• Comparative Statements: Comparing financial data of two or more years.
• Common Size Statements: Converting figures into percentages of a common base (e.g., Sales or Total Assets).
• Trend Analysis: Calculating trend percentages over a series of years.
• Ratio Analysis: Calculating accounting ratios to assess profitability, liquidity, and solvency.
• Cash Flow Analysis: Analyzing the inflow and outflow of cash.

• Analysis: It refers to the process of simplifying and rearranging financial data from the complex financial statements into meaningful categories to understand the relationships between various items.
• Interpretation: It refers to explaining the meaning and significance of the processed data (analysis). It involves drawing conclusions about the profitability, solvency, and liquidity of the business based on the analysis.

• Helps in judging the Profitability and operational efficiency of the firm.
• Helps in assessing the Solvency (both short-term and long-term) of the business.
• Facilitates Comparative Studies (inter-firm and intra-firm).
• Helps management in Decision Making and forecasting future trends.

• Absolute figures for two periods.
• Absolute change (Increase/Decrease).
• Percentage change (Increase/Decrease).

• For Balance Sheet, the common base is Total Assets (Total Equity & Liabilities).
• For Statement of P&L, the common base is Revenue from Operations (Net Sales).

Techniques of Financial Analysis

1. Comparative Statements: Statements of two or more years are placed side by side to facilitate comparison. They show absolute data, absolute change, and percentage change.
2. Common Size Statements: Statements where individual items are converted into percentage of a common base (e.g., Sales for Income Statement, Total Assets for Balance Sheet).
3. Trend Analysis: A base year is selected, and subsequent years’ data are expressed as a percentage of the base year to determine the trend (upward/downward).
4. Ratio Analysis: It establishes a relationship between various accounting figures (e.g., Current Assets and Current Liabilities) to assess liquidity, solvency, and profitability.
5. Cash Flow Analysis: It studies the sources (inflow) and uses (outflow) of cash during a period.

Limitations of Financial Analysis

• Historical Nature: It analyzes past data which may not be relevant for future decisions.
• Ignores Price Level Changes: It fails to account for inflation, making long-term comparison difficult.
• Qualitative Factors Ignored: It only considers monetary facts, ignoring non-monetary factors like management quality.
• Affected by Window Dressing: If the original statements are manipulated, the analysis will be misleading.
• Lack of Standard Norms: Different accounting policies (e.g., Depreciation methods) make inter-firm comparison difficult.

Trend percentages (or Trend Analysis) involves calculating the percentage relationship that each item of different years bears to the same item in the base year. It is highly useful because:

• Direction of Change: It clearly indicates the direction (increase, decrease, or constant) of financial items over a period of time.
• Growth Assessment: It helps in assessing the growth rate of key figures like Sales, Profits, and Assets.
• Future Forecasting: By studying the past trend, management can project future performance and plan accordingly.
• Simplicity: It is easier for a layman to understand percentages (e.g., “Sales have grown by 20%”) than complex absolute figures.
• Detecting Weaknesses: If the trend of expenses is rising faster than the trend of sales, it acts as an early warning signal for inefficiency.

Importance: Comparative statements place the figures of current year and previous year side-by-side. They help in:

• Showing the absolute change in items.
• Showing the percentage change, which makes the data comparable even if the scale of operation changes.
• Identifying the weak and strong points of the business operations.

Illustration: Comparative Income Statement

In this example, while Sales increased by 50%, Profit only increased by 25% because Expenses rose disproportionately by 66.67%. This highlights inefficiency in cost control.

• Analysis: It is the methodical classification and processing of the data given in the financial statements. It involves breaking down complex data into simple elements (like ratios or percentages).
• Interpretation: It is the process of drawing meaning and significance from the analyzed data. It involves explaining why a ratio is low or high and what it means for the future of the company.

Importance:

• For Investors: To judge the safety and return on their investment.
• For Management: To evaluate operational efficiency and locate areas of waste.
• For Creditors: To determine the liquidity and ability of the firm to pay debts.
• For Employees: To negotiate for better wages based on profitability.

Preparation Process: In a Common Size Statement, each item is expressed as a percentage of a common base.

• Income Statement: Base = Revenue from Operations (Net Sales) = 100%. All expenses and incomes are expressed as a % of Sales.
• Balance Sheet: Base = Total Assets (or Total Equity & Liabilities) = 100%. All assets and liabilities are expressed as a % of Total.

Example: Common Size Income Statement

This clearly shows that although absolute Gross Profit increased, the Gross Profit Margin fell from 40% to 35% because the Cost of Goods Sold rose from 60% to 65% of sales.