FINANCIAL STATEMENT

INTRODUCTION:-
Accounting is the process of identifying measuring and communicating
economic information to permit informed judgements and decisions by users of the
information. It involves recording, classifying and summarizing various business
transactions. The end product of business transactions are the financial statement
comprising the primarily the position statement or the balance sheet and income
statement or the profit and loss account. These statements are the outcomes of
summarizing process of accounting and are therefore the sources of information on
the basis of which conclusions are drawn about the profitability and the financial
position of the concern.

MEANING OF THE FINANCIAL STATEMENT:-

A financial statement is a collection of data organised according to logical
and consistent accounting procedure. Its purpose is to convey an understanding of
some financial aspects of a business firm. The term financial statement generally
refers to two statements: i) the position statement or the balance sheet and ii) the
income statement or the profit and loss account .These statements are used to
convey management and other interested outsiders the profitability and the
financial position of a firm .

Financial statements are the outcomes of summarizing

process of accounting. In the words of John N. Myer , “The financial statement
provide a summary of the accounts of a business enterprise, the balance sheet
reflecting the assets, liability and capital as on a certain date and the income
statement showing the results of operation during a certain period” . Financial
statements are prepared as an end result of financial accounting and are measures
of financial information of an enterprise.

According to John Myer, “The financial

statement are composed of data which are the result of a combination of (1)
records facts concerning the business transactions (2) conventions adopted to
facilitate the accounting technique (3) postulates, or assumptions made to and (4)
personal judgement used in the conventions and the postulates .”

OBJECTIVE OF FINANCIAL STATEMENTS:-

 To provide reliable financial information about economic resources and
obligations of a business firm.
 To provide other needed information about changes in such economic
resources and obligations.
 To provide reliable information about changes in net resources (resources
less obligations) arising out of business activities.
 To provide financial information the assists in estimating the earning
potentials of business.
 To disclose, to the extent possible other information related to the financial
statements that is relevant to the needs of the users of statements.

TYPES OF FINANCIAL STATEMENTS:-

Financial statements must include:-

 A balance sheet
 An income statement
 A statement of changes in owner’s account and
 A statement of changes in financial

Balance Sheet
The American Institute of certified Public Accountants defines Balance sheet
as, “A tabular statements of summary of balances (debits and credits) carried
forward after an actual and constructive closing of books of accounts and keep
according to principles of accounting.” The purpose of the balance sheet is to show
the resources that the company has, i.e. its assets, and from where those resources
come from, i.e. its liabilities and investments by owners and outsiders.

Income statement (Profit and Loss Account)

An income statement is prepared to determine the operational position of the
concern. It s a statement of revenues earned and the expenses incurred for earning
more than the income then there will be a loss . The income statement is prepared
for a particular period, generally a year.

Statement of Changes in Owners’ Equity (Retained Earnings)

The term owner equity refers to the claims of the owners of the business
(shareholders) against the assets of the firm. It consists of two elements; (i) paid-up
share capital, i.e. the initial amount of funds invested by the shareholders: and (ii)
retained earning reserves and surplus representing undistributed profits.

Statement of changes in financial position

The statement of changes in financial position may take any of the following two
forms:

 Funds Flow Statement

The funds flow statement is designed to analyze the changes in the

financial condition of a business enterprise between two periods. This
statement will show the sources from which the funds are received and the
uses to which these have been put.

 Cash Flow Statement

 A statement of changes in the financial position of a firm on cash basis is
called Cash Flow Statement. It summarizes the causes of changes in cash
position of a business enterprise between dates of two balances sheets. The
statement is very much similar to the statement of changes in working
capital, i.e. Funds Flow Statement.

LIMITATIONS OF FINANCIAL STATEMENTS:-

The financial statements suffer from the following limitations:

 Only interim reports

These statements do not give a final picture of the concern. The data
given in these statements is only approximate. The actual position can only be
determined with the business is sold or liquidated. His allocation expenses and
incomes will depend upon the person judgement of the accountant. The existences
of contingent assets and liabilities also make the statements imprecise. So financial
statements do not give the final picture and they are at the most interim reports.

