Financial Statement Analysis Objectives
The main objective of the analysis financial statement for any company is to provide the necessary information which is required by the users of the financial statement for the informative decision making, assessing the current and past performance of the company, prediction of the success or failure of the business, etc.
Top 4 objectives of Financial Statement Analysis are as follows –
- To know the current position of the company
- Eliminating Discrepancies if any
- Future Decision Making
- Minimize the Chances of Fraud
Let us discuss each one of them in detail
Top 4 Objectives of Financial Statements Analysis?
#1 – To know the Current Position
Promoters/owners want to know whether the company is heading in the right direction or they are lagging in their targets, which they have planned in the past. Regular recording of financial transactions helps them to understand their financial position and helps them analyze prospects in a better way.
Example: Suppose the company had previously planned to double its revenues over the next five years. We have revenue data of the company for the last four years.
As you can see in the above example, the company is performing well in the first two years and looks like it will reach the desired target or maybe perform better than their desired target. But in the FY 2018-19, the revenue growth of the company declined to single-digit levels, i.e., around 6% on a YoY basis.
The decline in revenue will be a cause of concern for the management but will be able to gear up their team in time to work more efficiently to reach their target.
#2 – Eliminating Discrepancies if any
Recording of day to day transactions, i.e., sales and purchase, expenses or incomes, or other statements, help them understand where they need to improve and make quick decisions in case of any discrepancies.
Example 1: Suppose a company named A has targeted sales of 1500 crores in this financial year. The quarterly sales report shows sales of just 300 crores in the first quarter.
The above example shows the revenue earned by ABC Ltd. each month. During the first three months, the revenue numbers are increasing, but after that, there was a consistent decline in the revenue. Maintaining each month’s revenue will help the management to get engaged with the sales team and find out the reasons for the fall in revenue numbers, eliminate discrepancies and will act accordingly to stop the dip in revenue numbers and try to reach the target as planned.
The above example shows that the profit of the firm increases, but due to excess expenses, the ratio of the increase in net profits with respect to increased gross profit is less.
Gross profit increased by approximately 25%, whereas net profit increases just 13-14%. Recording and analyzing will help them eradicate the errors in the future due to which there is a decrease in net profits from the actual expected.
#3 – Future Decision Making
Quarterly statements like sales book, purchase, trading a/c, or manufacturing a/c helps them in executing their plans in a better way. This provides them the opportunity to make future decisions with reliable information. There is a new practice of preparing provisional final accountsFinal AccountsFinal Accounts is the final stage of the accounting process, in which the various ledgers maintained in the Trial Balance (Books of Accounts) of the organization are presented in the specified way to provide the profitability and financial position of the entity for a specified period to stakeholders and other interested parties, i.e. Trading Account, Statement of Profit & Loss, Balance Sheet, and so on. even by small companies. Analyzing financial statements on a short term basis helps the organization to make efficient decisions.
Example: Suppose the company’s operating margin is around 12-13% for the last 7-8 quarters. But in the previous quarter, the operating margin drops significantly to 7-8 %.
The company is performing well on revenue front but more precisely maintaining the operating margin at consistent levels with an increase in sales numbers. But in the quarter ending June-19, the operating margin dips to 7%, which is way below the average of 12-13%, which the company is managing over the last 5-6 quarters.
There may be many reasons for the fall in the operating margin like increase in raw material, a decrease in sales price due to demand or increase indirect expensesIndirect ExpensesIndirect expenses are the general costs incurred for running business operations and management in any enterprise. In simple terms, when you want to buy grocery from a supermarket, the transportation cost to get you to the supermarket and back is the indirect expenses. like wages or electricity and the company after reviewing it will need to change the future strategy and make some decisions depending upon the reason for the fall in operating margin in the last quarter.
Financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. help to understand the reason and make future decisions depending on the situation. Let’s assume the reason is decreasing in Sales Price. Management can take the necessary steps to understand the future market sentiments and identify the reasons for the decrease in the sales price and can opt for strategy according to it.
#4 – Minimize the Chances of Fraud
This is not the main objective of analyzing transactions but the one which cannot be neglected. Often we come across the news that the employee cheated his boss, which led to huge losses for the company. Analyzing the statements will make sure that the employee will be aware that the management is aware of everything that is happening in the company and also if any suspicion arises on any financial entry, management can have a look into the matter and will be able to solve it without incurring extra losses.
Example: Excess commission given by the accounts department to the agents of the company, or there is a difference in the purchase of raw material. Since the company records or maintains an individual account of each supplier, they can analyze each account, which will lead to the conclusion, and the company will not have to suffer losses due to the fraud done by one of his own employees.
In the above example, there is a surge in the conveyance expenses and general expenses of the firm. More than three-fold increase in the expenses are a case of suspicion, and management would want to have a look at the voucher and verify who has to pay it, received it, and for what purpose.
Financial statements are important for all stakeholders. Investors need to analyze the financial statements before making any investment in the company.
- Same way, banks will be more comfortable in granting loans to those companies whose financial books are well maintained and shows a clear picture of their profits. This makes them more confident that the company will be able to pay future debt obligations.
- Government agencies have their self-interest in the financials of the company. The collection of taxes from the companies is done on the basis of information provided by the accounting department of the companyAccounting Department Of The CompanyThe accounting department looks after preparing financial statements, maintaining a general ledger, paying bills, preparing customer bills, payroll, and more. In other words, they are responsible for managing the overall economic front of the business.. Companies have to submit tax returns on a quarterly basis, which are analyzed by government authorities.
- Overall the financial statement analysis makes a difference in the performance of companies. Companies with regular analyzing of financials can intercept their problems within time and can opt for a strategy that can help them attain their future targets.
- Also, the companies with a better understanding of their financials can cope with the worst business scenarios in a better way as they know the financial strength of their balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company..
This has been a guide to the Objectives of Financial Statement Analysis. Here we discuss the top 4 objectives along with examples and explanations. You can learn more about accounting from the following articles –