Chapter analysis-of-financial-statements: Analysis of Financial Statements Short Questions | accountancy Class 12 CBSE

Chapter analysis-of-financial-statements: Analysis of Financial Statements Short Questions | accountancy Class 12 CBSE | ByteNotes.in

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Question 1

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What is meant by 'Analysis of Financial Statements'?

It is the process of critically evaluating financial information contained in financial statements to understand and make decisions regarding the operations of the firm.
It is a study of relationships among various financial facts and figures to gain insight into the profitability and operational efficiency of the firm.
It aims to assess the financial health and future prospects of the enterprise by regrouping and analysing information provided by financial statements.

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Question 2

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Distinguish between 'Analysis' and 'Interpretation' as used in financial statement analysis.

Analysis means simplification of financial data by methodical classification of the information given in the financial statements.
Interpretation means explaining the meaning and significance of the data derived from the financial statements.
The two are complementary — analysis is useless without interpretation, and interpretation without analysis is difficult or even impossible.

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Question 3

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How is financial analysis significant to trade payables of a company?

Trade payables use financial analysis to appraise not only the ability of the company to meet its short-term obligations but also to judge its continued ability to meet all financial obligations in future.
They are particularly interested in the firm's ability to meet their claims over a very short period of time.
Their analysis therefore evaluates the firm's liquidity position to determine the safety of their dues.

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Question 4

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Why do long-term lenders analyse the financial statements of a company?

Long-term lenders are concerned with the firm's long-term solvency and survival, so they analyse profitability over a period of time.
They examine the firm's ability to generate cash so that it can pay interest and repay the principal amount of the loan.
They also study the relationship between various sources of funds (capital structure relationships) and use historical financial statements to assess future solvency and profitability.

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Question 5

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What are comparative statements? Why are they also called 'horizontal analysis'?

Comparative statements show the profitability and financial position of a firm for different periods of time in a comparative form, including both absolute and percentage changes.
They are called horizontal analysis because the comparison is made across time periods — that is, horizontally from one year to another.
They apply to the balance sheet and statement of profit and loss, and the figures indicate the trend and direction of financial position and operating results.

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Question 6

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What is a Common Size Statement? Why is it also known as 'vertical analysis'?

A common size statement expresses each item of a financial statement as a percentage of a common base item, such as revenue from operations for P&L and total assets for the balance sheet.
It is called vertical analysis because the comparison is made within a single time period by relating each line item vertically to the common total.
It allows comparison of firms of different sizes and facilitates both intra-firm and inter-firm comparisons.

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Question 7

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State any two objectives of analysing financial statements.

To assess the current profitability and operational efficiency of the firm as a whole as well as its different departments so as to judge the financial health of the firm.
To identify the reasons for change in the profitability or financial position of the firm over time.
To judge the ability of the firm to repay its debt and to assess both short-term and long-term liquidity position of the firm.

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Question 8

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What is Trend Analysis? State its importance.

Trend analysis is a technique of studying the operational results and financial position over a series of years using percentage changes in selected data relative to a base year.
The trend percentage is the percentage relationship in which each item of different years bears to the same item in the base year.
It is important because, with its long-run view, it may point to basic changes in the nature of the business and helps detect problems or signs of good or poor management.

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Question 9

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What is Ratio Analysis? What aspects of an enterprise can it assess?

Ratio analysis describes the significant relationships which exist between various items of a balance sheet and a statement of profit and loss of a firm.
As a technique of financial analysis, accounting ratios measure the comparative significance of the individual items of the income and position statements.
Through ratio analysis, it is possible to assess the profitability, solvency, and efficiency of an enterprise.

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Question 10

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What is Cash Flow Analysis? Explain the concept of cash inflow and cash outflow.

Cash Flow Analysis refers to the analysis of actual movement of cash into and out of an organisation during an accounting year.
The flow of cash into the business is called cash inflow or positive cash flow, while the flow of cash out of the firm is called cash outflow or negative cash flow.
The difference between the inflow and outflow of cash is the net cash flow; a cash flow statement summarises the causes for changes in the cash position between the dates of two balance sheets.

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Question 11

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How does financial analysis help the finance manager of a firm?

Financial analysis focuses on facts and relationships related to managerial performance, corporate efficiency, financial strengths and weaknesses, and creditworthiness, helping the finance manager make rational decisions.
The tools of analysis help study accounting data to determine continuity of operating policies, investment value of the business, credit ratings, and testing the efficiency of operations.
The techniques are equally important in financial control, enabling the finance manager to review actual financial operations, analyse causes of major deviations, and take corrective action wherever indicated.

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Question 12

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Why is financial analysis significant for investors?

Investors who have invested money in the firm's shares are interested in the firm's earnings, so they concentrate on the analysis of the firm's present and future profitability.
They are also interested in the firm's capital structure to ascertain its influence on the firm's earnings and risk exposure.
They evaluate the efficiency of management and determine whether a change is needed; in some large companies, the shareholders' interest is limited to deciding whether to buy, sell, or hold shares.

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Question 13

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State any two limitations of financial analysis.

Financial analysis does not consider price level changes, which can make comparisons between periods misleading in times of inflation or deflation.
Financial analysis may be misleading without knowledge of changes in the accounting procedure followed by a firm, as different methods yield different figures.
Monetary information alone is considered in financial analysis while important non-monetary aspects of the business are completely ignored.

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Chapter analysis-of-financial-statements: Analysis of Financial Statements | Short Questions

What is meant by 'Analysis of Financial Statements'?

Distinguish between 'Analysis' and 'Interpretation' as used in financial statement analysis.

How is financial analysis significant to trade payables of a company?

Why do long-term lenders analyse the financial statements of a company?

What are comparative statements? Why are they also called 'horizontal analysis'?

What is a Common Size Statement? Why is it also known as 'vertical analysis'?

State any two objectives of analysing financial statements.

What is Trend Analysis? State its importance.

What is Ratio Analysis? What aspects of an enterprise can it assess?

What is Cash Flow Analysis? Explain the concept of cash inflow and cash outflow.

How does financial analysis help the finance manager of a firm?

Why is financial analysis significant for investors?

State any two limitations of financial analysis.

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