be given in statement should be recognized and rearranged. It

    will involve the grouping similar data under same heads. Breaking down of

    individual components of statement according to nature. The data is reduced to

    a standard form. A relationship is established among financial statements with the

    help of tools & techniques of analysis such as ratios, trends, common size, fund

    flow etc.

    The information is interpreted in a simple and understandable way. The significance

    and utility of financial data is explained for help indecision making.

    The conclusions drawn from interpretation are presented to the management in the

    form of reports.

    Analyzing financial statements involves evaluating three characteristics of a company:

    its liquidity, its profitability, and its insolvency. A short-term creditor, such as a bank, is

    primarily interested in the ability of the borrower to pay obligations when they come due.

    The liquidity of the borrower is extremely important in evaluating the safety of a loan.

    Along-term creditor, such as a bondholder, however, looks to profitability and solvency


    measures that indicate the company‟s ability to survive over a long period of time. Long-

    term creditors consider such measures as the amount of debt in the company‟s capital

    structure and its ability to meet interest payments. Similarly, stockholders are interested

    in the profitability and solvency of the company. They want to assess the likelihood of

    dividends and the growth potential of the stock

    1.5 Advantages of Financial Statement Analysis:

    There are various advantages of financial statements analysis. The major benefit is that

    the investors get enough idea to decide about the investments of their funds in the

    specific company. Secondly, regulatory authorities like International Accounting

    Standards Board can ensure whether the company is following accounting standards or

    not. Thirdly, financial statements analysis can help the government agencies to analyze

    the taxation due to the company. Moreover, company can analyze its own performance

    over the period of time through financial statements analysis.

    Review Questions
    Define financial analysis and Financial statement analysis
    Describe the Features of Financial Analysis
    Determine the Purpose of Analysis of financial statements
    Outline the Procedure of Financial Statement Analysis
    Appreciate the importance of Financial Statement Analysis:

    10
    i) References
    The Analysis and Use of Financial Statements (3rd edition) by White, Sondi &
    Fried (Wiley 2003)

    Financial Reporting and Analysis (4th edition) by Revsine, Collins, Johnson, and
    Mittelstaedt (McGraw-Hill Irwin 2009)

    Financial Statement Analysis & Valuation (2nd edition) by Easton, McAnally,


    Fairfield, and Zhang (Cambridge Business Publishers 2009)

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