 Do not give exact position

The financial statements are expressed in monetary values, so they appear
to vive final and accurate position. The value of fixed assets in the balance sheet
neither represents the value for which fixed assets can be sold nor the amount
which will be required to replace these assets. The balance sheet is prepared on
presumption of a going concern. The concern is expected to continue in the future.
So fixed assets are shown at cost less accumulate depreciation. There are certain
assets in the balance sheet such as preliminary expenses. Good will discount on
issue of shares which will realise nothing at the time of liquidation though they are
shown in the balance sheet.

 Historical costs
The financial statements are prepared on the basis of historical cost or
original costs. The value of assets decreases with the passage of time current price
changes are not taken in to account. The statements are not prepared keeping in
view the present economic condition.

 Impact of non-monetary factors ignored

There are certain factors which have a bearing on the financial position
and operating result of the business but they do not become a part of these
statements because they cannot be measured in monetary terms. Such factors may
include the reputation of the management, credit worthiness of the concern,
sources and commitments for purchases and sales, co-operaticoncern, sources and
commitments for purchases and sales, co-operation of the employees etc.

 No precision
The precision of financial statement date is not possible because the
statements deal with matters which cannot be precisely stated. The dates are
recorded by conventional procedures followed over the years. Various
conventions, postulates, personal judgements etc are used for developing the data.

MEANING AND CONCEPT OF FINANCIAL ANALYSIS

The term “Financial Statement Analysis” includes both ‘Analysis’ and
‘interpretation’. A distinction should, therefore, be made between the two terms.
While the term ‘Analysis’ is used to mean the simplification of financial data by
methodical classification of the data given in the financial statements,
interpretation means explaining the meaning and significance of the data so
simplified . However, both analysis and interpretation are interlined and
complimentary to each other analysis is useless without interpretation and
interpretation without analysis is difficult or even impossible. Most of the authors
have used the term ‘analysis’ only to cover the meaning of both analysis and
interpretation as the objective of analysis is to study the relationship between
various items of financial statements by interpretation . We have also used the term
‘Financial Statement Analysis’ or simply ‘Financial Analysis’ to cover the
meaning of both analysis and interpretation
TYPES OF FINANCIAL ANALYSIS
According to material used, financial analysis can be of two types :

(a) External analysis

(b) Internal analysis
On the basis of modus operand; According to the method of operation
followed in the analysis can also be of two types.
(a) Horizontal analysis

(b) Vertical analysis

Horizontal Analysis
Horizontal analysis refers to the comparison of financial data of a company
for several years. The figures for this type of analysis are presented horizontally
over a number of columns. These figures of the various years are comparing with
standard or base year. A base year is a year chosen as beginning point. This type of
analysis is called “Dynamic Analysis” as it is based on the data from year to year
rather than on data of any one year.

Vertical Analysis
Vertical analysis is refers to the study of relationship of the various items in
the financial statements of one accounting period. In this types of analysis the
figure from financial statement of a year are compared with a base selected from
the same year’s statement. It is also known as “Static Analysis”.

METHODS OR DEVICES OF FINANCIAL ANALYSIS

Comparative statements

 Trend analysis
 Common size analysis
 Funds flow analysis
 Cash flow analysis
 Ratio analysis
 Cost-volume profit analysis
Comparative Statement
The comparative financial statements are statements of financial position at
different periods of time. From practical point of view, generally, two financial
statements are prepared in comparative form for financial analysis purposes. The
comparative statements may show in:-

 Absolute figures
 Changes in absolute figures i.e. increase or decrease in absolute figures
 Absolute data in terms of percentages
 Increase or decrease in terms of percentages

The two comparative statements are:-

 Balance sheet &

 Income statements
Comprehensive Balance Sheet
The comprehensive balance sheet analysis is the study of the trend of the same
items, group of items and computed items in two or more balance sheets of the
same business enterprise on different dates. The changes in periodic balance sheet
items reflect the conduct of a business. The changes can be observed by
comparison of balance sheet at the beginning and at the end of a period and these
changes can help in forming an opening about the progress of an enterprise .While
interpreting comparative balance sheet the interpreter is expected to study the
following aspects :

 Current financial position and liquidity position of the business

 Long-term financial position of the business

RATIO ANALYSIS -- THE THEORITICAL CONCEPT

We fall sick or we are weak, we consult the doctor to know about the cause
and take preventive measures to cure. That is the way doctor puts different therapy
to know about the same fashion in order to know financial health status or strength
and weakness a financial manager puts different. Ratio analysis is one of them. The
methods of expressing items which are related to each other are for the purpose of
financial analysis referred to as ratio analysis.