The Analysis of Financial Statements

The objective of public accounting reports is to reveal or describe the economic activities of a company. In this sense, accounting reports represent raw material to be used in developing an understanding of a company and its operations The statements provide much useful information, but by analysis and study of them additional relationships and activities may be revealed The underlying principles of accounting analysis are to be found in infor­mation theory and communication theory. But the practice is best re­vealed by a study ofwhat analysts do, and in practice ratio analysis and trend studies are widely used analytical techniques. While analysis of all types of accounting reports is desirable for disclosure of information on a company's activities, the process can best be ex­plained by emphasizing methods of analyzing the public accounting

The purposes for which information is needed will indicate the types of analyses to be made. In broad terms, there are three types of analyses:

1. General-purpose analysis, which aims merely to reveal more com­pletely the information in accounting statements, and to relate it to other factors in the company and the economy.

2. Analysis for credit or investment purposes, which aims to disclose relationships which bear upon the financial effectiveness of the company.

3. Analysis for management purposes, which aims to disclose success­ful and unsuccessful plans and operations.

Preliminary Arrangements

Regardless of the purpose for which an analysis is made, certain preliminary steps must be taken to arrange the data in suitable form. They include the following tasks:

1. Selecting and collecting relevant standards for evaluating an analysis.

2. Rounding off amounts, e.g., to the nearest hundreds or thousands of dollars.

3. Reclassifying accounts, especially if comparative statements over a period of time are used, so that a uniform classification will be used in all analyses.

In some instances, segregating and grouping accounts according to different classification systems.

5. Selecting, computing, and interpreting various statistical measures, economic indicators, ratios, comparisons, and relationships which reveal significant information.

Standards for Comparison. There is limited significance to any analy­sis which does not provide a basis for determining whether the informa­tion developed by the analysis is favorable or unfavorable. If compara­tive data are not available or cannot be developed, other analyses should be made for which comparative data will be available.

For every analysis, there should be some type of standard against which the resulting information may be compared. These standards may be:

1. Informal—sometimes only a "feeling" on the part of the reader of the analyzed data.

2. Past results against which current results may be compared.

3. Results of other companies in the same industry (there are a number of limitations to this type of standard, because companies are seldom entirely comparable).

Date: 2016-01-14; view: 657