UNIT 4 – FINANCIAL STATEMENT ANALYSIS

ASSIGNMENT

1. Which are the users that can be benefitted from financial statement analysis and
how?
Financial statement analysis provides valuable insights into a company's financial performance and health.
Various users can benefit from this analysis in different ways. Some of the key users and how they can
benefit from financial statement analysis are:

Investors: Investors can use financial statement analysis to assess the financial stability and profitability of a
company, helping them make informed investment decisions. They can identify trends in financial
performance, assess risk, and estimate potential returns.

Lenders and Creditors: Lenders, such as banks, and creditors, like suppliers, can use financial statement
analysis to evaluate a company's ability to meet its debt obligations. It helps them determine the
creditworthiness of the company and decide on lending terms or credit limits.

Management: Company management can use financial statement analysis to evaluate the effectiveness of
their financial strategies and make informed decisions about resource allocation, cost control, and growth
initiatives. It aids in monitoring key financial metrics and identifying areas that require attention.

Regulators and Tax Authorities: Regulators use financial statement analysis to ensure companies comply
with financial reporting standards and regulations. Tax authorities use financial statements to assess tax
liabilities and compliance.

Analysts and Financial Advisors: Financial analysts and advisors use financial statement analysis to provide
recommendations to investors, companies, or individuals. They can offer insights into the potential of an
investment or strategies for improving financial performance.

Competitors: Competitors may analyze the financial statements of rival companies to gain insights into their
financial health, cost structures, and strategies.

Suppliers: Suppliers may assess a customer's financial statements to evaluate their ability to pay bills on
time, assess credit risk, and negotiate favorable terms.

Employees: Employees can use financial statement analysis to gauge the financial stability of their employer,
which can be important for job security and understanding the company's capacity for compensation and
benefits.

Potential Business Partners: Companies considering mergers, acquisitions, or partnerships can analyze the
financial statements of potential partners to assess compatibility and financial health.

Government and Public Interest Groups: Government agencies and public interest groups may use financial
statement analysis to monitor the financial health and performance of companies in sectors that affect public
welfare or the economy.

Academics and Researchers: Academics and researchers use financial statement data to conduct studies
and research on various financial topics, contributing to the body of financial knowledge.
 2. Explain the meaning of financial statement analysis.

Financial statement analysis is the process of evaluating a company's financial statements (including the
income statement, balance sheet, and cash flow statement) to assess its financial performance, health, and
overall stability. The primary goal of financial statement analysis is to gain insights into a company's financial
condition, profitability, and the efficiency of its operations. It is a critical tool for various stakeholders,
including investors, creditors, management, and analysts, to make informed decisions.

3. Which types financial statements are analysed and how?

Financial statement analysis typically involves the examination of three primary types of financial
statements:

1. Income Statement (Profit and Loss Statement): The income statement provides an overview of a
company's revenues, expenses, and profits over a specific period (usually a fiscal year or a quarter). It
is essential for assessing a company's profitability.
Key elements analyzed on the income statement include:
Revenue or sales: To understand the company's primary sources of income.
Cost of goods sold (COGS): To evaluate the cost of producing goods or services.
Gross profit: Calculated as revenue minus COGS, indicating profitability from core operations.
Operating expenses: Such as salaries, marketing, and administrative costs.
Operating income: The result of subtracting operating expenses from gross profit.
Net income: The company's final profit after all expenses are accounted for.

2. Balance Sheet (Statement of Financial Position): The balance sheet provides a snapshot of a
company's financial position at a specific point in time. It lists assets, liabilities, and shareholders'
equity.
Key elements analyzed on the balance sheet include:
Current assets: Such as cash, accounts receivable, and inventory.
Non-current assets: Including property, plant, and equipment, and investments.
Current liabilities: Such as accounts payable and short-term debt.
Long-term liabilities: Including long-term debt and deferred tax liabilities.
Shareholders' equity: Representing the residual interest in the assets of the company.

