Financial Analysis with reference to Ratio Analysis

Shaharu B.

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Financial Analysis with reference to Ratio Analysis

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Abstract

Financial statements are prepared for the purpose of presenting a periodical review or report by the management and deal with state of investment in business and result achieved during the period under view. They reflect a combination of recorded facts, accounting conventions and personal judgments. From this it is clear that financial statements are affected by three things i.e. recorded facts, accounting conventions and personal judgments. Only those facts which are recorded in the business books will be reflected in the financial statements.

The following points reflect truly the nature of financial statements of business entities:
(i) These are reports or summarized reviews about the performance, achievements and weaknesses of the concern.
(ii) These are prepared at the end of the accounting period so that various parties may take decisions of their future actions in respect of the relationship with the concerns.
(iii) The reliability of financial statements depends on the reliability of the accounting data. These statements cannot be said to be true and fair representatives of the strengths or profitability of the concern if there are numerous frauds and defalcations in the accounts.

Nature of financial statements
Importance of financial statements
Limitations of financial statements
Meaning of analysis of financial statements
Objectives of financial analysis
Types of financial statements analysis
1. The nature of the analyst and the material used by him
2. The objective of the analysis
3. The modus operandi of the analysis
Limitations of financial statements analysis
1. Historical nature of financial statements
2. No substitute for judgment
3. Reliability of figures
4. Reliability of figures
5. Single year analysis is not valuable and useful
6. Results may have different interpretation
7. Change in accounting methods
8. Shortcoming of the tool of analysis
Detailed information on financial analysis in respect with ratio analysis
Importance of ratio analysis
1. Useful in financial position analysis
2. Useful in simplifying accounting figures
3. Useful in assessing the operational efficiency
4. Useful in forecasting purpose
5. Useful in locating the weak spots of the business
6. Useful in comparison of performance
Classification of ratios
1. Profitability ratios
2. Financial ratios
3. Stability ratios
4. Solvency ratios
Conclusion

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[...] The main objectives of analysis of financial statements are to assess: The present and future earning capacity or profitability of the concern, The operational efficiency of the concern as a whole and of its various parts or departments, (iii) The short term and long term solvency of the term for the benefit of the debenture holders and trade creditors, The comparative study in regard to one firm with another firm or one department with another department, The possibility of developments in the future by making forecast and preparing budgets, The financial stability of a business concern, (vii) The real meaning and significance of financial data, and (viii)The long-term liquidity of its funds. [...]

[...] Ratio is given as= Total expenditure X 100 Total income Financial Ratios: These ratios are calculated to judge the financial position of the concern from long term as well as short term solvency point of view Liquidity Ratios: If it is decided to study position of the concerns, in order to highlight the relative strength of the concerns in meeting their current obligations to maintain sound liquidity and pinpoint the difficulties if any in it, then liquidity ratios are calculated. [...]

[...] Ratio of Cash Management: This is to be worked out with reference to the total cost of establishment expenditure to working capital. It reveals the cost for operating and managing the bank. The bank should inculcate cost consciousness among its staff and management so that higher profits can be achieved. Ratio of Cash Management= Total Expenditure X 100 Working Capital Solvency ratios are very important to understand whether bank is standing on a sound path Profitability Ratios: 1. Return on Capital Employed= This ratio is an indicator of earning capacity of the capital employed in the business. [...]

[...] This ratio is determined to ascertain the soundness of long term financial policies of the company and is known as external-internal equity ratio. It is calculated as follows: Debt equity Ratio= Long term debts Share holders' funds Share holders' funds= Equity share capital + Profit & loss a/c + Capital reserves + Revenue reserves + Reserves for contingencies, sinking funds for renewal of fixed assets or redemption of debentures. The ideal case for this is Solvency Ratios: 1. Ratio of Cash to Deposits= This ratio indicates the liquidity position of the bank in terms of meeting its day to day demand for cash. [...]

[...] Importance of Ratio analysis: Ratio analysis stands for the process of determining and presenting the relationship of items and groups of items in the financial statements. It is an important technique of financial analysis. It is a way by which stability and health of a concern can be judged. The following are the main points of importance of ratio analysis: Useful in Financial position analysis: Accounting ratios reveal the financial position of the concern. This helps the banks, insurance companies and other financial institutions in lending and making investment decisions. [...]

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