1. https://www.investopedia.

com/ask/answers/what-is-finance/
2. https://www.accountingtools.com/articles/what-are-the-qualitative-characteristics-of-financial-statem.html
3. https://www.yourarticlelibrary.com/accounting/financial-statements/financial-statements-features-
importance-and-limitations/61727

What Is Finance?
Finance is a broad term that describes activities associated with banking, leverage or debt, credit, capital
markets, money, and investments. Basically, finance represents money management and the process of
acquiring needed funds. Finance also encompasses the oversight, creation, and study of money, banking,
credit, investments, assets, and liabilities that make up financial systems.

Many of the basic concepts in finance originate from microeconomic and macroeconomic theories. One of

the most fundamental theories is the time value of money, which essentially states that a dollar today is
worth more than a dollar in the future.

What Is Financial Statement Analysis?

Financial statement analysis is the process of analyzing a company's financial statements for decision-

making purposes. External stakeholders use it to understand the overall health of an organization as well as
to evaluate financial performance and business value. Internal constituents use it as a monitoring tool for
managing the finances.

KEY TAKEAWAYS
 Financial statement analysis is used by internal and external stakeholders to evaluate business
performance and value.
 Financial accounting calls for all companies to create a balance sheet, income statement, and cash
flow statement which form the basis for financial statement analysis.

 Horizontal, vertical, and ratio analysis are three techniques analysts use when analyzing financial
statements.

How to Analyze Financial Statements

The financial statements of a company record important financial data on every aspect of a business’s
activities. As such, they can be evaluated on the basis of past, current, and projected performance.

In general, financial statements are centered around generally accepted accounting principles  (GAAP) in
the U.S. These principles require a company to create and maintain three main financial statements: the
balance sheet, the income statement, and the cash flow statement. Public companies have stricter standards
for financial statement reporting. Public companies must follow GAAP, which requires accrual
accounting.1  Private companies have greater flexibility in their financial statement preparation and also
have the option to use either accrual or cash accounting. 2

Several techniques are commonly used as part of financial statement analysis. Three of the most important
techniques include horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis compares
data horizontally, by analyzing values of line items across two or more years. Vertical analysis looks at the
vertical effects line items have on other parts of the business and also the business’s proportions. Ratio
analysis uses important ratio metrics to calculate statistical relationships.

Types of Financial Statements

Companies use the balance sheet, income statement, and cash flow statement to manage the operations of
their business and also to provide transparency to their stakeholders. All three statements are interconnected
and create different views of a company’s activities and performance.

Balance Sheet

The balance sheet is a report of a company's financial worth in terms of book value. It is broken into three
parts to include a company’s assets, liabilities, and shareholders' equity. Short-term assets such as cash and
accounts receivable can tell a lot about a company’s operational efficiency; liabilities include the company's
expense arrangements and the debt capital it is paying off; and shareholder’s equity includes details on
equity capital investments and retained earnings from periodic net income. The balance sheet must balance
assets and liabilities to equal shareholder’s equity. This figure is considered a company’s book value and
serves as an important performance metric that increases or decreases with the financial activities of a
company.

Income Statement

The income statement breaks down the revenue a company earns against the expenses involved in its
business to provide a bottom line, meaning the net profit or loss. The income statement is broken into three
parts that help to analyze business efficiency at three different points. It begins with revenue and the direct
costs associated with revenue to identify gross profit. It then moves to operating profit, which subtracts
indirect expenses such as marketing costs, general costs, and depreciation. Finally, after deducting interest
and taxes, the net income is reached.

Basic analysis of the income statement usually involves the calculation of gross profit margin, operating
profit margin, and net profit margin, which each divide profit by revenue. Profit margin helps to show
where company costs are low or high at different points of the operations.
Cash Flow Statement

The cash flow statement provides an overview of the company's cash flows from operating activities,
investing activities, and financing activities. Net income is carried over to the cash flow statement where it
is included as the top line item for operating activities. Like its title, investing activities include cash flows
involved with firmwide investments. The financing activities section includes cash flow from both debt and
equity financing. The bottom line shows how much cash a company has available.

CHARACTERISTICS

The following are all qualitative characteristics of financial statements .

Understandability

The information must be readily understandable to users of the financial statements. This means that
information must be clearly presented, with additional information supplied in the supporting
footnotes as needed to assist in clarification.

Relevance

The information must be relevant to the needs of the users, which is the case when the information
influences their economic decisions. This may involve reporting particularly relevant information, or
information whose omission or misstatement could influence the economic decisions of users.

Reliability

The information must be free of material error and bias, and not misleading. Thus, the information
should faithfully represent transactions and other events, reflect the underlying substance of events,
and prudently represent estimates and uncertainties through proper disclosure.

Comparability

The information must be comparable to the financial information presented for other accounting
periods , so that users can identify trends in the performance and financial position of the reporting
entity.

Financial Statements: Features, Importance and Limitations

Features of Financial Statements:

1. The Financial Statements should be relevant for the purpose for which they are prepared. Unnecessary and
confusing disclosures should be avoided and all those that are relevant and material should be reported to the
public.

2. They should convey full and accurate information about the performance, position, progress and prospects
of an enterprise. It is also important that those who prepare and present the financial statements should not
allow their personal prejudices to distort the facts.

3. They should be easily comparable with previous statements or with those of similar concerns or industry.
Comparability increases the utility of financial statements.