3. Cash Flow Statement: The cash flow statement provides insights into how cash flows in and out of a
company's operations, investments, and financing activities.
It is divided into three sections:
Operating activities: Cash generated from core business operations.
Investing activities: Cash flows from buying or selling assets (e.g., investments, property).
Financing activities: Cash flows from borrowing, issuing or repurchasing stock, and paying dividends.
 4. Differentiate between horizontal and vertical analysis of financial statements

S. No. Horizontal Analysis Vertical Analysis

1. Horizontal analysis, also known as trend Vertical analysis, also known as common-size
analysis, is used to evaluate the changes in analysis, is used to evaluate the relative
financial statement line items over multiple proportions or composition of individual line
periods, usually across consecutive years. It items in the financial statements. It focuses on
focuses on assessing the trends and changes in assessing the relative significance of each line
individual line items or accounts. item in relation to a base item.
It compares financial data from one period to Vertical analysis typically selects a base item
data from previous periods, such as comparing for each financial statement. In the income
this year's income statement to the previous statement, total revenue is often used as the
year's or multiple years to identify trends. base, while in the balance sheet, total assets
are frequently chosen as the base.
Horizontal analysis typically presents data in a It presents each line item as a percentage of
side-by-side format, showing the absolute or the chosen base item, which makes it easier to
percentage changes between periods for each compare the relative importance of various
line item. components within a financial statement.
The most common method of horizontal To perform vertical analysis, you divide each
analysis involves calculating the dollar amount line item by the base item and express it as a
or percentage change between a given period percentage. For example, in a vertical analysis
and a previous period. For example, it might of an income statement, each expense item
calculate the increase or decrease in revenue might be expressed as a percentage of total
from one year to the next. revenue.
It helps in identifying trends and patterns in It helps stakeholders understand the
financial data. Stakeholders can see whether a composition of financial statements and
specific line item is increasing or decreasing highlights the relative weight of different
and assess the significance of these changes. elements within those statements. It can
identify where a company allocates its
resources or incurs its costs.
Horizontal analysis is suitable for comparing a Vertical analysis is particularly useful for
company's performance over time, showing comparing the composition of financial
how the company has evolved and whether it statements between companies or within the
has improved or deteriorated. same company over different periods. It allows
for easy comparisons of the relative weight of
line items.
 5. Write down the significance of analysis of financial statement.

The analysis of financial statements is a critical process with significant importance for various stakeholders,
including investors, creditors, management, regulators, and other parties. Here are the key significances of
financial statement analysis:

Assessing Financial Health: Financial statement analysis helps stakeholders evaluate a company's financial
health, stability, and overall well-being. It provides insights into a company's ability to meet its financial
obligations and withstand economic challenges.

Investment Decision-Making: Investors use financial statement analysis to make informed decisions about
buying, holding, or selling a company's securities (e.g., stocks and bonds). It aids in assessing the investment's
potential return and risk.

Credit Evaluation: Lenders and creditors rely on financial statement analysis to determine a company's
creditworthiness and ability to repay loans. It assists in setting credit limits, interest rates, and other lending
terms.

Resource Allocation: Company management uses financial analysis to allocate resources effectively. It informs
decisions related to budgeting, capital expenditures, and strategic planning. Management can identify areas
that need improvement and allocate resources accordingly.

Strategic Planning: Financial statement analysis provides critical data for strategic planning and decision-
making. It helps companies identify growth opportunities, evaluate expansion plans, and make acquisitions or
divestitures.

Performance Assessment: Companies use financial analysis to measure their own financial performance
against internal goals and external benchmarks. It helps in evaluating whether the company is meeting its
financial objectives.

Disclosure and Transparency: For publicly traded companies, the analysis of financial statements contributes
to transparency in financial reporting. It ensures that financial information is accessible to investors,
regulators, and the public, promoting accountability.

Compliance and Regulation: Regulatory authorities use financial statement analysis to monitor compliance
with accounting standards, reporting requirements, and regulations. This helps maintain integrity in financial
reporting.

Competitive Positioning: Companies assess their financial performance relative to competitors using financial
statement analysis. It helps them identify strengths and weaknesses and devise strategies for competitive
advantage.

Risk Assessment: Stakeholders can identify and assess various financial risks through financial analysis. This
includes liquidity risk, credit risk, market risk, and operational risk, allowing for risk mitigation measures.
Investor Relations: Financial statement analysis plays a crucial role in investor relations by providing
transparency and confidence to shareholders. It helps companies communicate their financial performance
effectively.

Mergers and Acquisitions: In mergers and acquisitions (M&A) transactions, financial statement analysis helps
evaluate the financial condition of target companies. It assists in determining the value of the deal and the
potential benefits or risks.

Tax Planning: Financial statement analysis helps in tax planning by identifying tax implications and optimizing
tax strategies to minimize tax liabilities legally.

Academic Research: Researchers and academics use financial statements as data sources for studies and
research, contributing to the development of financial theory and practice.

Employee Consideration: Employees may use financial statement analysis to assess their employer's financial
stability and the company's capacity for compensation and benefits.