Financial statement analysis consists of the application of analytical tools and techniques to the data in financial statements in order to derive from them measurements and relationships that are significant and useful for decision making (ICFAI Center for Management Research ICMR). The process of financial analysis can be described in various ways, depending on the objectives to be obtained. Financial analysis can be used as a preliminary screening tool of future financial conditions and results. It may be used as a forecasting tool of future financial conditions and results. It may be used as a process of evaluation and diagnosis of managerial, operating, or other problem areas. Above all, financial analysis reduces reliance on intuition, guesses and thus narrows the areas of uncertainty that is present in all decision making processes. Financial analysis does not lessen the need for judgment but rather establishes a sound and systematic basis for its rational application.
In the analysis of financial statements, the analyst has a variety of tools available from which he can choose those best suited to his specific purpose. The following are the important tools of analysis.
Ratios are well known and the most widely used tools of financial analysis. ...
The analysis of ratios can disclose relationships as well as bases of comparison that reveal conditions and trends that cannot be detected by going through the individual components of the ratio. The usefulness of ratios is ultimately dependant on their intelligent and skillful interpretation.
Ratios are used by different people for various purposes. As ratio analysis mainly helps in valuing the firm in quantitative terms, two groups of people are interested in the valuation of the firm and they are creditors and shareholders (Blackwell publishing). Creditors are again divided into short-term creditors and long-term creditors. Short-term creditors hold obligations that will soon mature and they are concerned with the firm's ability to pay its bills promptly. In the short run, the amount of liquid assets determines the ability clear off current liabilities. These persons are interested in liquidity. Long-term creditors hold bonds or mortgages against the firm and are interested in current payments of interest and eventual repayment of principal. The firm must be sufficiently liquid in the short-term and have adequate profits for the long-term. These persons examine both the liquidity and profitability of the firm (ICFAI Center for Management Research ICMR).
Ratio Analysis - A strategic tool
Insight into the financial situation of a company will quickly place its condition in perspective. The critical areas in any profit or non-profit organization can be summed up as follows:
Scanning and using funds
Planning for securing and using funds
Reporting all transactions and results to appropriate parties
Facts can be gathered and tentative conclusions can be