Question

Financial statement analysis is an integral part of business analysis. In addition, explain why financial statements are important to the decision-making process in financial analysis. Also, identify and discuss some of their limitations for analysis purposes.

Answer 1

Financial analysis refers to analysis of income statement, balance sheet position and cash flow statement of a company which includes analysis of profitability, solvency and liquidity of a company before making any investment decision.

Importance of financial statements in decision making process in financial analysis

1) Financial statements of the company includes the profitability, stability, liquidity and solvency of the company. This helps the investors or the decision makers to get more information about the company's business performance.

2) Financial analysis helps the decision makers to analysis the entire situation of the company.

3) With the help of financial statements of the company, the decision makers can calculate various financial ratios and can compare with past performance to better understand the trend of the company.

4) Financial analysis helps to understand whether the company will be able to meet its financial obligations in future and whether the company has sufficient funds to invest in profitable projects.

Limitations of financial analysis

1) One of the major limitations of financial analysis is that the financial statements could be subject to fraud that is there might be increase in sales or other financial variables without actual increase in sales.

2) The financial statements would not have effect of inflation which would under value the assets and liabilities specially the long term one.

3) There are various other business issue also be considered before making any decision that is the major customers, management, internal process of the company which will not be reflected in the financial statements.

4) The financial statements provide historical value that is the details about the things which has alreadu happen, it does not give details about the performance of the company in the future.