FINANCIAL STATEMENT ANALYSIS

Financial Statement Analysis



Financial Statement Analysis

Financial Statement

Financial statements are a main source of financial information for an organization. Users analyze these statements to evaluate the ability of an organization to use its resources efficiently and effectively and form expectations about risks and returns by studying the changes in assets, liabilities, earnings and cash flows over time.

Type of Information

A balance sheet shows the assets, liabilities and owners' equity at a point in time, for example a balance sheet prepared on March 31st, 2011 provides a snapshot of the assets, liabilities and owners' equity for that entity at that point in time. The income statement and statement of cash flows help explain the changes in balance sheet accounts during a period of time. Balance sheets for the beginning and ending of a fiscal period reveal changes in an entity's resources and finances. Examining an entity's income statement and statement of cash flows will reveal major events that caused these changes. The relationship between financial statements can be attributed to the manner in which the numbers on one statement explain numbers on other statements (Vincent and Terry, 2002).

The limitations of financial statements

Financial statements are many times based on numbers derived from estimates and allocations. For example, when calculating depreciation, one has to estimate the cost of an asset that was used up during a fiscal period and allocate that amount to the depreciation expense for that period.  These are estimates and not exact numbers since it is difficult to exactly determine how much of an asset is consumed during a particular fiscal period.  Also frequently management has to use their judgment when determining how certain expenses and revenues are recorded. These decisions and estimates mean that accounting numbers are not as precise as they might appear.

Financial statements primarily report the purchase or exchange price of an asset or liability at the time it is acquired or incurred. The recorded values are not adjusted for inflation or for changes in the appreciation or depreciation of the assets or liabilities. Therefore the true value of an asset is ambiguous (Thomas, 2001).

Even though the financial statements include the primary transactions that occur as part of an entity's business activities, there are no guarantees that all important transactions are fully recorded in the financial statements. Accountants and managers sometimes disagree about when certain activities should be recognized. Also, they may disagree about ...