Question

Why does the management of any companies analyze financial statements? Explain by using the different tools in analyzing financial statement with proper numerical example.

Answer 1

Financial statements tell us about the financial position of a company over a given time. This enables the management to distinguish and examine the health of one organization to another. So it is the basic requirement to analyze financial statements while taking investment decisions, future planning, fundraising, expansion decisions, and making resource allocations.

Financial statements prepared to know the detailed information about assets, liabilities, shareholder equity, reserves, expenses, and profit or loss for the financial year. Financial statements analysis can provide the management about its performance as well as compared to the competitors. Financial statements help management in trend analysis.

Financial statements analysis includes trend analysis, ratio analysis, benchmarking, comparative financial statement, cash flow analysis and funds flow analysis.

Comparative statement analysis:
This tool provides information regarding the profitability and performance of the current year over the previous year.
For Example,
With the given information illustrate the comparative statement of profit and loss of ABC Co. Ltd.:

Comparative statement of profit and loss for the year ended March 31, 2018, and 2019:

From the above example, we can understand that in the year 2018-19 the company has good earnings and it has a good sound position.

Trend analysis:

Trend analysis is considering the operational events and financial situation over a range of years. By observing this analysis, the sign of good or poor management can found.

For example,
Find out the trend percentages from the following information on sales, inventory, and profit of ABC Ltd., taking 2015 as the base year and interpret.

Interpretation:

• The sales increased in all the years up to 2019, though in various proportions. The percentage in 2019 is 200 as contrasted to 100 in 2010. The increase in sales is adequate.
• Profit has considerably improved. The profits have grown in good proportion than sales which symbolizes that the company has been capable to minimize the cost of goods sold and constrain the managing costs.

Ratio Analysis:
It represents the meaningful connection that subsists between different items of a balance sheet and a statement of profit and loss of a firm.

Turnover ratio:
If the turnover ratio is high then the company is efficiently utilizing its assets. If a business has a low turnover ratio then it is not efficiently utilizing its assets to produce sales, and some adjustments need to make. The same way accounts receivable ratio and accounts payable ratio useful to understand the effectiveness in collecting in accounts receivables and paying in accounts payable.

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