Question

What do you understand by analysis and interpretation of financial statements? Discuss its importance.

Answer 1

Financial Analysis has great importance to various accounting users on various matters. Income Statements, Balance Sheets and other financial data provide information about expenses and sources of income, profit or loss and also helps in assessing the financial position of a business. These financial data are not useful until they are analysed. There are various tools and methods such as Ratio Analysis, Cash Flow Statements that make the financial data to cater varying needs of various accounting users.

The following are the reasons that advocate in favour of Financial Analysis:

1. It helps in evaluating the profit earning capacity and financial feasibility of a business.

2. It helps in assessing the long-term solvency of the business.

3. It helps in evaluating the relative financial status of a firm in comparison to other competitive firms.

4. It assists management in decision making process, drafting various plans and also in establishing an effective controlling system.