Analysis of Financial Statements Class 12 Notes: CBSE Accountancy Chapter 4

1. What do you mean by Analysis of Financial Statements?

Financial statement analysis involves making informed assessments of a company's current and past financial status and operational outcomes. Its main goal is to make reliable estimates and forecasts about future conditions. This process reveals connections and highlights both strong and weak aspects of a business.

Importance of Analysis of Financial Statements:

• Assessing managerial performance, corporate efficiency, financial strengths, weaknesses, and creditworthiness, enabling informed decisions by finance managers.

• Ensuring efficient resource allocation and maintaining the financial health of the firm, allowing top management to evaluate operational success and internal controls.

• Evaluating a company's ability to meet both short-term and long-term financial obligations, crucial for suppliers in maintaining business relationships.

• Analyzing historical financial data to predict future solvency and profitability, influencing decisions by long-term lenders.

• Assisting investors in evaluating management effectiveness, understanding the firm's financial structure, and predicting potential earnings.

• Supporting labor unions in determining the feasibility of wage increases based on productivity and pricing.

• Providing economists and researchers with insights into current business conditions and economic trends for broader economic analysis and forecasts.

2. The goals of analyzing financial statements are:

• Evaluate how profitable and efficient the entire company and its departments are, to determine its financial well-being.

• Determine the significance of various aspects of the company's financial status.

• Identify the reasons behind changes in the company's profitability and financial status.

• Assess the company's capability to repay debts and evaluate its short-term and long-term financial liquidity.

• Financial Statements are created using factual data and numbers. 

• They follow specific Accounting Conventions and are built on assumptions called postulates. 

• Personal judgement plays a role at times in preparing these statements.

3. Tools of Analysis of Financial Statements: Here are the simplified descriptions of the tools used to analyze financial statements:

• Comparative Statements: These show how profitable and financially stable a firm is over different periods, comparing key financial statements like the balance sheet and profit and loss statement.

• Common Size Statements: These indicate the relationship of different items in a financial statement to a common item, expressed as percentages.

• Trend Analysis: This method studies how a company's operations and financial health change over multiple years, highlighting significant shifts in business direction.

• Ratio Analysis: This assesses the relationships between various items in a balance sheet and profit and loss statement, helping to evaluate a company's profitability, financial stability, and efficiency.

• Cash Flow Analysis: This examines the actual movement of cash into and out of an organization, detailing cash inflows (positive) and outflows (negative), with the difference being the net cash flow reflected in a cash flow statement.

4. What is a Comparative Statement?

A Comparative Statement includes both profit and loss statements and balance sheets with columns for figures from both the current year and the previous year. It shows changes during the year in both absolute and relative terms, helping understand account balances and operational activities, as well as increases and decreases in various dates.

5. How to prepare Comparative Statements?

To prepare Comparative Statements, follow these steps:

• List absolute figures for two different time periods, like Year 1 and Year 2.

• Determine the change in absolute figures by subtracting Year 1 from Year 2, noting if it's an increase (+) or decrease (–), and record this in Column 4.

• Optionally, calculate the percentage change by comparing the difference to Year 1 and place this in Column 5.

Refer to the table below for a clearer explanation:

Comparative Statement

6. What is a Common Size Statement?

A Common Size Statement is a financial tool used to analyze how a company's financial position and operational results change over time. It's also called a component percentage statement. Each item in this statement is shown as a percentage of the total revenue or aggregate figure to which that item belongs.

7. To prepare a Common Size Statement:

• List absolute figures for two different time periods, such as Year 1 and Year 2.

• Choose a common base, often set as 100. For instance, revenue from operations could be the base for the profit and loss statement, and total assets or liabilities could be the base for the balance sheet.

• Calculate the percentage of each item listed in Columns 2 and 3. These percentages are then shown in Columns 4 and 5, respectively.

Refer to the table below for a clearer understanding:

Common Size Statement

8. Limitations of Analysis of Financial Statements:

The limitations of the Analysis of Financial Statements are mentioned below:

• Analysis of financial statements does not consider price level changes

• Can be misleading if interrupted by changes to the accounting procedure of the company

• It is just a study of the reports of the company

• Only monetary information is given importance, non-monetary aspects are ignored

• The statements are prepared according to the accounting concepts and thus leave room for error since it does not know about the current position of the company.

5 Important Topics of Analysis of Financial Statements Class 12 Notes Chapter 4 Accountancy

Importance of Chapter 4 Analysis of Financial Statements Notes

• Revision Notes help assess a company's financial well-being by analysing profitability, liquidity, and efficiency through ratios and trends.

• Provides stakeholders such as investors, creditors, and managers with insights to make informed decisions based on financial data interpretation.

• Facilitates evaluating a company's performance over time and benchmarking against industry standards.

• Assists in predicting future financial trends and outcomes, supporting strategic planning and risk management.

• Improves the ability to analyse complex financial data and derive meaningful insights.

• Encourages financial transparency and compliance with regulatory standards through accurate reporting and analysis.

Tips for Learning the Class 12 Accountancy Chapter 4 Analysis of Financial Statements Notes

• Begin by learning fundamental concepts like ratios, cash flows, and how to compare financial statements.

• Solve problems and review examples to see how to use financial analysis methods in real situations.

• Create visual tools to connect different financial statements and understand them better.

• Study real companies' financial statements to see how these concepts work in practice.

• Use videos or interactive resources to help you understand more complex ideas.

• Keep going over your notes and key ideas to make sure you remember them well.

Conclusion

CBSE Class 12 Accountancy Revision Notes for Chapter 4, Analysis of Financial Statements, provide a clear understanding of how to assess a company's financial health through ratios, cash flows, and comparative analysis. These notes help students grasp complex financial concepts with practical examples and visual aids, ensuring thorough preparation for exams. Vedantu's resources further enhance learning with accessible PDFs and expert guidance aligned with the Class 12 syllabus, supporting students in achieving a comprehensive understanding and confidence in financial statement analysis.

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