4. They should be prepared in a classified form so that a better and meaningful analysis could be made.

5. The financial statements should be prepared and presented at the right time. Undue delay in their
preparation would reduce the significance and utility of these statements.

6. The financial statements must have general acceptability and understanding. This can be achieved only by
applying certain “generally accepted accounting principles” in their preparation.

7. The financial statements should not be affected by inconsistencies arising out of personal judgment and
procedural choices exercised by the accountant.

8. Financial Statements should comply with the legal requirements if any, as regards form, contents, and
disclosures and methods. In India, companies are required to present their financial statements according to
the Companies Act, 1956.

Importance of Financial Statements:

The importance of financial statements lies in their utility to satisfy the varied interest of different categories
of parties such as management, creditors, public, etc.

1. Importance to Management:
Increase in size and complexities of factors affecting the business operations necessitate a scientific and
analytical approach in the management of modern business enterprises.

The management team requires up to date, accurate and systematic financial information for the purposes.
Financial statements help the management to understand the position, progress and prospects of business vis-
a-vis the industry.

By providing the management with the causes of business results, they enable them to formulate appropriate
policies and courses of action for the future. The management communicates only through these financial
statements, their performance to various parties and justify their activities and thereby their existence.
A comparative analysis of financial statements reveals the trend in the progress and position of enterprise
and enables the management to make suitable changes in the policies to avert unfavorable situations.

2. Importance to the Shareholders:

Management is separated from ownership in the case of companies. Shareholders cannot, directly, take part
in the day-to-day activities of business. However, the results of these activities should be reported to
shareholders at the annual general body meeting in the form of financial statements.

These statements enable the shareholders to know about the efficiency and effectiveness of the management
and also the earning capacity and financial strength of the company.

By analyzing the financial statements, the prospective shareholders could ascertain the profit earning
capacity, present position and future prospects of the company and decide about making their investments in
this company.

Published financial statements are the main source of information for the prospective investors.

3. Importance to Lenders/Creditors:
The financial statements serve as a useful guide for the present and future suppliers and probable lenders of a
company.

It is through a critical examination of the financial statements that these groups can come to know about the
liquidity, profitability and long-term solvency position of a company. This would help them to decide about
their future course of action.

4. Importance to Labour:
Workers are entitled to bonus depending upon the size of profit as disclosed by audited profit and loss
account. Thus, P & L a/c becomes greatly important to the workers. In wages negotiations also, the size of
profits and profitability achieved are greatly relevant.

5. Importance to the Public:

Business is a social entity. Various groups of society, though directly not connected with business, are
interested in knowing the position, progress and prospects of a business enterprise.

They are financial analysts, lawyers, trade associations, trade unions, financial press, research scholars and
teachers, etc. It is only through these published financial statements these people can analyze, judge and
comment upon business enterprise.
6. Importance to National Economy:
The rise and growth of corporate sector, to a great extent, influence the economic progress of a country.
Unscrupulous and fraudulent corporate managements shatter the confidence of the general public in joint
stock companies, which is essential for economic progress and retard the economic growth of the country.

Financial Statements come to the rescue of general public by providing information by which they can
examine and assess the real worth of the company and avoid being cheated by unscrupulous persons.

The law endeavors to raise the level of business morality by compelling the companies to prepare financial
statements in a clear and systematic form and disclose material information.

This has increased the confidence of the public in companies. Financial statements are also essential for the
various regulatory bodies such as tax authorities, Registrar of companies, etc. They can judge whether the
regulations are being strictly followed and also whether the regulations are producing the desired effect or
not, by evaluating the financial statements.

Limitations of Financial Statements:

Most of the limitations are mainly due to the cumulative effect of recorded facts, accounting conventions and
personal judgment on financial statements. Unless they are prepared specially they fail to reflect the current
economic picture of business. As such, financial statements have a number of limitations.

The important limitations are as follows:

1. Information is Incomplete and Inexact:
The financial statements are interim reports usually prepared for an accounting period. Hence, the financial
information as revealed by them is neither complete nor exact.

The true financial position or ultimate gain or loss, can be known only when the business is closed down.
2. Qualitative Information is Ignored:
Financial statements depict only those items of quantitative information that are expressed in monetary
terms.

But, a number of qualitative factors, such as the reputation and prestige of the management with the public,
cordial industrial relations and efficiency of workers, customer satisfaction, competitive strength, etc., which
cannot be expressed in monetary terms , are not depicted by the financial statements.

However, these factors are essential for understanding the real financial condition and the operating results
of the business.
3. Financial Statements Mainly Show Historical Information:
As the financial statements are compiled on the basis of historical costs, they fail to take into account such
factors as the decrease in money value or increase in the price level changes. Since these statements deal
with past data only, they are of little value in decision-making.

4. Financial Statements are Based on Accounting Concepts and Conventions.

Accounting concepts and conventions used the preparation of financial statements make them unrealistic.

For example the income statement prepared on the basis of the convention of conservatism fails to disclose
the true income, for it includes probable losses and ignores probable income.

Similarly the value of fixed asset is shown in the balance sheet on the ‘going concern concept’. This means
that the value of the asset rarely represents the amount of cash, which would be realized on liquidation.
5. Personal Judgment Influence Financial Statements:
Many items in the financial statements are left to the personal judgment of the accountant. For example, the
method of inventory valuation, the method of depreciation the treatment of deferred revenue expenditure,
etc., depend on the personal judgment of the accountant.