2nd PUC Analysis of Financial Statements Long Answer Questions With Answers<\/strong><\/p>\nQuestion 1.
\nDescribe the different techniques of financial analysis and explain the limitations of financial analysis.
\nAnswer:
\nThe various techniques used in financial analysis are as follows:
\nComparative Statements: These statements depict the figures of two or more accounting years simultaneously that help to access the profitability and financial position of a business. The Comparative Statements help us in analysing the trend of the financial position of the business. These statements also enable us to undertake various types of comparisons like inter\u00acfirm comparisons and intra-firm comparisons. It presents the change in the financial items both in absolute as well as percentage terms. Therefore, these statements help in measuring the efficiency of the business in relative terms. The analyses based on these statements are known as Horizontal Analysis.<\/p>\n
Common Size Statements: These statements depict the relationship between various items of financial statements and some common items (like Net Sales and the Total of Balance Sheet) in percentage terms. In other words, various items of Trading and Profit and Loss Account such as Cost of Goods Sold, Non-Operating Incomes and Expenses are expressed in terms of percentage ofNet Sales. On the other hand, different items of Balance Sheet such as Fixed Assets,<\/p>\n
Current Assets, Share Capital, etc. are expressed in terms of percentage of Total of Balance Sheet. These percentage figures are easily comparable with that of the previous years\u2019 (i.e. inter-firm comparison) and with that of the figures of other firms in the same industry (i.e. inter-firm comparison) as well. The analyses based on these statements are commonly known as Vertical Analysis.<\/p>\n
Trend Analysis: This analysis undertakes the study of trend in the financial positions and the operating performance of a business over a series of successive years. In this technique, a particular year is assumed to be the base year and the figures of all other years are expressed in percentage terms of the base year\u2019s figures. These trends (or the percentage figures) not only helps in assessing the operational efficiency and the financial position of the business but also helps in detecting the problems and inefficiencies.<\/p>\n
Ratio Analysis: This technique depicts the relationship between various items of Balance Sheet and the Income Statements. It helps in ascertaining the profitability, operational efficiency, solvency, etc of a firm.. The analysis expresses financial items in terms of percentage, fraction, proportion and as number of times. It enables budgetary controls by assessing the qualitative relationship among different financial variables. This analysis provides vital information to different accounting users regarding the financial position, viability and performance of a firm. It also facilitates decision making and policy designing process.<\/p>\n
Cash Flow Analysis: This analysis is presented in the form of a statement showing inflows and outflows of cash and cash equivalents from operating, investing and financing activities of a company during a particular period of time. It helps in analysing the reasons of receipts and payments in cash and change in the cash balances during an accounting year in a company.<\/p>\n
Limitations of Financial Analysis
\nThe limitations of Financial Analysis are:
\nIgnores Changes in the Price level: The financial analysis fails to capture the change in price level. The figures of different years are taken on nominal values and not in real terms (i.e. not taking price change into considerations).<\/p>\n
Misleading and Wrong Information: The financial analysis fails to reveal the change in the accounting procedures and practices. Consequently they may provide wrong and misleading information.<\/p>\n
Interim and Final Picture: The financial analysis presents only the interim report and \u2018 thereby provides incomplete information. They fail to provide the final and holistic picture.<\/p>\n
<\/p>\n
Ignores Qualitative and Non-monetary Aspects: The financial analysis reveals only the monetary aspects. In other words, these analyses consider only that information that can be expressed only in monetary terms. These analyses fail to disclose managerial efficiency, growth prospects, and other non-operational efficiency of a business.<\/p>\n
Accounting Concepts and Conventions: The financial analysis are based an accounting concepts and conventions. Therefore, the analysis and conclusions based on such analyses may not be reliable. For example, the analysis considers only the book-value of various items (i.e. according to the Going Concept) and consequently ignores the present market value of those items. Hence, the analysis may not be realistic.<\/p>\n
Involves Personal Biasness: The financial analysis reflects the personal biasness and personal value judgments of the accountants and clerks involved. There are different techniques used by different personnel for charging depreciation (original cost or written-down value method) and also for inventory valuation. The use of different techniques by different people reduces the effectiveness of the financial analysis.<\/p>\n
Unsuitable for Comparisons: Due to the involvement of personal value judgment, personal biasness and use of different techniques by different accountant, various types of comparisons such as inter-firm and intra-firm comparisons may not be possible and reliable.<\/p>\n
Question 2.
\nExplain the usefulness of trend percentages in interpretation of financial performance of a company.
\nAnswer:
\nThe Trend Analysis presents each financial item in percentage terms for each year. These . Trend Analyses not only help the accounting users to assess the financial performance of the business but also assist them to form an opinion about various tendencies and predict the future trend of the business.
\nUsefulness and Importance of Trend Analysis
\nThe following are the various importance of Trend Analysis:
\n1. Assists in forecasting: The trends provided by Trend Analysis help the accounting users to forecast the future trend of the business.<\/p>\n
2. Percentage Terms: The trends are expressed in percentage terms. Analysing the percentage figures is easy and also less time consuming.<\/p>\n
3. User Friendly: As the trends are expressed in percentage figures, so it is the most popular financial analysis to analyse the financial performance and operational efficiency of the company. In other weirds, one needs not to have an in-depth and sophisticated
\nknowledge of accounting in order to analyse these percentage trends.<\/p>\n
4. Presents a Broader Picture: The trend analysis presents a broader picture about the financial performance, viability and operational efficiency of a business. Generally, companies prefer to present their financial data for a period of 5 or 10 years in forms of percentage trends, whereas the other techniques of Financial Analysis lack this popularity.<\/p>\n
Question 3.
\nWhat is the importance of comparative statements? Illustrate your answer with particular reference to comparative income statement.
\nAnswer:
\nThe following are the importance of Comparative Statements.
\n1. Simple Presentation: The Comparative Statements present the financial data in a simpler form. Moreover, the year-wise data of the same items are presented side-by\u00acside, which not only makes the presentation clear but also enables easy comparisons (both intra-firm and inter-firm) conclusive.<\/p>\n
2. Easy for Drawing Conclusion: The presentation of comparative statement is so effective that it enables the analyst to draw conclusion quickly and easily and that too without any ambiguity<\/p>\n
3. Easy to Forecast: The comparative analysis of profitability and operational efficiency of a business over a period of time helps in analysing the trend and also assists the management to forecast and draft various future plans and policy measures accordingly.<\/p>\n
4. Easy Detection of Problems: By comparing the financial data of two or more years, the financial management can easily detect the problems. While comparing the data, some items may have increased while others have decreased or remained constant. The comparative analysis not only enables the management in ‘locating the problems but also helps them to put various budgetary controls and corrective measures to check whether the current performance is aligned with that of the planned targets.<\/p>\n
From the following information prepare comparative statement of profit and loss for the year ending 31st March, 2013 and 31st March, 2014 of Ritu Co. Ltd:
\n<\/p>\n
Comparative statement of Profit and Loss ofRitu Co. Ltd, for the year ending 31st March, 2014 and 31st March, 2015
\n<\/p>\n
<\/p>\n
Question 4.
\nWhat do you understand by analysis and interpretation of financial statements? Discuss their importance.
\nAnswer:
\nFinancial Analysis has great importance to various accounting users on various matters. Income Statements, Balance Sheets and other financial data provide information about expenses and sources of income, profit or loss and also helps in assessing the financial position of a business. These financial data are not useful until they are analysed. There are various tools and methods such as Ratio Analysis, Cash Flow Statements that make the financial data to cater varying needs of various accounting users.
\nThe following are the reasons that advocate in favour of Financial Analysis:<\/p>\n