What is financial statement analysis? Objectives, parties interested in financial statement and types of financial statement analysis

Introduction and Meaning

The term  'Financial analysis' also known as analysis and interpretation of Financial statement  refers to the process of determining financial strength and weakness of the firm by establishing strategies Relationships between the item of the balance sheet, profit and loss Account and other Operative data. "Analysing financial statement" according to Metcalf and titard, is a process of evaluating the Relationships between components part of financial statement to obtain a better understanding of a firm's position and performance.

Definitions

In the word of Myers, "Financial statement analysis is largely a study of relationship among the various financial factors in a business as disclose by the single set of statement, and a study of trend of these factors as shown in a series of statement".

The purpose of financial analysis is to diagnose the information contained in financial statement so as to judge the profitability and financial soundness of the firm. The term financial statement Analysis include both Analysis and interpretation.

Objectives and importance of Financial statement analysis

The following purpose or objectives of financial statement Analysis may be stated to bring out significance of such analysis

1. To asses the earning capacity or profitability of the firm.
2. To asses the operational efficiency and managerial effectiveness.
3. To asses the short-term as well as long term solvency position of the firm.
4. To identify the reason for change in profitability and financial position of the firm.
5. To make inter firm comparison.
6. To make forecast about future prospects of the firm. 
7. To asses the progress of the firm over a period of time.
8. To help in decision making and Control.
9. To guide or determine the dividend action.
10. To provide important information for granting credit.

Parties interested in financial statement Analysis

1. Investors or potential investors.
2. Management.
3. Creditors or suppliers.
4. Banker and financial institution.
5. Employees.
6. Government.
7. Trade association.
8. Stock Exchange.
9. Economist and researchers.
10. Taxation authorities.

Types of Financial statement analysis

(1) On the basis of material use : According to material use, financial analysis can be of two types,  (a) External analysis,  and (b) Internal analysis.

(a) External analysis : The analysis is done by the outsiders who don't have access to the detail external Accounting record of the business firm. These outsiders include investors, potential investors, creditors, potential creditors, Government agencies, credit agencies and the general public. For external Analysis these external parties to the firm depend almost entirely on the publisiesed financial statement.

(b)  Internal Analysis  : Internal analysis is conducted by the persons who have access to the internal Accounting records of the firm is known as Internal Analysis. Such analysis, therefore be performed by the executives and employee of the organisation as well as government agencies which have statutory blower invested in them.

(2) On the basis of modes operate: Under this basis financial statement Analysis can be classified into two types ; (a) Horizontal analysis, and (b) Vertical analysis

(a) Horizontal analysis : Horizontal analysis refers to the comparison of financial data of a company for several years. The figure for the type of analysis are presented horizontally over a number of columns. The figure of various years compared with standard or base year. As base year  a year choose as beginning point, This type of analysis is also called dynamic analysis it is based on the data from year to year rather than a data of any one year.

(b)  Vertical analysis  : Vertical analysis refers to the study of relationship of the various items in the financial statement of one accounting period. In this type of analysis the figure  from financial statement of a year are compared with base selected from the same year's statement. It also known as static analysis. Common size statement and financial ratio are the two tools employed in vertical analysis.

(3) On the basis of entities involves : On the basis of entities involves in the analysis. can be divided into two types (a) Cross sectional or inter-firm Analysis, and (b) Time series or intra firm analysis.

(a) Cross sectional or inter-firm Analysis : Cross Analysis involves comparison of financial data of a firm with other firms (competitors) or industry average for the same time period.

(b)  Time series or Inter-firm Analysis : Time series analysis involves the study of performance of the same firm over a period of time.

(4)  On the basis of time horizon or objectives of Analysis : Financial Analysis can be divided of two types; (a) short term analysis , and (b) Long term Analysis.

(a) short term analysis :  Short term analysis measures the liquidity position of a firm, i,e. the short term paying capacity of a firm or the firm's ability to meets it's current obligation.

(b)  Long term Analysis : Long term Analysis involves the study of  firm's ability to meets the interest costs and repayments schedules of it's long term obligation. The solvency, stability, and profitability are measured under this type of analysis.