Question
Explain the techniques of financial statements analysis.
Answer :
Word Count : 931
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Financial statement analysis refers to the process of examining and interpreting the information contained in financial statements to assess the financial performance and position of a business enterprise. In Accountancy and Financial Management, it plays a vital role in decision-making for investors, creditors, management, and other stakeholders. Various techniques are used to analyze financial statements effectively, each providing different insights into profitability, liquidity, solvency, and operational efficiency. One of the most important techniques is comparative financial statement analysis. In this method, financial statements of different accounting periods are placed side by side to identify changes in figures over time. For example, comparative income statements reveal changes in revenue, expenses, and net profit across years, while comparative balance sheets show variations in assets, liabilities, and shareholders’ equity. By calculating the increase or decrease in absolute terms and in percentage terms, analysts can determine growth trends, performance improvement, or signs of financial distress. This technique helps management evaluate progress and identify areas that require corrective action. Another significant technique is common-size financial statement analysis. In this method, each item in the financial statement is expressed as a percentage of a common base figure. In a common-size income statement, all items are shown as a percentage of net sales, while in a common-size balance sheet, each item is presented as a percentage of total assets or total liabilities and equity. This technique is especially useful for comparing companies of different sizes or comparing the same company over different periods. It eliminates the impact of size differences and highlights the relative importance of each component, making it easier to evaluate cost structure, asset composition, and capital structure. Trend analysis is another widely used technique. It involves studying the movement of financial data over a number of years by selecting a base year and expressing subsequent years’ figures as a percentage of the base year figure. This technique helps in identifying patterns of growth or decline. For instance, if sales show
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