MBA (Finance) – IV Semester, Investment and Portfolio Management, Unit 2.3
Define Financial Analysis
The best source of financial information about a company is its own financial statements. This is a primary source of information for evaluating the investment prospects in the particular company’s stock. Financial statement analysis is the study of a company’s financial statement from various viewpoints. The statement gives the historical and current information about the company’s operations. Historical financial statement helps to predict the future. The current information aids to analyse the present status of the company.
Financial Analysis
The two main statements used in the analysis are:
Balance sheet
Profit and loss account
The Balance Sheet
The balance sheet shows all the company’s sources of funds (liabilities and stockholders’ equity) and uses of funds at a given point of time. The balance sheet can either be in the horizontal form or vertical form. Table show the balance sheet of Sky Company in horizontal and vertical form respectively.
The balance sheet provides an account of the capital structure of
the Sky Company. The network and the outstanding long term debt are known from
the balance sheet. The debt has certain advantages in terms of cost and market
acceptability. The use of debt creates financial leverage beneficial or
detrimental to the shareholders depending on the size and stability of
earnings.
If revenues are stable and certain, a large amount of debt can be
carried and it is beneficial to the shareholder. If the earnings fluctuate, the
debt should below in the capital structure, so that the payment of interest may
not be detrimental to the shareholders. It is better for the investor to avoid
a company with excessive debt component in its capital structure. From the
balance sheet, liquidity position of the company can also be assessed with the
information on current assets and current liabilities. The overall ability to
pay its short term obligations can be found out.
The Profit and Loss Account
Analysis of the financial condition of the company requires a
report on the flow of funds too. The income statement reports the flow of funds
from business operations that takes place in between two points of time. It
lists down the items of income and expenditure. The difference between the
income and expenditure represents profit or loss for the period. It is also
called income and expenditure statement. Profit and loss account of the Sky
Ltd., is given in table. The investor should be aware of the limitations of the
financial statements.
