Types of financial statement analysis
Financial statements analysis are classified according to their objectives, Materials used and Modus operandi.
Financial statement analysis, according to objectives are further subdivided into Short term and long term.
Short term analysis include
- Working capital position analysis,
- Liquidity analysis,
- Return analysis,
- Profitability analysis,
- Activity analysis.
Long term analysis include
- Profitability analysis,
- Capital structure analysis,
- Financial position,
- Future prospects.
Financial statement analysis according to materials used include Internal and External analysis. Financial statement analysis according to modus operandi include Horizontal and vertical analysis. They are briefly explained below.
1. Internal Analysis: Internal analysis is made by the top management executives with the help of Management Accountant. The finance and accounting department of the business concern have direct approach to all the relevant financial records. Such analysis emphasis on the overall performance of the business concern and assessing the profitability of various activities and operations.
2. External Analysis: Shareholders as investors, banks, financial institutions, material suppliers, government department and tax authorities and the like are doing the external analysis. They are fully depending upon the published financial statements. The objective of analysis is varying from one party to another.
3. Short Term Analysis: The short term analysis of financial statement is primarily concerned with the working capital analysis so that a forecast may be made of the prospects for future earnings, ability to pay interest, debt maturities – both current and long term and probability of a sound dividend policy.
A business concern has enough funds in hand to meet its current needs and sufficient borrowing capacity to meet its contingencies. In this aspect, the liquidity position of the business concern is determined through analyzing current assets and current liabilities. Hence, ratio analysis is highly useful for short term analysis.
4. Long Term Analysis: There must be a minimum rate of return on investment. It is necessary for the growth and development of the company and to meet the cost of capital. Financial planning is also necessary for the continued success of a company. The fixed assets structure, leverage analysis, ownership pattern of securities and the like are made in the long term analysis.
5. Horizontal Analysis: It is otherwise called as dynamic analysis. When financial statements for a number of years are viewed and analyzed, the analysis is called horizontal analysis. The preparation of comparative statements is an example of this type of analysis.
6. Vertical Analysis: It is otherwise called as static analysis. Under this type of analysis, the ratios are calculated from the balance sheet of one year and/or from the profit and loss account of one year. It is used for short term analysis only.