Explain in detail the meaning, Nature, objective and limitation of Financial Analysis.
Answers
Answer:MEANING
Financial statements are basically reports that depict financial and accounting information relating to businesses. A company’s management uses it to communicate with external stakeholders. These include shareholders, tax authorities, regulatory bodies, investors, creditors, etc.
Financial statements basically include the following reports:
Balance sheet
Profit and Loss statement
Cash flow statement
Explanation:NATURE
Financial statements are prepared using facts relating to events, which are recorded chronologically. We have to first record all these facts in monetary terms. Then, we have to process them using all applicable rules and procedures. Finally, we can now use all this data to generate financial statements.
Based on this understanding, the nature of financial statements depends on the following points:
Recorded facts: We need to first record facts in monetary form to create financial statements. For this, we need to account for figures of accounts like fixed assets, cash, trade receivables, etc.
Accounting conventions: Accounting Standards prescribe certain conventions applicable in the process of accounting. We have to apply these conventions while preparing financial statements. For example, valuation of inventory at cost price or market price, depending on whichever is lower.
Postulates: Apart from conventions, even postulates play a big role in the preparation of financial statements. Postulates are basically presumptions that we must make in accounting. For example, the going concern postulate presumes a business will exist for a long time. Hence, we have to treat assets on a historical cost basis.
Personal judgments: Even personal opinions and judgments play a big role in the preparation of financial statements. Thus, we have to rely on our own estimates while calculating things like depreciation.
Now that we understand the meaning and nature of financial statements, a glance at their objectives would be appreciable.
Objectives of Financial Statements
Stakeholders of a company heavily rely on financial statements to understand its functioning. They portray the true state of affairs of the company. Here are some objectives of financial statements:
Financial statements show an accurate state of a company’s economic assets and liabilities. External stakeholders like investors and authorities generally do not possess this information otherwise.
They help in predicting the extent of a company’s capacity to earn profits. Shareholders and investors can use this data to make their financial decisions.
Financial statements of a company depict the effectiveness of its management. How well a company is performing depends on its profitability, which these statements show.
They even help readers of these statements know the accounting policies used in them. This helps in understanding statements more comprehensively.
These statements also provide information relating to the company’s cash flows. Investorsnvestors and creditors can use this data to predict the company’s liquidity and cash requirements.
Finally, financial statements explain the social impact of businesses. This is because it shows how the company’s external factors affect its functioning
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