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The main function of financial analysis is the pinpointing of the strength and weaknesses of a
business undertaking by regrouping and analysis of figures contained in financial statements, by
making comparisons of various components and by examining their content. The analysis and
interpretation of financial statements represent the last of the four major steps of accounting.
The first three steps involving the work of the accountant in the accumulation and
summarisation of financial and operating data as well as in the construction of financial
statements are:
(i) Analysis of each transaction to determine the accounts to be debited and credited and the
measurement and variation of each transaction to determine the amounts involved.
(ii) Recording of the information in the journals, summarisation in ledgers and preparation of a
worksheet.
(iii) Preparation of financial statements.
The fourth step of accounting, the analysis and interpretation of financial statements, results in
the presentation of information that aids the business managers, investors and creditors.
External analysis is an analysis based on information easily available to outsiders (externals) for
the business. Outsiders include creditors, suppliers, investors, and government agencies
regulating the business in a normal way.
These parties do not have access to the internal records (information) of the concern and
generally obtain data for analysis from the published financial statements. Thus an analysis done
by outsiders is known as external analysis.
Internal analysis is an analysis done on the basis of information obtained from the internal and
unpublished records and books. While conducting this analysis, the analyst is a part of the
enterprise he is analysing. Analysis for managerial purposes is the internal type of analysis and is
conducted by executives and employees of the enterprise as well as governmental and court
agencies which may have major regulatory and other jurisdiction over the business.
Horizontal analysis is also known as ‘dynamic analysis’ or ‘trend analysis’. This analysis is
done by analysing the statements over a period of time. Under this analysis, we try to examine as
to what has been the periodical trend of various items shown in the statement. The horizontal
analysis consists of a study of the behaviour of each of the entities in the statement.
1. Ratio Analysis:
Two individual items on the statements can be compared with one another and the relationship is
expressed as a ratio. Ratios are computed for items on the same financial statement or on
different statements. These ratios are compared with those of prior years and with those of other
companies to make them more meaningful.
In fact, these statements are substantially an analysis of static aspects of financial statements.
Under this context, it is imperative to study and to analyse the fund movements in the business
concern. Such a study or analysis may be undertaken by using another tool of financial analysis,
which is called ‘Statement of Sources, and Uses of Funds’ or simply ‘Fund Statement’ or Fund
Flow Analysis.
This statement is also called by other several names and they are:
(a) Application of Funds Statement.
(b) Statement of Sources and Applications of Funds.
(c) Statement of Funds Supplied and Applied.
(d) Where Got and Where Gone Statement.
(e) Statement of Resources Provided and Applied.
(f) Fund Movement Statement.
(g) Inflow-Outflow of Fund Statement.
Fund statement is a new contribution of science of accounting but has become the doyen of tools
of Financial Analysis.
The term cash can be viewed in two senses. In a narrow sense, it includes actual cash in the form
of notes and coins and bank drafts held by a firm and the deposits withdraw able on demand the
company has held in commercial banks. But in a broader sense, it also includes what are called
‘marketable securities’ which are those securities which can be immediately sold or converted
into cash if required.
Cash flow statement is a statement of cash flow and cash flow signifies the movements of cash in
and out of a business concern. Inflow of cash is known as sources of cash and outflow of cash is
called uses of cash. This statement also depicts factors for such inflow and outflow of cash.
Thus cash flow statement is a statement designed to highlight upon the causes which bring
changes in cash position between two Balance Sheets dates. It virtually takes the nature and
character of cash receipts and cash payments though the basic information used in the
preparation of this statement differs from that which is used in recording cash receipts and cash
payments.
This is particularly useful to the management, credit grantors, investors and others. As regards
the management, it is helpful in budgeting cash requirements.