Utility of Financial Statement Analysis

Utility of Financial Statement Analysis

  The financial statements are a mirror, which reflect the financial position & operating strength or weakness of an organization. These statements are useful to the following parties.

1) Management: the financial statements are useful for assessing the efficiency of different cost centers & enables the management to exercise cost control.

2) Creditors: the trade creditors are to be paid in a short period. This liability is to be met out of the current assets of a firm. Hence, the creditors are interested in the current solvency of a firm.

3) Bankers: the banker is interested to see that the loan amount is secure & that the customer will pay interest regularly to the bank. The bank would therefore analyse the balance sheet to know a firm’s balance sheet to know its financial strength & profit & loss account to know its earning capacity. Since a banker has numerous customers the financial statement analysis makes his work easier.

4) Investors: the investors include both short term & long-term investors. They are interested in the security of their principal amount & receiving regular interests. Their analyse the long term solvency of the firm as well as its future prospects.

5) Government: the financial statements enable to assess tax liability of business firms. It also enables them to frame laws & as well as check whether the rules & laws are followed.

6) Trade Associations: these associations provide service & protection to its members. They analyse the financial statements for the purpose of providing facilities to the members.

7) Stock Exchange: the stock exchange is concerned with the buying & selling of securities of various companies. The stock brokers analyse the financial statements so as to judge the financial position of the companies & fix the prices of securities.

Limitations of Financial Statements Analysis

       The financial statements are relevant & useful. The utility of these statements is dependent upon a number of factors. These statements do suffer from the following limitations.

1) Only Interim Reports. The financial statements do not give a final picture. The actual position of a firm can truly be judged when a business is sold or liquidated. The data are given is only approximate ie accounting periods of one year only during the lifetime of the business. The costs & incomes have to be apportioned every year, which is done on the personal judgement of the accountant. So it doesn’t give a final picture of the firm.

2) Historical Costs & No Exact Position. The financial statements are expressed in monetary values so as to give an accurate picture. But the fixed assets represented in the balance sheet neither represents the value at which these assets can be sold or replaced. The price changes in the asset value is not taken into account. They are presented at cost less depreciation. Moreover the profitability shown in the profit & loss account may not be the true earning capacity. The profits may have gone up due to abnormal causes or increase in prices & not due to increase in efficiency.

3) Impact of Non – Monetary Factors Ignored. There are certain factors which have a bearing on the financial position & operating results but cannot be shown in the financial statements as they are cannot be expressed in monetary terms. These factors may be the reputation of the management, co – operation of employees, credit worthiness of the firm, etc.