Financial Statements Analysis (FINANCIAL STATEMENT ANALYSIS) refers to the process of the critical examination of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm. The FINANCIAL STATEMENT ANALYSIS is basically a study of the relationship among various financial facts and figures is given in a set of financial statements. The basic financial statements i.e. the Balance Sheet and the Income Statement, already discussed in the preceding lesson contain a whole lot of historical data. The complex figures as given in these financial statements are dissected/broken up into simple and valuables elements and significant relationships are established between the elements of the same statement or different financial statements. This process of dissection, establishing relationships and interpretation thereof to understand the working and financial position of a firm is called the FINANCIAL STATEMENT ANALYSIS. Thus, FINANCIAL STATEMENT ANALYSIS is the process of establishing and identifying the financial weaknesses and strength of the firm. It is indicative of two aspects of a firm i.e. the profitability and the financial position and it is what is known as the objectives of the FINANCIAL STATEMENT ANALYSIS.

Objectives of the FINANCIAL STATEMENT ANALYSIS: Broadly, the objective of the FINANCIAL STATEMENT ANALYSIS is to understand the information contained in financial statements with a view to know the weaknesses and strength of the firm and to make a forecast about the future prospects of the firm and thereby enabling the financial analyst to take different decisions regarding the operations of the firm. The objectives of the FINANCIAL STATEMENT ANALYSIS can be identified as: To assess the present profitability and operating efficiency of the firm as a whole as well as for its different departments and segments. To find out the relative importance of different components of the financial position of the firm. To identify the reasons for change in the profitability/financial position of the firm, and To assess the short term as well as the long term liquidity position of the firm.

Types of Financial AnalysisFinancial analysis can be classified into different categories depending upon (1) the material used, and (2) the modus operandi of analysis.1. On the Basis of Material Used: Under this category the financial analysis can be of two types: a) External Analysis; b) Internal Analysisa. External Analysis: The outsiders to the business carry out this kind of analysis, which includes investors, credit agencies, government agencies and other creditors who have no access to the internal records of the company. In the recent times this analysis has gathered momentum towards better corporategovernance and government regulations for more detailed disclosure of information by the companies in their financial statements.b. Internal Analysis: In contrary to the above this analysis is done by those who have access to the books of accounts and other information related to the business. The analysis is done depending upon the objective to be achieved through this analysis.2. On the basis of Modus Operandi: In this case too, the financial analysis can be of two types: a) Horizontal Analysis; b) Vertical Analysisa Horizontal Analysis: Under this financial statements for a number of years are reviewed and analyzed. The current years figures are compared with standard or base year.b Vertical Analysis: Under this type of analysis a study is made of the quantitative relationship of the various items in financial statements on a particular date. For example, the ratios of different items of costs for a particular period may be calculated with the sales for that period. These types of financial analysis are useful in comparing the performance of several companies in the same group, or divisions or departments in the same company.In addition to above, the FINANCIAL STATEMENT ANALYSIS for a firm can be undertaken in different ways. There is 'the best' technique of the FINANCIAL STATEMENT ANALYSIS, which can be applied to all the firms under all the situations. The type of the FINANCIAL STATEMENT ANALYSIS undertaken depends upon the person doing the FINANCIAL STATEMENT ANALYSIS and the purpose of which the FINANCIAL STATEMENT ANALYSIS has been undertaken. Different person/parties may undertake the FINANCIAL STATEMENT ANALYSIS for different purposes. The persons/parties, who are usually interested in the FINANCIAL STATEMENT ANALYSIS, may be the shareholders, the creditors, the financial institutions, the investors and the management itself. The FINANCIAL STATEMENT ANALYSIS can be classified into different categories as follows: a) Internal and External FINANCIAL STATEMENT ANALYSIS; b) Dynamic and Static FINANCIAL STATEMENT ANALYSISa) Internal and External FINANCIAL STATEMENT ANALYSIS: The FINANCIAL STATEMENT ANALYSIS is said to be internal when it is done by a person who has access to the books of the account and other related information of the firm. This type of FINANCIAL STATEMENT ANALYSIS is conducted for measuring the operational and managerial efficiency at different hierarchy levels of the firm. This type of analysis is quite comprehensive and reliable. In order to undertake internal FINANCIAL STATEMENT ANALYSIS, either an employee of the same firm or an outside agency may be entrusted the responsibility. External FINANCIAL STATEMENT ANALYSIS, on the other hand, is one, which is conducted by an outsider without having any access to the basic accounting record of the firm. These outsiders may be the creditors, the investors, the shareholders, the credit rating agencies etc. The external FINANCIAL STATEMENT ANALYSIS is dependent on the published financial data of the firm and consequently can serve only limited purpose.b) Dynamic and Static FINANCIAL STATEMENT ANALYSIS: The FINANCIAL STATEMENT ANALYSIS is said to be dynamic if it covers a period of several years. Financial data/information for different years is incorporated in the FINANCIAL STATEMENT ANALYSIS to assess the progress of the firm. This type of FINANCIAL STATEMENT ANALYSIS is also called the horizontal analysis. The dynamic FINANCIAL STATEMENT ANALYSIS is useful for long-term trend analysis and planning. In dynamic FINANCIAL STATEMENT ANALYSIS, the figures/data for a year are placed and compared with the figures/data for several other years and changes from 1 year to another are identified. Since, the dynamic analysis covers a period of more than 1 year (may be up to 5 years or 10 years), is given a considerable insight into areas of financial weaknesses and strength of the firm. On the other hand, the static FINANCIAL STATEMENT ANALYSIS covers a period of 1 year only and the analysis is made on the basis of only one set of financial statements.So, it is study in terms of information at a particular date only. It is also called vertical FINANCIAL STATEMENT ANALYSIS. Impliedly, the static FINANCIAL STATEMENT ANALYSIS fails to incorporate the periodic changes and therefore, may not be very conducive to a proper understanding of the financial position of the firm. It may be noted that both the dynamic and static FINANCIAL STATEMENT ANALYSIS should be conducted simultaneously as both are indispensable for understanding the profitability and financial position of the firm.On the basis of the above discussion, it can be said that FINANCIAL STATEMENT ANALYSIS investigative and thought provoking process in nature. The basic objective of FINANCIAL STATEMENT ANALYSIS is financial planning and forecasting on the basis of meaningful interpretation of the financial information. It is forward looking exercise. Since, decisions are going to be taken on the basis of the FINANCIAL STATEMENT ANALYSIS, the analyst must be careful, precise, analytical, objective and intelligent enough to undertake the FINANCIAL STATEMENT ANALYSIS in a systematic way.