Accounting process involves recording, classifying and summarizing various business transactions. Accountants are maintained to determine the profitability of the enterprise and to find out its financial position. Financial statement is a summarized view of the financial position of the firm. Therefore much can be learned about a firm by a careful examination of its financial statements. The analysis of financial statements is an important aid to financial analysis. The analysis of financial statement is a process of evaluating relationship between component part of financial statements to obtain a better understanding of the firm’s position and performance.
It is prepared for the purpose of presenting a periodical review or reports on the progress by the management and deal with a) the status of investments in the business and b) the results achieved during a period under review. The statement disclosing status of investments is known as Balance Sheet and the statement showing the result is known as profit and loss account.
A firm communicates financial information to the users through financial statements and reports. The financial statements contain summarized information of the firm’s financial affairs, organized systematically. They are means to present the firm’s financial situation to users. The preparation of the financial statements is the responsibility of the top management. The two basic financial statement prepared are balance sheet and profit and loss account. As investors and financial analysis to examine the firm’s performance in order to make investment decisions use these statements, they should be prepared very carefully and contain as much information as possible.
Nature of financial statement
Financial statements are prepared for the purpose of presenting a periodical review or report on progress by the management and deal with the status of investment in the business and the results achieved during the period under review.
According to the American institute of certified public accounting, financial statement reflect” a combination of recorded facts, accounting conventions and personal judgements and conventions applied affect them materially”. This implies the data exhibited in the financial statements are affected by recorded facts, accounting conventions and personal judgement
a) Recorded facts:
The term – recorded facts refer to the data taken out from the accounting records. The cost or historical cost is the basis of recording various transactions.
b) Accounting conventions:
Certain accounting conventions are followed while preparing financial statements. The conventions of valuating stock at cost or market price whichever lower is followed. The use of the accounting conventions makes financial statements comparable, simple and realistic.
The accountant makes certain assumption while making accounting records. One of these assumptions is that the enterprise is treated as a going concern. Another assumption is that the value of money will remain the same in accounting periods.
d) Personal judgement:
Even though there are certain accounting conventions followed in preparing financial statements the personal judgement of the accountant also plays an important part. For example, instead of valuing closing stock either at cost or market price, the accountant may use last in first out, first in first out or average cost method.
Person interested in financial statements
The following are the groups who like to make use of financial statements.
1.Owners: They are especially interested in the current and long – term profitability of their equity investment. They expect growing earning and dividends, which will bring about growth in the economic value of stock.
2.Investors: They are especially interested in the current and long...