Uses:
Financial
Statement analysis involves using the output of the standard business
information system found in all businesses to judge the performance and
riskiness at an instance or over time. A business may have other information
systems for managers but all business must conform with generally accepted
standards with their accounting statements.
There
are several steps in the use of Financial Statement Analysis:
1.Understanding
the basic statements
2.Inherent
problems with the system
3.Use
of ratio analysis
4.Interpreting
the analysis
5.Using
the analysis
As
example, Ratio Analysis :
You may be able to discover facts and trends about
the risk and profitability of a company and also something about the quality
and efficiency of the management by examining the financial statements. This
process is called ratio analysis and is not perfect nor does it give definitive
answers but it can serve as an early warning or alarm system to alert owners,
lenders and managers to general problems. It is very common in everyday use.
- Limitations
Many things can impact the calculation of ratios and make
comparisons difficult. The limitations include:
The use of estimates in allocating costs to each period.
The ratios will be as accurate as the estimates.
The cost principle is used to prepare financial
statements. Financial data is not adjusted for price changes or
inflation/deflation.
Companies have a choice of accounting methods (for
example, inventory LIFO vs FIFO and depreciation methods). These differences
impact ratios and make it difficult to compare companies using different
methods.
Companies may have different fiscal year ends making
comparison difficult if the industry is cyclical.
Diversified companies are difficult to classify for
comparison purposes.
Financial statement analysis does not provide answers to
all the users' questions. In fact, it usually generates more questions!