All financial statements are essentially historically historical documents. They tell what has occurred during a particular period of time. However most users of financial statements are concerned as to what will happen in the foreseeable future. Stockholders are worried with future dividends and revenue. Creditors are concerned with the company’s future ability to repay its debts. Managers are worried with the company’s ability to fund future extension.
Despite the fact that financial claims are historical documents, they can still provide valuable information bearing on all of these concerns. Financial statement analysis involves careful collection of data from financial statements for the principal purpose of forecasting the financial health of the company. This is achieved by examining trends in key financial data, evaluating financial data across companies, and examining key financial ratios. Managers are also broadly concerned with the financial ratios.
First the ratios provide indicators of how well the business and its business units are performing. A few of these ratios would be utilized in a well-balanced scorecard approach normally. The specific ratios selected depend on the business’s strategy. For instance an organization that wants to highlight responsiveness to customers may carefully monitor the inventory turnover ratio. Since managers must be accountable to shareholders and may desire to raise funds from external sources, managers must focus on the financial ratios used by external inventories to evaluate the business’s investment potential and creditworthiness. Although financial statement analysis is an extremely useful tool, it offers two limitations.
These two restrictions involve the comparability of financial data between companies and the necessity to look beyond ratios. Comparison of one company with another can offer valuable clues about the financial health of a business. Unfortunately, distinctions in accounting methods between companies sometime helps it is difficult to compare the companies’ financial data.
An inexperienced analyst may presume that ratios are sufficient in themselves as a basis for wisdom about the future. Nothing at all could be from the truth further. Conclusions predicated on ratio analysis must be thought to be tentative. Ratios should not be viewed as an end, but they should be looked at as a starting point rather, as indications of what things to pursue in better depth.
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They raise many questions, however they seldom answer any question independently. In addition to ratios, other sources of data should be analyzed to make judgments about the future of an organization. They analyst should look, for example, at industry developments, technological changes, changes in consumer preferences, changes in wide economic factors, and changes within the company itself. A recently available change in a key management position, for example, may provide a basis for optimism about the near future, even though the previous performance of the company might have been mediocre. Few figures appearing on financial statements have much significance standing by themselves.
It is the relationship of one shape to some other and the total amount and direction of change as time passes that are important in financial record analysis. How exactly does the analyst type in on significant romantic relationship? How exactly does the analyst to seek out the key tendencies and changes in an ongoing company? Three analytical techniques are used widely; dollar and percentage changes on statements, common-size statements, and accounting ratios.