As we known business is concerned with the financial activities. In order to ascertain the business every enterprise prepares the certain statement, known as financial statement. Financial statements at least refer to the two statements which are prepared by a business concern at the end of the financial year. These are:
- Income statement or Trading and Profit and Loss account which is prepared by a business concern in order to known the profit earned and loss sustained during a specific period.
- Position statement or Balance Sheet which is prepares by a business concern on a particular date in order to known them financial position.
These statements are added the statement of Retained Earnings and some other statement (such as fund flow statements, cash flow statements, etc.) and schedules of fixed assets (such as Investments and Equipments) and Debtors etc. to give a full view of financial affairs.
”Financial Statements” are interim reports, presented annually and provide a summary of the accounts of business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and the income statement showing the results of operation during a certain period.
TYPES OF FINANCIAL STATEMENTS
Financial Statement primarily includes two basic statements:
- The income statement or profit and loss account
- The position statement or balance sheet.
However, generally accepted accounting principle (GAAP) specifies that a complete set of financial statements must include;
1. An Income Statement
2. A Balance Sheet.
3. A Statement of changes in owners account.
4. A Statement of changes in financial position.
ACCORDING TO THE NATURE OF THE ANALYSIST AND THE MATERIAL USED
On this basis, the financial analysis can be external and internal analysis:
EXTERNAL ANALYSIS - This analysis is made by those persons who are not directly concern with the enterprise. These include investors, potential investors, creditors, potential creditors, governments’ agencies, credit agencies and the general public. They do not have access to the enterprise. They do not have access to the detail records of the company and have to depend mostly on published statements.
INTERNAL ANALYSIS – The internal analysis made by those persons who have access to the books of accounts. They are the members of the organization. Analysis of financial statements or other financial data for managerial purposes is the example of internal type of analysis. The internal analyst can give more reliable result than external analyst because every type of information is at its disposal.
ON THE BASIS OF THE OBJECTIVES OF THE ANALYSIS
On this basis, the analysis can be long-term and short-term analysis:
Long-term Analysis – This analysis is made in order to study the long-term financial stability, solvency and liquidity as well as profitability and earning capacity of a business concern. The purpose of making such type of analysis is to know whether in the long run the concern will be able to earn a minimum amount which will be sufficient to maintain a reasonable rate of return on the investment so as to provide funds required for modernization, growth and development of the business and to meet its costs of capital. This type of analysis helps the long-term financial planning which is essential for the continued success of a business.
Short-term Analysis: This analysis is done to know the short-term solvency of the firm. Stability and liquidity of the firm is also determined by short-term analysis. To know the Earning capacity of the business, Short term analysis is very important for the firm. The main objective of short term analysis is to know whether the firm have sufficient funds available or not to meet the short term requirement and it have capacity of borrowing fund or not to meet the demand in future. The Short Term Analysis is prepared by taking the reference to the items of current assets and current liabilities to know sufficient knowledge about the company’s current position which may be helpful for short-term financial planning and long-term planning.
ACCORDING TO THE MODUS OPERANDI OF THE ANALYSIS
On the basis, the analysis may be horizontal analysis and vertical.
Horizontal or Dynamic 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. The figures of the various years are compared 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. This is very useful for long-term trend analysis and planning.
Vertical or Static Analysis: This analysis is made to review and analyze the financial statement of one particular year only. In this analysis the figures from financial statement of a year are compared with a base selected from the same year’s statement. Common size financial statements are financial ratios is the two tools employed in vertical analysis.