Introduction A financial statement is a compilation of data, which is logically and consistently organized according to accounting principles. Its purpose is to convey an understanding of some financial aspects of a business firm. It may show a position at a moment in time, as in the case of a balance sheet, or may reveal a series of activities over a given period of time, as in the case of an income statement, financial statements are the major means through which firms present their financial situation to stockholders, creditors, and the general public. The majority of firms include extensive financial statements in their annual reports, which receive wide distribution. The major purposes and type of financial information in the financial statements Financial statements are very important for decision making because they provide accounting information to be used by various parties. Financial statements they quantify the information in financial nature and of economic entities for useful economic entities. There are two types of information users of accounting. The first is the internal uses who make economic decisions which is directly affecting the internal operations of a company.
This group consists of management, employees and directors. There is another group who use financial statements to make decisions which are concerning their relationships to the enterprise. These groups include: creditors, investors, financial analysts, environmentalist, government agencies and other interested parties. The information used by each party forms the basis of preparation of financial statements. This information which if used for the purpose of decision making must be provided in a timely manner. External users of financial statements require diverse accounting information due the fact that they make a variety of decision concerning their relationship with the organization. The external information users decisions they make usually affect the companies resource allocation and the information they provide should be useful to foster the decision making process. Financial statement analysis consists of the application of analytical tools and techniques to the data in financial statements in order to derive from them measurements and relationships that are significant and useful foe decision making (ICFAI Centre for Management Research ICMR).
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The process of financial analysis can be described in various ways. Depending on objectives to be obtained. Financial analysis can be used as a preliminary screening tool of future financial conditions and results. It maybe used as a process of forecasting tool of future financial conditions and results. It may be used as a process of evaluation and diagnosis of managerial, operating, or other problem areas. Above all, financial analysis reduces reliance on intuition, guesses and thus narrows the areas of uncertainty that is present in all decision making processes. Financial analysis does not lessen the need for judgment by rather establishes sound and systematic basis for its rational application. How items in common-size statements are presented A pervasive problem when comparing a firm?s performance over time is that the firm?s size is always changing. Firms of different sizes are also difficult to compare. Common-size statements are used to standardize financial statement components by expressing them as a percentage of a relevant base. The balance sheet components can be shown as a percentage of total sales, and in the direct method cash flow statement, the components of cash flow from operations can be related to cash collections. Common-size statements provide the analyst with useful information as a first step in developing insights into the economic characteristics of different industries and of over time may be traced to variations in cost of goods sold as a percentage of sales. Changes in this ratio may indicate the efficacy of the firm?s efforts to streamline its operations and/or a change in pricing strategies. Additionally, differences over time in a single firm or between firms due to operating, financing, and investing decisions made by management and external economic factors are often highlighted by common-size statements. How ratios in ratio analysis are computed and used Facts can be gathered and tentative conclusions can be drawn in the initial scanning of operations. Later, analyzing can provide information and understanding considerable depth. A ratio analysis measures how a company is doing in comparison with past years and its competitors in the industry.
Ratio analysis is a popular tool among financial analysts. This mainly attributable to the simplicity in calculation and indication of the direction in which further probing is necessary. With respect to this argument, some of the important ratios that can be used for gauging the efficiency of working capital management are discussed in detail in forthcoming paragraphs. In addition to liquidity and profitability, the owners of the firm i.e. the shareholders are concerned about the policies of the firm that affect the market price of the firm?s stock. Without liquidity, the firm cannot pay cash dividends. Without profits, the firm would not be able to declare dividends. With poor policies, the common stock would trade at low prices in the market. Keeping in view the above discussions regarding the category of users, financial ratios fall into three groups as follows: ? Liquidity ratios ? Profitability or efficiency ratios ? Ownership ratios o Earnings ratios o Dividend ratios o Leverage ratios %uF0A7 Capital Structure ratios %uF0A7 Coverage ratios All the above mentioned categories of ratios are discussed in detail as under.