25-07-2012, 11:19 AM
Detailed Study on Ratio Analysis as a Tool for Financial Statement Analysis
Detailed Study on Ratio Analysis as a Tool for Financial Statement Analysis.doc (Size: 56.5 KB / Downloads: 40)
INTRODUCTION
After preparation of the financial statements, one may be interested in analyzing the financial statements with the help of different tools such as comparative statement, common size statement, ratio analysis, trend analysis, fund flow analysis, cash flow analysis, etc. In this process a meaningful relationship is established between two or more accounting figures for comparison. We know business is mainly concerned with the financial activities. In order to ascertain the financial status of the business every enterprise prepares certain statements, known as financial statements. Financial statements are mainly prepared for decision making purposes. But the information as is provided in the financial statements is not adequately helpful in drawing a meaningful conclusion. Thus, an effective analysis and interpretation of financial statements is required. Analysis means establishing a meaningful relationship between various items of the two financial statements with each other in such a way that a conclusion is drawn. The term financial analysis is also known as analysis and interpretation of financial statements. It refers to the establishing meaningful relationship between various items of the two financial statements i.e. Income statement and position statement. It determines financial strength and weaknesses of the firm.
The ratio is an arithmetical expression i.e. relationship of one number to another. It may be defined as an indicated quotient of the mathematical expression. It is expressed as a proportion or a fraction or in percentage or in terms of number of times. A financial ratio is the relationship between two accounting figures expressed mathematically. Ratios provide clues to the financial position of a concern. These are the indicators of financial strength, soundness, position or weakness of an enterprise. One can draw conclusions about the financial position of a concern with the help of accounting ratios.
LITERATURE REVIEW
1. Management Accounting
Any successful business owner is constantly evaluating the performance of his or her company, comparing it with the company's historical figures, with its industry competitors, and even with successful businesses from other industries. To complete a thorough examination of your company's effectiveness, however, you need to look at more than just easily attainable numbers like sales, profits, and total assets. You must be able to read between the lines of your financial statements and make the seemingly inconsequential numbers accessible and comprehensible. This massive data overload could seem staggering. Luckily, there are many well-tested ratios out there that make the task a bit less daunting.
2. Financial Accounting
Ratios are highly important profit tools in financial analysis that help financial analysts implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Although ratios report mostly on past performances, they can be predictive too, and provide lead indications of potential problem areas. Ratio analysis is primarily used to compare a company's financial figures over a period of time, a method sometimes called trend analysis. Through trend analysis, you can identify trends, good and bad, and adjust your business practices accordingly. You can also see how your ratios stack up against other businesses, both in and out of your industry. There are several considerations you must be aware of when comparing ratios from one financial period to another or when comparing the financial ratios of two or more companies.
3. Essential of Financial Accounting
A financial ratio is simply a comparison of two measure¬ments of a business to each other. For example, a measurement of income may be compared to a measurement of size. The two measurements are expressed in terms of a ratio of one number to another number. The measurements can also be expressed in terms of the percent that one is to another. For example, a farm business with a net farm income of $25,000 and a value of farm production of $100,000 has a net income to value of farm production ratio of 1:4. Expressed in percent¬age terms, this same farm business has a net income that is 25 percent of the value of farm production.
4. http://en.wikipediawiki/Financial_ratio
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical value taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Security analysts use financial ratios to compare the strengths and weaknesses in various companies.[1] If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.
5. www.iibf.org.in/uploads/caiibfmramodule_c.ppt
The term ‘solvency’ refers to the ability of a concern to meet its long term obligations. The long-term liability of a firm is towards debenture holders, financial institutions providing medium and long term loans and other creditors selling goods on credit. These ratios indicate firm’s ability to meet the fixed interest and its costs and repayment schedules associated with its long term borrowings.
PRESENT STUDY
Financial statements are projection and management tools and should be used by management to analyze the business. Ratios use information from these reports to reveal the financial status of the company. Ratios allow you to judge the company’s relative performance compared to others in the industry and to its previous performance. Ratios also help you see relationships or correlations between financial items on different statements. By measuring performance in percentages rather than raw numbers, ratios allow you to evaluate the company’s performance over a period of time, to compare the company to other companies of different sizes but in the same or similar business, and to plan for the future. Calculating financial ratios should become part of your regular financial reporting process. The ratios can then be assessed at the same time as the other financial reports.
Financial statements are projection and management tools and should be used by management to analyze the business. Ratios use information from these reports to reveal the financial status of the company. Ratios allow you to judge the company’s relative performance compared to others in the industry and to its previous performance. Ratios also help you see relationships or correlations between financial items on different statements.
By measuring performance in percentages rather than raw numbers, ratios allow you to evaluate the company’s performance over a period of time, to compare the company to other companies of different sizes but in the same or similar business, and to plan for the future. Calculating financial ratios should become part of your regular financial reporting process. The ratios can then be assessed at the same time as the other financial reports.
Research Problem
How ratio analysis can be used as a tool for knowing the position of the enterprise from different point of views and to assess the efficiency and performance of an enterprise?