Analysis of Financial Statements

Analysis of financial statements means studying financial statements to understand the real condition of a business.

Financial statements give numbers.

Analysis helps us understand the meaning behind those numbers.

Example: a company earned profit of Rs.1,00,000. This number alone is not enough.

We should ask whether profit is increasing, whether the company can pay short-term bills, whether loans are too high, whether cash is coming in, and whether the company is better than last year.

Simple line: Financial statement analysis means reading the story behind the numbers.

Financial statements are useful, but they are only the starting point.

Analysis helps understand whether the business is profitable.

It shows whether the company can pay short-term liabilities.

It shows whether the company has too much debt.

It helps compare this year with last year.

It helps compare one company with another company.

It helps investors, banks, owners, and managers make decisions.

Simple line: Financial statement analysis helps people make better decisions.

Riya wants to invest in a company.

Company A has profit Rs.1,00,000.

Company B has profit Rs.80,000.

At first, Company A looks better.

But after analysis, Riya finds Company A has high profit, very high loans, and low cash balance.

Company B has slightly lower profit, low debt, strong cash balance, and growing sales.

Now Riya understands that only profit is not enough.

Simple line: Analysis helps us avoid judging a company by one number only.

Preparing financial statements means making reports.

Analysing financial statements means studying those reports.

Preparation shows numbers.

Analysis explains the meaning of numbers.

Example: preparation says profit is Rs.1,00,000. Analysis asks whether this profit is good or bad.

Example: preparation says loan is Rs.5,00,000. Analysis asks whether debt is too high.

Memory line: Preparation gives numbers. Analysis gives understanding.

Financial statement analysis asks whether the company is earning profit.

It asks whether profit is increasing.

It asks whether the company can pay short-term dues.

It asks whether the company has too much debt.

It asks whether the company is using assets properly.

It asks whether cash is coming in.

It asks whether the company is improving or declining.

It asks whether the company is better than competitors.

Simple line: Analysis checks the health of a company.

Owners and shareholders want to know whether the company is earning profit.

Investors want to decide whether to invest.

Banks and lenders want to know whether the company can repay loans.

Management wants to improve business decisions.

Suppliers want to know whether the company can pay them.

Employees may want to know whether the company is stable.

Simple line: Different users ask different questions from the same financial statements.

Comparative Statements compare two or more years.

Example: sales increased from Rs.5,00,000 to Rs.6,00,000.

Common Size Statements convert numbers into percentages.

Example: expenses are 60% of sales.

Ratio Analysis uses ratios to understand profit, liquidity, debt, and efficiency.

Example: Current Ratio shows short-term payment ability.

Cash Flow Analysis shows where cash came from and where cash went.

Simple line: These tools help us understand financial statements better.

Profitability means the ability of a business to earn profit.

Example: Riya Stationery Ltd. has sales Rs.5,00,000 and expenses Rs.4,00,000.

Profit is Rs.1,00,000.

Profitability asks whether the company is earning enough profit from its sales.

Simple line: Profitability tells whether the company is earning well.

Liquidity means the ability of a company to pay short-term liabilities.

Example: the company has to pay suppliers Rs.50,000 soon.

It has cash Rs.20,000, debtors Rs.40,000, and stock Rs.30,000.

The company may be able to pay because it has current assets.

Simple line: Liquidity tells whether the company can pay short-term bills.

Solvency means the ability of a company to survive and pay long-term debts.

Example: a company has high loans and debentures.

Analysis asks whether the company can repay these long-term debts.

Simple line: Liquidity is short-term payment ability. Solvency is long-term financial strength.

Efficiency means how well the company uses its resources.

Example: two companies both have machines worth Rs.5,00,000.

Company A earns sales of Rs.10,00,000.

Company B earns sales of Rs.4,00,000.

Company A is using its machines more efficiently.

Simple line: Efficiency tells how well the business uses assets, stock, and money.

One year's number may not tell the full story.

We should compare this year with last year.

We should compare one company with another company.

We can also compare actual performance with expected performance.

Example: profit this year is Rs.1,00,000, but last year profit was Rs.2,00,000.

So profit has decreased.

Simple line: Comparison helps us understand whether performance is improving or falling.

Financial statement analysis is useful, but it has limits.

It uses past data.

It may not show future problems.

Different companies may use different accounting policies.

Numbers alone do not show everything.

Non-financial factors are also important.

Window dressing may make statements look better than reality.

Example: a company may show profit, but customers may be unhappy.

Simple line: Analysis is powerful, but it should be used with common sense.