Question

In 600 words (300 each) answer the following questions and also provide citation and references to justify your answers.

Q1. Explain the purpose of the three major financial statements (i.e. the statement of cash flows, the income statement and the statement of financial position) and discuss how together they provide an overview of the financial health of a firm .

Q2. Ratio analysis is a widely used technique for evaluating the financial performance and stability of a business. However, there are many limitations to ratio analysis. Discuss the main limitations below .

Answer 1

Answer to Q1

The purpose of three major financial statements provides the information and health of a company to general public and shareholders of the firm. All three financial statements provides the company's visiblity into earning capability, effective cash flow for the firm, how strong the company assets in balance sheet.It is also provides the credibility of the firm to a creditor to deal with a company in furture. Balance sheet provides the company the main funds is being used, it also provides the how well a company working capital is managed, how is the long term assets utlized to generate the profitability. Cash flow statement provide what's is the cash from operational acitivty , vs investing vs financing activity.

Cash flow from operating activity provides cash recived from the sales of products and services, cash paid out for the cost of production , payment towards credtiors and chages in amount of current assets and current liablity in balance sheet.

Cash from Investing activity provides the purchase and sale of company assets, Cash from financing acitivity provides the fund source of the company.

An income statement provides about the companies income and expenses details , what is total Revenue , other revenue companies is genrating and also the detailed about all expenses like Salary, selling and general adminstrative expenses , profit out of this and gross margin .

Answer to Q2

Main limitations of Ratio Analysis:

It doesn't talk about the sizes of a company how big the company is and should be comapre with.

It fails when it comes to analysis information like seasonal sales generated by company.

It doens't consider market conditions its just talked about what has happened inside the company.

It can't be used to compare with different industry as it is only relevent to comparing in the same industry.

It ignore about customer visibility.

It is purely based on historical data doesn't talk about futuristic approach .

There are no well established rules of thumb when it comes to ratio analysis different prospects to different ratios are in the market and being analysied in different way.

Ratio analysis is only for quantitative analysis it ignore the factor for qualitative analysis like if a management purchases huge number of raw materials due to furturstic demands of the prodcuts are high but current increase in raw materials purchase will not consider that impact while doing calculation like inventory turnover and other ratios.

Financial Ratios are only a clue and a very high level view of the company, we need to dig down to product, customer and detailed level to figure out what exactly happening in the company.