09-08-2012, 12:13 PM
Analysis of
Financial Statement using Ratio Analysis
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INTRODUCTION
Finance is the life blood of business. It is rightly termed as the science of
money. Finance is very essential for the smooth running of the business.
According to Wheeler, Finance is that business activity which is
concerned with the organization and conversation of capital funds in meeting
financial needs and overall objectives of a business enterprise.
Financial management is that managerial activity which is concerned with
the planning and controlling of a firm financial reserve. Financial management as
a academic discipline, has undergone fundamental changes as regards its scope
and coverage. In the early years of its evolution it was treated synonymously with
the raising of funds. In the current literature pertaining to this growing academic
discipline, a broader scope so as to include in addition to procurement of funds,
efficient use of resources is universally recognized.
Financial analysis can be defined as a study of relationship between many
factors as disclosed by the statement and study of the trend of these factors.
The basis for financial planning, analysis and decision-making is the
financial information. Financial information is needed to predict, compare and
evaluate the firms earning ability. It is also required to aid in economic decision
making investment and financing decision making. The financing information of
an enterprise is contained in the financial statements or accounting reports.
FINANCIAL STATEMENTS:
Financial statements contain summaries, information of the firms financial
affairs, organized systematically. They are the means to present the firms
financial situation to the users. Preparation of the financial statements is the
responsibility of top management.
RATIO ANALYSIS:
Ratio analysis is the most used tool of analysis. A ratio is quotient of two
numbers and is expression of relationship between the figures or two amounts. It
indicates a quantitative relationship, which is used for qualified judgment and
division making. The relationship between two accounting figures is known as
ratio. These ratios may be compared with the previous year or base year ratios of
the same firm.
OBJECTIVES OF RATIO ANALYSIS:
The main objective of ratio analysis is to show the firms relative strengths
and weakness. The objectives of ratio analysis are as follows:
• It determines the financial condition and financial performance of the firm.
• It involves comparison for a useful interpretation of the financial statements.
• It helps in finding solutions to unfavorable financial statements.
• It helps to take suitable corrective measures when the financial conditions
and performance are unfavorable to the firm, in comparison to other firms in
the same industry.
• With the help of this analysis, an analyst can determine the
! The ability of the firm to meet its obligations.
! The efficiency with which the firm is utilizing its various assets in
generating sales.
! The overall operating efficiency and performance of the firm.
NATURE OF RATIO ANALYSIS:
Ratio analysis is a technique of analysis and interpreting of financial
statements. It is the process of establishing and interpreting various ratios for
helping in making certain decisions. However, ratio analysis is not an end in
itself. It is only a means of better understanding of financial strengths and
weakness of any institution. The following are the steps involved in ratio analysis:
1. Selection of relevant data from the statements depending upon the
objective of the analysis.
2. Calculation of appropriate ratios from the above data.
3. Comparison of the calculated ratios with the past ratios of the same
institute, or with the ratios developed from projected financial statements, or the
ratios of some other institution.