What is Financial Analysis? Objectives,Importance

Meaning and Definition of Financial Analysis

Financial Analysis is also known as ‘Financial Statement’. With the help of various items provided in the ‘profit and loss account’, ‘Balance sheet’ and other operative data and their strategic inter-relationship, it is possible to ascertain the financial strength and weaknesses of an organization, through the process of “financial Analysis’.

According to Myers__ “Financial statements analysis is largely a study of relationship among the various financial factors in a business as disclosed by single set-of statements and study of the trend of these factors as shown in a series of statement”.

According to Hampton__” Analysis of financial statement is the process of determining the significant operating and financial characteristics of a firm from accounting data”.

Objectives of Financial Analysis

1. Assessment of past performance: Trend revealed through the various financial data,like ‘sales’, ‘cost of goods sold’, ‘Operating expenses’, ‘net income’, ‘cashflow’,etc.

2. Assessment of current position: Through the exercise of financial statement analysis, the current status of an organization with regard to the type of assets held by it and the nature of its liabilities,etc. can be ascertained.

3. Prediction of profitability and growth prospects: The assessment and forecasting of the ‘Earning Prospects’ of a business organizations can be made through the exercise of ‘Financial statement analysis’. It helps the prospective investors in comparing and choosing an investment out of the many investment opportunities available before them.

4. Assessment of the operational efficiency: “financial statement analysis’ facilitates the assessment of the ‘Operational Efficiency’ of an organization’s management. It can be done through setting standards with the actual performance on the basis of certain parameters and comparing them with the actual performance of the organization.

Importance of Financial Analysis

1. Measure of short-term solvency: An organization’s ability to pay its short-term liabilities is referred to as its ‘Short Term solvency’, assessment of which can be made through the ‘financial statement analysis’.

2. Measurement of long-term solvency: An organization’s ability to repay its ‘long term liability’, i.e. bonds and debentures issued by it and other secured liabilities, is referred to as its long term solvency.

3. Measurement of operating efficiency: Through the analysis of financial statements of an organization, the position with regard to its profitability can easily be ascertained.

4. Measurement of profitability: Financial statement measurement of profitability of organization. Which helps in taking decision by the ‘Investors’ and ‘Lenders’.

Limitations of Financial Analysis

  1. Absence of standard universally accepted terminology
  2. Overlooking Qualitative aspects
  3. Result in absence of absolute data
  4. Overlooks price level changes
  5. Suffering from limitations of financial statements