Accounting For Managers - Ratio Analysis
Nature Of Financial Analysis
The focus of financial analysis is on the key figures contained in the financial statements and the significant relationship that exists between them. “analyzing financial statements is a process of evaluating the relationship between the component parts of the financial statements to obtain a better understanding of a firm’s position and performance”.
The type of relationship to be investigated depends upon the objective
and purpose of evaluation. The purpose of evaluation of financial statements
differs among various groups: creditors, shareholders, potential investors,
management and so on. For example, short-term creditors are primarily
interested in judging the firm’s ability to pay its currently-maturing
obligations. The relevant information for them is the composition of the
short-term (current) liabilities. The debenture-holders or financial
institutions granting long-term loans would be concerned with examining the
capital structures, past and projected earnings and changes in the financial
position. The shareholders as well as potential investors would
naturally be interested in the earnings per share and dividends per share as
these factors are likely to have a significant bearing on the market price of
shares. The management of the firms, in contrast, analyses the financial
statements for self-evaluation and decision making.
The first task of the financial analyst is to select the information
relevant to the decision under consideration from the total information
contained in the financial statements. The second step involved in financial
analysis is to arrange the information in such a way as to highlight
significant relationships. The final step is the interpretation and drawing of
inferences and conclusions. In brief, financial analysis is the process of selection,
relation and evaluation.
