Financial Statement Analysis is the analysis of financial statements that helps a company to find out overall financial position of the company for the various parties. In the next section, you will know the advantages and disadvantages of financial statement analysis.
Significance/Advantages of Financial Statement Analysis
The advantages of financial statement analysis are as follows:
1) Measurement of Short-Term Solvency
A corporation’s capability to pay its brief-term liabilities is ‘Short Term Solvency’, which evaluates through the Financial Statements Analysis. If a business enterprise has a fine ‘Short Term Solvency’, its creditors might no longer hesitate in lending price range to it. On the other hand, if an employer suffers from the lack of ‘Short Term Solvency’, the creditors would refrain from lending budget to it.
2) Measurement of Long-Term Solvency
A business enterprise’s capacity to pay off its ‘Long Term Liabilities’, i.e. bonds and debentures issued by using it and different secured liabilities, is ‘Long Term Solvency’. A business enterprise having such functionality is Solvent. Thus, an organisation’s reputation in terms of long-term solvency is discoverable through the analysis of economic statements.
3) Measurement of Operating Efficiency
Through the evaluation of the Financial Statements of an organisation, the placement in regards to its profitability is, without problems, ascertainable. If a company is incurring losses, the reasons thereof may also observe through such analysis, and necessary corrective moves may help to shrink losses and turn the loss-incurring company right into a profit-earning enterprise.
4) Measurement of Profitability
The present income ability of an agency as well as forecasting in respect of its future income, gathered through the profits ratio analysis, inputs for which must furnish through the Financial Statements. Measuring profitability is a critical indicator that helps make choices between the Investors” and “Lenders’ (Banks/Fls).
5) Comparison of Inter-Firm Position
The assessment of the economic position of one employer with that of another organisation is an exercise undertaken via Financial Analysis. Such a comparative examination is useful in finding out the route of action helpful for Investors and other stakeholders”.
Disadvantages of Financial Statement Analysis
The disadvantages of financial statement analysis are as follows:
1) Absence of Standard Universally Accepted Terminology
The Financial Statement Analysis is a part of accounting, which is only sometimes genuine technological know-how. Consequently, the terminology used in its miles differs from the one that’s standardised or universally well-known.
2) Overlooking Qualitative Aspects
Under the Financial Statement Analysis, there may be no attention to the “Qualitative Aspect of a commercial enterprise. The complete exercise focuses on the Quantitative Aspects of the business even as the Qualitative Aspects, many of which are full-size, entirely ignored.
3) Result in Absence of Absolute Data
As there may be a loss of the ‘Absolute Data’, the conclusions arrived at through the Financial Statement Analysis might need the correction in absolute phrases.
4) Overlooks Price Level Changes
As the fees of the identical commodity differ from 365 days to some other, the ‘Cost of Production’, ‘Sales’ and the Value of Assets are affected. Therefore, the comparison of ratios determined by the presumption that the fees of the commodities in two distinctive years remain identical won’t maintain correctly.
5) Suffering from Limitations of Financial Statements
A few inherent weaknesses are winning within the Financial Statements because the books of debts are maintained on the premise that Historical Data Analysis based on such financial statements may not reflect the actual photograph.