FINANCIAL STATEMENT ANALYSIS- Significance and Limitations

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Financial statements includes Trading, Profit and Loss Account and Balance Sheet. Expressing the financial items in these financial statements brings a meaningful information.

Financial statement – Definition:

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.

Financial statement analysis is an important part of the overall financial assessment. The different users look at the business concern  from their respective view point and are interested in knowing about its profitability and financial condition. A detailed cause and effect study of the profitability and financial condition is the overall objective of financial statement analysis.

Significance of Financial Statement Analysis:

1. Judging the earning capacity or profitability of a business concern.

2. Analysing the short term and long term solvency of the business concern.

3. Helps in making comparative studies between various firms.

4. Assists in preparing budgets.

Limitations of Financial Statement Analysis:

Analysis of financial statements helps to ascertain the strength and weakness of the business concern, but at the same time it suffers from the following limitations.

1. It analyses what has happened till date and does not reflect the future.

2. It ignores price level changes.

3. Financial analysis takes into consideration only monetary matters, qualitative aspects are ignored.

4. The conclusions of the analysis is based on the correctness of the financial statements.

5. Analysis is a means to an end and not the end itself.

6. As there is variation in accounting practices followed by different firms a valid comparison of their financial analysis is not possible.

There are different ways by which financial statement analysis can be undertaken and one important and usual technique used among them is Ratio Analysis.

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