Financial Analysis is defined as being the process of identifying financial

strength and weakness of a business by establishing relationship between the

elements of balance sheet and income statement. The information pertaining
to the financial statements is of great importance through which
interpretation and analysis is made. It is through the process of financial
analysis that the key performance indicators, such as, liquidity solvency,
profitability as well as the efficiency of operations of a business entity
may be ascertained, while short term and long term prospects of a business
may be evaluated. Thus, identifying the weakness, the intent is to arrive at
recommendations as well as forecasts for the future of a business entity.
Financial analysis focuses on the financial statements, as they are a
disclosure of a financial performance of a business entity. A
Financial Statement is an organized collection of data
according to logical and consistent accounting procedures.
Its purpose is to convey an understanding of some financial
aspects of a business firm. It may show assets position at
a moment of time as in the case of balance sheet, or may
reveal a series of activities over a given period of times, as
in the case of an income statement.

Since there is recurring need to evaluate the past performance,

present financial position, the position of liquidity and to assist in
forecasting the future prospects of the organization, various
financial statements are to be examined in order that the forecast
on the earnings may be made and the progress of the company be
ascertained.
The financial statements are: Income statement, balance sheet,
statement of earnings, statement of changes in financial position
and the cash flow statement. The income statement, having been
termed as profit and loss account is the most useful financial
statement to enlighten what has happened to the business between
the specified time intervals while showing, revenues, expenses
gains and losses. Balance sheet is a statement which shows the
financial position of a business at certain point of time. The
distinction between income statement and the balance sheet is that
the former is for a period and the latter indicates the financial
position on a particular date. However, on the basis of financial
statements, the objective of financial analysis is to
draw information to facilitate decision making, to evaluate the
strength and the weakness of a business, to determine the earning
capacity, to provide insights on liquidity, solvency and profitability
and to decide the future prospects of a business entity.
There are various types of Financial analysis. They are briefly
mentioned herein:

External analysis: The external analysis is done on the basis of

published financial statements by those who do not have access to
the accounting information, such as, stock holders, banks, creditors,
and the general public.
Internal Analysis: This type of analysis is done by finance
and accounting department. The objective of such analysis is to
provide the information to the top management, while assisting in
the decision making process.
Short term Analysis: It is concerned with the working capital
analysis. It involves the analysis of both current assets and current
liabilities, so that the cash position (liquidity) may be determined.
Horizontal Analysis: The comparative financial statements are an
example of horizontal analysis, as it involves analysis of financial
statements for a number of years. Horizontal analysis is also
regarded as Dynamic Analysis.
Vertical Analysis: it is performed when financial ratios are to be
calculated for one year only. It is also called as static analysis.
An assortment of techniques is employed in analyzing
financial statements. They are: Comparative Financial
Statements, statement of changes in working capital, common size
balance sheets and income statements, trend analysis and ratio
analysis.

Comparative Financial Statements: It is an important method of

analysis which is used to make comparison between two financial
statements. Being a technique of horizontal analysis and applicable
to both financial statements, income statement and balance sheet,
it provides meaningful information when compared to the similar
data of prior periods. The comparative statement of income
statements enables to review the operational performance and to
draw conclusions, whereas the balance sheets, presenting a change
in the financial position during the period, show the effects of
operations on the assets and liabilities. Thus, the absolute change
from one period to another may be determined.
Statement of Changes in Working Capital: The objective of this
analysis is to extract the information relating to working capital. The
amount of net working capital is determined by deducting the total
of current liabilities from the total of current assets. The statement
of changes in working capital provides the information in relation to
working capital between two financial periods.
Common Size Statements: The figures of financial statements are
converted to percentages. It is performed by taking the total
balance sheet as 100. The balance sheet items are expressed as the
ratio of each asset to total assets and the ratio of each liability to
total liabilities. Thus, it shows the relation of each component to the
whole - Hence, the name common size.
Trend Analysis: It is an important tool of horizontal analysis. Under
this analysis, ratios of different items of the financial statements for

various periods are calculated and the comparison is made

accordingly. The analysis over the prior years indicates the trend or
direction. Trend analysis is a useful tool to know whether the
financial health of a business entity is improving in the course of
time or it is deteriorating.
Ratio Analysis: The most popular way to analyze the financial
statements is computing ratios. It is an important and widely used
tool of analysis of financial statements. While developing a
meaningful relationship between the individual items or group of
items of balance sheets and income statements, it highlights the
key performance indicators, such as, liquidity, solvency and
profitability of a business entity. The tool of ratio analysis performs
in a way that it makes the process of comprehension of financial
statements simpler, at the same time, it reveals a lot about the
changes in the financial condition of a business entity.
It must be noted that Financial analysis is a continuous process
being applicable to every business to evaluate its past performance
and current financial position. It is useful in various situations to
provide managers the information that is needed for critical
decisions. The process of financial analysis provides
the information about the ability of a business entity to earn income
while sustaining both short term and long term growth.