Ratio Analysis
INTERPRETATION OF FINANCIAL STATEMENTS
Ways of interpreting financial statements
- Using individual items contained in financial statement.
- Using ratios computed from items contained in Financial Statement (Ratio analysis)
Reasons for interpreting accounts
Accounts have to be analyzed and interpreted for the following logical points
(1) Evaluation of the trading performance of a firm in order to have a measure of the quality of management running it.
(2) Appraisal and monitoring of the constituents of the Capital Structure and the cost associated with them
(3) Whether or not an enterprise has solid liquidity base – a position of being able to meet contractual obligations as they are due is revealed.
(4) Comparison of the operations of an enterprise for two or more years or between similar firms within the same industry could assist merger or ‘take-over considerations.
(5) The ‘static’ or ‘historical cost’ nature of accounting information calls for more educative and concise indices for performance control.
LIMITATIONS OF FINANCIAL STATEMENTS
(i) Financial statements are prepared on going concern basis while company may fold up few months after the financial statement date.
(ii) Application of accounting concept and convention may not be the same from organization to organization.
(iii) Financial statements are prepared to show true and fair view hence the actual figures may not be shown in financial statement.
(iv) Financial statement only discloses monetary facts. Non-monetary facts can only be disclosed in the notes to the financial statements.
(v) Financial statement of two or more companies may be difficult to compare unless the statement of accounting policies used for the preparation of the statement is known.
THE LIMITATIONS OF ACCOUNTING RATIO ANALYSIS
(1) The differences in the methods adopted by two enterprises may distort the result of analysis and therefore misinform judgment. An example of
Ways of interpreting financial statements
- Using individual items contained in financial statement.
- Using ratios computed from items contained in Financial Statement (Ratio analysis)
Reasons for interpreting accounts
Accounts have to be analyzed and interpreted for the following logical points
(1) Evaluation of the trading performance of a firm in order to have a measure of the quality of management running it.
(2) Appraisal and monitoring of the constituents of the Capital Structure and the cost associated with them
(3) Whether or not an enterprise has solid liquidity base – a position of being able to meet contractual obligations as they are due is revealed.
(4) Comparison of the operations of an enterprise for two or more years or between similar firms within the same industry could assist merger or ‘take-over considerations.
(5) The ‘static’ or ‘historical cost’ nature of accounting information calls for more educative and concise indices for performance control.
LIMITATIONS OF FINANCIAL STATEMENTS
(i) Financial statements are prepared on going concern basis while company may fold up few months after the financial statement date.
(ii) Application of accounting concept and convention may not be the same from organization to organization.
(iii) Financial statements are prepared to show true and fair view hence the actual figures may not be shown in financial statement.
(iv) Financial statement only discloses monetary facts. Non-monetary facts can only be disclosed in the notes to the financial statements.
(v) Financial statement of two or more companies may be difficult to compare unless the statement of accounting policies used for the preparation of the statement is known.
THE LIMITATIONS OF ACCOUNTING RATIO ANALYSIS
(1) The differences in the methods adopted by two enterprises may distort the result of analysis and therefore misinform judgment. An example of