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Inter-Firm Comparison
Inter-rm comparison becomes easy with the help of nancial analysis. It helps in assessing
own performance as well as that of others, if merges and acquisitions are to be considered.
Making Forecasts & Preparing Budgets. Past nancial statement analysis helps a great deal
in assessing developments in the future, especially the next year. For example, given a
certain investment, it may be possible to forecast the next year’s prot on the basis of
earning capacity shown in the past. Analysis thus helps in preparing the budgets.
Understandable
Financial analysis helps the users of the nancial statements to understand the complicated
matter in simplied manner. Dierent date can be made more attractive by charts and
diagrams which can be easily understood Uses of Financial Statement
Security Analysis
It is a process by which the investor comes to know whether the rm is fullling hi
expectation with regard to payment of dividend, capital appreciation and security of
money. Such analysis is done by a security analyst who is interested in cashgenerating
ability, dividend payout policy and the behavior of share prices
Credit Analysis
Such analysis is useful when a rm oers credit to a new customer or a dealer. The manager
of the rm would like to know whether to extend credit to them or not. Such analysis is also
useful for a bank before granting loan to the public.
Debt Analysis
Such analysis is done by the rm to know the borrowing capacity of a prospective borrower.
Dividend Decision
Financial analysis helps the rm in deciding about the rate of dividend. Management would
have to decide about how much portion of earnings to distribute and how much to retain.
Such decisions indicate the protability of the rm and hence to some extent aect the
behavior of share prices
Historical Analysis
Financial statement analysis is a historical analysis. It analysis what has happened till date.
It does not reect the future. Person like shareholders, investors, etc are more interested in
knowing the likely position in the future.
The average 10-K annual report is stuffed with dozens of dense footnotes and adjusted
numbers offered as alternatives to the recognized numbers contained in the body of the
income statement and balance sheet. For example, companies often disclose six or eight
versions of earnings per share, such as the "as reported," "adjusted," and "pro forma"
versions for both basic and diluted EPS. But the average individual investor probably does
not have the time to fully assimilate these documents.
Therefore, it may be wise to first look at industry dynamics and the corresponding
company business model and let these guide your investigation. While all investors care
about generic figures, such as revenue and EPS, each industry tends to emphasize certain
metrics. And these metrics often lead or foreshadow the generic performance results.
The table below illustrates this idea by showing some of the focus areas of a few specific
industries. For each industry, please keep in mind that the list of focus areas is only a
"starter set"--it is hardly exhaustive. Also, in a few cases, the table gives key factors not
found in the financial statements in order to highlight their shortcomings:
You can analyze balance sheet numbers through a series of ratio tests to draw conclusions,
check your cash status, and track your debt. Because these are the types of tests financial
institutions and potential investors use to determine whether or not to loan money to or
invest in your company, it’s a good idea to run these tests yourself before seeking loans or
investors.
When you approach a bank or other financial institution for a loan, you can expect the
lender to use one of two ratios to test your cash flow: the current ratio and the acid test
ratio (also known as the quick ratio).
Current ratio
This ratio compares your current assets to your current liabilities. It provides a quick
glimpse of your company’s ability to pay its bills.
The acid test ratio only uses the financial figures in your company’s Cash account, Accounts
Receivable, and Marketable Securities. Although it’s similar to the current ratio in that it
examines current assets and liabilities, the acid test ratio is a stricter test of a company’s
ability to pay bills.
The assets part of this calculation doesn’t take inventory into account because it can’t
always be converted to cash as quickly as other current assets and because, in a slow
market, selling your inventory may take a while.
Before you even consider whether or not to take on additional debt, you should always
check out your debt condition. One common ratio that you can use to assess your
company’s debt position is the debt to equity ratio. This ratio compares what your business
owes to what your business owns.
Calculating your debt to equity ratio is a two-step process:
BOOKS
Agrawal, N.P (1983) Analysis of Financial Statements, National Publishing House, New
Delhi.
Anil Kumar (2000): Working Capital Management of Munjal Shows Ltd; in M.Com
Dissertation submitted to University of Rajasthan Jaipur
Archer, Stephen H. & D Arrnosio (1987): The Theory of Business Finance, New York and
London.
Batty, J. (Second ed.) Management Accounting, Macdonald & Event Ltd., London.
Beckman, Theodore N. (1992): Credits and Collection Management and Theory, Me Graw
Hill, New Delhi.Brigham,
Butchest F.F and Hicks C.M (1948): Corporate Finance, New York.